Case Study

Strategic Management Model

Gathering Information

Societal Environment: General forces

Natural Environment: Resources and

climate

Task Environment:

Industry analysis

Internal: Strengths and Weaknesses

Structure: Chain of command

Culture: Beliefs, expectations,

values

Resources: Assets, skills, competencies,

knowledge

External: Opportunities

and Threats

Developing Long-range Plans

Mission

Reason for existence Objectives

What results to accomplish by when

Strategies

Plan to achieve the mission & objectives

Policies

Broad guidelines for decision making

Environmental Scanning:

Strategy Formulation:

Feedback/Learning: Make corrections as needed

Putting Strategy into Action

Monitoring Performance

Programs

Activities needed to accomplish a plan

Budgets

Cost of the programs Procedures

Sequence of steps needed to do the job

Performance

Actual results

Strategy Implementation:

Evaluation and Control:

THIRTEENTH EDITION

Strategic Management

and Business Policy

TOWARD GLOBAL SUSTAINABILITY

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THIRTEENTH EDITION

Thomas L. Wheelen Formerly with University of Virginia Trinity College, Dublin, Ireland

J. David Hunger Iowa State University St. John’s University

Strategic Management

and Business Policy

TOWARD GLOBAL SUSTAINABILITY

with major contributions by

Kathryn E. Wheelen

Alan N. Hoffman Bentley University

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Library of Congress Cataloging-in-Publication Data Wheelen, Thomas L.

Strategic management and business policy : toward global sustainability / Thomas L. Wheelen, J. David Hunger. — 13th ed.

p. cm. Includes bibliographical references and index. ISBN-13: 978-0-13-215322-5 ISBN-10: 0-13-215322-X

1. Strategic planning. 2. Strategic planning—Case studies. 3. Sustainability. I. Hunger, J. David, II. Title.

HD30.28.W43 2012 658.4'012—dc22

2011013549

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Dedicated to

KATHY, RICHARD, AND TOM BETTY, KARI AND JEFF, MADDIE AND MEGAN, SUZI AND NICK, SUMMER AND KACEY, LORI, MERRY AND DYLAN, AND WOOFIE (ARF!).

SPECIAL DEDICATION TO KATHRYN WHEELEN:

Kathryn has worked on every phase of the case section of this book. Until this edition, she also managed the construction of the Case Instructor’s Manual. She has done every job with a high level of dedication

and concern for both the case authors and the readers of this book.

NOLA AKALA

DAVID ALEVY

TARA ALGEO

DAVID ARMSTRONG

MIKE ASKEW

LAURA BAILEY

NICK BAKER

ALICIA BARNES

ASHLEY BARNES

ALICE BARR

SHERRY BARTEL

KENDRA BASSI

JAY BECKENSTEIN

JOSH BECKENSTEIN

NICOLE BELL

CATHY BENNETT

KATIE BOLLIN

SCOTT BORDEN

JENNIFER BOYLE

AUNDREA BRIDGES

SUZANNE BROWN

ALEXANDRA BUEHLER

KYLE BURDETTE

WHITNEY CAMERON

RUTH CARDIFF

AMY CAREY

MEGAN CARRICO

MARTI CARTER

ANDREA CATULLO-LINN

MEREDITH CHANDLER

LUKE CLAEYS

KAYLEE CLAYMORE

BRIAN COBB

JENNIFER COLE

TARYLL CONNOLLY

THAYNE CONRAD

DONNA CONROY

CAITLIN COUTHEN

MEGAN JOY COWART

CYNDI CRIMMINS

KASEY CROCKETT

DAN CURRIER

KELLY DAN

MICHLENE DAOUD HEALY

STACY DAVIS

FRANK DEL CASTILLO

MEREDITH DELA ROSA

CHRIS DELANEY

GEORGE DEVENNEY

DANA DODGE (Frick)

KATE DOLDER

BARBARA DONLON

HEIDI DRESSLER

TRACY DYBALSKI

BRIAN DYK

KIM ECK

TRISH EICHHOLD

KRISTIN ELBER

KELSEY ELLIOTT

KATIE EYNON

GENEVA FARROW

MARIA FELIBERTY

MIKE FINER

MICHELLE FINNERTY

CANDAS FLETCHER

ROBERT FLORY

MARCIA FLYNN

BRAD FORRESTER

MARGARET FRENCH

STEPHANIE FRITSON

MARK GAFFNEY

MICHELLE GARCIA-JUCHTER

SYBIL GERAUD

AMBER GOECKE

CAROLYN GOGOLIN

ADAM GOLDSTEIN

BETH GRUNFELD

MICAELA HAIDLE

GREG HAITH

DEMETRIUS HALL

BRIDGET HANNENBERG

BRYAN HARRELL

TARA HARTLEY

KENNY HARVEY

ALISON HASKINS

CAROL HAWKS

JENNIFER HEILBRUNN

CHRISTINE HENRY

LYNN HICKS

JULIE HILDEBRAND

DAUNNE HINGLE

WENDI HOLLAND

CHRISTY HUMENIUK

GENE HUMENIUK

ANDREA IORIO

SUSAN JACKSON

PAM JEFFRIES

BRITTANY JUCHNOWSKI

ANJALI JUSTUS

CHERYL KABB

LAURA KAPPES

GIA KAUL

JULIE KESTENBAUM

KARTAPURKH KHALSA

KIM KIEHLER

AMANDA KILLEEN

WALT KIRBY

MARY-JO KOVACH

ROBYN KOVAR

GREG KRAMP

DANIEL KRAUSS

MICHAEL KRISANDA

GINA LaMANTIA

CHAFIKA LANDERS

DOROTHY LANDRY

DUSTIN LANGE

ALIX LaSCOLA

JOE LEE

APRIL LEMONS

KIMBERLY LENAGHAN

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vi

TRICIA LISCIO

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PATRICIA MARTINEZ

CHRISTINA MASTROGIOVANNI

SONNY MATHARU

TONY MATHIAS

BROOK MATTHEWS

GEORGIA MAY

ALICIA MCAULIFFE

MASON McCARTNEY

KAREN McFADYEN

BRIAN McGARRY

MICHELLE McGOVERN

IRENE McGUINNESS

RYAN McHENRY

CRISTIN McMICHAEL

KEVIN MEASELLE

RAY MEDINA

KELLY MEIERHOFER

MOLLY MEINERS

MATT MESAROS

SHALON MILLER

JAMI MINARD

WILLIAM MINERICH

EMILY MITCHELL

JILINE MIX

JULIE MOREL

RAFAEL MORENO

TRACY MORSE

OLIVIA MOUG

DOLLY MUNIZ

TRICIA MURPHY

LAUREN MURROW

AMBER MYLLION (Parks)

LINDA NELSON

LYNNE NICLAIR

BOB NISBET

BETSY NIXON

TOM NIXON

LAURA NOAH

COLLEEN O’DELL

DEBBIE OGILIVE

SARI ORLANSKY

DAVE OSTROW

DARCEY PALMER

KRISTINA PARKER

TONI PAYNE

JULIANNE PETERSON

MELISSA PFISTNER

CANDACE PINATARO

BELEN POLTORAK

ELIZABETH POPIELARZ

MEGAN PRENDERGAST

NICOLE PRICE

JILL PROMESSO

LENNY ANN RAPER

JOSH RASMUSSEN

AMANDA RAY

SONYA REED

RICHARD RESCH

MARY RHODES

BRAD RITTER

DAN ROBERTSON

MATT ROBINSON

JENNIFER ROSEN

DOROTHY ROSENE

KELLEEN ROWE

RICH ROWE

PEYTON ROYTEK

SENG SAECHAO

STEVE SARTORI

LYNDA SAX

BOB SCANLON

MARCUS SCHERER

KIMBERLY SCHEYVING

HEIDI SCHICK (Miller)

BRAD SCHICK

CHRIS SCHMIDT

DEBORAH SCHMIDT

MOLLY SCHMIDT

CORRINA SCHULTZ

WHITNEY SEAGO

CHRISTIANA SERLE

MARTHA SERNAS

MARY SHAPIRO

BARBARA SHERRY

KEN SHIPBAUGH

DAVE SHULER

JESSICA SIEMINSKI

LEA SILVERMAN

AUTUMN SLAUGHTER

KRISTA SLAVICEK

SCOTT SMITH

ADRIENNE SNOW

LEE SOLOMONIDES

BEN STEPHEN

DAN SULLIVAN

JOHN SULLIVAN

LORI SULLIVAN

STEPHANIE SURFUS

AMANDA SVEC

CHRISTINA TATE

SARAH THOMAS

ABBY THORNBLADH

KATY TOWNLEY

ELIZABETH TREPKOWSKI

TARA TRIPP

CAROLYN TWIST

JOE VIRZI

AMANDA VOLZ

BRITNEY WALKER

MADELEINE WATSON

BEN WEBER

DANIEL WELLS

MARK WHEELER

LIZ WILDES

MICHELLE WILES

BRIAN WILLIAMS

ERIN WILLIAMS

CINDY WILLIAMSON

RACHEL WILLIS

SIMON WONG

KIMBERLY WOODS

JACKIE WRIGHT

HEATHER WRUBLESKY

GEORGE YOUNG

MARY ZIMMERMANN

KACIE ZIN

D E D I C AT I O N vii

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Brief Contents

PART ONE Introduction to Strategic Management and Business Policy 1

C H A P T E R 1 Basic Concepts of Strategic Management 2 C H A P T E R 2 Corporate Governance 42 C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 70

PART TWO Scanning the Environment 93

C H A P T E R 4 Environmental Scanning and Industry Analysis 94 C H A P T E R 5 Internal Scanning: Organizational Analysis 136

PART THREE Strategy Formulation 173

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 174 C H A P T E R 7 Strategy Formulation: Corporate Strategy 204 C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 236

PART FOUR Strategy Implementation and Control 269

C H A P T E R 9 Strategy Implementation: Organizing for Action 270 C H A P T E R 1 0 Strategy Implementation: Staffing and Directing 300 C H A P T E R 1 1 Evaluation and Control 328

PART FIVE Introduction to Case Analysis 363

C H A P T E R 1 2 Suggestions for Case Analysis 364

PART SIX WEB CHAPTERS Other Strategic Issues

W E B C H A P T E R A Strategic Issues in Managing Technology & Innovation W E B C H A P T E R B Strategic Issues in Entrepreneurial Ventures & Small Businesses W E B C H A P T E R C Strategic Issues in Not-For-Profit Organizations

PART SEVEN Cases in Strategic Management 1-1

GLOSSARY G-1

NAME INDEX I-1

SUBJECT INDEX I-7

ix

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Contents

Preface xxix

PART ONE Introduction to Strategic Management and Business Policy 1

C H A P T E R 1 Basic Concepts of Strategic Management 2 1.1 The Study of Strategic Management 5

Phases of Strategic Management 5

Benefits of Strategic Management 6

1.2 Globalization and Environmental Sustainability: Challenges to Strategic Management 7

Impact of Globalization 8

Impact of Environmental Sustainability 8

Global Issue: REGIONAL TRADE ASSOCIATIONS REPLACE NATIONAL TRADE BARRIERS 9

Environmental Sustainability Issue: PROJECTED EFFECTS OF CLIMATE CHANGE 12

1.3 Theories of Organizational Adaptation 12

1.4 Creating a Learning Organization 13

1.5 Basic Model of Strategic Management 14

Environmental Scanning 16

Strategy Formulation 17

Strategy Highlight 1.1: DO YOU HAVE A GOOD MISSION STATEMENT? 18

Strategy Implementation 21

Evaluation and Control 22

Feedback/Learning Process 23

1.6 Initiation of Strategy: Triggering Events 23

Strategy Highlight 1.2: TRIGGERING EVENT AT UNILEVER 24

1.7 Strategic Decision Making 25

What Makes a Decision Strategic 25

Mintzberg’s Modes of Strategic Decision Making 25

Strategic Decision-Making Process: Aid to Better Decisions 27

1.8 The Strategic Audit: Aid to Strategic Decision-Making 28

1.9 End of Chapter Summary 29

APPENDIX 1.A Strategic Audit of a Corporation 34

xi

C H A P T E R 2 Corporate Governance 42 2.1 Role of the Board of Directors 45

Responsibilities of the Board 45

Members of a Board of Directors 48

Strategy Highlight 2.1: AGENCY THEORY VERSUS STEWARDSHIP THEORY IN CORPORATE GOVERNANCE 50

Nomination and Election of Board Members 53

Organization of the Board 54

Impact of the Sarbanes-Oxley Act on U.S. Corporate Governance 55

Global Issue: CORPORATE GOVERNANCE IMPROVEMENTS THROUGHOUT THE WORLD 56

Trends in Corporate Governance 57

2.2 The Role of Top Management 58

Responsibilities of Top Management 58

Environmental Sustainability Issue: CONFLICT AT THE BODY SHOP 59

2.3 End of Chapter Summary 62

C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 70 3.1 Social Responsibilities of Strategic Decision Makers 72

Responsibilities of a Business Firm 72

Sustainability: More than Environmental? 75

Corporate Stakeholders 75

Environmental Sustainability Issue: THE DOW JONES SUSTAINABILITY INDEX 76

Strategy Highlight 3.1: JOHNSON & JOHNSON CREDO 78

3.2 Ethical Decision Making 79

Some Reasons for Unethical Behavior 79

Strategy Highlight 3.2: UNETHICAL PRACTICES AT ENRON AND WORLDCOM EXPOSED BY “WHISTLE-BLOWERS” 80

Global Issue: HOW RULE-BASED AND RELATIONSHIP-BASED GOVERNANCE SYSTEMS AFFECT ETHICAL BEHAVIOR 81

Encouraging Ethical Behavior 83

3.3 End of Chapter Summary 86

Ending Case for Part One: BLOOD BANANAS 90

PART TWO Scanning the Environment 93

C H A P T E R 4 Environmental Scanning and Industry Analysis 94 4.1 Environmental Scanning 98

Identifying External Environmental Variables 98

Environmental Sustainability Issue: MEASURING AND SHRINKING YOUR PERSONAL CARBON FOOTPRINT 100

xii C O N T E N T S

Global Issue: IDENTIFYING POTENTIAL MARKETS IN DEVELOPING NATIONS 107

Identifying External Strategic Factors 108

4.2 Industry Analysis: Analyzing the Task Environment 109

Porter’s Approach to Industry Analysis 110

Industry Evolution 114

Categorizing International Industries 114

International Risk Assessment 115

Strategic Groups 115

Strategic Types 117

Hypercompetition 117

Using Key Success Factors to Create an Industry Matrix 118

Strategy Highlight 4.1: MICROSOFT IN A HYPERCOMPETITIVE INDUSTRY 118

4.3 Competitive Intelligence 120

Sources of Competitive Intelligence 121

Strategy Highlight 4.2: EVALUATING COMPETITIVE INTELLIGENCE 122

Monitoring Competitors for Strategic Planning 122

4.4 Forecasting 123

Danger of Assumptions 123

Useful Forecasting Techniques 124

4.5 The Strategic Audit: A Checklist for Environmental Scanning 125

4.6 Synthesis of External Factors—EFAS 126

4.7 End of Chapter Summary 127

APPENDIX 4.A Competitive Analysis Techniques 133

C H A P T E R 5 Internal Scanning: Organizational Analysis 136 5.1 A Resource-Based Approach to Organizational Analysis 138

Core and Distinctive Competencies 138

Using Resources to Gain Competitive Advantage 139

Determining the Sustainability of an Advantage 140

5.2 Business Models 142

5.3 Value-Chain Analysis 143

Strategy Highlight 5.1: A NEW BUSINESS MODEL AT SMARTYPIG 144

Industry Value-Chain Analysis 145

Corporate Value-Chain Analysis 146

5.4 Scanning Functional Resources and Capabilities 147

Basic Organizational Structures 147

Corporate Culture: The Company Way 149

C O N T E N T S xiii

Global Issue: MANAGING CORPORATE CULTURE FOR GLOBAL COMPETITIVE ADVANTAGE: ABB VERSUS MATSUSHITA 150

Strategic Marketing Issues 151

Strategic Financial Issues 153

Strategic Research and Development (R&D) Issues 154

Strategic Operations Issues 156

Strategic Human Resource (HRM) Issues 158

Environmental Sustainability Issue: USING ENERGY EFFICIENCY FOR COMPETITIVE ADVANTAGE AND QUALITY OF WORK LIFE 161

Strategic Information Systems/Technology Issues 162

5.5 The Strategic Audit: A Checklist for Organizational Analysis 163

5.6 Synthesis of Internal Factors 164

5.7 End of Chapter Summary 165

Ending Case for Part Two: BOEING BETS THE COMPANY 170

PART THREE Strategy Formulation 173

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 174 6.1 Situation Analysis: SWOT Analysis 176

Generating a Strategic Factors Analysis Summary (SFAS) Matrix 176

Finding a Propitious Niche 177

Global Issue: SAB DEFENDS ITS PROPITIOUS NICHE 181

6.2 Review of Mission and Objectives 181

6.3 Generating Alternative Strategies by Using a TOWS Matrix 182

6.4 Business Strategies 183

Porter’s Competitive Strategies 183

Environmental Sustainability Issue: PATAGONIA USES SUSTAINABILITY AS DIFFERENTIATION COMPETITIVE STRATEGY 187

Cooperative Strategies 195

6.5 End of Chapter Summary 199

C H A P T E R 7 Strategy Formulation: Corporate Strategy 204 7.1 Corporate Strategy 206

7.2 Directional Strategy 206

Growth Strategies 207

Strategy Highlight 7.1: TRANSACTION COST ECONOMICS ANALYZES VERTICAL GROWTH STRATEGY 210

xiv C O N T E N T S

Global Issue: COMPANIES LOOK TO INTERNATIONAL MARKETS FOR HORIZONTAL GROWTH 212

Strategy Highlight 7.2: SCREENING CRITERIA FOR CONCENTRIC DIVERSIFICATION 215

Controversies in Directional Growth Strategies 216

Stability Strategies 217

Retrenchment Strategies 218

7.3 Portfolio Analysis 220

BCG Growth-Share Matrix 221

Environmental Sustainability Issue: GENERAL MOTORS AND THE ELECTRIC CAR 222

GE Business Screen 223

Advantages and Limitations of Portfolio Analysis 225

Managing a Strategic Alliance Portfolio 225

7.4 Corporate Parenting 226

Developing a Corporate Parenting Strategy 227

Horizontal Strategy and Multipoint Competition 228

7.5 End of Chapter Summary 229

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 236 8.1 Functional Strategy 238

Marketing Strategy 238

Financial Strategy 239

Research and Development (R&D) Strategy 241

Operations Strategy 242

Global Issue: INTERNATIONAL DIFFERENCES ALTER WHIRLPOOL’S OPERATIONS STRATEGY 243

Purchasing Strategy 244

Environmental Sustainability Issue: OPERATIONS NEED FRESH WATER AND LOTS OF IT! 245

Logistics Strategy 246

Human Resource Management (HRM) Strategy 246

Information Technology Strategy 247

8.2 The Sourcing Decision: Location of Functions 247

8.3 Strategies to Avoid 250

8.4 Strategic Choice: Selecting the Best Strategy 251

Constructing Corporate Scenarios 251

Process of Strategic Choice 257

C O N T E N T S xv

8.5 Developing Policies 258

8.6 End of Chapter Summary 259

Ending Case for Part Three: KMART AND SEARS: STILL STUCK IN THE MIDDLE? 266

PART FOUR Strategy Implementation and Control 269

C H A P T E R 9 Strategy Implementation: Organizing for Action 270 9.1 Strategy Implementation 272

9.2 Who Implements Strategy? 273

9.3 What Must Be Done? 273

Developing Programs, Budgets, and Procedures 274

Environmental Sustainability Issue: FORD’S SOYBEAN SEAT FOAM PROGRAM 274

Strategy Highlight 9.1: THE TOP TEN EXCUSES FOR BAD SERVICE 277

Achieving Synergy 278

9.4 How Is Strategy to Be Implemented? Organizing for Action 278

Structure Follows Strategy 279

Stages of Corporate Development 280

Organizational Life Cycle 283

Advanced Types of Organizational Structures 285

Reengineering and Strategy Implementation 288

Six Sigma 289

Designing Jobs to Implement Strategy 290

Strategy Highlight 9.2: DESIGNING JOBS WITH THE JOB CHARACTERISTICS MODEL 291

9.5 International Issues in Strategy Implementation 291

International Strategic Alliances 292

Stages of International Development 293

Global Issue: MULTIPLE HEADQUARTERS: A SIXTH STAGE OF INTERNATIONAL DEVELOPMENT? 294

Centralization Versus Decentralization 294

9.6 End of Chapter Summary 296

C H A P T E R 1 0 Strategy Implementation: Staffing and Directing 300 10.1 Staffing 302

Staffing Follows Strategy 303

Selection and Management Development 305

Strategy Highlight 10.1: HOW HEWLETT-PACKARD IDENTIFIES POTENTIAL EXECUTIVES 306

Problems in Retrenchment 308

International Issues in Staffing 309

xvi C O N T E N T S

10.2 Leading 311

Managing Corporate Culture 311

Environmental Sustainability Issue: ABBOTT LABORATORIES’ NEW PROCEDURES FOR GREENER COMPANY CARS 312

Action Planning 316

Management by Objectives 318

Total Quality Management 318

International Considerations in Leading 319

Global Issue: CULTURAL DIFFERENCES CREATE IMPLEMENTATION PROBLEMS IN MERGER 321

10.3 End of Chapter Summary 322

C H A P T E R 1 1 Evaluation and Control 328 11.1 Evaluation and Control in Strategic Management 330

11.2 Measuring Performance 332

Appropriate Measures 332

Types of Controls 332

Activity-Based Costing 334

Enterprise Risk Management 335

Primary Measures of Corporate Performance 335

Environmental Sustainability Issue: HOW GLOBAL WARMING COULD AFFECT CORPORATE VALUATION 340

Primary Measures of Divisional and Functional Performance 342

International Measurement Issues 344

Global Issue: COUNTERFEIT GOODS AND PIRATED SOFTWARE: A GLOBAL PROBLEM 346

11.3 Strategic Information Systems 347

Enterprise Resource Planning (ERP) 347

Radio Frequency Identification (RFID) 348

Divisional and Functional IS Support 348

11.4 Problems in Measuring Performance 348

Short-Term Orientation 349

Goal Displacement 350

11.5 Guidelines for Proper Control 351

Strategy Highlight 11.1: SOME RULES OF THUMB IN STRATEGY 351

11.6 Strategic Incentive Management 352

11.7 End of Chapter Summary 354

Ending Case for Part Four: HEWLETT-PACKARD BUYS EDS 360

C O N T E N T S xvii

PART FIVE Introduction to Case Analysis 363

C H A P T E R 1 2 Suggestions for Case Analysis 364 12.1 The Case Method 365

12.2 Researching the Case Situation 366

12.3 Financial Analysis: A Place to Begin 366

Analyzing Financial Statements 369

Environmental Sustainability Issue: IMPACT OF CARBON TRADING 370

Global Issue: FINANCIAL STATEMENTS OF MULTINATIONAL CORPORATIONS: NOT ALWAYS WHAT THEY SEEM 371

Common-Size Statements 371

Z-value and Index of Sustainable Growth 371

Useful Economic Measures 372

12.4 Format for Case Analysis: The Strategic Audit 373

12.5 End of Chapter Summary 375

APPENDIX 12.A Resources for Case Research 377

APPENDIX 12.B Suggested Case Analysis Methodology Using the Strategic Audit 380

APPENDIX 12.C Example of a Student-Written Strategic Audit 383

Ending Case for Part Five: IN THE GARDEN 391

GLOSSARY G-1

NAME INDEX I-1

SUBJECT INDEX I-1

PART SIX WEB CHAPTERS Other Strategic Issues

W E B C H A P T E R A Strategic Issues in Managing Technology and Innovation 1 The Role of Management

Strategy Highlight 1: EXAMPLES OF INNOVATION EMPHASIS IN MISSION STATEMENTS

2 Environmental Scanning

External Scanning

Internal Scanning

3 Strategy Formulation

Product vs. Process R&D

Technology Sourcing

Global Issue: USE OF INTELLECTUAL PROPERTY AT HUAWEI TECHNOLOGIES

Importance of Technological Competence

Categories of Innovation

Product Portfolio

xviii C O N T E N T S

4 Strategy Implementation

Developing an Innovative Entrepreneurial Culture

Organizing for Innovation: Corporate Entrepreneurship

Strategy Highlight 2: HOW NOT TO DEVELOP AN INNOVATIVE ORGANIZATION

5 Evaluation and Control

Evaluation and Control Techniques

Evaluation and Control Measures

6 End of Chapter Summary

W E B C H A P T E R B Strategic Issues in Entrepreneurial Ventures and Small Businesses 1 Importance of Small Business and Entrepreneurial Ventures

Global Issue: ENTREPRENEURSHIP: SOME COUNTRIES ARE MORE SUPPORTIVE THAN OTHERS

Definition of Small-Business Firms and Entrepreneurial Ventures

The Entrepreneur as Strategist

2 Use of Strategic Planning and Strategic Management

Degree of Formality

Usefulness of the Strategic Management Model

Usefulness of the Strategic Decision-Making Process

3 Issues in Corporate Governance

Boards of Directors and Advisory Boards

Impact of the Sarbanes-Oxley Act

4 Issues in Environmental Scanning and Strategy Formulation

Sources of Innovation

Factors Affecting a New Venture’s Success

Strategy Highlight 1: SUGGESTIONS FOR LOCATING AN OPPORTUNITY AND FORMULATING A BUSINESS STRATEGY

5 Issues in Strategy Implementation

Substages of Small Business Development

Transfer of Power and Wealth in Family Businesses

6 Issues in Evaluation and Control

7 End of Chapter Summary

W E B C H A P T E R C Strategic Issues in Not-for-Profit Organizations 1 Why Not-for-Profit?

Global Issue: WHICH IS BEST FOR SOCIETY: BUSINESS OR NOT-FOR-PROFIT?

C O N T E N T S xix

2 Importance of Revenue Source

Sources of Not-for-Profit Revenue

Patterns of Influence on Strategic Decision Making

Usefulness of Strategic Management Concepts and Techniques

3 Impact of Constraints on Strategic Management

Impact on Strategy Formulation

Impact on Strategy Implementation

Impact on Evaluation and Control

4 Not-for-Profit Strategies

Strategic Piggybacking

Strategy Highlight 1: RESOURCES NEEDED FOR SUCCESSFUL STRATEGIC PIGGYBACKING

Mergers

Strategic Alliances

5 End of Chapter Summary

PART SEVEN Cases in Strategic Management 1-1

S E C T I O N A Corporate Governance and Social Responsibility: Executive Leadership

CASE 1 The Recalcitrant Director at Byte Products Inc.: Corporate Legality versus Corporate Responsibility 1-7 (Contributors: Dan R. Dalton, Richard A. Cosier, and Cathy A. Enz) A plant location decision forces a confrontation between the board of directors and the CEO regarding an issue in social responsibility and ethics.

CASE 2 The Wallace Group 2-1 (Contributor: Laurence J. Stybel) Managers question the company’s strategic direction and how it is being managed by its founder and CEO. Company growth has resulted not only in disorganization and confusion among employees, but in poor overall performance. How should the board deal with the company’s founder?

S E C T I O N B Business Ethics

CASE 3 Everyone Does It 3-1 (Contributors: Steven M. Cox and Shawana P. Johnson) When Jim Willis, Marketing VP, learns that the launch date for the company’s new satellite will be late by at least a year, he is told by the company’s president to continue using the earlier published date for the launch. When Jim protests that the use of an incorrect date to market contracts is unethical, he is told that spacecraft are never launched on time and that it is common industry practice to list unrealistic launch dates. If a realistic date was used, no one would contract with the company.

xx C O N T E N T S

CASE 4 The Audit 4-1 (Contributors: John A. Kilpatrick, Gamewell D. Gantt, and George A. Johnson) A questionable accounting practice by the company being audited puts a new CPA in a difficult position. Although the practice is clearly wrong, she is being pressured by her manager to ignore it because it is common in the industry.

S E C T I O N C International Issues in Strategic Management

CASE 5 Starbucks’ Coffee Company: The Indian Dilemma 5-1 (Contributors: Ruchi Mankad and Joel Sarosh Thadamalla) Starbucks is the world’s largest coffee retailer with over 11,000 stores in 36 countries and over 10,000 employees. The case focuses on India as a potential market for the coffee retailer, presenting information on India’s societal environment and beverage industry. Profiles are provided for various existing coffee shop chains in India. The key issue in the case revolves around the question: Are circumstances right for Starbucks to enter India?

CASE 6 Guajilote Cooperativo Forestal: Honduras 6-1 (Contributors: Nathan Nebbe and J. David Hunger) This forestry cooperative has the right to harvest, transport, and sell fallen mahogany trees in La Muralla National Park of Honduras. Although the cooperative has been successful thus far, it is facing some serious issues: low prices for its product, illegal logging, deforestation by poor farmers, and possible world trade restrictions on the sale of mahogany.

S E C T I O N D General Issues in Strategic Management

I N D U S T R Y O N E : Information Technology CASE 7 Apple Inc.: Performance in a Zero-Sum World Economy 7-1

(Contributors: Kathryn E. Wheelen, Thomas L. Wheelen II, Richard D. Wheelen, Moustafa H. Abdelsamad, Bernard A. Morin, Lawrence C. Pettit, David B. Croll, and Thomas L. Wheelen) Apple, the first company to mass-market a personal computer, had become a minor player in an industry dominated by Microsoft. After being expelled from the company in 1985, founder Steve Jobs returned as CEO in 1997 to reenergize the firm. The introduction of the iPod in 2001, followed by the iPad, catapulted Apple back into the spotlight. However, in 2011 Jobs was forced to take his third medical leave, leading to questions regarding his ability to lead Apple. How can Apple continue its success? How dependent is the company on Steve Jobs?

CASE 8 iRobot: Finding the Right Market Mix? 8-1 (Contributor: Alan N. Hoffman) Founded in 1990, iRobot was among the first companies to introduce robotic technology into the consumer market. Employing over 500 robotic professionals, the firm planned to lead the robotics industry. Unfortunately, its largest revenue source, home care robots, are a luxury good and vulnerable to recessions. Many of iRobot’s patents are due to expire by 2019. The firm is highly dependent upon suppliers to make its consumer products and the U.S. government for military sales. What is the best strategy for its future success?

CASE 9 Dell Inc.: Changing the Business Model (Mini Case) 9-1 (Contributor: J. David Hunger) Dell, once the largest PC vendor in the world, is now battling with Acer for second place in the global PC market. Its chief advantages—direct marketing and power over suppliers—no longer provided a competitive advantage. The industry’s focus has shifted from desktop PCs to mobile computing, software, and technology services, areas of relative weakness for Dell. Is it time for Dell to change its strategy?

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CASE 10 Rosetta Stone Inc.: Changing the Way People Learn Languages 10-1 (Contributors: Christine B. Buenafe and Joyce P. Vincelette) Rosetta Stone’s mission was to change the way people learn languages. The company blended language learning with technology at a time when globalization connected more and more individuals and institutions to each other. How should the company move forward? Would it be appropriate for Rosetta Stone to offer products like audio books or services in order to increase market share? Which international markets could provide the company with a successful future?

CASE 11 Logitech (Mini Case) 11-1 (Contributor: Alan N. Hoffman) Logitech, the world’s leading provider of computer peripherals, was on the forefront of mouse, keyboard, and video conferencing technology. By 2010, however, Logitech’s products were threatened by new technologies, such as touch pads, that could replace both the mouse and keyboard. As the peripherals market begins to disintegrate, Logitech is considering a change in strategy.

I N D U S T R Y T W O : INTERNET COMPANIES

CASE 12 Google Inc. (2010): The Future of the Internet Search Engine 12-1 (Contributor: Patricia A. Ryan) Google, an online company that provides a reliable Internet search engine, was founded in 1998 and soon replaced Yahoo as the market leader in Internet search engines. By 2010, Google was one of the strongest brands in the world. Nevertheless, its growth by acquisition strategy was showing signs of weakness. Its 2006 acquisition of YouTube had thus far not generated significant revenue growth. Groupon, a shopping Web site, rebuffed Google’s acquisition attempt in 2010. Is it time for a strategic change?

CASE 13 Reorganizing Yahoo! 13-1 (Contributors: P. Indu and Vivek Gupta) Yahoo! created the first successful Internet search engine, but by 2004 it was losing its identity. Was it a search engine, a portal, or a media company? On December 5, 2006, Yahoo’s CEO announced a reorganization of the company into three groups. It was hoped that a new mission statement and a new structure would make Yahoo leaner and more responsive to customers. Would this be enough to turn around the company?

I N D U S T R Y T H R E E : ENTERTAINMENT AND LEISURE

CASE 14 TiVo Inc.: TiVo vs. Cable and Satellite DVR: Can TiVo survive? 14-1 (Contributors: Alan N. Hoffman, Randy Halim, Rangki Son, and Suzanne Wong) TiVo was founded to create a device capable of recording digitized video on a computer hard drive for television viewing. Even though revenues had jumped from $96 million in 2003 to $259 million in 2007, the company had never earned a profit. Despite many alliances, TiVo faced increasing competition from generic DVRs offered by satellite and cable companies. How long can the company continue to sell TiVo DVRs when the competition sells generic DVRs at a lower price or gives them away for free?

CASE 15 Marvel Entertainment Inc. 15-1 (Contributors: Ellie A. Fogarty and Joyce P. Vincelette) Marvel Entertainment was known for its comic book characters Captain America, Spider Man, the Fantastic Four, the Incredible Hulk, the Avengers, and the X-Men. With its 2008 self-produced films, Iron Man and The Incredible Hulk, Marvel had expanded out of comic books to become a leader in the entertainment industry. The company was no longer competing against other comic book publishers like DC Comics, but was now competing against entertainment giants like Walt Disney and NBC Universal. What should Marvel’s management do to ensure the company’s future success?

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CASE 16 Carnival Corporation and plc (2010) 16-1 (Contributors: Michael J. Keeffe, John K. Ross III, Sherry K. Ross, Bill J. Middlebrook, and Thomas L. Wheelen) With its “fun ship,” Carnival Cruises changed the way people think of ocean cruises. The cruise became more important than the destination. Through acquisition, Carnival expanded its product line to encompass an entire range of industry offerings. How can Carnival continue to grow in the industry it now dominates?

I N D U S T R Y F O U R : TRANSPORTATION

CASE 17 Chrysler in Trouble 17-1 (Contributors: Barnali Chakraborty and Vivek Gupta) On April 30, 2009, Chrysler Motors, the third-largest auto manufacturer in the United States, filed for bankruptcy protection along with its 24 wholly owned U.S. subsidiaries. As a condition of the U.S. federal government’s loan of more than $8 billion, Fiat was given 20% of the new Chrysler Corporation with the option of increasing its stake to 51% by 2016 after the new company had repaid the federal government’s loan. What does Chrysler need to do to ensure the success of its partnership with Fiat?

CASE 18 Tesla Motors Inc. (Mini Case) 18-1 (Contributor: J. David Hunger) Tesla Motors was founded in 2004 to produce electric automobiles. Its first car, the Tesla Roadster, sold for $101,000. It could accelerate from zero to 60 mph in 3.9 seconds and cruise for 236 miles on a single charge. In contrast to existing automakers, Tesla sold and serviced its cars through the Internet and its own Tesla stores. With the goal of building a full line of electric vehicles, Tesla Motors faced increasing competition from established automakers. How could Tesla Motors succeed in an industry dominated by giant global competitors?

CASE 19 Harley-Davidson Inc. 2008: Thriving through a Recession 19-1 (Contributors: Patricia A. Ryan and Thomas Wheelen) Harley-Davidson 2008: Thriving Through Recession is a modern success story of a motorcycle company that turned itself around by emphasizing quality manufacturing and image marketing. After consistently growing through the 1990s, sales were showing signs of slowing as the baby boomers continued to age. Safety was also becoming an issue. For the first time in recent history, sales and profits declined in 2007 from 2006. Analysts wondered how the company would be affected in a recession. How does Harley-Davidson continue to grow at its past rate?

CASE 20 JetBlue Airways: Growing Pains? 20-1 (Contributors: Shirisha Regani and S. S. George) JetBlue Airways had been founded as a “value player” in the niche between full service airlines and low-cost carriers. Competition had recently intensified and several airlines were taking advantage of bankruptcy protection to recapture market share through price cuts. JetBlue’s operating costs were rising as a result of increasing fuel costs, aircraft maintenance expenses, and service costs. Has JetBlue been growing too fast and was growth no longer sustainable?

CASE 21 TomTom: New Competition Everywhere! 21-1 (Contributor: Alan N. Hoffman) TomTom, an Amsterdam-based company that provided navigation services and devices, led the navigation systems market in Europe and was second in popularity in the United States. However, the company was facing increasing competition from other platforms using GPS technology like cell phones and Smartphones with a built-in navigation function. As its primary markets in the United States and Europe mature, how can the company ensure its future growth and success?

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I N D U S T R Y F I V E : CLOTHING

CASE 22 Volcom Inc.: Riding the Wave 22-1 (Contributors: Christine B. Buenafe and Joyce P. Vincelette) Volcom was formed south of Los Angeles in 1991 as a clothing company rooted in the action sports of skateboarding, surfing, and snowboarding. By 2008, Volcom-branded products were sold throughout the United States and in over 40 countries. It did not own any manufacturing facilities, but instead worked with foreign contract manufacturers. As a primary competitor in the boardsports community, Volcom was committed to maintaining its brand, position, and lifestyle and needed to reassess its strategy.

CASE 23 TOMS Shoes (Mini Case) 23-1 (Contributor: J. David Hunger) Founded in 2006 by Blake Mycoskie, TOMS Shoes is an American footwear company based in Santa Monica, California. Although TOMS Shoes is a for-profit business, its mission is more like that of a not-for-profit organization. The firm’s reason for existence is to donate to children in need one new pair of shoes for every pair of shoes sold. By 2010, the company had sold over one million pairs of shoes. How should the company plan its future growth?

I N D U S T R Y S I X : SPECIALTY RETAILING

CASE 24 Best Buy Co. Inc.: Sustainable Customer Centricity Model? 24-1 (Contributor: Alan N. Hoffman) Best Buy, the largest consumer electronics retailer in the United States, operates 4,000 stores in North America, China, and Turkey. Best Buy distinguishes itself from competitors by deploying a differentiation strategy based on superior service rather than low price. The recent recession has stressed its finances and the quality of its customer service. How can Best Buy continue to have innovative products, top-notch employees, and superior customer service while facing increased competition, operational costs, and financial stress?

CASE 25 The Future of Gap Inc. 25-1 (Contributor: Mridu Verma) Gap Inc. offered clothing, accessories, and personal care products under the Gap, Banana Republic, and Old Navy brands. After a new CEO introduced a turnaround strategy, sales increased briefly, then fell. Tired of declining sales, the board of directors hired Goldman Sachs to explore strategies to improve, ranging from the sale of its stores to spinning off a single division.

CASE 26 Rocky Mountain Chocolate Factory Inc. (2008) 26-1 (Contributors: Annie Phan and Joyce P. Vincelette) Rocky Mountain Chocolate Factory had five company-owned and 329 franchised stores in 38 states, Canada, and the United Arab Emirates. Even though revenues and net income had increased from 2005 through 2008, they had been increasing at a decreasing rate. Candy purchased from the factory by the stores had actually dropped 9% in 2008 from 2007. Was the bloom off the rose at Rocky Mountain Chocolate?

CASE 27 Dollar General Corporation (Mini Case) 27-1 (Contributor: Kathryn E. Wheelen) With annual revenues of $12.7 billion and 9,200 stores in 35 states, Dollar General is the largest of the discount “dollar stores” in the United States. Although far smaller than its “big brothers” Wal-Mart and Target, Dollar General has done very well during the recent economic recession. In 2011, it plans to open 625 new stores in three new states. Given that the company has substantial long-term debt, is this the right time to expand the company’s operations?

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I N D U S T R Y S E V E N : MANUFACTURING

CASE 28 Inner-City Paint Corporation (Revised) 28-1 (Contributors: Donald F. Kuratko and Norman J. Gierlasinski) Inner-City Paint makes paint for sale to contractors in the Chicago area. However, the founder’s lack of management knowledge is creating difficulties for the firm, and the company is in financial difficulty. Unless something is done soon, it may go out of business.

CASE 29 The Carey Plant 29-1 (Contributors: Thomas L. Wheelen and J. David Hunger) The Carey Plant was a profitable manufacturer of quality machine parts until it was acquired by the Gardner Company. Since its acquisition, the plant has been plagued by labor problems, increasing costs, leveling sales, and decreasing profits. Gardner Company’s top management is attempting to improve the plant’s performance and better integrate its activities with those of the corporation by selecting a new person to manage the plant.

I N D U S T R Y E I G H T: FOOD AND BEVERAGE

CASE 30 The Boston Beer Company: Brewers of Samuel Adams Boston Lager (Mini Case) 30-1 (Contributor: Alan N. Hoffman) The Boston Beer Company was founded in 1984 by Jim Koch, viewed as the pioneer of the American craft beer revolution. Brewing over 1 million barrels of 25 different styles of beer, Boston Beer is the sixth-largest brewer in the United States. Even though overall domestic beer sales declined 1.2% in 2010, sales of craft beer have increased 20% since 2002, with Boston Beer’s increasing 22% from 2007 to 2009. How can the company continue its rapid growth in a mature industry?

CASE 31 Wal-Mart and Vlasic Pickles 31-1 (Contributor: Karen A. Berger) A manager of Vlasic Foods International closed a deal with Wal-Mart that resulted in selling more pickles than Vlasic had ever sold to any one account. The expected profit of one to two cents per jar was not sustainable, however, due to unplanned expenses. Vlasic’s net income plummeted and the company faced bankruptcy. Given that Wal-Mart was Vlasic’s largest customer, what action should management take?

CASE 32 Panera Bread Company (2010): Still Rising Fortunes? 32-1 (Contributors: Joyce Vincelette and Ellie A. Fogarty) Panera Bread is a successful bakery-café known for its quality soups and sandwiches. Even though Panera’s revenues and net earnings have been rising rapidly, new unit expansion throughout North America has fueled this growth. Will revenue growth stop once expansion slows? The retirement of CEO Ronald Shaich, the master baker who created the “starter” for the company’s phenomenal growth, is an opportunity to rethink Panera’s growth strategy.

CASE 33 Whole Foods Market (2010): How to Grow in an Increasingly Competitive Market? (Mini Case) 33-1 (Contributors: Patricia Harasta and Alan N. Hoffman) Whole Foods Market is the world’s leading retailer of natural and organic foods. The company differentiates itself from competitors by focusing on innovation, quality, and service excellence, allowing it to charge premium prices. Although the company dominates the natural/organic foods category in North America, it is facing increasing competition from larger food retailers, such as Wal- Mart, who are adding natural/organic foods to their offerings.

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CASE 34 Burger King (Mini Case) 34-1 (Contributor: J. David Hunger) Founded in Florida in 1953, Burger King has always trailed behind McDonald’s as the second-largest fast-food hamburger chain in the world. Although its total revenues dropped only slightly from 2009, its 2010 profits dropped significantly, due to high expenses. Burger King’s purchase by an investment group in 2010 was an opportunity to rethink the firm’s strategy.

CASE 35 Church & Dwight: Time to Rethink the Portfolio? 35-1 (Contributor: Roy A. Cook) Church & Dwight, the maker of ARM & HAMMER Baking Soda, has used brand extension to successfully market multiple consumer products based on sodium bicarbonate. Searching for a new growth strategy, the firm turned to acquisitions. Can management successfully achieve a balancing act based on finding growth through expanded uses of sodium bicarbonate while assimilating a divergent group of consumer products into an expanding international footprint?

S E C T I O N E Web Mini Cases Additional Mini Cases Available on the Companion Web Site at www.pearsonhighered.com/wheelen.

W E B C A S E 1 Eli Lily & Company (Contributor: Maryanne M. Rouse) A leading pharmaceutical company, Eli Lilly produces a wide variety of ethical drugs and animal health products. Despite an array of new products, the company’s profits declined after the firm lost patent protection for Prozac. In addition, the FDA found quality problems at several of the company’s manufacturing sites, resulting in a delay of new product approvals. How should Lily position itself in a very complex industry?

W E B C A S E 2 Tech Data Corporation (Contributor: Maryanne M. Rouse) Tech Data, a distributor of information technology and logistics management, has rapidly grown through acquisition to become the second-largest global IT distributor. Sales and profits have been declining, however, since 2001. As computers become more like a commodity, the increasing emphasis on direct distribution by manufacturers threaten wholesale distributors like Tech Data.

W E B C A S E 3 Stryker Corporation (Contributor: Maryanne M. Rouse) Stryker is a leading maker of specialty medical and surgical products, a market expected to show strong sales growth. Stryker markets its products directly to hospitals and physicians in the United States and 100 other countries. Given the decline in the number of hospitals due to consolidation and cost containment efforts by government programs and health care insurers, the industry expects continued downward pressure on prices. How can Stryker effectively deal with these developments?

W E B C A S E 4 Sykes Enterprises (Contributor: Maryanne M. Rouse) Sykes provides outsourced customer relationship management services worldwide in a highly competitive, fragmented industry. Like its customers, Sykes has recently been closing its call centers in America and moving to Asia in order to reduce costs. Small towns felt betrayed by the firm’s decision to leave—especially after providing financial incentives to attract the firm. Nevertheless, declining revenue and net income has caused the company’s stock to drop to an all-time low.

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W E B C A S E 5 Pfizer Inc. (Contributor: Maryanne M. Rouse) With its acquisition in 2000 of rival pharmaceutical firm Warner-Lambert for its Lipitor prescription drug, Pfizer has become the world’s largest ethical pharmaceutical company in terms of sales. Already the leading company in the United States, Pfizer’s purchase of Pharmacia in 2002 moved Pfizer from fourth to first place in Europe. Will large size hurt or help the company’s future growth and profitability in an industry facing increasing scrutiny?

W E B C A S E 6 Williams-Sonoma (Contributor: Maryanne M. Rouse) Williams-Sonoma is a specialty retailer of home products. Following a related diversification growth strategy, the company operates 415 Williams-Sonoma, Pottery Barn, and Hold Everything retail stores throughout North America. Its direct sales segment includes six retail catalogues and three e-commerce sites. The company must deal with increasing competition in this fragmented industry characterized by low entry barriers.

W E B C A S E 7 Tyson Foods Inc. (Contributor: Maryanne M. Rouse) Tyson produces and distributes beef, chicken, and pork products in the United States. It acquired IBP, a major competitor, but has been the subject of lawsuits by its employees and the EPA. How should management deal with its poor public relations and position the company to gain and sustain competitive advantage in an industry characterized by increasing consolidation and intense competition?

W E B C A S E 8 Southwest Airlines Company (Contributor: Maryanne M. Rouse) The fourth-largest U.S. airline in terms of passengers carried and second-largest in scheduled domestic departures, Southwest was the only domestic airline to remain profitable in 2001. Emphasizing high- frequency, short-haul, point-to-point, and low-fare service, the airline has the lowest cost per available seat mile flown of any U.S. major passenger carrier. Can Southwest continue to be successful as competitors increasingly imitate its competitive strategy?

W E B C A S E 9 Outback Steakhouse Inc. (Contributor: Maryanne M. Rouse) With 1,185 restaurants in 50 states and 21 foreign countries, Outback (OSI) is one of the largest casual dining restaurant companies in the world. In addition to Outback Steakhouse, the company is composed of Carrabba’s Italian Grill, Fleming’s Prime Steakhouse & Wine Bar, Bonefish Grill, Roy’s, Lee Roy Selmon’s, Cheeseburger in Paradise, and Paul Lee’s Kitchen. Analysts wonder how long OSI can continue to grow by adding new types of restaurants to its portfolio.

W E B C A S E 10 Intel Corporation (Contributor: J. David Hunger) Although more than 80% of the world’s personal computers and servers use its microprocessors, Intel is facing strong competition from AMD in a maturing market. Sales growth is slowing. Profits are expected to rise only 5% in 2006 compared to 40% annual growth previously. The new CEO decides to reinvent Intel to avoid a fate of eventual decline.

W E B C A S E 11 AirTran Holdings Inc. (Contributor: Maryanne M. Rouse) AirTran (known as ValuJet before a disastrous crash in the Everglades) is the second-largest low- fare scheduled airline (after Southwest) in the United States in terms of departures and, along with Southwest, the only U.S. airline to post a profit in 2004. The company’s labor costs as a percentage of sales are the lowest in the industry. Will AirTran continue to be successful in this highly competitive industry?

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W E B C A S E 12 Boise Cascade/Office Max (Contributor: Maryanne M. Rouse) Boise Cascade, an integrated manufacturer and distributor of paper, packaging, and wood products, purchased OfficeMax, the third-largest office supplies catalogue retailer (after Staples and Office Depot), in 2003. Soon thereafter, Boise announced that it was selling its land, plants, headquarters location, and even its name to an equity investment firm. Upon completion of the sale in 2004, the company assumed the name of OfficeMax. Can this manufacturer become a successful retailer?

W E B C A S E 13 H. J. Heinz Company (Contributor: Maryanne M. Rouse) Heinz, a manufacturer and marketer of processed food products, pursued global growth via market penetration and acquisitions. Unfortunately, its modest sales growth was primarily from its acquisitions. Now that the firm has divested a number of lines of businesses and brands to Del Monte Foods, analysts wonder how a 20% smaller Heinz will grow its sales and profits in this very competitive industry.

W E B C A S E 14 Nike Inc. (Contributor: Maryanne M. Rouse) Nike is the largest maker of athletic footwear and apparel in the world with a U.S. market share exceeding 40%. Since almost all its products are manufactured by 700 independent contractors (99% of which are in Southeast Asia), Nike is a target of activists opposing manufacturing practices in developing nations. Although industry sales growth in athletic footwear is slowing, Nike refused to change its product mix in 2002 to suit Foot Locker, the dominant global footwear retailer. Is it time for Nike to change its strategy and practices?

W E B C A S E 15 Six Flags Inc.: The 2006 Business Turnaround (Contributor: Patricia A. Ryan) Known for its fast roller coasters and adventure rides, Six Flags has successfully built a group of regional theme and water parks in the United States. Nevertheless, the company has not turned a profit since 1998. Long-term debt had increased to 61% of total assets by 2005. New management is implementing a retrenchment strategy, but industry analysts are unsure if this will be enough to save the company.

W E B C A S E 16 Lowe’s Companies Inc. (Contributor: Maryanne M. Rouse) As the second-largest U.S. “big box” home improvement retailer (behind Home Depot), Lowe’s competes in a highly fragmented industry. The company has grown with the increase in home ownership and has no plans to expand internationally. With more than 1,000 stores in 2004, Lowe’s intended to increase its U.S. presence with 150 store openings per year in 2005 and 2006. Are there limits to Lowe’s current growth strategy?

W E B C A S E 17 Movie Gallery Inc. (Contributor: J. David Hunger) Movie Gallery is the second-largest North American video retail rental company, specializing in the rental and sale of movies and video games through its Movie Gallery and Hollywood Entertainment stores. Growing through acquisitions, the company is heavily in debt. The recent rise of online video rental services, such as Netflix, is cutting into retail store revenues and reducing the company’s cash flow. With just $135 million in cash at the end of 2005, Movie Gallery’s management finds itself facing possible bankruptcy.

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Preface

Welcome to the 13th edition of Strategic Management and Business Policy! Although the chapters are the same as those in the 12th edition, many of the cases are new and different. We completely revised seven of your favorite cases (Apple, Dell, Google, Carnival, Panera Bread, Whole Foods, and Church & Dwight) and added 12 brand-new ones (iRobot, Rosetta Stone, Logitech, Chrysler, Tesla Motors, TomTom, Volcom, TOMS Shoes, Best Buy, Dollar General, Boston Beer, and Burger King) for a total of 19 new cases! More than half of the cases in this book are new to this edition! Although we still make a distinction between full-length and mini cases, we have interwoven them throughout the book to better identify them with their industries.

This edition continues the theme that runs throughout all 12 chapters: global environmental sustainability. This strategic issue will become even more important in the years ahead, as all of us struggle to deal with the consequences of climate change, global warming, and energy availability. We continue to be the most comprehensive strategy book on the market, with chapters ranging from corporate governance and social responsibility to competitive strategy, functional strategy, and strategic alliances. To keep the size of the book manageable, we offer special issue chapters dealing with technology, entrepreneurship, and not-for-profit organiza- tions on the Web site (www.pearsonhighered.com/wheelen).

FEATURES NEW TO THIS 13th EDITION Nineteen New Cases: Both Full Length and Mini Length Eleven full-length new or updated comprehensive cases and eight mini-length cases have been added to support the 16 popular full-length cases carried forward from past editions. Twelve of the cases are brand new. Seven are updated favorites from past editions. Of the 35 cases appearing in this book, 22 are exclusive and do not appear in other books.

� Five of the new cases deal with technology issues (Apple, iRobot, Dell, Rosetta Stone, and Logitech).

� One of the new cases deals with the Internet (Google). � One new case involves entertainment (Carnival). � Three new cases are of old and new transportation firms (Chrysler, TomTom, and Tesla

Motors). � Two new cases are of entrepreneurial clothing companies (Volcom and TOMS Shoes). � Two new specialty retailing cases spotlight electronics (Best Buy) and variety (Dollar

General). � Five new cases come from the food, beverage, and restaurant industries (Boston Beer,

Panera Bread, Whole Foods Market, Burger King, and Church & Dwight).

HOW THIS BOOK IS DIFFERENT FROM OTHER STRATEGY TEXTBOOKS This book contains a Strategic Management Model that runs through the first 11 chapters and is made operational through the Strategic Audit, a complete case analysis methodology. The Strategic Audit provides a professional framework for case analysis in terms of external

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and internal factors and takes the student through the generation of strategic alternatives and implementation programs.

To help the student synthesize the many factors in a complex strategy case, we developed three useful techniques:

� External Factor Analysis (EFAS) Table in Chapter 4 This reduces the external Opportunities and Threats to the 8 to 10 most important exter- nal factors facing management.

� Internal Factor Analysis (IFAS) Table in Chapter 5 This reduces the internal Strengths and Weaknesses to the 8 to 10 most important internal factors facing management.

� Strategic Factor Analysis Summary (SFAS) Matrix in Chapter 6 This condenses the 16 to 20 factors generated in the EFAS and IFAS Tables into the 8 to 10 most important (strategic) factors facing the company. These strategic factors become the basis for generating alternatives and a recommendation for the company’s future direction.

Suggestions for Case Analysis are provided in Appendix 12.B (end of Chapter 12) and contain step-by-step procedures for how to use the Strategic Audit in analyzing a case. This appendix includes an example of a student-written Strategic Audit. Thousands of students around the world have applied this methodology to case analysis with great success. The Case Instructor’s Manual contains examples of student-written Strategic Audits for each of the full-length comprehensive strategy cases.

FEATURES FOCUSED ON ENVIRONMENTAL SUSTAINABILITY � Each chapter contains a boxed insert dealing with an issue in environmental sustainability.

� Each chapter ends with Eco Bits, interesting tidbits of ecological information, such as the number of plastic bags added to landfills each year.

� Special sections on sustainability are found in Chapters 1 and 3.

� A section on the natural environment is included in the societal and task environments in Chapter 4.

TIME-TESTED FEATURES This edition contains many of the same features and content that helped make previous editions success- ful. Some of the features are the following:

xxx P R E FA C E

� A Strategic Management Model runs through- out the first 11 chapters as a unifying concept. (Explained in Chapter 1)

� The Strategic Audit, a way to operationalize the strategic decision- making process, serves as a checklist in case analysis. (Chapter 1)

� Corporate governance is examined in terms of the roles, re- sponsibilities, and interactions of top management and the board of directors and includes the impact of the Sarbanes-Oxley Act. (Chapter 2)

� Social responsibility and managerial ethics are examined in detail in terms of how they affect strategic decision making. They include the process of stakeholder analysis and the concept of social capital. (Chapter 3)

� Equal emphasis is placed on environmental scan- ning of the societal environment as well as on the task environment. Topics include forecasting and Miles and Snow’s typology in addition to compet- itive intelligence techniques and Porter’s industry analysis. (Chapter 4)

Discretionary

Ethical

LegalEconomic

Social Responsibilities

FIGURE 3–1 Responsibilities

of Business

SOURCE: Based on A. B. Carroll, “A Three Dimensional Conceptual Model of Corporate Performance,” Academy of Management Review (October 1979), pp. 497–505; A. B. Carroll, “Managing Ethically with Global Stakeholders: A Present and Future Challenge,” Academy of Management Executive (May 2004), pp. 114–120; and A. B. Carroll, “The Pyramid of Corporate Social Responsibility: Toward the Moral Management of Organizational Stakeholders,” Business Horizons (July–August 1991), pp. 39–48.

� Core and distinctive competencies are examined within the framework of the resource- based view of the firm. (Chapter 5)

� Organizational analysis includes material on business models, supply chain management, and corporate reputation. (Chapter 5)

� Internal and external strategic factors are emphasized through the use of specially designed EFAS, IFAS, and SFAS tables. (Chapters 4, 5, and 6)

� Functional strategies are examined in light of outsourcing. (Chapter 8)

P R E FA C E xxxi

� Two chapters deal with issues in strategy implementation, such as organizational and job design plus strategy-manager fit, action planning, corporate culture, and international strate- gic alliances. (Chapters 9 and 10)

� A separate chapter on evaluation and control explains the importance of measurement and incentives to organizational performance. (Chapter 11)

� Suggestions for in-depth case analysis pro- vide a complete listing of financial ratios, rec- ommendations for oral and written analysis, and ideas for further research. (Chapter 12)

xxxii P R E FA C E

� The Strategic Audit Worksheet is based on the time-tested Strategic Audit and is designed to help students organize and structure daily case preparation in a brief period of time. The worksheet works exceedingly well for checking the level of daily student case preparation—especially for open class dis- cussions of cases. (Chapter 12)

� Special chapters deal with strategic issues in managing technology and innovation, entrepreneurial ventures and small businesses, and not-for-profit organizations. (Web Chapters A, B, and C, respectively) These issues are often ignored by other strategy textbooks, but are available on this book’s Web site at www.pearsonhighered.com/wheelen.

� An experiential exercise focusing on the material covered in each chapter helps the reader to apply strategic concepts to an actual situation.

� A list of key terms and the pages in which they are discussed enable the reader to keep track of important concepts as they are introduced in each chapter.

� Learning objectives begin each chapter. � Each Part ends with a short case that acts to integrate the material discussed within

the previous chapters. � Timely, well-researched, and class-tested cases deal with interesting companies and

industries. Many of the cases are about well-known, publicly held corporations—ideal subjects for further research by students wishing to “update” the cases.

Both the text and the cases have been class-tested in strategy courses and revised based on feedback from students and instructors. The first 11 chapters are organized around a Strategic Management Model that begins each chapter and provides a structure for both content and case analysis. We emphasize those concepts that have proven to be most useful in under- standing strategic decision making and in conducting case analysis. Our goal was to make the text as comprehensive as possible without getting bogged down in any one area. Endnote references are provided for those who wish to learn more about any particular topic. All cases are about actual organizations. The firms range in size from large, established multinationals to small, entrepreneurial ventures, and cover a broad variety of issues. As an aid to case analysis, we propose the Strategic Audit as an analytical technique.

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SUPPLEMENTS Instructor Resource Center At www.pearsonhighered.com/irc, instructors can access teaching resources available with this text in downloadable, digital format. Registration is simple and gives you immediate ac- cess to new titles and new editions. As a registered faculty member, you can download re- source files and receive immediate access and instructions for installing course management content on your campus server. In case you ever need assistance, our dedicated technical sup- port team is ready to assist instructors with questions about the media supplements that ac- company this text. Visit http://247.pearsoned.com/ for answers to frequently asked questions and toll-free user support phone numbers. The Instructor Resource Center provides the fol- lowing electronic resources.

Instructor’s Manuals Two comprehensive Instructor’s Manuals have been carefully constructed to accompany this book. The first one accompanies the concepts chapters; the second one accompanies the cases.

Concepts Instructor’s Manual To aid in discussing the 12 strategy chapters as well as the three web special issue chapters, the Concepts Instructor’s Manual includes:

� Suggestions for Teaching Strategic Management: These include various teaching methods and suggested course syllabi.

� Chapter Notes: These include summaries of each chapter, suggested answers to discus- sion questions, and suggestions for using end-of-chapter cases/exercises and part-ending cases, plus additional discussion questions (with answers) and lecture modules.

Case Instructor’s Manual To aid in case method teaching, the Case Instructor’s Manual includes detailed suggestions for use, teaching objectives, and examples of student analyses for each of the full-length com- prehensive cases. This is the most comprehensive Instructor’s Manual available in strategic management. A standardized format is provided for each case:

1. Case Abstract

2. Case Issues and Subjects

3. Steps Covered in the Strategic Decision-Making Process

4. Case Objectives

5. Suggested Classroom Approaches

6. Discussion Questions

7. Case Author’s Teaching Note

8. Student-Written Strategic Audit, if appropriate

9. EFAS, IFAS, and SFAS Exhibits

10. Financial Analysis—ratios and common-size income statements, if appropriate

PowerPoint Slides PowerPoint slides, provided in a comprehensive package of text outlines and figures corre- sponding to the text, are designed to aid the educator and supplement in-class lectures.

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Test Item File This Test Item File contains over 1,200 questions, including multiple-choice, true/false, and essay questions. Each question is followed by the correct answer, page reference, AACSB category, and difficulty rating.

TestGen TestGen software is preloaded with all of the Test Item File questions. It allows instructors to manually or randomly view test questions, and to add, delete, or modify test-bank questions as needed to create multiple tests.

Videos on DVD Exciting and high-quality video clips help deliver engaging topics to the classroom to help students better understand the concepts explained in the textbook. Please contact your local representative to receive a copy of the DVD.

CourseSmart CourseSmart eTextbooks were developed for students looking to save on required or recom- mended textbooks. Students simply select their eText by title or author and purchase immedi- ate access to the content for the duration of the course using any major credit card. With a CourseSmart eText, students can search for specific keywords or page numbers, take notes online, print out reading assignments that incorporate lecture notes, and bookmark important passages for later review. For more information or to purchase a CourseSmart eTextbook, visit www.coursesmart.com.

A c k n o w l e d g m e n t s We thank the many people at Prentice Hall/Pearson who helped to make this edition possi- ble. We thank our editor, Kim Norbuta. We are especially grateful to Kim’s project manager, Claudia Fernandes, who managed to keep everything on an even keel. We also thank Becca Groves and Emily Bush, who took the book through the production process.

We are very thankful to Jeanne McNett, Assumption College; Bob McNeal, Alabama State University; Don Wicker, Brazosport College; Dan Kipley, Azusa Pacific University; Roxanna Wright, Plymouth State University; Kristl Davison, University of Mississippi; Francis Fabian, University of Memphis; Susan Fox-Wolfgramm, Hawaii Pacific University; Conrad Francis, Nova Southeastern University; and Gene Simko, Monmouth University for their constructive criticism of the 12th edition cases. They helped us to decide which of our favorite cases to keep and which to delete or update.

We are very grateful to Kathy Wheelen for her first-rate administrative support of the cases and to Alan N. Hoffman for helping us with the Case Instructor’s Manual. We are especially thankful to the many students who tried out the cases we chose to include in this book. Their comments helped us find any flaws in the cases before the book went to the printer.

In addition, we express our appreciation to Wendy Klepetar, Management Department Chair of Saint John’s University and the College of Saint Benedict, for her support and provision of the resources so helpful to revise a textbook. Both of us acknowledge our debt to

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Dr. William Shenkir and Dr. Frank S. Kaulback, former Deans of the McIntire School of Commerce of the University of Virginia, for the provision of a work climate most supportive to the original development of this book.

We offer a special thanks to the hundreds of case authors who have provided us with excellent cases for the 13 editions of this book. We consider many of these case authors to be our friends. A special thanks to you!! The adage is true: The path to greatness is through others.

Lastly, to the many strategy instructors and students who have moaned to us about their problems with the strategy course: We have tried to respond to your problems and concerns as best we could by providing a comprehensive yet usable text coupled with recent and complex cases. To you, the people who work hard in the strategy trenches, we acknowledge our debt. This book is yours.

T. L. W. Saint Petersburg, Florida

J. D. H. St. Joseph, Minnesota

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About the Contributors

MOUSTAFA H. ABDELSAMAD, DBA (George Washington University), is Dean of the College of Business at Texas A&M University–Corpus Christi. He previously served as Dean of the College of Business and Industry at University of Massachusetts–Dartmouth and as Professor of Finance and Associate Dean of Graduate Studies in Business at Virginia Commonwealth University. He is Editor–in-Chief of SAM Advanced Management Journal and International President of the Society of Advancement of Management. He is author of A Guide to Capital Expenditure Analysis and two chapters in the Dow Jones–Irwin Capital Budgeting Handbook. He is the author and coauthor of numerous articles in various publications.

Hitesh (John) P. Adhia, CPA, MS and BA (University of South Florida), is the President and Chief Investment Officer of Adhia Investment Advisors, Inc. (the “Firm”). Mr. Adhia is a CPA and has been in the finace industry since 1982. Mr Adhia is the founder and Investment Man- ager for the Adhia Twenty Fund, and the Adhia Health Care Fund, the Adhia Short Term Ad- vantage Fund, the Adhia Arbitrage Fund, and the Adhia Derivative Fund. Prior to forming Adhia Investment Advisors, Mr. Adhia owned a Tampa-based public accounting practice and also served as Acting CFO and Independent Advisor to the Well Care Group of Companies. Mr. Adhia has over twenty years experience in managing fixed income strategies.

KAREN A. BERGER, PhD (M. Phil and New York University), MBA (University of Connecticut), MA (Columbia University), and BA (S.U.N.Y. at Buffalo), is Chairperson of the Marketing Department and Associate Professor of Marketing at Pace University. She previously held aca- demic positions with New York University, Stern School of Business, and Mercy College. Berger has published literature in the field of Marketing and has won several teaching awards.

CHRISTINE B. BUENAFE, student of The College of New Jersey, co-author with Joyce Vincelette of the Rosetta Stone and Volcom cases in this edition.

BARNALI CHAKRABORTY, is a faculty member at the ICFAI Center for Management Research (ICMR).

RICHARD A. COISER, PhD (University of Iowa), is Dean and Leeds Professor of Management at Purdue University. He formerly was Dean and Fred B. Brown Chair at the University of Oklahoma and was Associate Dean for Academics and Professor of Business Administration at Indiana University. He served as Chairperson of the Department of Management at Indiana University. For seven years prior to assuming his current position, he was a Planning Engineer with Western Electric Company and Instructor of Management and Quantitative Methods at the University of Notre Dame. Dr. Coiser is interested in researching the managerial decision- making process, organization responses to external forces, and participative management. He has published in Behavior Science, Academy of Management Journal, Academy of Manage- ment Review, Organizational Behavior and Human Performance, Management Science, Strategic Management Journal, Business Horizons, Decision Sciences, Personnel Psychology, Journal of Creative Behavior, International Journal of Management, The Business Quarterly, Public Administration Quarterly, Human Relations, and other journals. In addition, Dr. Coiser has presented numerous papers at professional meetings and has coauthored a management

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text. He has been active in many executive development programs and has acted as management- education consultant for several organizations. Dr. Coiser is the recipient of Teaching Excellence Awards in the MBA Program at Indiana and a Richard D. Irwin Fellowship. He be- longs to the Institute of Management, Sigma Iota Epsilon, and the Decision Sciences Institute.

ROY A. COOK, DBA (Mississippi State University), is past Associate Dean of the School of Business Administration and previously a Professor at Fort Lewis College, Durango, Col- orado. He has written a best-selling textbook, Tourism: The Business of Travel, now in its 2nd edition, and has two forthcoming textbooks: Cases and Experiential Exercises in Hu- man Resource Management and Guide to Business Etiquette. He has authored numerous ar- ticles, cases, and papers based on his extensive experience in the hospitality industry and research interests in the areas of strategy, small business management, human resource man- agement, and communication. Dr. Cook has served as the Director of Colorado’s Center for Tourism Research® and Editor of The Annual Advances in Business Cases, and also on the editorial boards of the Business Case Journal, the Journal of Business Strategies, and the Journal of Teaching and Tourism. He is a member of the Academy of Management, Society for Case Research (past President), and the International Society of Travel and Tourism Ed- ucators. Dr. Cook teaches courses in Strategic Management, Small Business Management, Tourism and Resort Management, and Human Resource Management.

STEVEN M. COX, PhD (University of Nebraska), is an Associate Professor of Marketing, McColl School of Business, Queens University of Charlotte. He has a 25-year career in execu- tive level marketing and sales positions with AT&T, GE, and several satellite imaging compa- nies. He owns and manages LSI, a geographic information system company. He currently serves as a case reviewer for the Business Case Journal and the Southeast Case Research Journal.

DAVID B. CROLL, PhD (Pennsylvania State University), is Professor Emeritus of Accounting at the McIntire School of Commerce, the University of Virginia. He was Visiting Associate Pro- fessor at the Graduate Business School, the University of Michigan. He is on the editorial board of SAM Advanced Management Journal. He has published in the Accounting Review and the Case Research Journal. His cases appear in 12 accounting and management textbooks.

DAN R. DALTON, PhD (University of California, Irvine), is the Dean of the Graduate School of Business, Indiana University, and Harold A. Polipl Chair of Strategic Management. He was for- merly with General Telephone & Electronics for 13 years. Widely published in business and psychology periodicals, his articles have appeared in the Academy of Management Journal, Journal of Applied Psychology, Personnel Psychology, Academy of Management Review, and Strategic Management Journal.

CATHY A. ENZ, PhD (Ohio State University), is the Lewis G. Schaeneman Jr. Professor of Innovation and Dynamic Management at Cornell University’s School of Hotel Administra- tion. She is also the Executive Director of the Center for Hospitality Research at that insti- tution. Her doctoral degree is in Organization Theory and Behavior. Professor Enz has written numerous articles, cases, and books on corporate culture, value sharing, change management, and strategic human resource management effects on performance. Professor Enz consults extensively in the service sector and serves on the Board of Directors for two hospitality-related organizations.

ELLIE A. FOGARTY, EdD (University of Pennsylvania), MBA (Temple University), MLS (University of Pittsburgh), and BA (Immaculata University), is the Director of Compliance and Ethics at The College of New Jersey (TCNJ). Previously, she served as the Associate Provost for Planning and Resource Allocation, Executive Assistant to the Provost, and Business and

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Economics Librarian, all at TCNJ. She has written five cases used in earlier editions of Strategic Management and Business Policy. She has taught management courses at both TCNJ and Rutgers University.

GAMEWELL D. GANTT, JD, CPA, is Professor of Accounting and Management in the College of Business at Idaho State University in Pocatello. Idaho, where he teaches a variety of legal studies courses. He is past President of the Rocky Mountain Academy of Legal Studies in Busi- ness and a past Chair of the Idaho Endowment Investment Fund Board. His published articles and papers have appeared in journals including Midwest Law Review, Business Law Review, Copyright World, and Intellectual Property World. His published cases have appeared in sev- eral textbooks and in Annual Advances in Business Cases.

S. S. GEORGE is a faculty associate at the ICFAI Center for Management Research (ICMR).

NORMAN J. GIERLASINSKI, DBA, CPA, CFE, CIA, is Professor of Accounting at Central Washington University. He served as Chairman of the Small Business Division of the Midwest Business Administration Association. He has authored or coauthored cases for professional associations and the Harvard Case Study Series. He has authored various articles in profes- sional journals as well as serving as a contributing author for textbooks and as a consultant to many organizations. He also served as a reviewer for various publications.

VIVEK GUPTA is a faculty member at the ICFAI Center for Management Research (ICMR).

RENDY HALIN, MBA and BS (Bentley University), is currently focusing on equity and com- modity trading, as well as venturing on a new startup company. Actively involved in his church ministry, he is also contributing his time and thought on how to properly manage the church’s management and financial report effectively.

PATRICIA HARASTA, MBA (Bentley McCallum Graduate School of Business), is Director of Quality Assurance at CA (formerly Computer Associates). She manages a distributed team responsible for new development and maintenance QA activities for products that provide management of applications such as SAP, Microsoft Exchange, Lotus Domino, WebSphere, WebLogic, MQ, and Web Servers.

ALAN N. HOFFMAN, MBA, DBA (Indiana University), is Professor of Strategic Management and Director of the MBA program at the McCallum Graduate School, Bentley University. His major areas of interest include strategic management, global competition, investment strategy, and technology. Professor Hoffman is coauthor of The Strategic Management Casebook and Skill Builder textbook. His recent publications have appeared in the Academy of Management Journal, Human Relations, the Journal of Business Ethics, the Journal of Business Research, and Business Horizons. He has authored more than 20 strategic management cases including The Boston YWCA, Ryka Inc., Liz Claiborne, Ben & Jerry’s, Cisco Systems, Sun Microsys- tems, Palm Inc., Handspring, Ebay, AOL/Time Warner, McAfee, Apple Computer, Tivo Inc., and Wynn Resorts. He is the recipient of the 2004 Bentley University Teaching Innovation Award for his course: “The Organizational Life Cycle—The Boston Beer Company Brewers of Samuel Adams Lager Beer.”

J. DAVID HUNGER, PhD (Ohio State University), is currently Strategic Management Scholar in Residence at Saint John’s University in Minnesota. He is also Professor Emeritus at Iowa State University where he taught for 23 years. He previously taught at George Mason University, the University of Virginia, and Baldwin-Wallace College. He worked in brand management at Proc- ter & Gamble Company, worked as a selling supervisor at Lazarus Department Store, and

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served as a Captain in U.S. Army Military Intelligence. He has been active as a consultant and trainer to business corporations, as well as to state and federal government agencies. He has written numerous articles and cases that have appeared in the Academy of Management Jour- nal, International Journal of Management, Human Resource Management, Journal of Business Strategies, Case Research Journal, Business Case Journal, Handbook of Business Strategy, Journal of Management Case Studies, Annual Advances in Business Cases, Journal of Retail Banking, SAM Advanced Management Journal, and Journal of Management, among others. Dr. Hunger is a member of the Academy of Management, North American Case Research Association, Society for Case Research, North American Management Society, Textbook and Academic Authors Association, and the Strategic Management Society. He is past President of the North American Case Research Association, the Society for Case Research, and the Iowa State University Press Board of Directors. He also served as a Vice President of the U.S. Asso- ciation for Small Business and Entrepreneurship. He was Academic Director of the Pappajohn Center for Entrepreneurship at Iowa State University. He has served on the editorial review boards of SAM Advanced Management Journal, Journal of Business Strategies, and Journal of Business Research. He has served on the Board of Directors of the North American Case Research Association, the Society for Case Research, the Iowa State University Press, and the North American Management Society. He is coauthor with Thomas L. Wheelen of Strategic Management and Business Policy and Essentials of Strategic Management plus Concepts in Strategic Management and Business Policy and Cases in Strategic Management and Business Policy, as well as Strategic Management Cases (PIC: Preferred Individualized Cases), and a monograph assessing undergraduate business education in the United States. The 8th edition of Strategic Management and Business Policy received the McGuffey Award for Excellence and Longevity in 1999 from the Text and Academic Authors Association. Dr. Hunger received the Best Case Award given by the McGraw-Hill Publishing Company and the Society for Case Research in 1991 for outstanding case development. He is listed in various versions of Who’s Who, including Who’s Who in the United States and Who’s Who in the World. He was also recognized in 1999 by the Iowa State University College of Business with its Innovation in Teaching Award and was elected a Fellow of the Teaching and Academic Authors Association and of the North American Case Research Association.

P. INDU is a student of Vivek Gupta at the ICFAI Center of Management Research (ICMR).

GEORGE A. JOHNSON, PhD, is Professor of Management and Director of the Idaho State University MBA program. He has published in the fields of Management Education, Ethics, Project Management, and Simulation. He is also active in developing and publishing case material for educational purposes. His industry experience includes several years as a Pro- ject Manager in the development and procurement of aircraft systems.

SHAWANA P. JOHNSON, PhD (Case Western Reserve University), is president of Global Mar- keting Insights, Inc. She has 27 years of management and marketing experience in the Hi-Tech Information and Geospatial Technology Industry with companies such as Lockheed Martin and General Electric Aerospace.

MICHAEL KEEFFE, PhD (University of Arkansas), is Associate Professor of Management and Chair of Undergraduate Assurance of Learning in the McCoy College of Business Administra- tion, Texas State University. He was the developer and draft writer of the College of Business policy and procedure system, co-director of initial AACSB-International accreditation efforts, sponsor of the Alpha Chi University Honor Society for over a decade, and developed and im- plemented the Assurance of Learning system for the McCoy College. Additionally, he has been Chair or Acting Chair of three departments in the college. With over a dozen journal articles and

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numerous refereed proceedings, Dr. Keeffe is an avid case writer with over 21 cases appearing in 32 textbooks over the last 20 years.

JOHN A. KILPATRICK, PhD (University of Iowa), is Professor of Management and Interna- tional Business, Idaho State University. He has taught in the areas of business and business ethics for over 25 years. He served as Co-Chair of the management track of the Institute for Behavioral and Applied Management from its inception and continues as a board member for that organization. He is author of The Labor Content of American Foreign Trade, and is coauthor of Issues in International Business. His cases have appeared in a number of orga- nizational behavior and strategy texts and casebooks, and in Annual Advances in Business Cases.

DONALD F. KURATKO is the Jack M. Gill Chair of Entrepreneurship, Professor of Entrepreneur- ship, and Executive Director of the Johnson Center for Entrepreneurship & Innovation at The Kelley School of Business, Indiana University–Bloomington. He has published over 150 ar- ticles on aspects of entrepreneurship, new venture development, and corporate entrepreneurship. His work has been published in journals such as Strategic Management Journal, Academy of Management Executive, Journal of Business Venturing, Entrepreneurship Theory & Practice, Journal of Small Business Management, Journal of Small Business Strategy, Family Business Re- view, and Advanced Management Journal. Dr. Kuratko has authored 20 books, Entrepreneurship: Theory, Process, Practice, 7th edition (South-Western/Thomson Publishers, 2007), as well as Strategic Entrepreneurial Growth, 2nd edition (South-Western/Thomson Pub- lishers, 2004), Corporate Entrepreneurship (South-Western/Thomson Publishers, 2007), and Effective Small Business Management, 7th edition (Wiley & Sons Publishers, 2001). In addition, Dr. Kuratko has been consultant on Corporate Entrepreneurship and Entrepreneurial Strategies to a number of major corporations such as Anthem Blue Cross/Blue Shield, AT&T, United Tech- nologies, Ameritech, The Associated Group (Acordia), Union Carbide Corporation, Service- Master, and TruServ. Before coming to Indiana University, he was the Stoops Distinguished Professor of Entrepreneurship and Founding Director of the Entrepreneurship Program at Ball State University. In addition, he was the Executive Director of The Midwest Entrepreneurial Ed- ucation Center.

Dr. Kuratko’s honors include earning the Ball State University College of Business Teach- ing Award 15 consecutive years as well as being the only professor in the history of Ball State University to achieve all four of the university’s major lifetime awards: Outstanding Young Faculty (1987); Outstanding Teaching Award (1990); Outstanding Faculty Award (1996); and Outstanding Researcher Award (1999). He was also honored as the Entrepreneur of the Year for the state of Indiana and was inducted into the Institute of American Entrepreneurs Hall of Fame (1990). He has been honored with The George Washington Medal of Honor; the Leavey Foundation Award for Excellence in Private Enterprise; the NFIB Entrepreneurship Excel- lence Award; and the National Model Innovative Pedagogy Award for Entrepreneurship. In addition, Dr. Kuratko was named the National Outstanding Entrepreneurship Educator (by the U.S. Association for Small Business and Entrepreneurship) and selected as one of the Top 3 Entrepreneurship Professors in the United States by the Kauffman Foundation, Ernst & Young, Inc. magazine, and Merrill Lynch. He received the Thomas W. Binford Memorial Award for Outstanding Contribution to Entrepreneurial Development from the Indiana Health Industry Forum. Dr. Kuratko has been named a 21st Century Entrepreneurship Research Fellow by the National Consortium of Entrepreneurship Centers as well as the U.S. Association for Small Business & Entrepreneurship Scholar for Corporate Entrepreneurship in 2003. Finally, he has been honored by his peers in Entrepreneur magazine as one of the Top 2 Entrepreneurship

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Program Directors in the nation for three consecutive years including the #1 Entrepreneurship Program Director in 2003.

RUCHI MANKAD is a former faculty member at the ICFAI Center for Management Research (ICMR).

BILL J. MIDDLEBROOK, PhD (University of North Texas), is Professor of Management at Southwest Texas State University. He served as Acting Chair of the Department of Man- agement and Marketing, published in numerous journals, served as a consultant in industry, and is currently teaching and researching in the fields of Strategic Management and Human Resources.

BERNARD A. MORIN, B.S., M.B.A., Ph.D., Professor Emeritus of Commerce at the University of Virginia.

NATHAN NEBBE, MBA and MA (Iowa State University), has significant interests in the in- digenous peoples of the Americas. With an undergraduate degree in Animal Ecology, he served as a Peace Corps Volunteer in Honduras, where he worked at the Honduran national forestry school ESNAACIFORE (Escuela National de Ciencias Forestales). After some time in the Peace Corps, Nathan worked for a year on a recycling project for the Town of Ignacio and the Southern Ute Indian Tribe in southwestern Colorado. Following his expe- rience in Colorado, Nathan returned to Iowa State University where he obtained his MBA, followed by an MA in Anthropology. He is currently studying how globalization of the Chilian forestry industry is affecting the culture of the indigenous Mapuche people of south central Chile.

LAWRENCE C. PETTIT, Jr., B.S., M.S., D.B.A., Professor Emeritus of Commerce at the McIntire School of Commerce University of Virginia.

ANNIE PHAN, BS (The College of New Jersey), is currently an associate at Goldman Sachs Asset Management, and is an MBA candidate at New York University Leonard N. Stern School of Business. In addition, she has assisted with research for The Global Corporate Brand Book.

SHIRISHA REGANI is a faculty associate at the ICFAI Center for Management Research (ICMR).

JOHN K. ROSS III, PhD (University of North Texas), is Associate Professor of Management at Southwest Texas State University. He has served as SBI Director, Associate Dean, Chair of the Department of Management and Marketing, published in numerous journals, and is currently teaching and researching in the fields of Strategic Management and Human Resource.

SHERRY K. ROSS, CPA (Texas), MBA (Southwest Texas State University), is a Senior Lecturer at Texas State University–San Marcos, Texas. She is the core course coordinator for financial accounting and teaches introductory financial accounting courses. Her recent work experience is Executive Director of a not-for-profit corporation.

MARYANNE M. ROUSE, CPA, MBA (University of South Florida) was a faculty member, As- sistant Dean, and Director of Management Education and Development at the College of Business Administration of the University of South Florida until her retirement.

PATRICIA A. RYAN, PhD (University of South Florida), is an Associate Professor of Finance, Colorado State University. She currently serves on the Board of Directors of the Midwest Finance Association and was the Associate Editor of the Business Case Journal. Her research

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interests lie in corporate finance, specifically initial public offerings, capital budgeting, and case writing. She has published in the Journal of Business and Management, the Business Case Journal, Educational and Psychological Measurement, the Journal of Research in Finance, the Journal of Financial and Strategic Decisions, and the Journal of Accounting and Finance Research. Her research has been cited in the Wall Street Journal, CFO Magazine, and Investment Dealers Digest.

RANGKI SON, MBA, earned his degree in Finance at the McCallum Graduate School of Busi- ness, Bentley University, in May 2007. He is currently working for KPMG Korea as a Business Performance Service Consultant.

LAURENCE J. STYBEL, EdD (Harvard University), is cofounder of Stybel Peabody Lincolnshire, a Boston-based management consulting firm devoted to enhancing career effectiveness of executives who report to boards of directors. Its services include search, outplacement, outplacement avoidance, and valued executive career consulting. Stybel Peabody Lincolnshire was voted “Best Outplacement Firm” by the readers of Massachusetts Lawyers Weekly. Its programs are the only ones officially endorsed by the Massachusetts Hospital Association and the Financial Executives Institute. He serves on the Board of Directors of the New England Chap- ter of the National Association of Corporate Directors and the Boston Human Resources Asso- ciation. His home page can be found at www.stybelpeabody.com. The “Your Career” department of the home page contains downloadable back issues of his monthly Boston Business Journal column, “Your Career.”

JOEL SAROSH THADAMALLA is a faculty member at the ICFAI center for Management Research (ICMR).

MRIDU VERMA serves as a Consulting Editor at ICFAI Business School (ICMR).

JOYCE P. VINCELETTE, DBA (Indiana University), is a Professor of Management and the Coordinator of Management and Interdisciplinary Business Programs at The College of New Jersey. She was previously a faculty member at the University of South Florida. She has au- thored and coauthored various articles, chapters, and cases that have appeared in management journals and strategic management texts and casebooks. She is also active as a consultant and trainer for a number of local and national business organizations as well as for a variety of not- for-profit and government agencies. She currently teaches and conducts research in the fields of Strategic Management and Leadership.

KATHRYN E. WHEELEN, MEd (Nova Southern University), BA, LMT, (University of Tampa), has worked as an Administrative Assistant for case and textbook development with the Thomas L. Wheelen Company (circa 1879). She works as a Special Education Teacher in the Hillsborough County School District at Citrus Park Elementary School, Tampa, Florida.

RICHARD D. WHEELEN, BS (University of South Florida), has worked as a case research assistant. He is currently practicing in the field of Health Care. He currently lives in Everett, Washington.

THOMAS L. WHEELEN, DBA (George Washington University), MBA (Babson College) and BS cum laude (Boston College), has taught as Visiting Professor at Trinity College of the University of Dublin, University of South Florida as Professor of Strategic Management, the McIntire School of Commerce of the University of Virginia as the Ralph A. Beeton Professor of Free Enterprise, and Visiting Professor at both the University of Arizona and Northeastern

A B O U T T H E C O N T R I B U T O R S xliii

University. He was also affiliated with the University of Virginia College of Continuing Education, where he served in the following capacities: (1) Coordinator for Business Educa- tion (1978–1983, 1971–1976)—approve all undergraduate courses offered at seven regional centers and approved faculty; (2) Liaison Faculty and Consultant to the National Academy of the FBI Academy (1972–1983) and; (3) developed, sold, and conducted over 200 seminars for local, state, and national governments, and companies for McIntire School of Commerce and Continuing Education. He worked at General Electric Company, holding various management positions (1961–1965); U.S. Navy Supply Corps (SC)–Lt. (SC) USNR–Assistant Supply Officer aboard nuclear support tender (1957–1960). He has been published in the monograph, An Assessment of Undergraduate Business Education in the United States (with J. D. Hunger), 1980. He’s also authored 60 published books, with 14 books translated into eight languages (Arabic, Bahasa, Indonesia, Chinese, Chinese Simplified, Greek, Italian, Japanese, Portuguese and Thai); he is coauthor with J. D. Hunger of four active books: Strategic Management and Business Policy, 13th edition (2012); Concepts in Strategic Management and Business Policy, 13th edition (2012); Strategic Management and Business Policy, 13th edition International edition (2012); and Essentials of Strategic Management, 5th edition (2011). He is co-editor of Developments in Information Systems (1974) and Collective Bargaining in the Public Sector (1977), and co-developer of the software program STrategic Financial ANalyzer (ST. FAN) (1989, 1990, 1993—different versions). He has authored over 40 articles that have appeared in such journals as the Journal of Management, Business Quarterly, Personnel Journal, SAM Advanced Management Journal, Journal of Retailing, International Journal of Management, and the Handbook of Business Strategy. He has created roughly 280 cases appearing in over 83 text and case books, as well as the Business Case Journal, Journal of Management Case Studies, International Journal of Case Studies, and Research and Case Research Journal. He has won numerous awards, including the following: (1) Fellow elected by the Society for Ad- vancement of Management in 2002; (2) Fellow elected by the North American Case Research Association in 2000; (3) Fellow elected by the Text and Academic Authors Association in 2000; (4) 1999 Phil Carroll Advancement of Management Award in Strategic Management from the Society for Advancement of Management; (5) 1999 McGuffey Award for Excellence and Longevity for Strategic Management and Business Policy, 6th edition from the Text and Academic Authors Association; (6) 1996/97 Teaching Incentive Program Award for teaching undergraduate strategic management; (7) Fulbright, 1996–1997, to Ireland, which he had to decline; (8) Endowed Chair, Ralph A. Beeton Professor, at University of Virginia (1981–1985); (9) Sesquicentennial Associateship research grant from the Center for Advanced Studies at the University of Virginia, 1979–1980; (10) Small Business Administration (Small Business Institute) supervised undergraduate team that won District, Regional III, and Honor- able Mention Awards; and (11) awards for two articles. Dr. Wheelen currently serves on the Board of Directors of Adhia Mutual Fund, Society for Advancement of Management, and on the Editorial Board and is the Associate Editor of SAM Advanced Management Journal. He served on the Board of Directors of Lazer Surgical Software Inc, and Southern Management Association and on the Editorial Boards of the Journal of Management and Journal of Management Case Studies, Journal of Retail Banking, Case Research Journal, and Business Case Journal. He was Vice President of Strategic Management for the Society for the Advancement of Management, and President of the North American Case Research Associa- tion. Dr. Wheelen is a member of the Academy of Management, Beta Gamma Sigma, Southern Management Association, North American Case Research Association, Society for Advance- ment of Management, Society for Case Research, Strategic Management Association, and World Association for Case Method Research and Application. He has been listed in Who’s Who in Finance and Industry, Who’s Who in the South and Southwest, and Who’s Who in American Education.

xliv A B O U T T H E C O N T R I B U T O R S

THOMAS L. WHEELEN II, BA (Boston College), has worked as a Case Research Assistant.

SUZANNE WONG was born and raised in Jakarta, Indonesia. She graduated with a dual BSBA degree in Finance and Marketing from Northeastern University in 2004, followed by an MBA in Finance from Bentley University in 2006. Upon graduation, Suzanne joined Fidelity Investments’ parent company FMRCo in Boston as an Analyst in Technol- ogy Risk Management–Information Security. She plans to continue the future operational success of her parents’ pharmaceutical company in Indonesia.

A B O U T T H E C O N T R I B U T O R S xlv

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THIRTEENTH EDITION

Strategic Management

and Business Policy

TOWARD GLOBAL SUSTAINABILITY

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P A R T1 Introduction to

Strategic Management and Business

Policy

How does a company become successful and stay successful? Certainly not

by playing it safe and following the traditional ways of doing business! Taking a

strategic risk is what General Electric (GE) did when it launched its Ecomagination

strategic initiative in 2005. According to Jeffrey Immelt, Chairman and CEO:

Ecomagination is GE’s commitment to address challenges, such as the need for cleaner,

more efficient sources of energy, reduced emissions, and abundant sources of clean water.

And we plan to make money doing it. Increasingly for business, “green” is green.1

Immelt announced in a May 9, 2005, conference call that the company planned to more

than double its spending on research and development from $700 million in 2004 to $1.5 bil-

lion by 2010 for cleaner products ranging from power generation to locomotives to water pro-

cessing. The company intended to introduce 30 to 40 new products, including more efficient

lighting and appliances, over the next two years. It also expected to double revenues from busi-

nesses that made wind turbines, treat water, and reduce greenhouse-emitting gases to at least

$20 billion by 2010. In addition to working with customers to develop more efficient power gen-

erators, the company planned to reduce its own emission of greenhouse gases by 1% by 2012

and reduce the intensity of those gases 30% by 2008.2 In 2006, GE’s top management informed

the many managers of its global business units that in the future they would be judged not only

by the usual measures, such as return on capital, but that they would also be accountable for

achieving corporate environmental objectives.

Ecomagination was a strategic change for GE, a company that had previously been con-

demned by environmentalists for its emphasis on coal and nuclear power and for polluting the

Hudson and Housatonic rivers with polychlorinated biphenyls (PCBs) in the 1980s. Over the

years, GE had been criticized for its lack of social responsibility and for its emphasis on prof-

itability and financial performance over social and environmental objectives. What caused GE’s

management to make this strategic change?

In the 18 months before launching its new environmental strategy, GE invited managers

from companies in various industries to participate in two-day “dreaming sessions” during

which they were asked to imagine life in 2015—and the products they, as customers, would

need from GE. The consensus was a future of rising fuel costs, restrictive environmental regula-

tions, and growing consumer expectations for cleaner technologies, especially in the energy in-

dustry. Based on this conclusion, GE’s management made the strategic decision to move in a new

basic concepts of Strategic Management

C H A P T E R 1

3

� Understand the benefits of strategic management

� Explain how globalization and environmental sustainability influence strategic management

� Understand the basic model of strategic management and its components

� Identify some common triggering events that act as stimuli for strategic change

� Understand strategic decision-making modes

� Use the strategic audit as a method of analyzing corporate functions and activities

Learning Objectives

Gathering Information

Putting Strategy into Action

Monitoring Performance

Societal Environment: General forces

Natural Environment: Resources and

climate

Task Environment:

Industry analysis

Internal: Strengths and Weaknesses

Structure: Chain of command

Culture: Beliefs, expectations,

values

Resources: Assets, skills, competencies,

knowledge

Programs

Activities needed to accomplish a plan

Budgets

Cost of the programs Procedures

Sequence of steps needed to do the job

Performance

Actual results

External: Opportunities

and Threats

Developing Long-range Plans

Mission

Reason for existence Objectives

What results to accomplish by when

Strategies

Plan to achieve the mission & objectives

Policies

Broad guidelines for decision making

Environmental Scanning:

Strategy Formulation:

Strategy Implementation:

Evaluation and Control:

Feedback/Learning: Make corrections as needed

After reading this chapter, you should be able to:

direction. According to Vice Chairman David Calhoun, “We decided that if this is what our

customers want, let’s stop putting our heads in the sand, dodging environmental inter-

ests, and go from defense to offense.”3

Following GE’s announcement of its new strategic initiative, analysts raised questions

regarding the company’s ability to make Ecomagination successful. They not only ques-

tioned CEO Immelt’s claim that green could be profitable as well as socially responsible,

but they also wondered if Immelt could transform GE’s incremental approach to innova-

tion to one of pursuing riskier technologies, such as fuel cells, solar energy, hydrogen stor-

age, and nanotechnology.4 Other companies had made announcements of green

initiatives, only to leave them withering on the vine when they interfered with profits. For

example, FedEx had announced in 2003 that it would soon be deploying clean-burning hy-

brid trucks at a rate of 3,000 per year, eventually cutting emissions by 250,000 tons of

greenhouse gases. Four years later, FedEx had purchased fewer than 100 hybrid vehicles,

less than 1% of its fleet! With hybrid trucks costing 75% more than conventional trucks,

it would take 10 years for the fuel savings to pay for the costly vehicles. FedEx manage-

ment concluded that breaking even over a 10-year period was not the best use of com-

pany capital. As a result of this and other experiences, skeptics felt that most large

companies were only indulging in greenwash when they talked loudly about their sus-

tainability efforts, but followed through with very little actual results.5

CEO Immelt had put his reputation at risk by personally leading GE’s Ecomagination

initiative. Skeptics wondered if the environmental markets would materialize and if they

would be as profitable as demanded by GE’s shareholders. Would a corporate culture

known for its pursuit of the Six Sigma statistics-based approach to quality control be able

to create technological breakthroughs and new green businesses? If Immelt was correct,

not only would GE benefit, but other companies would soon follow GE’s lead. If, however,

he was wrong, Immelt would have led his company down a dead end where it would be

difficult to recover from the damage to its reputation and financial standing. According to

a 25-year veteran of GE, “Jeff is asking us to take a really big swing . . . . This is hard for us.”6

4 PA RT 1 Introduction to Strategic Management and Business Policy

C H A P T E R 1 Basic Concepts of Strategic Management 5

1.1 The Study of Strategic Management Strategic management is a set of managerial decisions and actions that determines the long- run performance of a corporation. It includes environmental scanning (both external and in- ternal), strategy formulation (strategic or long-range planning), strategy implementation, and evaluation and control. The study of strategic management, therefore, emphasizes the moni- toring and evaluating of external opportunities and threats in light of a corporation’s strengths and weaknesses. Originally called business policy, strategic management incorporates such topics as strategic planning, environmental scanning, and industry analysis.

PHASES OF STRATEGIC MANAGEMENT Many of the concepts and techniques that deal with strategic management have been developed and used successfully by business corporations such as General Electric and the Boston Con- sulting Group. Over time, business practitioners and academic researchers have expanded and refined these concepts. Initially, strategic management was of most use to large corporations op- erating in multiple industries. Increasing risks of error, costly mistakes, and even economic ruin are causing today’s professional managers in all organizations to take strategic management se- riously in order to keep their companies competitive in an increasingly volatile environment.

As managers attempt to better deal with their changing world, a firm generally evolves through the following four phases of strategic management:7

Phase 1—Basic financial planning: Managers initiate serious planning when they are re- quested to propose the following year’s budget. Projects are proposed on the basis of very little analysis, with most information coming from within the firm. The sales force usu- ally provides the small amount of environmental information. Such simplistic operational planning only pretends to be strategic management, yet it is quite time consuming. Nor- mal company activities are often suspended for weeks while managers try to cram ideas into the proposed budget. The time horizon is usually one year.

Phase 2—Forecast-based planning: As annual budgets become less useful at stimulating long- term planning, managers attempt to propose five-year plans. At this point they consider proj- ects that may take more than one year. In addition to internal information, managers gather any available environmental data—usually on an ad hoc basis—and extrapolate current trends five years into the future. This phase is also time consuming, often involving a full month of managerial activity to make sure all the proposed budgets fit together. The process gets very political as managers compete for larger shares of funds. Endless meetings take place to eval- uate proposals and justify assumptions. The time horizon is usually three to five years.

Phase 3—Externally oriented (strategic) planning: Frustrated with highly political yet inef- fectual five-year plans, top management takes control of the planning process by initiating strategic planning. The company seeks to increase its responsiveness to changing markets and competition by thinking strategically. Planning is taken out of the hands of lower-level managers and concentrated in a planning staff whose task is to develop strategic plans for the corporation. Consultants often provide the sophisticated and innovative techniques that the planning staff uses to gather information and forecast future trends. Ex-military experts develop competitive intelligence units. Upper-level managers meet once a year at a resort “retreat” led by key members of the planning staff to evaluate and update the current strate- gic plan. Such top-down planning emphasizes formal strategy formulation and leaves the implementation issues to lower management levels. Top management typically develops five-year plans with help from consultants but minimal input from lower levels.

6 PA RT 1 Introduction to Strategic Management and Business Policy

Phase 4—Strategic management: Realizing that even the best strategic plans are worthless without the input and commitment of lower-level managers, top management forms plan- ning groups of managers and key employees at many levels, from various departments and workgroups. They develop and integrate a series of strategic plans aimed at achiev- ing the company’s primary objectives. Strategic plans at this point detail the implementa- tion, evaluation, and control issues. Rather than attempting to perfectly forecast the future, the plans emphasize probable scenarios and contingency strategies. The sophisticated an- nual five-year strategic plan is replaced with strategic thinking at all levels of the organi- zation throughout the year. Strategic information, previously available only centrally to top management, is available via local area networks and intranets to people throughout the organization. Instead of a large centralized planning staff, internal and external plan- ning consultants are available to help guide group strategy discussions. Although top man- agement may still initiate the strategic planning process, the resulting strategies may come from anywhere in the organization. Planning is typically interactive across levels and is no longer top down. People at all levels are now involved.

General Electric, one of the pioneers of strategic planning, led the transition from strategic planning to strategic management during the 1980s.8 By the 1990s, most other corporations around the world had also begun the conversion to strategic management.

BENEFITS OF STRATEGIC MANAGEMENT Strategic management emphasizes long-term performance. Many companies can manage short-term bursts of high performance, but only a few can sustain it over a longer period of time. For example, of the original Forbes 100 companies listed in 1917, only 13 have survived to the present day. To be successful in the long-run, companies must not only be able to execute current activities to satisfy an existing market, but they must also adapt those activities to sat- isfy new and changing markets.9

Research reveals that organizations that engage in strategic management generally out- perform those that do not.10 The attainment of an appropriate match, or “fit,” between an or- ganization’s environment and its strategy, structure, and processes has positive effects on the organization’s performance.11 Strategic planning becomes increasingly important as the envi- ronment becomes more unstable.12 For example, studies of the impact of deregulation on the U.S. railroad and trucking industries found that companies that changed their strategies and structures as their environment changed outperformed companies that did not change.13

A survey of nearly 50 corporations in a variety of countries and industries found the three most highly rated benefits of strategic management to be:

� Clearer sense of strategic vision for the firm.

� Sharper focus on what is strategically important.

� Improved understanding of a rapidly changing environment.14

A recent survey by McKinsey & Company of 800 executives found that formal strategic planning processes improve overall satisfaction with strategy development.15 To be effective, however, strategic management need not always be a formal process. It can begin with a few simple questions:

1. Where is the organization now? (Not where do we hope it is!)

2. If no changes are made, where will the organization be in one year? two years? five years? 10 years? Are the answers acceptable?

3. If the answers are not acceptable, what specific actions should management undertake? What are the risks and payoffs involved?

C H A P T E R 1 Basic Concepts of Strategic Management 7

Bain & Company’s 2007 Management Tools and Trends survey of 1,221 global executives revealed strategic planning to be the most used management tool—used by 88% of respon- dents. Strategic planning is particularly effective at identifying new opportunities for growth and in ensuring that all managers have the same goals.16 Other highly-ranked strategic man- agement tools were mission and vision statements (used by 79% of respondents), core compe- tencies (79%), scenario and contingency planning (69%), knowledge management (69%), strategic alliances (68%), and growth strategy tools (65%).17 A study by Joyce, Nohria, and Roberson of 200 firms in 50 subindustries found that devising and maintaining an engaged, fo- cused strategy was the first of four essential management practices that best differentiated be- tween successful and unsuccessful companies.18 Based on these and other studies, it can be concluded that strategic management is crucial for long-term organizational success.

Research into the planning practices of companies in the oil industry concludes that the real value of modern strategic planning is more in the strategic thinking and organizational learning that is part of a future-oriented planning process than in any resulting written strate- gic plan.19 Small companies, in particular, may plan informally and irregularly. Nevertheless, studies of small- and medium-sized businesses reveal that the greater the level of planning in- tensity, as measured by the presence of a formal strategic plan, the greater the level of finan- cial performance, especially when measured in terms of sales increases.20

Planning the strategy of large, multidivisional corporations can be complex and time con- suming. It often takes slightly more than a year for a large company to move from situation as- sessment to a final decision agreement. For example, strategic plans in the global oil industry tend to cover four to five years. The planning horizon for oil exploration is even longer—up to 15 years.21 Because of the relatively large number of people affected by a strategic decision in a large firm, a formalized, more sophisticated system is needed to ensure that strategic planning leads to successful performance. Otherwise, top management becomes isolated from developments in the business units, and lower-level managers lose sight of the corporate mission and objectives.

1.2 Globalization and Environmental Sustainability: Challenges to Strategic Management

Not too long ago, a business corporation could be successful by focusing only on making and selling goods and services within its national boundaries. International considerations were min- imal. Profits earned from exporting products to foreign lands were considered frosting on the cake, but not really essential to corporate success. During the 1960s, for example, most U.S. com- panies organized themselves around a number of product divisions that made and sold goods only in the United States. All manufacturing and sales outside the United States were typically managed through one international division. An international assignment was usually considered a message that the person was no longer promotable and should be looking for another job.

Similarly, until the later part of the 20th century, a business firm could be very successful without being environmentally sensitive. Companies dumped their waste products in nearby streams or lakes and freely polluted the air with smoke containing noxious gases. Responding to complaints, governments eventually passed laws restricting the freedom to pollute the en- vironment. Lawsuits forced companies to stop old practices. Nevertheless, until the dawn of the 21st century, most executives considered pollution abatement measures to be a cost of busi- ness that should be either minimized or avoided. Rather than clean up a polluting manufac- turing site, they often closed the plant and moved manufacturing offshore to a developing nation with fewer environmental restrictions. Sustainability, as a term, was used to describe competitive advantage, not the environment.

8 PA RT 1 Introduction to Strategic Management and Business Policy

IMPACT OF GLOBALIZATION Today, everything has changed. Globalization, the integrated internationalization of markets and corporations, has changed the way modern corporations do business. As Thomas Fried- man points out in The World Is Flat, jobs, knowledge, and capital are now able to move across borders with far greater speed and far less friction than was possible only a few years ago.22

For example, the inter-connected nature of the global financial community meant that the mortgage lending problems of U.S. banks led to a global financial crisis in 2008. The world- wide availability of the Internet and supply-chain logistical improvements, such as con- tainerized shipping, mean that companies can now locate anywhere and work with multiple partners to serve any market. To reach the economies of scale necessary to achieve the low costs, and thus the low prices, needed to be competitive, companies are now thinking of a global market instead of national markets. Nike and Reebok, for example, manufacture their athletic shoes in various countries throughout Asia for sale on every continent. Many other companies in North America and Western Europe are outsourcing their manufacturing, soft- ware development, or customer service to companies in China, Eastern Europe, or India. Large pools of talented software programmers, English language proficiency, and lower wages in India enables IBM to employ 75,000 people in its global delivery centers in Banga- lore, Delhi, or Kolkata to serve the needs of clients in Atlanta, Munich, or Melbourne.23 In- stead of using one international division to manage everything outside the home country, large corporations are now using matrix structures in which product units are interwoven with country or regional units. International assignments are now considered key for anyone in- terested in reaching top management.

As more industries become global, strategic management is becoming an increasingly im- portant way to keep track of international developments and position a company for long-term competitive advantage. For example, General Electric moved a major research and develop- ment lab for its medical systems division from Japan to China in order to learn more about de- veloping new products for developing economies. Microsoft’s largest research center outside Redmond, Washington, is in Beijing. According to Wilbur Chung, a Wharton professor, “Whatever China develops is rolled out to the rest of the world. China may have a lower GDP per-capita than developed countries, but the Chinese have a strong sense of how products should be designed for their market.”24

The formation of regional trade associations and agreements, such as the European Union, NAFTA, Mercosur, Andean Community, CAFTA, and ASEAN, is changing how international business is being conducted. See the Global Issue feature to learn how regional trade associ- ations are forcing corporations to establish a manufacturing presence wherever they wish to market goods or else face significant tariffs. These associations have led to the increasing har- monization of standards so that products can more easily be sold and moved across national boundaries. International considerations have led to the strategic alliance between British Air- ways and American Airlines and to the acquisition of the Miller Brewing Company by South African Breweries (SAB), among others.

IMPACT OF ENVIRONMENTAL SUSTAINABILITY Environmental sustainability refers to the use of business practices to reduce a company’s im- pact upon the natural, physical environment. Climate change is playing a growing role in busi- ness decisions. More than half of the global executives surveyed by McKinsey & Company in 2007 selected “environmental issues, including climate change,” as the most important issue fac- ing them over the next five years.25 A 2005 survey of 27 large, publicly-held, multinational cor- porations based in North America revealed that 90% believed that government regulation was

C H A P T E R 1 Basic Concepts of Strategic Management 9

imminent and 67% believed that such regulation would come between 2010 and 2015.26 Ac- cording to Eileen Claussen, President of the Pew Center on Global Climate Change:

There is a growing consensus among corporate leaders that taking action on climate change is a responsible business decision. From market shifts to regulatory constraints, climate change poses real risks and opportunities that companies must begin planning for today, or risk losing ground

Formed as the European Eco- nomic Community in 1957,

the European Union (EU) is the most significant trade association in

the world. The goal of the EU is the com- plete economic integration of its 27 member countries so that goods made in one part of Europe can move freely without ever stopping for a customs inspection. The EU in- cludes Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hun- gary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slove- nia, Spain, Sweden, and the United Kingdom. Others, in- cluding Croatia, Macedonia, and Turkey, have either recently applied or are in the process of applying. The EU is less than half the size of the United States of America, but has 50% more population. One currency, the euro, is be- ing used throughout the region as members integrate their monetary systems. The steady elimination of barriers to free trade is providing the impetus for a series of mergers, acquisitions, and joint ventures among business corpora- tions. The requirement of at least 60% local content to avoid tariffs has forced many U.S. and Asian companies to abandon exporting in favor of having a strong local pres- ence in Europe.

Canada, the United States, and Mexico are affiliated eco- nomically under the North American Free Trade Agree- ment (NAFTA). The goal of NAFTA is improved trade among the three member countries rather than complete economic integration. Launched in 1994, the agreement re- quired all three members to remove all tariffs among them- selves over 15 years, but they were allowed to have their own tariff arrangements with nonmember countries. Cars and trucks must have 62.5% North American content to qualify for duty-free status. Transportation restrictions and other regulations have been being significantly reduced. A number of Asian and European corporations, such as Swe- den’s Electrolux, have built manufacturing facilities in Mex- ico to take advantage of the country’s lower wages and easy access to the entire North American region.

GLOBAL issue REGIONAL TRADE ASSOCIATIONS REPLACE NATIONAL TRADE BARRIERS

South American countries are also working to harmonize their trading relationships with each other and to form trade associations. The establishment of the Mercosur (Mercosul in Portuguese) free-trade area among Argentina, Brazil, Uruguay, and Paraguay means that a manufacturing pres- ence within these countries is becoming essential to avoid tariffs for nonmember countries. Venezuela has applied for admission to Mercosur. The Andean Community (Comu- nidad Andina de Naciones) is a free-trade alliance composed of Columbia, Ecuador, Peru, Bolivia, and Chile. On May 23, 2008, the Union of South American Nations was formed to unite the two existing free-trade areas with a secretariat in Ecuador and a parliament in Bolivia.

In 2004, the five Central American countries of El Sal- vador, Guatemala, Honduras, Nicaragua, and Costa Rica plus the United States signed the Central American Free Trade Agreement (CAFTA). The Dominican Republic joined soon thereafter. Previously, Central American textile manufacturers had to pay import duties of 18%–28% to sell their clothes in the United States unless they bought their raw material from U.S. companies. Under CAFTA, members can buy raw material from anywhere and their exports are duty free. In addition, CAFTA eliminated import duties on 80% of U.S. goods exported to the region, with the remaining tariffs being phased out over 10 years.

The Association of Southeast Asian Nations (ASEAN)—composed of Brunei Darussalam, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singa- pore, Thailand, and Vietnam—is in the process of linking its members into a borderless economic zone by 2020. Tar- iffs had been significantly reduced among member coun- tries by 2008. Increasingly referred to as ASEAN+3, ASEAN now includes China, Japan, and South Korea in its annual summit meetings. The ASEAN nations negotiated linkage of the ASEAN Free Trade Area (AFTA) with the existing free- trade area of Australia and New Zealand. With the EU ex- tending eastward and NAFTA extending southward to someday connect with CAFTA and the Union of South American Nations, pressure is building on the independent Asian nations to join ASEAN.

10 PA RT 1 Introduction to Strategic Management and Business Policy

to their more forward-thinking competitors. Prudent steps taken now to address climate change can improve a company’s competitive position relative to its peers and earn it a seat at the table to influence climate policy. With more and more action at the state level and increasing scientific clarity, it is time for businesses to craft corporate strategies that address climate change.27

Porter and Reinhardt warn that “in addition to understanding its emissions costs, every firm needs to evaluate its vulnerability to climate-related effects such as regional shifts in the availability of energy and water, the reliability of infrastructures and supply chains, and the prevalence of infectious diseases.”28 Swiss Re, the world’s second-largest reinsurer, estimated that the overall economic costs of climate catastrophes related to climate change threatens to double to $150 billion per year by 2014. The insurance industry’s share of this loss would be $30–$40 billion annually.29

The effects of climate change on industries and companies throughout the world can be grouped into six categories of risks: regulatory, supply chain, product and technology, litiga- tion, reputational, and physical.30

1. Regulatory Risk: Companies in much of the world are already subject to the Kyoto Pro- tocol, which requires the developed countries (and thus the companies operating within them) to reduce carbon dioxide and other greenhouse gases by an average of 6% from 1990 levels by 2012. The European Union has an emissions trading program that allows companies that emit greenhouse gases beyond a certain point to buy additional allowances from other companies whose emissions are lower than that allowed. Companies can also earn credits toward their emissions by investing in emissions abatement projects outside their own firms. Although the United States withdrew from the Kyoto Protocol, various regional, state, and local government policies affect company activities in the U.S. For ex- ample, seven Northeastern states, six Western states, and four Canadian provinces have adopted proposals to cap carbon emissions and establish carbon-trading programs.

2. Supply Chain Risk: Suppliers will be increasingly vulnerable to government regulations— leading to higher component and energy costs as they pass along increasing carbon-related costs to their customers. Global supply chains will be at risk from an increasing intensity of major storms and flooding. Higher sea levels resulting from the melting of polar ice will create problems for seaports. China, where much of the world’s manufacturing is cur- rently being outsourced, is becoming concerned with environmental degradation. In 2006, 12 Chinese ministries produced a report on global warming foreseeing a 5%–10% reduc- tion in agricultural output by 2030; more droughts, floods, typhoons, and sandstorms; and a 40% increase in population threatened by plague.31

The increasing scarcity of fossil-based fuel is already boosting transportation costs sig- nificantly. For example, Tesla Motors, the maker of an electric-powered sports car, trans- ferred assembly of battery packs from Thailand to California because Thailand’s low wages were more than offset by the costs of shipping thousand-pound battery packs across the Pa- cific Ocean.32 Although the world production of oil had leveled off at 85 million barrels a day by 2008, the International Energy Agency predicted global demand to increase to 116 million barrels by 2030. Given that output from existing fields was falling 8% annu- ally, oil companies must develop up to seven million barrels a day in additional capacity to meet projected demand. Nevertheless, James Mulva, CEO of ConocoPhilips, estimated in late 2007 that the output of oil will realistically stall at around 100 million barrels a day.33

3. Product and Technology Risk: Environmental sustainability can be a prerequisite to prof- itable growth. For example, worldwide investments in sustainable energy (including wind, solar, and water power) more than doubled to $70.9 billion from 2004 to 2006.34 Sixty per- cent of U.S. respondents to an Environics study stated that knowing a company is mindful of its impact on the environment and society makes them more likely to buy their products

C H A P T E R 1 Basic Concepts of Strategic Management 11

and services.35 Carbon-friendly products using new technologies are becoming increas- ingly popular with consumers. Those automobile companies, for example, that were quick to introduce hybrid or alternative energy cars gained a competitive advantage.

4. Litigation Risk: Companies that generate significant carbon emissions face the threat of lawsuits similar to those in the tobacco, pharmaceutical, and building supplies (e.g., as- bestos) industries. For example, oil and gas companies were sued for greenhouse gas emissions in the federal district court of Mississippi, based on the assertion that these companies contributed to the severity of Hurricane Katrina. As of October 2006, at least 16 cases were pending in federal or state courts in the U.S. “This boomlet in global warm- ing litigation represents frustration with the White House’s and Congress’ failure to come to grips with the issue,” explained John Echeverria, executive director of Georgetown University’s Environmental Law & Policy Institute.36

5. Reputational Risk: A company’s impact on the environment can heavily affect its over- all reputation. The Carbon Trust, a consulting group, found that in some sectors the value of a company’s brand could be at risk because of negative perceptions related to climate change. In contrast, a company with a good record of environmental sustainability may create a competitive advantage in terms of attracting and keeping loyal consumers, em- ployees, and investors. For example, Wal-Mart’s pursuit of environmental sustainability as a core business strategy has helped soften its negative reputation as a low-wage, low- benefit employer. By setting objectives for its retail stores of reducing greenhouse gases by 20%, reducing solid waste by 25%, increasing truck fleet efficiency by 25%, and us- ing 100% renewable energy, it is also forcing its suppliers to become more environmen- tally sustainable.37 Tools have recently been developed to measure sustainability on a variety of factors. For example, the SAM (Sustainable Asset Management) Group of Zurich, Switzerland, has been assessing and documenting the sustainability performance of over 1,000 corporations annually since 1999. SAM lists the top 15% of firms in its Sus- tainability Yearbook and classifies them into gold, silver, and bronze categories.38

Business Week published its first list of the world’s 100 most sustainable corporations Jan- uary 29, 2007. The Dow Jones Sustainability Indexes and the KLD Broad Market Social Index, which evaluate companies on a range of environmental, social, and governance cri- teria are used for investment decisions.39 Financial services firms, such as Goldman Sachs, Bank of America, JPMorgan Chase, and Citigroup have adopted guidelines for lending and asset management aimed at promoting clean-energy alternatives.40

6. Physical Risk: The direct risk posed by climate change includes the physical effects of droughts, floods, storms, and rising sea levels. Average Arctic temperatures have risen four to five degrees Fahrenheit (two to three degrees Celsius) in the past 50 years, leading to melting glaciers and sea levels rising one inch per decade.41 Industries most likely to be af- fected are insurance, agriculture, fishing, forestry, real estate, and tourism. Physical risk can also affect other industries, such as oil and gas, through higher insurance premiums paid on facilities in vulnerable areas. Coca-Cola, for example, studies the linkages between climate change and water availability in terms of how this will affect the location of its new bottling plants. The warming of the Tibetan plateau has led to a thawing of the per- mafrost—thereby threatening the newly-completed railway line between China and Ti- bet.42 (See the Environmental Sustainability Issue feature for a more complete list of projected effects of climate change.)

Although global warming remains a controversial topic, the best argument in favor of working toward environmental sustainability is a variation of Pascal’s Wager on the existence of God:

The same goes for global warming. If you accept it as reality, adapting your strategy and prac- tices, your plants will use less energy and emit fewer effluents. Your packaging will be more

12 PA RT 1 Introduction to Strategic Management and Business Policy

SOURCE: F. G. Sussman and J. R. Freed, “Adapting to Climate Change: A Business Approach,” Paper prepared for the Pew Cen- ter on Global Climate Change (April 2008), pp. 5–6.

� Annual precipitation increases in most of northern Eu- rope, Canada, northeastern U.S., and the Arctic.

� Winter precipitation increases in northern Asia and the Tibetan Plateau.

� Dry spells increase in length and frequency in the Mediter- ranean, Australia, and New Zealand; seasonal droughts increase in many mid-latitude continent interiors.

EXTREME WEATHER-RELATED EVENTS

� Increasing intense tropical cyclone activity. � Increasing frequency of flash floods and large-area

floods in many regions. � Increasing risk of drought in Australia, eastern New

Zealand, and the Mediterranean, with seasonal droughts in central Europe and Central America.

� Increasing wildfires in arid and semi-arid areas such as Australia and the western U.S.

OTHER RELATED EFFECTS

� Decreasing snow season length and depth in Europe and North America.

� Fewer cold days and nights leading to decreasing frosts. � Accelerated glacier loss. � Reduction in and warming of permafrost.

According to the Intergov- ernmental Panel on Climate

Change (IPCC), the global cli- mate system is projected to in-

clude a number of changes during the 21st century:

TEMPERATURE INCREASE

� Global average warming of approximately 0.2 degrees Celsius each decade.

� Long-term warming associated with doubled carbon dioxide concentrations in the range of 2 to 4.5 degrees Celsius.

� Fewer cold days and nights; warmer and more frequent hot days and nights.

� Increased frequency, intensity, and duration of heat waves in central Europe, western U.S., East Asia, and Korea.

SEA LEVEL RISE

� Sea level will continue to rise due to thermal expansion of seawater and loss of land ice at greater rates.

� Sea level rise of 18 to 59 centimeters by the end of the 21st century.

� Warming will continue contributing to sea level rise for many centuries even if greenhouse gas concentrations are stabilized.

PRECIPITATION AND HUMIDITY

� Increasing numbers of wet days in high latitudes; in- creasing numbers of dry spells in subtropical areas.

PROJECTED EFFECTS OF CLIMATE CHANGE

ENVIRONMENTAL sustainability issue

biodegradable, and your new products will be able to capture any markets created by severe weather effects. Yes, global warming might not be as damaging as some predict, and you might have invested more than you needed, but it’s just as Pascal said: Given all the possible outcomes, the upside of being ready and prepared for a “fearsome event” surely beats the alternative.43

1.3 Theories of Organizational Adaptation Globalization and environmental sustainability present real challenges to the strategic manage- ment of business corporations. How can any one company keep track of all the changing tech- nological, economic, political–legal, and sociocultural trends around the world and make the necessary adjustments? This is not an easy task. Various theories have been proposed to account for how organizations obtain fit with their environment. The theory of population ecology, for

C H A P T E R 1 Basic Concepts of Strategic Management 13

1.4 Creating a Learning Organization Strategic management has now evolved to the point that its primary value is in helping an or- ganization operate successfully in a dynamic, complex environment. To be competitive in dy- namic environments, corporations are becoming less bureaucratic and more flexible. In stable environments such as those that existed in years past, a competitive strategy simply involved defining a competitive position and then defending it. As it takes less and less time for one product or technology to replace another, companies are finding that there is no such thing as a permanent competitive advantage. Many agree with Richard D’Aveni, who says in his book Hypercompetition that any sustainable competitive advantage lies not in doggedly following a centrally managed five-year plan but in stringing together a series of strategic short-term thrusts (as Intel does by cutting into the sales of its own offerings with periodic introductions of new products).48 This means that corporations must develop strategic flexibility—the abil- ity to shift from one dominant strategy to another.49

Strategic flexibility demands a long-term commitment to the development and nurturing of critical resources. It also demands that the company become a learning organization—an organization skilled at creating, acquiring, and transferring knowledge and at modifying its be- havior to reflect new knowledge and insights. Organizational learning is a critical component of competitiveness in a dynamic environment. It is particularly important to innovation and new product development.50 For example, both Hewlett-Packard and British Petroleum (BP) use an extensive network of informal committees to transfer knowledge among their cross-functional teams and to help spread new sources of knowledge quickly.51 Siemens, a major electronics company, created a global knowledge-sharing network, called ShareNet, in order to quickly spread information technology throughout the firm. Based on its experience with ShareNet, Siemens established PeopleShareNet, a system that serves as a virtual expert marketplace for

example, proposes that once an organization is successfully established in a particular envi- ronmental niche, it is unable to adapt to changing conditions. Inertia prevents the organization from changing. The company is thus replaced (is bought out or goes bankrupt) by other organizations more suited to the new environment. Although it is a popular theory in sociol- ogy, research fails to support the arguments of population ecology.44 Institution theory, in contrast, proposes that organizations can and do adapt to changing conditions by imitating other successful organizations. To its credit, many examples can be found of companies that have adapted to changing circumstances by imitating an admired firm’s strategies and man- agement techniques.45 The theory does not, however, explain how or by whom successful new strategies are developed in the first place. The strategic choice perspective goes one step further by proposing that not only do organizations adapt to a changing environment, but they also have the opportunity and power to reshape their environment. This perspective is supported by research indicating that the decisions of a firm’s management have at least as great an impact on firm performance as overall industry factors.46 Because of its emphasis on managers making rational strategic decisions, the strategic choice perspective is the dominant one taken in strategic management. Its argument that adaptation is a dynamic process fits with the view of organizational learning theory, which says that an organization adjusts defen- sively to a changing environment and uses knowledge offensively to improve the fit between itself and its environment. This perspective expands the strategic choice perspective to include people at all levels becoming involved in providing input into strategic decisions.47

In agreement with the concepts of organizational learning theory, an increasing number of companies are realizing that they must shift from a vertically organized, top-down type of organization to a more horizontally managed, interactive organization. They are attempting to adapt more quickly to changing conditions by becoming “learning organizations.”

14 PA RT 1 Introduction to Strategic Management and Business Policy

facilitating the creation of cross-cultural teams composed of members with specific knowledge and competencies.52

Learning organizations are skilled at four main activities:

� Solving problems systematically

� Experimenting with new approaches

� Learning from their own experiences and past history as well as from the experiences of others

� Transferring knowledge quickly and efficiently throughout the organization53

Business historian Alfred Chandler proposes that high-technology industries are defined by “paths of learning” in which organizational strengths derive from learned capabilities.54 Ac- cording to Chandler, companies spring from an individual entrepreneur’s knowledge, which then evolves into organizational knowledge. This organizational knowledge is composed of three basic strengths: technical skills, mainly in research; functional knowledge, such as pro- duction and marketing; and managerial expertise. This knowledge leads to new businesses where the company can succeed and creates an entry barrier to new competitors. Chandler points out that once a corporation has built its learning base to the point where it has become a core company in its industry, entrepreneurial startups are rarely able to successfully enter. Thus, organizational knowledge becomes a competitive advantage.

Strategic management is essential for learning organizations to avoid stagnation through con- tinuous self-examination and experimentation. People at all levels, not just top management, par- ticipate in strategic management—helping to scan the environment for critical information, suggesting changes to strategies and programs to take advantage of environmental shifts, and working with others to continuously improve work methods, procedures, and evaluation tech- niques. For example, Motorola developed an action learning format in which people from mar- keting, product development, and manufacturing meet to argue and reach agreement about the needs of the market, the best new product, and the schedules of each group producing it. This ac- tion learning approach overcame the problems that arose previously when the three departments met and formally agreed on plans but continued with their work as if nothing had happened.55 Re- search indicates that involving more people in the strategy process results in people not only view- ing the process more positively, but also acting in ways that make the process more effective.56

Organizations that are willing to experiment and are able to learn from their experiences are more successful than those that are not.57 For example, in a study of U.S. manufacturers of diagnostic imaging equipment, the most successful firms were those that improved prod- ucts sold in the United States by incorporating some of what they had learned from their man- ufacturing and sales experiences in other nations. The less successful firms used the foreign operations primarily as sales outlets, not as important sources of technical knowledge.58 Re- search also reveals that multidivisional corporations that establish ways to transfer knowledge across divisions are more innovative than other diversified corporations that do not.59

1.5 Basic Model of Strategic Management Strategic management consists of four basic elements:

� Environmental scanning � Strategy formulation � Strategy implementation � Evaluation and control

C H A P T E R 1 Basic Concepts of Strategic Management 15

Environmental Scanning

Strategy Formulation

Strategy Implementation

Evaluation and

Control

FIGURE 1–1 Basic Elements of

the Strategic Management

Process

Figure 1–1 illustrates how these four elements interact; Figure 1–2 expands each of these elements and serves as the model for this book. This model is both rational and prescriptive. It is a planning model that presents what a corporation should do in terms of the strategic man- agement process, not what any particular firm may actually do. The rational planning model predicts that as environmental uncertainty increases, corporations that work more diligently to analyze and predict more accurately the changing situation in which they operate will outper- form those that do not. Empirical research studies support this model.60 The terms used in Figure 1–2 are explained in the following pages.

Gathering Information

Putting Strategy into Action

Monitoring Performance

Societal Environment: General forces

Natural Environment: Resources and

climate

Task Environment:

Industry analysis

Internal: Strengths and Weaknesses

Structure: Chain of command

Culture: Beliefs, expectations,

values

Resources: Assets, skills, competencies,

knowledge

Programs

Activities needed to accomplish a plan

Budgets

Cost of the programs Procedures

Sequence of steps needed to do the job

Performance

Actual results

External: Opportunities

and Threats

Developing Long-range Plans

Mission

Reason for existence Objectives

What results to accomplish by when

Strategies

Plan to achieve the mission & objectives

Policies

Broad guidelines for decision making

Environmental Scanning:

Strategy Formulation:

Strategy Implementation:

Evaluation and Control:

Feedback/Learning: Make corrections as needed

FIGURE 1–2 Strategic Management Model

SOURCE: T. L. Wheelen, “Strategic Management Model,” adapted from “Concepts of Management,” presented to Society for Advancement of Management (SAM), International Meeting, Richmond, VA, 1981. T.L. Wheelen and SAM. Copyright © 1982, 1985, 1988, and 2005 by T.L. Wheelen and J.D. Hunger. Revised 1989, 1995, 1998, 2000 and 2005. Reprinted with permission.

16 PA RT 1 Introduction to Strategic Management and Business Policy

Environmental scanning is the monitoring, evaluating, and disseminating of information from the external and internal environments to key people within the corporation. Its purpose is to identify strategic factors—those external and internal elements that will determine the future of the corporation. The simplest way to conduct environmental scanning is through SWOT analysis. SWOT is an acronym used to describe the particular Strengths, Weaknesses, Opportunities, and Threats that are strategic factors for a specific company. The external en- vironment consists of variables (Opportunities and Threats) that are outside the organization and not typically within the short-run control of top management. These variables form the context within which the corporation exists. Figure 1–3 depicts key environmental variables. They may be general forces and trends within the natural or societal environments or specific factors that operate within an organization’s specific task environment—often called its industry. (These external variables are defined and discussed in more detail in Chapter 4.)

The internal environment of a corporation consists of variables (Strengths and Weaknesses) that are within the organization itself and are not usually within the short-run

ENVIRONMENTAL SCANNING

Sociocultural Forces

Economic Forces

Political–Legal Forces

Societal Environment

Technological Forces

Structure Culture

Resources

Governments

Natural Physical

Environment

Wildlife

Physical Resources

Climate

Shareholders

Suppliers

Competitors

Trade Associations

Communities

Creditors

Customers

Employees/ Labor Unions

Special Interest Groups

Task Environment

(Industry)

Internal Environment

FIGURE 1–3 Environmental Variables

C H A P T E R 1 Basic Concepts of Strategic Management 17

control of top management. These variables form the context in which work is done. They in- clude the corporation’s structure, culture, and resources. Key strengths form a set of core com- petencies that the corporation can use to gain competitive advantage. (These internal variables and core competencies are defined and discussed in more detail in Chapter 5.)

STRATEGY FORMULATION Strategy formulation is the development of long-range plans for the effective management of environmental opportunities and threats, in light of corporate strengths and weaknesses (SWOT). It includes defining the corporate mission, specifying achievable objectives, devel- oping strategies, and setting policy guidelines.

Mission An organization’s mission is the purpose or reason for the organization’s existence. It tells what the company is providing to society—either a service such as housecleaning or a prod- uct such as automobiles. A well-conceived mission statement defines the fundamental, unique purpose that sets a company apart from other firms of its type and identifies the scope or do- main of the company’s operations in terms of products (including services) offered and mar- kets served. Research reveals that firms with mission statements containing explicit descriptions of customers served and technologies used have significantly higher growth than firms without such statements.61 A mission statement may also include the firm’s values and philosophy about how it does business and treats its employees. It puts into words not only what the company is now but what it wants to become—management’s strategic vision of the firm’s future. The mission statement promotes a sense of shared expectations in employees and communicates a public image to important stakeholder groups in the company’s task environ- ment. Some people like to consider vision and mission as two different concepts: Mission de- scribes what the organization is now; vision describes what the organization would like to become. We prefer to combine these ideas into a single mission statement.62 Some companies prefer to list their values and philosophy of doing business in a separate publication called a values statement. For a listing of the many things that could go into a mission statement, see Strategy Highlight 1.1.

One example of a mission statement is that of Google:

To organize the world’s information and make it universally accessible and useful.63

Another classic example is that etched in bronze at Newport News Shipbuilding, unchanged since its founding in 1886:

We shall build good ships here—at a profit if we can—at a loss if we must—but always good ships.64

A mission may be defined narrowly or broadly in scope. An example of a broad mission statement is that used by many corporations: “Serve the best interests of shareowners, cus- tomers, and employees.” A broadly defined mission statement such as this keeps the company from restricting itself to one field or product line, but it fails to clearly identify either what it makes or which products/markets it plans to emphasize. Because this broad statement is so general, a narrow mission statement, such as the preceding examples by Google and Newport News Shipbuilding, is generally more useful. A narrow mission very clearly states the organi- zation’s primary business, but it may limit the scope of the firm’s activities in terms of the product or service offered, the technology used, and the market served. Research indicates that a narrow mission statement may be best in a turbulent industry because it keeps the firm fo- cused on what it does best; whereas, a broad mission statement may be best in a stable envi- ronment that lacks growth opportunities.65

18 PA RT 1 Introduction to Strategic Management and Business Policy

4. Does the statement describe the strategic positioning that the company prefers in a way that helps to identify the sort of competitive advantage it will look for?

5. Does the statement identify values that link with the organization’s purpose and act as beliefs with which employees can feel proud?

6. Do the values resonate with and reinforce the organization’s strategy?

7. Does the statement describe important behavior standards that serve as beacons of the strategy and the values?

8. Are the behavior standards described in a way that enables individual employees to judge whether they are behaving correctly?

9. Does the statement give a portrait of the company, capturing the culture of the organization?

10. Is the statement easy to read?

Andrew Campbell, a direc- tor of Ashridge Strategic

Management Centre and a long-time contributor to Long

Range Planning, proposes a means for evaluating a mission state-

ment. Arguing that mission statements can be more than just an expression of a company’s purpose and ambition, he suggests that they can also be a company flag to rally around, a signpost for all stakeholders, a guide to behav- ior, and a celebration of a company’s culture. For a com- pany trying to achieve all of the above, evaluate its mission statement using the following 10-question test. Score each question 0 for no, 1 for somewhat, or 2 for yes. According to Campbell, a score of over 15 is exceptional, and a score of less than 10 suggests that more work needs to be done.

1. Does the statement describe an inspiring purpose that avoids playing to the selfish interests of the stakeholders?

2. Does the statement describe the company’s responsibility to its stakeholders?

3. Does the statement define a business domain and explain why it is attractive?

DO YOU HAVE A GOOD MISSION STATEMENT?

SOURCE: Reprinted from Long Range Planning, Vol. 30, No. 6, 1997, Campbell “Mission Statements”, pp. 931–932, Copyright © 1997 with permission of Elsevier.

STRATEGY highlight 1.1

Objectives Objectives are the end results of planned activity. They should be stated as action verbs and tell what is to be accomplished by when and quantified if possible. The achievement of cor- porate objectives should result in the fulfillment of a corporation’s mission. In effect, this is what society gives back to the corporation when the corporation does a good job of ful- filling its mission. For example, by providing society with gums, candy, iced tea, and car- bonated drinks, Cadbury Schweppes, has become the world’s largest confectioner by sales. One of its prime objectives is to increase sales 4%–6% each year. Even though its profit margins were lower than those of Nestlé, Kraft, and Wrigley, its rivals in confectionary, or those of Coca-Cola or Pepsi, its rivals in soft drinks, Cadbury Schweppes’ management es- tablished the objective of increasing profit margins from around 10% in 2007 to the mid- teens by 2011.66

The term goal is often used interchangeably with the term objective. In this book, we pre- fer to differentiate the two terms. In contrast to an objective, we consider a goal as an open- ended statement of what one wants to accomplish, with no quantification of what is to be achieved and no time criteria for completion. For example, a simple statement of “increased profitability” is thus a goal, not an objective, because it does not state how much profit the firm wants to make the next year. A good objective should be action-oriented and begin with the word to. An example of an objective is “to increase the firm’s profitability in 2010 by 10% over 2009.”

C H A P T E R 1 Basic Concepts of Strategic Management 19

Some of the areas in which a corporation might establish its goals and objectives are:

� Profitability (net profits)

� Efficiency (low costs, etc.)

� Growth (increase in total assets, sales, etc.)

� Shareholder wealth (dividends plus stock price appreciation)

� Utilization of resources (ROE or ROI)

� Reputation (being considered a “top” firm)

� Contributions to employees (employment security, wages, diversity)

� Contributions to society (taxes paid, participation in charities, providing a needed product or service)

� Market leadership (market share)

� Technological leadership (innovations, creativity)

� Survival (avoiding bankruptcy)

� Personal needs of top management (using the firm for personal purposes, such as provid- ing jobs for relatives)

Strategies A strategy of a corporation forms a comprehensive master plan that states how the corpo- ration will achieve its mission and objectives. It maximizes competitive advantage and min- imizes competitive disadvantage. For example, even though Cadbury Schweppes was a major competitor in confectionary and soft drinks, it was not likely to achieve its challeng- ing objective of significantly increasing its profit margin within four years without making a major change in strategy. Management therefore decided to cut costs by closing 33 facto- ries and reducing staff by 10%. It also made the strategic decision to concentrate on the con- fectionary business by divesting its less-profitable Dr. Pepper/Snapple soft drinks unit. Management was also considering acquisitions as a means of building on its existing strengths in confectionary by purchasing either Kraft’s confectionary unit or the Hershey Company.

The typical business firm usually considers three types of strategy: corporate, business, and functional.

1. Corporate strategy describes a company’s overall direction in terms of its general atti- tude toward growth and the management of its various businesses and product lines. Cor- porate strategies typically fit within the three main categories of stability, growth, and retrenchment. Cadbury Schweppes, for example, was following a corporate strategy of re- trenchment by selling its marginally profitable soft drink business and concentrating on its very successful confectionary business.

2. Business strategy usually occurs at the business unit or product level, and it emphasizes improvement of the competitive position of a corporation’s products or services in the specific industry or market segment served by that business unit. Business strategies may fit within the two overall categories, competitive and cooperative strategies. For example, Staples, the U.S. office supply store chain, has used a competitive strategy to differenti- ate its retail stores from its competitors by adding services to its stores, such as copying, UPS shipping, and hiring mobile technicians who can fix computers and install networks. British Airways has followed a cooperative strategy by forming an alliance with Ameri- can Airlines in order to provide global service. Cooperative strategy may thus be used to

20 PA RT 1 Introduction to Strategic Management and Business Policy

provide a competitive advantage. Intel, a manufacturer of computer microprocessors, uses its alliance (cooperative strategy) with Microsoft to differentiate itself (competitive strategy) from AMD, its primary competitor.

3. Functional strategy is the approach taken by a functional area to achieve corporate and business unit objectives and strategies by maximizing resource productivity. It is con- cerned with developing and nurturing a distinctive competence to provide a company or business unit with a competitive advantage. Examples of research and development (R&D) functional strategies are technological followership (imitation of the products of other companies) and technological leadership (pioneering an innovation). For years, Magic Chef had been a successful appliance maker by spending little on R&D but by quickly imitating the innovations of other competitors. This helped the company to keep its costs lower than those of its competitors and consequently to compete with lower prices. In terms of marketing functional strategies, Procter & Gamble (P&G) is a master of marketing “pull”—the process of spending huge amounts on advertising in order to cre- ate customer demand. This supports P&G’s competitive strategy of differentiating its products from those of its competitors.

Business firms use all three types of strategy simultaneously. A hierarchy of strategy is a grouping of strategy types by level in the organization. Hierarchy of strategy is a nest- ing of one strategy within another so that they complement and support one another. (See Figure 1–4.) Functional strategies support business strategies, which, in turn, support the corporate strategy(ies).

Just as many firms often have no formally stated objectives, many firms have unstated, incremental, or intuitive strategies that have never been articulated or analyzed. Often the only way to spot a corporation’s implicit strategies is to look not at what management says but at what it does. Implicit strategies can be derived from corporate policies, programs approved (and disapproved), and authorized budgets. Programs and divisions favored by budget in- creases and staffed by managers who are considered to be on the fast promotion track reveal where the corporation is putting its money and its energy.

Corporate Strategy: Overall Direction of

Company and Management of Its Businesses

Business Strategy:

Competitive and Cooperative Strategies

Functional Strategy:

Maximize Resource Productivity

FIGURE 1–4 Hierarchy

of Strategy

C H A P T E R 1 Basic Concepts of Strategic Management 21

Policies A policy is a broad guideline for decision making that links the formulation of a strategy with its implementation. Companies use policies to make sure that employees throughout the firm make decisions and take actions that support the corporation’s mission, objectives, and strate- gies. For example, when Cisco decided on a strategy of growth through acquisitions, it estab- lished a policy to consider only companies with no more than 75 employees, 75% of whom were engineers.67 Consider the following company policies:

� 3M: 3M says researchers should spend 15% of their time working on something other than their primary project. (This supports 3M’s strong product development strategy.)

� Intel: Intel cannibalizes its own product line (undercuts the sales of its current products) with better products before a competitor does so. (This supports Intel’s objective of mar- ket leadership.)

� General Electric: GE must be number one or two wherever it competes. (This supports GE’s objective to be number one in market capitalization.)

� Southwest Airlines: Southwest offers no meals or reserved seating on airplanes. (This supports Southwest’s competitive strategy of having the lowest costs in the industry.)

� Exxon: Exxon pursues only projects that will be profitable even when the price of oil drops to a low level. (This supports Exxon’s profitability objective.)

Policies such as these provide clear guidance to managers throughout the organization. (Strategy formulation is discussed in greater detail in Chapters 6, 7, and 8.)

STRATEGY IMPLEMENTATION Strategy implementation is a process by which strategies and policies are put into action through the development of programs, budgets, and procedures. This process might involve changes within the overall culture, structure, and/or management system of the entire organi- zation. Except when such drastic corporatewide changes are needed, however, the implemen- tation of strategy is typically conducted by middle- and lower-level managers, with review by top management. Sometimes referred to as operational planning, strategy implementation of- ten involves day-to-day decisions in resource allocation.

Programs A program is a statement of the activities or steps needed to accomplish a single-use plan. It makes a strategy action oriented. It may involve restructuring the corporation, changing the company’s internal culture, or beginning a new research effort. For example, Boeing’s strat- egy to regain industry leadership with its proposed 787 Dreamliner meant that the company had to increase its manufacturing efficiency in order to keep the price low. To significantly cut costs, management decided to implement a series of programs:

� Outsource approximately 70% of manufacturing.

� Reduce final assembly time to three days (compared to 20 for its 737 plane) by having suppliers build completed plane sections.

� Use new, lightweight composite materials in place of aluminum to reduce inspection time.

� Resolve poor relations with labor unions caused by downsizing and outsourcing.

Another example is a set of programs used by automaker BMW to achieve its objective of increasing production efficiency by 5% each year: (a) shorten new model development time from 60 to 30 months, (b) reduce preproduction time from a year to no more than five months,

22 PA RT 1 Introduction to Strategic Management and Business Policy

and (c) build at least two vehicles in each plant so that production can shift among models de- pending upon demand.

Budgets A budget is a statement of a corporation’s programs in terms of dollars. Used in planning and control, a budget lists the detailed cost of each program. Many corporations demand a certain percentage return on investment, often called a “hurdle rate,” before management will approve a new program. This ensures that the new program will significantly add to the corporation’s profit performance and thus build shareholder value. The budget thus not only serves as a de- tailed plan of the new strategy in action, it also specifies through pro forma financial state- ments the expected impact on the firm’s financial future.

For example, General Motors budgeted $4.3 billion to update and expand its Cadillac line of automobiles. With this money, the company was able to increase the number of mod- els from five to nine and to offer more powerful engines, sportier handling, and edgier styling. The company reversed its declining market share by appealing to a younger market. (The average Cadillac buyer in 2000 was 67 years old.)68 Another example is the $8 billion budget that General Electric established to invest in new jet engine technology for regional- jet airplanes. Management decided that an anticipated growth in regional jets should be the company’s target market. The program paid off when GE won a $3 billion contract to pro- vide jet engines for China’s new fleet of 500 regional jets in time for the 2008 Beijing Olympics.69

Procedures Procedures, sometimes termed Standard Operating Procedures (SOP), are a system of se- quential steps or techniques that describe in detail how a particular task or job is to be done. They typically detail the various activities that must be carried out in order to complete the cor- poration’s program. For example, when the home improvement retailer Home Depot noted that sales were lagging because its stores were full of clogged aisles, long checkout times, and too few salespeople, management changed its procedures for restocking shelves and pricing the products. Instead of requiring its employees to do these activities at the same time they were working with customers, management moved these activities to when the stores were closed at night. Employees were then able to focus on increasing customer sales during the day. Both UPS and FedEx put such an emphasis on consistent, quality service that both com- panies have strict rules for employee behavior, ranging from how a driver dresses to how keys are held when approaching a customer’s door. (Strategy implementation is discussed in more detail in Chapters 9 and 10.)

EVALUATION AND CONTROL Evaluation and control is a process in which corporate activities and performance results are monitored so that actual performance can be compared with desired performance. Managers at all levels use the resulting information to take corrective action and resolve problems. Al- though evaluation and control is the final major element of strategic management, it can also pinpoint weaknesses in previously implemented strategic plans and thus stimulate the entire process to begin again.

Performance is the end result of activities.70 It includes the actual outcomes of the strate- gic management process. The practice of strategic management is justified in terms of its abil- ity to improve an organization’s performance, typically measured in terms of profits and return on investment. For evaluation and control to be effective, managers must obtain clear, prompt, and unbiased information from the people below them in the corporation’s hierarchy. Using

C H A P T E R 1 Basic Concepts of Strategic Management 23

this information, managers compare what is actually happening with what was originally planned in the formulation stage.

For example, when market share (followed by profits) declined at Dell in 2007, Michael Dell, founder, returned to the CEO position and reevaluated his company’s strategy and oper- ations. Planning for continued growth, the company’s expansion of its computer product line into new types of hardware, such as storage, printers, and televisions, had not worked as planned. In some areas, like televisions and printers, Dell’s customization ability did not add much value. In other areas, like services, lower-cost competitors were already established. Michael Dell concluded, “I think you’re going to see a more streamlined organization, with a much clearer strategy.”71

The evaluation and control of performance completes the strategic management model. Based on performance results, management may need to make adjustments in its strategy for- mulation, in implementation, or in both. (Evaluation and control is discussed in more detail in Chapter 11.)

FEEDBACK/LEARNING PROCESS Note that the strategic management model depicted in Figure 1–2 includes a feedback/learning process. Arrows are drawn coming out of each part of the model and taking information to each of the previous parts of the model. As a firm or business unit develops strategies, pro- grams, and the like, it often must go back to revise or correct decisions made earlier in the process. For example, poor performance (as measured in evaluation and control) usually in- dicates that something has gone wrong with either strategy formulation or implementation. It could also mean that a key variable, such as a new competitor, was ignored during environ- mental scanning and assessment. In the case of Dell, the personal computer market had ma- tured and by 2007 there were fewer growth opportunities available within the industry. Even Jim Cramer, host of the popular television program, Mad Money, was referring to computers in 2008 as “old technology” having few growth prospects. Dell’s management needed to re- assess the company’s environment and find better opportunities to profitably apply its core competencies.

1.6 Initiation of Strategy: Triggering Events After much research, Henry Mintzberg discovered that strategy formulation is typically not a regular, continuous process: “It is most often an irregular, discontinuous process, proceeding in fits and starts. There are periods of stability in strategy development, but also there are pe- riods of flux, of groping, of piecemeal change, and of global change.”72 This view of strategy formulation as an irregular process can be explained by the very human tendency to continue on a particular course of action until something goes wrong or a person is forced to question his or her actions. This period of strategic drift may result from inertia on the part of the orga- nization, or it may reflect management’s belief that the current strategy is still appropriate and needs only some fine-tuning.

Most large organizations tend to follow a particular strategic orientation for about 15 to 20 years before making a significant change in direction.73 This phenomenon, called punctuated equilibrium, describes corporations as evolving through relatively long periods of stability (equilibrium periods) punctuated by relatively short bursts of fundamental change (revolutionary periods).74 After this rather long period of fine-tuning an existing strategy, some sort of shock to the system is needed to motivate management to seriously reassess the corpo- ration’s situation.

24 PA RT 1 Introduction to Strategic Management and Business Policy

A triggering event is something that acts as a stimulus for a change in strategy. Some pos- sible triggering events are:75

� New CEO: By asking a series of embarrassing questions, a new CEO cuts through the veil of complacency and forces people to question the very reason for the corporation’s existence.

� External intervention: A firm’s bank suddenly refuses to approve a new loan or suddenly demands payment in full on an old one. A key customer complains about a serious prod- uct defect.

� Threat of a change in ownership: Another firm may initiate a takeover by buying a com- pany’s common stock.

� Performance gap: A performance gap exists when performance does not meet expecta- tions. Sales and profits either are no longer increasing or may even be falling.

� Strategic inflection point: Coined by Andy Grove, past-CEO of Intel Corporation, a strategic inflection point is what happens to a business when a major change takes place due to the introduction of new technologies, a different regulatory environment, a change in customers’ values, or a change in what customers prefer.76

Unilever is an example of one company in which a triggering event forced management to radically rethink what it was doing. See Strategy Highlight 1.2 to learn how a slumping stock price stimulated a change in strategy at Unilever.

decades of operating in almost every country in the world, the company had become fat with unnecessary bureau- cracy and complexity. Unilever’s traditional emphasis on the autonomy of its country managers had led to a lack of synergy and a duplication of corporate structures. Country managers had been making strategic decisions without re- gard for their effect on other regions or on the corporation as a whole. Starting at the top, two joint chairmen were re- placed by one sole chief executive. In China, three compa- nies with three chief executives were replaced by one company with one person in charge. Overall staff was cut from 223,000 in 2004 to 179,000 in 2008. By 2010, man- agement planned close to 50 of its 300 factories and to eliminate 75 of 100 regional centers. Twenty thousand more jobs were selected to be eliminated over a four-year period. Ralph Kugler, manager of Unilever’s home and per- sonal care division, exhibited confidence that after these changes, the company was better prepared to face com- petition. “We are much better organized now to defend ourselves,” he stated.

Unilever, the world’s second- largest consumer goods

company, received a jolt in 2004 when its stock price fell

sharply after management had warned investors that profits would be

lower than anticipated. Even though the company had been the first consumer goods company to enter the world’s emerging economies in Africa, China, India, and Latin America with a formidable range of products and lo- cal knowledge, its sales faltered when rivals began to at- tack its entrenched position in these markets. Procter & Gamble’s (P&G) acquisition of Gillette had greatly bolstered P&G’s growing portfolio of global brands and allowed it to undermine Unilever’s global market share. For example, when P&G targeted India for a sales initiative in 2003–04, profit margins fell at Unilever’s Indian subsidiary from 20% to 13%.

An in-depth review of Unilever’s brands revealed that its brands were doing as well as were those of its rivals. Some- thing else was wrong. According to Richard Rivers, Unilever’s head of corporate strategy, “We were just not executing as well as we should have.”

Unilever’s management realized that it had no choice but to make-over the company from top to bottom. Over

TRIGGERING EVENT AT UNILEVER

SOURCE: Summarized from “The Legacy that Got Left on the Shelf,” The Economist (February 2, 2008), pp. 77–79.

STRATEGY highlight 1.2

C H A P T E R 1 Basic Concepts of Strategic Management 25

MINTZBERG’S MODES OF STRATEGIC DECISION MAKING Some strategic decisions are made in a flash by one person (often an entrepreneur or a pow- erful chief executive officer) who has a brilliant insight and is quickly able to convince oth- ers to adopt his or her idea. Other strategic decisions seem to develop out of a series of small incremental choices that over time push an organization more in one direction than another.

1.7 Strategic Decision Making The distinguishing characteristic of strategic management is its emphasis on strategic decision making. As organizations grow larger and more complex, with more uncertain environments, decisions become increasingly complicated and difficult to make. In agreement with the strate- gic choice perspective mentioned earlier, this book proposes a strategic decision-making framework that can help people make these decisions regardless of their level and function in the corporation.

WHAT MAKES A DECISION STRATEGIC Unlike many other decisions, strategic decisions deal with the long-run future of an entire or- ganization and have three characteristics:

1. Rare: Strategic decisions are unusual and typically have no precedent to follow.

2. Consequential: Strategic decisions commit substantial resources and demand a great deal of commitment from people at all levels.

3. Directive: Strategic decisions set precedents for lesser decisions and future actions throughout an organization.77

One example of a strategic decision with all of these characteristics was that made by Genen- tech, a biotechnology company that had been founded in 1976 to produce protein-based drugs from cloned genes. After building sales to $9 billion and profits to $2 billion in 2006, the com- pany’s sales growth slowed and its stock price dropped in 2007. The company’s products were reaching maturity with few new ones in the pipeline. To regain revenue growth, management de- cided to target autoimmune diseases, such as multiple sclerosis, rheumatoid arthritis, lupus, and 80 other ailments for which there was no known lasting treatment. This was an enormous oppor- tunity, but also a very large risk for the company. Existing drugs in this area either weren’t effec- tive for many patients or caused side effects that were worse than the disease. Competition from companies like Amgen and Novartis were already vying for leadership in this area. A number of Genentech’s first attempts in the area had failed to do well against the competition.

The strategic decision to commit resources to this new area was based on a report from a British physician that the Genentech’s cancer drug Rituxan eased the agony of rheumatoid arthri- tis in five of his patients. CEO Arthur Levinson was so impressed with this report that he imme- diately informed Genentech’s board of directors. He urged them to support a full research program for Rituxan in autoimmune disease. With the board’s blessing, Levinson launched a pro- gram to study the drug as a treatment for rheumatoid arthritis, MS, and lupus. The company de- ployed a third of its 1,000 researchers to pursue new drugs to fight autoimmune diseases. In 2006, Rituxan was approved to treat rheumatoid arthritis and captured 10% of the market. The com- pany was working on some completely new approaches to autoimmune disease. The research mandate was to consider ideas others might overlook. “There’s this tremendous herd instinct out there,” said Levinson. “That’s a great opportunity, because often the crowd is wrong.”78

26 PA RT 1 Introduction to Strategic Management and Business Policy

According to Henry Mintzberg, the three most typical approaches, or modes, of strategic de- cision making are entrepreneurial, adaptive, and planning (a fourth mode, logical incremen- talism, was added later by Quinn):79

� Entrepreneurial mode: Strategy is made by one powerful individual. The focus is on op- portunities; problems are secondary. Strategy is guided by the founder’s own vision of di- rection and is exemplified by large, bold decisions. The dominant goal is growth of the corporation. Amazon.com, founded by Jeff Bezos, is an example of this mode of strategic decision making. The company reflected Bezos’ vision of using the Internet to market books and more. Although Amazon’s clear growth strategy was certainly an advantage of the entrepreneurial mode, Bezos’ eccentric management style made it difficult to retain senior executives.80

� Adaptive mode: Sometimes referred to as “muddling through,” this decision-making mode is characterized by reactive solutions to existing problems, rather than a proactive search for new opportunities. Much bargaining goes on concerning priorities of objec- tives. Strategy is fragmented and is developed to move a corporation forward incremen- tally. This mode is typical of most universities, many large hospitals, a large number of governmental agencies, and a surprising number of large corporations. Encyclopaedia Britannica Inc., operated successfully for many years in this mode, but it continued to rely on the door-to-door selling of its prestigious books long after dual-career couples made that marketing approach obsolete. Only after it was acquired in 1996 did the company change its door-to-door sales to television advertising and Internet marketing. The company now charges libraries and individual subscribers for complete access to Brittanica.com and of- fers CD-ROMs in addition to a small number of its 32-volume print set.81

� Planning mode: This decision-making mode involves the systematic gathering of appro- priate information for situation analysis, the generation of feasible alternative strategies, and the rational selection of the most appropriate strategy. It includes both the proactive search for new opportunities and the reactive solution of existing problems. IBM under CEO Louis Gerstner is an example of the planning mode. When Gerstner accepted the po- sition of CEO in 1993, he realized that IBM was in serious difficulty. Mainframe comput- ers, the company’s primary product line, were suffering a rapid decline both in sales and market share. One of Gerstner’s first actions was to convene a two-day meeting on corpo- rate strategy with senior executives. An in-depth analysis of IBM’s product lines revealed that the only part of the company that was growing was services, but it was a relatively small segment and not very profitable. Rather than focusing on making and selling its own com- puter hardware, IBM made the strategic decision to invest in services that integrated infor- mation technology. IBM thus decided to provide a complete set of services from building systems to defining architecture to actually running and managing the computers for the customer—regardless of who made the products. Because it was no longer important that the company be completely vertically integrated, it sold off its DRAM, disk-drive, and lap- top computer businesses and exited software application development. Since making this strategic decision in 1993, 80% of IBM’s revenue growth has come from services.82

� Logical incrementalism: A fourth decision-making mode can be viewed as a synthesis of the planning, adaptive, and, to a lesser extent, the entrepreneurial modes. In this mode,

C H A P T E R 1 Basic Concepts of Strategic Management 27

STRATEGIC DECISION-MAKING PROCESS: AID TO BETTER DECISIONS Good arguments can be made for using either the entrepreneurial or adaptive modes (or logi- cal incrementalism) in certain situations.85 This book proposes, however, that in most situa- tions the planning mode, which includes the basic elements of the strategic management process, is a more rational and thus better way of making strategic decisions. Research indi- cates that the planning mode is not only more analytical and less political than are the other modes, but it is also more appropriate for dealing with complex, changing environments.86 We therefore propose the following eight-step strategic decision-making process to improve the making of strategic decisions (see Figure 1–5):

1. Evaluate current performance results in terms of (a) return on investment, profitabil- ity, and so forth, and (b) the current mission, objectives, strategies, and policies.

2. Review corporate governance—that is, the performance of the firm’s board of directors and top management.

3. Scan and assess the external environment to determine the strategic factors that pose Opportunities and Threats.

4. Scan and assess the internal corporate environment to determine the strategic factors that are Strengths (especially core competencies) and Weaknesses.

5. Analyze strategic (SWOT) factors to (a) pinpoint problem areas and (b) review and re- vise the corporate mission and objectives, as necessary.

6. Generate, evaluate, and select the best alternative strategy in light of the analysis con- ducted in step 5.

7. Implement selected strategies via programs, budgets, and procedures.

8. Evaluate implemented strategies via feedback systems, and the control of activities to ensure their minimum deviation from plans.

This rational approach to strategic decision making has been used successfully by corpo- rations such as Warner-Lambert, Target, General Electric, IBM, Avon Products, Bechtel Group Inc., and Taisei Corporation.

top management has a reasonably clear idea of the corporation’s mission and objectives, but, in its development of strategies, it chooses to use “an interactive process in which the organization probes the future, experiments and learns from a series of partial (incremen- tal) commitments rather than through global formulations of total strategies.”83 Thus, although the mission and objectives are set, the strategy is allowed to emerge out of debate, discussion, and experimentation. This approach appears to be useful when the environ- ment is changing rapidly and when it is important to build consensus and develop needed resources before committing an entire corporation to a specific strategy. In his analysis of the petroleum industry, Grant described strategic planning in this industry as “planned emergence.” Corporate headquarters established the mission and objectives but allowed the business units to propose strategies to achieve them.84

28 PA RT 1 Introduction to Strategic Management and Business Policy

1.8 The Strategic Audit: Aid to Strategic Decision-Making The strategic decision-making process is put into action through a technique known as the strategic audit. A strategic audit provides a checklist of questions, by area or issue, that en- ables a systematic analysis to be made of various corporate functions and activities. (See Appendix 1.A at the end of this chapter.) Note that the numbered primary headings in the au- dit are the same as the numbered blocks in the strategic decision-making process in Figure 1–5. Beginning with an evaluation of current performance, the audit continues with environmental scanning, strategy formulation, and strategy implementation, and it concludes with evaluation and control. A strategic audit is a type of management audit and is extremely useful as a diag- nostic tool to pinpoint corporatewide problem areas and to highlight organizational strengths and weaknesses.87 A strategic audit can help determine why a certain area is creating problems for a corporation and help generate solutions to the problem.

A strategic audit is not an all-inclusive list, but it presents many of the critical questions needed for a detailed strategic analysis of any business corporation. Some questions or even some areas might be inappropriate for a particular company; in other cases, the questions may

1(a)

3(a) 3(b)

Strategy Formulation:

Steps 1–6

1(b) 2

Evaluate Current Performance Results

Review Corporate Governance: Board of Directors Top Man- agement

Examine and Evaluate the Current: Mission Objectives Strategies Policies

5(a)

4(b)

Select Strategic Factors (SWOT) in Light of Current Situation

Analyze Internal Factors: Strengths Weak- nesses

Analyze External Factors: Opportun- ities Threats

Scan and Assess External Environment: Natural Societal Task

4(a)

Scan and Assess Internal Environment: Structure Culture Resources

FIGURE 1–5 Strategic Decision-

Making Process

SOURCE: T. L. Wheelen and J. D. Hunger, Strategic Decision-Making Process. Copyright © 1994 and 1997 by Wheelen & Hunger Associates. Reprinted by permission.

C H A P T E R 1 Basic Concepts of Strategic Management 29

End of Chapter S U M M A R Y Strategy scholars Donald Hambrick and James Fredrickson propose that a good strategy has five elements, providing answers to five questions:

1. Arenas: Where will we be active?

2. Vehicles: How will we get there?

3. Differentiators: How will we win in the marketplace?

4. Staging: What will be our speed and sequence of moves?

5. Economic logic: How will we obtain our returns?88

This chapter introduces you to a well-accepted model of strategic management (Figure 1–2) in which environmental scanning leads to strategy formulation, strategy imple- mentation, and evaluation and control. It further shows how that model can be put into action

Strategy Implementation:

Step 7

Evaluation and Control:

Step 8

5(b) 6(a) 6(b)

Select and Recommend Best Alternative

Generate and Evaluate Strategic Alternatives

7 8

Evaluate and Control

Implement Strategies: Programs Budgets Procedures

Review and Revise as Necessary: Mission Objectives

be insufficient for a complete analysis. However, each question in a particular area of a strate- gic audit can be broken down into an additional series of sub-questions. An analyst can develop these sub-questions when they are needed for a complete strategic analysis of a company.

30 PA RT 1 Introduction to Strategic Management and Business Policy

E C O - B I T S � The world’s primary energy consumption by fuel in

2004 was 35% oil, 25% coal, 21% natural gas, 10% bio- mass and waste, 6% nuclear, 2% hydroelectric, and 1% other renewable.90

� The price per watt of photovoltaic modules used in so- lar power dropped from $18 in 1980 to $4 in 2007.91

� Since 1869 world crude oil prices, adjusted for infla- tion, have averaged $21.66 per barrel in 2006 dollars. By 2008, the price per barrel reached $140 for the first time in history.92

D I S C U S S I O N Q U E S T I O N S 1. Why has strategic management become so important to

today’s corporations?

2. How does strategic management typically evolve in a corporation?

3. What is a learning organization? Is this approach to strategic management better than the more traditional

top-down approach in which strategic planning is prima- rily done by top management?

4. Why are strategic decisions different from other kinds of decisions?

5. When is the planning mode of strategic decision making superior to the entrepreneurial and adaptive modes?

S T R A T E G I C P R A C T I C E E X E R C I S E S Mission statements vary widely from one company to another. Why is one mission statement better than another? Using Campbell’s questions in Strategy Highlight 1.2 as a start- ing point, develop criteria for evaluating any mission state- ment. Then do one or both of the following exercises:

1. Evaluate the following mission statement of Celestial Seasonings. How many points would Campbell give it?

Our mission is to grow and dominate the U.S. specialty tea market by exceeding consumer expectations with the best tasting, 100% natural hot and iced teas, packaged

with Celestial art and philosophy, creating the most val- ued tea experience. Through leadership, innovation, fo- cus, and teamwork, we are dedicated to continuously improving value to our consumers, customers, employ- ees, and stakeholders with a quality-first organization.93

2. Using the Internet, find the mission statements of three different organizations, which can be business or not-for- profit. (Hint: Check annual reports and 10K forms. They can often be found via a link on a company’s Web page or through Hoovers.com.) Which mission statement is best? Why?

K E Y T E R M S budget (p. 22) business strategy (p. 19) corporate strategy (p. 19)

environmental scanning (p. 16) environmental sustainability (p. 8) evaluation and control (p. 22)

external environment (p. 16) functional strategy (p. 20) globalization (p. 8)

through the strategic decision-making process (Figure 1–5) and a strategic audit (Appendix 1.A). As pointed out by Hambrick and Fredrickson, “strategy consists of an inte- grated set of choices.”89 The questions “Where will we be active?” and “How will we get there?” are dealt with by a company’s mission, objectives, and corporate strategy. The question “How will we win in the marketplace?” is the concern of business strategy. The question “What will be our speed and sequence of moves?” is answered not only by business strategy and tac- tics but also by functional strategy and by implemented programs, budgets, and procedures. The question “How will we obtain our returns?” is the primary emphasis of the evaluation and con- trol element of the strategic management model. Each of these questions and topics will be dealt with in greater detail in the chapters to come. Welcome to the study of strategic management!

C H A P T E R 1 Basic Concepts of Strategic Management 31

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hierarchy of strategy (p. 20) institution theory (p. 13) internal environment (p. 16) learning organization (p. 13) mission (p. 17) objective (p. 18) organizational learning theory (p. 13) performance (p. 22) phases of strategic management (p. 5)

policy (p. 21) population ecology (p. 12) procedure (p. 22) program (p. 21) strategic audit (p. 28) strategic choice perspective (p. 13) strategic decision (p. 25) strategic decision-making process (p. 27)

strategic factor (p. 16) strategic management (p. 5) strategy (p. 19) strategy formulation (p. 17) strategy implementation (p. 21) SWOT analysis (p. 16) triggering event (p. 24) vision (p. 17)

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39. L. T. Mendonca and J. Oppenheim, “Investing in Sustainability: An Interview with Al Gore and David Blood,” McKinsey Quar- terly (May 2007).

40. A. J. Hoffman, Getting Ahead of the Curve: Corporate Strate- gies that Address Climate Change (Ann Arbor: University of Michigan, 2006), p. 2.

41. J. K. Bourne, Jr., “Signs of Change,” National Geographic (Special Report on Changing Climate, 2008), pp. 7–21.

42. “Melting Asia,” The Economist (June 7, 2008), pp. 29–32. 43. J. Welch and S. Welch, “The Global Warming Wager,” Business

Week (February 26, 2007), p. 130. 44. J. A. C. Baum, “Organizational Ecology,” in Handbook of Or-

ganization Studies, edited by S. R. Clegg, C. Handy, and W. Nord (London: Sage, 1996), pp. 77–114.

45. B. M. Staw and L. D. Epstein, “What Bandwagons Bring: Ef- fects of Popular Management Techniques on Corporate Perfor- mance, Reputation, and CEO Pay,” Administrative Science Quarterly (September 2000), pp. 523–556; M. B. Lieberman and S. Asaba, “Why Do Firms Imitate Each Other?” Academy of Management Review (April 2006), pp. 366–385.

46. T. W. Ruefli and R. R. Wiggins, “Industry, Corporate, and Seg- ment Effects and Business Performance: A Non-Parametric Ap- proach,” Strategic Management Journal (September 2003), pp. 861–879; Y. E. Spanos, G. Zaralis, and S. Lioukas, “Strategy and Industry Effects on Profitability: Evidence from Greece,” Strategic Management Journal (February 2004), pp. 139–165; E. H. Bowman and C. E. Helfat, “Does Corporate Strategy Mat- ter?” Strategic Management Journal (January 2001), pp. 1–23; T. H. Brush, P. Bromiley, and M. Hendrickx, “The Relative In- fluence of Industry and Corporation on Business Segment Per- formance: An Alternative Estimate,” Strategic Management Journal (June 1999), pp. 519–547; K. M. Gilley, B. A. Walters, and B. J. Olson, “Top Management Team Risk Taking Propensi- ties and Firm Performance: Direct and Moderating Effects,” Journal of Business Strategies (Fall 2002), pp. 95–114.

47. For more information on these theories, see A. Y. Lewin and H. W. Voloberda, “Prolegomena on Coevolution: A Framework for Re- search on Strategy and New Organizational Forms,” Organization Science (October 1999), pp. 519–534, and H. Aldrich, Organizations Evolving (London: Sage, 1999), pp. 43–74.

48. R. A. D’Aveni, Hypercompetition (New York: The Free Press, 1994). Hypercompetition is discussed in more detail in Chapter 4.

49. R. S. M. Lau, “Strategic Flexibility: A New Reality for World- Class Manufacturing,” SAM Advanced Management Journal (Spring 1996), pp. 11–15.

50. M. A. Hitt, B. W. Keats, and S. M. DeMarie, “Navigating in the New Competitive Landscape: Building Strategic Flexibility and Competitive Advantage in the 21st Century,” Academy of Management Executive (November 1998), pp. 22–42.

51. D. Lei, J. W. Slocum, and R. A. Pitts, “Designing Organizations for Competitive Advantage: The Power of Unlearning and Learning,” Organizational Dynamics (Winter 1999), pp. 24–38; M. Goold, “Making Peer Groups Effective: Lessons from BP’s Experience,” Long Range Planning (October 2005), pp. 429–443.

52. S. C. Voelpel, M. Dous, and T. H. Davenport, “Five Steps to Cre- ating a Global Knowledge-Sharing System: Siemens’ ShareNet,” Academy of Management Executive (May 2005), pp. 9–23.

53. D. A. Garvin, “Building a Learning Organization,” Harvard Business Review (July/August 1993), p. 80. See also P. M. Senge, The Fifth Discipline: The Art and Practice of the Learn- ing Organization (New York: Doubleday, 1990).

54. A. D. Chandler, Inventing the Electronic Century (New York: The Free Press, 2001).

55. T. T. Baldwin, C. Danielson, and W. Wiggenhorn, “The Evolu- tion of Learning Strategies in Organizations: From Employee Development to Business Redefinition,” Academy of Manage- ment Executive (November 1997), pp. 47–58.

56. N. Collier, F. Fishwick, and S. W. Floyd, “Managerial Involve- ment and Perceptions of Strategy Process,” Long Range Plan- ning (February 2004), pp. 67–83; J. A. Parnell, S. Carraher, and K. Holt, “Participative Management’s Influence on Effective Strategic Planning,” Journal of Business Strategies (Fall 2002), pp. 161–179; M. Ketokivi and X. Castaner, “Strategic Planning as an Integrative Device,” Administrative Science Quarterly (September 2004), pp. 337–365.

57. E. W. K. Tsang, “Internationalization as a Learning Process: Sin- gapore MNCs in China,” Academy of Management Executive (February 1999), pp. 91–101; J. M. Shaver, W. Mitchell, and

32 PA RT 1 Introduction to Strategic Management and Business Policy

B. Yeung, “The Effect of Own-Firm and Other Firm Experience on Foreign Direct Investment Survival in the U.S., 1987–92,” Strategic Management Journal (November 1997), pp. 811–824; P. Kale and H. Singh, “Building Firm Capabilities through Learn- ing: The Role of the Alliance Learning Process in Alliance Capa- bility and Firm-Level Alliance Success,” Strategic Management Journal (October 2007), pp. 981–1000; H. Barkema and M. Schi- jven, “How Do Firms Learn to Make Acquisitions? A Review of Past Research and an Agenda for the Future,” Journal of Manage- ment (June 2008), pp. 594–634; D. D. Bergh and E. N-K Lim, “Learning How to Restructure: Absorptive Capacity and Impro- visational Views of Restructuring Actions and Performance,” Strategic Management Journal (June 2008), pp. 593–616.

58. W. Mitchell, J. M. Shaver, and B. Yeung, “Getting There in a Global Industry: Impacts on Performance of Changing Interna- tional Presence,” Strategic Management Journal (September 1992), pp. 419–432.

59. D. J. Miller, M. J. Fern, and L. B. Cardinal, “The Use of Knowl- edge for Technological Innovation Within Diversified Firms,” Academy of Management Journal (April 2007), pp. 308–326.

60. R. Wiltbank, N. Dew, S. Read, and S. D. Sarasvathy, “What To Do Next? The Case for Non-Predictive Strategy,” Strategic Management Journal (October 2006), pp. 981–998; J. A. Smith, “Strategies for Start-Ups,” Long Range Planning (December 1998), pp. 857–872.

61. J. S. Sidhu, “Business-Domain Definition and Performance: An Empirical Study,” SAM Advanced Management Journal (Au- tumn 2004), pp. 40–45.

62. See A. Campbell and S. Yeung, “Brief Case: Mission, Vision, and Strategic Intent,” Long Range Planning (August 1991), pp. 145–147; S. Cummings and J. Davies, “Mission, Vision, Fu- sion,” Long Range Planning (December 1994), pp. 147–150.

63. S. Baker, “Google and the Wisdom of Clouds,” Business Week (December 24, 2007), pp. 49–55. Courtesy of Google Inc. GOOGLE is a trademark of Google Inc.

64. J. Cosco, “Down to the Sea in Ships,” Journal of Business Strat- egy (November/December 1995), p. 48.

65. J. S. Sidhu, E. J. Nijssen, and H. R. Commandeur, “Business Domain Definition Practice: Does It Affect Organizational Per- formance?” Long Range Planning (June 2000), pp. 376–401.

66. “Time to Break Off a Chunk,” The Economist (December 15, 2007), pp. 75–76.

67. K. M. Eisenhardt and D. N. Sull, “Strategy as Simple Rules,” Harvard Business Review (January 2001), p. 110.

68. D. Welch, “Cadillac Hits the Gas,” Business Week (Septem- ber 4, 2000), p. 50.

69. S. Holmes, “GE: Little Engines That Could,” Business Week (January 20, 2003), pp. 62–63.

70. H. A. Simon, Administrative Behavior, 2nd edition (New York: The Free Press, 1957), p. 231.

71. L. Lee and P. Burrows, “Is Dell Too Big for Michael Dell?” Business Week (February 12, 2007), p. 33.

72. H. Mintzberg, “Planning on the Left Side and Managing on the Right,” Harvard Business Review (July–August 1976), p. 56.

73. R. A. Burgelman and A. S. Grove, “Let Chaos Reign, Then Reign In Chaos—Repeatedly: Managing Strategic Dynamics for Corporate Longevity,” Strategic Management Journal (Oc- tober 2007), pp. 965–979.

74. See E. Romanelli and M. L. Tushman, “Organizational Transfor- mation as Punctuated Equilibrium: An Empirical Test,” Academy of Management Journal (October 1994), pp. 1141–1166.

75. S. S. Gordon, W. H. Stewart, Jr., R. Sweo, and W. A. Luker, “Convergence versus Strategic Reorientation: The Antecen- dents of Fast-Paced Organizational Change,” Journal of Man- agement, Vol. 26, No. 5 (2000), pp. 911–945.

76. Speech to the 1998 Academy of Management, reported by S. M. Puffer, “Global Executive: Intel’s Andrew Grove on Competi- tiveness,” Academy of Management Executive (February 1999), pp. 15–24.

77. D. J. Hickson, R. J. Butler, D. Cray, G. R. Mallory, and D. C. Wilson, Top Decisions: Strategic Decision Making in Organi- zations (San Francisco: Jossey-Bass, 1986), pp. 26–42.

78. A. Weintraub, “Genentech’s Gamble,” Business Week (Decem- ber 17, 2007), pp. 44–48.

79. H. Mintzberg, “Strategy-Making in Three Modes,” California Management Review (Winter 1973), pp. 44–53.

80. F. Vogelstein, “Mighty Amazon,” Fortune (May 26, 2003), pp. 60–74.

81. M. Wong, “Once-Prized Encyclopedias Fall into Disuse,” Des Moines Register (March 9, 2004), p. 3D.

82. L. V. Gerstner, Who Says Elephants Can’t Dance? (New York: HarperCollins, 2002).

83. J. B. Quinn, Strategies for Change: Logical Incrementalism (Homewood, IL.: Irwin, 1980), p. 58.

84. R. M. Grant, “Strategic Planning in a Turbulent Environment: Evidence from the Oil Majors,” Strategic Management Journal (June 2003), pp. 491–517.

85. G. Gavetti and J. W. Rivkin, “Seek Strategy the Right Way at the Right Time,” Harvard Business Review (January 2008), pp. 22–23.

86. P. J. Brews and M. R. Hunt, “Learning to Plan and Planning to Learn: Resolving the Planning School/Learning School De- bate,” Strategic Management Journal (October 1999), pp. 889–913; I. Gold and A. M. A. Rasheed, “Rational Decision- Making and Firm Performance: The Moderating Role of the Environment,” Strategic Management Journal (August 1997), pp. 583–591; R. L. Priem, A. M. A. Rasheed, and A. G. Kotulic, “Rationality in Strategic Decision Processes, Environmental Dynamism and Firm Performance,” Journal of Management, Vol. 21, No. 5 (1995), pp. 913–929; J. W. Dean, Jr., and M. P. Sharfman, “Does Decision Process Matter? A Study of Strate- gic Decision-Making Effectiveness,” Academy of Management Journal (April 1996), pp. 368–396.

87. T. L. Wheelen and J. D. Hunger, “Using the Strategic Audit,” SAM Advanced Management Journal (Winter 1987), pp. 4–12; G. Donaldson, “A New Tool for Boards: The Strategic Audit,” Harvard Business Review (July–August 1995), pp. 99–107.

88. D. C. Hambrick and J. W. Fredrickson, “Are You Sure You Have a Strategy?” Academy of Management Executive (No- vember, 2001), pp. 48–59.

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Statements That Hit the Mark (New York: Currency Doubleday, 1995), p. 53. Courtesy of Celestial Seasonings.

C H A P T E R 1 Basic Concepts of Strategic Management 33

I. Current Situation

A. Current Performance How did the corporation perform the past year overall in terms of return on investment, market share, and profitability?

B. Strategic Posture What are the corporation’s current mission, objectives, strategies, and policies?

1. Are they clearly stated, or are they merely implied from performance?

2. Mission: What business(es) is the corporation in? Why?

3. Objectives: What are the corporate, business, and functional objectives? Are they con- sistent with each other, with the mission, and with the internal and external environments?

4. Strategies: What strategy or mix of strategies is the corporation following? Are they consistent with each other, with the mission and objectives, and with the internal and external environments?

5. Policies: What are the corporation’s policies? Are they consistent with each other, with the mission, objectives, and strategies, and with the internal and external environments?

6. Do the current mission, objectives, strategies, and policies reflect the corporation’s in- ternational operations, whether global or multidomestic?

II. Corporate Governance

A. Board of Directors 1. Who is on the board? Are they internal (employees) or external members?

2. Do they own significant shares of stock?

3. Is the stock privately held or publicly traded? Are there different classes of stock with different voting rights?

4. What do the board members contribute to the corporation in terms of knowledge, skills, background, and connections? If the corporation has international operations, do board members have international experience? Are board members concerned with environ- mental sustainability?

Strategic Audit of a Corporation

A P P E N D I X 1.A

SOURCE: T.L. Wheelen, J.D. Hunger, Strategic Audit of a Corporation, Copyright © 1982 by Wheelen & Hunger Associates. Reprinted by permission. Revised 1988, 1991, 1994, 1997, 2000, 2002, 2005, and 2008.

34

C H A P T E R 1 Basic Concepts of Strategic Management 35

5. How long have the board members served on the board?

6. What is their level of involvement in strategic management? Do they merely rubber-stamp top management’s proposals or do they actively participate and suggest future directions? Do they evaluate management’s proposals in terms of environmental sustainability?

B. Top Management 1. What person or group constitutes top management?

2. What are top management’s chief characteristics in terms of knowledge, skills, back- ground, and style? If the corporation has international operations, does top management have international experience? Are executives from acquired companies considered part of the top management team?

3. Has top management been responsible for the corporation’s performance over the past few years? How many managers have been in their current position for less than three years? Were they promoted internally or externally hired?

4. Has top management established a systematic approach to strategic management?

5. What is top management’s level of involvement in the strategic management process?

6. How well does top management interact with lower-level managers and with the board of directors?

7. Are strategic decisions made ethically in a socially responsible manner?

8. Are strategic decisions made in an environmentally sustainable manner?

9. Do top executives own significant amounts of stock in the corporation?

10. Is top management sufficiently skilled to cope with likely future challenges?

III. External Environment: Opportunities and Threats (SWOT)

A. Natural Physical Environment: Sustainability Issues 1. What forces from the natural physical environmental are currently affecting the corpo-

ration and the industries in which it competes? Which present current or future threats? Opportunities? a. Climate, including global temperature, sea level, and fresh water availability b. Weather-related events, such as severe storms, floods, and droughts c. Solar phenomena, such as sun spots and solar wind

2. Do these forces have different effects in other regions of the world?

B. Societal Environment 1. What general environmental forces are currently affecting both the corporation and the

industries in which it competes? Which present current or future threats? Opportunities? a. Economic b. Technological c. Political–legal d. Sociocultural

2. Are these forces different in other regions of the world?

36 PA RT 1 Introduction to Strategic Management and Business Policy

C. Task Environment 1. What forces drive industry competition? Are these forces the same globally or do they

vary from country to country? Rate each force as high, medium, or low. a. Threat of new entrants b. Bargaining power of buyers c. Threat of substitute products or services d. Bargaining power of suppliers e. Rivalry among competing firms f. Relative power of unions, governments, special interest groups, etc.

2. What key factors in the immediate environment (that is, customers, competitors, sup- pliers, creditors, labor unions, governments, trade associations, interest groups, local communities, and shareholders) are currently affecting the corporation? Which are cur- rent or future Threats? Opportunities?

D. Summary of External Factors (List in the EFAS Table 4–5, p. 126) Which of these forces and factors are the most important to the corporation and to the in- dustries in which it competes at the present time? Which will be important in the future?

IV. Internal Environment: Strengths and Weaknesses (SWOT)

A. Corporate Structure 1. How is the corporation structured at present?

a. Is the decision-making authority centralized around one group or decentralized to many units?

b. Is the corporation organized on the basis of functions, projects, geography, or some combination of these?

2. Is the structure clearly understood by everyone in the corporation?

3. Is the present structure consistent with current corporate objectives, strategies, policies, and programs, as well as with the firm’s international operations?

4. In what ways does this structure compare with those of similar corporations?

B. Corporate Culture 1. Is there a well-defined or emerging culture composed of shared beliefs, expectations,

and values?

2. Is the culture consistent with the current objectives, strategies, policies, and programs?

3. What is the culture’s position on environmental sustainability?

4. What is the culture’s position on other important issues facing the corporation (that is, on productivity, quality of performance, adaptability to changing conditions, and internationalization)?

5. Is the culture compatible with the employees’ diversity of backgrounds?

6. Does the company take into consideration the values of the culture of each nation in which the firm operates?

C H A P T E R 1 Basic Concepts of Strategic Management 37

C. Corporate Resources 1. Marketing

a. What are the corporation’s current marketing objectives, strategies, policies, and programs?

i. Are they clearly stated or merely implied from performance and/or budgets? ii. Are they consistent with the corporation’s mission, objectives, strategies, and

policies and with internal and external environments? b. How well is the corporation performing in terms of analysis of market position and

marketing mix (that is, product, price, place, and promotion) in both domestic and in- ternational markets? How dependent is the corporation on a few customers? How big is its market? Where is it gaining or losing market share? What percentage of sales comes from developed versus developing regions? Where are current products in the product life cycle?

i. What trends emerge from this analysis? ii. What impact have these trends had on past performance and how might these

trends affect future performance? iii. Does this analysis support the corporation’s past and pending strategic decisions? iv. Does marketing provide the company with a competitive advantage?

c. How well does the corporation’s marketing performance compare with that of sim- ilar corporations?

d. Are marketing managers using accepted marketing concepts and techniques to eval- uate and improve product performance? (Consider product life cycle, market seg- mentation, market research, and product portfolios.)

e. Does marketing adjust to the conditions in each country in which it operates? f. Does marketing consider environmental sustainability when making decisions? g. What is the role of the marketing manager in the strategic management process?

2. Finance a. What are the corporation’s current financial objectives, strategies, and policies and

programs? i. Are they clearly stated or merely implied from performance and/or budgets?

ii. Are they consistent with the corporation’s mission, objectives, strategies, and policies and with internal and external environments?

b. How well is the corporation performing in terms of financial analysis? (Consider ra- tio analysis, common size statements, and capitalization structure.) How balanced, in terms of cash flow, is the company’s portfolio of products and businesses? What are investor expectations in terms of share price?

i. What trends emerge from this analysis? ii. Are there any significant differences when statements are calculated in con-

stant versus reported dollars? iii. What impact have these trends had on past performance and how might these

trends affect future performance? iv. Does this analysis support the corporation’s past and pending strategic decisions? v. Does finance provide the company with a competitive advantage?

c. How well does the corporation’s financial performance compare with that of simi- lar corporations?

d. Are financial managers using accepted financial concepts and techniques to evalu- ate and improve current corporate and divisional performance? (Consider financial leverage, capital budgeting, ratio analysis, and managing foreign currencies.)

e. Does finance adjust to the conditions in each country in which the company operates? f. Does finance cope with global financial issues? g. What is the role of the financial manager in the strategic management process?

38 PA RT 1 Introduction to Strategic Management and Business Policy

3. Research and Development (R&D) a. What are the corporation’s current R&D objectives, strategies, policies, and programs?

i. Are they clearly stated or merely implied from performance or budgets? ii. Are they consistent with the corporation’s mission, objectives, strategies and poli-

cies and with internal and external environments? iii. What is the role of technology in corporate performance? iv. Is the mix of basic, applied, and engineering research appropriate given the cor-

porate mission and strategies? v. Does R&D provide the company with a competitive advantage?

b. What return is the corporation receiving from its investment in R&D? c. Is the corporation competent in technology transfer? Does it use concurrent engi-

neering and cross-functional work teams in product and process design? d. What role does technological discontinuity play in the company’s products? e. How well does the corporation’s investment in R&D compare with the investments

of similar corporations? How much R&D is being outsourced? Is the corporation us- ing value-chain alliances appropriately for innovation and competitive advantage?

f. Does R&D adjust to the conditions in each country in which the company operates? g. Does R&D consider environmental sustainability in product development and

packaging? h. What is the role of the R&D manager in the strategic management process?

4. Operations and Logistics a. What are the corporation’s current manufacturing/service objectives, strategies,

policies, and programs? i. Are they clearly stated or merely implied from performance or budgets?

ii. Are they consistent with the corporation’s mission, objectives, strategies, and policies and with internal and external environments?

b. What are the type and extent of operations capabilities of the corporation? How much is done domestically versus internationally? Is the amount of outsourcing ap- propriate to be competitive? Is purchasing being handled appropriately? Are sup- pliers and distributors operating in an environmentally sustainable manner? Which products have the highest and lowest profit margins?

i. If the corporation is product oriented, consider plant facilities, type of manu- facturing system (continuous mass production, intermittent job shop, or flexi- ble manufacturing), age and type of equipment, degree and role of automation and/or robots, plant capacities and utilization, productivity ratings, and avail- ability and type of transportation.

ii. If the corporation is service oriented, consider service facilities (hospital, theater, or school buildings), type of operations systems (continuous service over time to same clientele or intermittent service over time to varied clientele), age and type of supporting equipment, degree and role of automation and use of mass commu- nication devices (diagnostic machinery, video machines), facility capacities and utilization rates, efficiency ratings of professional and service personnel, and availability and type of transportation to bring service staff and clientele together.

c. Are manufacturing or service facilities vulnerable to natural disasters, local or national strikes, reduction or limitation of resources from suppliers, substantial cost increases of materials, or nationalization by governments?

d. Is there an appropriate mix of people and machines (in manufacturing firms) or of support staff to professionals (in service firms)?

e. How well does the corporation perform relative to the competition? Is it balancing in- ventory costs (warehousing) with logistical costs (just-in-time)? Consider costs per unit of labor, material, and overhead; downtime; inventory control management and scheduling of service staff; production ratings; facility utilization percentages; and number of clients successfully treated by category (if service firm) or percentage of orders shipped on time (if product firm).

C H A P T E R 1 Basic Concepts of Strategic Management 39

i. What trends emerge from this analysis? ii. What impact have these trends had on past performance and how might these

trends affect future performance? iii. Does this analysis support the corporation’s past and pending strategic decisions? iv. Does operations provide the company with a competitive advantage?

f. Are operations managers using appropriate concepts and techniques to evaluate and improve current performance? Consider cost systems, quality control and reliabil- ity systems, inventory control management, personnel scheduling, TQM, learning curves, safety programs, and engineering programs that can improve efficiency of manufacturing or of service.

g. Do operations adjust to the conditions in each country in which it has facilities? h. Do operations consider environmental sustainability when making decisions? i. What is the role of the operations manager in the strategic management process?

5. Human Resources Management (HRM) a. What are the corporation’s current HRM objectives, strategies, policies, and pro-

grams? i. Are they clearly stated or merely implied from performance and/or budgets?

ii. Are they consistent with the corporation’s mission, objectives, strategies, and policies and with internal and external environments?

b. How well is the corporation’s HRM performing in terms of improving the fit be- tween the individual employee and the job? Consider turnover, grievances, strikes, layoffs, employee training, and quality of work life.

i. What trends emerge from this analysis? ii. What impact have these trends had on past performance and how might these

trends affect future performance? iii. Does this analysis support the corporation’s past and pending strategic decisions? iv. Does HRM provide the company with a competitive advantage?

c. How does this corporation’s HRM performance compare with that of similar cor- porations?

d. Are HRM managers using appropriate concepts and techniques to evaluate and im- prove corporate performance? Consider the job analysis program, performance ap- praisal system, up-to-date job descriptions, training and development programs, attitude surveys, job design programs, quality of relationships with unions, and use of autonomous work teams.

e. How well is the company managing the diversity of its workforce? What is the company’s record on human rights? Does the company monitor the human rights record of key suppliers and distributors?

f. Does HRM adjust to the conditions in each country in which the company oper- ates? Does the company have a code of conduct for HRM for itself and key sup- pliers in developing nations? Are employees receiving international assignments to prepare them for managerial positions?

g. What is the role of outsourcing in HRM planning? h. What is the role of the HRM manager in the strategic management process?

6. Information Technology (IT) a. What are the corporation’s current IT objectives, strategies, policies, and programs?

i. Are they clearly stated or merely implied from performance and/or budgets? ii. Are they consistent with the corporation’s mission, objectives, strategies, and

policies and with internal and external environments? b. How well is the corporation’s IT performing in terms of providing a useful database,

automating routine clerical operations, assisting managers in making routine deci- sions, and providing information necessary for strategic decisions?

i. What trends emerge from this analysis? ii. What impact have these trends had on past performance and how might these

trends affect future performance?

40 PA RT 1 Introduction to Strategic Management and Business Policy

iii. Does this analysis support the corporation’s past and pending strategic decisions? iv. Does IT provide the company with a competitive advantage?

c. How does this corporation’s IT performance and stage of development compare with that of similar corporations? Is it appropriately using the Internet, intranet, and extranets?

d. Are IT managers using appropriate concepts and techniques to evaluate and improve corporate performance? Do they know how to build and manage a complex data- base, establish Web sites with firewalls and virus protection, conduct system analy- ses, and implement interactive decision-support systems?

e. Does the company have a global IT and Internet presence? Does it have difficulty with getting data across national boundaries?

f. What is the role of the IT manager in the strategic management process?

D. Summary of Internal Factors (List in the IFAS Table 5–2, p.164) Which of these factors are core competencies? Which, if any, are distinctive competen- cies? Which of these factors are the most important to the corporation and to the indus- tries in which it competes at the present time? Which might be important in the future? Which functions or activities are candidates for outsourcing?

V. Analysis of Strategic Factors (SWOT)

A. Situational Analysis (List in SFAS Matrix, Figure 6–1, p. 179) Of the external (EFAS) and internal (IFAS) factors listed in III.D and IV.D, which are the strategic (most important) factors that strongly affect the corporation’s present and future performance?

B. Review of Mission and Objectives 1. Are the current mission and objectives appropriate in light of the key strategic factors

and problems?

2. Should the mission and objectives be changed? If so, how?

3. If they are changed, what will be the effects on the firm?

VI. Strategic Alternatives and Recommended Strategy

A. Strategic Alternatives (See the TOWS Matrix, Figure 6–3, p. 182) 1. Can the current or revised objectives be met through more careful implementation of

those strategies presently in use (for example, fine-tuning the strategies)?

2. What are the major feasible alternative strategies available to the corporation? What are the pros and cons of each? Can corporate scenarios be developed and agreed on? (Al- ternatives must fit the natural physical environment, societal environment, industry, and corporation for the next three to five years.) a. Consider stability, growth, and retrenchment as corporate strategies. b. Consider cost leadership and differentiation as business strategies.

C H A P T E R 1 Basic Concepts of Strategic Management 41

c. Consider any functional strategic alternatives that might be needed for reinforcement of an important corporate or business strategic alternative.

B. Recommended Strategy 1. Specify which of the strategic alternatives you are recommending for the corporate,

business, and functional levels of the corporation. Do you recommend different busi- ness or functional strategies for different units of the corporation?

2. Justify your recommendation in terms of its ability to resolve both long- and short-term problems and effectively deal with the strategic factors.

3. What policies should be developed or revised to guide effective implementation?

4. What is the impact of your recommended strategy on the company’s core and distinc- tive competencies?

VII. Implementation

A. What Kinds of Programs (for Example, Restructuring the Corporation or Instituting TQM) Should Be Developed to Implement the Recommended Strategy? 1. Who should develop these programs?

2. Who should be in charge of these programs?

B. Are the Programs Financially Feasible? Can Pro Forma Budgets Be Developed and Agreed On? Are Priorities and Timetables Appropriate to Individual Programs?

C. Will New Standard Operating Procedures Need to Be Developed?

VIII. Evaluation and Control

A. Is the Current Information System Capable of Providing Sufficient Feedback on Implementation Activities and Performance? Can It Measure Strategic Factors? 1. Can performance results be pinpointed by area, unit, project, or function?

2. Is the information timely?

3. Is the corporation using benchmarking to evaluate its functions and activities?

B. Are Adequate Control Measures in Place to Ensure Conformance with the Recommended Strategic Plan? 1. Are appropriate standards and measures being used?

2. Are reward systems capable of recognizing and rewarding good performance?

On paper, Robert Nardelli, seemed to be doing everything right. Selected

personally by the founders, Arthur Blank, Kenneth Langone, and Bernard Marcus,

the board of directors felt that the company was lucky to have hired Nardelli from

General Electric to be CEO of Home Depot in December 2000. Between 2000 and

2005, the company opened more than 900 stores, doubled sales to $81.5 billion, and

achieved earnings per share growth of at least 20% every year. According to Nardelli, the com-

pany had the strongest balance sheet in the industry and tremendous potential for future

growth. The board loved Nardelli and had been happy to support his decisions.

The stockholders, however, were not as satisfied with Nardelli’s performance. They won-

dered why Home Depot’s common stock had fallen 30% since Nardelli had taken charge of the

company. In addition, Nardelli was increasingly being attacked for having “excessive compen-

sation,” given the firm’s poor stock performance. People questioned why he was receiving $38.1

million annually in salary, cash bonuses, and stock options. Nardelli was one of the six executives

highlighted in a July 24, 2006 Fortune article entitled “The Real CEO Pay Problem.”1

Stockholders were unhappy with Nardelli’s tendency to manipulate negative performance

data. For example, when same-store sales failed to increase in 2005, he announced that man-

agement would no longer report that figure. When a Business Week reporter questioned his

persuading the board not to use stock price to decide his compensation, Nardelli responded that

he and the board had felt that the leadership team should be measured on things over which

the team had direct control, such as earnings per share instead of stock price compared to the

retail index.2

Since Nardelli saw little growth opportunity in the company’s retail stores, he pushed to

make the stores run more efficiently. Importing ideas, people, and management concepts from

the military was one way to reshape an increasingly unwieldy Home Depot into a more central-

ized and efficient organization. Under Nardelli, the emphasis was on building a disciplined man-

ager corps, one predisposed to following orders, operating in high-pressure environments, and

executing with high standards.3 He hired ex-military to be store managers. The previous con-

stant flow of ideas and suggestions flowing up the organization from Home Depot’s many em-

ployees was replaced by major decisions and goals flowing down from top management.

Former Home Depot executives reported that a “culture of fear” had caused customer ser-

vice to decline. The once-heavy ranks of full-time store employees had been replaced with part-

timers to reduce labor costs. Since 2001, 98% of Home Depot’s 170 top executives had left the

corporate Governance

C H A P T E R 2

43

� Describe the role and responsibilities of the board of directors in corporate governance

� Understand how the composition of a board can affect its operation

� Describe the impact of the Sarbanes-Oxley Act on corporate governance in the United States

� Discuss trends in corporate governance � Explain how executive leadership is an

important part of strategic management

Learning Objectives

Gathering Information

Putting Strategy into Action

Monitoring Performance

Societal Environment: General forces

Natural Environment: Resources and

climate

Task Environment:

Industry analysis

Internal: Strengths and Weaknesses

Structure: Chain of command

Culture: Beliefs, expectations,

values

Resources: Assets, skills, competencies,

knowledge

Programs

Activities needed to accomplish a plan

Budgets

Cost of the programs Procedures

Sequence of steps needed to do the job

Performance

Actual results

External: Opportunities

and Threats

Developing Long-range Plans

Mission

Reason for existence Objectives

What results to accomplish by when

Strategies

Plan to achieve the mission & objectives

Policies

Broad guidelines for decision making

Environmental Scanning:

Strategy Formulation:

Strategy Implementation:

Evaluation and Control:

Feedback/Learning: Make corrections as needed

After reading this chapter, you should be able to:

company. The University of Michigan’s American Customer Satisfaction Index, compiled in

2005, revealed that Home Depot, with a score of 67, had slipped to last place among

major U.S. retailers.

Nardelli did not react well to criticism. For example, the agenda for the May 2006

shareholders meeting contained a number of shareholder proposals dealing with “exces-

sive” senior management compensation, separating the position of Chairman of the

Board from another management position, requiring a majority (instead of plurality) vote

for board member elections, shareholder approval for future “extraordinary” retirement

benefits for senior executives, and disclosure of the monetary value of executive benefits.

The votes on these proposals indicated an unusually high level of shareholder dissent,

with at least one-third of shareholders voting for every proposal—votes cast before the

meeting. Upon arriving at the annual shareholders meeting, people were surprised to

note a number of changes from previous annual meetings. For one thing, except for CEO

Nardelli, none of the members of the board of directors were present. For another, share-

holders were allowed to speak about their shareholder proposals, but each had a time

limit that was carefully tracked by a giant clock. Nardelli did not present a performance

review, refused to acknowledge comments or answer questions, and adjourned the meet-

ing after 30 minutes. Many of the shareholders were enraged by Nardelli’s arrogance.

Pushed by the shareholders to reduce the CEO’s large compensation package, the

board of directors finally asked Nardelli to accept future stock awards being tied to in-

creases in the company’s stock price. Nardelli flatly refused and instead quit the company

in January 2007—taking with him a $210 million retirement package. Observers could not

understand why the board had been so generous with a CEO who during his tenure had

been more concerned with building his own compensation than in building shareholder

wealth.4

Home Depot’s shareholders are not the only ones who are concerned with question-

able top managers and weak boards of directors. A record 1,169 shareholder resolutions

were proposed in the U.S. during 2007. Proposals on CEO pay and other governance issues

received record high support votes of 30% to 60% from investors.5 Successful shareholder

activist campaigns increased in Europe from less than 10 in 2001 to over 50 in 2007.6

Research revealing that managers at 29% of all U.S. public corporations had back-dated

stock options in order to boost executive pay led to civil charges and shareholder lawsuits

in addition to criminal indictments.7 Board members are increasingly being held account-

able for poor corporate governance. For example, 10 former directors from WorldCom

and Enron agreed to pay $18 million and $13 million, respectively, of their own money to

settle lawsuits launched by enraged stockholders over the unethical and even criminal ac-

tions of top management overseen by a passive board of directors.8

44 PA RT 1 Introduction to Strategic Management and Business Policy

C H A P T E R 2 Corporate Governance 45

2.1 Role of the Board of Directors A corporation is a mechanism established to allow different parties to contribute capital, ex- pertise, and labor for their mutual benefit. The investor/shareholder participates in the profits of the enterprise without taking responsibility for the operations. Management runs the com- pany without being responsible for personally providing the funds. To make this possible, laws have been passed that give shareholders limited liability and, correspondingly, limited in- volvement in a corporation’s activities. That involvement does include, however, the right to elect directors who have a legal duty to represent the shareholders and protect their interests. As representatives of the shareholders, directors have both the authority and the responsibil- ity to establish basic corporate policies and to ensure that they are followed.9

The board of directors, therefore, has an obligation to approve all decisions that might af- fect the long-run performance of the corporation. This means that the corporation is fundamen- tally governed by the board of directors overseeing top management, with the concurrence of the shareholder. The term corporate governance refers to the relationship among these three groups in determining the direction and performance of the corporation.10

Over the past decade, shareholders and various interest groups have seriously questioned the role of the board of directors in corporations. They are concerned that inside board mem- bers may use their position to feather their own nests and that outside board members often lack sufficient knowledge, involvement, and enthusiasm to do an adequate job of monitoring and providing guidance to top management. Instances of widespread corruption and question- able accounting practices at Enron, Global Crossing, WorldCom, Tyco, and Qwest, among oth- ers, seem to justify their concerns. Home Depot’s board, for example, seemed more interested in keeping CEO Nardelli happy than in promoting shareholder interests.

The general public has not only become more aware and more critical of many boards’ apparent lack of responsibility for corporate activities, it has begun to push government to de- mand accountability. As a result, the board as a rubber stamp of the CEO or as a bastion of the “old-boy” selection system is being replaced by more active, more professional boards.

RESPONSIBILITIES OF THE BOARD Laws and standards defining the responsibilities of boards of directors vary from country to country. For example, board members in Ontario, Canada, face more than 100 provincial and federal laws governing director liability. The United States, however, has no clear national standards or federal laws. Specific requirements of directors vary, depending on the state in which the corporate charter is issued. There is, nevertheless, a developing worldwide consen- sus concerning the major responsibilities of a board. Interviews with 200 directors from eight countries (Canada, France, Germany, Finland, Switzerland, the Netherlands, the United King- dom, and Venezuela) revealed strong agreement on the following five board of director re- sponsibilities, listed in order of importance:

1. Setting corporate strategy, overall direction, mission, or vision

2. Hiring and firing the CEO and top management

3. Controlling, monitoring, or supervising top management

4. Reviewing and approving the use of resources

5. Caring for shareholder interests11

These results are in agreement with a survey by the National Association of Corporate Directors, in which U.S. CEOs reported that the four most important issues boards should

46 PA RT 1 Introduction to Strategic Management and Business Policy

address are corporate performance, CEO succession, strategic planning, and corporate gov- ernance.12 Directors in the United States must make certain, in addition to the duties just listed, that the corporation is managed in accordance with the laws of the state in which it is incorporated. Because more than half of all publicly traded companies in the United States are incorporated in the state of Delaware, this state’s laws and rulings have more impact than do those of any other state.13 Directors must also ensure management’s adherence to laws and regulations, such as those dealing with the issuance of securities, insider trading, and other conflict-of-interest situations. They must also be aware of the needs and demands of constituent groups so that they can achieve a judicious balance among the interests of these diverse groups while ensuring the continued functioning of the corporation.

In a legal sense, the board is required to direct the affairs of the corporation but not to man- age them. It is charged by law to act with due care. If a director or the board as a whole fails to act with due care and, as a result, the corporation is in some way harmed, the careless direc- tor or directors can be held personally liable for the harm done. This is no small concern given that one survey of outside directors revealed that more than 40% had been named as part of lawsuits against corporations.14 For example, board members of Equitable Life in Britain were sued for up to $5.4 billion for failure to question the CEO’s reckless policies.15 For this rea- son, corporations have found that they need directors and officers’ liability insurance in order to attract people to become members of boards of directors.

A 2008 global survey of directors by McKinsey & Company revealed the average amount of time boards spend on a given issue during their meetings:16

� Strategy (development and analysis of strategies)—24%

� Execution (prioritizing programs and approving mergers and acquisitions)—24%

� Performance management (development of incentives and measuring performance)—20%

� Governance and compliance (nominations, compensation, audits)—17%

� Talent management—11%

Role of the Board in Strategic Management How does a board of directors fulfill these many responsibilities? The role of the board of di- rectors in strategic management is to carry out three basic tasks:

� Monitor: By acting through its committees, a board can keep abreast of developments in- side and outside the corporation, bringing to management’s attention developments it might have overlooked. A board should at the minimum carry out this task.

� Evaluate and influence: A board can examine management’s proposals, decisions, and actions; agree or disagree with them; give advice and offer suggestions; and outline alter- natives. More active boards perform this task in addition to monitoring.

� Initiate and determine: A board can delineate a corporation’s mission and specify strate- gic options to its management. Only the most active boards take on this task in addition to the two previous ones.

Board of Directors’ Continuum A board of directors is involved in strategic management to the extent that it carries out the three tasks of monitoring, evaluating and influencing, and initiating and determining. The board of directors’ continuum shown in Figure 2–1 shows the possible degree of involve- ment (from low to high) in the strategic management process. Boards can range from phantom boards with no real involvement to catalyst boards with a very high degree of involvement.17

Research suggests that active board involvement in strategic management is positively related to a corporation’s financial performance and its credit rating.18

C H A P T E R 2 Corporate Governance 47

DEGREE OF INVOLVEMENT IN STRATEGIC MANAGEMENT

Low (Passive)

Rubber StampPhantom

Never knows what to do, if anything; no degree of involvement.

Formally reviews selected issues that officers bring to its attention.

Involved to a limited degree in the perfor- mance or review of selected key decisions, indicators, or programs of managment.

Approves, questions, and makes final de- cisions on mis- sion, strategy, policies, and objectives. Has active board committees. Performs fiscal and manage- ment audits.

Takes the leading role in establishing and modifying the mission, objectives, strategy, and policies. It has a very active strategy committee.

Permits officers to make all decisions. It votes as the officers recom- mend on action issues.

Minimal Review

Nominal Participation

Active Participation Catalyst

High (Active)

FIGURE 2–1 Board of Directors’ Continuum

SOURCE: T. L. Wheelen and J. D. Hunger, “Board of Directors’ Continuum,” Copyright © 1994 by Wheelen and Hunger Associates. Reprinted by permission.

Highly involved boards tend to be very active. They take their tasks of monitoring, eval- uating and influencing, and initiating and determining very seriously; they provide advice when necessary and keep management alert. As depicted in Figure 2–1, their heavy involve- ment in the strategic management process places them in the active participation or even cat- alyst positions. Although 74% of public corporations have periodic board meetings devoted primarily to the review of overall company strategy, the boards may not have had much influ- ence in generating the plan itself.19 A 2008 global survey of directors by McKinsey & Company found that 43% of respondents had high to very high influence in creating corporate value. Thirty-eight percent stated that they had moderate influence and 18% reported that they had little to very little influence. Those boards reporting high influence typically shared a common plan for creating value and had healthy debate about what actions the company should take to create value. Together with top management, these high-influence boards considered global trends and future scenarios and developed plans. In contrast, those boards with low influence tended not to do any of these things.20 These results are supported by a 2006 survey by Korn/Ferry International revealing that 30% of directors felt that their CEO was not utilizing them to their full capacity. In the same study, 73% of the directors indicated that were not con- tent with an oversight role mandated by regulation and wanted to be more involved in setting strategic plans.21 Nevertheless, studies indicate that boards are becoming increasingly active. For example, in a global survey of directors conducted by McKinsey & Company in 2005, 64% of the respondents indicated that they were more actively involved in the core areas of com- pany performance and value creation than they had been five years earlier. This percentage was higher in large companies (77%) and in publicly held companies (75%).22

These and other studies suggest that most large publicly owned corporations have boards that operate at some point between nominal and active participation. Some corporations with actively participating boards are Target, Medtronic, Best Western, Service Corporation Inter- national, Bank of Montreal, Mead Corporation, Rolm and Haas, Whirlpool, 3M, Apria Healthcare, General Electric, Pfizer, and Texas Instruments.23 Target, a corporate governance leader, has a board that each year sets three top priorities, such as strategic direction, capital allocation, and succession planning. Each of these priority topics is placed at the top of the agenda

48 PA RT 1 Introduction to Strategic Management and Business Policy

for at least one meeting. Target’s board also devotes one meeting a year to setting the strategic direction for each major operating division.24

As a board becomes less involved in the affairs of the corporation, it moves farther to the left on the continuum (see Figure 2–1). On the far left are passive phantom or rubber-stamp boards that typically never initiate or determine strategy unless a crisis occurs. In these situations, the CEO also serves as Chairman of the Board, personally nominates all directors, and works to keep board members under his or her control by giving them the “mushroom treatment”—throw manure on them and keep them in the dark!

Generally, the smaller the corporation, the less active is its board of directors in strategic management.25 In an entrepreneurial venture, for example, the privately held corporation may be 100% owned by the founders—who also manage the company. In this case, there is no need for an active board to protect the interests of the owner-manager shareholders—the interests of the owners and the managers are identical. In this instance, a board is really unnecessary and only meets to satisfy legal requirements. If stock is sold to outsiders to finance growth, however, the board becomes more active. Key investors want seats on the board so they can oversee their in- vestment. To the extent that they still control most of the stock, however, the founders dominate the board. Friends, family members, and key shareholders usually become members, but the board acts primarily as a rubber stamp for any proposals put forward by the owner-managers. In this type of company, the founder tends to be both CEO and Chairman of the Board and the board includes few people who are not affiliated with the firm or family.26 This cozy relationship be- tween the board and management should change, however, when the corporation goes public and stock is more widely dispersed. The founders, who are still acting as management, may sometimes make decisions that conflict with the needs of the other shareholders (especially if the founders own less than 50% of the common stock). In this instance, problems could occur if the board fails to become more active in terms of its roles and responsibilities.

MEMBERS OF A BOARD OF DIRECTORS The boards of most publicly owned corporations are composed of both inside and outside direc- tors. Inside directors (sometimes called management directors) are typically officers or execu- tives employed by the corporation. Outside directors (sometimes called non-management directors) may be executives of other firms but are not employees of the board’s corporation. Al- though there is yet no clear evidence indicating that a high proportion of outsiders on a board re- sults in improved financial performance,27 there is a trend in the United States to increase the number of outsiders on boards and to reduce the total size of the board.28 The board of direc- tors of a typical large U.S. corporation has an average of 10 directors, 2 of whom are insiders.29

Outsiders thus account for 80% of the board members in large U.S. corporations (approxi- mately the same as in Canada). Boards in the UK typically have 5 inside and 5 outside directors, whereas in France boards usually consist of 3 insiders and 8 outsiders. Japanese boards, in contrast, contain 2 outsiders and 12 insiders.30 The board of directors in a typical small U.S. corporation has four to five members, of whom only one or two are outsiders.31

Research from large and small corporations reveals a negative relationship between board size and firm profitability.32

People who favor a high proportion of outsiders state that outside directors are less biased and more likely to evaluate management’s performance objectively than are inside directors. This is the main reason why the U.S. Securities and Exchange Commission (SEC) in 2003 re- quired that a majority of directors on the board be independent outsiders. The SEC also re- quired that all listed companies staff their audit, compensation, and nominating/corporate governance committees entirely with independent, outside members. This view is in agree- ment with agency theory, which states that problems arise in corporations because the agents

C H A P T E R 2 Corporate Governance 49

(top management) are not willing to bear responsibility for their decisions unless they own a substantial amount of stock in the corporation. The theory suggests that a majority of a board needs to be from outside the firm so that top management is prevented from acting selfishly to the detriment of the shareholders. For example, proponents of agency theory argue that man- agers in management-controlled firms (contrasted with owner-controlled firms in which the founder or family still own a significant amount of stock) select less risky strategies with quick payoffs in order to keep their jobs.33 This view is supported by research revealing that manager- controlled firms (with weak boards) are more likely to go into debt to diversify into unrelated markets (thus quickly boosting sales and assets to justify higher salaries for themselves), thus resulting in poorer long-term performance than owner-controlled firms.34 Boards with a larger proportion of outside directors tend to favor growth through international expansion and inno- vative venturing activities than do boards with a smaller proportion of outsiders.35 Outsiders tend to be more objective and critical of corporate activities. For example, research reveals that the likelihood of a firm engaging in illegal behavior or being sued declines with the addition of outsiders on the board.36 Research on family businesses has found that boards with a larger number of outsiders on the board tended to have better corporate governance and better per- formance than did boards with fewer outsiders.37

In contrast, those who prefer inside over outside directors contend that outside directors are less effective than are insiders because the outsiders are less likely to have the necessary interest, availability, or competency. Stewardship theory proposes that, because of their long tenure with the corporation, insiders (senior executives) tend to identify with the corporation and its success. Rather than use the firm for their own ends, these executives are thus most in- terested in guaranteeing the continued life and success of the corporation. (See Strategy High- light 2.1 for a discussion of Agency Theory contrasted with Stewardship Theory.) Excluding all insiders but the CEO reduces the opportunity for outside directors to see potential succes- sors in action or to obtain alternate points of view of management decisions. Outside directors may sometimes serve on so many boards that they spread their time and interest too thin to ac- tively fulfill their responsibilities. The average board member of a U.S. Fortune 500 firm serves on three boards. Research indicates that firm performance decreases as the number of directorships held by the average board member increases.38 Although only 40% of surveyed U.S. boards currently limit the number of directorships a board member may hold in other cor- porations, 60% limit the number of boards on which their CEO may be a member.39

Those who question the value of having more outside board members point out that the term outsider is too simplistic because some outsiders are not truly objective and should be considered more as insiders than as outsiders. For example, there can be:

1. Affiliated directors, who, though not really employed by the corporation, handle the le- gal or insurance work for the company or are important suppliers (thus dependent on the current management for a key part of their business). These outsiders face a conflict of in- terest and are not likely to be objective. As a result of recent actions by the U.S. Congress, Securities and Exchange Commission, New York Stock Exchange, and NASDAQ, affili- ated directors are being banned from U.S. corporate boardrooms. U.S. boards can no longer include representatives of major suppliers or customers or even professional organizations that might do business with the firm, even though these people could provide valuable knowledge and expertise.40 The New York Stock Exchange decided in 2004 that anyone paid by the company during the previous three years could not be classified as an inde- pendent outside director.41

2. Retired executive directors, who used to work for the company, such as the past CEO who is partly responsible for much of the corporation’s current strategy and who probably groomed the current CEO as his or her replacement. In the recent past, many boards of large firms kept the firm’s recently retired CEO on the board for a year or two after retirement as

50 PA RT 1 Introduction to Strategic Management and Business Policy

AGENCY THEORY VERSUS STEWARDSHIP THEORY IN CORPORATE GOVERNANCE

Managers of large, modern publicly held corporations are

typically not the owners. In fact, most of today’s top managers own

only nominal amounts of stock in the corporation they manage. The real owners (shareholders) elect boards of di- rectors who hire managers as their agents to run the firm’s day-to-day activities. Once hired, how trustworthy are these executives? Do they put themselves or the firm first?

Agency Theory. As suggested in the classic study by Berle and Means, top managers are, in effect, “hired hands” who may very likely be more interested in their personal welfare than that of the shareholders. For example, man- agement might emphasize strategies, such as acquisitions, that increase the size of the firm (to become more power- ful and to demand increased pay and benefits) or that di- versify the firm into unrelated businesses (to reduce short-term risk and to allow them to put less effort into a core product line that may be facing difficulty) but that re- sult in a reduction of dividends and/or stock price.

Agency theory is concerned with analyzing and resolv- ing two problems that occur in relationships between principals (owners/shareholders) and their agents (top management):

1. The agency problem that arises when (a) the desires or objectives of the owners and the agents conflict or (b) it is difficult or expensive for the owners to verify what the agent is actually doing. One example is when top management is more interested in raising its own salary than in increasing stock dividends.

2. The risk-sharing problem that arises when the owners and agents have different attitudes toward risk. Executives may not select risky strategies because they fear losing their jobs if the strategy fails.

According to agency theory, the likelihood that these problems will occur increases when stock is widely held (that is, when no one shareholder owns more than a small percentage of the total common stock), when the board of directors is composed of people who know little of the company or who are personal friends of top management, and when a high percentage of board members are inside (management) directors.

To better align the interests of the agents with those of the owners and to increase the corporation’s overall perfor-

mance, agency theory suggests that top management have a significant degree of ownership in the firm and/or have a strong financial stake in its long-term performance. In support of this argument, research indicates a positive relationship between corporate performance and the amount of stock owned by directors.

Stewardship Theory. In contrast, stewardship theory suggests that executives tend to be more motivated to act in the best interests of the corporation than in their own self-interests. Whereas agency theory focuses on extrinsic rewards that serve the lower-level needs, such as pay and security, stewardship theory focuses on the higher-order needs, such as achievement and self-actualization. Stew- ardship theory argues that senior executives over time tend to view the corporation as an extension of themselves. Rather than use the firm for their own ends, these execu- tives are most interested in guaranteeing the continued life and success of the corporation. The relationship between the board and top management is thus one of principal and steward, not principal and agent (“hired hand”). Stewardship theory notes that in a widely held corporation, the shareholder is free to sell his or her stock at any time. In fact, the average share of stock is held less than 10 months. A diversified investor or speculator may care little about risk at the company level—preferring management to assume extraordinary risk so long as the return is ade- quate. Because executives in a firm cannot easily leave their jobs when in difficulty, they are more interested in a merely satisfactory return and put heavy emphasis on the firm’s continued survival. Thus, stewardship theory argues that in many instances top management may care more about a company’s long-term success than do more short-term ori- ented shareholders.

For more information about agency and stewardship theory, see A. A. Berle and G. C. Means, The Modern Corporation and Private Property (NY: Macmillan, 1936). Also see J. H. Davis, F. D. Schoorman, and L. Donaldson, “Toward a Stewardship Theory of Management,” Academy of Management Review (January 1997), pp. 20–47; P. J. Lane, A. A. Cannella, Jr. & M. H. Lubatkin, “Agency Problems as Antecedents to Unrelated Mergers and Diversification: Amihud and Lev Reconsidered,” Strategic Management Journal (June 1998), pp. 555–578; M. L. Hayward and D. C. Hambrick, “Explaining the Premiums Paid for Large Acquisitions: Evidence of CEO Hubris,” Administrative Science Quarterly (March 1997), pp. 103–127; and C. M. Christensen and S. D. Anthony, “Put Investors in their Place,” Business Week (May 28, 2007), p. 108.

STRATEGY highlight 2.1

C H A P T E R 2 Corporate Governance 51

a courtesy, especially if he/she had performed well as the CEO. It is almost certain, how- ever, that this person will not be able to objectively evaluate the corporation’s performance. Because of the likelihood of a conflict of interest, only 31% of boards in the Americas, 25% in Europe, and 20% in Australasia now include the former CEO on their boards.42

3. Family directors, who are descendants of the founder and own significant blocks of stock (with personal agendas based on a family relationship with the current CEO). The Schlitz Brewing Company, for example, was unable to complete its turnaround strategy with a non-family CEO because family members serving on the board wanted their money out of the company, forcing it to be sold.43

The majority of outside directors are active or retired CEOs and COOs of other corpora- tions. Others are major investors/shareholders, academicians, attorneys, consultants, former government officials, and bankers. Given that 66% of the outstanding stock in the largest U.S. and UK corporations is now owned by institutional investors, such as mutual funds and pen- sion plans, these investors are taking an increasingly active role in board membership and ac- tivities.44 For example, TIAA-CREF’s Corporate Governance team monitors governance practices of the 4,000 companies in which it invests its pension funds through its Corporate Assessment Program. If its analysis of a company reveals problems, TIAA-CREF first sends letters stating its concerns, followed up by visits, and it finally sponsors a shareholder resolu- tion in opposition to management’s actions.45 Institutional investors are also powerful in many other countries. In Germany, bankers are represented on almost every board—primarily be- cause they own large blocks of stock in German corporations. In Denmark, Sweden, Belgium, and Italy, however, investment companies assume this role. For example, the investment com- pany Investor casts 42.5% of the Electrolux shareholder votes, thus guaranteeing itself posi- tions on the Electrolux board.

Boards of directors have been working to increase the number of women and minorities serving on boards. Korn/Ferry International reports that of the Fortune 1000 largest U.S. firms, 85% had at least one woman director in 2006 (compared to 69% in 1995), comprising 15% of total directors. Approximately one-half of the boards in Europe included a female director, comprising 9% of total directors. (The percentage of female directors in Europe in 2006 ranged from less than 1% in Portugal to almost 40% in Norway.)46 Korn/Ferry’s survey also revealed that 76% of the U.S. boards had at least one ethnic minority in 2006 (African-American, 47%; Latino, 19%; Asian, 10%) as director compared to only 47% in 1995, comprising around 14% of total directors.47 Among the top 200 S&P companies in the U.S., however, 84% have at least one African-American director.48 The globalization of business is having an impact on board membership. According to the Spencer Stuart executive recruiting firm, 33% of U.S. boards had an international director.49 Europe was the most “globalized” region of the world, with most companies reporting one or more non-national directors.50 Although Asian and Latin American boards are still predominantly staffed by nationals, they are working to add more in- ternational directors.51

Outside directors serving on the boards of large Fortune 1000 U.S. corporations annually earned on average $58,217 in cash plus an average of $75,499 in stock options. Most of the companies (63%) paid their outside directors an annual retainer plus a fee for every meeting attended.52 Directors serving on the boards of small companies usually received much less compensation (around $10,000). One study found directors of a sample of large U.S. firms to hold on average 3% of their corporations’ outstanding stock.53

The vast majority of inside directors are the chief executive officer and either the chief op- erating officer (if not also the CEO) or the chief financial officer. Presidents or vice presidents of key operating divisions or functional units sometimes serve on the board. Few, if any, in- side directors receive any extra compensation for assuming this extra duty. Very rarely does a U.S. board include any lower-level operating employees.

52 PA RT 1 Introduction to Strategic Management and Business Policy

Codetermination: Should Employees Serve on Boards? Codetermination, the inclusion of a corporation’s workers on its board, began only recently in the United States. Corporations such as Chrysler, Northwest Airlines, United Airlines (UAL), and Wheeling-Pittsburgh Steel added representatives from employee associations to their boards as part of union agreements or Employee Stock Ownership Plans (ESOPs). For exam- ple, United Airlines workers traded 15% in pay cuts for 55% of the company (through an ESOP) and 3 of the firm’s 12 board seats. In this instance, workers represent themselves on the board not so much as employees but primarily as owners. At Chrysler, however, the United Auto Workers union obtained a temporary seat on the board as part of a union contract agreement in exchange for changes in work rules and reductions in benefits. This was at a time when Chrysler was facing bankruptcy in the late 1970s. In situations like this when a director represents an in- ternal stakeholder, critics raise the issue of conflict of interest. Can a member of the board, who is privy to confidential managerial information, function, for example, as a union leader whose primary duty is to fight for the best benefits for his or her members? Although the movement to place employees on the boards of directors of U.S. companies shows little likelihood of increas- ing (except through employee stock ownership), the European experience reveals an increasing acceptance of worker participation (without ownership) on corporate boards.

Germany pioneered codetermination during the 1950s with a two-tiered system: (1) a su- pervisory board elected by shareholders and employees to approve or decide corporate strat- egy and policy and (2) a management board (composed primarily of top management) appointed by the supervisory board to manage the company’s activities. Most other Western European countries have either passed similar codetermination legislation (as in Sweden, Denmark, Norway, and Austria) or use worker councils to work closely with management (as in Belgium, Luxembourg, France, Italy, Ireland, and the Netherlands).

Interlocking Directorates CEOs often nominate chief executives (as well as board members) from other firms to mem- bership on their own boards in order to create an interlocking directorate. A direct interlocking directorate occurs when two firms share a director or when an executive of one firm sits on the board of a second firm. An indirect interlock occurs when two corporations have directors who also serve on the board of a third firm, such as a bank.

Although the Clayton Act and the Banking Act of 1933 prohibit interlocking directorates by U.S. companies competing in the same industry, interlocking continues to occur in almost all corporations, especially large ones. Interlocking occurs because large firms have a large impact on other corporations and these other corporations, in turn, have some control over the firm’s inputs and marketplace. For example, most large corporations in the United States, Japan, and Germany are interlocked either directly or indirectly with financial institutions.54

Eleven of the 15 largest U.S. corporations have at least two board members who sit together on another board. Twenty percent of the 1,000 largest U.S. firms share at least one board member.55

Interlocking directorates are useful for gaining both inside information about an uncertain environment and objective expertise about potential strategies and tactics.56 For example, Kleiner Perkins, a high-tech venture capital firm, not only has seats on the boards of the com- panies in which it invests, but it also has executives (which Kleiner Perkins hired) from one entrepreneurial venture who serve as directors on others. Kleiner Perkins refers to its network of interlocked firms as its keiretsu, a Japanese term for a set of companies with interlocking business relationships and share-holdings.57 Family-owned corporations, however, are less likely to have interlocking directorates than are corporations with highly dispersed stock own- ership, probably because family-owned corporations do not like to dilute their corporate con- trol by adding outsiders to boardroom discussions.

C H A P T E R 2 Corporate Governance 53

There is some concern, however, when the chairs of separate corporations serve on each other’s boards. Twenty-two such pairs of corporate chairs (who typically also served as their firm’s CEO) existed in 2003. In one instance, the three chairmen of Anheuser-Busch, SBC Communications, and Emerson Electric served on all three of the boards. Typically a CEO sits on only one board in addition to his or her own—down from two additional boards in previ- ous years. Although such interlocks may provide valuable information, they are increasingly frowned upon because of the possibility of collusion.58 Nevertheless, evidence indicates that well-interlocked corporations are better able to survive in a highly competitive environment.59

NOMINATION AND ELECTION OF BOARD MEMBERS Traditionally the CEO of a corporation decided whom to invite to board membership and merely asked the shareholders for approval in the annual proxy statement. All nominees were usually elected. There are some dangers, however, in allowing the CEO free rein in nominating directors. The CEO might select only board members who, in the CEO’s opin- ion, will not disturb the company’s policies and functioning. Given that the average length of service of a U.S. board member is for three three-year terms (but can range up to 20 years for some boards), CEO-friendly, passive boards are likely to result. This is especially likely given that only 7% of surveyed directors indicated that their company had term limits for board members. Nevertheless, 60% of U.S. boards and 58% of European boards have a mandatory retirement age—typically around 70.60 Research reveals that boards rated as least effective by the Corporate Library, a corporate governance research firm, tend to have members serving longer (an average of 9.7 years) than boards rated as most effective (7.5 years).61 Directors selected by the CEO often feel that they should go along with any proposal the CEO makes. Thus board members find themselves accountable to the very management they are charged to oversee. Because this is likely to happen, more boards are using a nominating committee to nominate new outside board members for the shareholders to elect. Ninety-seven percent of large U.S. corporations now use nominating committees to identify potential directors. This practice is less common in Europe where 60% of boards use nominating committees.62

Many corporations whose directors serve terms of more than one year divides the board into classes and staggers elections so that only a portion of the board stands for election each year. This is called a staggered board. Sixty-three percent of U.S. boards currently have stag- gered boards.63 Arguments in favor of this practice are that it provides continuity by reducing the chance of an abrupt turnover in its membership and that it reduces the likelihood of elect- ing people unfriendly to management (who might be interested in a hostile takeover) through cumulative voting. An argument against staggered boards is that they make it more difficult for concerned shareholders to curb a CEO’s power—especially when that CEO is also Chair- man of the Board. An increasing number of shareholder resolutions to replace staggered boards with annual elections of all board members are currently being passed at annual meetings.

When nominating people for election to a board of directors, it is important that nominees have previous experience dealing with corporate issues. For example, research reveals that a firm makes better acquisition decisions when the firm’s outside directors have had experience with such decisions.64

A survey of directors of U.S. corporations revealed the following criteria in a good director:

� Willing to challenge management when necessary—95%

� Special expertise important to the company—67%

� Available outside meetings to advise management—57%

� Expertise on global business issues—41%

54 PA RT 1 Introduction to Strategic Management and Business Policy

� Understands the firm’s key technologies and processes—39%

� Brings external contacts that are potentially valuable to the firm—33%

� Has detailed knowledge of the firm’s industry—31%

� Has high visibility in his or her field—31%

� Is accomplished at representing the firm to stakeholders—18%65

ORGANIZATION OF THE BOARD The size of a board in the United States is determined by the corporation’s charter and its by- laws, in compliance with state laws. Although some states require a minimum number of board members, most corporations have quite a bit of discretion in determining board size. The av- erage large, publicly held U.S. firm has 10 directors on its board. The average small, privately- held company has four to five members. The average size of boards elsewhere is Japan, 14; Non-Japan Asia, 9; Germany, 16; UK, 10; and France, 11.66

Approximately 70% of the top executives of U.S. publicly held corporations hold the dual designation of Chairman and CEO. (Only 5% of the firms in the UK have a combined Chair/CEO.)67 The combined Chair/CEO position is being increasingly criticized because of the potential for conflict of interest. The CEO is supposed to concentrate on strategy, planning, external relations, and responsibility to the board. The Chairman’s responsibility is to ensure that the board and its committees perform their functions as stated in the board’s charter. Further, the Chairman schedules board meetings and presides over the annual shareholders’ meeting. Critics of having one person in the two offices ask how the board can properly oversee top management if the Chairman is also a part of top management. For this reason, the Chairman and CEO roles are separated by law in Germany, the Netherlands, South Africa, and Finland. A similar law has been considered in the United Kingdom and Australia. Although research is mixed regarding the impact of the combined Chair/CEO position on overall corporate finan- cial performance, firm stock price and credit ratings both respond negatively to announcements of CEOs also assuming the Chairman position.68 Research also shows that corporations with a combined Chair/CEO have a greater likelihood of fraudulent financial reporting when CEO stock options are not present.69

Many of those who prefer that the Chairman and CEO positions be combined agree that the outside directors should elect a lead director. This person is consulted by the Chair/CEO regarding board affairs and coordinates the annual evaluation of the CEO.70 The lead director position is very popular in the United Kingdom, where it originated. Of those U.S. companies combining the Chairman and CEO positions, 96% had a lead director.71 This is one way to give the board more power without undermining the power of the Chair/CEO. The lead director be- comes increasingly important because 94% of U.S. boards in 2006 (compared to only 41% in 2002) held regular executive sessions without the CEO being present.72 Nevertheless, there are many ways in which an unscrupulous Chair/CEO can guarantee a director’s loyalty. Research indicates that an increase in board independence often results in higher levels of CEO ingrati- ation behavior aimed at persuading directors to support CEO proposals. Long-tenured direc- tors who support the CEO may use social pressure to persuade a new board member to conform to the group. Directors are more likely to be recommended for membership on other boards if they “don’t rock the boat” and engage in low levels of monitoring and control behav- ior.73 Even in those situations when the board has a nominating committee composed only of outsiders, the committee often obtains the CEO’s approval for each new board candidate.74

The most effective boards accomplish much of their work through committees. Although they do not usually have legal duties, most committees are granted full power to act with the authority of the board between board meetings. Typical standing committees (in order of

C H A P T E R 2 Corporate Governance 55

prevalence) are the audit (100%), compensation (99%), nominating (97%), corporate gover- nance (94%), stock options (84%), director compensation (52%), and executive (43%) com- mittees.75 The executive committee is usually composed of two inside and two outside directors located nearby who can meet between board meetings to attend to matters that must be settled quickly. This committee acts as an extension of the board and, consequently, may have almost unrestricted authority in certain areas.76 Except for the executive, finance, and in- vestment committees, board committees are now typically staffed only by outside directors. Although each board committee typically meets four to five times annually, the average audit committee met nine times during 2006.77

IMPACT OF THE SARBANES-OXLEY ACT ON U.S. CORPORATE GOVERNANCE

In response to the many corporate scandals uncovered since 2000, the U.S. Congress passed the Sarbanes-Oxley Act in June 2002. This act was designed to protect shareholders from the ex- cesses and failed oversight that characterized failures at Enron, Tyco, WorldCom, Adelphia Communications, Qwest, and Global Crossing, among other prominent firms. Several key el- ements of Sarbanes-Oxley were designed to formalize greater board independence and over- sight. For example, the act requires that all directors serving on the audit committee be independent of the firm and receive no fees other than for services of the director. In addition, boards may no longer grant loans to corporate officers. The act has also established formal pro- cedures for individuals (known as “whistleblowers”) to report incidents of questionable ac- counting or auditing. Firms are prohibited from retaliating against anyone reporting wrongdoing. Both the CEO and CFO must certify the corporation’s financial information. The act bans auditors from providing both external and internal audit services to the same company. It also requires that a firm identify whether it has a “financial expert” serving on the audit com- mittee who is independent from management.

Although the cost to a large corporation of implementing the provisions of the law was $8.5 million in 2004, the first year of compliance, the costs to a large firm fell to $1–$5 million annually during the following years as accounting and information processes were refined and made more efficient.78 Pitney Bowes, for example, saved more than $500,000 in 2005 simply by consolidating four accounts receivable offices into one. Similar savings were realized at Cisco and Genentech.79 An additional benefit of the increased disclosure require- ments is more reliable corporate financial statements. Companies are now reporting numbers with fewer adjustments for unusual charges and write-offs, which in the past have been used to boost reported earnings.80 The new rules have also made it more difficult for firms to post-date executive stock options. “This is an unintended consequence of disclosure,” remarked Gregory Taxin, CEO of Glass, Lewis & Company, a stock research firm.81 See the Global Issue feature to learn how corporate governance is being improved in other parts of the world.

Improving Governance In implementing the Sarbanes-Oxley Act, the U.S. Securities and Exchange Commission (SEC) required in 2003 that a company disclose whether it has adopted a code of ethics that applies to the CEO and to the company’s principal financial officer. Among other things, the SEC requires that the audit, nominating, and compensation committees be staffed entirely by outside directors. The New York Stock Exchange reinforced the mandates of Sarbanes-Oxley by requiring that companies have a nominating/governance committee composed entirely of independent outside directors. Similarly, NASDAQ rules require that nominations for new di- rectors be made by either a nominating committee of independent outsiders or by a majority of independent outside directors.82

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CORPORATE GOVERNANCE IMPROVEMENTS THROUGHOUT THE WORLD

Countries throughout the world are working to im-

prove corporate governance. Provisions that are roughly equiv-

alent to Sarbanes-Oxley are in place in France and Japan, while both China and Canada are im- plementing similar rules. In the UK, the Cadbury Report has led to revisions to the Combined Code of Conduct that have placed additional responsibilities on non-management di- rectors, altered board and committee composition, and modified the roles of the CEO and Chairman. The adoption of recommendations from the government-sponsored Cromme Commission has reduced the power of manage- ment directors and increased the transparency of Germany’s two-tier system of governance. Italy has implemented the Draghi Law of 1998 and the Preda Code of Conduct. Since many corporations in non-Japan Asia are family-controlled or have stock that is at least partially owned by the state, the Anglo-American system of corporate governance does not quite fit. Nevertheless, many of the changes in other parts of the world, such as CEO performance reviews and executive succession planning, are taking place in Asian corporations.

In an attempt to make Korean businesses more attrac- tive to foreign investors, for example, the South Korean government recommended that companies listed on the stock exchange introduce a two-tiered structure. One structure was to consist entirely of non-executive (outside) directors. One of the few companies to immediately adopt this new system of governance was Pohang Iron & Steel Company Ltd. (POSCO), the world’s largest steelmaker. POSCO was listed on the New York Stock Exchange and had significant operations in the United States, plus a joint venture with U.S. Steel. According to Youn-Gil Ro, Corpo- rate Information Team Manager, “We needed professional advice on international business practices as well as Amer- ican practices.”

SOURCES: A. L. Nazareth, “Keeping SarbOx Is Crucial,” Business Week (November 13, 2006), p. 134; 33rd Annual Board of Directors Study (New York: Korn/Ferry International, 2007); C. A. Mallin, editor, Handbook on International Corporate Governance (Northampton, Massachusetts: Edward Elgar Publishing, 2006). Globalizing the Board of Directors: Trends and Strategies (New York: Conference Board, 1999), p. 16.

Partially in response to Sarbanes-Oxley, a survey of directors of Fortune 1000 U.S. compa- nies by Mercer Delta Consulting and the University of Southern California revealed that 60% of directors were spending more time on board matters than before Sarbanes-Oxley, with 85% spending more time on their company’s accounts, 83% more on governance practices, and 52% on monitoring financial performance.83 Newly elected outside directors with financial manage- ment experience increased to 10% of all outside directors in 2003 from only 1% of outsiders in 1998.84 Seventy-eight percent of Fortune 1000 U.S. boards in 2006 required that directors own stock in the corporation, compared to just 36% in Europe, and 26% in Asia.85

Evaluating Governance To help investors evaluate a firm’s corporate governance, a number of independent rating services, such as Standard & Poor’s (S&P), Moody’s, Morningstar, The Corporate Library, Institutional Shareholder Services (ISS), and Governance Metrics International (GMI), have established criteria for good governance. Business Week annually publishes a list of the best and worst boards of U.S. corporations. Whereas rating service firms like S&P, Moody’s, and The Corporate Library use a wide mix of research data and criteria to evaluate companies, ISS and GMI have been criticized because they primarily use public records to score firms, using simple checklists.86 In contrast, the S&P Corporate Governance Scoring System researches four major issues:

� Ownership Structure and Influence

� Financial Stakeholder Rights and Relations

GLOBAL issue

C H A P T E R 2 Corporate Governance 57

� Financial Transparency and Information Disclosure

� Board Structure and Processes

Although the S&P scoring system is proprietary and confidential, independent re- search using generally accepted measures of S&P’s four issues revealed that moving from the poorest- to the best-governed categories nearly doubled a firm’s likelihood of receiv- ing an investment-grade credit rating.87

Avoiding Governance Improvements A number of corporations are concerned that various requirements to improve corporate gov- ernance will constrain top management’s ability to effectively manage the company. For ex- ample, more U.S. public corporations have gone private in the years since the passage of Sarbanes-Oxley than before its passage. Other companies use multiple classes of stock to keep outsiders from having sufficient voting power to change the company. Insiders, usually the company’s founders, get stock with extra votes, while others get second-class stock with fewer votes. For example, Brian Roberts, CEO of Comcast, owns “superstock” that represents only 0.4% of outstanding common stock but guarantees him one-third of the voting stock. The In- vestor Responsibility Research Center reports that 11.3% of the companies it monitored in 2004 had multiple classes, up from 7.5% in 1990.88

Another approach to sidestepping new governance requirements is being used by corpora- tions such as Google, Infrasource Services, Orbitz, and W&T Offshore. If a corporation in which an individual group or another company controls more than 50% of the voting shares de- cides to become a “controlled company,” the firm is then exempt from requirements by the New York Stock Exchange and NASDAQ that a majority of the board and all members of key board committees be independent outsiders. According to governance authority Jay Lorsch, this will result in a situation in which “the majority shareholders can walk all over the minority.”89

TRENDS IN CORPORATE GOVERNANCE The role of the board of directors in the strategic management of a corporation is likely to be more active in the future. Although neither the composition of boards nor the board leadership structure has been consistently linked to firm financial performance, better governance does lead to higher credit ratings and stock prices. A McKinsey survey reveals that investors are willing to pay 16% more for a corporation’s stock if it is known to have good corporate gov- ernance. The investors explained that they would pay more because, in their opinion (1) good governance leads to better performance over time, (2) good governance reduces the risk of the company getting into trouble, and (3) governance is a major strategic issue.90

Some of today’s trends in governance (particularly prevalent in the United States and the United Kingdom) that are likely to continue include the following:

� Boards are getting more involved not only in reviewing and evaluating company strategy but also in shaping it.

� Institutional investors, such as pension funds, mutual funds, and insurance companies, are becoming active on boards and are putting increasing pressure on top management to improve corporate performance. This trend is supported by a U.S. SEC requirement that a mutual fund must publicly disclose the proxy votes cast at company board meetings in its portfolio. This reduces the tendency for mutual funds to rubber-stamp management proposals.91

� Shareholders are demanding that directors and top managers own more than token amounts of stock in the corporation. Research indicates that boards with equity ownership use quantifiable, verifiable criteria (instead of vague, qualitative criteria) to evaluate the CEO.92 When compensation committee members are significant shareholders, they tend

58 PA RT 1 Introduction to Strategic Management and Business Policy

to offer the CEO less salary but with a higher incentive component than do compensation committee members who own little to no stock.93

� Non-affiliated outside (non-management) directors are increasing their numbers and power in publicly held corporations as CEOs loosen their grip on boards. Outside mem- bers are taking charge of annual CEO evaluations.

� Women and minorities are being increasingly represented on boards.

� Boards are establishing mandatory retirement ages for board members—typically around age 70.

� Boards are evaluating not only their own overall performance, but also that of individual directors.

� Boards are getting smaller—partially because of the reduction in the number of insiders but also because boards desire new directors to have specialized knowledge and expertise instead of general experience.

� Boards continue to take more control of board functions by either splitting the combined Chair/CEO into two separate positions or establishing a lead outside director position.

� Boards are eliminating 1970s anti-takeover defenses that served to entrench current man- agement. In just one year, for example, 66 boards repealed their staggered boards and 25 eliminated poison pills.94

� As corporations become more global, they are increasingly looking for board members with international experience.

� Instead of merely being able to vote for or against directors nominated by the board’s nominating committee, shareholders may eventually be allowed to nominate board mem- bers. This was originally proposed by the U.S. Securities and Exchange Commission in 2004, but was not implemented. Supported by the AFL-CIO, a more open nominating process would enable shareholders to vote out directors who ignore shareholder interests.95

� Society, in the form of special interest groups, increasingly expects boards of directors to balance the economic goal of profitability with the social needs of society. Issues dealing with workforce diversity and environmental sustainability are now reaching the board level. (See the Environmental Sustainability Issue feature for an example of a conflict between a CEO and the board of directors over environmental issues.)

2.2 The Role of Top Management The top management function is usually conducted by the CEO of the corporation in coordi- nation with the COO (Chief Operating Officer) or president, executive vice president, and vice presidents of divisions and functional areas.96 Even though strategic management involves everyone in the organization, the board of directors holds top management primarily respon- sible for the strategic management of a firm.97

RESPONSIBILITIES OF TOP MANAGEMENT Top management responsibilities, especially those of the CEO, involve getting things ac- complished through and with others in order to meet the corporate objectives. Top manage- ment’s job is thus multidimensional and is oriented toward the welfare of the total

C H A P T E R 2 Corporate Governance 59

CONFLICT AT THE BODY SHOP

of Roddick’s social and environmental “radicalism,” the board forced her to resign as CEO. Roddick and her husband (with just 18% of the stock) remained on the board as co- chairmen until 2002, when they were replaced. Roddick continued to carry out public relations functions for the company and traveled the world in search of new product ideas, but no longer had any control over the strategic direc- tion of the firm she had founded.

On March 17, 2006, the Body Shop’s board agreed to the company’s sale to L’Oreal for a premium of 34.2% over the company’s stock price. The sale was perceived by ob- servers as quite ironic, given that for years Anita Roddick had criticized L’Oreal for its animal testing practices and for its exploitation of women in the workplace. On its Web site, Naturewatch said: “We feel that the Body Shop has ‘sold out’ and is not standing on its principles.” Animal rights activists and some consumers vowed to boycott Body Shop stores. Within three weeks of the announce- ment, the Body Shop’s “satisfaction” rating compiled by BrandIndex fell 11 points, to 14, its “buzz” rating fell by 10 points, to �4, and its “general impression” fell by 3 points, to 19. One Body Shop customer reflected the widespread dissatisfaction: “The Body Shop used to be my high street “safe house,” a place where I could walk into and know that what I bought was okay, that people were actually benefiting from my purchase. . . . By buying from the Body Shop, you are now no longer supporting ethical con- sumerism. If I want legitimate fair-trade, non-animal tested products, I can find them easily, at the same price, else- where.”

When Anita Roddick opened the first Body Shop

in 1976, she probably had no idea that she would become

one of the first “green” business executives. She simply liked the idea of

selling cosmetics in small sizes that were made from natu- ral ingredients. By 1998, her entrepreneurial venture grew through franchising into a global business with 1,594 shops in 47 countries. Roddick’s personal philosophy in fa- vor of human rights, endangered wildlife, and the environ- ment, while being strongly against the use of animals in testing cosmetics, became an inherent part of the com- pany’s philosophy of business. Reflecting an environmental awareness far in advance of other firms, the company’s pub- lication, This Is the Body Shop, stated: “We aim to avoid ex- cessive packaging, to refill our bottles, and to recycle our packaging and use raw materials from renewable sources when technologically and economically feasible.” The com- pany drafted the European Union’s Eco-Management and Audit Regulation in 1991 and the company’s first environ- mental statement, The Green Book, in 1992.

The Body Shop became a publicly traded corporation in 1984 when it was listed on London’s Unlisted Securities Market for just 95 pence per stock. By 1986, the stock price had increased ten-fold in value and was listed on the Lon- don Stock Exchange. The company grew quickly to be worth 700 million British pounds in 1991. Although the in- flux of money from the sale of stock enabled the company to expand throughout the world, there were disadvantages to having shareholders and a board of directors. Some shareholders began to complain that the company was di- verting money into social projects instead of maximizing profits. Roddick had used her position as CEO to join the Body Shop with Greenpeace’s “Save the Whales” cam- paign and to form alliances with Amnesty International and Friends of the Earth. Although the company continued to grow in size, its market value was declining by 1998. Tiring

SOURCES: E. A. Fogarty, J. P. Vincelette, and T. L. Wheelen, “The Body Shop International PLC: Anita Roddick, OBE,” in T. L. Wheelen and J. D. Hunger, Strategic Management and Business Policy, 8th ed. (Upper Saddle River, NJ: Prentice Hall, 2002), pp. 7.1–7.26; D. Purkayastha and R. Fernando, The Body Shop: Social Responsi- bility or Sustained Greenwashing? (Hyderabad, India: ICFAI Center for Management Research, 2006).

ENVIRONMENTAL sustainability issue

organization. Specific top management tasks vary from firm to firm and are developed from an analysis of the mission, objectives, strategies, and key activities of the corporation. Tasks are typically divided among the members of the top management team. A diversity of skills can thus be very important. Research indicates that top management teams with a diversity of functional backgrounds, experiences, and length of time with the company tend to be signifi- cantly related to improvements in corporate market share and profitability.98 In addition, highly diverse teams with some international experience tend to emphasize international

60 PA RT 1 Introduction to Strategic Management and Business Policy

growth strategies and strategic innovation, especially in uncertain environments, to boost fi- nancial performance.99 The CEO, with the support of the rest of the top management team, must successfully handle two primary responsibilities that are crucial to the effective strategic management of the corporation: (1) provide executive leadership and a strategic vision and (2) manage the strategic planning process.

Executive Leadership and Strategic Vision Executive leadership is the directing of activities toward the accomplishment of corporate objectives. Executive leadership is important because it sets the tone for the entire corpora- tion. A strategic vision is a description of what the company is capable of becoming. It is of- ten communicated in the company’s mission and vision statements (as described in Chapter 1). People in an organization want to have a sense of mission, but only top management is in the position to specify and communicate this strategic vision to the general workforce. Top man- agement’s enthusiasm (or lack of it) about the corporation tends to be contagious. The impor- tance of executive leadership is illustrated by Steve Reinemund, past-CEO of PepsiCo: “A leader’s job is to define overall direction and motivate others to get there.”100

Successful CEOs are noted for having a clear strategic vision, a strong passion for their com- pany, and an ability to communicate with others. They are often perceived to be dynamic and charismatic leaders—which is especially important for high firm performance and investor con- fidence in uncertain environments.101 They have many of the characteristics of transformational leaders—that is, leaders who provide change and movement in an organization by providing a vision for that change.102 For instance, the positive attitude characterizing many well- known industrial leaders—such as Bill Gates at Microsoft, Anita Roddick at the Body Shop, Richard Branson at Virgin, Steve Jobs at Apple Computer, Phil Knight at Nike, Bob Lutz at General Motors, and Louis Gerstner at IBM—has energized their respective corporations. These transformational leaders have been able to command respect and to influence strategy for- mulation and implementation because they tend to have three key characteristics:103

1. The CEO articulates a strategic vision for the corporation: The CEO envisions the company not as it currently is but as it can become. The new perspective that the CEO’s vision brings to activities and conflicts gives renewed meaning to everyone’s work and enables employees to see beyond the details of their own jobs to the functioning of the to- tal corporation.104 Louis Gerstner proposed a new vision for IBM when he proposed that the company change its business model from computer hardware to services: “If cus- tomers were going to look to an integrator to help them envision, design, and build end- to-end solutions, then the companies playing that role would exert tremendous influence over the full range of technology decisions—from architecture and applications to hard- ware and software choices.”105 In a survey of 1,500 senior executives from 20 different countries, when asked the most important behavioral trait a CEO must have, 98% re- sponded that the CEO must convey “a strong sense of vision.”106

2. The CEO presents a role for others to identify with and to follow: The leader em- pathizes with followers and sets an example in terms of behavior, dress, and actions. The CEO’s attitudes and values concerning the corporation’s purpose and activities are clear- cut and constantly communicated in words and deeds. For example, when design engi- neers at General Motors had problems with monitor resolution using the Windows operating system, Steve Ballmer, CEO of Microsoft, personally crawled under conference room tables to plug in PC monitors and diagnose the problem.107 People know what to ex- pect and have trust in their CEO. Research indicates that businesses in which the general manager has the trust of the employees have higher sales and profits with lower turnover than do businesses in which there is a lesser amount of trust.108

C H A P T E R 2 Corporate Governance 61

3. The CEO communicates high performance standards and also shows confidence in the followers’ abilities to meet these standards: The leader empowers followers by rais- ing their beliefs in their own capabilities. No leader ever improved performance by set- ting easily attainable goals that provided no challenge. Communicating high expectations to others can often lead to high performance.109 The CEO must be willing to follow through by coaching people. As a result, employees view their work as very important and thus motivating.110 Ivan Seidenberg, chief executive of Verizon Communications, was closely involved in deciding Verizon’s strategic direction, and he showed his faith in his people by letting his key managers handle important projects and represent the company in public forums. “All of these people could be CEOs in their own right. They are war- riors and they are on a mission,” explained Seidenberg. Grateful for his faith in them, his managers were fiercely loyal both to him and the company.111

The negative side of confident executive leaders is that their very confidence may lead to hubris, in which their confidence blinds them to information that is contrary to a decided course of action. For example, overconfident CEOs tend to charge ahead with mergers and acquisitions even though they are aware that most acquisitions destroy shareholder value. Re- search by Tate and Malmendier found that “overconfident CEOs are more likely to conduct mergers than rational CEOs at any point in time. Overconfident CEOs view their company as undervalued by outside investors who are less optimistic about the prospects of the firm.” Overconfident CEOs were most likely to make acquisitions when they could avoid selling new stock to finance them, and they were more likely to do deals that diversified their firm’s lines of businesses.112

Managing the Strategic Planning Process As business corporations adopt more of the characteristics of the learning organization, strate- gic planning initiatives can come from any part of an organization. A survey of 156 large cor- porations throughout the world revealed that, in two-thirds of the firms, strategies were first proposed in the business units and sent to headquarters for approval.113 However, unless top management encourages and supports the planning process, strategic management is not likely to result. In most corporations, top management must initiate and manage the strategic plan- ning process. It may do so by first asking business units and functional areas to propose strate- gic plans for themselves, or it may begin by drafting an overall corporate plan within which the units can then build their own plans. Research suggests that bottom-up strategic planing may be most appropriate in multidivisional corporations operating in relatively stable environ- ments but that top-down strategic planning may be most appropriate for firms operating in tur- bulent environments.114 Other organizations engage in concurrent strategic planning in which all the organization’s units draft plans for themselves after they have been provided with the organization’s overall mission and objectives.

Regardless of the approach taken, the typical board of directors expects top management to manage the overall strategic planning process so that the plans of all the units and functional areas fit together into an overall corporate plan. Top management’s job therefore includes the tasks of evaluating unit plans and providing feedback. To do this, it may require each unit to justify its proposed objectives, strategies, and programs in terms of how well they satisfy the organization’s overall objectives in light of available resources. If a company is not organized into business units, top managers may work together as a team to do strategic planning. CEO Jeff Bezos tells how this is done at Amazon.com:

We have a group called the S Team—S meaning “senior” [management]—that stays abreast of what the company is working on and delves into strategy issues. It meets for about four hours every Tuesday. Once or twice a year the S Team also gets together in a two-day meeting where

62 PA RT 1 Introduction to Strategic Management and Business Policy

End of Chapter S U M M A R Y Who determines a corporation’s performance? According to the popular press, it is the chief executive officer who seems to be personally responsible for a company’s success or failure. When a company is in trouble, one of the first alternatives usually presented is to fire the CEO. That was certainly the case at the Walt Disney Company under Michael Eisner and Hewlett- Packard under Carly Fiorina. Both CEOs were first viewed as transformational leaders who made needed strategic changes to their companies. After a few years, both were perceived to be the primary reason for their company’s poor performance and were fired by their boards. The truth is rarely this simple.

According to research by Margarethe Wiersema, firing the CEO rarely solves a corpora- tion’s problems. In a study of CEO turnover caused by dismissals and retirements in the 500 largest public U.S. companies, 71% of the departures were involuntary. In those firms in which the CEO was fired or asked to resign and replaced by another, Wiersema found no significant improvement in the company’s operating earnings or stock price. She couldn’t find a single measure suggesting that CEO dismissal had a positive effect on corporate performance! Wiersema placed the blame for the poor results squarely on the shoulders of the boards of di- rectors. Boards typically lack an in-depth understanding of the business and consequently rely too heavily on executive search firms that know even less about the business. According to Wiersema, boards that successfully managed the executive succession process had three things in common:

� The board set the criteria for candidate selection based on the strategic needs of the company.

� The board set realistic performance expectations rather than demanding a quick fix to please the investment community.

� The board developed a deep understanding of the business and provided strong strategic oversight of top management, including thoughtful annual reviews of CEO performance.118

As noted at the beginning of this chapter, corporate governance involves not just the CEO or the board of directors. It involves the combined active participation of the board, top man- agement, and shareholders. One positive result of the many corporate scandals occurring over

different ideas are explored. Homework is assigned ahead of time. . . . Eventually we have to choose just a couple of things, if they’re big, and make bets.115

In contrast to the seemingly continuous strategic planning being done at Amazon.com, most large corporations conduct the strategic planning process just once a year—often at off- site strategy workshops attended by senior executives.116

Many large organizations have a strategic planning staff charged with supporting both top management and the business units in the strategic planning process. This staff may prepare the background materials used in senior management’s off-site strategy workshop. This plan- ning staff typically consists of fewer than ten people, headed by a senior executive with the ti- tle of Director of Corporate Development or Chief Strategy Officer. The staff’s major responsibilities are to:

1. Identify and analyze companywide strategic issues, and suggest corporate strategic alter- natives to top management.

2. Work as facilitators with business units to guide them through the strategic planning process.117

C H A P T E R 2 Corporate Governance 63

the past decade is the increased interest in governance. Institutional investors are no longer content to be passive shareholders. Thanks to new regulations, boards of directors are taking their responsibilities more seriously and including more independent outsiders on key over- sight committees. Top managers are beginning to understand the value of working with boards as partners, not just as adversaries or as people to be manipulated. Although there will always be passive shareholders, rubber-stamp boards, and dominating CEOs, the simple truth is that good corporate governance means better strategic management.

E C O - B I T S � DuPont, originally founded in 1802 to make gunpowder

and explosives, was a major producer in 1990 of nitrous oxides and fluorocarbons—gases with a global warm- ing potential 310 and 11,700 times that of carbon diox- ide, respectively.

� DuPont was the first company to phase-out CFCs and the first to develop and commercialize CFC alternatives for refrigeration and air conditioning.

� DuPont’s reputation changed from “Top U.S. Polluter of 1995” to Business Week’s list of “Top Green Compa- nies” in 2005; meanwhile, its earnings per share in- creased from $1 in 2003 to $3.25 in 2007.119

D I S C U S S I O N Q U E S T I O N S 1. When does a corporation need a board of directors?

2. Who should and should not serve on a board of directors? What about environmentalists or union leaders?

3. Should a CEO be allowed to serve on another company’s board of directors?

4. What would be the result if the only insider on a corpora- tion’s board were the CEO?

5. Should all CEOs be transformational leaders? Would you like to work for a transformational leader?

S T R A T E G I C P R A C T I C E E X E R C I S E A. Think of the best manager for whom you have ever

worked. What was it about this person that made him or her such a good manager? Consider the following state-

ments as they pertain to that person. Fill in the blank in front of each statement with one of the following values:

STRONGLY AGREE � 5; AGREE � 4; NEUTRAL � 3; DISAGREE � 2; STRONGLY DISAGREE � 1.

1. ___ I respect him/her personally, and want to act in a way that merits his/her respect and admiration. ___

2. ___ I respect her/his competence about things she/he is more experienced about than I. ___

3. ___ He/she can give special help to those who coop- erate with him/her. ___

4. ___ He/she can apply pressure on those who coop- erate with him/her. ___

5. ___ He/she has a legitimate right, considering his/her position, to expect that his/her sugges- tions will be carried out. ___

6. ___ I defer to his/her judgment in areas with which he/she is more familiar than I. ___

7. ___ He/she can make things difficult for me if I fail to follow his/her advice. ___

8. ___ Because of his/her job title and rank, I am obli- gated to follow his/her suggestions. ___

9. ___ I can personally benefit by cooperating with him/her. ___

10. ___ Following his/her advice results in better deci- sions. ___

11. ___ I cooperate with him/her because I have high re- gard for him/her as an individual. ___

12. ___ He/she can penalize those who do not follow his/her suggestions. ___

64 PA RT 1 Introduction to Strategic Management and Business Policy

BEST MANAGER

Reward Coercive Legitimate Referent Expert 3. 4. 5. 1. 2.

9. 7. 8. 11. 6.

15. 12. 13. 14. 10.

Total Total Total Total Total

WORST MANAGER

Reward Coercive Legitimate Referent Expert 3. 4. 5. 1. 2.

9. 7. 8. 11. 6.

15. 12. 13. 14. 10.

Total Total Total Total Total

K E Y T E R M S affiliated director (p. 49) agency theory (p. 48) board of directors’ continuum (p. 46) board of director responsibilities (p. 45) codetermination (p. 52) corporate governance (p. 45)

due care (p. 46) executive leadership (p. 60) inside director (p. 48) interlocking directorate (p. 52) lead director (p. 54) outside director (p. 48)

Sarbanes-Oxley Act (p. 55) stewardship theory (p. 49) strategic vision (p. 60) top management responsibilities (p. 58) transformational leader (p. 60)

13. ___ I feel I have to cooperate with him/her. ___

14. ___ I cooperate with him/her because I wish to be identified with him/her. ___

15. ___ Cooperating with him/her can positively affect my performance. ___

B. Now think of the worst manager for whom you have ever worked. What was it about this person that made him or her such a poor manager? Please consider the state- ments above as they pertain to that person. Please place a number after each statement with one of the values from 5 � strongly agree to 1 � strongly disagree.

C. Add the values you marked for the best manager within each of the five categories of power below. Then do the same for the values you marked for the worst manager.

SOURCE: Questionnaire developed by J. D. Hunger from the article “Influence and Information: An Exploratory Investigation of the Boundary Role Person’s Bases of Power” by Robert Spekman, Academy of Management Journal, March 1979. Copyright © 2004 by J. David Hunger.

D. Consider the differences between how you rated your best and your worst manager. How different are the two profiles? In many cases, the best manager’s profile tends to be similar to that of transformational leaders in that the best manager tends to score highest on referent, followed by expert and reward, power—especially when com-

pared to the worst manager’s profile. The worst manager often scores highest on coercive and legitimate power, followed by reward power. The results of this survey may help you to answer the fifth discussion question for this chapter.

C H A P T E R 2 Corporate Governance 65

N O T E S 1. R. Kirkland, “The Real CEO Pay Problem,” Fortune (July 10,

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12. Reported by E. L. Biggs in “CEO Succession Planning: An Emerging Challenge for Boards of Directors,” Academy of Management Executive (February 2004), pp. 105–107.

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66 PA RT 1 Introduction to Strategic Management and Business Policy

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39. 33rd Annual Board of Directors Study (New York: Korn/Ferry International, 2007), p. 21.

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41. I. Sager, “The Boardroom: New Rules, New Loopholes,” Business Week (November 29, 2004), p. 13.

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52. 33rd Annual Board of Directors Study (New York: Korn/Ferry International, 2007), p. 15.

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54. M. L. Gerlach, “The Japanese Corporate Network: A Block- model Analysis,” Administrative Science Quarterly (March 1992), pp. 105–139.

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59. J. A. C. Baum and C. Oliver, “Institutional Linkages and Orga- nizational Mortality,” Administrative Science Quarterly (June 1991) pp. 187–218; J. P. Sheppard, “Strategy and Bankruptcy: An Exploration into Organizational Death,” Journal of Man- agement (Winter 1994), pp. 795–833.

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71. D. R. Dalton, M. A. Hitt, S. Trevis Certo, and C. M. Dalton, “The Fundamental Agency Problem and Its Mitigation,” Chap- ter One in Academy of Management Annals, edited by J. F. Westfall and A. F. Brief (London: Rutledge, 2007).

72. 33rd Annual Board of Directors Study (New York: Korn/Ferry International, 2007), p. 21.

73. J. D. Westphal and I. Stern, “Flattery Will Get You Everywhere (Especially If You Are a Male Caucasian): How Ingratiation, Boardroom Behavior, and Demographic Minority Status Affect

C H A P T E R 2 Corporate Governance 67

91. A. Borrus and L. Young, “Nothing Like a Little Exposure,” Business Week (September 13, 2004), p. 92.

92. P. Silva, “Do Motivation and Equity Ownership Matter in Board of Directors’ Evaluation of CEO Performance?” Journal of Management Issues (Fall 2005), pp. 346–362.

93. L. He and M. J. Conyon, “The Role of Compensation Commit- tees in CEO and Committee Compensation Decisions,” paper presented to Academy of Management (Seattle, WA, 2003).

94. P. Coy, E. Thornton, M. Arndt, B. Grow, and A. Park, “Shake, Rattle, and Merge,” Business Week (January 10, 2005), pp. 32–35.

95. L. Lavelle, “A Fighting Chance for Boardroom Democracy,” Business Week (June 9, 2003), p. 50; L. Lavelle, “So That’s Why Boards Are Waking Up,” Business Week (January 19, 2004), pp. 72–73.

96. For a detailed description of the COO’s role, see N. Bennett and S. A. Miles, “Second in Command,” Harvard Business Review (May 2006), pp. 71–78.

97. S. Finkelstein and D. C. Hambrick, Strategic Leadership: Top Executives and Their Impact on Organizations (St. Louis: West, 1996).

98. H. G. Barkema and O. Shvyrkov, “Does Top Management Team Diversity Promote or Hamper Foreign Expansion?” Strategic Management Journal (July 2007), pp. 663–680; D. C. Ham- brick, T. S. Cho, and M-J Chen, “The Influence of Top Manage- ment Team Heterogeneity on Firms’ Competitive Moves,” Administrative Science Quarterly (December 1996), pp. 659–684.

99. P. Pitcher and A. D. Smith, “Top Management Heterogeneity: Personality, Power, and Proxies,” Organization Science (January–February 2001), pp. 1–18; M. A. Carpenter and J. W. Fredrickson, “Top Management Teams, Global Strategic Posture, and the Moderating Role of Uncertainty,” Academy of Management Journal (June 2001), pp. 533–545; M. A. Carpen- ter, “The Implications of Strategy and Social Context for the Relationship Between Top Management Team Heterogeneity and Firm Performance,” Strategic Management Journal (March 2002), pp. 275–284; L. Tihanyi, A. E. Ellstrand, C. M. Daily, and D. R. Dalton, “Composition of the Top Management Team and Firm International Expansion,” Journal of Management, Vol. 26, No. 6 (2000), pp. 1157–1177.

100. “One on One with Steve Reinemund,” Business Week (Decem- ber 17, 2001), Special advertising insert on leadership by Hei- drick & Struggles, executive search firm.

101. D. A. Waldman, G. G. Ramirez, R. J. House, and P. Puranam, “Does Leadership Matter? CEO Leadership Attributes and Profitability Under Conditions of Perceived Environmental Un- certainty,” Academy of Management Journal (February 2001), pp. 134–143; F. J. Flynn and B. M. Staw, “Lend Me Your Wal- lets: The Effect of Charismatic Leadership on External Support for an Organization,” Strategic Management Journal (April 2004), pp. 309–330.

102. J. Burns, Leadership (New York: HarperCollins, 1978); B. Bass, “From Transactional to Transformational Leadership: Learning to Share the Vision,” Organizational Dynamics, Vol. 18 (1990), pp. 19–31; W. Bennis and B. Nanus, Leaders: Strategies for Taking Charge (New York: HarperCollins, 1997).

103. Based on R. J. House, “A 1976 Theory of Charismatic Leader- ship,” in J. G. Hunt and L. L. Larson (Eds.), Leadership: The Cutting Edge (Carbondale, IL: Southern Illinois University Press, 1976), pp. 189–207. Also see J. Choi, “A Motivational Theory of Charismatic Leadership: Envisioning, Empathy, and Empowerment,” Journal of Leadership and Organizational Studies (2006), Vol. 13, No. 1, pp. 24–43.

104. I. D. Colville and A. J. Murphy, “Leadership as the Enabler of Strategizing and Organizing,” Long Range Planning (Decem- ber 2006), pp. 663–677.

105. L. V. Gerstner Jr., Who Says Elephants Can’t Dance? (New York: HarperCollins, 2002), p. 124.

106. M. Lipton, “Demystifying the Development of an Organizational Vision,” Sloan Management Review (Summer 1996), p. 84.

107. S. Hahn, “Why High Tech Has to Stay Humble,” Business Week (January 19, 2004), pp. 76–77.

108. J. H. David, F. D. Schoorman, R. Mayer, and H. H. Tan, “The Trusted General Manager and Business Unit Performance: Em- pirical Evidence of a Competitive Advantage,” Strategic Man- agement Journal (May 2000), pp. 563–576.

109. D. B. McNatt and T. A. Judge, “Boundary Conditions of the Galatea Effect: A Field Experiment and Constructive Replica- tion,” Academy of Management Journal (August 2004), pp. 550–565.

110. R. F. Piccolo and J. A. Colquitt, “Transformational Leadership and Job Behaviors: The Mediating Role of Core Job Character- istics,” Academy of Management Journal (April 2006), pp. 327–340; J. E. Bono and T. A. Judge, “Self-Concordance at Work: Toward Understanding the Motivational Effects of Transformational Leaders,” Academy of Management Journal (October 2003), pp. 554–571.

111. T. Lowry, R. O. Crockett, and I. M. Kunii, “Verizon’s Gutsy Bet,” Business Week (August 4, 2003), pp. 52–62.

112. G. Tate and U. Malmendier, “Who Makes Acquisitions? CEO Overconfidence and the Market’s Reaction,” summarized by Knowledge @ Wharton (February 25, 2004).

113. M. C. Mankins and R. Steele, “Stop Making Plans, Start Mak- ing Decisions,” Harvard Business Review (January 2006), pp. 76–84.

114. T. R. Eisenmann and J. L. Bower, “The Entrepreneurial M Form: Strategic Integration in Global Media Firms,” Organization Science (May–June 2000), pp. 348–355.

115. J. Kirby and T. A. Stewart, “The Institutional Yes,” Harvard Business Review (October 2007), p. 76.

116. M. C. Mankins and R. Steele, “Stop Making Plans, Start Mak- ing Decisions,” Harvard Business Review (January 2006), pp. 76–84; G. P. Hodgkinson, R. Whittington, G. Johnson,

68 PA RT 1 Introduction to Strategic Management and Business Policy

and M. Schwarz, “The Role of Strategy Workshops in Strategy Development Processes: Formality, Communication, Co-ordination and Inclusion,” Long Range Planning (October 2006), pp. 479–496; B. Frisch and L. Chandler, “Off-Sites That Work,” Harvard Business Review (June 2006), pp. 117–126.

117. For a description of the Chief Strategy Officer, see R. T. S. Breene, P. F. Nunes, and W. E. Shill, “The Chief Strategy

Officer,” Harvard Business Review (October 2007), pp. 84–93; R. Dye, “How Chief Strategy Officers Think about their Role: A Roundtable,” McKinsey Quarterly (May 2008), pp. 1–8.

118. M. Wiersema, “Holes at the Top: Why CEO Firings Backfire,” Harvard Business Review (December 2002), pp. 70–77.

119. C. Laszlo, Sustainable Value: How the World’s Leading Companies Are Doing Well by Doing Good (Stanford, CA: Stanford University Press, 2008), pp. 81–88.

C H A P T E R 2 Corporate Governance 69

Only a few miles from the gleaming skyscrapers of prosperous Minneapolis was a neighborhood littered with shattered glass from stolen cars and derelict

houses used by drug lords. During the 1990s, the Hawthorne neighborhood

became a no-man’s-land where gun battles terrified local residents and raised

the per capita murder rate 70% higher than that of New York.

Executives at General Mills became concerned when the murder rate reached a

record high in 1996. The company’s headquarters was located just five miles away from

Hawthorne, then the city’s most violent neighborhood. Working with law enforcement, politi-

cians, community leaders, and residents, General Mills spent $2.5 million and donated thou-

sands of employee hours to help clean up Hawthorne. Crack houses were demolished to make

way for a new elementary school. Dilapidated houses in the neighborhood’s core were rebuilt.

General Mills provided grants to help people buy Hawthorne’s houses. By 2003, homicides were

down 32% and robberies had declined 56% in Hawthorne.

This story was nothing new for General Mills, a company often listed in Fortune magazine’s

“Most Admired Companies,” ranked third most socially responsible company in a survey con-

ducted by The Wall Street Journal and Harris Interactive, and fourth in Business Week’s 2007 sur-

vey of “most generous corporate donors.” Since 2000, the company has annually contributed

5% of pretax profits to a wide variety of social causes. In 2007, for example, the company do-

nated $82 million to causes ranging from education and the arts to social services. Every day, the

company ships three truckloads of Cheerios, Wheaties, and other packaged goods to food banks

throughout the nation. Community performance is even reflected in the performance reviews

of top management. According to Christina Shea, president of General Mills Foundation, “We

take as innovative approach to giving back to our communities as we do in our business.” For

joining with a nonprofit organization and a minority-owned food company to create 150 inner-

city jobs, General Mills received Business Ethics’ annual corporate citizenship award.1

Was this the best use of General Mills’ time and money? At a time when companies were

being pressured to cut costs and outsource jobs to countries with cheaper labor, what do busi-

ness corporations owe their local communities? Should business firms give away shareholders’

money, support social causes, and ask employees to donate their time to the community? Crit-

ics argue that this sort of thing is done best by government and not-for-profit charities. Isn’t the

primary goal of business to maximize profits, not to be a social worker?

social responsibility and ethics in Strategic Management

C H A P T E R 3

71

� Compare and contrast Friedman’s traditional view with Carroll’s contemporary view of social responsibility

� Understand the relationship between social responsibility and corporate performance

� Explain the concept of sustainability

� Conduct a stakeholder analysis � Explain why people may act unethically � Describe different views of ethics

according to the utilitarian, individual rights, and justice approaches

Learning Objectives

Gathering Information

Putting Strategy into Action

Monitoring Performance

Societal Environment: General forces

Natural Environment: Resources and

climate

Task Environment:

Industry analysis

Internal: Strengths and Weaknesses

Structure: Chain of command

Culture: Beliefs, expectations,

values

Resources: Assets, skills, competencies,

knowledge

Programs

Activities needed to accomplish a plan

Budgets

Cost of the programs Procedures

Sequence of steps needed to do the job

Performance

Actual results

External: Opportunities

and Threats

Developing Long-range Plans

Mission

Reason for existence Objectives

What results to accomplish by when

Strategies

Plan to achieve the mission & objectives

Policies

Broad guidelines for decision making

Environmental Scanning:

Strategy Formulation:

Strategy Implementation:

Evaluation and Control:

Feedback/Learning: Make corrections as needed

After reading this chapter, you should be able to:

3.1 Social Responsibilities of Strategic Decision Makers Should strategic decision makers be responsible only to shareholders, or do they have broader responsibilities? The concept of social responsibility proposes that a private corporation has responsibilities to society that extend beyond making a profit. Strategic decisions often affect more than just the corporation. A decision to retrench by closing some plants and discontinu- ing product lines, for example, affects not only the firm’s workforce but also the communities where the plants are located and the customers with no other source for the discontinued prod- uct. Such situations raise questions of the appropriateness of certain missions, objectives, and strategies of business corporations. Managers must be able to deal with these conflicting in- terests in an ethical manner to formulate a viable strategic plan.

RESPONSIBILITIES OF A BUSINESS FIRM What are the responsibilities of a business firm and how many of them must be fulfilled? Milton Friedman and Archie Carroll offer two contrasting views of the responsibilities of busi- ness firms to society.

Friedman’s Traditional View of Business Responsibility Urging a return to a laissez-faire worldwide economy with a minimum of government regula- tion, Milton Friedman argues against the concept of social responsibility. A business person who acts “responsibly” by cutting the price of the firm’s product to prevent inflation, or by making expenditures to reduce pollution, or by hiring the hard-core unemployed, according to Friedman, is spending the shareholder’s money for a general social interest. Even if the busi- nessperson has shareholder permission or encouragement to do so, he or she is still acting from motives other than economic and may, in the long run, harm the very society the firm is try- ing to help. By taking on the burden of these social costs, the business becomes less efficient— either prices go up to pay for the increased costs or investment in new activities and research is postponed. These results negatively affect—perhaps fatally—the long-term efficiency of a business. Friedman thus referred to the social responsibility of business as a “fundamentally subversive doctrine” and stated that:

There is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.2

Following Friedman’s reasoning, the management of General Mills was clearly guilty of misusing corporate assets and negatively affecting shareholder wealth. The millions spent in social services could have been invested in new product development or given back as divi- dends to the shareholders. Instead of General Mills’ management acting on its own, sharehold- ers could have decided which charities to support.

Carroll’s Four Responsibilities of Business Friedman’s contention that the primary goal of business is profit maximization is only one side of an ongoing debate regarding corporate social responsibility (CSR). According to William J. Byron, Distinguished Professor of Ethics at Georgetown University and past-President of Catholic University of America, profits are merely a means to an end, not an end in itself. Just as a person needs food to survive and grow, so does a business corporation need profits to sur- vive and grow. “Maximizing profits is like maximizing food.” Thus, contends Byron, maxi- mization of profits cannot be the primary obligation of business.3

72 PA RT 1 Introduction to Strategic Management and Business Policy

C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 73

Discretionary

Ethical

LegalEconomic

Social Responsibilities

FIGURE 3–1 Responsibilities

of Business

As shown in Figure 3–1, Archie Carroll proposes that the managers of business organi- zations have four responsibilities: economic, legal, ethical, and discretionary.4

1. Economic responsibilities of a business organization’s management are to produce goods and services of value to society so that the firm may repay its creditors and shareholders.

2. Legal responsibilities are defined by governments in laws that management is expected to obey. For example, U.S. business firms are required to hire and promote people based on their credentials rather than to discriminate on non-job-related characteristics such as race, gender, or religion.

3. Ethical responsibilities of an organization’s management are to follow the generally held beliefs about behavior in a society. For example, society generally expects firms to work with the employees and the community in planning for layoffs, even though no law may require this. The affected people can get very upset if an organization’s management fails to act according to generally prevailing ethical values.

4. Discretionary responsibilities are the purely voluntary obligations a corporation as- sumes. Examples are philanthropic contributions, training the hard-core unemployed, and providing day-care centers. The difference between ethical and discretionary responsibil- ities is that few people expect an organization to fulfill discretionary responsibilities, whereas many expect an organization to fulfill ethical ones.5

Carroll lists these four responsibilities in order of priority. A business firm must first make a profit to satisfy its economic responsibilities. To continue in existence, the firm must follow the laws, thus fulfilling its legal responsibilities. There is evidence that companies found guilty of violating laws have lower profits and sales growth after conviction.6 To this point Carroll and Friedman are in agreement. Carroll, however, goes further by arguing that business man- agers have responsibilities beyond economic and legal ones.

Having satisfied the two basic responsibilities, according to Carroll, a firm should look to fulfilling its social responsibilities. Social responsibility, therefore, includes both ethical and discretionary, but not economic and legal, responsibilities. A firm can fulfill its ethical respon- sibilities by taking actions that society tends to value but has not yet put into law. When ethi- cal responsibilities are satisfied, a firm can focus on discretionary responsibilities—purely voluntary actions that society has not yet decided are important. For example, when Cisco Sys- tems decided to dismiss 6,000 full-time employees, it provided a novel severance package. Those employees who agreed to work for a local nonprofit organization for a year would re- ceive one-third of their salaries plus benefits and stock options and be the first to be rehired. Nonprofits were delighted to hire such highly qualified people and Cisco was able to maintain its talent pool for when it could hire once again.7

SOURCE: Based on A. B. Carroll, “A Three Dimensional Conceptual Model of Corporate Performance,” Academy of Management Review (October 1979), pp. 497–505; A. B. Carroll, “Managing Ethically with Global Stakeholders: A Present and Future Challenge,” Academy of Management Executive (May 2004), pp. 114–120; and A. B. Carroll, “The Pyramid of Corporate Social Responsibility: Toward the Moral Management of Organizational Stakeholders,” Business Horizons (July–August 1991), pp. 39–48.

As societal values evolve, the discretionary responsibilities of today may become the eth- ical responsibilities of tomorrow. For example, in 1990, 86% of people in the U.S. believed that obesity was caused by the individuals themselves, with only 14% blaming either corpo- rate marketing or government guidelines. By 2003, however, only 54% blamed obesity on in- dividuals and 46% put responsibility on corporate marketing and government guidelines. Thus, the offering of healthy, low-calorie food by food processors and restaurants is moving rapidly from being a discretionary to an ethical responsibility.8 One example of this change in values is the film documentary Super Size Me, which criticizes the health benefits of eating McDonald’s deep-fried fast food. (McDonald’s responded by offering more healthy food items.)

Carroll suggests that to the extent that business corporations fail to acknowledge discre- tionary or ethical responsibilities, society, through government, will act, making them legal re- sponsibilities. Government may do this, moreover, without regard to an organization’s economic responsibilities. As a result, the organization may have greater difficulty in earning a profit than it would have if it had voluntarily assumed some ethical and discretionary responsibilities.

Both Friedman and Carroll argue their positions based on the impact of socially respon- sible actions on a firm’s profits. Friedman says that socially responsible actions hurt a firm’s efficiency. Carroll proposes that a lack of social responsibility results in increased government regulations, which reduce a firm’s efficiency.

Friedman’s position on social responsibility appears to be losing traction with business ex- ecutives. For example, a 2006 survey of business executives across the world by McKinsey & Company revealed that only 16% felt that business should focus solely on providing the highest possible returns to investors while obeying all laws and regulations, contrasted with 84% who stated that business should generate high returns to investors but balance it with contributions to the broader public good.9 A 2007 survey of global executives by the Economist Intelligence Unit found that the percentage of companies giving either high or very high priority to corpo- rate social responsibility had risen from less than 40% in 2004 to over 50% in 2007 and was expected to increase to almost 70% by 2010.10

Empirical research now indicates that socially responsible actions may have a positive ef- fect on a firm’s financial performance. Although a number of studies in the past have found no significant relationship,11 an increasing number are finding a small, but positive relationship.12

A recent in-depth analysis by Margolis and Walsh of 127 studies found that “there is a posi- tive association and very little evidence of a negative association between a company’s social performance and its financial performance.”13 Another meta-analysis of 52 studies on social responsibility and performance reached this same conclusion.14

According to Porter and Kramer, “social and economic goals are not inherently conflict- ing, but integrally connected.”15 Being known as a socially responsible firm may provide a company with social capital, the goodwill of key stakeholders, that can be used for competi- tive advantage.16 Target, for example, tries to attract socially concerned younger consumers by offering brands from companies that can boost ethical track records and community involve- ment.17 In a 2004 study conducted by the strategic marketing firm Cone, Inc., eight in ten Americans said that corporate support of social causes helps earn their loyalty. This was a 21% increase since 1997.18

Being socially responsible does provide a firm a more positive overall reputation.19 A sur- vey of more than 700 global companies by the Conference Board reported that 60% of the managers state that citizenship activities had led to (1) goodwill that opened doors in local communities and (2) an enhanced reputation with consumers.20 Another survey of 140 U.S. firms revealed that being more socially responsible regarding environmental sustainability resulted not only in competitive advantages but also in cost savings.21 For example, compa- nies that take the lead in being environmentally friendly, such as by using recycled materials, preempt attacks from environmental groups and enhance their corporate image. Programs to

74 PA RT 1 Introduction to Strategic Management and Business Policy

C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 75

reduce pollution, for example, can actually reduce waste and maximize resource productivity. One study that examined 70 ecological initiatives taken by 43 companies found the average payback period to be 18 months.22 Other examples of benefits received from being socially responsible are:23

� Their environmental concerns may enable them to charge premium prices and gain brand loyalty (for example, Ben & Jerry’s Ice Cream).

� Their trustworthiness may help them generate enduring relationships with suppliers and distributors without requiring them to spend a lot of time and money policing contracts.

� They can attract outstanding employees who prefer working for a responsible firm (for example, Procter & Gamble and Starbucks).

� They are more likely to be welcomed into a foreign country (for example, Levi Strauss).

� They can utilize the goodwill of public officials for support in difficult times.

� They are more likely to attract capital infusions from investors who view reputable com- panies as desirable long-term investments. For example, mutual funds investing only in socially responsible companies more than doubled in size from 1995 to 2007 and outper- formed the S&P 500 list of stocks.24

SUSTAINABILITY: MORE THAN ENVIRONMENTAL? As a term, sustainability may include more than just ecological concerns and the natural envi- ronment. Crane and Matten point out that the concept of sustainability can be broadened to in- clude economic and social as well as environmental concerns. They argue that it is sometimes impossible to address the sustainability of the natural environment without considering the so- cial and economic aspects of relevant communities and their activities. For example, even though environmentalists may oppose road-building programs because of their effect on wildlife and conservation efforts, others point to the benefits to local communities of less traf- fic congestion and more jobs.25 Dow Jones & Company, a leading provider of global business news and information, developed a sustainability index that considers not only environmen- tal, but also economic and social factors. See the Environmental Sustainability Issue feature to learn the criteria Dow Jones uses in its index.

The broader concept of sustainability has much in common with Carroll’s list of business responsibilities presented earlier. In order for a business corporation to be sustainable, that is, to be successful over a long period of time, it must satisfy all of its economic, legal, ethical, and discretionary responsibilities. Sustainability thus involves many issues, concerns, and tradeoffs—leading us to an examination of corporate stakeholders.

CORPORATE STAKEHOLDERS The concept that business must be socially responsible sounds appealing until we ask, “Re- sponsible to whom?” A corporation’s task environment includes a large number of groups with interest in a business organization’s activities. These groups are referred to as stakeholders because they affect or are affected by the achievement of the firm’s objectives.26 Should a cor- poration be responsible only to some of these groups, or does business have an equal respon- sibility to all of them?

A survey of the U.S. general public by Harris Poll revealed that 95% of the respondents felt that U.S. corporations owe something to their workers and the communities in which they op- erate and that they should sometimes sacrifice some profit for the sake of making things better for their workers and communities. People were concerned that business executives seemed to

76 PA RT 1 Introduction to Strategic Management and Business Policy

NOTE: For more information on SAM Sustainable Asset Manage- ment, see Sustainability Yearbook 2008, available from PriceWa- terHouseCoopers (www.pwc.com).

SOURCES: Dow Jones Indexes Web site (www.djindexes.com/) as of July 15, 2008 and A. Crane and D. Matten, Business Ethics: A European Perspective (Oxford: Oxford University Press, 2004), pp. 214–215.

� Environmental sustainability. This includes environ- mental reporting, eco-design and efficiency, environmen- tal management systems, and executive commitment to environmental issues.

� Economic sustainability. This includes codes of con- duct and compliance, anti-corruption policies, corpo- rate governance, risk and crisis management, strategic planning, quality and knowledge management, and supply chain management.

� Social sustainability. This includes corporate citizen- ship, philanthropy, labor practices, human capital devel- opment, social reporting, talent attraction and retention, and stakeholder dialogue.

Dow Jones & Company, a leading provider of global

business news and informa- tion, pioneered in 1999 the first

index of common stocks that rates corporations according to their perfor-

mance on sustainability. This index has grown to include multiple sustainability indexes, such as a World Index, North America Index, and United States Index, among oth- ers. The Dow Jones Sustainability Index (DJSI) follows a “best in class” approach that identifies sustainability lead- ers in each industry. Companies are evaluated against gen- eral and industry-specific criteria and ranked with their peers. Data come from questionnaires, submitted docu- mentation, corporate policies, reports, and available public information. Since its inception, the Dow Jones Sustain- ability Index has slightly outperformed its well-known Dow Jones Industrial Index. Based on SAM (Sustainable Asset Management AG) Research’s corporate sustainability as- sessment, Dow Jones includes not only environmental, but also economic and social criteria in its sustainability index.

THE DOW JONES SUSTAINABILITY INDEX

ENVIRONMENTAL sustainability issue

be more interested in making profits and boosting their own pay than they were in the safety and quality of the products made by their companies.27 The percentage of the U.S. general public that agreed that business leaders could be trusted to do what is right “most of the time or almost always” fell from 36% in 2002 to 28% in 2006.28 These negative feelings receive some support from a study that revealed that the CEOs at the 50 U.S. companies that outsourced the greatest number of jobs received a greater increase in pay than did the CEOs of 365 U.S. firms overall.29

In any one strategic decision, the interests of one stakeholder group can conflict with those of another. For example, a business firm’s decision to use only recycled materials in its man- ufacturing process may have a positive effect on environmental groups but a negative effect on shareholder dividends. In another example, Maytag Corporation’s top management decided to move refrigerator production from Galesburg, Illinois, to a lower-wage location in Mexico. On the one hand, shareholders were generally pleased with the decision because it would lower costs. On the other hand, officials and local union people were very unhappy at the loss of jobs when the Galesburg plant closed. Which group’s interests should have priority?

In order to answer this question, the corporation may need to craft an enterprise strategy—an overarching strategy that explicitly articulates the firm’s ethical relationship with its stakeholders. This requires not only that management clearly state the firm’s key ethical values, but also that it understands the firm’s societal context, and undertakes stakeholder analysis to identify the concerns and abilities of each stakeholder.30

Stakeholder Analysis Stakeholder analysis is the identification and evaluation of corporate stakeholders. This can be done in a three-step process.

C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 77

The first step in stakeholder analysis is to identify primary stakeholders, those who have a direct connection with the corporation and who have sufficient bargaining power to directly affect corporate activities. Primary stakeholders are directly affected by the corporation and usually include customers, employees, suppliers, shareholders, and creditors.

But who exactly are a firm’s customers or employees and what do they want? This is not always a simple exercise. For example, Intel’s customers were clearly computer manufactur- ers because that’s to whom Intel sold its electronic chips. When a math professor found a small flaw in Intel’s Pentium microprocessor in 1994, computer users demanded that Intel replace the defective chips. At first Intel refused to do so because it hadn’t sold to these individuals. According to then-CEO Andy Grove, “I got irritated and angry because of user demands that we take back a device we didn’t sell.” Intel wanted the PC users to follow the supply chain and complain to the firms from whom they had bought the computers. Gradually Grove was per- suaded that Intel had a direct duty to these consumers. “Although we didn’t sell to these indi- viduals directly, we marketed to them. . . . It took me a while to understand this,” explained Grove. In the end, Intel paid $450 million to replace the defective parts.31

Aside from the Intel example, business corporations usually know their primary stake- holders and what they want. The corporation systematically monitors these stakeholders be- cause they are important to a firm’s meeting its economic and legal responsibilities. Employees want a fair day’s pay and fringe benefits. Customers want safe products and value for price paid. Shareholders want dividends and stock price appreciation. Suppliers want pre- dictable orders and bills paid. Creditors want commitments to be met on time. In the normal course of affairs, the relationship between a firm and each of its primary stakeholders is regu- lated by written or verbal agreements and laws. Once a problem is identified, negotiation takes place based on costs and benefits to each party. (Government is not usually considered a pri- mary stakeholder because laws apply to all in a category and usually cannot be negotiated.)

The second step in stakeholder analysis is to identify the secondary stakeholders—those who have only an indirect stake in the corporation but who are also affected by corporate activ- ities. These usually include nongovernmental organizations (NGOs, such as Greenpeace), ac- tivists, local communities, trade associations, competitors, and governments. Because the corporation’s relationship with each of these stakeholders is usually not covered by any written or verbal agreement, there is room for misunderstanding. As in the case of NGOs and activists, there actually may be no relationship until a problem develops—usually brought up by the stakeholder. In the normal course of events, these stakeholders do not affect the corporation’s ability to meet its economic or legal responsibilities. Aside from competitors, these secondary stakeholders are not usually monitored by the corporation in any systematic fashion. As a result, relationships are usually based on a set of questionable assumptions about each other’s needs and wants. Although these stakeholders may not directly affect a firm’s short-term profitability, their actions could determine a corporation’s reputation and thus its long-term performance.

The third step in stakeholder analysis is to estimate the effect on each stakeholder group from any particular strategic decision. Because the primary decision criteria are typically eco- nomic, this is the point where secondary stakeholders may be ignored or discounted as unim- portant. For a firm to fulfill its ethical or discretionary responsibilities, it must seriously consider the needs and wants of its secondary stakeholders in any strategic decision. For ex- ample, how much will specific stakeholder groups lose or gain? What other alternatives do they have to replace what may be lost?

Stakeholder Input Once stakeholder impacts have been identified, managers should decide whether stake- holder input should be invited into the discussion of the strategic alternatives. A group is more likely to accept or even help implement a decision if it has some input into which

78 PA RT 1 Introduction to Strategic Management and Business Policy

ment for those qualified. We must provide competent management, and their actions must be just and ethical.

We are responsible to the communities where we live and work and to the world community as well. We must be good citizens—support good works and charities and bear our fair share of taxes. We must encourage civic improve- ments and better health and education. We must maintain in good order the property we are privileged to use, and protecting the environment and natural resources.

Our final responsibility is to our stockholders. Business must make a sound profit. We must experiment with new ideas. Research must be carried on, innovative programs developed, and mistakes paid for. New equipment must be purchased, new facilities provided, and new products launched. Reserves must be created for adverse times. When we operate according to these principles, the stock- holders should realize a fair return.

We believe our first respon- sibility is to the doctors,

nurses, and patients, to mothers and fathers and all

others who use our products and services. In meeting their needs every-

thing we do must be of high quality. We must constantly strive to reduce our costs in order to maintain reasonable prices. Customers’ orders must be serviced promptly and accurately. Our suppliers and distributors must have an op- portunity to make a fair profit.

We are responsible to our employees, the men and women who work with us throughout the world. Everyone must be considered as an individual. We must respect their dignity and recognize their merit. They must have a sense of security in their jobs. Compensation must be fair and ad- equate, and working conditions clean, orderly, and safe. We must be mindful of ways to help our employees fulfill their family responsibilities. Employees must feel free to make suggestions and complaints. There must be equal opportunity for employment, development, and advance-

JOHNSON & JOHNSON CREDO

SOURCE: Johnson & Johnson Company Web site, September 28, 2004. (http://www.jnj.com) Copyright by Johnson & Johnson. All rights reserved. Reprinted by permission.

STRATEGY highlight 3.1

alternative is chosen and how it is to be implemented. In the case of Maytag’s decision to close its Galesburg, Illinois, refrigeration plant, the community was not a part of the deci- sion. Nevertheless, management decided to inform the local community of its decision three years in advance of the closing instead of the 60 days required by law. Although the an- nouncement created negative attention, it gave the Galesburg employees and townspeople more time to adjust to the eventual closing.

Given the wide range of interests and concerns present in any organization’s task environ- ment, one or more groups, at any one time, probably will be dissatisfied with an organization’s activities—even if management is trying to be socially responsible. A company may have some stakeholders of which it is only marginally aware. For example, when Ford Motor Com- pany extended its advertising to magazines read by gay and lesbian readers in 2005, manage- ment had no idea that the American Family Association (AFA) would argue that this was tantamount to promoting a homosexual agenda and call for a boycott of all Ford products. In response, Ford pulled its ads. Gay and lesbian groups then protested Ford’s backpedaling. Ford then placed corporate ads in many of the same publications, which gays saw as clumsy and the AFA saw as backsliding.32

Therefore, before making a strategic decision, strategic managers should consider how each alternative will affect various stakeholder groups. What seems at first to be the best de- cision because it appears to be the most profitable may actually result in the worst set of con- sequences to the corporation. One example of a company that does its best to consider its responsibilities to its primary and secondary stakeholders when making strategic decisions is Johnson & Johnson. See Strategy Highlight 3.1 for the J & J Credo.

C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 79

3.2 Ethical Decision Making Some people joke that there is no such thing as “business ethics.” They call it an oxymoron— a concept that combines opposite or contradictory ideas. Unfortunately, there is some truth to this sarcastic comment. For example, a survey by the Ethics Resource Center of 1,324 employ- ees of 747 U.S. companies found that 48% of employees surveyed said that they had engaged in one or more unethical and/or illegal actions during the past year. The most common ques- tionable behaviors involved cutting corners on quality (16%), covering up incidents (14%), abusing or lying about sick days (11%), and lying to or deceiving customers (9%).33 Some 52% of workers reported observing at least one type of misconduct in the workplace, but only 55% reported it.34 From 1996 to 2005, top managers at 2,270 firms (29.2% of the firms analyzed) had backdated or otherwise manipulated stock option grants to take advantage of favorable share-price movements.35 In a survey, 53% of employees in corporations of all sizes admitted that they would be willing to misrepresent corporate financial statements if asked to do so by a superior.36 A survey of 141 chief financial executives (CFOs) revealed that 17% had been pressured by their CEOs over a five-year period to misrepresent the company’s financial re- sults. Five percent admitted that they had succumbed to the request.37

Around 53,000 cases of suspected mortgage fraud were reported by banks in 2007. The most common type of mortgage fraud was misstatement of income or assets, followed by forged documents, inflated appraisals, and misrepresentation of a buyer’s intent to occupy a property as a primary residence.38 In one instance, Allison Bice, office manager at Leonard Fazio’s RE/MAX A-1 Best Realtors in Urbandale, Iowa, admitted that she submitted fake in- voices and copies of checks drawn on a closed account as part of a scheme to obtain more money from Homecoming Financial, a mortgage company that had hired Fazio’s agency to re- sell foreclosed homes. “I was directed by Mr. Fazio to have the bills be larger to Homecom- ings because we didn’t make much money on commissions,” Bice told a federal jury in Des Moines. “He told me that everybody in the business does it.”39

A study of more than 5,000 graduate students at 32 colleges and universities in the United States and Canada revealed that 56% of business students and 47% of non-business students admitted to cheating at least once during the past year. Cheating was more likely when a stu- dent’s peers also cheated.40 In another example, 6,000 people paid $30 to enter a VIP section on ScoreTop.com’s Web site to obtain access to actual test questions posted by those who had recently taken the Graduate Management Admission Test (GMAT). In response, the Graduate Management Admission Council promised to cancel the scores of anyone who posted “live” questions to the site or knowingly read them.41 Given this lack of ethical behavior among stu- dents, it is easy to understand why some could run into trouble if they obtained a job at a cor- poration having an unethical culture, such as Enron, WorldCom, or Tyco. (See Strategy Highlight 3.2 for examples of unethical practices at Enron and Worldcom.)

SOME REASONS FOR UNETHICAL BEHAVIOR Why are many business people perceived to be acting unethically? It may be that the involved people are not even aware that they are doing something questionable. There is no worldwide standard of conduct for business people. This is especially important given the global nature of business activities. Cultural norms and values vary between countries and even between dif- ferent geographic regions and ethnic groups within a country. For example, what is considered in one country to be a bribe to expedite service is sometimes considered in another country to be normal business practice. Some of these differences may derive from whether a country’s

80 PA RT 1 Introduction to Strategic Management and Business Policy

ment. None of that will protect Enron if these transac- tions are ever disclosed in the bright light of day.

At WorldCom, Cynthia Cooper, an internal auditor, noted that some of the company’s capital expenditures should have been listed on the second-quarter financial statements as expenses. When she mentioned this to both WorldCom’s controller and its chief financial officer, she was told to stop what she was doing and to delay the au- dit until the third quarter (when expensing the transactions would not be noticed). Instead, Cooper informed the board of directors’ audit committee. Two weeks later, WorldCom announced that it was reducing earnings by $3.9 billion, the largest restatement in history.

Corporate scandals at Enron, WorldCom, and Tyco, among

other international companies, have caused people around the

world to seriously question the ethics of business executives. Enron, in particular, has become infamous for the question- able actions of its top executives in the form of (1) off- balance sheet partnerships used to hide the company’s dete- riorating finances, (2) revenue from long-term contracts being recorded in the first year instead of being spread over multiple years, (3) financial reports being falsified to inflate executive bonuses, and (4) manipulation of the electricity market—leading to a California energy crisis. Only Sherron Watkins, an Enron accountant, was willing to speak out re- garding the questionable nature of these practices. In a now- famous memo to then-CEO Kenneth Lay, Watkins warned:

I realize that we have had a lot of smart people looking at this and a lot of accountants including AA & Co. [Arthur Andersen] have blessed the accounting treat-

UNETHICAL PRACTICES AT ENRON AND WORLDCOM EXPOSED BY “WHISTLE-BLOWERS”

SOURCES: G. Colvin, “Wonder Women of Whistleblowers,” Fortune (August 12, 2002), p. 56; W. Zellner, “The Deadly Sins of Enron,” Business Week (October 14, 2002), pp. 26–28; M. J. Mandel, “And the Enron Award Goes to . . . Enron,” Business Week (May 20, 2002), p. 46.

STRATEGY highlight 3.2

governance system is rule-based or relationship-based. Relationship-based countries tend to be less transparent and have a higher degree of corruption than do rule-based countries.42 See the Global Issue feature for an explanation of country governance systems and how they may affect business practices.

Another possible reason for what is often perceived to be unethical behavior lies in differ- ences in values between business people and key stakeholders. Some businesspeople may be- lieve profit maximization is the key goal of their firm, whereas concerned interest groups may have other priorities, such as the hiring of minorities and women or the safety of their neigh- borhoods. Of the six values measured by the Allport-Vernon-Lindzey Study of Values test (aes- thetic, economic, political, religious, social, and theoretical), both U.S. and UK executives consistently score highest on economic and political values and lowest on social and religious ones. This is similar to the value profile of managers from Japan, Korea, India, and Australia, as well as those of U.S. business school students. U.S. Protestant ministers, in contrast, score highest on religious and social values and very low on economic values.43

This difference in values can make it difficult for one group of people to understand an- other’s actions. For example, even though some people feel that the advertising of cigarettes and alcoholic drinks (especially to youth) is unethical, the people managing these companies can respond that they are simply offering a product; “Let the buyer beware” is a traditional saying in free-market capitalism. They argue that customers in a free market democracy have the right to choose how they spend their money and live their lives. Social progressives may contend that business people working in tobacco, alcoholic beverages, and gambling indus- tries are acting unethically by making and advertising products with potentially dangerous and expensive side effects, such as cancer, alcoholism, and addiction. People working in these in- dustries could respond by asking whether it is ethical for people who don’t smoke, drink, or

C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 81

HOW RULE-BASED AND RELATIONSHIP-BASED GOVERNANCE SYSTEMS AFFECT ETHICAL BEHAVIOR

based system in a developing nation is inherently nontrans- parent due to the local and non-verifiable nature of its in- formation. A business person needs to develop and nurture a wide network of personal relationships. What you know is less important than who you know.

The investment in time and money needed to build the necessary relationships to conduct business in a developing nation creates a high entry barrier for any newcomers to an industry. Thus, key industries in developing nations tend to be controlled by a small number of companies, usually pri- vately owned, family-controlled conglomerates. Because public information is unreliable and insufficient for deci- sions, strategic decisions may depend more on a CEO play- ing golf with the prime minister than with questionable market share data. In a relationship-based system, the cul- ture of the country (and the founder’s family) strongly af- fects corporate culture and business ethics. What is “fair” depends on whether one is a family member, a close friend, a neighbor, or a stranger. Because behavior tends to be less controlled by laws and agreed-upon standards than by tradition, businesspeople from a rule-based developed nation perceive the relationship-based system in a develop- ing nation to be less ethical and more corrupt. According to Larry Smeltzer, ethics professor at Arizona State Univer- sity: “The lack of openness and predictable business stan- dards drives companies away. Why would you want to do business in, say Libya, where you don’t know the rules?”

SOURCES: S. Li, S. H. Park, and S. Li, “The Great Leap Forward: The Transition from Relation-Based Governance to Rule-Based Governance,” Organizational Dynamics, Vol. 33, No. 1 (2003), pp. 63–78; M. Davids, “Global Standards, Local Problems,” Journal of Business Strategy (January/February 1999), pp. 38–43; “The Opacity Index,” Economist (September 18, 2004), p. 106.

gamble to reject another person’s right to do so. One example is the recent controversy over the marketing of “alcopops,” caffeinated malt beverages containing twice as much alcohol as many beers in the U.S. Critics of Sparks and Tilt call them alcoholic beverages disguised as energy drinks aimed at luring underage drinkers.44

Seventy percent of executives representing 111 diverse national and multinational corpo- rations reported that they bend the rules to attain their objectives.45 The three most common reasons given were:

� Organizational performance required it—74%

� Rules were ambiguous or out of date—70%

� Pressure from others and everyone does it—47%

The developed nations of the world operate under gover-

nance systems quite different from those used by developing

nations. The developed nations and the business firms within them follow well-recognized rules in their dealings and financial reporting. To the extent that a country’s rules force business corporations to publicly dis- close in-depth information about the company to potential shareholders and others, that country’s financial and legal system is said to be transparent. Transparency is said to simplify transactions and reduce the temptation to behave illegally or unethically. Finland, the United Kingdom, Hong Kong, the United States, and Australia have very transpar- ent business climates. The Kurtzman Group, a consulting firm, developed an opacity index that measures the risks associated with unclear legal systems, regulations, eco- nomic policies, corporate governance standards, and cor- ruption in 48 countries. The countries with the most opaque/least transparent ratings are Indonesia, Venezuela, China, Nigeria, India, Egypt, and Russia.

Developing nations tend to have relationship-based governance. Transactions are based on personal and im- plicit agreements, not on formal contracts enforceable by a court. Information about a business is largely local and private—thus cannot be easily verified by a third party. In contrast, rule-based governance relies on publicly verifiable information—the type of information that is typically not available in a developing country. The rule-based system has an infrastructure, based on accounting, auditing, rat- ings systems, legal cases, and codes, to provide and moni- tor this information. If present in a developing nation, the infrastructure is not very sophisticated. This is why invest- ing in a developing country is very risky. The relationship-

GLOBAL issue

82 PA RT 1 Introduction to Strategic Management and Business Policy

The financial community’s emphasis on short-term earnings performance is a significant pressure for executives to “manage” quarterly earnings. For example, a company achieving its forecasted quarterly earnings figure signals the investment community that its strategy and op- erations are proceeding as planned. Failing to meet its targeted objective signals that the com- pany is in trouble—thus causing the stock price to fall and shareholders to become worried. Research by Degeorge and Patel involving more than 100,000 quarterly earnings reports re- vealed that a preponderance (82%) of reported earnings exactly matched analysts’ expectations or exceeded them by 1%. The disparity between the number of earnings reports that missed estimates by a penny and the number that exceeded them by a penny suggests that executives who risked falling short of forecasts “borrowed” earnings from future quarters.46

In explaining why executives and accountants at Enron engaged in unethical and illegal ac- tions, former Enron vice president Sherron Watkins used the “frogs in boiling water” analogy. If, for example, one were to toss a frog into a pan of boiling water, according to the folk tale, the frog would quickly jump out. It might be burned, but the frog would survive. However, if one put a frog in a pan of cold water and turned up the heat very slowly, the frog would not sense the increasing heat until it was too lethargic to jump out and would be boiled. According to Watkins:

Enron’s accounting moved from creative to aggressive, to fraudulent, like the pot of water mov- ing from cool to lukewarm to boiling; those involved with the creative transactions soon found themselves working on the aggressive transactions and were finally in the uncomfortable situa- tion of working on fraudulent deals.47

Moral Relativism Some people justify their seemingly unethical positions by arguing that there is no one ab- solute code of ethics and that morality is relative. Simply put, moral relativism claims that morality is relative to some personal, social, or cultural standard and that there is no method for deciding whether one decision is better than another.

At one time or another, most managers have probably used one of the four types of moral relativism—naïve, role, social group, or cultural—to justify questionable behavior.48

Naïve relativism: Based on the belief that all moral decisions are deeply personal and that in- dividuals have the right to run their own lives, adherents of moral relativism argue that each person should be allowed to interpret situations and act on his or her own moral val- ues. This is not so much a belief as it is an excuse for not having a belief or is a common excuse for not taking action when observing others lying or cheating.

Role relativism: Based on the belief that social roles carry with them certain obligations to that role, adherents of role relativism argue that a manager in charge of a work unit must put aside his or her personal beliefs and do instead what the role requires, that is, act in the best interests of the unit. Blindly following orders was a common excuse provided by Nazi war criminals after World War II.

Social group relativism: Based on a belief that morality is simply a matter of following the norms of an individual’s peer group, social group relativism argues that a decision is considered legitimate if it is common practice, regardless of other considerations (“everyone’s doing it”). A real danger in embracing this view is that the person may in- correctly believe that a certain action is commonly accepted practice in an industry when it is not.

Cultural relativism: Based on the belief that morality is relative to a particular culture, soci- ety, or community, adherents of cultural relativism argue that people should understand the practices of other societies, but not judge them. This view not only suggests that one should not criticize another culture’s norms and customs, but also that it is acceptable to personally follow these norms and customs (“When in Rome, do as the Romans do.”).

C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 83

Although these arguments make some sense, moral relativism could enable a person to justify almost any sort of decision or action, so long as it is not declared illegal.

Kohlberg’s Levels of Moral Development Another reason why some business people might be seen as unethical is that they may have no well-developed personal sense of ethics. A person’s ethical behavior is affected by his or her level of moral development, certain personality variables, and such situational factors as the job itself, the supervisor, and the organizational culture.49 Kohlberg proposes that a person pro- gresses through three levels of moral development.50 Similar in some ways to Maslow’s hi- erarchy of needs, in Kohlberg’s system, the individual moves from total self-centeredness to a concern for universal values. Kohlberg’s three levels are as follows:

1. The preconventional level: This level is characterized by a concern for self. Small chil- dren and others who have not progressed beyond this stage evaluate behaviors on the ba- sis of personal interest—avoiding punishment or quid pro quo.

2. The conventional level: This level is characterized by considerations of society’s laws and norms. Actions are justified by an external code of conduct.

3. The principled level: This level is characterized by a person’s adherence to an internal moral code. An individual at this level looks beyond norms or laws to find universal val- ues or principles.

Kohlberg places most people in the conventional level, with fewer than 20% of U.S. adults in the principled level of development.51 Research appears to support Kohlberg’s concept. For example, one study found that individuals higher in cognitive moral development, lower in Machiavellianism, with a more internal locus of control, a less-relativistic moral philosophy, and higher job satisfaction are less likely to plan and enact unethical choices.52

ENCOURAGING ETHICAL BEHAVIOR Following Carroll’s work, if business people do not act ethically, government will be forced to pass laws regulating their actions—and usually increasing their costs. For self-interest, if for no other reason, managers should be more ethical in their decision making. One way to do that is by developing codes of ethics. Another is by providing guidelines for ethical behavior.

Codes of Ethics A code of ethics specifies how an organization expects its employees to behave while on the job. Developing codes of ethics can be a useful way to promote ethical behavior, especially for peo- ple who are operating at Kohlberg’s conventional level of moral development. Such codes are currently being used by more than half of U.S. business corporations. A code of ethics (1) clar- ifies company expectations of employee conduct in various situations and (2) makes clear that the company expects its people to recognize the ethical dimensions in decisions and actions.53

Various studies indicate that an increasing number of companies are developing codes of ethics and implementing ethics training workshops and seminars. However, research also indi- cates that when faced with a question of ethics, managers tend to ignore codes of ethics and try to solve dilemmas on their own.54 To combat this tendency, the management of a company that wants to improve its employees’ ethical behavior should not only develop a comprehensive code of ethics but also communicate the code in its training programs, in its performance ap- praisal system, policies and procedures, and through its own actions.55 It may even include key values in its values and mission statements. According to a 2004 survey of CEOs by the Busi- ness Roundtable Institute for Corporate Ethics, 74% of CEOs confirmed that their companies

84 PA RT 1 Introduction to Strategic Management and Business Policy

had made changes within the previous two years in how they handled or reported ethics issues. Specific changes reported were:

� Enhanced internal reporting and communications—33%

� Ethics hotlines—17%

� Improved compliance procedures—12%

� Greater oversight by the board of directors—10%56

In addition, U.S. corporations have attempted to support whistle-blowers, those employ- ees who report illegal or unethical behavior on the part of others. The U.S. False Claims Act gives whistle-blowers 15% to 30% of any damages recovered in cases where the government is defrauded. Even though the Sarbanes-Oxley Act forbids firms from retaliating against any- one reporting wrongdoing, 82% of those who uncovered fraud from 1996 to 2004 reported be- ing ostracized, demoted, or pressured to quit.57

Corporations appear to benefit from well-conceived and implemented ethics programs. For example, companies with strong ethical cultures and enforced codes of conduct have fewer unethical choices available to employees—thus fewer temptations.58 A study by the Open Compliance and Ethics Group found that no company with an ethics program in place for 10 years or more experienced “reputational damage” in the last five years.59 Some of the com- panies identified in surveys as having strong moral cultures are Canon, Hewlett-Packard, Johnson & Johnson, Levi Strauss, Medtronic, Motorola, Newman’s Own, Patagonia, S. C. Johnson, Shorebank, Smucker, and Sony.60

A corporation’s management should consider establishing and enforcing a code of ethical behavior for those companies with which it does business—especially if it outsources its man- ufacturing to a company in another country. For example, Gap International, one of Ameri- can’s largest fashion retailers, developed one of the most rigorous codes of conduct for its suppliers. Its suppliers must comply with all child-labor laws on hiring, working hours, over- time, and working conditions. Workers must be at least 14 years of age. Rather than simply canceling business with suppliers using child labor, Gap requires suppliers to stop using child workers and to provide them with schooling instead, while continuing to pay them regularly and guaranteeing them a job once they reach legal age. In one year, Gap canceled contracts with 23 factories that did not meet its standards.61

Gap’s experience, however, may be unusual. Recent surveys of over one hundred compa- nies in the Global 2000 uncovered that 64% have some code of conduct that regulates supplier conduct, but only 40% require suppliers to actually take any action with respect to the code, such as disseminating it to employees, offering training, certifying compliance, or even read- ing or acknowledging receipt of the code.62

It is important to note that having a code of ethics for suppliers does not prevent harm to a corporation’s reputation if one of its offshore suppliers is able to conceal abuses. Numerous Chinese factories, for example, keep double sets of books to fool auditors and distribute scripts for employees to recite if they are questioned. Consultants have found new business helping Chinese companies evade audits.63

Guidelines for Ethical Behavior Ethics is defined as the consensually accepted standards of behavior for an occupation, a trade, or a profession. Morality, in contrast, is the precepts of personal behavior based on religious or philosophical grounds. Law refers to formal codes that permit or forbid certain behaviors and may or may not enforce ethics or morality.64 Given these definitions, how do we arrive at a comprehensive statement of ethics to use in making decisions in a specific occupation, trade, or profession? A starting point for such a code of ethics is to consider the three basic ap- proaches to ethical behavior:65

C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 85

1. Utilitarian approach: The utilitarian approach proposes that actions and plans should be judged by their consequences. People should therefore behave in a way that will pro- duce the greatest benefit to society and produce the least harm or the lowest cost. A prob- lem with this approach is the difficulty in recognizing all the benefits and the costs of any particular decision. Research reveals that only the stakeholders who have the most power (ability to affect the company), legitimacy (legal or moral claim on company resources), and urgency (demand for immediate attention) are given priority by CEOs.66 It is therefore likely that only the most obvious stakeholders will be considered, while others are ignored.

2. Individual rights approach: The individual rights approach proposes that human be- ings have certain fundamental rights that should be respected in all decisions. A particular decision or behavior should be avoided if it interferes with the rights of others. A problem with this approach is in defining “fundamental rights.” The U.S. Constitution includes a Bill of Rights that may or may not be accepted throughout the world. The approach can also encourage selfish behavior when a person defines a personal need or want as a “right.”

3. Justice approach: The justice approach proposes that decision makers be equitable, fair, and impartial in the distribution of costs and benefits to individuals and groups. It follows the principles of distributive justice (people who are similar on relevant dimensions such as job seniority should be treated in the same way) and fairness (liberty should be equal for all persons). The justice approach can also include the concepts of retributive justice (pun- ishment should be proportional to the offense) and compensatory justice (wrongs should be compensated in proportion to the offense). Affirmative action issues such as reverse dis- crimination are examples of conflicts between distributive and compensatory justice.

Cavanagh proposes that we solve ethical problems by asking the following three ques- tions regarding an act or a decision:

1. Utility: Does it optimize the satisfactions of all stakeholders?

2. Rights: Does it respect the rights of the individuals involved?

3. Justice: Is it consistent with the canons of justice?

For example, is padding an expense account ethical? Using the utility criterion, this ac- tion increases the company’s costs and thus does not optimize benefits for shareholders or cus- tomers. Using the rights approach, a person has no right to the money (otherwise, we wouldn’t call it “padding”). Using the justice criterion, salary and commissions constitute ordinary com- pensation, but expense accounts compensate a person only for expenses incurred in doing his or her job—expenses that the person would not normally incur except in doing the job.67

Another approach to resolving ethical dilemmas is by applying the logic of the philoso- pher Immanuel Kant. Kant presents two principles (called categorical imperatives) to guide our actions:

1. A person’s action is ethical only if that person is willing for that same action to be taken by everyone who is in a similar situation. This is the same as the Golden Rule: Treat oth- ers as you would like them to treat you. For example, padding an expense account would be considered ethical if the person were also willing for everyone else to do the same if they were the boss. Because it is very doubtful that any manager would be pleased with expense account padding, the action must be considered unethical.

2. A person should never treat another human being simply as a means but always as an end. This means that an action is morally wrong for a person if that person uses others merely as means for advancing his or her own interests. To be moral, the act should not restrict other people’s actions so that they are disadvantaged in some way.68

86 PA RT 1 Introduction to Strategic Management and Business Policy

D I S C U S S I O N Q U E S T I O N S 1. What is the relationship between corporate governance

and social responsibility?

2. What is your opinion of Gap International’s having a code of conduct for its suppliers? What would Milton Fried- man say? Contrast his view with Archie Carroll’s view.

3. Does a company have to act selflessly to be considered socially responsible? For example, when building a new plant, a corporation voluntarily invested in additional equipment that enabled it to reduce its pollution emis- sions beyond any current laws. Knowing that it would be

very expensive for its competitors to do the same, the firm lobbied the government to make pollution regula- tions more restrictive on the entire industry. Is this com- pany socially responsible? Were its managers acting ethically?

4. Are people living in a relationship-based governance sys- tem likely to be unethical in business dealings?

5. Given that people rarely use a company’s code of ethics to guide their decision making, what good are the codes?

In his book Defining Moments, Joseph Badaracco states that most ethics problems deal with “right versus right” problems in which neither choice is wrong. These are what he calls “dirty hands problems” in which a person has to deal with very specific situations that are covered only vaguely in corporate credos or mission statements. For example, many mission state- ments endorse fairness but fail to define the term. At the personal level, fairness could mean playing by the rules of the game, following basic morality, treating everyone alike and not playing favorites, treating others as you would want to be treated, being sensitive to individ- ual needs, providing equal opportunity for everyone, or creating a level playing field for the disadvantaged. According to Badaracco, codes of ethics are not always helpful because they tend to emphasize problems of misconduct and wrongdoing, not a choice between two accept- able alternatives, such as keeping an inefficient plant operating for the good of the community or closing the plant and relocating to a more efficient location to lower costs.69

This chapter provides a framework for understanding the social responsibilities of a busi- ness corporation. Following Carroll, it proposes that a manager should consider not only the economic and legal responsibilities of a firm but also its ethical and discretionary responsibil- ities. It also provides a method for making ethical choices, whether they are right versus right or some combination of right and wrong. It is important to consider Cavanaugh’s questions us- ing the three approaches of utilitarian, rights, and justice plus Kant’s categorical imperatives when making a strategic decision. A corporation should try to move from Kohlberg’s conven- tional to a principled level of ethical development. If nothing else, the frameworks should con- tribute to well-reasoned strategic decisions that a person can defend when interviewed by hostile media or questioned in a court room.

E C O - B I T S � An Australian nut orchard converts the shells of old

Macintosh computers into houses for pest-eating birds.

� Nike gathers old athletic shoes and turns them into raw material for “sports surfaces” like tennis courts and run- ning tracks.

� The British company Ecopods sells stylish coffins made from hardened recycled paper.

� It takes three months for a recycled aluminum can to re- turn to the supermarket shelf in reincarnated form.70

End of Chapter S U M M A R Y

C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 87

S T R A T E G I C P R A C T I C E E X E R C I S E It is 1982. Zombie Savings and Loan is in trouble. This is a time when many savings and loans (S&Ls) are in financial dif- ficulty. Zombie holds many 30-year mortgages at low fixed- interest rates in its loan portfolio. Interest rates have risen significantly, and the Deregulation Act of 1980 has given Zombie and other S&Ls the right to make business loans and hold up to 20% of its assets as such. Because interest rates in general have risen, but the rate that Zombie receives on its old mortgages has not, Zombie must now pay out higher interest rates to its deposit customers or see them leave, and it has neg- ative cash flow until rates fall below the rates in its mortgage portfolio or Zombie itself fails.

In present value terms, Zombie is insolvent, but the ac- counting rules of the time do not require marking assets to mar- ket, so Zombie is allowed to continue to operate and is faced with two choices: It can wait and hope interest rates fall before it is declared insolvent and is closed down, or it can raise fresh (insured) deposits and make risky loans that have high interest rates. Risky loans promise high payoffs (if they are repaid), but the probability of loss to Zombie and being closed later with greater loss to the Federal Savings & Loan Insurance Corpora-

tion (FSLIC) is high. Zombie stays in business if its gamble pays off, and it loses no more than it has already lost if the gam- ble does not pay off. Indeed, if not closed, Zombie will raise increasingly greater new deposits and make more risky loans until it either wins or is shut down by the regulators.

Waiting for lower interest rates and accepting early closure if lower rates do not arrive is certainly in the best interest of the FSLIC and of the taxpayers, but the manager of Zombie has more immediate responsibilities, such as employees’ jobs, mortgage customers, depositors, the local neighborhood, and his or her job. As a typical S&L, Zombie’s depositors are its shareholders and vote according to how much money they have in savings accounts with Zombie. If Zombie closes, depositors may lose some, but not all of their money, because their deposits are insured by the FSLIC. There is no other provider of home mortgages in the immediate area. What should the manager do?

SOURCE: Adapted from D. W. Swanton, “Teaching Students the Nature of Moral Hazard: An Ethical Component for Finance Classes,” paper presented to the annual meeting of the Academy of Finance, Chicago (March 13, 2003). Reprinted with permission.

categorical imperatives (p. 85) code of ethics (p. 83) ethics (p. 84) individual rights approach (p. 85) justice approach (p. 85)

law (p. 84) levels of moral development (p. 83) morality (p. 84) moral relativism (p. 82) social responsibility (p. 72)

stakeholder analysis (p. 76) stakeholders (p. 75) utilitarian approach (p. 85) whistle-blowers (p. 84)

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88 PA RT 1 Introduction to Strategic Management and Business Policy

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C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 89

90 PA RT 1 Introduction to Strategic Management and Business Policy

Ending Case for Part One BLOOD BANANAS

Every company hates to be blackmailed, but that was exactly what was happening to one of America’s largest fruit growing and processing companies, Chiquita Brands. Carlos Castaño, leader of the United Self De- fense Forces of Columbia (AUC), a Colombian paramil- itary organization, had just proposed that it would be in the best interests of Chiquita Brands and its subsidiary in Colombia, Banadex, to pay the AUC a few thousand dollars per month for “security” services. The security services were little more than protection from the AUC itself. Unfortunately, the local law enforcement agencies as well as the U.S. government were in no position to of- fer legitimate protection from paramilitary groups like the AUC. Chiquita was forced to decide whether to pay the AUC for protection or risk the lives of Chiquita em- ployees in Colombia.

Chiquita Brands International Inc., headquartered in Cincinnati, Ohio, was a leading international mar- keter and distributor of high-quality fresh produce that was sold under the Chiquita® premium brand and related trademarks. The company was one of the largest banana producers in the world and a major supplier of bananas in Europe and North America. The company had rev- enues of approximately $4.5 billion and employed about 25,000 people in 70 countries in 2006.

Chiquita Brands, formerly United Brands and United Fruit, had been operating fruit plantations in Colombia for nearly 100 years. Chiquita’s Banadex was responsible for 4,400 direct and an additional 8,000 in- direct jobs in Colombia, jobs that were almost entirely performed by local (Colombian) workers. The company “contributed almost $70 million annually to the Colom- bian economy in the form of capital expenditures, pay- roll, taxes, social security, pensions, and local purchases of goods and services.” Banadex was responsible for managing Chiquita’s extensive plantation holding and was Chiquita’s most profitable international operation.

By the 1990s, Colombia had become a very vio- lent country. Kidnappings and murders of wealthy Colombians and foreigners had become common- place. The U.S. State Department had issued several advisories warning U.S. citizens about the dangers of travel to the country. In 1997, Carlos Castaño, leader of the AUC, met with senior officials of Banadex and offered to provide security services to the Banadex workers and property in Colombia. The AUC, often described as a “death squad,” was one of the most vi- olent, paramilitary organizations that existed in Colombia. Estimated by the U.S. State Department to number between 8,000 and 11,000 members, their ac- tivities included assassinations, guerrilla warfare, and drug trafficking. So far the AUC had not been desig- nated a Foreign Terrorist Organization by the U.S. State Department, so it was not illegal to do business with the AUC. The implication of the offer for Banadex employees was obvious. Extortion or not, the implica- tion of non-participation by Banadex would put employees at serious risk.

The options for Chiquita were straightforward: agree to pay, refuse to pay, or exit the country. The ramifica- tions of any of the actions, however, were not pleasant.

Agree to Pay: If Chiquita agreed to pay for “protection” they might forestall killings and kidnappings; how- ever, they would be financing a group of terrorists. The money it paid would be used to further the ac- tivities of AUC.

Refuse to Pay: If Chiquita chose to reject the offer of “protection” from Castaño, then there was the real likelihood that Banadex employees would be kid- napped and/or executed. There was ample evidence of the brutality of the AUC and similar organiza- tions currently operating in Colombia. While a le- gitimate security company might be found to protect the plantations and employees, the cost to hire suf- ficient men to withstand a force of 8,000–11,000 paramilitary fighters would be inordinately expen- sive. Only governments had the strength to mount such a protective service and neither the U.S. nor Colombian governments were willing to support such an effort. Furthermore, it was unlikely that the Colombian government would welcome a merce- nary force hired by Chiquita into the country.

Exit the Country: If the decision was made to abandon the plantations in Colombia what would happen to

This case was written by Steven M. Cox, Bradley W. Brooks, and S. Catherine Anderson of the Queens University of Charlotte and ap- peared in the Journal of Critical Incidents, Volume 1 (2008). Copy- right © 2008 by Steven M. Cox, Bradley W. Brooks, and S. Catherine Anderson. Edited for publication in Strategic Management and Busi- ness Policy, 12th edition and Concepts in Strategic Management and Business Policy, 12th edition. Reprinted by permission of the authors and the Society for Case Research.

C H A P T E R 3 Social Responsibility and Ethics in Strategic Management 91

the 12,000 individuals whose livelihoods depended upon the work or workers on the plantation? Contribut- ing $70 million annually to the economy, a rapid exit would represent a significant loss to the Colombian people. Further, Banadex exports represented a

significant portion of the bananas sold by Chiquita brands. The loss of this supply would not only affect Chiquita Brands’ profitability and share- holder value but also the profitability of numerous Chiquita distributors around the world.

Study Question

1. What should Chiquita do?

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P A R T2 Scanning the

Environment

The Arctic is undergoing an extraordinary transformation—a transformation

that will have global impact not only on wildlife, but upon many countries

and a number of industries. Some of the most significant environmental changes

are retreating sea ice, melting glaciers, thawing permafrost, increasing coastal

erosion, and shifting vegetation zones. The average temperature of the Arctic has risen

at twice the rate of the rest of the planet. According to Impacts of a Warming Arctic: Arctic

Climate Impact Assessment, a 2004 report by the eight-nation Arctic Council, the melting of the

area’s highly reflective snow and sea ice is uncovering darker land and ocean surfaces, further in-

creasing the absorption of the sun’s heat. Reductions in Arctic sea ice will drastically shrink marine

habitats for polar bears, ice seals, and some seabirds. The warming of the tundra will likely boost

greenhouse gases by releasing long-stored quantities of methane and carbon dioxide.

In addition to containing a large percentage of the world’s water as ice, the Arctic is a large

storehouse of natural resources. Given that the Arctic Ocean could be ice-free in the summer by

2040, countries bordering the Arctic are already positioning themselves for exploitation of these

resources. Lawson Brigham, Alaska Office Director of the U.S. Arctic Research Commission and

a former chief of strategic planning for the U.S. Coast Guard, examined how regional warming

will affect transportation systems, resource development, indigenous Arctic peoples, regional

environmental degradation and protection schemes, and overall geopolitical issues. From this,

he proposes four possible scenarios for the Arctic in 2040:

1. Globalized frontier: In this scenario, the Arctic by 2040 has become an integral component

of the global economic system, but is itself a semi-lawless frontier with participants jockey-

ing for control. The summer sea ice has completely disappeared for a two-week period, al-

lowing greater marine access and commercial shipping throughout the area. The famous

“Northwest Passage” dreamed by 16th century navigators is now a reality. Rising prices for

oil, natural gas, nickel, copper, zinc, and freshwater in conjunction with an easily accessible

and less-harsh climate have made Arctic natural resource exploitation economically viable.

Even though overfishing has reduced fish stocks, Arctic tourism is flourishing. By now, well-

worn oil and gas pipelines in western Siberia and Alaska are experiencing recurring serious

environmental scanning and Industry Analysis

C H A P T E R 4

95

� Recognize aspects of an organization’s environment that can influence its long- term decisions

� Identify the aspects of an organization’s environment that are most strategically important

� Conduct an industry analysis to understand the competitive forces that influence the intensity of rivalry within an industry

� Understand how industry maturity affects industry competitive forces

� Categorize international industries based on their pressures for coordination and local responsiveness

� Construct strategic group maps to assess the competitive positions of firms in an industry

� Identify key success factors and develop an industry matrix

� Use publicly available information to conduct competitive intelligence

� Know how to develop an industry scenario � Be able to construct an EFAS table that

summarizes external environmental factors

Learning Objectives

Gathering Information

Putting Strategy into Action

Monitoring Performance

Societal Environment: General forces

Natural Environment: Resources and

climate

Task Environment:

Industry analysis

Internal: Strengths and Weaknesses

Structure: Chain of command

Culture: Beliefs, expectations,

values

Resources: Assets, skills, competencies,

knowledge

Programs

Activities needed to accomplish a plan

Budgets

Cost of the programs Procedures

Sequence of steps needed to do the job

Performance

Actual results

External: Opportunities

and Threats

Developing Long-range Plans

Mission

Reason for existence Objectives

What results to accomplish by when

Strategies

Plan to achieve the mission & objectives

Policies

Broad guidelines for decision making

Environmental Scanning:

Strategy Formulation:

Strategy Implementation:

Evaluation and Control:

Feedback/Learning: Make corrections as needed

After reading this chapter, you should be able to:

spills. By 2020, Canada, Denmark (Greenland), Norway, Russia, and the United States

had asserted their sovereignty over sea bed resources beyond 200 nautical miles—leav-

ing only two small regions in the central Arctic Ocean under international jurisdiction.

Environmental concerns that once fostered polar cooperation have been replaced by

economic and political interests. The protection, development, and governance of the

Svalbard Islands became a problem when Russia refused to recognize Norway’s 200-

nautical mile exclusive economic zone around the islands. Issues regarding freedom of

navigation and commercial access rights are highly contentious. The eight permanent

members of the Arctic Council have increasingly excluded outside participation in the

Council’s deliberations.

2. Adaptive frontier: In this scenario, the Arctic in 2040 is being drawn much more slowly

into the global economy. The area is viewed as an international resource. Competition

among the Arctic countries for control of the region’s resources never grew beyond a

low level and the region is the scene of international cooperation among many inter-

national stakeholders. The indigenous peoples throughout the area have organized

and now have significant influence over decisions relating to regional environmental

protection and economic development. The exploitation of Arctic oil and gas is re-

stricted to the few key areas that are most cost-competitive. Air and water transporta-

tion systems flourish throughout the area. Commercially viable fishing has continued,

thanks to stringent harvesting quotas and other bilateral agreements. The Arctic Coun-

cil is a proactive forum resolving several disputes and engaging the indigenous peoples

in all deliberations. Nevertheless, the impact of global warming on the Arctic is wide-

spread and serious. Contingency planning for manmade and natural emergencies is ad-

vanced and well coordinated. Sustainable development is widely supported by most

stakeholders. The Arctic region has become a model for habitat protection. Arctic na-

tional parks have expanded modestly and adapted to deal with increased tourism.

3. Fortress frontier: In this scenario, widespread resource exploitation and increased in-

ternational tension exist throughout the Arctic. The region is viewed by much of the

global community as a storehouse of natural resources that is being jealously guarded

by a handful of wealthy circumpolar nations. Although the Arctic is part of the global

economic system, any linkage is controlled by the most powerful Arctic countries for

their own benefit. By 2040, the Arctic is undergoing extreme environmental stress, as

global warming continues unabated. Many indigenous peoples have been displaced

from their traditional homelands due to extreme environmental events. Illegal immi-

gration becomes an issue in many subarctic regions. Although air and marine trans-

portation routes are open, foreign access has been periodically suspended for

political or security reasons. Russia and Canada, in particular, continue to tightly con-

trol marine access through the Northern Sea Route and Northwest Passage. Fishing

rights have been suspended to all but the Arctic countries. Oil and gas exploration

and production has intensified throughout the Arctic. The Svalbard Islands, claimed

96 PA RT 2 Scanning the Environment

by Norway, have been a source of potential conflict over access to living and nonliv-

ing resources. Norway, Russia, and the United States have increased military forces in

the region. Rather than dealing with sustainable development, the Arctic Council fo-

cuses on economic and security concerns, such as illegal immigrants and controlling

the flow of exports from the Arctic consortium. Early in the 21st century, the five

countries bordering the Arctic declared their sovereignty over resources beyond

200 nautical miles to the edge of the continental shelf extensions. By 2030, the Arctic

Council unilaterally took jurisdiction over the two small regions that remained within

international jurisdiction. Arctic tourism thrives, since many other traditional destina-

tions are experiencing turmoil and a shortage of necessities.

4. Equitable frontier: In this scenario, the Arctic is integrated with the global economic

system by 2040, but international concern for sustainable development has slowed the

region’s economic development. Mutual respect and cooperation among the circum-

polar nations allows for the development of a respected Arctic governance system.

Even though the world is working hard to reduce greenhouse gas emissions, the Arc-

tic continues to warm. Transport user fees and other eco-taxes are used to support en-

dangered wildlife and impacted indigenous communities. The growth of the Northern

Sea Route and Northwest Passage has enabled significant efficiencies in commercial

shipping. Canada and Russia have maintained stringent marine regulations that em-

phasize environmental protection. Despite differences over freedom of navigation,

the United States, Canada, and Russia have negotiated an agreement that allows a

seamless voyage around Alaska and through the routes under a uniform set of opera-

tional procedures. The Arctic Council has created regional disaster teams to respond to

maritime and other emergencies. Boundary disputes have been resolved and fishing

rights have been allocated to various nations. The University of the Arctic has brought

quality online education to easy reach of all northern citizens. The Arctic Council has

brokered an agreement to allow 30,000 environmental refugees to settle in subarctic

territories. Oil exploration and production in the Arctic has slowed considerably. Arc-

tic tourism continues its steady growth, prompting national and regional parliaments

to establish additional wilderness lands funded by tourist fees. There is low military

presence in the region, thanks to the diplomatic efforts of the Arctic Council.

The Arctic is a complex, but relatively small region. These four scenarios suggest how

climate change combined with a growing need for natural resources might impact this re-

gion and the world.1

� Which of the four preceding scenarios is most likely?

� Which industries are likely to be affected (either positively or negatively) by the

warming of the Arctic?

� If in an affected industry, how could a business corporation prepare for each of these

scenarios?

C H A P T E R 4 Environmental Scanning and Industry Analysis 97

4.1 Environmental Scanning

A changing environment can help as well as hurt a company. Many pioneering com-

panies have gone out of business because of their failure to adapt to environmental

change or, even worse, because of their failure to create change. For example, Baldwin

Locomotive, the major manufacturer of steam locomotives, was very slow in making the

switch to diesel locomotives. General Electric and General Motors soon dominated the

diesel locomotive business and Baldwin went out of business. The dominant manufactur-

ers of vacuum tubes failed to make the change to transistors and consequently lost this

market. Eastman Kodak, the pioneer and market leader of chemical-based film photogra-

phy, continues to struggle with its transition to the newer digital technology. Failure to

adapt is, however, only one side of the coin. The aforementioned Arctic warming exam-

ple shows how a changing environment can create new opportunities at the same time it

destroys old ones. The lesson is simple: To be successful over time, an organization needs

to be in tune with its external environment. There must be a strategic fit between what

the environment wants and what the corporation has to offer, as well as between what

the corporation needs and what the environment can provide.

Current predictions are that the environment for all organizations will become even

more uncertain with every passing year. What is environmental uncertainty? It is the

degree of complexity plus the degree of change that exists in an organization’s external

environment. As more and more markets become global, the number of factors a company

must consider in any decision becomes huge and much more complex. With new technolo-

gies being discovered every year, markets change and products must change with them.

On the one hand, environmental uncertainty is a threat to strategic managers be-

cause it hampers their ability to develop long-range plans and to make strategic decisions

to keep the corporation in equilibrium with its external environment. On the other hand,

environmental uncertainty is an opportunity because it creates a new playing field in

which creativity and innovation can play a major part in strategic decisions.

98 PA RT 2 Scanning the Environment

Before an organization can begin strategy formulation, it must scan the external environment to identify possible opportunities and threats and its internal environment for strengths and weak- nesses. Environmental scanning is the monitoring, evaluation, and dissemination of information from the external and internal environments to key people within the corporation. A corporation uses this tool to avoid strategic surprise and to ensure its long-term health. Research has found a positive relationship between environmental scanning and profits.2 Approximately 70% of exec- utives around the world state that global social, environmental, and business trends are increas- ingly important to corporate strategy, according to a 2008 survey by McKinsey & Company.3

IDENTIFYING EXTERNAL ENVIRONMENTAL VARIABLES In undertaking environmental scanning, strategic managers must first be aware of the many variables within a corporation’s natural, societal, and task environments (see Figure 1–3). The

C H A P T E R 4 Environmental Scanning and Industry Analysis 99

natural environment includes physical resources, wildlife, and climate that are an inherent part of existence on Earth. These factors form an ecological system of interrelated life. The societal environment is mankind’s social system that includes general forces that do not di- rectly touch on the short-run activities of the organization that can, and often do, influence its long-run decisions. These factors affect multiple industries and are as follows:

� Economic forces that regulate the exchange of materials, money, energy, and information. � Technological forces that generate problem-solving inventions. � Political–legal forces that allocate power and provide constraining and protecting laws

and regulations.

� Sociocultural forces that regulate the values, mores, and customs of society.

The task environment includes those elements or groups that directly affect a corporation and, in turn, are affected by it. These are governments, local communities, suppliers, competitors, customers, creditors, employees/labor unions, special-interest groups, and trade associations. A corporation’s task environment is typically the industry within which the firm operates. Industry analysis (popularized by Michael Porter) refers to an in-depth examination of key factors within a corporation’s task environment. The natural, societal, and task environments must be monitored to detect the strategic factors that are likely in the future to have a strong impact on corporate success or failure. Changes in the natural environment usually affect a business corporation first through its impact on the societal environment in terms of resource availability and costs and then upon the task environment in terms of the growth or decline of particular industries.

Scanning the Natural Environment The natural environment includes physical resources, wildlife, and climate that are an in- herent part of existence on Earth. Until the 20th century, the natural environment was gen- erally perceived by business people to be a given—something to exploit, not conserve. It was viewed as a free resource, something to be taken or fought over, like arable land, dia- mond mines, deep water harbors, or fresh water. Once they were controlled by a person or entity, these resources were considered assets and thus valued as part of the general eco- nomic system—a resource to be bought, sold, or sometimes shared. Side effects, such as pollution, were considered to be externalities, costs not included in a business firm’s ac- counting system, but felt by others. Eventually these externalities were identified by gov- ernments, which passed regulations to force business corporations to deal with the side effects of their activities.

The concept of sustainability argues that a firm’s ability to continuously renew itself for long-term success and survival is dependent not only upon the greater economic and social sys- tem of which it is a part, but also upon the natural ecosystem in which the firm is embedded.4

A business corporation must thus scan the natural environment for factors that might previously have been taken for granted, such as the availability of fresh water and clean air. Global warm- ing means that aspects of the natural environment, such as sea level, weather, and climate, are becoming increasingly uncertain and difficult to predict. Management must therefore scan not only the natural environment for possible strategic factors, but also include in its strategic decision-making processes the impact of its activities upon the natural environment. In a world concerned with global warming, a company should measure and reduce its carbon footprint— the amount of greenhouse gases it is emitting into the air. Research reveals that scanning the market for environmental issues is positively related to firm performance because it helps man- agement identify opportunities to fulfill future market demand based upon environmentally friendly products or processes.5 See the Environmental Sustainability Issue feature to learn how individuals can also measure and shrink their personal carbon footprints.

Scanning the Societal Environment: STEEP Analysis The number of possible strategic factors in the societal environment is very high. The number becomes enormous when we realize that, generally speaking, each country in the world can be represented by its own unique set of societal forces—some of which are very similar to those of neighboring countries and some of which are very different.

For example, even though Korea and China share Asia’s Pacific Rim area with Thai- land, Taiwan, and Hong Kong (sharing many similar cultural values), they have very differ- ent views about the role of business in society. It is generally believed in Korea and China (and to a lesser extent in Japan) that the role of business is primarily to contribute to na- tional development; however in Hong Kong, Taiwan, and Thailand (and to a lesser extent in the Philippines, Indonesia, Singapore, and Malaysia), the role of business is primarily to make profits for the shareholders.6 Such differences may translate into different trade regu- lations and varying difficulty in the repatriation of profits (the transfer of profits from a for- eign subsidiary to a corporation’s headquarters) from one group of Pacific Rim countries to another.

100 PA RT 2 Scanning the Environment

SOURCES: B. Walsh and T. Sharples, “Sizing Up Carbon Footprints,” Time (May 26, 2008), pp. 53–55 and www.carbonrally.com.

mated 18% of global carbon emissions, eating a ham- burger results in carbon emissions by the consumer. Some- thing as small as an iPod adds to a person’s carbon footprint due not only to the energy used to produce and transport the product, but also to the energy used to charge it over its lifetime—approximately 68 pounds of CO2. Both the Nature Conservancy and the U.S. Environ- mental Protection Agency provide ways to measure an in- dividual carbon footprint. The EPA even offers a carbon calculator on its Web site, epa.gov.

Carbonrally offers concrete ways to start cutting carbon emissions. One 2008 contest challenged people to avoid bottled soda, tea, and sports drinks for a month for an av- erage individual savings of 25.7 pounds of CO2.

Other challenges were using a clothesline to dry one laundry load a week, unplugging computers every night for one month, and using a personal cup for coffee instead of using a disposable cup. By the end of 2008, nearly 15,000 individuals had completed a challenge, effectively reducing over 1,622.57 tons of CO2.

Given that global carbon dioxide emissions total more than 28 billion tons annually, one person’s reductions can seem very small. Why bother? Carbonrally might respond that the best way to change the world is one person at a time.

As people become more “green,” that is more con-

scious of environmental sus- tainability, they wonder what they

can do as individuals to reduce the emission of green- house gases. This is an important issue given that a typical American produces more than 20 tons of carbon dioxide annually—a very large carbon footprint. Even a homeless American has a carbon footprint of 8.5 tons, more than twice the global average! The first problem for concerned individuals is finding a way to measure the size of their own carbon footprint. The second problem is developing feasible programs to reduce that footprint in some mean- ingful way.

The Web site carbonrally.com solves these problems by presenting competitive environmental challenges and keeping score by translating green actions into pounds of carbon dioxide averted. For instance, cutting the time of a daily shower by two minutes for a month reduces CO2 emissions by 15.3 pounds. According to Kelsey Schroeder, who has logged savings of more than 1,000 pounds of emissions, “This has been a great motivational technique. We just want to keep going and see if we can do better.”

How does Carbonrally calculate someone’s carbon shoe size? Since everything a person does that is powered by fossil fuels has a carbon dioxide cost, many activities have the potential of being counted. Commuting in a gasoline powered car has obvious carbon costs, but so does eating a hamburger. Since livestock are responsible for an esti-

MEASURING AND SHRINKING YOUR PERSONAL CARBON FOOTPRINT

ENVIRONMENTAL sustainability issue

C H A P T E R 4 Environmental Scanning and Industry Analysis 101

STEEP Analysis: Monitoring Trends in the Societal and Natural Environments. As shown in Table 4–1, large corporations categorize the societal environment in any one geographic region into four areas and focus their scanning in each area on trends that have corporatewide relevance. By including trends from the natural environment, this scanning can be called STEEP Analysis, the scanning of Sociocultural, Technological, Economic, Ecological, and Political-legal environmental forces.7 (It may also be called PESTEL Analysis for Political, Economic, Sociocultural, Technological, Ecological, and Legal forces.) Obviously, trends in any one area may be very important to firms in one industry but of lesser importance to firms in other industries.

Trends in the economic part of the societal environment can have an obvious impact on business activity. For example, an increase in interest rates means fewer sales of major home appliances. Why? A rising interest rate tends to be reflected in higher mortgage rates. Because higher mortgage rates increase the cost of buying a house, the demand for new and used houses tends to fall. Because most major home appliances are sold when people change houses, a re- duction in house sales soon translates into a decline in sales of refrigerators, stoves, and dish- washers and reduced profits for everyone in the appliance industry. Changes in the price of oil have a similar impact upon multiple industries, from packaging and automobiles to hospital- ity and shipping.

The rapid economic development of Brazil, Russia, India, and China (often called the BRIC countries) is having a major impact on the rest of the world. By 2007, China had become the world’s second-largest economy according to the World Bank. With India graduating more English-speaking scientists, engineers, and technicians than all other nations combined, it has become the primary location for the outsourcing of services, computer software, and telecom- munications.8 Eastern Europe has become a major manufacturing supplier to the European Union countries. According to the International Monetary Fund, emerging markets make up less than one-third of total world gross domestic product (GDP), but account for more than half of GDP growth.9

TABLE 4–1 Some Important Variables in the Societal Environment

Economic Technological Political–Legal Sociocultural

GDP trends

Interest rates

Money supply

Inflation rates

Unemployment levels

Wage/price controls

Devaluation/revaluation

Energy alternatives

Energy availability and cost

Disposable and discretionary income

Currency markets

Global financial system

Total government spending for R&D

Total industry spending for R&D

Focus of technological efforts

Patent protection

New products

New developments in technology transfer from lab to marketplace

Productivity improvements through automation

Internet availability

Telecommunication infrastructure

Computer hacking activity

Antitrust regulations

Environmental protection laws

Global warming legislation

Immigration laws

Tax laws

Special incentives

Foreign trade regulations

Attitudes toward foreign companies

Laws on hiring and promotion

Stability of government

Outsourcing regulation

Foreign “sweat shops”

Lifestyle changes

Career expectations

Consumer activism

Rate of family formation

Growth rate of population

Age distribution of population

Regional shifts in population

Life expectancies

Birthrates

Pension plans

Health care

Level of education

Living wage

Unionization

Changes in the technological part of the societal environment can also have a great impact on multiple industries. Improvements in computer microprocessors have not only led to the widespread use of personal computers but also to better automobile engine performance in terms of power and fuel economy through the use of microprocessors to monitor fuel injection. Digi- tal technology allows movies and music to be available instantly over the Internet or through ca- ble service, but it also means falling fortunes for video rental shops such as the Movie Gallery and CD stores such as Tower Records. Advances in nanotechnology are enabling companies to manufacture extremely small devices that are very energy efficient. Developing biotechnology, including gene manipulation techniques, is already providing new approaches to dealing with disease and agriculture. Researchers at George Washington University have identified a number of technological breakthroughs that are already having a significant impact on many industries:

� Portable information devices and electronic networking: Combining the computing power of the personal computer, the networking of the Internet, the images of the televi- sion, and the convenience of the telephone, these appliances will soon be used by a major- ity of the population of industrialized nations to make phone calls, send e-mail, and transmit documents and other data. Even now, homes, autos, and offices are being con- nected (via wires and wirelessly) into intelligent networks that interact with one another. This trend is being supported by the development of cloud computing, in which a person can tap into computing power elsewhere through a Web connection.10 The traditional stand- alone desktop computer may soon join the manual typewriter as a historical curiosity.

� Alternative energy sources: The use of wind, geothermal, hydroelectric, solar, biomass, and other alternative energy sources should increase considerably. Over the past two decades, the cost of manufacturing and installing a photovoltaic solar-power system has decreased by 20% with every doubling of installed capacity. The cost of generating elec- tricity from conventional sources, in contrast, has been rising along with the price of pe- troleum and natural gas.11

� Precision farming: The computerized management of crops to suit variations in land characteristics will make farming more efficient and sustainable. Farm equipment dealers such as Case and John Deere add this equipment to tractors for an additional $6,000 or so. It enables farmers to reduce costs, increase yields, and decrease environmental impact. The old system of small, low-tech farming is becoming less viable as large corporate farms increase crop yields on limited farmland for a growing population.

� Virtual personal assistants: Very smart computer programs that monitor e-mail, faxes, and phone calls will be able to take over routine tasks, such as writing a letter, retrieving a file, making a phone call, or screening requests. Acting like a secretary, a person’s vir- tual assistant could substitute for a person at meetings or in dealing with routine actions.

� Genetically altered organisms: A convergence of biotechnology and agriculture is cre- ating a new field of life sciences. Plant seeds can be genetically modified to produce more needed vitamins or to be less attractive to pests and more able to survive. Animals (includ- ing people) could be similarly modified for desirable characteristics and to eliminate ge- netic disabilities and diseases.

� Smart, mobile robots: Robot development has been limited by a lack of sensory devices and sophisticated artificial intelligence systems. Improvements in these areas mean that robots will be created to perform more sophisticated factory work, run errands, do house- hold chores, and assist the disabled.12

Trends in the political–legal part of the societal environment have a significant impact not only on the level of competition within an industry but also on which strategies might be successful.13

For example, periods of strict enforcement of U.S. antitrust laws directly affect corporate growth

102 PA RT 2 Scanning the Environment

C H A P T E R 4 Environmental Scanning and Industry Analysis 103

strategy. As large companies find it more difficult to acquire another firm in the same or a related industry, they are typically driven to diversify into unrelated industries.14 High levels of taxation and constraining labor laws in Western European countries stimulate companies to alter their competitive strategies or find better locations elsewhere. It is because Germany has some of the highest labor and tax costs in Europe that German companies have been forced to compete at the top end of the market with high-quality products or else move their manufacturing to lower-cost countries.15 Government bureaucracy can create multiple regulations and make it almost impos- sible for a business firm to operate profitably in some countries. For example, the number of days needed to obtain the government approvals necessary to start a new business vary from only one day in Singapore to 14 in Mexico, 59 in Saudi Arabia, 87 in Indonesia, to 481 in the Congo.16

The $66 trillion global economy operates through a set of rules established by the World Trade Organization (WTO). Composed of 153 member nations and 30 observer nations, the WTO is a forum for governments to negotiate trade agreements and settle trade disputes. Orig- inally founded in 1947 as the General Agreement on Tariffs and Trade (GATT), the WTO was created in 1995 to extend the ground rules for international commerce. The system’s purpose is to encourage free trade among nations with the least undesirable side effects. Among its prin- ciples is trade without discrimination. This is exemplified by its most-favored nation clause, which states that a country cannot grant a trading partner lower customs duties without grant- ing them to all other WTO member nations. Another principle is that of lowering trade barri- ers gradually though negotiation. It implements this principle through a series of rounds of trade negotiations. As a result of these negotiations, industrial countries’ tariff rates on indus- trial goods had fallen steadily to less than 4% by the mid-1990s. The WTO is currently nego- tiating its ninth round of negotiations, called the Doha Round. The WTO is also in favor of fair competition, predictability of member markets, and the encouragement of economic develop- ment and reform. As a result of many negotiations, developed nations have started to allow duty-free and quota-free imports from almost all products from the least-developed countries.17

Demographic trends are part of the sociocultural aspect of the societal environment. Even though the world’s population is growing from 3.71 billion people in 1970 to 6.82 billion in 2010 to 8.72 billion by 2040, not all regions will grow equally. Most of the growth will be in the developing nations. The population of the developed nations will fall from 14% of the to- tal world population in 2000 to only 10% in 2050.18 Around 75% of the world will live in a city by 2050 compared to little more than half in 2008.19 Developing nations will continue to have more young than old people, but it will be the reverse in the industrialized nations. For exam- ple, the demographic bulge in the U.S. population caused by the baby boom in the 1950s con- tinues to affect market demand in many industries. This group of 77 million people now in their 50s and 60s is the largest age group in all developed countries, especially in Europe. (See Table 4–2.) Although the median age in the United States will rise from 35 in 2000 to 40 by 2050, it will increase from 40 to 47 during the same time period in Germany, and it will in- crease up to 50 in Italy as soon as 2025.20 By 2050, one in three Italians will be over 65, nearly

TABLE 4–2 Generation Born Age in 2005 Number

WWII/Silent Generation 1932–1945 60–73 32 million Baby Boomers 1946–1964 41–59 77 million Generation X 1965–1977 28–40 45 million Generation Y 1978–1994 11–27 70 million

SOURCE: Developed from data listed in D. Parkinson, Voices of Experience: Mature Workers in the Future Work- force (New York: The Conference Board, 2002), p. 19.

Current U.S. Generations

double the number in 2005.21 With its low birthrate, Japan’s population is expected to fall from 127.6 million in 2004 to around 100 million by 2050.22 China’s stringent birth control policy is causing the ratio of workers to retirees to fall from 20 to 1 during the early 1980s to 2.5 to one by 2020.23 Companies with an eye on the future can find many opportunities to offer prod- ucts and services to the growing number of “woofies” (well-off old folks—defined as people over 50 with money to spend).24 These people are very likely to purchase recreational vehicles (RVs), take ocean cruises, and enjoy leisure sports, such as boating, fishing, and bowling, in addition to needing financial services and health care. Anticipating the needs of seniors for pre- scription drugs is one reason the Walgreen Company has been opening a new corner pharmacy every 19 hours!25

To attract older customers, retailers will need to place seats in their larger stores so aging shoppers can rest. Washrooms need to be more accessible. Signs need to be larger. Restaurants need to raise the level of lighting so people can read their menus. Home appliances need sim- pler and larger controls. Automobiles need larger door openings and more comfortable seats. Zimmer Holdings, an innovative manufacturer of artificial joints, is looking forward to its mar- ket growing rapidly over the next 20 years. According to J. Raymond Elliot, chair and CEO of Zimmer, “It’s simple math. Our best years are still in front of us.”26

Eight current sociocultural trends are transforming North America and the rest of the world:

1. Increasing environmental awareness: Recycling and conservation are becoming more than slogans. Busch Gardens, for example, has eliminated the use of disposable styrofoam trays in favor of washing and reusing plastic trays.

2. Growing health consciousness: Concerns about personal health fuel the trend toward physical fitness and healthier living. As a result, sales growth is slowing at fast-food “burgers and fries” retailers such as McDonald’s. Changing public tastes away from sugar-laden processed foods forced Interstate Bakeries, the maker of Twinkies and Won- der Bread, to declare bankruptcy in 2004. In 2008, the French government was consider- ing increasing sales taxes on extra-fatty, salty, or sugary products.27 The European Union forbade the importation of genetically altered grain (“Frankenfood”) because of possible side effects. The spread of AIDS to more than 40 million people worldwide adds even fur- ther impetus to the health movement.

3. Expanding seniors market: As their numbers increase, people over age 55 will become an even more important market. Already some companies are segmenting the senior pop- ulation into Young Matures, Older Matures, and the Elderly—each having a different set of attitudes and interests. Both mature segments, for example, are good markets for the health care and tourism industries; whereas, the elderly are the key market for long-term care facilities. The desire for companionship by people whose children are grown is caus- ing the pet care industry to grow 4.5% annually in the United States. In 2007, for exam- ple, 71.1 million households in the U.S. spent $41 billion on their pets—more than the gross domestic product of all but 16 countries in the world.28

4. Impact of Generation Y Boomlet: Born between 1978 and 1994 to the baby boom and X generations, this cohort is almost as large as the baby boom generation. In 1957, the peak year of the postwar boom, 4.3 million babies were born. In 1990, there were 4.2 million births in Generation Y’s peak year. By 2000, they were overcrowding elementary and high schools and entering college in numbers not seen since the baby boomers. Now in its teens and 20s, this cohort is expected to have a strong impact on future products and services.

5. Declining mass market: Niche markets are defining the marketers’ environment. People want products and services that are adapted more to their personal needs. For example, Estée Lauder’s “All Skin” and Maybelline’s “Shades of You” lines of cosmetic products are specifically made for African-American women. “Mass customization”—the making

104 PA RT 2 Scanning the Environment

C H A P T E R 4 Environmental Scanning and Industry Analysis 105

and marketing of products tailored to a person’s requirements (Dell for example, and Gateway computers)—is replacing the mass production and marketing of the same prod- uct in some markets. Only 10% of the 6,200 magazines sold in the United States in 2004 were aimed at the mass market, down from 30% in the 1970s.29

6. Changing pace and location of life: Instant communication via e-mail, cell phones, and overnight mail enhances efficiency, but it also puts more pressure on people. Merging the personal computer with the communication and entertainment industries through tele- phone lines, satellite dishes, and cable television increases consumers’ choices and allows workers to leave overcrowded urban areas for small towns and telecommute via personal computers and modems.

7. Changing household composition: Single-person households, especially those of single women with children, could soon become the most common household type in the United States. Married-couple households slipped from nearly 80% in the 1950s to 50.7% of all households in 2002.30 By 2007, for the first time in U.S. history, more than half of women were single.31 Thirty-eight percent of U.S. children are currently being born out of wed- lock.32 A typical family household is no longer the same as it was once portrayed in The Brady Bunch in the 1970s or The Cosby Show in the 1980s.

8. Increasing diversity of workforce and markets: Between now and 2050, minorities will account for nearly 90% of population growth in the United States. Over time, group percentages of the total United States population are expected to change as follows: Non- Hispanic Whites—from 90% in 1950 to 74% in 1995 to 53% by 2050; Hispanic Whites—from 9% in 1995 to 22% in 2050; Blacks—from 13% in 1995 to 15% in 2050; Asians—from 4% in 1995 to 9% in 2050; American Indians—1%, with slight increase.33

Heavy immigration from the developing to the developed nations is increasing the number of minorities in all developed countries and forcing an acceptance of the value of diversity in races, religions, and life style. For example, 24% of the Swiss population was born elsewhere.34 Traditional minority groups are increasing their numbers in the work- force and are being identified as desirable target markets. For example, Sears, Roebuck transformed 97 of its stores in October 2004 into “multicultural stores” containing fash- ions for Hispanic, African-American, and Asian shoppers.35

International Societal Considerations. Each country or group of countries in which a company operates presents a unique societal environment with a different set of economic, technological, political–legal, and sociocultural variables for the company to face. International societal environments vary so widely that a corporation’s internal environment and strategic management process must be very flexible. Cultural trends in Germany, for example, have resulted in the inclusion of worker representatives in corporate strategic planning. Because Islamic law (sharia) forbids interest (riba), loans of capital in Islamic countries must be arranged on the basis of profit-sharing instead of interest rates.36

Differences in societal environments strongly affect the ways in which a multinational corporation (MNC), a company with significant assets and activities in multiple countries, conducts its marketing, financial, manufacturing, and other functional activities. For example, Europe’s lower labor productivity, due to a shorter work week and restrictions on the ability to lay off unproductive workers, forces European-based MNCs to expand operations in countries where labor is cheaper and productivity is higher.37 Moving manufacturing to a lower-cost lo- cation, such as China, was a successful strategy during the 1990s, but a country’s labor costs rise as it develops economically. For example, China required all firms in January 2008 to consult employees on material work-related issues, enabling the country to achieve its stated objective of having trade unions in all of China’s non-state-owned enterprises. By September 2008, the All-China Federation of Trade Unions had signed with 80% of the largest foreign companies.38

106 PA RT 2 Scanning the Environment

To account for the many differences among societal environments from one country to an- other, consider Table 4–3. It includes a list of economic, technological, political–legal, and so- ciocultural variables for any particular country or region. For example, an important economic variable for any firm investing in a foreign country is currency convertibility. Without convert- ibility, a company operating in Russia cannot convert its profits from rubles to dollars or euros. In terms of sociocultural variables, many Asian cultures (especially China) are less concerned with the values of human rights than are European and North American cultures. Some Asians actually contend that U.S. companies are trying to impose Western human rights requirements on them in an attempt to make Asian products less competitive by raising their costs.39

Before planning its strategy for a particular international location, a company must scan the particular country environment(s) in question for opportunities and threats, and it must compare those with its own organizational strengths and weaknesses. Focusing only on the de- veloped nations may cause a corporation to miss important market opportunities in the devel- oping nations of the world. Although those nations may not have developed to the point that they have significant demand for a broad spectrum of products, they may very likely be on the threshold of rapid growth in the demand for specific products like cell phones. This would be the ideal time for a company to enter this market—before competition is established. The key is to be able to identify the trigger point when demand for a particular product or service is ready to boom. See the Global Issue boxed highlight for an in-depth explanation of a tech- nique to identify the optimum time to enter a particular market in a developing nation.

Creating a Scanning System. How can anyone monitor and keep track of all the trends and factors in the worldwide societal environment? With the existence of the Internet, it is now possible to scan the entire world. Nevertheless, the vast amount of raw data makes scanning

TABLE 4–3 Some Important Variables in International Societal Environments

Economic Technological Political–Legal Sociocultural

Economic development

Per capita income

Climate

GDP trends

Monetary and fiscal policies

Unemployment levels

Currency convertibility

Wage levels

Nature of competition

Membership in regional economic associations, e.g., EU, NAFTA, ASEAN

Membership in World Trade Organization (WTO)

Outsourcing capability

Global financial system

Regulations on technology transfer

Energy availability/cost

Natural resource availability

Transportation network

Skill level of workforce

Patent-trademark protection

Internet availability

Telecommunication infrastructure

Computer hacking technology

New energy sources

Form of government

Political ideology

Tax laws

Stability of government

Government attitude toward foreign companies

Regulations on foreign ownership of assets

Strength of opposition groups

Trade regulations

Protectionist sentiment

Foreign policies

Terrorist activity

Legal system

Global warming laws

Immigration laws

Customs, norms, values

Language

Demographics

Life expectancies

Social institutions

Status symbols

Lifestyle

Religious beliefs

Attitudes toward foreigners

Literacy level

Human rights

Environmentalism

“Sweat shops”

Pension plans

Health care

Slavery

C H A P T E R 4 Environmental Scanning and Industry Analysis 107

SOURCE: D. Fraser and M. Raynor, “The Power of Parity,” Forecast (May/June, 1996), pp. 8–12; “A Survey of the World Economy: The Dragon and the Eagle,” Special Insert, Economist (October 2, 2004), p. 8; “The Big Mac Index: Food for Thought,” Economist (May 29, 2004), pp. 71–72.

were purchased in Mexico last year, using the PPP model would effectively increase the Mexican GDP by $5 million to $10 million. Using PPP, China becomes the world’s second-largest economy after the United States, fol- lowed by Japan, India, and Germany.

A trigger point identifies when demand for a particular product is about to rapidly increase in a country. Identify- ing a trigger point can be a very useful technique for de- termining when to enter a new market in a developing nation. Trigger points vary for different products. For exam- ple, an apparent trigger point for long-distance telephone services is at $7,500 in GDP per capita—a point when de- mand for telecommunications services increases rapidly. Once national wealth surpasses $15,000 per capita, de- mand increases at a much slower rate with further in- creases in wealth. The trigger point for life insurance is around $8,000 in GDP per capita. At this point, the de- mand for life insurance increases between 200% and 300% above those countries with GDP per capita below the trigger point.

Research by the Deloitte & Touche Consulting Group

reveals that the demand for a specific product increases ex-

ponentially at certain points in a country’s development. Identifying this

trigger point of demand is thus critical to entering emerg- ing markets at the best time. A trigger point is the time when enough people have enough money to buy what a company has to sell but before competition is established. This can be determined by using the concept of purchasing power parity (PPP), which measures the cost in dollars of the U.S.–produced equivalent volume of goods that an economy produces.

PPP offers an estimate of the material wealth a nation can purchase, rather than the financial wealth it creates as typically measured by Gross Domestic Product (GDP). As a result, restating a nation’s GDP in PPP terms reveals much greater spending power than market exchange rates would suggest. For example, a shoe shine costing $5 to $10 in New York City can be purchased for 50¢ in Mexico City. Consequently the people of Mexico City can enjoy the same standard of living (with respect to shoe shines) as people in New York City with only 5% to 10% of the money. Correcting for PPP restates all Mexican shoe shines at their U.S. purchase value of $5. If one million shoe shines

IDENTIFYING POTENTIAL MARKETS IN DEVELOPING NATIONS

GLOBAL issue

for information similar to drinking from a fire hose. It is a daunting task for even a large corporation with many resources. To deal with this problem, in 2002 IBM created a tool called WebFountain to help the company analyze the vast amounts of environmental data available on the Internet. WebFountain is an advanced information discovery system designed to help extract trends, detect patterns, and find relationships within vast amounts of raw data. For example, IBM sought to learn whether there was a trend toward more positive discussions about e-business. Within a week, the company had data that experts within the company used to replace their hunches with valid conclusions. The company uses WebFountain to:

� Locate negative publicity or investor discontent

� Track general trends

� Learn competitive information

� Identify emerging competitive threats

� Unravel consumer attitudes40

Scanning the Task Environment As shown in Figure 4–1, a corporation’s scanning of the environment includes analyses of all the relevant elements in the task environment. These analyses take the form of individual re- ports written by various people in different parts of the firm. At Procter & Gamble (P&G), for

108 PA RT 2 Scanning the Environment

Interest Group Analysis

Community Analysis

Market Analysis

Competitor Analysis

Supplier Analysis

Government Analysis

Analysis of Societal Environment Economic, Sociocultural, Technological, Political–Legal Factors

Selection of Strategic Factors

Opportunities Threats

FIGURE 4–1 Scanning External

Environment

example, people from each of the brand management teams work with key people from the sales and market research departments to research and write a “competitive activity report” each quarter on each of the product categories in which P&G competes. People in purchasing also write similar reports concerning new developments in the industries that supply P&G. These and other reports are then summarized and transmitted up the corporate hierarchy for top management to use in strategic decision making. If a new development is reported regard- ing a particular product category, top management may then send memos asking people throughout the organization to watch for and report on developments in related product areas. The many reports resulting from these scanning efforts, when boiled down to their essentials, act as a detailed list of external strategic factors.

IDENTIFYING EXTERNAL STRATEGIC FACTORS The origin of competitive advantage lies in the ability to identify and respond to environmen- tal change well in advance of competition.41 Although this seems obvious, why are some com- panies better able to adapt than others? One reason is because of differences in the ability of managers to recognize and understand external strategic issues and factors. For example, in a global survey conducted by the Fuld-Gilad-Herring Academy of Competitive Intelligence, two-thirds of 140 corporate strategists admitted that their firms had been surprised by as many as three high-impact events in the past five years. Moreover, as recently as 2003, 97% stated that their companies had no early warning system in place.42

No firm can successfully monitor all external factors. Choices must be made regarding which factors are important and which are not. Even though managers agree that strategic im- portance determines what variables are consistently tracked, they sometimes miss or choose to ignore crucial new developments.43 Personal values and functional experiences of a corpo- ration’s managers as well as the success of current strategies are likely to bias both their per- ception of what is important to monitor in the external environment and their interpretations of what they perceive.44

This willingness to reject unfamiliar as well as negative information is called strategic my- opia.45 If a firm needs to change its strategy, it might not be gathering the appropriate external

C H A P T E R 4 Environmental Scanning and Industry Analysis 109

4.2 Industry Analysis: Analyzing the Task Environment An industry is a group of firms that produces a similar product or service, such as soft drinks or financial services. An examination of the important stakeholder groups, such as suppliers and customers, in a particular corporation’s task environment is a part of industry analysis.

information to change strategies successfully. For example, when Daniel Hesse became CEO of Sprint Nextel in December 2007, he assumed that improving customer service would be one of his biggest challenges. He quickly discovered that none of the current Sprint Nextel execu- tives were even thinking about the topic. “We weren’t talking about the customer when I first joined,” said Hesse. “Now this is the No. 1 priority of the company.”46

One way to identify and analyze developments in the external environment is to use the issues priority matrix (see Figure 4–2) as follows:

1. Identify a number of likely trends emerging in the natural, societal, and task environ- ments. These are strategic environmental issues—those important trends that, if they occur, determine what the industry or the world will look like in the near future.

2. Assess the probability of these trends actually occurring, from low to medium to high.

3. Attempt to ascertain the likely impact (from low to high) of each of these trends on the corporation being examined.

A corporation’s external strategic factors are the key environmental trends that are judged to have both a medium to high probability of occurrence and a medium to high probability of im- pact on the corporation. The issues priority matrix can then be used to help managers decide which environmental trends should be merely scanned (low priority) and which should be monitored as strategic factors (high priority). Those environmental trends judged to be a cor- poration’s strategic factors are then categorized as opportunities and threats and are included in strategy formulation.

Probable Impact on Corporation

High Priority

High Priority

P ro

b a b

il it

y o

f O

c c u

rr e n

c e

Low Priority

Low Priority

Low Priority

High Priority

Medium Priority

Medium Priority

Medium Priority

High

H ig

h M

e d iu

m L o w

Medium Low

FIGURE 4–2 Issues Priority

Matrix

SOURCE: Reprinted from Long-Range Planning, Vol. 17, No. 3, 1984, Campbell, “Foresight Activities in the U.S.A.: Time for a Re-Assessment?” p. 46. Copyright © 1984 with permission from Elsevier.

110 PA RT 2 Scanning the Environment

Other Stakeholders

Relative Power

of Unions, Governments,

Special Interest

Groups, etc. Bargaining

Power of Buyers

Threat of New Entrants

Industry Competitors

Bargaining Power

of Suppliers

Rivalry Among Existing Firms

Threat of Substitute Products or Services

Potential Entrants

Buyers

Substitutes

Suppliers

FIGURE 4–3 Forces Driving

Industry Competition

PORTER’S APPROACH TO INDUSTRY ANALYSIS Michael Porter, an authority on competitive strategy, contends that a corporation is most con- cerned with the intensity of competition within its industry. The level of this intensity is deter- mined by basic competitive forces, as depicted in Figure 4–3. “The collective strength of these forces,” he contends, “determines the ultimate profit potential in the industry, where profit po- tential is measured in terms of long-run return on invested capital.”47 In carefully scanning its industry, a corporation must assess the importance to its success of each of six forces: threat of new entrants, rivalry among existing firms, threat of substitute products or services, bar- gaining power of buyers, bargaining power of suppliers, and relative power of other stakehold- ers.48 The stronger each of these forces, the more limited companies are in their ability to raise prices and earn greater profits. Although Porter mentions only five forces, a sixth—other stakeholders—is added here to reflect the power that governments, local communities, and other groups from the task environment wield over industry activities.

Using the model in Figure 4–3, a high force can be regarded as a threat because it is likely to reduce profits. A low force, in contrast, can be viewed as an opportunity because it may al- low the company to earn greater profits. In the short run, these forces act as constraints on a company’s activities. In the long run, however, it may be possible for a company, through its choice of strategy, to change the strength of one or more of the forces to the company’s advan- tage. For example, Dell’s early use of the Internet to market its computers was an effective way to negate the bargaining power of distributors in the PC industry.

A strategist can analyze any industry by rating each competitive force as high, medium, or low in strength. For example, the global athletic shoe industry could be rated as follows:

SOURCE: Reprinted with the permission of The Free Press, A Division of Simon & Schuster, from COMPETITIVE ADVANTAGE: Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980, 1988 by The Free Press. All rights reserved.

C H A P T E R 4 Environmental Scanning and Industry Analysis 111

rivalry is high (Nike, Reebok, New Balance, Converse, and Adidas are strong competitors worldwide), threat of potential entrants is low (the industry has reached maturity/sales growth rate has slowed), threat of substitutes is low (other shoes don’t provide support for sports ac- tivities), bargaining power of suppliers is medium but rising (suppliers in Asian countries are increasing in size and ability), bargaining power of buyers is medium but increasing (prices are falling as the low-priced shoe market has grown to be half of the U.S. branded athletic shoe market), and threat of other stakeholders is medium to high (government regulations and hu- man rights concerns are growing). Based on current trends in each of these competitive forces, the industry’s level of competitive intensity will continue to be high—meaning that sales in- creases and profit margins should continue to be modest for the industry as a whole.49

Threat of New Entrants New entrants to an industry typically bring to it new capacity, a desire to gain market share, and substantial resources. They are, therefore, threats to an established corporation. The threat of entry depends on the presence of entry barriers and the reaction that can be expected from existing competitors. An entry barrier is an obstruction that makes it difficult for a company to enter an industry. For example, no new domestic automobile companies have been success- fully established in the United States since the 1930s because of the high capital requirements to build production facilities and to develop a dealer distribution network. Some of the possi- ble barriers to entry are:

� Economies of scale: Scale economies in the production and sale of microprocessors, for example, gave Intel a significant cost advantage over any new rival.

� Product differentiation: Corporations such as Procter & Gamble and General Mills, which manufacture products such as Tide and Cheerios, create high entry barriers through their high levels of advertising and promotion.

� Capital requirements: The need to invest huge financial resources in manufacturing fa- cilities in order to produce large commercial airplanes creates a significant barrier to en- try to any competitor for Boeing and Airbus.

� Switching costs: Once a software program such as Excel or Word becomes established in an office, office managers are very reluctant to switch to a new program because of the high training costs.

� Access to distribution channels: Small entrepreneurs often have difficulty obtaining su- permarket shelf space for their goods because large retailers charge for space on their shelves and give priority to the established firms who can pay for the advertising needed to generate high customer demand.

� Cost disadvantages independent of size: Once a new product earns sufficient market share to be accepted as the standard for that type of product, the maker has a key ad- vantage. Microsoft’s development of the first widely adopted operating system (MS- DOS) for the IBM-type personal computer gave it a significant competitive advantage over potential competitors. Its introduction of Windows helped to cement that advan- tage so that the Microsoft operating system is now on more than 90% of personal com- puters worldwide.

� Government policy: Governments can limit entry into an industry through licensing re- quirements by restricting access to raw materials, such as oil-drilling sites in protected areas.

Rivalry among Existing Firms In most industries, corporations are mutually dependent. A competitive move by one firm can be expected to have a noticeable effect on its competitors and thus may cause retaliation. For

112 PA RT 2 Scanning the Environment

example, the entry by mail order companies such as Dell and Gateway into a PC industry previ- ously dominated by IBM, Apple, and Compaq increased the level of competitive activity to such an extent that any price reduction or new product introduction was quickly followed by similar moves from other PC makers. The same is true of prices in the United States airline industry. Ac- cording to Porter, intense rivalry is related to the presence of several factors, including:

� Number of competitors: When competitors are few and roughly equal in size, such as in the auto and major home appliance industries, they watch each other carefully to make sure that they match any move by another firm with an equal countermove.

� Rate of industry growth: Any slowing in passenger traffic tends to set off price wars in the airline industry because the only path to growth is to take sales away from a competitor.

� Product or service characteristics: A product can be very unique, with many qualities differentiating it from others of its kind or it may be a commodity, a product whose char- acteristics are the same, regardless of who sells it. For example, most people choose a gas station based on location and pricing because they view gasoline as a commodity.

� Amount of fixed costs: Because airlines must fly their planes on a schedule, regardless of the number of paying passengers for any one flight, they offer cheap standby fares whenever a plane has empty seats.

� Capacity: If the only way a manufacturer can increase capacity is in a large increment by building a new plant (as in the paper industry), it will run that new plant at full capacity to keep its unit costs as low as possible—thus producing so much that the selling price falls throughout the industry.

� Height of exit barriers: Exit barriers keep a company from leaving an industry. The brew- ing industry, for example, has a low percentage of companies that voluntarily leave the in- dustry because breweries are specialized assets with few uses except for making beer.

� Diversity of rivals: Rivals that have very different ideas of how to compete are likely to cross paths often and unknowingly challenge each other’s position. This happens of- ten in the retail clothing industry when a number of retailers open outlets in the same location—thus taking sales away from each other. This is also likely to happen in some countries or regions when multinational corporations compete in an increasingly global economy.

Threat of Substitute Products or Services A substitute product is a product that appears to be different but can satisfy the same need as another product. For example, e-mail is a substitute for the fax, Nutrasweet is a substitute for sugar, the Internet is a substitute for video stores, and bottled water is a substitute for a cola. According to Porter, “Substitutes limit the potential returns of an industry by placing a ceiling on the prices firms in the industry can profitably charge.”50 To the extent that switching costs are low, substitutes may have a strong effect on an industry. Tea can be considered a substitute for coffee. If the price of coffee goes up high enough, coffee drinkers will slowly begin switch- ing to tea. The price of tea thus puts a price ceiling on the price of coffee. Sometimes a diffi- cult task, the identification of possible substitute products or services means searching for products or services that can perform the same function, even though they have a different ap- pearance and may not appear to be easily substitutable.

Bargaining Power of Buyers Buyers affect an industry through their ability to force down prices, bargain for higher quality or more services, and play competitors against each other. A buyer or a group of buyers is pow- erful if some of the following factors hold true:

C H A P T E R 4 Environmental Scanning and Industry Analysis 113

� A buyer purchases a large proportion of the seller’s product or service (for example, oil filters purchased by a major auto maker).

� A buyer has the potential to integrate backward by producing the product itself (for exam- ple, a newspaper chain could make its own paper).

� Alternative suppliers are plentiful because the product is standard or undifferentiated (for example, motorists can choose among many gas stations).

� Changing suppliers costs very little (for example, office supplies are easy to find).

� The purchased product represents a high percentage of a buyer’s costs, thus providing an incentive to shop around for a lower price (for example, gasoline purchased for resale by convenience stores makes up half their total costs).

� A buyer earns low profits and is thus very sensitive to costs and service differences (for example, grocery stores have very small margins).

� The purchased product is unimportant to the final quality or price of a buyer’s products or services and thus can be easily substituted without affecting the final product adversely (for example, electric wire bought for use in lamps).

Bargaining Power of Suppliers Suppliers can affect an industry through their ability to raise prices or reduce the quality of pur- chased goods and services. A supplier or supplier group is powerful if some of the following factors apply:

� The supplier industry is dominated by a few companies, but it sells to many (for example, the petroleum industry).

� Its product or service is unique and/or it has built up switching costs (for example, word processing software).

� Substitutes are not readily available (for example, electricity).

� Suppliers are able to integrate forward and compete directly with their present customers (for example, a microprocessor producer such as Intel can make PCs).

� A purchasing industry buys only a small portion of the supplier group’s goods and ser- vices and is thus unimportant to the supplier (for example, sales of lawn mower tires are less important to the tire industry than are sales of auto tires).

Relative Power of Other Stakeholders A sixth force should be added to Porter’s list to include a variety of stakeholder groups from the task environment. Some of these groups are governments (if not explicitly included else- where), local communities, creditors (if not included with suppliers), trade associations, special-interest groups, unions (if not included with suppliers), shareholders, and complemen- tors. According to Andy Grove, Chairman and past CEO of Intel, a complementor is a com- pany (e.g., Microsoft) or an industry whose product works well with a firm’s (e.g., Intel’s) product and without which the product would lose much of its value.51 An example of com- plementary industries is the tire and automobile industries. Key international stakeholders who determine many of the international trade regulations and standards are the World Trade Or- ganization, the European Union, NAFTA, ASEAN, and Mercosur.

The importance of these stakeholders varies by industry. For example, environmental groups in Maine, Michigan, Oregon, and Iowa successfully fought to pass bills outlawing dis- posable bottles and cans, and thus deposits for most drink containers are now required. This effectively raised costs across the board, with the most impact on the marginal producers who

114 PA RT 2 Scanning the Environment

Multidomestic Global

Industry in which companies tailor their products to the specific needs of consumers in a particular country. Retailing Insurance Banking

Industry in which companies manufacture and sell the same products, with only minor adjustments made for individual countries around the world. Automobiles Tires Television sets

FIGURE 4–4 Continuum

of International Industries

could not internally absorb all these costs. The traditionally strong power of national unions in the United States’ auto and railroad industries has effectively raised costs throughout these in- dustries but is of little importance in computer software.

INDUSTRY EVOLUTION Over time, most industries evolve through a series of stages from growth through maturity to eventual decline. The strength of each of the six forces mentioned earlier varies according to the stage of industry evolution. The industry life cycle is useful for explaining and predicting trends among the six forces that drive industry competition. For example, when an industry is new, people often buy the product, regardless of price, because it fulfills a unique need. This usually occurs in a fragmented industry—where no firm has large market share, and each firm serves only a small piece of the total market in competition with others (for example, cleaning services).52 As new competitors enter the industry, prices drop as a result of competi- tion. Companies use the experience curve (discussed in Chapter 5) and economies of scale to reduce costs faster than the competition. Companies integrate to reduce costs even further by acquiring their suppliers and distributors. Competitors try to differentiate their products from one another’s in order to avoid the fierce price competition common to a maturing industry.

By the time an industry enters maturity, products tend to become more like commodities. This is now a consolidated industry—dominated by a few large firms, each of which strug- gles to differentiate its products from those of the competition. As buyers become more so- phisticated over time, purchasing decisions are based on better information. Price becomes a dominant concern, given a minimum level of quality and features, and profit margins decline. The automobile, petroleum, and major home appliance industries are examples of mature, con- solidated industries each controlled by a few large competitors. In the case of the United States major home appliance industry, the industry changed from being a fragmented industry (pure competition) composed of hundreds of appliance manufacturers in the industry’s early years to a consolidated industry (mature oligopoly) composed of three companies controlling over 90% of United States appliance sales. A similar consolidation is occurring now in European major home appliances.

As an industry moves through maturity toward possible decline, its products’ growth rate of sales slows and may even begin to decrease. To the extent that exit barriers are low, firms begin converting their facilities to alternate uses or sell them to other firms. The industry tends to consolidate around fewer but larger competitors. The tobacco industry is an example of an industry currently in decline.

CATEGORIZING INTERNATIONAL INDUSTRIES According to Porter, world industries vary on a continuum from multidomestic to global (see Figure 4–4).53 Multidomestic industries are specific to each country or group of countries. This type of international industry is a collection of essentially domestic industries, such as

C H A P T E R 4 Environmental Scanning and Industry Analysis 115

retailing and insurance. The activities in a subsidiary of a multinational corporation (MNC) in this type of industry are essentially independent of the activities of the MNC’s subsidiaries in other countries. Within each country, it has a manufacturing facility to produce goods for sale within that country. The MNC is thus able to tailor its products or services to the very specific needs of consumers in a particular country or group of countries having similar soci- etal environments.

Global industries, in contrast, operate worldwide, with MNCs making only small adjust- ments for country-specific circumstances. In a global industry an MNC’s activities in one country are significantly affected by its activities in other countries. MNCs in global industries produce products or services in various locations throughout the world and sell them, making only minor adjustments for specific country requirements. Examples of global industries are commercial aircraft, television sets, semiconductors, copiers, automobiles, watches, and tires. The largest industrial corporations in the world in terms of sales revenue are, for the most part, MNCs operating in global industries.

The factors that tend to determine whether an industry will be primarily multidomestic or primarily global are:

1. Pressure for coordination within the MNCs operating in that industry

2. Pressure for local responsiveness on the part of individual country markets

To the extent that the pressure for coordination is strong and the pressure for local responsive- ness is weak for MNCs within a particular industry, that industry will tend to become global. In contrast, when the pressure for local responsiveness is strong and the pressure for coordination is weak for multinational corporations in an industry, that industry will tend to be multidomes- tic. Between these two extremes lie a number of industries with varying characteristics of both multidomestic and global industries. These are regional industries, in which MNCs primarily coordinate their activities within regions, such as the Americas or Asia.54 The major home ap- pliance industry is a current example of a regional industry becoming a global industry. Japa- nese appliance makers, for example, are major competitors in Asia, but only minor players in Europe or America. The dynamic tension between the pressure for coordination and the pres- sure for local responsiveness is contained in the phrase, “Think globally but act locally.”

INTERNATIONAL RISK ASSESSMENT Some firms develop elaborate information networks and computerized systems to evaluate and rank investment risks. Small companies may hire outside consultants, such as Boston’s Arthur D. Little Inc., to provide political-risk assessments. Among the many systems that ex- ist to assess political and economic risks are the Business Environment Risk Index, the Econ- omist Intelligence Unit, and Frost and Sullivan’s World Political Risk Forecasts. The Economist Intelligence Unit, for example, provides a constant flow of analysis and forecasts on more than 200 countries and eight key industries. Regardless of the source of data, a firm must develop its own method of assessing risk. It must decide on its most important risk fac- tors and then assign weights to each.

STRATEGIC GROUPS A strategic group is a set of business units or firms that “pursue similar strategies with simi- lar resources.”55 Categorizing firms in any one industry into a set of strategic groups is very useful as a way of better understanding the competitive environment.56 Research shows that some strategic groups in the same industry are more profitable than others.57 Because a corpo- ration’s structure and culture tend to reflect the kinds of strategies it follows, companies or

116 PA RT 2 Scanning the Environment

Red Lobster Olive Garden

ChiChi’s

High

Shoney’s Denny’s

Country Kitchen

Perkins International House

of Pancakes

Ponderosa Bonanza

KFC Pizza Hut

Long John Silver’s

Arby’s Domino’s Hardee’s

Burger King

Wendy’s Dairy Queen Taco Bell McDonald’s

P ri

c e

Low Limited Menu

Product-Line Breadth Full Menu

FIGURE 4–5 Mapping Strategic

Groups in the U.S. Restaurant Chain Industry

business units belonging to a particular strategic group within the same industry tend to be strong rivals and tend to be more similar to each other than to competitors in other strategic groups within the same industry.58

For example, although McDonald’s and Olive Garden are a part of the same industry, the restaurant industry, they have different missions, objectives, and strategies, and thus they be- long to different strategic groups. They generally have very little in common and pay little at- tention to each other when planning competitive actions. Burger King and Hardee’s, however, have a great deal in common with McDonald’s in terms of their similar strategy of producing a high volume of low-priced meals targeted for sale to the average family. Consequently, they are strong rivals and are organized to operate similarly.

Strategic groups in a particular industry can be mapped by plotting the market positions of industry competitors on a two-dimensional graph, using two strategic variables as the ver- tical and horizontal axes (See Figure 4–5):

1. Select two broad characteristics, such as price and menu, that differentiate the companies in an industry from one another.

2. Plot the firms, using these two characteristics as the dimensions.

3. Draw a circle around those companies that are closest to one another as one strategic group, varying the size of the circle in proportion to the group’s share of total industry sales. (You could also name each strategic group in the restaurant industry with an iden- tifying title, such as quick fast food or buffet-style service.)

C H A P T E R 4 Environmental Scanning and Industry Analysis 117

STRATEGIC TYPES In analyzing the level of competitive intensity within a particular industry or strategic group, it is useful to characterize the various competitors for predictive purposes. A strategic type is a category of firms based on a common strategic orientation and a combination of structure, culture, and processes consistent with that strategy. According to Miles and Snow, competing firms within a single industry can be categorized into one of four basic types on the basis of their general strategic orientation.59 This distinction helps explain why companies facing sim- ilar situations behave differently and why they continue to do so over long periods of time.60

These general types have the following characteristics:

� Defenders are companies with a limited product line that focus on improving the effi- ciency of their existing operations. This cost orientation makes them unlikely to inno- vate in new areas. With its emphasis on efficiency, Lincoln Electric is an example of a defender.

� Prospectors are companies with fairly broad product lines that focus on product innova- tion and market opportunities. This sales orientation makes them somewhat inefficient. They tend to emphasize creativity over efficiency. Rubbermaid’s emphasis on new prod- uct development makes it an example of a prospector.

� Analyzers are corporations that operate in at least two different product-market areas, one stable and one variable. In the stable areas, efficiency is emphasized. In the variable areas, innovation is emphasized. Multidivisional firms, such as IBM and Procter & Gamble, which operate in multiple industries, tend to be analyzers.

� Reactors are corporations that lack a consistent strategy-structure-culture relationship. Their (often ineffective) responses to environmental pressures tend to be piecemeal strate- gic changes. Most major U.S. airlines have recently tended to be reactors—given the way they have been forced to respond to new entrants such as Southwest and JetBlue.

Dividing the competition into these four categories enables the strategic manager not only to monitor the effectiveness of certain strategic orientations, but also to develop scenarios of fu- ture industry developments (discussed later in this chapter).

Other dimensions, such as quality, service, location, or degree of vertical integration, could also be used in additional graphs of the restaurant industry to gain a better understand- ing of how the various firms in the industry compete. Keep in mind, however, that the two di- mensions should not be highly correlated; otherwise, the circles on the map will simply lie along the diagonal, providing very little new information other than the obvious.

HYPERCOMPETITION Most industries today are facing an ever-increasing level of environmental uncertainty. They are becoming more complex and more dynamic. Industries that used to be multidomestic are becoming global. New flexible, aggressive, innovative competitors are moving into estab- lished markets to rapidly erode the advantages of large previously dominant firms. Distribu- tion channels vary from country to country and are being altered daily through the use of sophisticated information systems. Closer relationships with suppliers are being forged to re- duce costs, increase quality, and gain access to new technology. Companies learn to quickly imitate the successful strategies of market leaders, and it becomes harder to sustain any com- petitive advantage for very long. Consequently, the level of competitive intensity is increasing in most industries.

118 PA RT 2 Scanning the Environment

from current products. Microsoft was one of the first com- panies to disprove this argument against cannibalization.

Bill Gates, Microsoft’s co-founder, chair, and CEO, real- ized that if his company didn’t replace its own DOS prod- uct line with a better product, someone else would (such as Linux or IBM’s OS/2 Warp). He knew that success in the software industry depends not so much on company size as on moving aggressively to the next competitive advan- tage before a competitor does. “This is a hypercompetitive market,” explained Gates. “Scale is not all positive in this business. Cleverness is the position in this business.” By 2008, Microsoft still controlled over 90% of operating sys- tems software and had achieved a dominant position in applications software as well.

Microsoft is a hypercompet- itive firm operating in a hy-

percompetitive industry. It has used its dominance in operating

systems (DOS and Windows) to move into a very strong position in appli-

cation programs such as word processing and spread- sheets (Word and Excel). Even though Microsoft held 90% of the market for personal computer operating systems in 1992, it still invested millions in developing the next gen- eration—Windows 95 and Windows NT. These were soon followed by Windows Me, XP, and Vista. Instead of trying to protect its advantage in the profitable DOS operating system, Microsoft actively sought to replace DOS with var- ious versions of Windows. Before hypercompetition, most experts argued against cannibalization of a company’s own product line because it destroys a very profitable product instead of harvesting it like a “cash cow.” According to this line of thought, a company would be better off defending its older products. New products would be introduced only if it could be proven that they would not take sales away

MICROSOFT IN A HYPERCOMPETITIVE INDUSTRY

SOURCE: Richard A. D’Aveni, “Hypercompetition: Managing the Dynamics of Strategic Maneuvering.” Copyright © 1994 by Richard A. D’Aveni. All rights reserved.

STRATEGY highlight 4.1

USING KEY SUCCESS FACTORS TO CREATE AN INDUSTRY MATRIX Within any industry there are usually certain variables—key success factors—that a com- pany’s management must understand in order to be successful. Key success factors are vari- ables that can significantly affect the overall competitive positions of companies within any particular industry. They typically vary from industry to industry and are crucial to determin- ing a company’s ability to succeed within that industry. They are usually determined by the

Richard D’Aveni contends that as this type of environmental turbulence reaches more in- dustries, competition becomes hypercompetition. According to D’Aveni:

In hypercompetition the frequency, boldness, and aggressiveness of dynamic movement by the players accelerates to create a condition of constant disequilibrium and change. Market stabil- ity is threatened by short product life cycles, short product design cycles, new technologies, fre- quent entry by unexpected outsiders, repositioning by incumbents, and tactical redefinitions of market boundaries as diverse industries merge. In other words, environments escalate toward higher and higher levels of uncertainty, dynamism, heterogeneity of the players and hostility.61

In hypercompetitive industries such as computers, competitive advantage comes from an up- to-date knowledge of environmental trends and competitive activity coupled with a willing- ness to risk a current advantage for a possible new advantage. Companies must be willing to cannibalize their own products (that is, replace popular products before competitors do so) in or- der to sustain their competitive advantage. See Strategy Highlight 4.1 to learn how Microsoft is operating in the hypercompetitive industry of computer software. (Hypercompetition is dis- cussed in more detail in Chapter 6.)

C H A P T E R 4 Environmental Scanning and Industry Analysis 119

economic and technological characteristics of the industry and by the competitive weapons on which the firms in the industry have built their strategies.62 For example, in the major home appliance industry, a firm must achieve low costs, typically by building large manufacturing facilities dedicated to making multiple versions of one type of appliance, such as washing ma- chines. Because 60% of major home appliances in the United States are sold through “power retailers” such as Sears and Best Buy, a firm must have a strong presence in the mass merchan- diser distribution channel. It must offer a full line of appliances and provide a just-in-time de- livery system to keep store inventory and ordering costs to a minimum. Because the consumer expects reliability and durability in an appliance, a firm must have excellent process R&D. Any appliance manufacturer that is unable to deal successfully with these key success factors will not survive long in the U.S. market.

An industry matrix summarizes the key success factors within a particular industry. As shown in Table 4–4, the matrix gives a weight for each factor based on how important that fac- tor is for success within the industry. The matrix also specifies how well various competitors in the industry are responding to each factor. To generate an industry matrix using two indus- try competitors (called A and B), complete the following steps for the industry being analyzed:

1. In Column 1 (Key Success Factors), list the 8 to 10 factors that appear to determine suc- cess in the industry.

2. In Column 2 (Weight), assign a weight to each factor, from 1.0 (Most Important) to 0.0 (Not Important) based on that factor’s probable impact on the overall industry’s current and fu- ture success. (All weights must sum to 1.0 regardless of the number of strategic factors.)

3. In Column 3 (Company A Rating), examine a particular company within the industry—for example, Company A. Assign a rating to each factor from 5 (Outstanding) to 1 (Poor) based on Company A’s current response to that particular factor. Each rating is a judgment regard- ing how well that company is specifically dealing with each key success factor.

TABLE 4–4 Industry Matrix

Key Success Factors Weight Company A Rating

Company A Weighted Score

Company B Rating

Company B Weighted Score

1 2 3 4 5 6

Total 1.00

SOURCE: T. L. Wheelen and J. D. Hunger, Industry Matrix. Copyright © 1997, 2001, and 2005 by Wheelen & Hunger Associates. Reprinted with permission.

5.0

Outstanding Above Average Average Below Average Poor

4.5 4.0

3.5 3.0

2.5 2.0

1.5 1.0

4. In Column 4 (Company A Weighted Score), multiply the weight in Column 2 for each factor by its rating in Column 3 to obtain that factor’s weighted score for Company A.

120 PA RT 2 Scanning the Environment

5. In Column 5 (Company B Rating), examine a second company within the industry - in this case, Company B. Assign a rating to each key success factor from 5.0 (Outstanding) to 1.0 (Poor), based on Company B’s current response to each particular factor.

6. In Column 6 (Company B Weighted Score), multiply the weight in Column 2 for each factor times its rating in Column 5 to obtain that factor’s weighted score for Company B.

7. Finally, add the weighted scores for all the factors in Columns 4 and 6 to determine the total weighted scores for companies A and B. The total weighted score indicates how well each company is responding to current and expected key success factors in the industry’s environment. Check to ensure that the total weighted score truly reflects the company’s current performance in terms of profitability and market share. (An average company should have a total weighted score of 3.)

The industry matrix can be expanded to include all the major competitors within an industry through the addition of two additional columns for each additional competitor.

4.3 Competitive Intelligence Much external environmental scanning is done on an informal and individual basis. Informa- tion is obtained from a variety of sources—suppliers, customers, industry publications, em- ployees, industry experts, industry conferences, and the Internet.63 For example, scientists and engineers working in a firm’s R&D lab can learn about new products and competitors’ ideas at professional meetings; someone from the purchasing department, speaking with supplier- representatives’ personnel, may also uncover valuable bits of information about a competitor. A study of product innovation found that 77% of all product innovations in scientific instru- ments and 67% in semiconductors and printed circuit boards were initiated by the customer in the form of inquiries and complaints.64 In these industries, the sales force and service depart- ments must be especially vigilant.

A recent survey of global executives by McKinsey & Company found that the single fac- tor contributing most to the increasing competitive intensity in their industries was the im- proved capabilities of competitors.65 Yet, without competitive intelligence, companies run the risk of flying blind in the marketplace. In a 2008 survey of global executives, the majority re- vealed that their companies typically learned about a competitor’s price change or significant innovation too late to respond before it was introduced into the market.66 According to work by Ryall, firms can have competitive advantages simply because their rivals have erroneous beliefs about them.67 This is why competitive intelligence has become an important part of en- vironmental scanning in most companies.

Competitive intelligence is a formal program of gathering information on a company’s competitors. Often called business intelligence, it is one of the fastest growing fields within strategic management. Research indicates that there is a strong association between corporate performance and competitive intelligence activities.68 According to a survey of competitive in- telligence professionals, the primary reasons for practicing competitive intelligence are to build industry awareness (90.6%), support the strategic planning process (79.2%), develop new products (73.6%), and create new marketing strategies and tactics.69 As early as the 1990s, 78% of large U.S. corporations conducted competitive intelligence activities.70 In about a third of the firms, the competitive/business intelligence function is housed in its own unit, with the remainder being housed within marketing, strategic planning, information services, business development (merger & acquisitions), product development, or other units.71 According to a

C H A P T E R 4 Environmental Scanning and Industry Analysis 121

2007 survey of 141 large American corporations, spending on competitive intelligence activ- ities was rising from $1 billion in 2007 to $10 billion by 2012.72 At General Mills, for exam- ple, all employees have been trained to recognize and tap sources of competitive information. Janitors no longer simply place orders with suppliers of cleaning materials; they also ask about relevant practices at competing firms!

SOURCES OF COMPETITIVE INTELLIGENCE Most corporations use outside organizations to provide them with environmental data. Firms such as A. C. Nielsen Co. provide subscribers with bimonthly data on brand share, retail prices, percentages of stores stocking an item, and percentages of stock-out stores. Strategists can use this data to spot regional and national trends as well as to assess market share. Information on market conditions, government regulations, industry competitors, and new products can be bought from “information brokers” such as Market Research.com (Findex), LexisNexis (com- pany and country analyses), and Finsbury Data Services. Company and industry profiles are generally available from the Hoover’s Web site, at www.hoovers.com. Many business corpo- rations have established their own in-house libraries and computerized information systems to deal with the growing mass of available information.

The Internet has changed the way strategists engage in environmental scanning. It provides the quickest means to obtain data on almost any subject. Although the scope and quality of In- ternet information is increasing geometrically, it is also littered with “noise,” misinformation, and utter nonsense. For example, a number of corporate Web sites are sending unwanted guests to specially constructed bogus Web sites.73 Unlike the library, the Internet lacks the tight bibli- ographic control standards that exist in the print world. There is no ISBN or Dewey Decimal System to identify, search, and retrieve a document. Many Web documents lack the name of the author and the date of publication. A Web page providing useful information may be accessible on the Web one day and gone the next. Unhappy ex-employees, far-out environmentalists, and prank-prone hackers create “blog” Web sites to attack and discredit an otherwise reputable cor- poration. Rumors with no basis in fact are spread via chat rooms and personal Web sites. This creates a serious problem for researchers. How can one evaluate the information found on the Internet? For a way to evaluate intelligence information, see Strategy Highlight 4.2.

Some companies choose to use industrial espionage or other intelligence-gathering tech- niques to get their information straight from their competitors. According to a survey by the American Society for Industrial Security, PricewaterhouseCoopers, and the United States Chamber of Commerce, Fortune 1000 companies lost an estimated $59 billion in one year alone due to the theft of trade secrets.74 By using current or former competitors’ employees and private contractors, some firms attempt to steal trade secrets, technology, business plans, and pricing strategies. For example, Avon Products hired private investigators to retrieve from a public dumpster documents (some of them shredded) that Mary Kay Corporation had thrown away. Oracle Corporation also hired detectives to obtain the trash of a think tank that had de- fended the pricing practices of its rival Microsoft. Studies reveal that 32% of the trash typi- cally found next to copy machines contains confidential company data, in addition to personal data (29%) and gossip (39%).75 Even P&G, which defends itself like a fortress from informa- tion leaks, is vulnerable. A competitor was able to learn the precise launch date of a concen- trated laundry detergent in Europe when one of its people visited the factory where machinery was being made. Simply asking a few questions about what a certain machine did, whom it was for, and when it would be delivered was all that was necessary.

Some of the firms providing investigatory services are Kroll Inc. with 4,000 employees in 25 countries, Fairfax, Security Outsourcing Solutions, Trident Group, and Diligence Inc.76

Trident, for example, specializes in helping American companies enter the Russian market and

122 PA RT 2 Scanning the Environment

is a U.S.-based corporate intelligence firm founded and managed by former veterans of Rus- sian intelligence services, like the KGB.77

To combat the increasing theft of company secrets, the United States government passed the Economic Espionage Act in 1996. The law makes it illegal (with fines up to $5 million and 10 years in jail) to steal any material that a business has taken “reasonable efforts” to keep se- cret and that derives its value from not being known.78 The Society of Competitive Intelligence Professionals (www.scip.org) urges strategists to stay within the law and to act ethically when searching for information. The society states that illegal activities are foolish because the vast majority of worthwhile competitive intelligence is available publicly via annual reports, Web sites, and libraries. Unfortunately, a number of firms hire “kites,” consultants with question- able reputations, who do what is necessary to get information when the selected methods do not meet SPIC ethical standards or are illegal. This allows the company that initiated the ac- tion to deny that it did anything wrong.79

MONITORING COMPETITORS FOR STRATEGIC PLANNING The primary activity of a competitive intelligence unit is to monitor competitors—organiza- tions that offer same, similar, or substitutable products or services in the business area in which a particular company operates. To understand a competitor, it is important to answer the fol- lowing 10 questions:

found through library research in sources such as Moody’s Industrials, Standard & Poor’s, or Value Line can generally be evaluated as having a reliability of A. The correctness of the data can still range anywhere from 1 to 5, but in most instances is likely to be either 1 or 2, but probably no worse than 3 or 4. Web sites are quite different.

Web sites, such as those sponsored by the U.S. Securi- ties and Exchange Commission (www.sec.gov), the Econo- mist (www.economist.com), or Hoovers Online (www .hoovers.com) are extremely reliable. Company-sponsored Web sites are generally reliable, but are not the place to go for trade secrets, strategic plans, or proprietary informa- tion. For one thing, many firms think of their Web sites pri- marily in terms of marketing and provide little data aside from product descriptions and distributors. Other compa- nies provide their latest financial statements and links to other useful Web sites. Nevertheless, some companies in very competitive industries may install software on their Web site to ascertain a visitor’s web address. Visitors from a competitor’s domain name are thus screened before they are allowed to access certain Web sites. They may not be allowed beyond the product information page or they may be sent to a bogus Web site containing misinformation. Cisco Systems, for example, uses its Web site to send visi- tors from other high-tech firms to a special Web page ask- ing if they would like to apply for a job at Cisco!

A basic rule in intelligence gathering is that before a

piece of information can be used in any report or briefing, it

must first be evaluated in two ways. First, the source of the information

should be judged in terms of its truthfulness and reliability. How trustworthy is the source? How well can a researcher rely upon it for truthful and correct information? One ap- proach is to rank the reliability of the source on a scale from A (extremely reliable), B (reliable), C (unknown reliability), D (probably unreliable), to E (very questionable reliability). The reliability of a source can be judged on the basis of the author’s credentials, the organization sponsoring the infor- mation, and past performance, among other factors. Second, the information or data should be judged in terms of its likelihood of being correct. The correctness of the data may be ranked on a scale from 1 (correct), 2 (proba- bly correct), 3 (unknown), 4 (doubtful), to 5 (extremely doubtful). The correctness of a piece of data or information can be judged on the basis of its agreement with other bits of separately-obtained information or with a general trend supported by previous data. For every piece of information found on the Internet, for example, list not only the URL of the Web page, but also the evaluation of the information from A1 (good stuff) to E5 (bad doodoo). Information

EVALUATING COMPETITIVE INTELLIGENCE

STRATEGY highlight 4.2

C H A P T E R 4 Environmental Scanning and Industry Analysis 123

1. Why do your competitors exist? Do they exist to make profits or just to support another unit?

2. Where do they add customer value—higher quality, lower price, excellent credit terms, or better service?

3. Which of your customers are the competitors most interested in? Are they cherry-picking your best customers, picking the ones you don’t want, or going after all of them?

4. What is their cost base and liquidity? How much cash do they have? How do they get their supplies?

5. Are they less exposed with their suppliers than your firm? Are their suppliers better than yours?

6. What do they intend to do in the future? Do they have a strategic plan to target your mar- ket segments? How committed are they to growth? Are there any succession issues?

7. How will their activity affect your strategies? Should you adjust your plans and operations?

8. How much better than your competitor do you need to be in order to win customers? Do either of you have a competitive advantage in the marketplace?

9. Will new competitors or new ways of doing things appear over the next few years? Who is a potential new entrant?

10. If you were a customer, would you choose your product over those offered by your com- petitors? What irritates your current customers? What competitors solve these particular customer complaints?80

To answer these and other questions, competitive intelligence professionals utilize a number of analytical techniques. In addition to the previously discussed SWOT analysis, Michael Porter’s industry forces analysis, and strategic group analysis, some of these techniques are Porter’s four- corner exercise, Treacy and Wiersema’s value disciplines, Gilad’s blind spot analysis, and war gaming.81 See Appendix 4.A for more information about these competitive analysis techniques.

Done right, competitive intelligence is a key input to strategic planning. Avnet Inc., one of the world’s largest distributors of electronic components, uses competitive intelligence in its growth by acquisition strategy. According to John Hovis, Avnet’s senior vice president of corporate planning and investor relations:

Our competitive intelligence team has a significant responsibility in tracking all of the varied competitors, not just our direct competitors, but all the peripheral competitors that have a po- tential to impact our ability to create value. . . . One of the things we are about is finding new acquisition candidates, and our competitive intelligence unit is very much involved with our ac- quisition team, in helping to profile potential acquisition candidates.82

4.4 Forecasting Environmental scanning provides reasonably hard data on the present situation and current trends, but intuition and luck are needed to accurately predict whether these trends will con- tinue. The resulting forecasts are, however, usually based on a set of assumptions that may or may not be valid.

DANGER OF ASSUMPTIONS Faulty underlying assumptions are the most frequent cause of forecasting errors. Neverthe- less, many managers who formulate and implement strategic plans rarely consider that their success is based on a series of basic assumptions. Many strategic plans are simply based on

124 PA RT 2 Scanning the Environment

USEFUL FORECASTING TECHNIQUES Various techniques are used to forecast future situations. They do not tell the future; they merely state what can be, not what will be. As such, they can be used to form a set of reasonable assump- tions about the future. Each technique has its proponents and its critics. A study of nearly 500 of the world’s largest corporations revealed trend extrapolation to be the most widely practiced form of forecasting—over 70% use this technique either occasionally or frequently.83 Simply stated, extrapolation is the extension of present trends into the future. It rests on the assumption that the world is reasonably consistent and changes slowly in the short run. Time-series meth- ods are approaches of this type; they attempt to carry a series of historical events forward into the future. The basic problem with extrapolation is that a historical trend is based on a series of patterns or relationships among so many different variables that a change in any one can drasti- cally alter the future direction of the trend. As a rule of thumb, the further back into the past you can find relevant data supporting the trend, the more confidence you can have in the prediction.

Brainstorming, expert opinion, and statistical modeling are also very popular forecasting techniques. Brainstorming is a non-quantitative approach that requires simply the presence of people with some knowledge of the situation to be predicted. The basic ground rule is to pro- pose ideas without first mentally screening them. No criticism is allowed. “Wild” ideas are en- couraged. Ideas should build on previous ideas until a consensus is reached.84 This is a good technique to use with operating managers who have more faith in “gut feel” than in more quan- titative number-crunching techniques. Expert opinion is a nonquantitative technique in which experts in a particular area attempt to forecast likely developments. This type of forecast is based on the ability of a knowledgeable person(s) to construct probable future developments based on the interaction of key variables. One application, developed by the RAND Corpora- tion, is the Delphi technique, in which separated experts independently assess the likelihoods of specified events. These assessments are combined and sent back to each expert for fine- tuning until agreement is reached. These assessments are most useful if they are shaped into several possible scenarios that allow decision makers to more fully understand their implica- tion.85 Statistical modeling is a quantitative technique that attempts to discover causal or at least explanatory factors that link two or more time series together. Examples of statistical modeling are regression analysis and other econometric methods. Although very useful in the grasping of historic trends, statistical modeling, such as trend extrapolation, is based on his- torical data. As the patterns of relationships change, the accuracy of the forecast deteriorates.

Prediction markets is a recent forecasting technique enabled by easy access to the Inter- net. As emphasized by James Surowiecki in The Wisdom of Crowds, the conclusions of large groups can often be better than those of experts because such groups can aggregate a large amount of dispersed wisdom.86 Prediction markets are small-scale electronic markets, fre- quently open to any employee, that tie payoffs to measurable future events, such as sales data

projections of the current situation. For example, few people in 2007 expected the price of oil (light, sweet crude, also called West Texas intermediate) to rise above $80 per barrel and were extremely surprised to see the price approach $150 by July 2008, especially since the price had been around $20 per barrel in 2002. U.S. auto companies, in particular, had continued to design and manufacture large cars, pick-up trucks, and SUVs under the assumption of gaso- line being available for around $2.00 a gallon. Market demand for these types of cars col- lapsed when the price of gasoline passed $3.00 to reach $4.00 a gallon in July 2008. In another example, many banks made a number of questionable mortgages based on the as- sumption that housing prices would continue to rise as they had in the past. When housing prices fell in 2007, these “sub-prime” mortgages were almost worthless—causing a number of banks to sell out or fail in 2008. Assumptions like these can be dangerous to your health!

for a computer workstation, the number of bugs in an application, or a product usage patterns. These markets yield prices on prediction contracts—prices that can be interpreted as market- aggregated forecasts.87 Companies including Microsoft, Google, and Eli Lilly have asked their employees to participate in prediction markets by betting on whether products will sell, when new offices will open, and whether profits will be high in the next quarter. Early predictions have been exceedingly accurate.88 Intrade.com offers a free Web site in which people can buy or sell various predictions in a manner similar to buying or selling common stock. On May 26, 2008, for example, Intrade.com listed the buying price for democratic presidential candidate Barack Obama as $91.50 compared to $8.00 for Hillary Clinton, and $37.70 for John McCain. Thus far, prediction markets have not been documented for long-term forecasting, so its value in strategic planning has not yet been established. Other forecasting techniques, such as cross- impact analysis (CIA) and trend-impact analysis (TIA), have not established themselves suc- cessfully as regularly employed tools.89

Scenario writing is the most widely used forecasting technique after trend extrapolation. Originated by Royal Dutch Shell, scenarios are focused descriptions of different likely futures presented in a narrative fashion. A scenario thus may be merely a written description of some future state, in terms of key variables and issues, or it may be generated in combination with other forecasting techniques. Often called scenario planning, this technique has been success- fully used by 3M, Levi-Strauss, General Electric, United Distillers, Electrolux, British Air- ways, and Pacific Gas and Electricity, among others.90 According to Mike Eskew, Chairman and CEO of United Parcel Service, UPS uses scenario writing to envision what its customers might need five to ten years in the future.91 The four Arctic scenarios that began this chapter are an example of scenario writing that should be an input to a transportation company’s strate- gic planning.

An industry scenario is a forecasted description of a particular industry’s likely future. Such a scenario is developed by analyzing the probable impact of future societal forces on key groups in a particular industry. The process may operate as follows:92

1. Examine possible shifts in the natural environment and in societal variables globally.

2. Identify uncertainties in each of the six forces of the task environment (that is, potential entrants, competitors, likely substitutes, buyers, suppliers, and other key stakeholders).

3. Make a range of plausible assumptions about future trends.

4. Combine assumptions about individual trends into internally consistent scenarios.

5. Analyze the industry situation that would prevail under each scenario.

6. Determine the sources of competitive advantage under each scenario.

7. Predict competitors’ behavior under each scenario.

8. Select the scenarios that are either most likely to occur or most likely to have a strong impact on the future of the company. Use these scenarios as assumptions in strategy formulation.

C H A P T E R 4 Environmental Scanning and Industry Analysis 125

4.5 The Strategic Audit: A Checklist for Environmental Scanning

One way of scanning the environment to identify opportunities and threats is by using the Strategic Audit found in Appendix 1.A at the end of Chapter 1. The audit provides a check- list of questions by area of concern. For example, Part III of the audit examines the natural, societal, and task environments. It looks at the societal environment in terms of economic, technological, political-legal, and sociocultural forces. It also considers the task environment

126 PA RT 2 Scanning the Environment

4.6 Synthesis of External Factors—EFAS After strategic managers have scanned the societal and task environments and identified a number of likely external factors for their particular corporation, they may want to refine their analysis of these factors by using a form such as that given in Table 4–5. Using an EFAS (Ex- ternal Factors Analysis Summary) Table is one way to organize the external factors into the generally accepted categories of opportunities and threats as well as to analyze how well a par- ticular company’s management (rating) is responding to these specific factors in light of the perceived importance (weight) of these factors to the company. To generate an EFAS Table for the company being analyzed, complete the following steps:

1. In Column 1 (External Factors), list the eight to ten most important opportunities and threats facing the company.

(industry) in terms of threat of new entrants, bargaining power of buyers and suppliers, threat of substitute products, rivalry among existing firms, and the relative power of other stake- holders.

TABLE 4–5 External Factor Analysis Summary (EFAS Table): Maytag as Example

External Factors Weight Rating Weighted

Score Comments

1 2 3 4 5

Opportunities

� Economic integration of European Community .20 4.1 .82 Acquisition of Hoover � Demographics favor quality appliances .10 5.0 .50 Maytag quality � Economic development of Asia .05 1.0 .05 Low Maytag presence � Opening of Eastern Europe .05 2.0 .10 Will take time � Trend to “Super Stores” .10 1.8 .18 Maytag weak in this channel

Threats

� Increasing government regulations .10 4.3 .43 Well positioned � Strong U.S. competition .10 4.0 .40 Well positioned � Whirlpool and Electrolux strong globally .15 3.0 .45 Hoover weak globally � New product advances .05 1.2 .06 Questionable � Japanese appliance companies .10 1.6 .16 Only Asian presence in

Australia Total Scores 1.00 3.15

NOTES: 1. List opportunities and threats (8–10) in Column 1. 2. Weight each factor from 1.0 (Most Important) to 0.0 (Not Important) in Column 2 based on that factor’s probable impact on the com-

pany’s strategic position. The total weights must sum to 1.00. 3. Rate each factor from 5.0 (Outstanding) to 1.0 (Poor) in Column 3 based on the company’s response to that factor. 4. Multiply each factor’s weight times its rating to obtain each factor’s weighted score in Column 4. 5. Use Column 5 (comments) for rationale used for each factor. 6. Add the individual weighted scores to obtain the total weighted score for the company in Column 4. This tells how well the company is

responding to the factors in its external environment.

SOURCE: T.L. Wheelen, J.D. Hunger, “External Factors Analysis Summary (EFAS)”. Copyright © 1987, 1988, 1989, 1990, and 2005 by T. L Wheelen. Copyright © 1991, 2003, and 2005 by Wheelen & Hunger Associates. Reprinted by permission.

C H A P T E R 4 Environmental Scanning and Industry Analysis 127

5.0

Outstanding Above Average Average Below Average Poor

4.5 4.0

3.5 3.0

2.5 2.0

1.5 1.0

4. In Column 4 (Weighted Score), multiply the weight in Column 2 for each factor times its rating in Column 3 to obtain that factor’s weighted score.

5. In Column 5 (Comments), note why a particular factor was selected and how its weight and rating were estimated.

6. Finally, add the weighted scores for all the external factors in Column 4 to determine the total weighted score for that particular company. The total weighted score indicates how well a particular company is responding to current and expected factors in its external en- vironment. The score can be used to compare that firm to other firms in the industry. Check to ensure that the total weighted score truly reflects the company’s current perfor- mance in terms of profitability and market share. The total weighted score for an average firm in an industry is always 3.0.

As an example of this procedure, Table 4–5 includes a number of external factors for Maytag Corporation with corresponding weights, ratings, and weighted scores provided. This table is appropriate for 1995, long before Maytag was acquired by Whirlpool. Note that Maytag’s total weight was 3.15, meaning that the corporation was slightly above average in the major home appliance industry at that time.

2. In Column 2 (Weight), assign a weight to each factor from 1.0 (Most Important) to 0.0 (Not Important) based on that factor’s probable impact on a particular company’s current strate- gic position. The higher the weight, the more important is this factor to the current and fu- ture success of the company. (All weights must sum to 1.0 regardless of the number of factors.)

3. In Column 3 (Rating), assign a rating to each factor from 5.0 (Outstanding) to 1.0 (Poor) based on that particular company’s specific response to that particular factor. Each rating is a judgment regarding how well the company is currently dealing with each specific ex- ternal factor.

End of Chapter S U M M A R Y Wayne Gretzky was one of the most famous people ever to play professional ice hockey. He wasn’t very fast. His shot was fairly weak. He was usually last in his team in strength training. He tended to operate in the back of his opponent’s goal, anticipating where his team members would be long before they got there and fed them passes so unsuspected that he would often surprise his own team members. In an interview with Time magazine, Gretzky stated that the key to winning is skating not to where the puck is but to where it is going to be. “People talk about skating, puck handling and shooting, but the whole sport is angles and caroms, forget- ting the straight direction the puck is going, calculating where it will be diverted, factoring in all the interruptions,” explained Gretzky.93

Environmental scanning involves monitoring, collecting, and evaluating information in order to understand the current trends in the natural, societal, and task environments. The

128 PA RT 2 Scanning the Environment

E C O - B I T S � The International Panel on Climate Change reports that

carbon dioxide emissions are rising faster than its worst-case scenario and that without new government action greenhouse gases will rise 25% to 90% over 2000 levels by 2030.

� China surpassed the United States in carbon emissions in 2006 by producing 6.6 billion tons of carbon dioxide, 24% of the world’s annual production of CO2.

� The total number of people affected by natural disasters has tripled over the past decade to two billion people.

� By 2025, 1.8 billion people could be living in water- scarce areas with the likely result being mass migra- tions out of these areas.94

D I S C U S S I O N Q U E S T I O N S 1. Discuss how a development in a corporation’s natural and

societal environments can affect the corporation through its task environment.

2. According to Porter, what determines the level of com- petitive intensity in an industry?

3. According to Porter’s discussion of industry analysis, is Pepsi Cola a substitute for Coca-Cola?

4. How can a decision maker identify strategic factors in a corporation’s external international environment?

5. Compare and contrast trend extrapolation with the writ- ing of scenarios as forecasting techniques.

S T R A T E G I C P R A C T I C E E X E R C I S E How far should people in a business firm go in gathering com- petitive intelligence? Where do you draw the line?

Evaluate each of the following approaches that a person could use to gather information about competitors. For each approach, mark your feeling about its appropriateness:

1 (DEFINITELY NOT APPROPRIATE), 2 (PROBABLY NOT APPROPRIATE), 3 (UNDECIDED), 4 (PROBABLY APPROPRIATE), OR 5 (DEFINITELY APPROPRIATE).

The business firm should try to get useful information about competitors by:

_____ Carefully studying trade journals

_____ Wiretapping the telephones of competitors

_____ Posing as a potential customer to competitors

_____ Getting loyal customers to put out a phony “request for proposal” soliciting competitors’ bids

_____ Buying competitors’ products and taking them apart

_____ Hiring management consultants who have worked for competitors

_____ Rewarding competitors’ employees for useful “tips”

_____ Questioning competitors’ customers and/or suppliers

_____ Buying and analyzing competitors’ garbage

_____ Advertising and interviewing for nonexistent jobs

information is then used to forecast whether these trends will continue or whether others will take their place. How will developments in the natural environment affect the world? What kind of developments can we expect in the societal environment to affect our industry? What will an industry look like in 10 to 20 years? Who will be the key competitors? Who is likely to fall by the wayside? We use this information to make certain assumptions about the future— assumptions that are then used in strategic planning. In many ways, success in the business world is like ice hockey: The key to winning is not to assume that your industry will continue as it is now but to assume that the industry will change and to make sure that your company will be in position to take advantage of those changes.

C H A P T E R 4 Environmental Scanning and Industry Analysis 129

_____ Taking public tours of competitors’ facilities

_____ Releasing false information about the company in order to confuse competitors

_____ Questioning competitors’ technical people at trade shows and conferences

_____ Hiring key people away from competitors

_____ Analyzing competitors’ labor union contracts

_____ Having employees date persons who work for competitors

_____ Studying aerial photographs of competitors’ facilities

After marking each of the preceding approaches, compare your responses to those of other people in your class. For each approach, the people marking 4 or 5 should say why they thought this particular act would be appropriate. Those who marked 1 or 2 should then state why they thought this act would be inappropriate.

Go to the Web site of the Society for Competitive Intelligence Professionals (www.scip.org). What does SCIP say about these approaches?

K E Y T E R M S competitive intelligence (p. 120) competitors (p. 122) complementor (p. 113) consolidated industry (p. 114) EFAS Table (p. 126) entry barrier (p. 111) environmental scanning (p. 98) environmental uncertainty (p. 98) exit barrier (p. 112) fragmented industry (p. 114) global industry (p. 115)

hypercompetition (p. 118) industry (p. 109) industry analysis (p. 99) industry matrix (p. 119) industry scenario (p. 125) issues priority matrix (p. 109) key success factor (p. 118) multidomestic industry (p. 114) multinational corporation (MNC)

(p. 105)

natural environment (p. 99) new entrant (p. 111) regional industries (p. 115) societal environment (p. 99) STEEP analysis (p. 101) strategic group (p. 115) strategic type (p. 117) substitute product (p. 112) task environment (p. 99)

N O T E S 1. L. W. Brigham, “Thinking about the Arctic’s Future: Scenarios

for 2040,” The Futurist (September–October 2007), pp. 27–34. 2. J. B. Thomas, S. M. Clark, and D. A. Gioia, “Strategic Sense-

making and Organizational Performance: Linkages Among Scanning, Interpretation, Action, Outcomes,” Academy of Man- agement Journal (April 1993), pp. 239–270; J. A. Smith, “Strategies for Start-Ups,” Long Range Planning (December 1998), pp. 857–872.

3. E. Stephenson and A. Pandit, “How Companies Act on Global Trends: A McKinsey Global Survey,” McKinsey Quarterly (April 2008).

4. W. E. Stead and J. G. Stead, Sustainable Strategic Management (Armonk, NY: M. E. Sharpe, 2004), p. 6.

5. F. Montabon, R. Sroufe, and R. Narasimhan, “An Examination of Corporate Reporting, Environmental Management Practices and Firm Performance,” Journal of Operations Management (August 2007), pp. 998–1014.

6. P. Lasserre and J. Probert, “Competing on the Pacific Rim: High Risks and High Returns,” Long Range Planning (April 1994), pp. 12–35.

7. J. J. McGonagle, “Mapping and Anticipating the Competitive Landscape,” Competitive Intelligence Magazine (March–April 2007), p. 49.

8. M. J. Cetron, “Economics: Prospects for the ‘Dragon’ and the ‘Tiger,’” Futurist (July–August 2004), pp. 10–11; “A Less Fiery Dragon,” The Economist (December 1, 2007), p. 92.

9. “Investing Without Borders: A Different Approach to Global Investing,” T. Rowe Price Report (Fall 2007), p. 1.

10. S. Hamm, “Cloud Computing Made Clear,” Business Week (May 5, 2008), p. 59.

11. P. Lorenz, D. Pinner, and T. Seitz, “The Economics of Solar Power,” McKinsey Quarterly (June 2008), p. 2.

12. W. E. Halal, “The Top 10 Emerging Technologies,” Special Re- port (World Future Society, 2000).

13. F. Dobbin and T. J. Dowd, “How Policy Shapes Competition: Early Railroad Foundings in Massachusetts,” Administrative Science Quarterly (September 1997), pp. 501–529.

14. A. Shleifer and R. W. Viskny, “Takeovers in the 1960s and the 1980s: Evidence and Implications,” in Fundamental Issues in Strategy: A Research Agenda, edited by R. P. Rumelt, D. E.

SOURCE: Developed from W. A. Jones, Jr., and N. B. Bryan, Jr., “Business Ethics and Business Intelligence: An Empirical Study of Information-Gathering Alternatives,” International Journal of Man- agement (June 1995), pp. 204–208. For actual examples of some of these activities, see J. Kerstetter, P. Burrows, J. Greene, G. Smith, and M. Conlin, “The Dark Side of the Valley,” Business Week (July 17, 2000), pp. 42–43.

130 PA RT 2 Scanning the Environment

Schendel, and D. J. Teece (Boston: Harvard Business School Press, 1994), pp. 403–418.

15. “The Problem with Solid Engineering,” The Economist (May 20, 2006), pp. 71–73.

16. “Doing Business,” The Economist (September 9, 2006), p. 98. 17. Web site, World Trade Organization, www.wto.org (accessed

July 31, 2008). 18. M. J. Cetron and O. Davies, “Trends Now Shaping the Future,”

The Futurist (March–April 2005), pp. 28–29; M. Cetron and O. Davies, “Trends Shaping Tomorrow’s World,” The Futurist (March–April 2008), pp. 35–52.

19. “Trend: Urbane Urban Portraits,” Business Week (April 28, 2008), p. 57.

20. “Old Europe,” Economist (October 2, 2004), pp. 49–50. 21. M. J. Cetron and O. Davies, “Trends Now Shaping the Future,”

The Futurist (March–April 2005), p. 30. 22. “The Incredible Shrinking Country,” Economist (November 13,

2004), pp. 45–46. 23. D. Levin, “Tradition Under Stress,” AARP Bulletin (July–August

2008), pp. 16–18. 24. J. Wyatt, “Playing the Woofie Card,” Fortune (February 6,

1995), pp. 130–132. 25. D. Carpenter, “Walgreen Pursues 12,000 Corners of Market,”

Des Moines Register (May 9, 2004), pp. 1D, 5D. 26. M. Arndt, “Zimmer: Growing Older Gracefully,” Business

Week (June 9, 2003), pp. 82–84. 27. “France Considering Raising Tax on Fatty, Sugary Foods,”

(Minneapolis) Star Tribune (August 7, 2008), p. A7. 28. H. Yen, “Empty Nesters Push Growth of Pet Health Care Busi-

nesses,” The (Ames, IA) Tribune (September 27, 2003), p. C8; D. Brady and C. Palmeri, “The Pet Economy,” Business Week (August 6, 2007), pp. 45–54; “Pampering Your Pet,” St. Cloud (MN) Times (September 8, 2007), p. 3A.

29. A. Bianco, “The Vanishing Mass Market,” Business Week (July 12, 2004), pp. 61–68.

30. M. Conlin, “UnMarried America,” Business Week (October 20, 2003), pp. 106–116.

31. “The Power of One,” Entrepreneur (June 2007), p. 28. 32. “BGSU Is Leader in Marriage Research,” BGSU Magazine

(Spring 2008), p. 18. 33. N. Irvin, II, “The Arrival of the Thrivals,” Futurist

(March–April 2004), pp. 16–23. 34. “The Trouble with Migrants,” The Economist (November 24,

2007), pp. 56–57. 35. “Multicultural Retailing,” Arizona Republic (October 10,

2004), p. D4. 36. “Islamic Finance: West Meets East,” Economist (October 25,

2003), p. 69. 37. “Giants Forced to Dance,” The Economist (May 26, 2007),

pp. 67–68. 38. “Membership Required,” The Economist (August 2, 2008),

p. 66. 39. J. Naisbitt, Megatrends Asia (New York: Simon & Schuster,

1996), p. 79. 40. A. Menon and A. Tomkins, “Learning About the Market’s Pe-

riphery: IBM’s WebFountain,” Long Range Planning (April 2004), pp. 153–162.

41. I. M. Cockburn, R. M. Henderson, and S. Stern, “Untangling the Origins of Competitive Advantage,” Strategic Management Jour- nal (October–November, 2000), Special Issue, pp. 1123–1145.

42. L. Fuld, “Be Prepared,” Harvard Business Review (November 2003), pp. 20–21.

43. H. Wissema, “Driving through Red Lights,” Long Range Plan- ning (October 2002), pp. 521–539; B. K. Boyd and J. Fulk, “Ex- ecutive Scanning and Perceived Uncertainty: A Multidimensional Model,” Journal of Management, Vol. 22, No. 1 (1996), pp. 1–21.

44. P. G. Audia, E. A. Locke, and K. G. Smith, “The Paradox of Success: An Archival and a Laboratory Study of Strategic Per- sistence Following Radical Environmental Change,” Academy of Management Journal (October 2000), pp. 837–853; M. L. McDonald and J. D. Westphal, “Getting By with the Advice of Their Friends” CEOs Advice Networks and Firms’ Strategic Responses to Poor Performance,” Administrative Science Quarterly (March 2003), pp. 1–32; R. A. Bettis and C. K. Pra- halad, “The Dominant Logic: Retrospective and Extension,” Strategic Management Journal (January 1995), pp. 5–14; J. M. Stofford and C. W. F. Baden-Fuller, “Creating Corporate Entre- preneurship,” Strategic Management Journal (September 1994), pp. 521–536; J. M. Beyer, P. Chattopadhyay, E. George, W. H. Glick, and D. Pugliese, “The Selective Perception of Managers Revisited,” Academy of Management Journal (June 1997), pp. 716–737.

45. H. I. Ansoff, “Strategic Management in a Historical Perspec- tive,” in International Review of Strategic Management, Vol. 2, No. 1 (1991), edited by D. E. Hussey (Chichester, England: Wi- ley, 1991), p. 61.

46. S. E. Ante, “Sprint’s Wake-Up Call,” Business Week (March 3, 2008), p. 54.

47. M. E. Porter, Competitive Strategy (New York: The Free Press, 1980), p. 3.

48. This summary of the forces driving competitive strategy is taken from Porter, Competitive Strategy, pp. 7–29.

49. M. McCarthy, “Rivals Scramble to Topple Nike’s Sneaker Su- premacy,” USA Today (April 3, 2003), pp. B1–B2; S. Holmes, “Changing the Game on Nike,” Business Week (January 22, 2007), p. 80.

50. Porter, Competitive Strategy, (New York: The Free Press, 1980), p. 23.

51. A. S. Grove, “Surviving a 10x Force,” Strategy & Leadership (January/February 1997), pp. 35–37.

52. A fragmented industry is defined as one whose market share for the leading four firms is equal to or less than 40% of total indus- try sales. See M. J. Dollinger, “The Evolution of Collective Strategies in Fragmented Industries,” Academy of Management Review (April 1990), pp. 266–285.

53. M. E. Porter, “Changing Patterns of International Competition,” California Management Review (Winter 1986), pp. 9–40.

54. A. M. Rugman, The Regional Multinationals: MNEs and Global Strategic Management (Cambridge: Cambridge Univer- sity Press, 2005).

55. K. J. Hatten and M. L. Hatten, “Strategic Groups, Asymmetri- cal Mobility Barriers, and Contestability,” Strategic Manage- ment Journal (July–August 1987), p. 329.

56. J. C. Short, D. J. Ketchen Jr., T. B. Palmer, and G. T. M. Hult, “Firm, Strategic Group, and Industry Influences on Perfor- mance,” Strategic Management Journal (February 2007), pp. 147–167; J. D. Osborne, C. I. Stubbart, and A. Ramaprasad, “Strategic Groups and Competitive Enactment: A Study of Dynamic Relationships Between Mental Models and

C H A P T E R 4 Environmental Scanning and Industry Analysis 131

Performance,” Strategic Management Journal (May 2001), pp. 435–454; A. Fiegenbaum and H. Thomas, “Strategic Groups as Reference Groups: Theory, Modeling and Empirical Examination of Industry and Competitive Strategy,” Strategic Management Journal (September 1995), pp. 461–476; H. R. Greve, “Managerial Cognition and the Mimities Adoption of Market Positions: What You See Is What You Do,” Strategic Management Journal (October 1998), pp. 967–988.

57. G. Leask and D. Parker, “Strategic Groups, Competitive Groups and Performance Within the U.K. Pharmaceutical Industry: Improving Our Understanding of the Competitive Process,” Strategic Management Journal (July 2007), pp. 723–745.

58. C. C. Pegels, Y. I. Song, and B. Yang, “Management Hetero- geneity, Competitive Interaction Groups, and Firm Perfor- mance,” Strategic Management Journal (September 2000), pp. 911–923; W. S. Desarbo and R. Grewal, “Hybrid Strategic Groups,” Strategic Management Journal (March 2008), pp. 293–317.

59. R. E. Miles and C. C. Snow, Organizational Strategy, Structure, and Process (New York: McGraw-Hill, 1978). See also D. J. Ketchen, Jr., “An Interview with Raymond E. Miles and Charles C. Snow,” Academy of Management Executive (Novem- ber 2003), pp. 97–104.

60. B. Kabanoff and S. Brown, “Knowledge Structures of Prospec- tors, Analyzers, and Defenders: Content, Structure, Stability, and Performance,” Strategic Management Journal (February 2008), pp. 149–171.

61. R. A. D’Aveni, Hypercompetition (New York: The Free Press, 1994), pp. xiii–xiv.

62. C. W. Hofer and D. Schendel, Strategy Formulation: Analytical Concepts (St. Paul: West Publishing Co., 1978), p. 77.

63. “Information Overload,” Journal of Business Strategy (January–February 1998), p. 4.

64. E. Von Hipple, Sources of Innovation (New York: Oxford Uni- versity Press, 1988), p. 4.

65. “An Executive Takes on the Top Business Trends: A McKinsey Global Survey,” McKinsey Quarterly (April 2006).

66. K. Coyne and J. Horn, “How Companies Respond to Competi- tors: A McKinsey Global Survey,” McKinsey Quarterly (Au- gust 2008).

67. M. D. Ryall, “Subjective Rationality, Self-Confirming Equilib- rium, and Corporate Strategy”, Management Science (Vol. 49, 2003), pp. 936–949.

68. C. H. Wee and M. L. Leow, “Competitive Business Intelligence in Singapore,” Journal of Strategic Marketing (Vol. 2, 1994), pp. 112–139.

69. A. Badr, E. Madden, and S. Wright, “The Contributions of CI to the Strategic Decision Making Process: Empirical Study of the European Pharmaceutical Industry,” Journal of Competitive In- telligence and Management (Vol. 3, No. 4, 2006), pp. 15–35.

70. R. G. Vedder, “CEO and CIO Attitudes about Competitive In- telligence,” Competitive Intelligence Magazine (October– December 1999), pp. 39–41.

71. D. Fehringer, B. Hohhof, and T. Johnson, “State of the Art: Competitive Intelligence,” Research Report of the Competitive Intelligence Foundation (2006), p. 6.

72. “Competitive Intelligence Spending ‘to Rise Tenfold’ in 5 Years,” Daily Research News (June 19, 2007).

73. S. H. Miller, “Beware Rival’s Web Site Subterfuge,” Competitive Intelligence Magazine (January–March 2000), p. 8.

74. E. Iwata, “More U.S. Trade Secrets Walk Out Door with For- eign Spies,” USA Today (February 13, 2003), pp. B1, B2.

75. Twenty-nine Percent Spy on Co-Workers,” USA Today (Au- gust 19, 2003), p. B1.

76. M. Orey, “Corporate Snoops,” Business Week (October 9, 2006), pp. 46–49; E. Javers, “Spies, Lies, & KPMG,” Business Week (February 26, 2007), pp. 86–88.

77. E. Javers, “I Spy—For Capitalism,” Business Week (August 13, 2007), pp. 54–56.

78. B. Flora, “Ethical Business Intelligence in NOT Mission Im- possible,” Strategy & Leadership (January/February 1998), pp. 40–41.

79. A. L. Penenberg and M. Berry, Spooked: Espionage in Corpo- rate America (Cambridge, MA: Perseus Publishing, 2000).

80. T. Kendrick and J. Blackmore, “Ten Things You Really Need to Know About Competitors,” Competitive Intelligence Magazine (September–October 2001), pp. 12–15.

81. For the percentage of CI professionals using each analytical technique, see A. Badr, E. Madden, and S. Wright, “The Contri- butions of CI to the Strategic Decision Making Process: Empir- ical Study of the European Pharmaceutical Industry,” Journal of Competitive Intelligence and Management (Vol. 3, No. 4, 2006), pp. 15–35; and D. Fehringer, B. Hohhof, and T. Johnson, “State of the Art: Competitive Intelligence,” Research Report of the Competitive Intelligence Foundation (2006).

82. “CI at Avnet: A Bottom-Line Impact,” Competitive Intelligence Magazine (July–September 2000), p. 5. For further information on competitive intelligence, see C. S. Fleisher and D. L. Blenkhorn, Controversies in Competitive Intelligence: The Enduring Issues (Westport, CT: Praeger Publishers, 2003); C. Vibert, Competitive Intelligence: A Framework for Web-Based Analysis and Decision Making (Mason, OH: Thomson/Southwestern, 2004); and C. S. Fleisher and B. E. Bensoussan, Strategic and Competitive Analysis (Upper Saddle River, NJ: Prentice Hall, 2003).

83. H. E. Klein and R. E. Linneman, “Environmental Assessment: An International Study of Corporate Practices,” Journal of Business Strategy (Summer 1984), p. 72.

84. A. F. Osborn, Applied Imagination (NY: Scribner, 1957); R. C. Litchfield, “Brainstorming Reconsidered: A Goal-Based View,” Academy of Management Review (July 2008), pp. 649– 668; R. I. Sutton, “The Truth About Brainstorming,” Inside Innovation, insert to Business Week (September 26, 2006), pp. 17–21.

85. R. S. Duboff, “The Wisdom of Expert Crowds,” Harvard Busi- ness Review (September 2007), p. 28.

86. J. Surowiecki, The Wisdom of Crowds (NY: Doubleday, 2004). 87. R. Dye, “The Promise of Prediction Markets: A Roundtable,”

McKinsey Quarterly (April 2008), pp. 83–93. 88. C. R. Sunstein, “When Crowds Aren’t Wise,” Harvard Business

Review (September 2006), pp. 20–21. 89. See L. E. Schlange and U. Juttner, “Helping Managers to Iden-

tify the Key Strategic Issues,” Long Range Planning (October 1997), pp. 777–786, for an explanation and application of the cross-impact matrix.

90. G. Ringland, Scenario Planning: Managing for the Future (Chichester, England: Wiley, 1998); N. C. Georgantzas and W. Acar, Scenario-Driven Planning: Learning to Manage Strate- gic Uncertainty (Westport, CN: Quorum Books, 1995); L. Fahey and R. M. Randall (eds), Learning from the Future: Competitive Foresight Scenarios (New York: John Wiley & Sons, 1998).

132 PA RT 2 Scanning the Environment

91. M. Eskew, “Stick with Your Vision,” Harvard Business Review (July–August 2007), pp. 56–57.

92. This process of scenario development is adapted from M. E. Porter, Competitive Advantage (New York: The Free Press, 1985), pp. 448–470.

93. H. C. Sashittal and A. R. Jassawalla, “Learning from Wayne Gretzky,” Organizational Dynamics (Spring 2002), pp. 341–355.

94. J. C. Glenn, “Scanning the Global Situation and Prospects for the Future,” The Futurist (January–February 2008), pp. 41–46.

95. M. E. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: The Free Press, 1980), pp. 47–75.

96. M. Treacy and F. Wiersema, The Discipline of Market Leaders (Reading, MA: Addison-Wesley, 1995).

97. Presentation by W. A. Rosenkrans, Jr., to the Iowa Chapter of the Society of Competitive Intelligence Professionals, Des Moines, IA (August 5, 2004).

98. B. Gilad, Early Warning (New York: AMACOM, 2004), pp. 97–103. Also see C. S. Fleisher and B. E. Bensoussan, Strategic and Competitive Analysis (Upper Saddle River, NJ: Prentice Hall, 2003), pp. 122–143.

99. Presentation by W. A. Rosenkrans, Jr., to the Iowa Chapter of the Society of Competitive Intelligence Professionals, Des Moines, IA (August 5, 2004). See also S. M. Shaker and M. P. Gembicki, War Room Guide to Competitive Intelligence (New York: McGraw-Hill, 1999).

100. L. Fahey, “Invented Competitors: A New Competitor Analysis Methodology,” Strategy & Leadership, Vol. 30, No. 6 (2002), pp. 5–12.

101. A. Beurschgens, “Using Business War Gaming to Generate Actionable Intelligence,” Competitive Intelligence Magazine (January–February 2008), pp. 43–45.

Analytical techniques commonly used in competitive intelligence are SWOT analysis, Porter’s industry forces, ratio analysis, and strategic group analysis (also called competitive cluster analysis). In addition to these are Porter’s four-corner exercise, Treacy and Wiersema’s value disciplines, and Gilad’s blind spot analysis. These can be used in a war game simulation in which people role-play different competitors and their possible future strategies.

Porter’s four-corner exercise involves analyzing a specific competitor’s future goals, assumptions, current strategies, and capabilities in order to compile a competitor’s response profile. See Figure 4–6. Having knowledge of a competitor’s goals allows predictions about how likely the competitor is to change strategy and respond to changing conditions. Identifying a competitor’s assumptions about itself and the industry can reveal blind spots about how management perceives its environment. Considering a com- petitor’s current strategy and how long it has been in place may indicate whether the company is likely to continue in its current direction. If a strategy is not stated explicitly, one should consider its actions and policies in order to note its implicit strategy. The last step is to objectively evaluate a competitor’s capa- bilities in terms of strengths and weaknesses. The competitor’s goals, assumptions, and current strategy influence the likelihood, timing, nature, and intensity of a competitor’s reactions. Its strengths and weak- nesses determine its ability to initiate or react to strategic moves and to deal with environmental changes.95

Treacy and Wiersema’s value disciplines involves the evaluation of a competitor in terms of three di- mensions: product leadership, operational excellence, and customer intimacy. (See Figure 4–7.) After an- alyzing 80 market-leading companies, Treacy and Wiersema noted that each of these firms developed a compelling and unmatched value proposition on one dimension but was able to maintain acceptable stan- dards on the other two dimensions. Operationally excellent companies deliver a combination of quality, price, and ease of purchase that no other can match in their market. An example is Dell Computer, a mas- ter of operational excellence. A product leader consistently strives to provide its market with leading-edge products or new applications of existing products or services. Johnson & Johnson is an example of a prod- uct leader that finds new ideas, develops them quickly, and then looks for ways to improve them. A com- pany that delivers value through customer intimacy bonds with its customers and develops high customer loyalty. IBM is an example of a company that pursues excellence in customer intimacy. IBM’s current strategy is to provide a total information technology service to its customers so that customers can totally rely on IBM to take care of any Information Technology (IT) problems.96 According to Wayne Rosenkrans, past president of SCIP, it is possible to mark a spot on each of the three value dimensions shown in Figure 4–7 for each competitor being analyzed. Then one can draw lines connecting each of the marks, resulting in a triangle that reveals that competitor’s overall value proposition.97

Gilad’s blind spot analysis is based on the premise that the assumptions held by decision makers re- garding their own company and their industry may act as perceptual biases or blind spots. As a result, (1) the firm may not be aware of strategically important developments, (2) the firm may inaccurately per- ceive strategically important developments, or (3) even if the firm is aware of important developments, it may learn too slowly to allow for a timely response. It is important to gather sufficient information about a competitor and its executives to be able to list top management’s assumptions about buyers’ pref- erences, the nature of the supply chain, the industry’s key success factors, barriers to entry, and the threat appeal of substitutes to customers. One should analyze the industry objectively without regard to these assumptions. Any gap between an objective industry analysis and a competitor’s top management as- sumptions is a potential blind spot. One should include these blind spots when considering how this com- petitor might respond to environmental change.98

Competitive Analysis Techniques

A P P E N D I X 4.A

133

134 PA RT 2 Scanning the Environment

What Drives the Competitor

What the Competitor Is Doing and Can Do

FUTURE GOALS

COMPETITOR’S RESPONSE PROFILE

At all levels of management and in multiple dimensions

Is the competitor satisfied with current position?

What likely moves or strategy shifts will the competitor make?

Where is the competitor vulnerable?

What will provoke the greatest and most effective retaliation by the competitor?

How the business is currently competing

Held about itself and the industry

Both strengths and weaknesses

CURRENT STRATEGY

ASSUMPTIONS CAPABILITIES

FIGURE 4–6 Four-Corner

Exercise: Porter’s Components

of Competitor Analysis

SOURCE: Reprinted with the permission of The Free Press, A Division of Simon & Schuster, from COMPETITIVE ADVANTAGE: Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980, 1998 by The Free Press. All rights reserved.

Rosenkrans suggests that an analyst should first use Porter’s industry forces technique to develop the four-corner analysis. Then the analyst should use the four-corner analysis to generate a strategic group (cluster) analysis. Finally, the analyst should include the three value dimensions to develop a blind spot analysis.

These techniques can be used to conduct a war game simulating the various competitors in the in- dustry. Gather people from various functional areas in your own corporation and put them into teams identified as industry competitors. Each company team should perform a complete analysis of the com- petitor it is role-playing. Each company team first creates starting strategies for its company and presents it to the entire group. Each company team then creates counter-strategies and presents them to the entire group. After all the presentations are complete, the full group creates new strategic considerations to be included as items to monitor in future environmental scanning.99 Some of the companies that have used war gaming successfully are Kimberly Clark, Baxter Healthcare, Lockheed Martin, Hewlett-Packard, and Dow Corning. If a corporation does not have the expertise needed to run a war game, it can utilize management consultants, like KappaWest, who prepare and facilitate a complete war game simulation.

Some competitive intelligence analysts take the war game approach one step further by creating an “invented” company that could appear in the future but does not exist today. A team brainstorms what type of strategy the invented competitor might employ. The strategy is often based on a new break- through product that is radically different from current offerings. Its goals, strategies, and competitive

C H A P T E R 4 Environmental Scanning and Industry Analysis 135

“Best product”

Product differentiation

Product Leadership

Operational Competence

Customer Responsive

Operational Excellence

“Best total cost”

Customer Intimacy

“Best total solution”

FIGURE 4–7 Value Discipline Triad

SOURCE: From DISCIPLINE OF MARKET LEADERS by Michael Treacy. Copyright © 1997 Michael Treacy. Reprinted by permission of Perseus Books Group.

posture should be different from any currently being used in the industry. According to Liam Fahey, an authority on competitive intelligence, “the invented competitor is proving to be a spur to bold and in- novative thinking.”100 War games are especially useful when (externally) the market is shifting, com- petitive rules are changing, new competitors are entering the industry, a significant competitor is changing its strategy, a firm’s competitive position is weakening, the “uncontrollables” are getting stronger, and/or when (internally) the company is “flying blind,” its current strategy is stale or confused, managers are over-confident or arrogant, and/or the firm suffers from a “silo” mentality.101

On January 10, 2008, a new automobile from Tata Motors was introduced to

the world at the Indian Auto Show in New Delhi. Called the People’s Car, the

new auto was planned to sell for $2,500 in India. Even though many manufactur-

ers were hoping to introduce cheap small cars into India and other developing na-

tions, Tata Motors seemed to have significant advantages that other companies

lacked. India’s low labor costs meant that Tata could engineer a new model for 20%

of the $350 million it would cost in developed nations. A factory worker in Mumbai

earned just $1.20 per hour, less than auto workers earned in China. The car was kept very sim-

ple. The company would save about $900 per car by skipping equipment that the U.S., Europe,

and Japan required for emissions control. The People’s Car did not have features like antilock

brakes, air bags, or support beams to protect passengers in case of a crash. The dashboard con-

tained just a speedometer, fuel gauge, and oil light. It lacked a radio, reclining seats, or power

steering. It came with a small 650 cc engine that generated only 70 horsepower, but obtained

50 to 60 miles per gallon. The car’s suspension system used old technology that was cheap, but

resulted in a rougher ride than in more expensive cars. More importantly, Tata Motors would

save money by using an innovative distribution strategy. Instead of selling completed cars to

dealers, Tata planned to supply kits that would then be assembled by the dealers. By eliminat-

ing large, centralized assembly plants, Tata could cut the car’s retail price by 20%.

Although Tata Motors intended to initially sell the people’s car in India and then offer it in

other developing markets, management felt that they could build a car that would meet U.S. or

European specifications for around $6,000—still a low price for an automobile. Given that Tata

Motors was able to acquire Jaguar and Land Rover from Ford later in the year, other auto com-

panies had to admit that Tata was on its way to becoming a major competitor in the industry.1

internal scanning: Organizational Analysis

C H A P T E R 5

137

� Apply the resource view of the firm to determine core and distinctive competencies

� Use the VRIO framework and the value chain to assess an organization’s competitive advantage and how it can be sustained

� Understand a company’s business model and how it could be imitated

Learning Objectives

Gathering Information

Putting Strategy into Action

Monitoring Performance

Societal Environment: General forces

Natural Environment: Resources and

climate

Task Environment:

Industry analysis

Internal: Strengths and Weaknesses

Structure: Chain of command

Culture: Beliefs, expectations,

values

Resources: Assets, skills, competencies,

knowledge

Programs

Activities needed to accomplish a plan

Budgets

Cost of the programs Procedures

Sequence of steps needed to do the job

Performance

Actual results

External: Opportunities

and Threats

Developing Long-range Plans

Mission

Reason for existence Objectives

What results to accomplish by when

Strategies

Plan to achieve the mission & objectives

Policies

Broad guidelines for decision making

Environmental Scanning:

Strategy Formulation:

Strategy Implementation:

Evaluation and Control:

Feedback/Learning: Make corrections as needed

After reading this chapter, you should be able to:

� Assess a company’s corporate culture and how it might affect a proposed strategy

� Scan functional resources to determine their fit with a firm’s strategy

� Construct an IFAS Table that summarizes internal factors

5.1 A Resource-Based Approach to Organizational Analysis

Scanning and analyzing the external environment for opportunities and threats is not enough to provide an organization a competitive advantage. Analysts must also look within the corpo- ration itself to identify internal strategic factors—critical strengths and weaknesses that are likely to determine whether a firm will be able to take advantage of opportunities while avoid- ing threats. This internal scanning, often referred to as organizational analysis, is concerned with identifying and developing an organization’s resources and competencies.

CORE AND DISTINCTIVE COMPETENCIES Resources are an organization’s assets and are thus the basic building blocks of the organiza- tion. They include tangible assets, such as its plant, equipment, finances, and location, human assets, in terms of the number of employees, their skills, and motivation, and intangible assets, such as its technology (patents and copyrights), culture, and reputation.2 Capabilities refer to a corporation’s ability to exploit its resources. They consist of business processes and routines that manage the interaction among resources to turn inputs into outputs. For example, a com- pany’s marketing capability can be based on the interaction among its marketing specialists, distribution channels, and sales people. A capability is functionally based and is resident in a particular function. Thus, there are marketing capabilities, manufacturing capabilities, and hu- man resource management capabilities. When these capabilities are constantly being changed and reconfigured to make them more adaptive to an uncertain environment, they are called dynamic capabilities.3 A competency is a cross-functional integration and coordination of ca- pabilities. For example, a competency in new product development in one division of a cor- poration may be the consequence of integrating management of information systems (MIS) capabilities, marketing capabilities, R&D capabilities, and production capabilities within the division. A core competency is a collection of competencies that crosses divisional bound- aries, is widespread within the corporation, and is something that the corporation can do ex- ceedingly well. Thus, new product development is a core competency if it goes beyond one division.4 For example, a core competency of Avon Products is its expertise in door-to-door selling. FedEx has a core competency in its application of information technology to all its op- erations. A company must continually reinvest in a core competency or risk its becoming a core rigidity or deficiency, that is, a strength that over time matures and may become a weak- ness.5 Although it is typically not an asset in the accounting sense, a core competency is a very valuable resource—it does not “wear out” with use. In general, the more core competencies are used, the more refined they get, and the more valuable they become. When core compe- tencies are superior to those of the competition, they are called distinctive competencies. For example, General Electric is well known for its distinctive competency in management devel- opment. Its executives are sought out by other companies hiring top managers.6

Barney, in his VRIO framework of analysis, proposes four questions to evaluate a firm’s competencies:

1. Value: Does it provide customer value and competitive advantage?

2. Rareness: Do no other competitors possess it?

3. Imitability: Is it costly for others to imitate?

4. Organization: Is the firm organized to exploit the resource?

138 PA RT 2 Scanning the Environment

C H A P T E R 5 Internal Scanning: Organizational Analysis 139

If the answer to each of these questions is yes for a particular competency, it is considered to be a strength and thus a distinctive competence.7 This should give the company a competi- tive advantage and lead to higher performance.8

It is important to evaluate the importance of a company’s resources, capabilities, and com- petencies to ascertain whether they are internal strategic factors—that is, particular strengths and weaknesses that will help determine the future of the company. This can be done by com- paring measures of these factors with measures of (1) the company’s past performance, (2) the company’s key competitors, and (3) the industry as a whole. To the extent that a resource (such as a firm’s cash situation), capability, or competency is significantly different from the firm’s own past, its key competitors, or the industry average, that resource is likely to be a strategic factor and should be considered in strategic decisions.

Even though a distinctive competency is certainly considered to be a corporation’s key strength, a key strength may not always be a distinctive competency. As competitors attempt to imitate another company’s competency (especially during hypercompetition), what was once a distinctive competency becomes a minimum requirement to compete in the industry.9

Even though the competency may still be a core competency and thus a strength, it is no longer unique. For example, when Maytag Company alone made high-quality home appliances, this ability was a distinctive competency. As other appliance makers imitated Maytag’s quality control and design processes, this continued to be a key strength (that is, a core competency) of Maytag, but it was less and less a distinctive competency.

USING RESOURCES TO GAIN COMPETITIVE ADVANTAGE Proposing that a company’s sustained competitive advantage is primarily determined by its re- source endowments, Grant proposes a five-step, resource-based approach to strategy analysis.

1. Identify and classify the firm’s resources in terms of strengths and weaknesses.

2. Combine the firm’s strengths into specific capabilities and core competencies.

3. Appraise the profit potential of these capabilities and competencies in terms of their po- tential for sustainable competitive advantage and the ability to harvest the profits result- ing from their use. Are there any distinctive competencies?

4. Select the strategy that best exploits the firm’s capabilities and competencies relative to external opportunities.

5. Identify resource gaps and invest in upgrading weaknesses.10

Where do these competencies come from? A corporation can gain access to a distinctive com- petency in four ways:

� It may be an asset endowment, such as a key patent, coming from the founding of the com- pany. For example, Xerox grew on the basis of its original copying patent.

� It may be acquired from someone else. For example, Whirlpool bought a worldwide dis- tribution system when it purchased Philips’s appliance division.

� It may be shared with another business unit or alliance partner. For example, Apple Computer worked with a design firm to create the special appeal of its personal computers and iPods.

� It may be carefully built and accumulated over time within the company. For example, Honda carefully extended its expertise in small motor manufacturing from motorcycles to autos and lawnmowers.11

There is some evidence that the best corporations prefer organic internal growth over acquisi- tions. One study of large global companies identified firms that outperformed their peers on

140 PA RT 2 Scanning the Environment

both revenue growth and profitability over a decade. These excellent performers generated value from knowledge-intensive intangibles, such as copyrights, trade secrets, or strong brands, not from acquisitions.12

The desire to build or upgrade a core competency is one reason entrepreneurial and other fast-growing firms often tend to locate close to their competitors. They form clusters— geographic concentrations of interconnected companies and industries. Examples in the United States are computer technology in Silicon Valley in northern California; light aircraft in Wichita, Kansas; financial services in New York City; agricultural equipment in Iowa and Illinois; and home furniture in North Carolina. According to Michael Porter, clusters provide access to employees, suppliers, specialized information, and complementary products.13 Be- ing close to one’s competitors makes it easier to measure and compare performance against rivals. Capabilities may thus be formed externally through a firm’s network resources. An example is the presence of many venture capitalists located in Silicon Valley who provide fi- nancial support and assistance to high-tech startup firms in the region. Employees from com- petitive firms in these clusters often socialize. As a result, companies learn from each other while competing with each other. Interestingly, research reveals that companies with core competencies have little to gain from locating in a cluster with other firms and therefore do not do so. In contrast, firms with the weakest technologies, human resources, training programs, suppliers, and distributors are strongly motivated to cluster. They have little to lose and a lot to gain from locating close to their competitors.14

DETERMINING THE SUSTAINABILITY OF AN ADVANTAGE Just because a firm is able to use its resources, capabilities, and competencies to develop a competitive advantage does not mean it will be able to sustain it. Two characteristics deter- mine the sustainability of a firm’s distinctive competency(ies): durability and imitability.

Durability is the rate at which a firm’s underlying resources, capabilities, or core com- petencies depreciate or become obsolete. New technology can make a company’s core com- petency obsolete or irrelevant. For example, Intel’s skills in using basic technology developed by others to manufacture and market quality microprocessors was a crucial capa- bility until management realized that the firm had taken current technology as far as possible with the Pentium chip. Without basic R&D of its own, it would slowly lose its competitive advantage to others. It thus formed a strategic alliance with HP to gain access to a needed technology.

Imitability is the rate at which a firm’s underlying resources, capabilities, or core com- petencies can be duplicated by others. To the extent that a firm’s distinctive competency gives it competitive advantage in the marketplace, competitors will do what they can to learn and imitate that set of skills and capabilities. Competitors’ efforts may range from reverse engi- neering (which involves taking apart a competitor’s product in order to find out how it works), to hiring employees from the competitor, to outright patent infringement. A core competency can be easily imitated to the extent that it is transparent, transferable, and replicable.

� Transparency is the speed with which other firms can understand the relationship of re- sources and capabilities supporting a successful firm’s strategy. For example, Gillette has always supported its dominance in the marketing of razors with excellent R&D. A com- petitor could never understand how the Sensor or Mach 3 razor was produced simply by taking one apart. Gillette’s razor design was very difficult to copy, partially because the manufacturing equipment needed to produce it was so expensive and complicated.

� Transferability is the ability of competitors to gather the resources and capabilities nec- essary to support a competitive challenge. For example, it may be very difficult for a wine

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maker to duplicate a French winery’s key resources of land and climate, especially if the imitator is located in Iowa.

� Replicability is the ability of competitors to use duplicated resources and capabilities to imitate the other firm’s success. For example, even though many companies have tried to imitate Procter & Gamble’s success with brand management by hiring brand managers away from P&G, they have often failed to duplicate P&G’s success. The competitors failed to identify less visible P&G coordination mechanisms or to realize that P&G’s brand management style conflicted with the competitor’s own corporate culture.

It is relatively easy to learn and imitate another company’s core competency or capability if it comes from explicit knowledge, that is, knowledge that can be easily articulated and commu- nicated. This is the type of knowledge that competitive intelligence activities can quickly iden- tify and communicate. Tacit knowledge, in contrast, is knowledge that is not easily communicated because it is deeply rooted in employee experience or in a corporation’s cul- ture.15 Tacit knowledge is more valuable and more likely to lead to a sustainable competitive advantage than is explicit knowledge because it is much harder for competitors to imitate.16

As explained by Michael Dell, founder of the Dell computer company, “others can understand what they do, but they can’t do it.”17 The knowledge may be complex and combined with other types of knowledge in an unclear fashion in such a way that even management cannot clearly explain the competency.18 Tacit knowledge is thus subject to a paradox. For a corporation to be successful and grow, its tacit knowledge must be clearly identified and codified if the knowledge is to be spread throughout the firm. Once tacit knowledge is identified and written down, however, it is easily imitable by competitors.19 This forces companies to establish com- plex security systems to safeguard their key knowledge.

An organization’s resources and capabilities can be placed on a continuum to the extent they are durable and can’t be imitated (that is, aren’t transparent, transferable, or replicable) by another firm. This continuum of sustainability is depicted in Figure 5–1. At one extreme are slow-cycle resources, which are sustainable because they are shielded by patents, geogra- phy, strong brand names, or tacit knowledge. These resources and capabilities are distinctive competencies because they provide a sustainable competitive advantage. Gillette’s razor tech- nology is a good example of a product built around slow-cycle resources. The other extreme includes fast-cycle resources, which face the highest imitation pressures because they are

High (Hard to lmitate)

Level of Resource Sustainability

Slow-Cycle Resource

• Strongly shielded • Standardized mass production

• Easily duplicated • Idea driven • Sony: Walkman• Economies of scale

• Complicated processes • Chrysler: Minivan

• Patents, brand name • Gilette: Sensor razor

Standard-Cycle Resources Fast-Cycle Resources

Low (Easy to lmitate)

FIGURE 5–1 Continuum of

Resource Sustainability

SOURCE: Copyright © 1992 by the Regents of the University of California. Reprinted from the California Management Review, Vol. 34, No. 3. By permission of The Regents.

142 PA RT 2 Scanning the Environment

based on a concept or technology that can be easily duplicated, such as Sony’s walkman. To the extent that a company has fast-cycle resources, the primary way it can compete success- fully is through increased speed from lab to marketplace. Otherwise, it has no real sustainable competitive advantage.

With its low-cost position and innovative marketing strategy, Tata Motors appeared to have a competitive advantage in making and selling its new People’s Car at the lowest price in the industry. Would this low-cost competitive advantage be sustainable? In terms of dura- bility, the car’s lack of safety or emissions equipment could be a disadvantage when India and other developing nations begin to require such technology. Given that most developing na- tions also have low labor costs, Tata’s low wages could be easily imitated—probably fairly quickly. For example, the Renault—Nissan auto firm had already formed an alliance in 2008 with Indian motorcycle maker Bajal Auto to launch a $3,000 car in India in 2009.20 Tata Motor’s strategy of selling its new car in kit form was highly imitable, assuming that a com- petitor’s car could be kept simple enough for dealers to assemble easily. Overall, the sustain- ability of Tata Motors’ competitive advantage seemed fairly low, given the fast-cycle nature of its resources.

5.2 Business Models When analyzing a company, it is helpful to learn what sort of business model it is following. This is especially important when analyzing Internet-based companies. A business model is a company’s method for making money in the current business environment. It includes the key structural and operational characteristics of a firm—how it earns revenue and makes a profit. A business model is usually composed of five elements:

� Who it serves

� What it provides

� How it makes money

� How it differentiates and sustains competitive advantage

� How it provides its product/service21

The simplest business model is to provide a good or service that can be sold so that revenues exceed costs and expenses. Other models can be much more complicated. Some of the many possible business models are:

� Customer solutions model: IBM uses this model to make money not by selling IBM products, but by selling its expertise to improve its customers’ operations. This is a con- sulting model.

� Profit pyramid model: General Motors offers a full line of automobiles in order to close out any niches where a competitor might find a position. The key is to get customers to buy in at the low-priced, low-margin entry point (Saturn’s basic sedans) and move them up to high-priced, high-margin products (SUVs and pickup trucks) where the company makes its money.

� Multi-component system/installed base model: Gillette invented this classic model to sell razors at break-even pricing in order to make money on higher-margin razor blades. HP does the same with printers and printer cartridges. The product is thus a system, not just one product, with one component providing most of the profits.

� Advertising model: Similar to the multi-component system/installed base model, this model offers its basic product free in order to make money on advertising. Originating in

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the newspaper industry, this model is used heavily in commercial radio and television. Internet-based firms, such as Google, offer free services to users in order to expose them to the advertising that pays the bills. This model is analogous to Mary Poppins’ “spoon- ful of sugar (content) helps the medicine (advertising) go down.”

� Switchboard model: In this model a firm acts as an intermediary to connect multiple sell- ers to multiple buyers. Financial planners juggle a wide range of products for sale to mul- tiple customers with different needs. This model has been successfully used by eBay and Amazon.com.

� Time model: Product R&D and speed are the keys to success in the time model. Being the first to market with a new innovation allows a pioneer like Sony to earn high margins. Once others enter the market with process R&D and lower margins, it’s time to move on.

� Efficiency model: In this model a company waits until a product becomes standardized and then enters the market with a low-priced, low-margin product that appeals to the mass market. This model is used by Wal-Mart, Dell, and Southwest Airlines.

� Blockbuster model: In some industries, such as pharmaceuticals and motion picture stu- dios, profitability is driven by a few key products. The focus is on high investment in a few products with high potential payoffs—especially if they can be protected by patents.

� Profit multiplier model: The idea of this model is to develop a concept that may or may not make money on its own but, through synergy, can spin off many profitable products. Walt Disney invented this concept by using cartoon characters to develop high-margin theme parks, merchandise, and licensing opportunities.

� Entrepreneurial model: In this model, a company offers specialized products/services to market niches that are too small to be worthwhile to large competitors but have the po- tential to grow quickly. Small, local brew pubs have been very successful in a mature in- dustry dominated by Anheuser-Busch. This model has often been used by small high-tech firms that develop innovative prototypes in order to sell off the companies (without ever selling a product) to Microsoft or DuPont.

� De Facto industry standard model: In this model, a company offers products free or at a very low price in order to saturate the market and become the industry standard. Once users are locked in, the company offers higher-margin products using this standard. For example, Microsoft packaged Internet Explorer free with its Windows software in order to take market share from Netscape’s Web browser.22

In order to understand how some of these business models work, it is important to learn where on the value chain the company makes its money. Although a company might offer a large number of products and services, one product line might contribute most of the profits. For ex- ample, ink and toner supplies for Hewlett-Packard’s printers make up more than half of the company’s profits while accounting for less than 25% of its sales.23 For an example of a new business model at SmartyPig, see Strategy Highlight 5.1.

5.3 Value-Chain Analysis A value chain is a linked set of value-creating activities that begin with basic raw materials com- ing from suppliers, moving on to a series of value-added activities involved in producing and marketing a product or service, and ending with distributors getting the final goods into the hands of the ultimate consumer. See Figure 5–2 for an example of a typical value chain for a manufac- tured product. The focus of value-chain analysis is to examine the corporation in the context of the overall chain of value-creating activities, of which the firm may be only a small part.

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a saver’s goal, such as a birthday or Christmas present. They can even view how close the saver is to reaching a goal.

� It creates rewards for reaching a savings goal by offer- ing 5% discounts from merchants, like Best Buy or Cir- cuit City, who offer the product being saved for.

� It offers the option for a saver to collect the money saved on an ATM debit card.

SmartyPig also offers gift cards for a friend or family member to purchase using e-mail or regular mail; cards that are not redeemable until an account has been opened and a goal has been selected.

The company’s co-founders spent over a year dealing with regulatory and security issues. “The hurdles to make it work were huge, but it’s the neatest savings device I’ve ever seen,” reported Tom Stanberry, Chairman and CEO of SmartyPig’s bank partner, West Bank.

Are you having difficulty saving up for an important

purchase like a trip or a car or a big-screen television? Would

savings go faster if your friends and family could contribute to your sav-

ings account? What if they lived far away from your cur- rent bank?

Mike Ferari and Jon Gaskell of Des Moines, Iowa, are co-founders of SmartyPig, an online company that pro- motes savings through social networking. According to Gaskell, it’s the 21st century version of a piggy bank—a new business model for motivating people to save money (instead of going into debt) for specific purchases. It’s not a bank, but it works in partnership with West Bank of Des Moines, Iowa to provide an innovative service at its www .smartypig.com Web site.

� It creates an online way for a person to save money (and earn interest) for a specific goal, like a vacation, a big- screen TV, or even a house.

� It merges a savings account with digital social network- ing so that friends and family can contribute money to

A NEW BUSINESS MODEL AT SMARTYPIG

SOURCE:“Online Company Promotes Savings,” Saint Cloud Times (April 27, 2008), p. 11A; A. Kamenetz, “Making Banking Fun,” Fast Company (September 2008); Corporate Web sites at www .smartpig.com and www.westbankiowa.com.

STRATEGY highlight 5.1

Raw Materials

Primary Manufacturing

Fabrication Distributor Retailer FIGURE 5–2

Typical Value Chain for a

Manufactured Product

Very few corporations include a product’s entire value chain. Ford Motor Company did when it was managed by its founder, Henry Ford I. During the 1920s and 1930s, the company owned its own iron mines, ore-carrying ships, and a small rail line to bring ore to its mile-long River Rouge plant in Detroit. Visitors to the plant would walk along an elevated walkway, where they could watch iron ore being dumped from the rail cars into huge furnaces. The re- sulting steel was poured and rolled out onto a moving belt to be fabricated into auto frames and parts while the visitors watched in awe. As visitors walked along the walkway, they ob- served an automobile being built piece by piece. Reaching the end of the moving line, the fin- ished automobile was driven out of the plant into a vast adjoining parking lot. Ford trucks would then load the cars for delivery to dealers. Although the Ford dealers were not employ- ees of the company, they had almost no power in the arrangement. Dealerships were awarded by the company and taken away if a dealer was at all disloyal. Ford Motor Company at that time was completely vertically integrated, that is, it controlled (usually by ownership) every stage of the value chain, from the iron mines to the retailers.

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INDUSTRY VALUE-CHAIN ANALYSIS The value chains of most industries can be split into two segments, upstream and downstream segments. In the petroleum industry, for example, upstream refers to oil exploration, drilling, and moving of the crude oil to the refinery, and downstream refers to refining the oil plus transporting and marketing gasoline and refined oil to distributors and gas station retailers. Even though most large oil companies are completely integrated, they often vary in the amount of expertise they have at each part of the value chain. Amoco, for example, had strong expertise downstream in marketing and retailing. British Petroleum, in contrast, was more dominant in upstream activities like exploration. That’s one reason the two companies merged to form BP Amoco.

An industry can be analyzed in terms of the profit margin available at any point along the value chain. For example, the U.S. auto industry’s revenues and profits are divided among many value-chain activities, including manufacturing, new and used car sales, gasoline retailing, in- surance, after-sales service and parts, and lease financing. From a revenue standpoint, auto manufacturers dominate the industry, accounting for almost 60% of total industry revenues. Profits, however, are a different matter. Auto leasing has been the most profitable activity in the value chain, followed by insurance and auto loans. The core activities of manufacturing and dis- tribution, however, earn significantly smaller shares of the total industry profits than they do of total revenues. For example, because auto sales have become marginally profitable, dealerships are now emphasizing service and repair. As a result of various differences along the industry value chain, manufacturers have moved aggressively into auto financing.24 Ford, for example, generated $1.2 billion in profits from financial services in 2007 compared to a loss of $5 billion from automobiles, even though financing accounted for only 10.5% of the company’s revenues!

In analyzing the complete value chain of a product, note that even if a firm operates up and down the entire industry chain, it usually has an area of expertise where its primary activ- ities lie. A company’s center of gravity is the part of the chain that is most important to the company and the point where its greatest expertise and capabilities lie—its core competencies. According to Galbraith, a company’s center of gravity is usually the point at which the com- pany started. After a firm successfully establishes itself at this point by obtaining a competi- tive advantage, one of its first strategic moves is to move forward or backward along the value chain in order to reduce costs, guarantee access to key raw materials, or to guarantee distribu- tion.25 This process, called vertical integration, is discussed in more detail in Chapter 7.

In the paper industry, for example, Weyerhauser’s center of gravity is in the raw materi- als and primary manufacturing parts of the value chain as shown in Figure 5–2. Weyerhauser’s expertise is in lumbering and pulp mills, which is where the company started. It integrated for- ward by using its wood pulp to make paper and boxes, but its greatest capability still lay in getting the greatest return from its lumbering activities. In contrast, P&G is primarily a con- sumer products company that also owned timberland and operated pulp mills. Its expertise is in the fabrication and distribution parts of the Figure 5–2 value chain. P&G purchased these assets to guarantee access to the large quantities of wood pulp it needed to expand its dispos- able diaper, toilet tissue, and napkin products. P&G’s strongest capabilities have always been in the downstream activities of product development, marketing, and brand management. It has never been as efficient in upstream paper activities as Weyerhauser. It had no real distinc- tive competency on that part of the value chain. When paper supplies became more plentiful (and competition got rougher), P&G gladly sold its land and mills to focus more on the part of the value chain where it could provide the greatest value at the lowest cost—creating and mar- keting innovative consumer products. As was the case with P&G’s experience in the paper in- dustry, it makes sense for a company to outsource any weak areas it may control internally on the industry value chain.

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CORPORATE VALUE-CHAIN ANALYSIS Each corporation has its own internal value chain of activities. See Figure 5–3 for an exam- ple of a corporate value chain. Porter proposes that a manufacturing firm’s primary activities usually begin with inbound logistics (raw materials handling and warehousing), go through an operations process in which a product is manufactured, and continue on to outbound logistics (warehousing and distribution), to marketing and sales, and finally to service (installation, re- pair, and sale of parts). Several support activities, such as procurement (purchasing), technol- ogy development (R&D), human resource management, and firm infrastructure (accounting, finance, strategic planning), ensure that the primary value chain activities operate effectively and efficiently. Each of a company’s product lines has its own distinctive value chain. Because most corporations make several different products or services, an internal analysis of the firm involves analyzing a series of different value chains.

The systematic examination of individual value activities can lead to a better understand- ing of a corporation’s strengths and weaknesses. According to Porter, “Differences among competitor value chains are a key source of competitive advantage.”26 Corporate value chain analysis involves the following three steps:

1. Examine each product line’s value chain in terms of the various activities involved in producing that product or service: Which activities can be considered strengths (core competencies) or weaknesses (core deficiencies)? Do any of the strengths provide com- petitive advantage and can they thus be labeled distinctive competencies?

2. Examine the “linkages” within each product line’s value chain: Linkages are the con- nections between the way one value activity (for example, marketing) is performed and the cost of performance of another activity (for example, quality control). In seeking ways for a corporation to gain competitive advantage in the marketplace, the same function can be performed in different ways with different results. For example, quality inspection of 100% of output by the workers themselves instead of the usual 10% by quality control

Support Activities

Firm Infrastructure (general management, accounting, finance, strategic planning)

Human Resource Management (recruiting, training, development)

Technology Development (R&D, product and process improvement)

Inbound Logistics (raw materials handling and warehousing)

Outbound Logistics (warehousing and distribution of finished product)

Marketing and Sales (advertising, promotion, pricing, channel relations)

Service (installation, repair, parts)

Primary Activities

Profit Margin

Operations (machining, assembling, testing)

Procurement (purchasing of raw materials, machines, supplies)

FIGURE 5–3 A Corporation’s

Value Chain

SOURCE: Reprinted with the permission of The Free Press, a Division of Simon & Schuster, from COMPETITIVE ADVANTAGE: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1998 by The Free Press. All rights reserved.

C H A P T E R 5 Internal Scanning: Organizational Analysis 147

inspectors might increase production costs, but that increase could be more than offset by the savings obtained from reducing the number of repair people needed to fix defective products and increasing the amount of salespeople’s time devoted to selling instead of ex- changing already-sold but defective products.

3. Examine the potential synergies among the value chains of different product lines or business units: Each value element, such as advertising or manufacturing, has an inher- ent economy of scale in which activities are conducted at their lowest possible cost per unit of output. If a particular product is not being produced at a high enough level to reach economies of scale in distribution, another product could be used to share the same dis- tribution channel. This is an example of economies of scope, which result when the value chains of two separate products or services share activities, such as the same marketing channels or manufacturing facilities. The cost of joint production of multiple products can be lower than the cost of separate production.

5.4 Scanning Functional Resources and Capabilities The simplest way to begin an analysis of a corporation’s value chain is by carefully examin- ing its traditional functional areas for potential strengths and weaknesses. Functional resources and capabilities include not only the financial, physical, and human assets in each area but also the ability of the people in each area to formulate and implement the necessary functional ob- jectives, strategies, and policies. These resources and capabilities include the knowledge of an- alytical concepts and procedural techniques common to each area as well as the ability of the people in each area to use them effectively. If used properly, these resources and capabilities serve as strengths to carry out value-added activities and support strategic decisions. In addi- tion to the usual business functions of marketing, finance, R&D, operations, human resources, and information systems/technology, we also discuss structure and culture as key parts of a business corporation’s value chain.

BASIC ORGANIZATIONAL STRUCTURES Although there is an almost infinite variety of structural forms, certain basic types predomi- nate in modern complex organizations. Figure 5–4 illustrates three basic organizational structures. The conglomerate structure is a variant of divisional structure and is thus not de- picted as a fourth structure. Generally speaking, each structure tends to support some corpo- rate strategies over others:

� Simple structure has no functional or product categories and is appropriate for a small, entrepreneur-dominated company with one or two product lines that operates in a reason- ably small, easily identifiable market niche. Employees tend to be generalists and jacks- of-all-trades. In terms of stages of development (to be discussed in Chapter 9), this is a Stage I company.

� Functional structure is appropriate for a medium-sized firm with several product lines in one industry. Employees tend to be specialists in the business functions that are impor- tant to that industry, such as manufacturing, marketing, finance, and human resources. In terms of stages of development (discussed in Chapter 9), this is a Stage II company.

� Divisional structure is appropriate for a large corporation with many product lines in sev- eral related industries. Employees tend to be functional specialists organized according to product/market distinctions. General Motors, for example, groups its various auto lines into the separate divisions of Saturn, Chevrolet, Pontiac, Buick, and Cadillac. Management

148 PA RT 2 Scanning the Environment

I. Simple Structure

II. Functional Structure

III. Divisional Structure*

Owner-Manager

Workers

Top Management

Manufacturing

Top Management

Product Division A

Manufacturing

Sales

*Strategic Business Units and the conglomerate structure are variants of the divisional structure.

Personnel

Finance Manufacturing

Sales Personnel

Finance

Product Division B

Sales Finance Personnel

FIGURE 5–4 Basic

Organizational Structures

attempts to find some synergy among divisional activities through the use of committees and horizontal linkages. In terms of stages of development (to be discussed in Chapter 9), this is a Stage III company.

� Strategic business units (SBUs) are a modification of the divisional structure. Strategic business units are divisions or groups of divisions composed of independent product- market segments that are given primary responsibility and authority for the management of their own functional areas. An SBU may be of any size or level, but it must have (1) a unique mission, (2) identifiable competitors, (3) an external market focus, and (4) control of its business functions.27 The idea is to decentralize on the basis of strategic elements rather than on the basis of size, product characteristics, or span of control and to create horizontal linkages among units previously kept separate. For example, rather than orga- nize products on the basis of packaging technology like frozen foods, canned foods, and bagged foods, General Foods organized its products into SBUs on the basis of consumer- oriented menu segments: breakfast food, beverage, main meal, dessert, and pet foods. In terms of stages of development (to be discussed in Chapter 9), this is also a Stage III company.

� Conglomerate structure is appropriate for a large corporation with many product lines in several unrelated industries. A variant of the divisional structure, the conglomerate structure (sometimes called a holding company) is typically an assemblage of legally in- dependent firms (subsidiaries) operating under one corporate umbrella but controlled through the subsidiaries’ boards of directors. The unrelated nature of the subsidiaries

C H A P T E R 5 Internal Scanning: Organizational Analysis 149

prevents any attempt at gaining synergy among them. In terms of stages of development (discussed in Chapter 9), this is also a Stage III company.

If the current basic structure of a corporation does not easily support a strategy under con- sideration, top management must decide whether the proposed strategy is feasible or whether the structure should be changed to a more advanced structure such as a matrix or network. (Ad- vanced structural designs such as the matrix and network are discussed in Chapter 9.)

CORPORATE CULTURE: THE COMPANY WAY There is an oft-told story of a person new to a company asking an experienced co-worker what an employee should do when a customer calls. The old-timer responded: “There are three ways to do any job—the right way, the wrong way, and the company way. Around here, we always do things the company way.” In most organizations, the “company way” is derived from the corpo- ration’s culture. Corporate culture is the collection of beliefs, expectations, and values learned and shared by a corporation’s members and transmitted from one generation of employees to an- other. The corporate culture generally reflects the values of the founder(s) and the mission of the firm.28 It gives a company a sense of identity: “This is who we are. This is what we do. This is what we stand for.” The culture includes the dominant orientation of the company, such as R&D at HP, high productivity at Nucor, customer service at Nordstrom, innovation at Google, or prod- uct quality at BMW. It often includes a number of informal work rules (forming the “company way”) that employees follow without question. These work practices over time become part of a company’s unquestioned tradition. The culture, therefore, reflects the company’s values.

Corporate culture has two distinct attributes, intensity and integration.29 Cultural inten- sity is the degree to which members of a unit accept the norms, values, or other culture con- tent associated with the unit. This shows the culture’s depth. Organizations with strong norms promoting a particular value, such as quality at BMW, have intensive cultures, whereas new firms (or those in transition) have weaker, less intensive cultures. Employees in an intensive culture tend to exhibit consistent behavior, that is, they tend to act similarly over time. Cultural integration is the extent to which units throughout an organization share a common culture. This is the culture’s breadth. Organizations with a pervasive dominant culture may be hierarchically controlled and power-oriented, such as a military unit, and have highly inte- grated cultures. All employees tend to hold the same cultural values and norms. In contrast, a company that is structured into diverse units by functions or divisions usually exhibits some strong subcultures (for example, R&D versus manufacturing) and a less integrated corporate culture.

Corporate culture fulfills several important functions in an organization:

1. Conveys a sense of identity for employees.

2. Helps generate employee commitment to something greater than themselves.

3. Adds to the stability of the organization as a social system.

4. Serves as a frame of reference for employees to use to make sense of organizational ac- tivities and to use as a guide for appropriate behavior.30

Corporate culture shapes the behavior of people in a corporation, thus affecting corporate performance. For example, corporate cultures that emphasize the socialization of new employ- ees have less employee turnover, leading to lower costs.31 Because corporate cultures have a powerful influence on the behavior of people at all levels, they can strongly affect a corpora- tion’s ability to shift its strategic direction. A strong culture should not only promote survival, but it should also create the basis for a superior competitive position by increasing motivation

150 PA RT 2 Scanning the Environment

and facilitating coordination and control.32 For example, a culture emphasizing constant re- newal may help a company adapt to a changing, hypercompetitive environment.33 To the ex- tent that a corporation’s distinctive competence is embedded in an organization’s culture, it will be a form of tacit knowledge and very difficult for a competitor to imitate. The Global Issue feature shows the differences between ABB Asea Brown Boveri AG and Matsushita Electric in terms of how they manage their corporate cultures in a global industry.

A change in mission, objectives, strategies, or policies is not likely to be successful if it is in opposition to the accepted culture of a firm. Foot-dragging and even sabotage may result, as employees fight to resist a radical change in corporate philosophy. As with structure, if an organization’s culture is compatible with a new strategy, it is an internal strength. But if the corporate culture is not compatible with the proposed strategy, it is a serious weakness. For ex- ample, when General Motors created a collaborative effort in 1996 among the three internal units of Saturn, International Operations, and Small Car Group for its proposed Delta Small Car Program, it caused a conflict with the company’s long-standing cultural tradition of unit autonomy. GM employees found that they were expected to cooperate with other GM employ- ees who did not share their views regarding vehicle requirements and architecture or of work

SOURCES: Summarized from J. Guyon, “ABB Fuses Units with One Set of Values,” Wall Street Journal (October 2, 1996), p. A15 and N. Holden, “Why Globalizing with a Conservative Corporate Culture Inhibits Localization of Management: The Telling Case of Matsushita Electric,” International Journal of Cross Cultural Management, Vol. 1, No. 1 (2001), pp. 53–72.

MEI is the third-largest electrical company in the world. Konosuke Matsushita founded the company in 1918. His management philosophy led to the company’s success but became institutionalized in the corporate culture—a cul- ture that was more focused on Japanese values than on cross-cultural globalization. As a result, MEI’s corporate culture does not adapt well to local conditions. Not only is MEI’s top management exclusively Japanese, its subsidiary managers are overwhelmingly Japanese. The company’s distrust of non-Japanese managers in the United States and some European countries results in a “rice-paper ceil- ing” that prevents non-Japanese people from being pro- moted into MEI subsidiaries’ top management. Foreign employees are often confused by the corporate philosophy that has not been adapted to suit local realities. MEI’s cor- porate culture perpetuates a cross-cultural divide that sep- arates the Japanese from the non-Japanese managers, leaving the non-Japanese managers feeling frustrated and undervalued. This divide prevents the flow of knowledge and experience from regional operations to the headquar- ters and may hinder MEI’s ability to compete globally.

Zurich-based ABB Asea Brown Boveri AG is a world-

wide builder of power plants, electrical equipment, and industrial

factories in 140 countries. By establishing one set of multicultural values throughout its global opera- tions, ABB’s management believes that the company will gain an advantage over its rivals Siemens AG of Germany, France’s Alcatel-Alsthom NV, and the U.S.’s General Electric Company. ABB is a company with no geographic base. In- stead, it has many “home” markets that can draw on exper- tise from around the globe. ABB created a set of 500 global managers who could adapt to local cultures while executing ABB’s global strategies. These people are multilingual and move around each of ABB’s 5,000 profit centers in 140 coun- tries. Their assignment is to cut costs, improve efficiency, and integrate local businesses with the ABB worldview.

Few multinational corporations are as successful as ABB in getting global strategies to work with local operations. In agreement with the resource-based view of the firm, the past Chairman of ABB, Percy Barnevik stated, “Our strength comes from pulling together. . . . If you can make this work real well, then you get a competitive edge out of the organization which is very, very difficult to copy.”

Contrast ABB’s globally-oriented corporate culture with the more Japanese-oriented parochial culture of Mat- sushita Electric Industrial Corporation (MEI) of Japan. Oper- ating under the brand names of Panasonic and Technic,

MANAGING CORPORATE CULTURE FOR GLOBAL COMPETITIVE ADVANTAGE: ABB VERSUS MATSUSHITA

GLOBAL issue

C H A P T E R 5 Internal Scanning: Organizational Analysis 151

STRATEGIC MARKETING ISSUES The marketing manager is a company’s primary link to the customer and the competition. The manager, therefore, must be especially concerned with the market position and marketing mix of the firm as well as with the overall reputation of the company and its brands.

Market Position and Segmentation Market position deals with the question, “Who are our customers?” It refers to the selection of specific areas for marketing concentration and can be expressed in terms of market, product, and geographic locations. Through market research, corporations are able to practice market segmentation with various products or services so that managers can discover what niches to seek, which new types of products to develop, and how to ensure that a company’s many prod- ucts do not directly compete with one another.

Marketing Mix Marketing mix refers to the particular combination of key variables under a corporation’s control that can be used to affect demand and to gain competitive advantage. These variables are product, place, promotion, and price. Within each of these four variables are several sub- variables, listed in Table 5–1, that should be analyzed in terms of their effects on divisional and corporate performance.

practices and processes. Significant cultural differences among the three units led to the pro- gram being abandoned in 2000.34

Corporate culture is also important when considering an acquisition. The merging of two dissimilar cultures, if not handled wisely, can create some serious internal conflicts. Procter & Gamble’s management knew, for example, that their 2005 acquisition of Gillette might create some cultural problems. Even though both companies were strong consumer goods marketers, they each had a fundamental difference that led to many, subtle differences between the cul- tures: Gillette sold its razors, toothbrushes, and batteries to men; whereas, P&G sold its health and beauty aids to women. Art Lafley, P&G’s CEO, admitted a year after the merger that it would take an additional year to 15 months to align the two companies.35

TABLE 5–1 Product Place Promotion Price

Marketing Mix Variables

Quality Channels Advertising List price Features Coverage Personal selling Discounts Options Locations Sales promotion Allowances Style Inventory Publicity Payment periods Brand name Transport Credit items Packaging Sizes Services Warranties Returns

SOURCE: KOTLER, PHILIP, MARKETING MANAGEMENT, 11th edition © 2003, p. 16. Reprinted by Pearson Education, Inc., Upper Saddle River, NJ.

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Introduction

* The right end of the Growth stage is often called Competitive Turbulence because of price and distribution competition that shakes out the weaker competitors. For further information, see C. R. Wasson, Dynamic Competitive Strategy and Product Life Cycles. 3rd ed. (Austin, TX: Austin Press, 1978).

Growth* Maturity

Time

S a le

s

Decline

FIGURE 5–5 Product Life Cycle

Product Life Cycle One of the most useful concepts in marketing, insofar as strategic management is concerned, is the product life cycle. As depicted in Figure 5–5, the product life cycle is a graph showing time plotted against the monetary sales of a product as it moves from introduction through growth and maturity to decline. This concept enables a marketing manager to examine the mar- keting mix of a particular product or group of products in terms of its position in its life cycle.

Brand and Corporate Reputation A brand is a name given to a company’s product which identifies that item in the mind of the consumer. Over time and with proper advertising, a brand connotes various characteristics in the consumers’ minds. For example, Disney stands for family entertainment. Ivory suggests “pure” soap. BMW means high-performance autos. A brand can thus be an important corpo- rate resource. If done well, a brand name is connected to the product to such an extent that a brand may stand for an entire product category, such as Kleenex for facial tissue. The objec- tive is for the customer to ask for the brand name (Coke or Pepsi) instead of the product cate- gory (cola). The world’s 10 most valuable brands in 2007 were Coca-Cola, Microsoft, IBM, GE, Nokia, Toyota, Intel, McDonald’s, Disney, and Mercedes-Benz, in that order. According to Business Week, the value of the Coca-Cola brand is worth $65.3 billion.36

A corporate brand is a type of brand in which the company’s name serves as the brand. Of the world’s top 10 world brands listed previously, all are company names. The value of a corporate brand is that it typically stands for consumers’ impressions of a company and can thus be extended onto products not currently offered—regardless of the company’s actual ex- pertise. For example, Caterpillar, a manufacturer of heavy earth-moving equipment, used con- sumer associations with the Caterpillar brand (rugged, masculine, construction-related) to market work boots. Thus, consumer impressions of a brand can suggest new product cate- gories to enter even though a company may have no competencies in making or marketing that type of product or service.37

A corporate reputation is a widely held perception of a company by the general pub- lic. It consists of two attributes: (1) stakeholders’ perceptions of a corporation’s ability to produce quality goods and (2) a corporation’s prominence in the minds of stakeholders.38 A

C H A P T E R 5 Internal Scanning: Organizational Analysis 153

good corporate reputation can be a strategic resource. It can serve in marketing as both a sig- nal and an entry barrier. It contributes to its goods having a price premium.39 Reputation is es- pecially important when the quality of a company’s product or service is not directly observable and can be learned only through experience. For example, retail stores are willing to stock a new product from P&G or Anheuser-Busch because they know that both companies market only good-quality products that are highly advertised. Like tacit knowledge, reputation tends to be long-lasting and hard for others to duplicate—thus providing sustainable compet- itive advantage.40 It can have a significant impact on a firm’s stock price.41 Research reveals a positive relationship between corporate reputation and financial performance.42

STRATEGIC FINANCIAL ISSUES A financial manager must ascertain the best sources of funds, uses of funds, and control of funds. All strategic issues have financial implications. Cash must be raised from internal or ex- ternal (local and global) sources and allocated for different uses. The flow of funds in the op- erations of an organization must be monitored. To the extent that a corporation is involved in international activities, currency fluctuations must be dealt with to ensure that profits aren’t wiped out by the rise or fall of the dollar versus the yen, euro, or other currencies. Benefits in the form of returns, repayments, or products and services must be given to the sources of out- side financing. All these tasks must be handled in a way that complements and supports over- all corporate strategy. A firm’s capital structure (amounts of debt and equity) can influence its strategic choices. For example, increased debt tends to increase risk aversion and decrease the willingness of management to invest in R&D.43

Financial Leverage The mix of externally generated short-term and long-term funds in relation to the amount and timing of internally generated funds should be appropriate to the corporate objectives, strate- gies, and policies. The concept of financial leverage (the ratio of total debt to total assets) is helpful in describing how debt is used to increase the earnings available to common sharehold- ers. When the company finances its activities by sales of bonds or notes instead of through stock, the earnings per share are boosted: the interest paid on the debt reduces taxable income, but fewer shareholders share the profits than if the company had sold more stock to finance its activities. The debt, however, does raise the firm’s break-even point above what it would have been if the firm had financed from internally generated funds only. High leverage may there- fore be perceived as a corporate strength in times of prosperity and ever-increasing sales, or as a weakness in times of a recession and falling sales. This is because leverage acts to magnify the effect on earnings per share of an increase or decrease in dollar sales. Research indicates that greater leverage has a positive impact on performance for firms in stable environments, but a negative impact for firms in dynamic environments.44

Capital Budgeting Capital budgeting is the analyzing and ranking of possible investments in fixed assets such as land, buildings, and equipment in terms of the additional outlays and additional receipts that will result from each investment. A good finance department will be able to prepare such cap- ital budgets and to rank them on the basis of some accepted criteria or hurdle rate (for exam- ple, years to pay back investment, rate of return, or time to break-even point) for the purpose of strategic decision making. Most firms have more than one hurdle rate and vary it as a func- tion of the type of project being considered. Projects with high strategic significance, such as entering new markets or defending market share, will often have low hurdle rates.45

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STRATEGIC RESEARCH AND DEVELOPMENT (R&D) ISSUES The R&D manager is responsible for suggesting and implementing a company’s technologi- cal strategy in light of its corporate objectives and policies. The manager’s job, therefore, in- volves (1) choosing among alternative new technologies to use within the corporation, (2) developing methods of embodying the new technology in new products and processes, and (3) deploying resources so that the new technology can be successfully implemented.

R&D Intensity, Technological Competence, and Technology Transfer The company must make available the resources necessary for effective research and devel- opment. A company’s R&D intensity (its spending on R&D as a percentage of sales revenue) is a principal means of gaining market share in global competition. The amount spent on R&D often varies by industry. For example, the U.S. computer software industry tradition- ally spends 13.5% of its sales dollar for R&D, whereas the paper and forest products indus- try spends only 1.0%.46 A good rule of thumb for R&D spending is that a corporation should spend at a “normal” rate for that particular industry unless its strategic plan calls for unusual expenditures.

Simply spending money on R&D or new projects does not mean, however, that the money will produce useful results. For example, Pharmacia Upjohn spent more of its revenues on re- search than any other company in any industry (18%), but it was ranked low in innovation.47

A company’s R&D unit should be evaluated for technological competence in both the devel- opment and the use of innovative technology. Not only should the corporation make a consis- tent research effort (as measured by reasonably constant corporate expenditures that result in usable innovations), it should also be proficient in managing research personnel and integrat- ing their innovations into its day-to-day operations. A company should also be proficient in technology transfer, the process of taking a new technology from the laboratory to the mar- ketplace. Aerospace parts maker Rockwell Collins, for example, is a master of developing new technology, such as the “heads-up display” (transparent screens in an airplane cockpit that tell pilots speed, altitude, and direction), for the military and then using it in products built for the civilian market.48

R&D Mix Basic R&D is conducted by scientists in well-equipped laboratories where the focus is on the- oretical problem areas. The best indicators of a company’s capability in this area are its patents and research publications. Product R&D concentrates on marketing and is concerned with product or product-packaging improvements. The best measurements of ability in this area are the number of successful new products introduced and the percentage of total sales and prof- its coming from products introduced within the past five years. Engineering (or process) R&D is concerned with engineering, concentrating on quality control, and the development of de- sign specifications and improved production equipment. A company’s capability in this area can be measured by consistent reductions in unit manufacturing costs and by the number of product defects.

Most corporations will have a mix of basic, product, and process R&D, which varies by industry, company, and product line. The balance of these types of research is known as the R&D mix and should be appropriate to the strategy being considered and to each prod- uct’s life cycle. For example, it is generally accepted that product R&D normally dominates the early stages of a product’s life cycle (when the product’s optimal form and features are still being debated), whereas process R&D becomes especially important in the later stages (when the product’s design is solidified and the emphasis is on reducing costs and improv- ing quality).

C H A P T E R 5 Internal Scanning: Organizational Analysis 155

Impact of Technological Discontinuity on Strategy The R&D manager must determine when to abandon present technology and when to develop or adopt new technology. Richard Foster of McKinsey and Company states that the displace- ment of one technology by another (technological discontinuity) is a frequent and strategi- cally important phenomenon. Such a discontinuity occurs when a new technology cannot simply be used to enhance the current technology, but actually substitutes for that technology to yield better performance. For each technology within a given field or industry, according to Foster, the plotting of product performance against research effort/expenditures on a graph re- sults in an S-shaped curve. He describes the process depicted in Figure 5–6:

Early in the development of the technology a knowledge base is being built and progress requires a relatively large amount of effort. Later, progress comes more easily. And then, as the limits of that technology are approached, progress becomes slow and expensive. That is when R&D dol- lars should be allocated to technology with more potential. That is also—not so incidentally— when a competitor who has bet on a new technology can sweep away your business or topple an entire industry.49

Computerized information technology is currently on the steep upward slope of its S-curve in which relatively small increments in R&D effort result in significant improve- ment in performance. This is an example of Moore’s Law, which states that silicon chips (microprocessors) double in complexity every 18 months.50 The presence of a technological discontinuity in the world’s steel industry during the 1960s explains why the large capital expenditures by U.S. steel companies failed to keep them competitive with the Japanese firms that adopted the new technologies. As Foster points out, “History has shown that as one technology nears the end of its S-curve, competitive leadership in a market generally changes hands.”51

What the S-Curves Reveal

Research Effort/Expenditure

In the corporate planning process, it is generally assumed that incremental progress in technology will occur. But past developments in a given technology cannot be extrapolated into the future because every technology has its limits. The key to competitiveness is to determine when to shift re- sources to a technology that has more potential.

Mature Technology New

Technology

P ro

d u

c t

P e rf

o rm

a n

c e

FIGURE 5–6 Technological Discontinuity

SOURCE: From “Are You Investing in the Wrong Technology?” P. Pascarella, Industry Week, July 25, 1983. Reprinted by permission of Penton Media, Inc.

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Christensen explains in The Innovator’s Dilemma why this transition occurs when a “dis- ruptive technology” enters an industry. In a study of computer disk drive manufacturers, he ex- plains that established market leaders are typically reluctant to move in a timely manner to a new technology. This reluctance to switch technologies (even when the firm is aware of the new technology and may have even invented it!) is because the resource allocation process in most companies gives priority to those projects (typically based on the old technology) with the greatest likelihood of generating a good return on investment—those projects appealing to the firm’s current customers (whose products are also based on the characteristics of the old technology). For example, in the 1980s a disk drive manufacturer’s customers (PC manufac- turers) wanted a better (faster) 5 1/4� drive with greater capacity. These PC makers were not interested in the new 3 1/2� drives based on the new technology because (at that time) the smaller drives were slower and had less capacity. Smaller size was irrelevant since these com- panies primarily made desk top personal computers which were designed to hold large drives.

The new technology is generally riskier and of little appeal to the current customers of es- tablished firms. Products derived from the new technology are more expensive and do not meet the customers’ requirements—requirements based on the old technology. New entrepre- neurial firms are typically more interested in the new technology because it is one way to ap- peal to a developing market niche in a market currently dominated by established companies. Even though the new technology may be more expensive to develop, it offers performance im- provements in areas that are attractive to this small niche, but of no consequence to the cus- tomers of the established competitors.

This was the case with the entrepreneurial manufacturers of 3 1/2� disk drives. These smaller drives appealed to the PC makers who were trying to increase their small PC market share by offering laptop computers. Size and weight were more important to these customers than were capacity and speed. By the time the new technology was developed to the point that the 3 1/2� drive matched and even surpassed the 5 1/4� drive in terms of speed and capacity (in addition to size and weight), it was too late for the established 5 1/4� disk drive firms to switch to the new technology. Once their customers begin demanding smaller products using the new technology, the established firms were unable to respond quickly and lost their leadership po- sition in the industry. They were able to remain in the industry (with a much reduced market share) only if they were able to utilize the new technology to be competitive in the new prod- uct line.52

The same phenomenon can be seen in many product categories ranging from flat-panel display screens to railroad locomotives to digital photography to musical recordings. For ex- ample, George Heilmeier created the first practical liquid-crystal display (LCD) in 1964 at RCA Labs. RCA unveiled the new display in 1968 with much fanfare about LCDs being the future of TV sets, but then refused to fund further development of the new technology. In con- trast, Japanese television and computer manufacturers invested in long-term development of LCDs. Today, Japanese, Korean, and Taiwanese companies dominate the $39 billion LCD business and RCA no longer makes televisions. Interestingly, Heilmeier received the Kyoto Prize in 2005 for his LCD invention.53

STRATEGIC OPERATIONS ISSUES The primary task of the operations (manufacturing or service) manager is to develop and op- erate a system that will produce the required number of products or services, with a certain quality, at a given cost, within an allotted time. Many of the key concepts and techniques pop- ularly used in manufacturing can be applied to service businesses.

In very general terms, manufacturing can be intermittent or continuous. In intermittent systems (job shops), the item is normally processed sequentially, but the work and sequence

C H A P T E R 5 Internal Scanning: Organizational Analysis 157

of the process vary. An example is an auto body repair shop. At each location, the tasks deter- mine the details of processing and the time required for them. These job shops can be very la- bor intensive. For example, a job shop usually has little automated machinery and thus a small amount of fixed costs. It has a fairly low break-even point, but its variable cost line (composed of wages and costs of special parts) has a relatively steep slope. Because most of the costs as- sociated with the product are variable (many employees earn piece-rate wages), a job shop’s variable costs are higher than those of automated firms. Its advantage over other firms is that it can operate at low levels and still be profitable. After a job shop’s sales reach break-even, however, the huge variable costs as a percentage of total costs keep the profit per unit at a rel- atively low level. In terms of strategy, this firm should look for a niche in the marketplace for which it can produce and sell a reasonably small quantity of custom-made goods.

In contrast, continuous systems are those laid out as lines on which products can be con- tinuously assembled or processed. An example is an automobile assembly line. A firm using continuous systems invests heavily in fixed investments such as automated processes and highly sophisticated machinery. Its labor force, relatively small but highly skilled, earns salaries rather than piece-rate wages. Consequently, this firm has a high amount of fixed costs. It also has a relatively high break-even point, but its variable cost line rises slowly. This is an example of operating leverage, the impact of a specific change in sales volume on net operat- ing income. The advantage of high operating leverage is that once the firm reaches break-even, its profits rise faster than do those of less automated firms having lower operating leverage. Continuous systems reap benefits from economies of scale. In terms of strategy, this firm needs to find a high-demand niche in the marketplace for which it can produce and sell a large quan- tity of goods. However, a firm with high operating leverage is likely to suffer huge losses dur- ing a recession. During an economic downturn, the firm with less automation and thus less leverage is more likely to survive comfortably because a drop in sales primarily affects vari- able costs. It is often easier to lay off labor than to sell off specialized plants and machines.

Experience Curve A conceptual framework that many large corporations have used successfully is the experience curve (originally called the learning curve). The experience curve suggests that unit produc- tion costs decline by some fixed percentage (commonly 20%–30%) each time the total accu- mulated volume of production in units doubles. The actual percentage varies by industry and is based on many variables: the amount of time it takes a person to learn a new task, scale economies, product and process improvements, and lower raw materials cost, among others. For example, in an industry with an 85% experience curve, a corporation might expect a 15% reduction in unit costs for every doubling of volume. The total costs per unit can be expected to drop from $100 when the total production is 10 units, to $85 ($100 x 85%) when production in- creases to 20 units, and to $72.25 ($85 x 85%) when it reaches 40 units. Achieving these results often means investing in R&D and fixed assets; higher fixed costs and less flexibility thus re- sult. Nevertheless the manufacturing strategy is one of building capacity ahead of demand in order to achieve the lower unit costs that develop from the experience curve. On the basis of some future point on the experience curve, the corporation should price the product or service very low to preempt competition and increase market demand. The resulting high number of units sold and high market share should result in high profits, based on the low unit costs.

Management commonly uses the experience curve in estimating the production costs of (1) a product never before made with the present techniques and processes or (2) current products produced by newly introduced techniques or processes. The concept was first ap- plied in the airframe industry and can be applied in the service industry as well. For exam- ple, a cleaning company can reduce its costs per employee by having its workers use the same equipment and techniques to clean many adjacent offices in one office building rather

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STRATEGIC HUMAN RESOURCE (HRM) ISSUES The primary task of the manager of human resources is to improve the match between indi- viduals and jobs. Research indicates that companies with good HRM practices have higher profits and a better survival rate than do firms without these practices.57 A good HRM depart- ment should know how to use attitude surveys and other feedback devices to assess employ- ees’ satisfaction with their jobs and with the corporation as a whole. HRM managers should also use job analysis to obtain job description information about what each job needs to ac- complish in terms of quality and quantity. Up-to-date job descriptions are essential not only for proper employee selection, appraisal, training, and development for wage and salary ad- ministration, and for labor negotiations, but also for summarizing the corporate-wide human resources in terms of employee-skill categories. Just as a company must know the number, type, and quality of its manufacturing facilities, it must also know the kinds of people it em- ploys and the skills they possess. The best strategies are meaningless if employees do not have the skills to carry them out or if jobs cannot be designed to accommodate the available work- ers. IBM, Procter & Gamble, and Hewlett-Packard, for example, use employee profiles to en- sure that they have the best mix of talents to implement their planned strategies. Because project managers at IBM are now able to scan the company’s databases to identify employee capabilities and availability, the average time needed to assemble a team has declined 20% for a savings of $500 million overall.58

Increasing Use of Teams Management is beginning to realize that it must be more flexible in its utilization of employees in order for human resources to be classified as a strength. Human resource managers, therefore, need to be knowledgeable about work options such as part-time work, job sharing, flex-time,

than just cleaning a few offices in multiple buildings. Although many firms have used ex- perience curves extensively, an unquestioning acceptance of the industry norm (such as 80% for the airframe industry or 70% for integrated circuits) is very risky. The experience curve of the industry as a whole might not hold true for a particular company for a variety of reasons.54

Flexible Manufacturing for Mass Customization The use of large, continuous, mass-production facilities to take advantage of experience-curve economies has recently been criticized. The use of Computer-Assisted Design and Computer- Assisted Manufacturing (CAD/CAM) and robot technology means that learning times are shorter and products can be economically manufactured in small, customized batches in a process called mass customization—the low-cost production of individually customized goods and services.55 Economies of scope (in which common parts of the manufacturing activities of various products are combined to gain economies even though small numbers of each prod- uct are made) replace Economies of scale (in which unit costs are reduced by making large numbers of the same product) in flexible manufacturing. Flexible manufacturing permits the low-volume output of custom-tailored products at relatively low unit costs through economies of scope. It is thus possible to have the cost advantages of continuous systems with the customer-oriented advantages of intermittent systems. The auto maker, BMW, for exam- ple, uses flexible manufacturing to customize cars to suit each buyer’s preference. It replaced its two assembly lines in its Spartanburg, South Carolina, plant with one flexible assembly line in 2006. According to spokesperson Bunny Richardson, “Until now, if we wanted to introduce an additional model, we’d have to construct a new line.”56

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extended leaves, and contract work, and especially about the proper use of teams. Over two- thirds of large U.S. companies are successfully using autonomous (self-managing) work teams in which a group of people work together without a supervisor to plan, coordinate, and evaluate their own work.59 Northern Telecom found productivity and quality to increase with work teams to such an extent that it was able to reduce the number of quality inspectors by 40%.60

As a way to move a product more quickly through its development stage, companies like Motorola, Chrysler, NCR, Boeing, and General Electric are using cross-functional work teams. Instead of developing products in a series of steps—beginning with a request from sales, which leads to design, then to engineering and on to purchasing, and finally to manufacturing (and of- ten resulting in a costly product rejected by the customer)—companies are tearing down the tra- ditional walls separating the departments so that people from each discipline can get involved in projects early on. In a process called concurrent engineering, the once-isolated specialists now work side by side and compare notes constantly in an effort to design cost-effective prod- ucts with features customers want. Taking this approach enabled Chrysler Corporation to reduce its product development cycle from 60 to 36 months.61 For such cross-functional work teams to be successful, the groups must receive training and coaching. Otherwise, poorly implemented teams may worsen morale, create divisiveness, and raise the level of cynicism among workers.62

Virtual teams are groups of geographically and/or organizationally dispersed coworkers that are assembled using a combination of telecommunications and information technologies to accomplish an organizational task.63 In the U.S. alone, more than half of companies having over 5,000 employees use virtual teams involving around 8.4 million people.64 According to the Gartner Group, more than 60% of professional employees now work in virtual teams.65 In- ternet, intranet, and extranet systems are combining with other new technologies, such as desk- top video conferencing and collaborative software, to create a new workplace in which teams of workers are no longer restrained by geography, time, or organizational boundaries. This technology allows about 12% of the U.S. workforce, who have no permanent office at their companies, to do team projects over the Internet and report to a manager thousands of miles away. More than 20 million people in the U.S. are engaged in telecommuting.66 Charles Grantham of Work Design Collaborative predicts that 40% of the workforce will be working remotely by 2012.67

As more companies outsource some of the activities previously conducted internally, the traditional organizational structure is being replaced by a series of virtual teams, which rarely, if ever, meet face-to-face. Such teams may be established as temporary groups to accomplish a specific task or may be more permanent to address continuing issues such as strategic planning. Membership on these teams is often fluid, depending upon the task to be accomplished. They may include not only employees from different functions within a company, but also members of various stakeholder groups, such as suppliers, customers, and law or consulting firms. The use of virtual teams to replace traditional face-to-face work groups is being driven by five trends:

1. Flatter organizational structures with increasing cross-functional coordination need

2. Turbulent environments requiring more inter-organizational cooperation

3. Increasing employee autonomy and participation in decision making

4. Higher knowledge requirements derived from a greater emphasis on service

5. Increasing globalization of trade and corporate activity68

Union Relations and Temporary/Part-Time Workers If the corporation is unionized, a good human resource manager should be able to work closely with the union. Even though union membership had dropped to only 12.1% of the U.S. work- force by 2007 compared to 20.1% in 1983, it still included 15.7 million people. Nevertheless,

160 PA RT 2 Scanning the Environment

only 7.5% of the 108,714 million private sector employees belonged to a union (compared to 35.9% of public sector employees).69 To save jobs, U.S. unions are increasingly willing to sup- port new strategic initiatives and employee involvement programs. For example, United Steel Workers hired Ron Bloom, an investment banker, to propose a strategic plan to make Goodyear Tire & Rubber globally competitive in a way that would preserve as many jobs as possible. In a recent contract, the union gave up $1.15 billion in wage and benefit concessions over three years in return for a promise by Goodyear’s top management to invest in 12 of its 14 U.S. factories, to limit imports from its factories in Brazil and Asia, and to maintain 85% of its 19,000-person workforce. The company also agreed to aggressively restructure the firm’s $5 billion debt. According to Bloom, “We told Goodyear, ‘We’ll make you profitable, but you’re going to adopt this strategy.’. . . We think the company should be a patient, long- term builder of value for the employees and shareholders.”70

Outside the United States, the average proportion of unionized workers among major in- dustrialized nations is around 50%. European unions tend to be militant, politically oriented, and much less interested in working with management to increase efficiency. Nationwide strikes can occur quickly. In contrast, Japanese unions are typically tied to individual compa- nies and are usually supportive of management. These differences among countries have sig- nificant implications for the management of multinational corporations.

To increase flexibility, avoid layoffs, and reduce labor costs, corporations are using more temporary (also known as contingent) workers. Over 90% of U.S. and European firms use tem- porary workers in some capacity; 43% use them in professional and technical functions.71 Ap- proximately 13% of the U.S. workforce are part-time workers. The percentage is even higher in Japan, where 26% of workers are part-time, and in the Netherlands, where 36% of all em- ployees work part-time.72 Labor unions are concerned that companies use temps to avoid hir- ing costlier unionized workers. At United Parcel Service, for example, 80% of the jobs created from 1993 to 1997 were staffed by part-timers, whose pay rates hadn’t changed since 1982. Fully 10% of the company’s 128,000 part-timers worked 30 hours or more per week, but were still paid at a lower rate than were full-time employees.73

Quality of Work Life and Human Diversity Human resource departments have found that to reduce employee dissatisfaction and union- ization efforts (or, conversely, to improve employee satisfaction and existing union relations), they must consider the quality of work life in the design of jobs. Partially a reaction to the tra- ditionally heavy emphasis on technical and economic factors in job design, quality of work life emphasizes improving the human dimension of work. The knowledgeable human resource manager, therefore, should be able to improve the corporation’s quality of work life by (1) in- troducing participative problem solving, (2) restructuring work, (3) introducing innovative re- ward systems, and (4) improving the work environment. It is hoped that these improvements will lead to a more participative corporate culture and thus higher productivity and quality products. Ford Motor Company, for example, rebuilt and modernized its famous River Rouge plant using flexible equipment and new processes. Employees work in teams and use Internet- connected PCs on the shop floor to share their concerns instantly with suppliers or product en- gineers. Workstations were redesigned to make them more ergonomic and reduce repetitive-strain injuries. “If you feel good while you’re working, I think quality and produc- tivity will increase, and Ford thinks that too, otherwise, they wouldn’t do this,” observed Jerry Sullivan, president of United Auto Workers Local 600.74

Companies are also discovering that by redesigning their plants and offices for improved energy efficiency, they can receive a side effect of improving their employees’ quality of work life—thus raising labor productivity. See the Environmental Sustainability Issue feature to learn how improved energy efficiency can not only cut costs, but also boost employee morale.

C H A P T E R 5 Internal Scanning: Organizational Analysis 161

SOURCE: Material based on M. Hirschland, J. M. Oppenheim, and A. P. Webb, “Using Energy More Efficiently: An Interview with the Rocky Mountain Institute’s Amory Lovins,” McKinsey Quarterly (July 2008), pp. 1–7.

lar power, geothermal, small hydro, and waste- or biomass- fueled plants. Lovins points out that a sixth of the world’s electricity and a third of new electricity now comes from mi- cropower because it’s cheaper with lower financial risk.

Lovins points out that energy redesigns often have side effects that may be far more valuable than the direct sav- ings. For example, a typical office pays around 160 times more in payroll than for energy. According to Lovins, his programs routinely get a 6% to 16% increase gain in la- bor productivity in more efficient buildings having im- proved thermal, visual, and acoustic comfort. “When people can see what they are doing, hear themselves think, breathe cleaner air, and feel more comfortable, they do more and better work,” says Lovins.

Amory Lovins, Co-founder and Chairman of the Rocky

Mountain Institute, works to ed- ucate business executives on how

the efficient use of energy can lead not only to lower costs, but also to competitive advantage and increased labor pro- ductivity. His Rocky Mountain Institute is a nonprofit orga- nization that develops and implements programs for energy and resource efficiency. According to Lovins:

In my team’s latest redesigns for $30 billion worth of fa- cilities in 29 sectors, we consistently found about 30 to 60 percent energy savings that could be captured through retrofits, which paid for themselves in two to three years. In new facilities, 40 to 90 percent savings could be gleaned—and with nearly always lower capital cost.

Lovins’ Rocky Mountain Institute promotes the use of micropower, on-site or decentralized energy production, such as waste-heat, or gas-fired cogeneration, wind and so-

USING ENERGY EFFICIENCY FOR COMPETITIVE ADVANTAGE AND QUALITY OF WORK LIFE

ENVIRONMENTAL sustainability issue

Human diversity refers to the mix in the workplace of people from different races, cul- tures, and backgrounds. Realizing that the demographics are changing toward an increasing percentage of minorities and women in the U.S. workforce, companies are now concerned with hiring and promoting people without regard to ethnic background. Research does indi- cate that an increase in racial diversity leads to an increase in firm performance.75 In a survey of 131 leading European companies, 67.2% stated that a diverse work force can provide com- petitive advantage.76 A manager from Nestlé stated: “To deliver products that meet the needs of individual consumers, we need people who respect other cultures, embrace diversity, and never discriminate on any basis.”77 Good human resource managers should be working to en- sure that people are treated fairly on the job and not harassed by prejudiced co-workers or man- agers. Otherwise, they may find themselves subject to lawsuits. Coca-Cola Company, for example, agreed to pay $192.5 million because of discrimination against African-American salaried employees in pay, promotions, and evaluations from 1995 and 2000. According to Chairman and CEO Douglas Daft, “Sometimes things happen in an unintentional manner. And I’ve made it clear that can’t happen anymore.”78

An organization’s human resources may be a key to achieving a sustainable competitive advantage. Advances in technology are copied almost immediately by competitors around the world. People, however, are not as willing to move to other companies in other countries. This means that the only long-term resource advantage remaining to corporations operating in the industrialized nations may lie in the area of skilled human resources.79 Research does reveal that competitive strategies are more successfully executed in those companies with a high level of commitment to their employees than in those firms with less commitment.80

162 PA RT 2 Scanning the Environment

STRATEGIC INFORMATION SYSTEMS/TECHNOLOGY ISSUES The primary task of the manager of information systems/technology is to design and manage the flow of information in an organization in ways that improve productivity and decision making. Information must be collected, stored, and synthesized in such a manner that it will answer important operating and strategic questions. A corporation’s information system can be a strength or a weakness in multiple areas of strategic management. It can not only aid in en- vironmental scanning and in controlling a company’s many activities, it can also be used as a strategic weapon in gaining competitive advantage.

Impact on Performance Information systems/technology offers four main contributions to corporate performance. First, (beginning in the 1970s with mainframe computers) it is used to automate existing back-office processes, such as payroll, human resource records, accounts payable and receivable, and to estab- lish huge databases. Second, (beginning in the 1980s) it is used to automate individual tasks, such as keeping track of clients and expenses, through the use of personal computers with word process- ing and spreadsheet software. Corporate databases are accessed to provide sufficient data to ana- lyze the data and create what-if scenarios. These first two contributions tend to focus on reducing costs. Third, (beginning in the 1990s) it is used to enhance key business functions, such as market- ing and operations. This third contribution focuses on productivity improvements. The system pro- vides customer support and help in distribution and logistics. For example, Federal Express found that by allowing customers to directly access its package-tracking database via its Internet Web site instead of their having to ask a human operator, the company saved up to $2 million annually.81

Business processes are analyzed to increase efficiency and productivity via reengineering. Enter- prise resource planning (ERP) application software, such as SAP, PeopleSoft, Oracle, Baan, and J.D. Edwards, (discussed further in Chapter 10) is used to integrate worldwide business activities so that employees need to enter information only once and that information is available to all cor- porate systems (including accounting) around the world. Fourth, (beginning in 2000) it is used to develop competitive advantage. For example, American Hospital Supply (AHS), a leading manu- facturer and distributor of a broad line of products for doctors, laboratories, and hospitals, devel- oped an order entry distribution system that directly linked the majority of its customers to AHS computers. The system was successful because it simplified ordering processes for customers, re- duced costs for both AHS and the customer, and allowed AHS to provide pricing incentives to the customer. As a result, customer loyalty was high and AHS’s share of the market became large.

A current trend in corporate information systems/technology is the increasing use of the Internet for marketing, intranets for internal communication, and extranets for logistics and distribution. An intranet is an information network within an organization that also has access to the external worldwide Internet. Intranets typically begin as ways to provide employees with company information such as lists of product prices, fringe benefits, and company poli- cies. They are then converted into extranets for supply chain management. An extranet is an information network within an organization that is available to key suppliers and customers. The key issue in building an extranet is the creation of “fire walls” to block extranet users from accessing the firm’s or other users’ confidential data. Once this is accomplished, companies can allow employees, customers, and suppliers to access information and conduct business on the Internet in a completely automated manner. By connecting these groups, companies hope to obtain a competitive advantage by reducing the time needed to design and bring new prod- ucts to market, slashing inventories, customizing manufacturing, and entering new markets.82

A recent development in information systems/technology is Web 2.0. Web 2.0 refers to the use of wikis, blogs, RSS (Really Simple Syndication), social networks (e.g., MySpace and Facebook), podcasts, and mash-ups through company Web sites to forge tighter links with cus- tomers and suppliers and to engage employees more successfully. A 2008 survey by McKinsey

C H A P T E R 5 Internal Scanning: Organizational Analysis 163

revealed the percentage of companies using individual Web 2.0 technologies to be Web ser- vices (58%), blogs (34%), RSS (33%), wikis (32%), podcasts (29%), social networking (28%), peer-to-peer (18%), and mash-ups (10%). The most heavily used tool is Web services, soft- ware that makes it easier to exchange information and conduct transactions. Wikis and blogs are being increasingly used in companies throughout the world. Satisfied users of these infor- mation technologies report that they are using these tools to interact with their customers, sup- pliers, and outside experts in product development efforts known as co-creation. For example, LEGO invited customers to suggest new models interactively and then financially rewarded the people whose ideas proved marketable.83

Supply Chain Management The expansion of the marketing-oriented Internet into intranets and extranets is making sig- nificant contributions to organizational performance through supply chain management. Supply chain management is the forming of networks for sourcing raw materials, manufac- turing products or creating services, storing and distributing the goods, and delivering them to customers and consumers.84 Research indicates that supplier network resources have a signif- icant impact on firm performance.85 A survey of global executives revealed that their interest in supply chains was first to reduce costs, and then to improve customer service and get new products to market faster.86 More than 85% of senior executives stated that improving their firm’s supply-chain performance was a top priority. Companies, like Wal-Mart, Dell, and Toy- ota, who are known to be exemplars in supply-chain management, spend only 4% of their rev- enues on supply chain costs compared to 10% by the average firm.87

Industry leaders are integrating modern information systems into their corporate value chains to harmonize companywide efforts and to achieve competitive advantage. For example, Heineken beer distributors input actual depletion figures and replenishment orders to the Nether- lands brewer through their linked Web pages. This interactive planning system generates time- phased orders based on actual usage rather than on projected demand. Distributors are then able to modify plans based on local conditions or changes in marketing. Heineken uses these modifi- cations to adjust brewing and supply schedules. As a result of this system, lead times have been reduced from the traditional 10–12 weeks to 4–6 weeks. This time savings is especially useful in an industry competing on product freshness. In another example, Procter & Gamble participates in an information network to move the company’s line of consumer products through Wal-Mart’s many stores. Radio-frequency identification (RFID) tags containing product information is used to track goods through inventory and distribution channels. As part of the network with Wal- Mart, P&G knows by cash register and by store what products have passed through the system every hour of each day. The network is linked by satellite communications on a real-time basis. With actual point-of-sale information, products are replenished to meet current demand and min- imize stockouts while maintaining exceptionally low inventories.88

5.5 The Strategic Audit: A Checklist for Organizational Analysis

One way of conducting an organizational analysis to ascertain a company’s strengths and weakness is by using the Strategic Audit found in Appendix 1.A at the end of Chapter 1. The audit provides a checklist of questions by area of concern. For example, Part IV of the audit examines corporate structure, culture, and resources. It looks at organizational resources and capabilities in terms of the functional areas of marketing, finance, R&D, operations, human resources, and information systems, among others.

164 PA RT 2 Scanning the Environment

TABLE 5–2 Internal Factor Analysis Summary (IFAS Table): Maytag as Example

Internal Factors Weight Rating Weighted

Score Comments

1 2 3 4 5

Strengths � Quality Maytag culture � Experienced top management � Vertical integration � Employer relations � Hoover’s international orientation

.15

.05

.10

.05

.15

5.0 4.2 3.9 3.0 2.8

.75

.21

.39

.15

.42

Quality key to success Know appliances Dedicated factories Good, but deteriorating Hoover name in cleaners

Weaknesses � Process-oriented R&D � Distribution channels � Financial position � Global positioning

� Manufacturing facilities

.05

.05

.15

.20

.05

2.2 2.0 2.0 2.1

4.0

.11

.10

.30

.42

.20

Slow on new products Superstores replacing small dealers High debt load Hoover weak outside the United Kingdom and Australia Investing now

Total Scores 1.00 3.05

NOTES:

1. List strengths and weaknesses (8–10) in Column 1. 2. Weight each factor from 1.0 (Most Important) to 0.0 (Not Important) in Column 2 based on that factor’s probable impact on the company’s

strategic position. The total weights must sum to 1.00. 3. Rate each factor from 5.0 (Outstanding) to 1.0 (Poor) in Column 3 based on the company’s response to that factor. 4. Multiply each factor’s weight times its rating to obtain each factor’s weighted score in Column 4. 5. Use Column 5 (comments) for rationale used for each factor. 6. Add the individual weighted scores to obtain the total weighted score for the company in Column 4. This tells how well the company is

responding to the factors in its internal environment.

SOURCE: T.L. Wheelen & J.D. Hunger, “Internal Factor Analysis Summary (IFAS)” Copyright © 1987, 1988, 1989, 1990 and 2005 by T.L. Wheelen. Copyright © 1991, 2003, and 2005 by Wheelen and Hunger Associates. Reprinted by permission.

5.6 Synthesis of Internal Factors After strategists have scanned the internal organizational environment and identified factors for their particular corporation, they may want to summarize their analysis of these factors us- ing a form such as that given in Table 5–2. This IFAS (Internal Factor Analysis Summary) Table is one way to organize the internal factors into the generally accepted categories of strengths and weaknesses as well as to analyze how well a particular company’s management is responding to these specific factors in light of the perceived importance of these factors to the company. Use the VRIO framework (Value, Rareness, Imitability, & Organization) to as- sess the importance of each of the factors that might be considered strengths. Except for its in- ternal orientation, this IFAS Table is built the same way as the EFAS Table described in Chapter 4 (in Table 4–5). To use the IFAS Table, complete the following steps:

1. In Column 1 (Internal Factors), list the eight to ten most important strengths and weak- nesses facing the company.

C H A P T E R 5 Internal Scanning: Organizational Analysis 165

2. In Column 2 (Weight), assign a weight to each factor from 1.0 (Most Important) to 0.0 (Not Important) based on that factor’s probable impact on a particular company’s current strategic position. The higher the weight, the more important is this factor to the current and future success of the company. All weights must sum to 1.0 regardless of the number of factors.

3. In Column 3 (Rating), assign a rating to each factor from 5.0 (Outstanding) to 1.0 (Poor) based on management’s specific response to that particular factor. Each rating is a judg- ment regarding how well the company’s management is currently dealing with each spe- cific internal factor.

4. In Column 4 (Weighted Score), multiply the weight in Column 2 for each factor times its rating in Column 3 to obtain that factor’s weighted score.

5. In Column 5 (Comments), note why a particular factor was selected and/or how its weight and rating were estimated.

6. Finally, add the weighted scores for all the internal factors in Column 4 to determine the total weighted score for that particular company. The total weighted score indicates how well a particular company is responding to current and expected factors in its internal en- vironment. The score can be used to compare that firm to other firms in its industry. Check to ensure that the total weighted score truly reflects the company’s current performance in terms of profitability and market share. The total weighted score for an average firm in an industry is always 3.0.

As an example of this procedure, Table 5–2 includes a number of internal factors for May- tag Corporation in 1995 (before Maytag was acquired by Whirlpool) with corresponding weights, ratings, and weighted scores provided. Note that Maytag’s total weighted score is 3.05, meaning that the corporation is about average compared to the strengths and weaknesses of others in the major home appliance industry.

End of Chapter S U M M A R Y Every day, about 17 truckloads of used diesel engines and other parts are dumped at a receiving facility at Caterpillar’s remanufacturing plant in Corinth, Mississippi. The filthy iron engines are then broken down by two workers, who manually hammer and drill for half a day until they have taken every bolt off the engine and put each component into its own bin. The engines are then cleaned and re-made at a half the cost of a new engine and sold for a tidy profit. This system works at Caterpillar because as a general rule, 70% of the cost to build something new is in the materials and 30% is in the labor. Remanufactur- ing simply starts the manufacturing process over again with materials that are essentially free and which already contain most of the energy costs needed to make them. The would- be discards become fodder for the next product, eliminating waste, and cutting costs. Caterpillar’s management was so impressed by the remanufacturing operation that they made the business a separate division in 2005. The unit earned more than $1 billion in sales in 2005 and expects 15% growth for many more years—given the steadily increasing cost of oil and raw materials.

Caterpillar’s remanufacturing unit was successful not only because of its capability of wringing productivity out of materials and labor, but also because it designed its products for re-use. Before they are built new, remanufactured products must be designed for disassembly. In order to achieve this, Caterpillar asks its designers to check a “Reman” box on Caterpillar’s

166 PA RT 2 Scanning the Environment

E C O - B I T S � The average number of plastic bottles used each year in

the U.S. per person: 200

� The average number of plastic bottles recycled each year in the U.S. per person: 40

� Revenue produced in 2007 by recycling and ancillary industries: $236 billion

� Share of electronic waste that is hauled overseas, stripped unsafely, and dumped: 80%90

D I S C U S S I O N Q U E S T I O N S 1. What is the relevance of the resource-based view of the

firm to strategic management in a global environment?

2. How can value-chain analysis help identify a company’s strengths and weaknesses?

3. In what ways can a corporation’s structure and culture be internal strengths or weaknesses?

4. What are the pros and cons of management’s using the experience curve to determine strategy?

5. How might a firm’s management decide whether it should continue to invest in current known technology or in new, but untested technology? What factors might en- courage or discourage such a shift?

S T R A T E G I C P R A C T I C E E X E R C I S E S Can you analyze a corporation using the Internet? Try the fol- lowing exercise.

1. Form into teams of around three to five people. Select a well-known publicly owned company to research. Inform the instructor of your choice.

2. Assign each person a separate task. One task might be to find the latest financial statements. Another would be to learn as much as possible about its top management and board of directors. Another might be to identify its business model. Another might be to identify its key competitors.

3. Conduct research on the company using the Internet only.

4. Meet with your team members to discuss what you have found. What are the company’s opportunities, threats, strengths, and weaknesses? Go back to the Internet for more information, if needed.

5. Prepare a 3- to-5 page typed report of the company. The report should include the following: a. Does the firm have any core competencies? Are any

of these distinctive (better than the competition) competencies? Does the firm have any competitive

product development checklist. The company also needs to know where its products are being used in order to take them back—known as the art of reverse logistics. This is achieved by Caterpillar’s excellent relationship with its dealers throughout the world as well as through fi- nancial incentives. For example, when a customer orders a crankshaft, that customer is offered a remanufactured one for half the cost of a new one—assuming the customer turns in the old crankshaft to Caterpillar. The products also should be built for performance with little regard for changing fashion. Since diesel engines change little from year to year, a remanufactured engine is very similar to a new engine and might perform even better.

Monitoring the external environment is only one part of environmental scanning. Strate- gists also need to scan a corporation’s internal environment to identify its resources, capabili- ties, and competencies. What are its strengths and weaknesses? At Caterpillar, management clearly noted that the environment was changing in a way to make its remanufactured product more desirable. It took advantage of its strengths in manufacturing and distribution to offer a recycling service for its current customers and a low-cost alternative product for those who could not afford a new Caterpillar engine. It also happened to be an environmentally friendly, sustainable business model. Caterpillar’s management felt that remanufacturing thus provided them with a strategic advantage over competitors who don’t remanufacture. This is an exam- ple of a company using its capabilities in key functional areas to expand its business by mov- ing into a new profitable position on its value chain.89

C H A P T E R 5 Internal Scanning: Organizational Analysis 167

K E Y T E R M S brand (p. 152) business model (p. 142) capabilities (p. 138) capital budgeting (p. 153) competency (p. 138) conglomerate structure (p. 148) continuum of sustainability (p. 141) core competencies (p. 138) corporate culture (p. 149) corporate reputation (p. 152) distinctive competencies (p. 138) divisional structure (p. 147) durability (p. 140) economies of scale (p. 158) economies of scope (p. 147)

experience curve (p. 157) explicit knowledge (p. 141) financial leverage (p. 153) functional structure (p. 147) IFAS Table (p. 164) imitability (p. 140) marketing mix (p. 151) operating leverage (p. 157) organizational analysis (p. 138) organizational structures (p. 147) product life cycle (p. 152) R&D intensity (p. 154) R&D mix (p. 154) replicability (p. 141)

resource (p. 138) simple structure (p. 147) strategic business units (SBUs) (p. 148) supply chain management (p. 163) tacit knowledge (p. 141) technological competence (p. 154) technological discontinuity (p. 155) technology transfer (p. 154) transferability (p. 140) transparency (p. 140) value chain (p. 143) virtual teams (p. 159) VRIO framework (p. 138)

advantage? Provide a SWOT analysis using EFAS and IFAS Tables.

b. What is the likely future of this firm if it continues on its current path?

c. Would you buy stock in this company? Assume that your team has $25,000 to invest. Allocate the money

among the four to five primary competitors in this in- dustry. List the companies, the number of shares pur- chased of each, the cost of each share as of a given date, and the total cost for each purchase assuming a typical commission used by an Internet broker, such as E-Trade or Scottrade.

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ganizational Capabilities Be? Towards a Dual-Process Model of Capability Dynamization,” Strategic Management Journal (September 2007), pp. 913–933.

4. M. Javidan, “Core Competence: What Does It Mean in Prac- tice?” Long Range Planning (February 1998), pp. 60–71.

5. M. A. Hitt, B. W. Keats, and S. M. DeMarie, “Navigating in the New Competitive Landscape: Building Strategic Flexibility and Competitive Advantage in the 21st Century,” Academy of Management Executive (November 1998), pp. 22–42; C. E. Helfat and M. A. Peteraf, “The Dynamic Resources-Based View: Capability Life Cycles,” Strategic Management Journal (October 2003), pp. 997–1010.

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7. J. B. Barney, Gaining and Sustaining Competitive Advantage. 2nd ed. (Upper Saddle River, NJ: Prentice Hall, 2002), pp. 159–172. Barney’s VRIO questions are very similar to those proposed by G. Hamel and S. K. Prahalad in their book, Competing for the Fu- ture (Boston: Harvard Business School Press, 1994) on pages 202–207 in which they state that to be distinctive, a compe- tency must (a) provide customer value, (b) be competitor unique, and (c) be extendable to develop new products and/or markets.

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the Resource-Based View of the Firm,” Strategic Management Journal (July 2008), pp. 745–768.

9. Barney, p. 161. 10. R. M. Grant, “The Resource-Based Theory of Competitive Ad-

vantage: Implications for Strategy Formulation,” California Management Review (Spring 1991), pp. 114–135.

11. P. J. Verdin, and P. J. Williamson, “Core Competencies, Com- petitive Advantage and Market Analysis: Forging the Links,” in Competence-Based Competition, edited by G. Hamel and A. Heene (New York: John Wiley and Sons, 1994), pp. 83–84; S. K. Ethiraj, P. Kale, M. S. Krishnan, and J. V. Singh, “Where Do Capabilities Come From and How Do They Matter? A Study in the Software Services Industry,” Strategic Management Journal (January 2005), pp. 701–719.

12. J. Devan, M. B. Klusas, and T. W. Ruefli, “The Elusive Goal of Cor- porate Outperformance,” McKinsey Quarterly Online (April 2007).

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14. J. M. Shaver and F. Flyer, “Agglomeration Economies, Firm Heterogeneity, and Foreign Direct Investment in the United States,” Strategic Management Journal (December 2000), pp. 1175–1193; W. Chung and A. Kalnins, “Agglomeration Ef- fects and Performance: A Test of the Texas Lodging Industry,” Strategic Management Journal (October 2001), pp. 969–988.

15. M. Polanyi, The Tacit Dimension (London: Routledge & Kegan Paul, 1966).

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Performance and Technological Knowledge,” Strategic Man- agement Journal (April 2002), pp. 285–305.

17. K. Maney, “Dell Business Model Turns to Muscle as Rivals Struggle,” USA Today (January 20, 2003), p. 2B.

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Central Forces of our Time,” Strategy & Leadership, Vol. 31, No. 2 (2003), pp. 61–62.

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28. E. H. Schein, The Corporate Culture Survival Guide (San Fran- cisco: Jossey-Bass, 1999), p. 12; L. C. Harris and E. Ogbonna, “The Strategic Legacy of Company Founders,” Long Range Planning (June 1999), pp. 333–343.

29. D. M. Rousseau, “Assessing Organizational Culture: The Case for Multiple Methods,” in Organizational Climate and Culture, edited by B. Schneider (San Francisco: Jossey-Bass, 1990), pp. 153–192.

30. L. Smircich, “Concepts of Culture and Organizational Analysis,” Administrative Science Quarterly (September 1983), pp. 345–346; D. Ravasi and M. Schultz, “Responding to Organizational Identity Threats: Exploring the Role of Organizational Culture,” Academy of Management Journal (June 2006), pp. 433–458.

31. D. G. Allen, “Do Organizational Socialization Tactics Influence Newcomer Embeddedness and Turnover?” Journal of Manage- ment (April 2006), pp. 237–256.

32. J. B. Sorensen, “The Strength of Corporate Culture and the Re- liability of Firm Performance,” Administrative Science Quar- terly (March 2002), pp. 70–91; R. E. Smerek and D. R. Denison, “Social Capital in Organizations: Understanding the Link to Firm Performance,” presentation to the Academy of Management (Philadelphia, 2007).

33. K. E. Aupperle, “Spontaneous Organizational Reconfiguration: A Historical Example Based on Xenophon’s Anabasis,” Organization Science (July–August 1996), pp. 445–460.

34. E. K. Briody, S. T. Cavusgil, and S. R. Miller, “Turning Three Sides into a Delta at General Motors: Enhancing Partnership In- tegration on Corporate Ventures,” Long Range Planning (Octo- ber 2004), pp. 421–434.

35. “Face Value: A Post-Modern Proctoid,” The Economist (April 15, 2006), p. 68.

36. D. Kiley, B. Helm, L. Lee, G. Edmundson, C. Edwards, and M. Scott, “Best Global Brands,” Business Week (August 6, 2007), pp. 56–64.

37. R. T. Wilcox, “The Hidden Potential of Powerful Brands,” Batten Briefings (Summer 2003), pp. 1, 4–5.

38. V. P. Rindova, I. O. Williamson, A. P. Petkova, and J. M. Sever, “Being Good or Being Known: An Empirical Examination of the Dimensions, Antecedents, and Consequences of Organiza- tional Reputation,” Academy of Management Journal (Decem- ber 2005), pp. 1033–1049.

39. V. P. Rindova, I. O. Williamson, A. P. Petkova, and J. M. Sever, “Being Good or Being Known: An Empirical Examination of the Dimensions, Antecedents, and Consequences of Organiza- tional Reputation,” Academy of Management Journal (Decem- ber 2005), pp. 1033–1049.

40. C. Fombrun and C. Van Riel, “The Reputational Landscape,” Cor- porate Reputation Review, Vol. 1, Nos. 1&2 (1997), pp. 5–13.

41. P. Engardio and M. Arndt, “What Price Reputation?” Business Week (July 9 & 16, 2007), pp. 70–79.

42. P. W. Roberts and G. R. Dowling, “Corporate Reputation and Sustained Financial Performance,” Strategic Management Journal (December 2002), pp. 1077–1093; J. Shamsie, “The Context of Dominance: An Industry-Driven Framework for Ex- ploiting Reputation,” Strategic Management Journal (March 2003), pp. 199–215; M. D. Michalisin, D. M. Kline, and R. D. Smith, “Intangible Strategic Assets and Firm Performance: A Multi-Industry Study of the Resource-Based View,” Journal of Business Strategies (Fall 2000), pp. 91–117; S. S. Standifird, “Reputation and E-Commerce: eBay Auctions and the Asym- metrical Impact of Positive and Negative Ratings,” Journal of Management, Vol. 27, No. 3 (2001), pp. 279–295.

43. R. L. Simerly and M. Li, “Environmental Dynamism, Capital Structure and Performance: A Theoretical Integration and an Empirical Test,” Strategic Management Journal (January 2000), pp. 31–49.

44. R. L. Simerly and M. Li, “Environmental Dynamism, Capital Structure and Performance: A Theoretical Integration and an Empirical Test,” Strategic Management Journal (January 2000), pp. 31–49; A. Heisz and S. LaRochelle-Cote, “Corporate Financial Leverage in Canadian Manufacturing: Consequences for Employment and Inventories,” Canadian Journal of Admin- istrative Science (June 2004), pp. 111–128.

45. J. M. Poterba and L. H. Summers, “A CEO Survey of U.S. Companies’ Time Horizons and Hurdle Rates,” Sloan Manage- ment Review (Fall 1995), pp. 43–53.

46. “R&D Scoreboard,” Business Week (June 27, 1994), pp. 81–103. 47. B. O’Reilly, “The Secrets of America’s Most Admired Corpo-

rations: New Ideas and New Products,” Fortune (March 3, 1997), p. 62.

48. C. Palmeri, “Swords to Plowshares—And Back Again,” Business Week (February 11, 2008), p. 66.

49. P. Pascarella, “Are You Investing in the Wrong Technology?” Industry Week (July 25, 1983), p. 37.

50. D. J. Yang, “Leaving Moore’s Law in the Dust,” U.S. News & World Report (July 10, 2000), pp. 37–38; R. Fishburne and M. Malone, “Laying Down the Laws: Gordon Moore and Bob Metcalfe in Conversation,” Forbes ASAP (February 21, 2000), pp. 97–100.

51. Pascarella, p. 38. 52. C. M. Christensen, The Innovator’s Dilemma (Boston: Harvard

Business School Press, 1997). 53. O. Port, “Flat-Panel Pioneer,” Business Week (December 12,

2005), p. 22. This phenomenon has also been discussed in terms of paradigm shifts in which a new development makes the old

168 PA RT 2 Scanning the Environment

C H A P T E R 5 Internal Scanning: Organizational Analysis 169

game obsolete—See Joel A. Barker, Future Edge (New York: William Morrow and Company, 1992).

54. For examples of experience curves for various products, see M. Gottfredson, S. Schaubert, and H. Saenz, “The New Leader’s Guide to Diagnosing the Business,” Harvard Business Review (February 2008), pp. 63–73.

55. B. J. Pine, Mass Customization: The New Frontier in Business Competition (Boston: Harvard Business School Press, 1993).

56. D. Coates, “The Art of Assembly,” Sports Car International (September 2007), p. 14; “One Line for Two: Spartanburg Re- vamps Assembly Process,” Roundel (January 2006), p. 31.

57. S. L Rynes, K. G. Brown, and A. E. Colbert, “Seven Common Misconceptions about Human Resource Practices: Research Findings Versus Practitioner Belief,” Academy of Management Executive (August 2002), pp. 92–103; R. S. Schuler and S. E. Jackson, “A Quarter-Century Review of Human Resource Man- agement in the U.S.: The Growth in Importance of the Interna- tional Perspective,” in Strategic Human Resource Management, 2nd ed., edited by R. S. Schuler and S. E. Jackson (Malden, MA: Blackwell Publishing, 2007), pp. 214–240; M. Guthridge and A. B. Komm, “Why Multinationals Struggle to Manage Talent,” McKinsey Quarterly (May 2008), pp. 1–5.

58. J. McGregor and S. Hamm, “Managing the Global Workforce,” Business Week (January 28, 2008), pp. 34–48; D. A. Ready and J. A. Conger, “Make Your Company a Talent Factory,” Harvard Business Review (June 2007), pp. 68–77.

59. E. E. Lawler, S. A. Mohrman, and G. E. Ledford, Jr., Creating High Performance Organizations (San Francisco: Jossey-Bass, 1995), p. 29.

60. A. Versteeg, “Self-Directed Work Teams Yield Long-Term Ben- efits,” Journal of Business Strategy (November/December 1990), pp. 9–12.

61. R. Sanchez, “Strategic Flexibility in Product Competition,” Strategic Management Journal (Summer 1995), p. 147.

62. A. R. Jassawalla and H. C. Sashittal, “Building Collaborative Cross-Functional New Product Teams,” Academy of Manage- ment Executive (August 1999), pp. 50–63.

63. A. M. Townsend, S. M. DeMarie, and A. R. Hendrickson, “Vir- tual Teams’ Technology and the Workplace of the Future,” Academy of Management Executive (August 1998), pp. 17–29.

64. S. A. Furst, M. Reeves, B. Rosen, and R. S. Blackburn, “Man- aging the Life Cycle of Virtual Teams,” Academy of Manage- ment Executive (May 2004), pp. 6–20; L. L. Martins, L. L. Gilson, and M. T. Maynard, “Virtual Teams: What Do We Know and Where Do We Go From Here?” Journal of Manage- ment, Vol. 30, No. 6 (2004), pp. 805–835.

65. C. B. Gibson and J. L. Gibbs, “Unpacking the Concept of Vir- tuality: The Effects of Geographic Dispersion, Electronic De- pendence, Dynamic Structure, and National Diversity on Team Innovation,” Administrative Science Quarterly (September 2006), pp. 451–495.

66. T. D. Golden and J. F. Veiga, “The Impact of Extent of Telecom- muting on Job Satisfaction: Resolving Inconsistent Findings,” Journal of Management (April 2005), pp. 301–318.

67. M. Conlin, “The Easiest Commute of All,” Business Week (De- cember 12, 2005), pp. 78–80.

68. Townsend, DeMarie, and Hendrickson, p. 18. 69. “News,” Bureau of Labor Statistics, U.S. Department of Labor

(January 25, 2008). 70. D. Welsh, “What Goodyear Got from Its Union,” Business Week

(October 20, 2003), pp. 148–149.

71. S. F. Matusik and C. W. L. Hill, “The Utilization of Contingent Work, Knowledge Creation, and Competitive Advantage,” Academy of Management Executive (October 1998), pp. 680–697; W. Mayrhofer and C. Brewster, “European Hu- man Resource Management: Researching Developments Over Time,” in Strategic Human Resource Management, 2nd ed. (Malden, MA: Blackwell Publishing, 2007), pp. 241–269.

72. “Part-time Work,” The Economist (June 24, 2006), p. 112. 73. A. Bernstein, “At UPS, Part-Time Work Is a Full-Time Issue,”

Business Week (June 16, 1997), pp. 88–90. 74. J. Muller, “A Ford Redesign,” Business Week (November 13,

2000), Special Report. 75. O. C. Richard, B. P. S. Murthi, and K. Ismail, “The Impact of

Racial Diversity on Intermediate and Long-Term Performance: The Moderating Role of Environmental Context,” Strategic Management Journal (December 2007), pp. 1213–1233; G. Colvin, “The 50 Best Companies for Asians, Blacks, and Hispanics,” Fortune (July 19, 1999), pp. 53–58.

76. V. Singh and S. Point, “Strategic Responses by European Com- panies to the Diversity Challenge: An Online Comparison,” Long Range Planning (August 2004), pp. 295–318.

77. Singh and Point, p. 310. 78. J. Bachman, “Coke to Pay $192.5 Million to Settle Lawsuit,”

The (Ames) Tribune (November 20, 2000), p. D4. 79. O. Gottschalg and M. Zollo, “Interest Alignment and Competi-

tive Advantage,” Academy of Management Review (April 2007), pp. 418–437.

80. J. Lee and D. Miller, “People Matter: Commitment to Employ- ees, Strategy, and Performance in Korean Firms,” Strategic Management Journal (June 1999), pp. 579–593.

81. A. Cortese, “Here Comes the Intranet,” Business Week (Febru- ary 26, 1996), p. 76.

82. D. Bartholomew, “Blue-Collar Computing,” Information Week (June 19, 1995), pp. 34–43.

83. J. Bughin, J. Manyika, A. Miller, and M. Cjhui, “Building the Web 2.0 Enterprise,” McKinsey Quarterly Online (July 2008); J. Bughin, M. Chui, and B. Johnson, “The Next Step in Open Innovation,” McKinsey Quarterly Online (June 2008), pp. 1–8.

84. C. C. Poirier, Advanced Supply Chain Management (San Fran- cisco: Berrett-Koehler Publishers, 1999), p. 2.

85. J. H. Dyer and N. W. Hatch, “Relation-Specific Capabilities and Barriers to Knowledge Transfers: Creating Advantage through Network Relationships,” Strategic Management Journal (Au- gust 2006), pp. 701–719.

86. D. Paulonis and S. Norton, “Managing Global Supply Chains,” McKinsey Quarterly Online (August 2008).

87. M. Cook and R. Hagey, “Why Companies Flunk Supply-Chain 101: Only 33 Percent Correctly Measure Supply-Chain Perfor- mance; Few Use the Right Incentives,” Journal of Business Strategy, Vol. 24, No. 4 (2003), pp. 35–42.

88. C. C. Poirer, pp. 3–5. For further information on RFID technol- ogy, see F. Taghaboni-Dutta and B. Velthouse, “RFID Technol- ogy is Revolutionary: Who Should Be Involved in This Game of Tag?” Academy of Management Perspectives (November 2006), pp. 65–78.

89. M. Arndt, “Everything Old Is New Again,” Business Week (Sep- tember 25, 2006), pp. 64–70.

90. R. Farzad, “Cash for Trash,” Business Week (August 4, 2008), pp. 36–46.

170 PA RT 2 Scanning the Environment

Ending Case for Part Two BOEING BETS THE COMPANY

The Boeing Company, a well-known U.S.-based manu- facturer of commercial and military aircraft, faced a dilemma in 2004. Long the leader of the global airframe manufacturing industry, Boeing had been slowly losing market share since the 1990s to the European-based Air- bus Industrie—now incorporated as the European Aero- nautic & Space Company (EADS). In December 2001, the EADS board of directors had committed the corpo- ration to an objective it had never before achieved—tak- ing from Boeing the leadership of the commercial aviation industry by building the largest commercial jet plane in the world, the Airbus 380. The A380 would carry 481 passengers in a normal multiple-class seating configuration compared to the 416 passengers carried by Boeing’s 747—400 in a similar seating configura- tion. The A380 would not only fly 621 miles farther than the 747, but it would cost airlines 15%–20% less per passenger to operate. With orders for 50 A380 aircraft in hand, the EADS board announced that the new plane would be ready for delivery during 2006. The proposed A380 program decimated the sales of Boeing’s jumbo jet. Since 2000, airlines had ordered only 10 Boeing 747s configured for passengers.

Boeing was clearly a company in difficulty in 2004. Distracted by the 1996 acquisitions of McDonnell Douglas and Rockwell Aerospace, Boeing’s top man- agement had spent the next few years strengthening the corporation’s historically weak position in aerospace and defense and had allowed its traditional competency in commercial aviation to deteriorate. Boeing, once the manufacturing marvel of the world, was now spending 10%–20% more than EADS (Airbus) to build a plane. The prices it asked for its planes were thus also higher. As a result, Boeing’s estimated market share of the com- mercial market slid from nearly 70% in 1996 to less than half that by the end of 2003. EADS claimed to have de- livered 300 aircraft to Boeing’s 285 and to have won 56% of the 396 orders placed by airlines in 2003—quite an improvement from 1994, when EADS controlled only one-fifth of the market! This was quite an

accomplishment, given that the A380 was so large that the modifications needed to accommodate it at airports would cost $80 to $100 million.

Even though defense sales now accounted for more than half of the company’s revenues, Boeing’s CEO re- alized that he needed to quickly act to regain Boeing’s leadership of the commercial part of the industry. In December 2003, the board approved the strategic deci- sion to promote a new commercial airplane, the Boeing 787, for sale to airlines. The 787 was a midrange air- craft, not a jumbo jet such as the A380. The 787 would carry between 220 and 250 passengers but consume 20% less fuel and be 10% cheaper to operate than its competitor, EADS’ current midrange plane, the smaller wide-body A330-200. It was to be made from a graphite/ epoxy resin instead of aluminum. It was designed to fly faster, higher, farther, cleaner, more quietly, and more efficiently than any other medium-sized jet. This was the first time since approving the 777 jet in 1990 that the company had launched an all-new plane program. De- velopment costs were estimated at $8 billion over five years. Depending on the results of these sales efforts, the board would decide sometime during 2004 to either be- gin or cancel the 787 construction program. If approved, the planes could be delivered in 2008—two years after the delivery of the A380.

The Boeing 787 decision was based on a completely different set of assumptions from those used by the EADS board to approve the A380. EADS top management be- lieved that the commercial market wanted even larger jumbo jets to travel long international routes. Airports in Asia, the Middle East, and Europe were becoming heavily congested. In these locations, the “hub-and-spoke” method of creating major airline hubs was flourishing. Using larger planes was a way of dealing with that con- gestion by flying more passengers per plane out of these hubs. EADS management believed that over the next 20 years, airlines and freight carriers would need a mini- mum of 1,500 more aircraft at least as big as the B747. EADS management had concluded that the key to con- trolling the future commercial market was by using larger, more expensive planes. The A380 was a very large bet on that future scenario. The A380 program would cost EADS almost $13 million before the first plane was delivered.

In contrast, Boeing’s management believed in a very different future scenario. Noting the success of Southwest and JetBlue, among other airlines in North America, it con- cluded that no more than 320 extra-large planes would be

This case was written by J. David Hunger for Strategic Management and Business Policy, 12th edition and for Concepts in Strategic Management and Business Policy, 12th edition. Copyright © 2008 by J. David Hunger. Reprinted by permission. References available upon request.

C H A P T E R 5 Internal Scanning: Organizational Analysis 171

sold in the future as the airline industry moved away from hub-and-spoke networks toward more direct flights be- tween smaller airports. The fragmentation of the airline in- dustry, with its emphasis on competing through lower costs was the primary rationale for Boeing’s fuel-efficient 787. A secondary reason was to deal with increasing passenger complaints about shrinking legroom and seat room on current planes flown by cost-conscious airlines. The 787 was designed with larger windows, seats, lava- tories, and overhead bins. The plane was being designed in both short- and long-range versions. Boeing’s manage- ment predicted a market for 2,000 to 3,000 such planes. Additional support for the midrange plane came from some industry analysts who predicted that the huge A380 would give new meaning to the term “cattle class.” To reach necessary economies of scale, the A380 would likely devote a large portion of both of its decks to econ- omy class, with passengers sitting three or four across, the same configuration as most of Boeing’s 747s.

Boeing’s strategy to regain industry leadership with its proposed 787 airplane meant that the company would have to increase its manufacturing efficiency in order to keep the price low. To significantly cut costs, management would be forced to implement a series of new programs:

� Outsource approximately 70% of manufacturing. Could it find suppliers who could consistently make the high-quality parts needed by Boeing?

� Reduce final assembly time to three days (compared to 20 for its 737 plane) by having suppliers build completed plane sections. Could this many suppliers meet Boeing’s exacting deadlines?

� Use new, lightweight composite materials in place of aluminum to reduce inspection time. Would the plane be as dependable and as easy to maintain as Boeing’s aluminum airplanes?

� Resolve poor relations with labor unions caused by downsizing and outsourcing. The machinists’ union would have to be given a greater voice in specifying manufacturing procedures. Would Boeing’s middle managers be willing to share power with an antago- nistic union?

Which vision of the future was correct? The long- term fortunes of both Boeing and EADS depended on two contrasting strategic decisions, based on two very different assessments of the market. If EADS was cor- rect, the market would continue to demand ever-larger airplanes. If Boeing was correct, the current wave of jumbo jets had crested, and a new wave of fuel-saving midrange jets would soon replace them. Which com- pany’s strategy had the best chance of succeeding?

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P A R T3

Strategy

Formulation

Midamar Corporation is a family-owned company in Cedar Rapids, Iowa, that

has carved out a growing niche for itself in the world food industry: supply-

ing food prepared according to strict religious standards. The company specializes

in halal foods, which are produced and processed according to Islamic law for sale

to Muslims. Why did it focus on this one type of food? According to owner-founder

Bill Aossey, “It’s a big world, and you can only specialize in so many places.”

Although halal foods are not as widely known as kosher foods (processed according to

Judaic law), their market is growing along with Islam, the world’s fastest-growing religion.

Midamar purchases halal-certified meat from Midwestern companies certified to conduct halal

processing. Certification requires practicing Muslims schooled in halal processing to slaughter

the livestock and to oversee meat and poultry processing.

Aossey is a practicing Muslim who did not imagine such a vast market when he founded his

business in 1974. “People thought it would be a passing fad,” remarked Aossey. The company has

grown to the point where it now exports halal-certified beef, lamb, and poultry to hotels, restau-

rants, and distributors in 30 countries throughout Asia, Africa, Europe, and North America. Its cus-

tomers include McDonald’s, Pizza Hut, and KFC. McDonald’s, for example, uses Midamar’s turkey

strips as a bacon-alternative in a breakfast product in Singapore.1

Midamar is successful because its chief executive formulated a strategy designed to give it

an advantage in a very competitive industry. It is an example of a differentiation focus compet-

itive strategy in which a company focuses on a particular target market to provide a differenti-

ated product or service. This strategy is one of the business competitive strategies discussed in

this chapter.

strategy formulation: situation analysis and Business Strategy

C H A P T E R 6

175

Gathering Information

Putting Strategy into Action

Monitoring Performance

Societal Environment: General forces

Natural Environment: Resources and

climate

Task Environment:

Industry analysis

Internal: Strengths and Weaknesses

Structure: Chain of command

Culture: Beliefs, expectations,

values

Resources: Assets, skills, competencies,

knowledge

Programs

Activities needed to accomplish a plan

Budgets

Cost of the programs Procedures

Sequence of steps needed to do the job

Performance

Actual results

External: Opportunities

and Threats

Developing Long-range Plans

Mission

Reason for existence Objectives

What results to accomplish by when

Strategies

Plan to achieve the mission & objectives

Policies

Broad guidelines for decision making

Environmental Scanning:

Strategy Formulation:

Strategy Implementation:

Evaluation and Control:

Feedback/Learning: Make corrections as needed

� Organize environmental and organizational information using SWOT analysis and a SFAS matrix

� Generate strategic options by using the TOWS matrix

� Understand the competitive and cooperative strategies available to corporations

� List the competitive tactics that would accompany competitive strategies

� Identify the basic types of strategic alliances

Learning Objectives After reading this chapter, you should be able to:

176 PA RT 3 Strategy Formulation

Strategy formulation, often referred to as strategic planning or long-range planning, is con- cerned with developing a corporation’s mission, objectives, strategies, and policies. It begins with situation analysis: the process of finding a strategic fit between external opportunities and internal strengths while working around external threats and internal weaknesses. As shown in the Strategic Decision-Making Process in Figure 1–5, step 5(a) is analyzing strategic factors in light of the current situation using SWOT analysis. SWOT is an acronym used to describe the particular Strengths, Weaknesses, Opportunities, and Threats that are strategic factors for a spe- cific company. SWOT analysis should not only result in the identification of a corporation’s dis- tinctive competencies—the particular capabilities and resources that a firm possesses and the superior way in which they are used—but also in the identification of opportunities that the firm is not currently able to take advantage of due to a lack of appropriate resources. Over the years, SWOT analysis has proven to be the most enduring analytical technique used in strategic man- agement. For example, in a 2007 McKinsey & Company global survey of 2,700 executives, 82% of the executives stated that the most relevant activities for strategy formulation were eval- uating the strengths and weaknesses of the organization and identifying top environmental trends affecting business unit performance over the next three to five years.2 A 2005 survey of competitive intelligence professionals found that SWOT analysis was used by 82.7% of the re- spondents, the second most frequently used technique, trailing only competitor analysis.3

It can be said that the essence of strategy is opportunity divided by capacity.4 An oppor- tunity by itself has no real value unless a company has the capacity (i.e., resources) to take ad- vantage of that opportunity. This approach, however, considers only opportunities and strengths when considering alternative strategies. By itself, a distinctive competency in a key resource or capability is no guarantee of competitive advantage. Weaknesses in other resource areas can prevent a strategy from being successful. SWOT can thus be used to take a broader view of strategy through the formula SA � O/(S – W) that is, (Strategic Alternative equals Op- portunity divided by Strengths minus Weaknesses). This reflects an important issue strategic managers face: Should we invest more in our strengths to make them even stronger (a distinc- tive competence) or should we invest in our weaknesses to at least make them competitive?

SWOT analysis, by itself, is not a panacea. Some of the primary criticisms of SWOT analysis are:

� It generates lengthy lists.

� It uses no weights to reflect priorities.

� It uses ambiguous words and phrases.

� The same factor can be placed in two categories (e.g., a strength may also be a weakness).

� There is no obligation to verify opinions with data or analysis.

� It requires only a single level of analysis.

� There is no logical link to strategy implementation.5

GENERATING A STRATEGIC FACTORS ANALYSIS SUMMARY (SFAS) MATRIX The EFAS and IFAS Tables plus the SFAS Matrix have been developed to deal with the criti- cisms of SWOT analysis. When used together, they are a powerful analytical set of tools for strategic analysis. The SFAS (Strategic Factors Analysis Summary) Matrix summarizes an organization’s strategic factors by combining the external factors from the EFAS Table with

6.1 Situational Analysis: SWOT Analysis

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 177

the internal factors from the IFAS Table. The EFAS and IFAS examples given of Maytag Cor- poration (as it was in 1995) in Tables 4–5 and 5–2 list a total of 20 internal and external fac- tors. These are too many factors for most people to use in strategy formulation. The SFAS Matrix requires a strategic decision maker to condense these strengths, weaknesses, opportu- nities, and threats into fewer than 10 strategic factors. This is done by reviewing and revising the weight given each factor. The revised weights reflect the priority of each factor as a deter- minant of the company’s future success. The highest-weighted EFAS and IFAS factors should appear in the SFAS Matrix.

As shown in Figure 6–1, you can create an SFAS Matrix by following these steps:

1. In Column 1 (Strategic Factors), list the most important EFAS and IFAS items. After each factor, indicate whether it is a Strength (S), Weakness (W), an Opportunity (O), or a Threat (T).

2. In Column 2 (Weight), assign weights for all of the internal and external strategic factors. As with the EFAS and IFAS Tables presented earlier, the weight column must total 1.00. This means that the weights calculated earlier for EFAS and IFAS will probably have to be adjusted.

3. In Column 3 (Rating), assign a rating of how the company’s management is responding to each of the strategic factors. These ratings will probably (but not always) be the same as those listed in the EFAS and IFAS Tables.

4. In Column 4 (Weighted Score), multiply the weight in Column 2 for each factor by its rating in Column 3 to obtain the factor’s rated score.

5. In Column 5 (Duration), depicted in Figure 6–1, indicate short-term (less than one year), intermediate-term (one to three years), or long-term (three years and beyond).

6. In Column 6 (Comments), repeat or revise your comments for each strategic factor from the previous EFAS and IFAS Tables. The total weighted score for the average firm in an industry is always 3.0.

The resulting SFAS Matrix is a listing of the firm’s external and internal strategic factors in one table. The example given in Figure 6–1 is for Maytag Corporation in 1995, before the firm sold its European and Australian operations and it was acquired by Whirlpool. The SFAS Matrix includes only the most important factors gathered from environmental scanning and thus provides information that is essential for strategy formulation. The use of EFAS and IFAS Tables together with the SFAS Matrix deals with some of the criticisms of SWOT analysis. For example, the use of the SFAS Matrix reduces the list of factors to a manageable number, puts weights on each factor, and allows one factor to be listed as both a strength and a weak- ness (or as an opportunity and a threat).

FINDING A PROPITIOUS NICHE One desired outcome of analyzing strategic factors is identifying a niche where an organiza- tion can use its core competencies to take advantage of a particular market opportunity. A niche is a need in the marketplace that is currently unsatisfied. The goal is to find a propitious niche—an extremely favorable niche—that is so well suited to the firm’s internal and exter- nal environment that other corporations are not likely to challenge or dislodge it.6 A niche is propitious to the extent that it currently is just large enough for one firm to satisfy its demand. After a firm has found and filled that niche, it is not worth a potential competitor’s time or money to also go after the same niche. Such a niche may also be called a strategic sweet spot

178 PA RT 3 Strategy Formulation

FIGURE 6–1 Strategic Factor Analysis Summary (SFAS) Matrix

*The most important external and internal factors are identified in the EFAS and IFAS tables as shown here by shading these factors.

Weighted External Strategic Factors Weight Rating Score Comments

1 2 3 4 5

Opportunities O1 Economic integration of

European Community .20 4.1 .82 Acquisition of Hoover O2 Demographics favor quality

appliances .10 5.0 .50 Maytag quality O3 Economic development of Asia .05 1.0 .05 Low Maytag presence O4 Opening of Eastern Europe .05 2.0 .10 Will take time O5 Trend to “Super Stores” .10 1.8 .18 Maytag weak in this channel

Threats T1 Increasing government regulations .10 4.3 .43 Well positioned T2 Strong U.S. competition .10 4.0 .40 Well positioned T3 Whirlpool and Electrolux strong

globally .15 3.0 .45 Hoover weak globally T4 New product advances .05 1.2 .06 Questionable T5 Japanese appliance companies .10 1.6 .16 Only Asian presence is Australia

Total Scores 1.00 3.15

Weighted Internal Strategic Factors Weight Rating Score Comments

1 2 3 4 5

Strengths S1 Quality Maytag culture .15 5.0 .75 Quality key to success S2 Experienced top management .05 4.2 .21 Know appliances S3 Vertical integration .10 3.9 .39 Dedicated factories S4 Employee relations .05 3.0 .15 Good, but deteriorating S5 Hoover’s international orientation .15 2.8 .42 Hoover name in cleaners

Weaknesses W1 Process-oriented R&D .05 2.2 .11 Slow on new products W2 Distribution channels .05 2.0 .10 Superstores replacing small

dealers W3 Financial position .15 2.0 .30 High debt load W4 Global positioning .20 2.1 .42 Hoover weak outside the

United Kingdom and Australia

W5 Manufacturing facilities .05 4.0 .20 Investing now

Total Scores 1.00 3.05

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 179

1 2 3 4 Duration 5 6

I N T E R M E

Strategic Factors (Select the most S D important opportunities/threats H I L from EFAS, Table 4–5 and the most O A O important strengths and weaknesses Weighted R T N from IFAS, Table 5–2) Weight Rating Score T E G Comments

S1 Quality Maytag culture (S) .10 5.0 .50 X Quality key to success S5 Hoover’s international

orientation (S) .10 2.8 .28 X X Name recognition W3 Financial position (W) .10 2.0 .20 X X High debt W4 Global positioning (W) .15 2.2 .33 X X Only in N.A., U.K., and

Australia O1 Economic integration of

European Community (O) .10 4.1 .41 X Acquisition of Hoover O2 Demographics favor quality (O) .10 5.0 .50 X Maytag quality O5 Trend to super stores (O + T) .10 1.8 .18 X Weak in this channel T3 Whirlpool and Electrolux (T) .15 3.0 .45 X Dominate industry T5 Japanese appliance

companies (T) .10 1.6 .16 X Asian presence

Total Scores 1.00 3.01

Notes: 1. List each of the most important factors developed in your IFAS and EFAS Tables in Column 1. 2. Weight each factor from 1.0 (Most Important) to 0.0 (Not Important) in Column 2 based on that factor’s probable impact on the compa-

ny’s strategic position. The total weights must sum to 1.00. 3. Rate each factor from 5.0 (Outstanding) to 1.0 (Poor) in Column 3 based on the company’s response to that factor. 4. Multiply each factor’s weight times its rating to obtain each factor’s weighted score in Column 4. 5. For duration in Column 5, check appropriate column (short term—less than 1 year; intermediate—1 to 3 years; long term—over 3 years). 6. Use Column 6 (comments) for rationale used for each factor.

SOURCE: T.L. Wheelen, J.D. Hunger, “Strategic Factor Analysis Summary (SFAS).” Copyright © 1987, 1988, 1989, 1990, 1991, 1992, 1993, 1994, 1995, 1996 and 2005 by T.L. Wheelen Copyright © 1997 and 2005 by Wheelen and Associates. Reprinted by permission.

(see Figure 6–2)—where a company is able to satisfy customers’ needs in a way that rivals cannot, given the context in which it operates.7

Finding such a niche or sweet spot is not always easy. A firm’s management must be al- ways looking for a strategic window—that is, a unique market opportunity that is available only for a particular time. The first firm through a strategic window can occupy a propitious niche and discourage competition (if the firm has the required internal strengths). One com- pany that successfully found a propitious niche was Frank J. Zamboni & Company, the man- ufacturer of the machines that smooth the ice at ice skating rinks. Frank Zamboni invented the

180 PA RT 3 Strategy Formulation

The Strategic Sweet Spot

The strategic sweet spot of a company

is where it meets customers’ needs in

a way that rivals can’t, given the context

in which it competes.

COMPANY’S capabilities

CONTEXT (technology, industry,

demographics, regulation, and so on)

COMPETITORS’ offerings

CUSTOMERS’ needs

SWEET SPOT

FIGURE 6–2 The Strategic

Sweet Spot

unique tractor-like machine in 1949 and no one has found a substitute for what it does. Before the machine was invented, people had to clean and scrape the ice by hand to prepare the sur- face for skating. Now hockey fans look forward to intermissions just to watch “the Zamboni” slowly drive up and down the ice rink, turning rough, scraped ice into a smooth mirror surface—almost like magic. So long as Zamboni’s company was able to produce the ma- chines in the quantity and quality desired, at a reasonable price, it was not worth another com- pany’s while to go after Frank Zamboni & Company’s propitious niche.

As a niche grows, so can a company within that niche—by increasing its operations’ ca- pacity or through alliances with larger firms. The key is to identify a market opportunity in which the first firm to reach that market segment can obtain and keep dominant market share. For example, Church & Dwight was the first company in the United States to successfully mar- ket sodium bicarbonate for use in cooking. Its Arm & Hammer brand baking soda is still found in 95% of all U.S. households. The propitious niche concept is crucial to the software indus- try. Small initial demand in emerging markets allows new entrepreneurial ventures to go after niches too small to be noticed by established companies. When Microsoft developed its first disk operating system (DOS) in 1980 for IBM’s personal computers, for example, the demand for such open systems software was very small—a small niche for a then very small Microsoft. The company was able to fill that niche and to successfully grow with it.

Niches can also change—sometimes faster than a firm can adapt to that change. A com- pany’s management may discover in their situation analysis that they need to invest heavily in the firm’s capabilities to keep them competitively strong in a changing niche. South African

SOURCE: D. J. Collis and M. G. Rukstad, “Can You Say What Your Strategy Is?” Reprinted by permission of Harvard Business Review. ‘The Strategic Sweet Spot’ from “Can You Say What Strategy is?” by D. J. Collis & M. G. Rukstad April 2008. Copyright © 2008 by the Harvard Business School Publishing Corporation. All rights reserved.

Out of 50 beers drunk by South Africans, 49 are

brewed by South African Breweries (SAB). Founded

more than a century ago, SAB controlled most of the local beer mar-

ket by 1950 with brands such as Castle and Lion. When the government repealed the ban on the sale of alcohol to blacks in the 1960s, SAB and other brewers competed for the rapidly growing market. SAB fought successfully to re- tain its dominance of the market. With the end of apartheid, foreign brewers have been tempted to break SAB’s near-monopoly but have been deterred by the entry barriers SAB has erected:

Entry Barrier #1: Every year for the past two decades SAB has reduced its prices. The “real” (adjusted for inflation) price of its beer is now half what it was during the 1970s. SAB has been able to achieve this through a continuous emphasis on productivity improvements— boosting production while cutting the workforce al- most in half. Keeping prices low has been key to SAB’s avoiding charges of abusing its monopoly.

Entry Barrier #2: In South Africa’s poor and rural areas, roads are rough, and electricity is undependable. SAB has long experience in transporting crates to remote vil- lages along bad roads and making sure that distributors have refrigerators (and electricity generators if needed). Many of its distributors are former employees who have

Breweries (SAB), for example, took this approach when management realized that the only way to keep competitors out of its market was to continuously invest in increased productiv- ity and infrastructure in order to keep its prices very low. See the Global Issue feature to see how SAB was able to successfully defend its market niche during significant changes in its environment.

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 181

GLOBAL issue SAB DEFENDS ITS PROPITIOUS NICHE

been helped by the company to start their own truck- ing businesses.

Entry Barrier #3: Most of the beer sold in South Africa is sold through unlicensed pubs called shebeens—most of which date back to apartheid, when blacks were not al- lowed licenses. Although the current government of South Africa would be pleased to grant pub licenses to blacks, the shebeen owners don’t want them. They en- joy not paying any taxes. SAB cannot sell directly to the shebeens, but it does so indirectly through wholesalers. The government, in turn, ignores the situation, prefer- ring that people drink SAB beer than potentially deadly moonshine.

To break into South Africa, a new entrant would have to build large breweries and a substantial distribution net- work. SAB would, in turn, probably reduce its prices still further to defend its market. The difficulties of operating in South Africa are too great, the market is growing too slowly, and (given SAB’s low cost position) the likely profit margin is too low to justify entering the market. Some for- eign brewers, such as Heineken, would rather use SAB to distribute their products throughout South Africa. With its home market secure, SAB purchased Miller Brewing to se- cure a strong presence in North America.

SOURCE: Summarized from “Big Lion, Small Cage,” The Economist (August 12, 2000), p. 56, and other sources.

6.2 Review of Mission and Objectives A reexamination of an organization’s current mission and objectives must be made before al- ternative strategies can be generated and evaluated. Even when formulating strategy, decision makers tend to concentrate on the alternatives—the action possibilities—rather than on a mis- sion to be fulfilled and objectives to be achieved. This tendency is so attractive because it is much easier to deal with alternative courses of action that exist right here and now than to re- ally think about what you want to accomplish in the future. The end result is that we often choose strategies that set our objectives for us rather than having our choices incorporate clear objectives and a mission statement.

182 PA RT 3 Strategy Formulation

6.3 Generating Alternative Strategies by Using a TOWS Matrix

Thus far we have discussed how a firm uses SWOT analysis to assess its situation. SWOT can also be used to generate a number of possible alternative strategies. The TOWS Matrix (TOWS is just another way of saying SWOT) illustrates how the external opportunities and threats facing a particular corporation can be matched with that company’s internal strengths and weaknesses to result in four sets of possible strategic alternatives. (See Figure 6–3.) This is a good way to use brainstorming to create alternative strategies that might not otherwise be considered. It forces strategic managers to create various kinds of growth as well as retrench- ment strategies. It can be used to generate corporate as well as business strategies.

INTERNAL FACTORS

(IFAS) EXTERNAL FACTORS (EFAS)

Strengths (S) Weaknesses (W)

Opportunities (O)

Threats (T)

SO Strategies WO Strategies

ST Strategies

List 5 – 10 internal strengths here

List 5 – 10 internal weaknesses here

List 5 – 10 external opportunities here

List 5 – 10 external threats here

Generate strategies here that use strengths to take advantage of opportunities

Generate strategies here that use strengths to avoid threats

Generate strategies here that minimize weaknesses and avoid threats

Generate strategies here that take advantage of opportunities by overcoming weaknesses

WT Strategies

FIGURE 6–3 TOWS Matrix

Problems in performance can derive from an inappropriate statement of mission, which may be too narrow or too broad. If the mission does not provide a common thread (a unify- ing theme) for a corporation’s businesses, managers may be unclear about where the company is heading. Objectives and strategies might be in conflict with each other. Divisions might be competing against one another rather than against outside competition—to the detriment of the corporation as a whole.

A company’s objectives can also be inappropriately stated. They can either focus too much on short-term operational goals or be so general that they provide little real guidance. There may be a gap between planned and achieved objectives. When such a gap occurs, either the strategies have to be changed to improve performance or the objectives need to be adjusted downward to be more realistic. Consequently, objectives should be constantly reviewed to ensure their useful- ness. This is what happened at Boeing when management decided to change its primary objec- tive from being the largest in the industry to being the most profitable. This had a significant effect on its strategies and policies. Following its new objective, the company cancelled its pol- icy of competing with Airbus on price and abandoned its commitment to maintaining a manu- facturing capacity that could produce more than half a peak year’s demand for airplanes.8

SOURCE: Reprinted from Long-Range Planning, Vol. 15, No. 2, 1982, Weihrich “The TOWS Matrix—A Tool For Situational Analysis,” p. 60. Copyright © 1982 with permission of Elsevier.

To generate a TOWS Matrix for Maytag Corporation in 1995, for example, use the Exter- nal Factor Analysis Summary (EFAS) Table listed in Table 4–5 from Chapter 4 and the In- ternal Factor Analysis Summary (IFAS) Table listed in Table 5–2 from Chapter 5. To build Figure 6–4, take the following steps:

1. In the Opportunities (O) block, list the external opportunities available in the company’s or business unit’s current and future environment from the EFAS Table (Table 4–5).

2. In the Threats (T) block, list the external threats facing the company or unit now and in the future from the EFAS Table (Table 4–5).

3. In the Strengths (S) block, list the specific areas of current and future strength for the company or unit from the IFAS Table (Table 5–2).

4. In the Weaknesses (W) block, list the specific areas of current and future weakness for the company or unit from the IFAS Table (Table 5–2).

5. Generate a series of possible strategies for the company or business unit under consider- ation based on particular combinations of the four sets of factors: � SO Strategies are generated by thinking of ways in which a company or business unit

could use its strengths to take advantage of opportunities. � ST Strategies consider a company’s or unit’s strengths as a way to avoid threats. � WO Strategies attempt to take advantage of opportunities by overcoming weaknesses. � WT Strategies are basically defensive and primarily act to minimize weaknesses and

avoid threats. The TOWS Matrix is very useful for generating a series of alternatives that the decision

makers of a company or business unit might not otherwise have considered. It can be used for the corporation as a whole (as is done in Figure 6–4 with Maytag Corporation before it sold Hoover Europe), or it can be used for a specific business unit within a corporation (such as Hoover’s floor care products). Nevertheless using a TOWS Matrix is only one of many ways to generate alternative strategies. Another approach is to evaluate each business unit within a corporation in terms of possible competitive and cooperative strategies.

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 183

6.4 Business Strategies Business strategy focuses on improving the competitive position of a company’s or business unit’s products or services within the specific industry or market segment that the company or business unit serves. Business strategy is extremely important because research shows that business unit effects have double the impact on overall company performance than do either corporate or industry effects.9 Business strategy can be competitive (battling against all com- petitors for advantage) and/or cooperative (working with one or more companies to gain ad- vantage against other competitors). Just as corporate strategy asks what industry(ies) the company should be in, business strategy asks how the company or its units should compete or cooperate in each industry.

PORTER’S COMPETITIVE STRATEGIES Competitive strategy raises the following questions:

� Should we compete on the basis of lower cost (and thus price), or should we differentiate our products or services on some basis other than cost, such as quality or service?

184 PA RT 3 Strategy Formulation

FIGURE 6–4 Generating a TOWS Matrix for Maytag Corporation

*The most important external and internal factors are identified in the EFAS and IFAS Tables as shown here by shading these factors.

Weighted Internal Strategic Factors Weight Rating Score Comments

1 2 3 4 5

Strengths S1 Quality Maytag culture .15 5.0 .75 Quality key to success S2 Experienced top management .05 4.2 .21 Know appliances S3 Vertical integration .10 3.9 .39 Dedicated factories S4 Employee relations .05 3.0 .15 Good, but deteriorating S5 Hoover’s international orientation .15 2.8 .42 Hoover name in cleaners

Weaknesses W1 Process-oriented R&D .05 2.2 .11 Slow on new products W2 Distribution channels .05 2.0 .10 Superstores replacing small

dealers W3 Financial position .15 2.0 .30 High debt load W4 Global positioning .20 2.1 .42 Hoover weak outside the

United Kingdom and Australia

W5 Manufacturing facilities .05 4.0 .20 Investing now

Total Scores 1.00 3.05

Weighted External Strategic Factors Weight Rating Score Comments

1 2 3 4 5

Opportunities O1 Economic integration of

European Community .20 4.1 .82 Acquisition of Hoover O2 Demographics favor quality

appliances .10 5.0 .50 Maytag quality O3 Economic development of Asia .05 1.0 .05 Low Maytag presence O4 Opening of Eastern Europe .05 2.0 .10 Will take time O5 Trend to “Super Stores” .10 1.8 .18 Maytag weak in this channel

Threats T1 Increasing government regulations .10 4.3 .43 Well positioned T2 Strong U.S. competition .10 4.0 .40 Well positioned T3 Whirlpool and Electrolux strong

globally .15 3.0 .45 Hoover weak globally T4 New product advances .05 1.2 .06 Questionable T5 Japanese appliance companies .10 1.6 .16 Only Asian presence is Australia

Total Scores 1.00 3.15

Internal Factors (IFAS Table 5–2)

Strengths (S) Weaknesses (W)

S1 Quality Maytag culture W1 Process-oriented R&D

External Factors S2 Experienced top management W2 Distribution channels

(EFAS Table 4–5) S3 Vertical integration W3 Financial position S4 Employee relations W4 Global positioning S5 Hoover’s international orientation W5 Manufacturing facilities

Opportunities (O) SO Strategies WO Strategies

O1 Economic integration of • Use worldwide Hoover distribution • Expand Hoover’s presence in European Community channels to sell both Hoover and continental Europe by improving

O2 Demographics favor quality Maytag major appliances. Hoover quality and reducing O3 Economic development of Asia • Find joint venture partners in manufacturing and distribution costs. O4 Opening of Eastern Europe Eastern Europe and Asia. • Emphasize superstore channel for all O5 Trend toward super stores non-Maytag brands.

Threats (T) ST Strategies WT Strategies

T1 Increasing government regulation • Acquire Raytheon’s appliance • Sell off Dixie-Narco Division to T2 Strong U.S. competition business to increase U.S. market reduce debt. T3 Whirlpool and Electrolux share. • Emphasize cost reduction to reduce

positioned for global economy • Merge with a Japanese major home break-even point. T4 New product advances appliance company. • Sell out to Raytheon or a Japanese T5 Japanese appliance companies • Sell off all non-Maytag brands and firm.

strongly defend Maytag’s U.S. niche.

Strengths Weaknesses

O pp

or tu

ni tie

s

Th rea

ts

� Should we compete head to head with our major competitors for the biggest but most sought-after share of the market, or should we focus on a niche in which we can satisfy a less sought-after but also profitable segment of the market?

Michael Porter proposes two “generic” competitive strategies for outperforming other corporations in a particular industry: lower cost and differentiation.10 These strategies are called generic because they can be pursued by any type or size of business firm, even by not- for-profit organizations:

� Lower cost strategy is the ability of a company or a business unit to design, produce, and market a comparable product more efficiently than its competitors.

� Differentiation strategy is the ability of a company to provide unique and superior value to the buyer in terms of product quality, special features, or after-sale service.

Porter further proposes that a firm’s competitive advantage in an industry is determined by its competitive scope, that is, the breadth of the company’s or business unit’s target mar- ket. Before using one of the two generic competitive strategies (lower cost or differentiation), the firm or unit must choose the range of product varieties it will produce, the distribution channels it will employ, the types of buyers it will serve, the geographic areas in which it will sell, and the array of related industries in which it will also compete. This should reflect an understanding of the firm’s unique resources. Simply put, a company or business unit can

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 185

choose a broad target (that is, aim at the middle of the mass market) or a narrow target (that is, aim at a market niche). Combining these two types of target markets with the two compet- itive strategies results in the four variations of generic strategies depicted in Figure 6–5. When the lower-cost and differentiation strategies have a broad mass-market target, they are simply called cost leadership and differentiation. When they are focused on a market niche (narrow target), however, they are called cost focus and differentiation focus. Although re- search does indicate that established firms pursuing broad-scope strategies outperform firms following narrow-scope strategies in terms of ROA (Return on Assets), new entrepreneurial firms have a better chance of surviving if they follow a narrow-scope rather than a broad- scope strategy.11

Cost leadership is a lower-cost competitive strategy that aims at the broad mass market and requires “aggressive construction of efficient-scale facilities, vigorous pursuit of cost re- ductions from experience, tight cost and overhead control, avoidance of marginal customer ac- counts, and cost minimization in areas like R&D, service, sales force, advertising, and so on.”12 Because of its lower costs, the cost leader is able to charge a lower price for its products than its competitors and still make a satisfactory profit. Although it may not necessarily have the lowest costs in the industry, it has lower costs than its competitors. Some companies suc- cessfully following this strategy are Wal-Mart (discount retailing), McDonald’s (fast-food restaurants), Dell (computers), Alamo (rental cars), Aldi (grocery stores), Southwest Airlines, and Timex (watches). Having a lower-cost position also gives a company or business unit a defense against rivals. Its lower costs allow it to continue to earn profits during times of heavy competition. Its high market share means that it will have high bargaining power relative to its suppliers (because it buys in large quantities). Its low price will also serve as a barrier to entry because few new entrants will be able to match the leader’s cost advantage. As a result, cost leaders are likely to earn above-average returns on investment.

Differentiation is aimed at the broad mass market and involves the creation of a product or service that is perceived throughout its industry as unique. The company or business unit may then charge a premium for its product. This specialty can be associated with design or brand im- age, technology, features, a dealer network, or customer service. Differentiation is a viable strat-

186 PA RT 3 Strategy Formulation

Competitive Advantage

Lower Cost Differentiation

N a rr

o w

T a rg

e t

B ro

a d T

a rg

e t

Cost Leadership Differentiation

Cost Focus Differentiation Focus

C o

m p

e ti

ti v e S

c o

p e

FIGURE 6–5 Porter’s Generic

Competitive Strategies

SOURCE: Reprinted with permission of The Free Press, A Division of Simon & Schuster, from THE COMPETITIVE ADVANTAGE OF NATIONS by Michael E. Porter. Copyright © 1990, 1998 by The Free Press. All rights reserved.

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 187

egy for earning above-average returns in a specific business because the resulting brand loyalty lowers customers’ sensitivity to price. Increased costs can usually be passed on to the buyers. Buyer loyalty also serves as an entry barrier; new firms must develop their own distinctive com- petence to differentiate their products in some way in order to compete successfully. Examples of companies that successfully use a differentiation strategy are Walt Disney Productions (en- tertainment), BMW (automobiles), Nike (athletic shoes), Apple Computer (computers and cell phones), and Pacar (trucks). Pacar Inc., for example, charges 10% more for its Kenworth and Peterbilt 10-wheel diesel trucks than does market-leader Chrysler’s Freightliner because of its focus on product quality and a superior dealer experience.13 Research does suggest that a differ- entiation strategy is more likely to generate higher profits than does a low-cost strategy because differentiation creates a better entry barrier. A low-cost strategy is more likely, however, to gen- erate increases in market share.14 For an example of a differentiation strategy based upon envi- ronmental sustainability, see the Environmental Sustainability Issue feature on Patagonia.

Cost focus is a low-cost competitive strategy that focuses on a particular buyer group or geographic market and attempts to serve only this niche, to the exclusion of others. In using cost focus, the company or business unit seeks a cost advantage in its target segment. A good example of this strategy is Potlach Corporation, a manufacturer of toilet tissue. Rather than

Patagonia is a highly re- spected designer and manu-

facturer of outdoor clothing, outdoor gear, footwear, and lug-

gage. Founded by Yvon Chouinard, an avid surfer and out- doorsman, the company reflects his commitment to both quality clothing and sustainable business practices. Since its founding in 1973, Patagonia has grown at a healthy rate and retained an excellent reputation in a highly com- petitive industry. It uses a differentiation competitive strat- egy emphasizing quality, but defines quality in a way differently from most other companies.

Our definition of quality includes a mandate for build- ing products and working with processes that cause the least harm to the environment. We evaluate raw mate- rials, invest in innovative technologies, rigorously police our waste and use a portion (1%) of our sales to sup- port groups working to make a real difference. We ac- knowledge that the wild world we love best is disappearing. That is why those of us who work here share a strong commitment to protecting undomesti- cated lands and waters. We believe in using business to inspire solutions to the environmental crisis.

Patagonia’s Web site includes not only the usual infor- mation about its products lines, but also an environmental section that examines the company’s business practices. Its

PATAGONIA USES SUSTAINABILITY AS DIFFERENTIATION COMPETITIVE STRATEGY

ENVIRONMENTAL sustainability issue

Footprint Chronicles is an interactive mini-site that allows the viewer to track the impact of 10 specific Patagonia prod- ucts from design through delivery. For example, the down sweater page tells how the company uses high-quality goose down from humanely raised geese. The down is min- imally processed and the shell is made of recycled polyester. One problem is that the company had to increase the weight of the shell fabric when it switched to recycled polyester. Another problem is that the zipper is treated with a water repellent that contains perfluorooctanoic acid (PFOA), which has been found to persist in the environ- ment and is not recyclable. The Web page tells that the company is investigating alternatives to the use of PFOA in water repellents and looking for ways to recycle down gar- ments. The page then asks for feedback and gives the viewer the opportunity to see what others are saying.

Chairman Chouinard is proud of his company’s reputa- tion as a “green” company, but also wants the firm to be economically sustainable as well. According to Chouinard, “I look at this company as an experiment to see if we can run it so it’s here 100 years from now and always makes the best-quality stuff.”

SOURCE: S. Hamm, “A Passion for the Plan,” Business Week (Au- gust 21/28, 2006), pp. 92–93 and corporate Web site accessed September 17, 2008, www.patagonia.com.

188 PA RT 3 Strategy Formulation

compete directly against Procter & Gamble’s Charmin, Potlach makes the house brands for Al- bertson’s, Safeway, Jewel, and many other grocery store chains. It matches the quality of the well-known brands, but keeps costs low by eliminating advertising and promotion expenses. As a result, Spokane-based Potlach makes 92% of the private-label bathroom tissue and one- third of all bathroom tissue sold in Western U.S. grocery stores.15

Differentiation focus, like cost focus, concentrates on a particular buyer group, product line segment, or geographic market. This is the strategy successfully followed by Midamar Corporation (distributor of halal foods), Morgan Motor Car Company (a manufacturer of clas- sic British sports cars), Nickelodeon (a cable channel for children), Orphagenix (pharmaceu- ticals), and local ethnic grocery stores. In using differentiation focus, a company or business unit seeks differentiation in a targeted market segment. This strategy is valued by those who believe that a company or a unit that focuses its efforts is better able to serve the special needs of a narrow strategic target more effectively than can its competition. For example, Orpha- genix is a small biotech pharmaceutical company that avoids head-to-head competition with big companies like AstraZenica and Merck by developing “orphan” drugs to target diseases that affect fewer than 200,000 people—diseases such as sickle cell anemia and spinal muscu- lar atrophy that big drug makers are overlooking.16

Risks in Competitive Strategies No one competitive strategy is guaranteed to achieve success, and some companies that have successfully implemented one of Porter’s competitive strategies have found that they could not sustain the strategy. As shown in Table 6–1, each of the generic strategies has risks. For ex- ample, a company following a differentiation strategy must ensure that the higher price it charges for its higher quality is not too far above the price of the competition; otherwise cus- tomers will not see the extra quality as worth the extra cost. This is what is meant in Table 6.1 by the term cost proximity. For years, Deere & Company was the leader in farm machinery until low-cost competitors from India and other developing countries began making low- priced products. Deere responded by building high-tech flexible manufacturing plants using mass-customization to cut its manufacturing costs and using innovation to create differenti- ated products which, although higher-priced, reduced customers’ labor and fuel expenses.17

TABLE 6–1 Risks of Generic Competitive Strategies

Risks of Cost Leadership Risks of Differentiation Risks of Focus

Cost leadership is not sustained: � Competitors imitate. � Technology changes. � Other bases for cost leadership

erode.

Differentiation is not sustained: � Competitors imitate. � Bases for differentiation become

less important to buyers.

The focus strategy is imitated. The target segment becomes structurally unattractive: � Structure erodes. � Demand disappears.

Proximity in differentiation is lost. Cost proximity is lost. Broadly targeted competitors overwhelm the segment: � The segment’s differences from other

segments narrow. � The advantages of a broad line increase.

Cost focusers achieve even lower cost in segments.

Differentiation focusers achieve even greater differentiation in segments.

New focusers subsegment the industry.

SOURCE: Reprinted with permission of The Free Press, a Division of Simon & Schuster, Inc. from COMPETITIVE ADVANTAGE: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1998 by The Free Press. All rights reserved.

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 189

Issues in Competitive Strategies Porter argues that to be successful, a company or business unit must achieve one of the previ- ously mentioned generic competitive strategies. Otherwise, the company or business unit is stuck in the middle of the competitive marketplace with no competitive advantage and is doomed to below-average performance. A classic example of a company that found itself stuck in the middle was K-Mart. The company spent a lot of money trying to imitate both Wal-Mart’s low-cost strategy and Target’s quality differentiation strategy—only to end up in bankruptcy with no clear competitive advantage. Although some studies do support Porter’s argument that companies tend to sort themselves into either lower cost or differentiation strategies and that successful companies emphasize only one strategy,18 other research suggests that some com- bination of the two competitive strategies may also be successful.19

The Toyota and Honda auto companies are often presented as examples of successful firms able to achieve both of these generic competitive strategies. Thanks to advances in tech- nology, a company may be able to design quality into a product or service in such a way that it can achieve both high quality and high market share—thus lowering costs.20 Although Porter agrees that it is possible for a company or a business unit to achieve low cost and differentia- tion simultaneously, he continues to argue that this state is often temporary.21 Porter does ad- mit, however, that many different kinds of potentially profitable competitive strategies exist. Although there is generally room for only one company to successfully pursue the mass- market cost leadership strategy (because it is so dependent on achieving dominant market share), there is room for an almost unlimited number of differentiation and focus strategies (depending on the range of possible desirable features and the number of identifiable market niches). Quality, alone, has eight different dimensions—each with the potential of providing a product with a competitive advantage (see Table 6–2).

Most entrepreneurial ventures follow focus strategies. The successful ones differentiate their product from those of other competitors in the areas of quality and service, and they fo- cus the product on customer needs in a segment of the market, thereby achieving a dominant

TABLE 6–2 1. Performance

2. Features

3. Reliability

4. Conformance

5. Durability

6. Serviceability

7. Aesthetics

8. Perceived Quality

Primary operating characteristics, such as a washing machine’s cleaning ability.

“Bells and whistles,” such as cruise control in a car, that supplement the basic functions.

Probability that the product will continue functioning without any significant maintenance.

Degree to which a product meets standards. When a customer buys a product out of the warehouse, it should perform identically to that viewed on the showroom floor.

Number of years of service a consumer can expect from a product before it significantly deteriorates. Differs from reliability in that a product can be durable but still need a lot of maintenance.

Product’s ease of repair.

How a product looks, feels, sounds, tastes, or smells.

Product’s overall reputation. Especially important if there are no objective, easily used measures of quality.

SOURCE: Reprinted with the permission of The Free Press, A Division of Simon & Schuster, Inc. from MANAGING QUALITY: The Strategic and Competitive Edge by David A. Garvin. Copyright © 1988 by David A. Garvin. All rights reserved.

The Eight Dimensions of Quality

190 PA RT 3 Strategy Formulation

share of that part of the market. Adopting guerrilla warfare tactics, these companies go after opportunities in market niches too small to justify retaliation from the market leaders.

Industry Structure and Competitive Strategy Although each of Porter’s generic competitive strategies may be used in any industry, certain strategies are more likely to succeed than others in some instances. In a fragmented industry, for example, where many small- and medium-sized local companies compete for relatively small shares of the total market, focus strategies will likely predominate. Fragmented indus- tries are typical for products in the early stages of their life cycles. If few economies are to be gained through size, no large firms will emerge and entry barriers will be low—allowing a stream of new entrants into the industry. Chinese restaurants, veterinary care, used-car sales, ethnic grocery stores, and funeral homes are examples. Even though P.F. Chang’s and the Panda Restaurant Group have firmly established themselves as chains in the United States, lo- cal, family-owned restaurants still comprise 87% of Asian casual dining restaurants.22

If a company is able to overcome the limitations of a fragmented market, however, it can reap the benefits of a broadly targeted cost-leadership or differentiation strategy. Until Pizza Hut was able to use advertising to differentiate itself from local competitors, the pizza fast- food business was a fragmented industry composed primarily of locally owned pizza parlors, each with its own distinctive product and service offering. Subsequently Domino’s used the cost-leader strategy to achieve U.S. national market share.

As an industry matures, fragmentation is overcome, and the industry tends to become a consolidated industry dominated by a few large companies. Although many industries start out being fragmented, battles for market share and creative attempts to overcome local or niche market boundaries often increase the market share of a few companies. After product standards become established for minimum quality and features, competition shifts to a greater empha- sis on cost and service. Slower growth, overcapacity, and knowledgeable buyers combine to put a premium on a firm’s ability to achieve cost leadership or differentiation along the dimen- sions most desired by the market. R&D shifts from product to process improvements. Overall product quality improves, and costs are reduced significantly.

The strategic rollup was developed in the mid-1990s as an efficient way to quickly consoli- date a fragmented industry. With the aid of money from venture capitalists, an entrepreneur ac- quires hundreds of owner-operated small businesses. The resulting large firm creates economies of scale by building regional or national brands, applies best practices across all aspects of mar- keting and operations, and hires more sophisticated managers than the small businesses could pre- viously afford. Rollups differ from conventional mergers and acquisitions in three ways: (1) they involve large numbers of firms, (2) the acquired firms are typically owner operated, and (3) the objective is not to gain incremental advantage, but to reinvent an entire industry.23 Rollups are cur- rently under way in the funeral industry led by Service Corporation International, Stewart Enter- prises, and the Loewen Group; and in the veterinary care industries by VCA (Veterinary Centers of America ) Antech Inc. Of the 22,000 pet hospitals in the U.S., VCA Antech had acquired 465 by July 2008 with plans to continue acquisitions for the foreseeable future.24

Once consolidated, an industry has become one in which cost leadership and differentia- tion tend to be combined to various degrees, even though one competitive strategy may be pri- marily emphasized. A firm can no longer gain and keep high market share simply through low price. The buyers are more sophisticated and demand a certain minimum level of quality for price paid. For example, low-cost office supplies retailer Staples introduced in 2007 a line of premium office supplies called “My Style, My Way” in order to halt sliding sales.25 Even Mc- Donald’s, long the leader in low-cost fast-food restaurants, has been forced to add healthier and more upscale food items, such as Asian chicken salad, comfortable chairs, and Wi-Fi In- ternet access in order to keep its increasingly sophisticated customer base.26 The same is true for firms emphasizing high quality. Either the quality must be high enough and valued by the

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 191

customer enough to justify the higher price or the price must be dropped (through lowering costs) to compete effectively with the lower priced products. Hewlett-Packard, for example, spent years restructuring its computer business in order to cut Dell’s cost advantage from 20% to just 10%.27 Consolidation is taking place worldwide in the automobile, airline, computer, and home appliance industries.

Hypercompetition and Competitive Advantage Sustainability Some firms are able to sustain their competitive advantage for many years,28 but most find that competitive advantage erodes over time. In his book Hypercompetition, D’Aveni proposes that it is becoming increasingly difficult to sustain a competitive advantage for very long. “Market stability is threatened by short product life cycles, short product design cycles, new technolo- gies, frequent entry by unexpected outsiders, repositioning by incumbents, and tactical redef- initions of market boundaries as diverse industries merge.”29 Consequently, a company or business unit must constantly work to improve its competitive advantage. It is not enough to be just the lowest-cost competitor. Through continuous improvement programs, competitors are usually working to lower their costs as well. Firms must find new ways not only to reduce costs further but also to add value to the product or service being provided.

The same is true of a firm or unit that is following a differentiation strategy. Maytag Cor- poration, for example, was successful for many years by offering the most reliable brand in North American major home appliances. It was able to charge the highest prices for Maytag brand washing machines. When other competitors improved the quality of their products, how- ever, it became increasingly difficult for customers to justify Maytag’s significantly higher price. Consequently Maytag Corporation was forced not only to add new features to its products but also to reduce costs through improved manufacturing processes so that its prices were no longer out of line with those of the competition. D’Aveni’s theory of hypercompetition is supported by developing research on the importance of building dynamic capabilities to better cope with un- certain environments (discussed previously in Chapter 5 in the resource-based view of the firm).

D’Aveni contends that when industries become hypercompetitive, they tend to go through escalating stages of competition. Firms initially compete on cost and quality, until an abun- dance of high-quality, low-priced goods result. This occurred in the U.S. major home appli- ance industry by 1980. In a second stage of competition, the competitors move into untapped markets. Others usually imitate these moves until the moves become too risky or expensive. This epitomized the major home appliance industry during the 1980s and 1990s, as strong U.S. and European firms like Whirlpool, Electrolux, and Bosch-Siemens established presences in both Europe and the Americas and then moved into Asia. Strong Asian firms like LG and Haier likewise entered Europe and the Americas in the late 1990s.

According to D’Aveni, firms then raise entry barriers to limit competitors. Economies of scale, distribution agreements, and strategic alliances made it all but impossible for a new firm to enter the major home appliance industry by the end of the 20th century. After the established players have entered and consolidated all new markets, the next stage is for the remaining firms to attack and destroy the strongholds of other firms. Maytag’s inability to hold onto its North American stronghold led to its acquisition by Whirlpool in 2006. Eventually, according to D’Aveni, the remaining large global competitors work their way to a situation of perfect competition in which no one has any advantage and profits are minimal.

Before hypercompetition, strategic initiatives provided competitive advantage for many years, perhaps for decades. Except for a few stable industries, this is no longer the case. Ac- cording to D’Aveni, as industries become hypercompetitive, there is no such thing as a sus- tainable competitive advantage. Successful strategic initiatives in this type of industry typically last only months to a few years. According to D’Aveni, the only way a firm in this kind of dynamic industry can sustain any competitive advantage is through a continuous se- ries of multiple short-term initiatives aimed at replacing a firm’s current successful products

192 PA RT 3 Strategy Formulation

with the next generation of products before the competitors can do so. Intel and Microsoft are taking this approach in the hypercompetitive computer industry.

Hypercompetition views competition, in effect, as a distinct series of ocean waves on what used to be a fairly calm stretch of water. As industry competition becomes more intense, the waves grow higher and require more dexterity to handle. Although a strategy is still needed to sail from point A to point B, more turbulent water means that a craft must continually adjust course to suit each new large wave. One danger of D’Aveni’s concept of hypercompetition, however, is that it may lead to an overemphasis on short-term tactics (discussed in the next sec- tion) over long-term strategy. Too much of an orientation on the individual waves of hyper- competition could cause a company to focus too much on short-term temporary advantage and not enough on achieving its long-term objectives through building sustainable competitive ad- vantage. Nevertheless, research supports D’Aveni’s argument that sustained competitive ad- vantage is increasingly a matter not of a single advantage maintained over time, but more a matter of sequencing advantages over time.30

Which Competitive Strategy Is Best? Before selecting one of Porter’s generic competitive strategies for a company or business unit, management should assess its feasibility in terms of company or business unit resources and capabilities. Porter lists some of the commonly required skills and resources, as well as orga- nizational requirements, in Table 6–3.

Competitive Tactics Studies of decision making report that half the decisions made in organizations fail because of poor tactics.31 A tactic is a specific operating plan that details how a strategy is to be imple- mented in terms of when and where it is to be put into action. By their nature, tactics are nar- rower in scope and shorter in time horizon than are strategies. Tactics, therefore, may be viewed

TABLE 6–3 Requirements for Generic Competitive Strategies

Generic Strategy Commonly Required Skills and Resources Common Organizational Requirements

Overall Cost Leadership

� Sustained capital investment and access to capital � Process engineering skills � Intense supervision of labor � Products designed for ease of manufacture � Low-cost distribution system

� Tight cost control � Frequent, detailed control reports � Structured organization and responsibilities � Incentives based on meeting strict

quantitative targets

Differentiation � Strong marketing abilities � Product engineering � Creative flair � Strong capability in basic research � Corporate reputation for quality or technological

leadership � Long tradition in the industry or unique

combination of skills drawn from other businesses � Strong cooperation from channels

� Strong coordination among functions in R&D, product development, and marketing

� Subjective measurement and incentives instead of quantitative measures

� Amenities to attract highly skilled labor, scientists, or creative people

Focus � Combination of the above policies directed at the particular strategic target

� Combination of the above policies directed at the particular strategic target

SOURCE: Reprinted with the permission of The Free Press, a Division of Simon & Schuster, from COMPETITIVE ADVANTAGE: Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980, 1998 by The Free Press. All rights reserved.

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 193

(like policies) as a link between the formulation and implementation of strategy. Some of the tac- tics available to implement competitive strategies are timing tactics and market location tactics.

Timing Tactics: When to Compete A timing tactic deals with when a company implements a strategy. The first company to man- ufacture and sell a new product or service is called the first mover (or pioneer). Some of the advantages of being a first mover are that the company is able to establish a reputation as an industry leader, move down the learning curve to assume the cost-leader position, and earn temporarily high profits from buyers who value the product or service very highly. A success- ful first mover can also set the standard for all subsequent products in the industry. A company that sets the standard “locks in” customers and is then able to offer further products based on that standard.32 Microsoft was able to do this in software with its Windows operating system, and Netscape garnered over an 80% share of the Internet browser market by being first to com- mercialize the product successfully. Research does indicate that moving first or second into a new industry or foreign country results in greater market share and shareholder wealth than does moving later.33 Being first provides a company profit advantages for about 10 years in consumer goods and about 12 years in industrial goods.34 This is true, however, only if the first mover has sufficient resources to both exploit the new market and to defend its position against later arrivals with greater resources.35 Gillette, for example, has been able to keep its leader- ship of the razor category (70% market share) by continuously introducing new products.36

Being a first mover does, however, have its disadvantages. These disadvantages can be, con- versely, advantages enjoyed by late-mover firms. Late movers may be able to imitate the tech- nological advances of others (and thus keep R&D costs low), keep risks down by waiting until a new technological standard or market is established, and take advantage of the first mover’s natural inclination to ignore market segments.37 Research indicates that successful late movers tend to be large firms with considerable resources and related experience.38 Microsoft is one ex- ample. Once Netscape had established itself as the standard for Internet browsers in the 1990s, Microsoft used its huge resources to directly attack Netscape’s position with its Internet Explorer. It did not want Netscape to also set the standard in the developing and highly lucrative intranet market inside corporations. By 2004, Microsoft’s Internet Explorer dominated Web browsers, and Netscape was only a minor presence. Nevertheless, research suggests that the advantages and disadvantages of first and late movers may not always generalize across industries because of differences in entry barriers and the resources of the specific competitors.39

Market Location Tactics: Where to Compete A market location tactic deals with where a company implements a strategy. A company or business unit can implement a competitive strategy either offensively or defensively. An offensive tactic usually takes place in an established competitor’s market location. A defensive tactic usually takes place in the firm’s own current market position as a defense against possi- ble attack by a rival.40

Offensive Tactics. Some of the methods used to attack a competitor’s position are:

� Frontal assault: The attacking firm goes head to head with its competitor. It matches the competitor in every category from price to promotion to distribution channel. To be success- ful, the attacker must have not only superior resources, but also the willingness to persevere. This is generally a very expensive tactic and may serve to awaken a sleeping giant, depress- ing profits for the whole industry. This is what Kimberly-Clark did when it introduced Hug- gies disposable diapers against P&G’s market-leading Pampers. The resulting competitive battle between the two firms depressed Kimberly-Clark’s profits.41

194 PA RT 3 Strategy Formulation

� Flanking maneuver: Rather than going straight for a competitor’s position of strength with a frontal assault, a firm may attack a part of the market where the competitor is weak. Texas Instruments, for example, avoided competing directly with Intel by developing mi- croprocessors for consumer electronics, cell phones, and medical devices instead of com- puters. Taken together, these other applications are worth more in terms of dollars and influence than are computers, where Intel dominates.42

� Bypass attack: Rather than directly attacking the established competitor frontally or on its flanks, a company or business unit may choose to change the rules of the game. This tactic attempts to cut the market out from under the established defender by offering a new type of product that makes the competitor’s product unnecessary. For example, instead of competing directly against Microsoft’s Pocket PC and Palm Pilot for the handheld com- puter market, Apple introduced the iPod as a personal digital music player. It was the most radical change to the way people listen to music since the Sony Walkman. By redefining the market, Apple successfully sidestepped both Intel and Microsoft, leaving them to play “catch-up.”43

� Encirclement: Usually evolving out of a frontal assault or flanking maneuver, encir- clement occurs as an attacking company or unit encircles the competitor’s position in terms of products or markets or both. The encircler has greater product variety (e.g., a complete product line, ranging from low to high price) and/or serves more markets (e.g., it dominates every secondary market). For example, Steinway was a major manufacturer of pianos in the United States until Yamaha entered the market with a broader range of pi- anos, keyboards, and other musical instruments. Although Steinway still dominates con- cert halls, it has only a 2% share of the U.S. market.44 Oracle is using this strategy in its battle against market leader SAP for enterprise resource planning (ERP) software by “sur- rounding” SAP with acquisitions.45

� Guerrilla warfare: Instead of a continual and extensive resource-expensive attack on a competitor, a firm or business unit may choose to “hit and run.” Guerrilla warfare is char- acterized by the use of small, intermittent assaults on different market segments held by the competitor. In this way, a new entrant or small firm can make some gains without se- riously threatening a large, established competitor and evoking some form of retaliation. To be successful, the firm or unit conducting guerrilla warfare must be patient enough to accept small gains and to avoid pushing the established competitor to the point that it must respond or else lose face. Microbreweries, which make beer for sale to local customers, use this tactic against major brewers such as Anheuser-Busch.

Defensive Tactics. According to Porter, defensive tactics aim to lower the probability of attack, divert attacks to less threatening avenues, or lessen the intensity of an attack. Instead of increasing competitive advantage per se, they make a company’s or business unit’s competitive advantage more sustainable by causing a challenger to conclude that an attack is unattractive. These tactics deliberately reduce short-term profitability to ensure long-term profitability:46

� Raise structural barriers. Entry barriers act to block a challenger’s logical avenues of attack. Some of the most important, according to Porter, are to: 1. Offer a full line of products in every profitable market segment to close off any entry

points (for example, Coca Cola offers unprofitable noncarbonated beverages to keep competitors off store shelves);

2. Block channel access by signing exclusive agreements with distributors; 3. Raise buyer switching costs by offering low-cost training to users; 4. Raise the cost of gaining trial users by keeping prices low on items new users are most

likely to purchase;

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 195

5. Increase scale economies to reduce unit costs; 6. Foreclose alternative technologies through patenting or licensing; 7. Limit outside access to facilities and personnel; 8. Tie up suppliers by obtaining exclusive contracts or purchasing key locations; 9. Avoid suppliers that also serve competitors; and

10. Encourage the government to raise barriers, such as safety and pollution standards or favorable trade policies.

� Increase expected retaliation: This tactic is any action that increases the perceived threat of retaliation for an attack. For example, management may strongly defend any erosion of market share by drastically cutting prices or matching a challenger’s promotion through a policy of accepting any price-reduction coupons for a competitor’s product. This coun- terattack is especially important in markets that are very important to the defending com- pany or business unit. For example, when Clorox Company challenged P&G in the detergent market with Clorox Super Detergent, P&G retaliated by test marketing its liq- uid bleach, Lemon Fresh Comet, in an attempt to scare Clorox into retreating from the de- tergent market. Research suggests that retaliating quickly is not as successful in slowing market share loss as a slower, but more concentrated and aggressive response.47

� Lower the inducement for attack: A third type of defensive tactic is to reduce a chal- lenger’s expectations of future profits in the industry. Like Southwest Airlines, a company can deliberately keep prices low and constantly invest in cost-reducing measures. With prices kept very low, there is little profit incentive for a new entrant.48

COOPERATIVE STRATEGIES A company uses competitive strategies and tactics to gain competitive advantage within an industry by battling against other firms. These are not, however, the only business strategy options available to a company or business unit for competing successfully within an industry. A company can also use cooperative strategies to gain competitive advantage within an industry by working with other firms. The two general types of cooperative strategies are collusion and strategic alliances.

Collusion Collusion is the active cooperation of firms within an industry to reduce output and raise prices in order to get around the normal economic law of supply and demand. Collusion may be explicit, in which case firms cooperate through direct communication and negotiation, or tacit, in which case firms cooperate indirectly through an informal system of signals. Explicit collusion is illegal in most countries and in a number of regional trade associations, such as the European Union. For example, Archer Daniels Midland (ADM), the large U.S. agricultural products firm, conspired with its competitors to limit the sales volume and raise the price of the food additive lysine. Executives from three Japanese and South Korean lysine manufac- turers admitted meeting in hotels in major cities throughout the world to form a “lysine trade association.” The three companies were fined more than $20 million by the U.S. federal gov- ernment.49 In another example, Denver-based Qwest signed agreements favoring competitors that agreed not to oppose Qwest’s merger with U.S. West or its entry into the long-distance business in its 14-state region. In one agreement, Qwest agreed to pay McLeodUSA almost $30 million to settle a billing dispute in return for McLeod’s withdrawing its objections to Qwest’s purchase of U.S. West.50

Collusion can also be tacit, in which case there is no direct communication among com- peting firms. According to Barney, tacit collusion in an industry is most likely to be success- ful if (1) there are a small number of identifiable competitors, (2) costs are similar among

196 PA RT 3 Strategy Formulation

firms, (3) one firm tends to act as the price leader, (4) there is a common industry culture that accepts cooperation, (5) sales are characterized by a high frequency of small orders, (6) large inventories and order backlogs are normal ways of dealing with fluctuations in demand, and (7) there are high entry barriers to keep out new competitors.51

Even tacit collusion can, however, be illegal. For example, when General Electric wanted to ease price competition in the steam turbine industry, it widely advertised its prices and publicly committed not to sell below those prices. Customers were even told that if GE reduced turbine prices in the future, it would give customers a refund equal to the price re- duction. GE’s message was not lost on Westinghouse, the major competitor in steam tur- bines. Both prices and profit margins remained stable for the next 10 years in this industry. The U.S. Department of Justice then sued both firms for engaging in “conscious paral- lelism” (following each other’s lead to reduce the level of competition) in order to reduce competition.

Strategic Alliances A strategic alliance is a long-term cooperative arrangement between two or more independent firms or business units that engage in business activities for mutual economic gain.52 Alliances between companies or business units have become a fact of life in modern business. In the U.S. software industry, for example, the percentage of publicly traded firms that engaged in al- liances increased from 32% in 1990 to 95% in 2001. During the same time period, the average number of alliances grew from four to more than 30 per firm.53 Each of the top 500 global busi- ness firms now averages 60 major alliances.54 Some alliances are very short term, only lasting long enough for one partner to establish a beachhead in a new market. Over time, conflicts over objectives and control often develop among the partners. For these and other reasons, around half of all alliances (including international alliances) perform unsatisfactorily.55 Others are more long lasting and may even be preludes to full mergers between companies.

Many alliances do increase profitability of the members and have a positive effect on firm value.56 A study by Cooper & Lybrand found that firms involved in strategic alliances had 11% higher revenue and 20% higher growth rate than did companies not involved in alliances.57

Forming and managing strategic alliances is a capability that is learned over time. Research reveals that the more experience a firm has with strategic alliances, the more likely that its al- liances will be successful.58 (There is some evidence, however, that too much partnering ex- perience with the same partners generates diminishing returns over time and leads to reduced performance.)59 Consequently, leading firms are making investments in building and develop- ing their partnering capabilities.60

Companies or business units may form a strategic alliance for a number of reasons, in- cluding:

1. To obtain or learn new capabilities: For example, General Motors and Chrysler formed an alliance in 2004 to develop new fuel-saving hybrid engines for their automobiles.61 Al- liances are especially useful if the desired knowledge or capability is based on tacit knowledge or on new poorly-understood technology.62 A study found that firms with strategic alliances had more modern manufacturing technologies than did firms without alliances.63

2. To obtain access to specific markets: Rather than buy a foreign company or build brew- eries of its own in other countries, Anheuser-Busch chose to license the right to brew and market Budweiser to other brewers, such as Labatt in Canada, Modelo in Mexico, and Kirin in Japan. As another example, U.S. defense contractors and aircraft manufacturers selling to foreign governments are typically required by these governments to spend a percentage of the contract/purchase value, either by purchasing parts or obtaining sub-contractors, in that

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 197

country. This is often achieved by forming value-chain alliances with foreign companies ei- ther as parts suppliers or as sub-contractors.64 In a survey by the Economist Intelligence Unit, 59% of executives stated that their primary reason for engaging in alliances was the need for fast and low-cost expansion into new markets.65

3. To reduce financial risk: Alliances take less financial resources than do acquisitions or going it alone and are easier to exit if necessary.66 For example, because the costs of de- veloping new large jet airplanes were becoming too high for any one manufacturer, Aerospatiale of France, British Aerospace, Construcciones Aeronáuticas of Spain, and Daimler-Benz Aerospace of Germany formed a joint consortium called Airbus Industrie to design and build such planes. Using alliances with suppliers is a popular means of out- sourcing an expensive activity.

4. To reduce political risk: Forming alliances with local partners is a good way to overcome deficiencies in resources and capabilities when expanding into international markets.67 To gain access to China while ensuring a positive relationship with the often restrictive Chi- nese government, Maytag Corporation formed a joint venture with the Chinese appliance maker, RSD.

Cooperative arrangements between companies and business units fall along a continuum from weak and distant to strong and close. (See Figure 6–6.) The types of alliances range from mutual service consortia to joint ventures and licensing arrangements to value-chain partnerships.68

Mutual Service Consortia. A mutual service consortium is a partnership of similar companies in similar industries that pool their resources to gain a benefit that is too expensive to develop alone, such as access to advanced technology. For example, IBM established a research alliance with Sony Electronics and Toshiba to build its next generation of computer chips. The result was the “cell” chip, a microprocessor running at 256 gigaflops—around ten times the performance of the fastest chips currently used in desktop computers. Referred to as a “supercomputer on a chip,” cell chips were to be used by Sony in its PlayStation 3, by Toshiba in its high-definition televisions, and by IBM in its super computers.69 The mutual service consortia is a fairly weak and distant alliance—appropriate for partners that wish to work together but not share their core competencies. There is very little interaction or communication among the partners.

Joint Venture. A joint venture is a “cooperative business activity, formed by two or more separate organizations for strategic purposes, that creates an independent business entity and allocates ownership, operational responsibilities, and financial risks and rewards to each member, while preserving their separate identity/autonomy.”70 Along with licensing arrangements, joint ventures lie at the midpoint of the continuum and are formed to pursue an

Weak and Distant

Mutual Service Consortia

Joint Venture, Licensing Arrangement

Value-Chain Partnership

Strong and Close

FIGURE 6–6 Continuum of Strategic

Alliances

SOURCE: R.M. Kanter, ‘Continuum of Strategic Alliances’ from “Collaborative Advantage: The Art of Alliances,” July-August 1994. Copyright © 1994 by the Harvard Business School Publishing Corporation. All rights reserved.

198 PA RT 3 Strategy Formulation

opportunity that needs a capability from two or more companies or business units, such as the technology of one and the distribution channels of another.

Joint ventures are the most popular form of strategic alliance. They often occur because the companies involved do not want to or cannot legally merge permanently. Joint ventures provide a way to temporarily combine the different strengths of partners to achieve an outcome of value to all. For example, Proctor & Gamble formed a joint venture with Clorox to produce food-storage wraps. P&G brought its cling-film technology and 20 full-time employees to the venture, while Clorox contributed its bags, containers, and wraps business.71

Extremely popular in international undertakings because of financial and political–legal constraints, forming joint ventures is a convenient way for corporations to work together with- out losing their independence. Around 30% to 55% of international joint ventures include three or more partners.72 Disadvantages of joint ventures include loss of control, lower profits, prob- ability of conflicts with partners, and the likely transfer of technological advantage to the part- ner. Joint ventures are often meant to be temporary, especially by some companies that may view them as a way to rectify a competitive weakness until they can achieve long-term dom- inance in the partnership. Partially for this reason, joint ventures have a high failure rate. Re- search indicates, however, that joint ventures tend to be more successful when both partners have equal ownership in the venture and are mutually dependent on each other for results.73

Licensing Arrangements. A licensing arrangement is an agreement in which the licensing firm grants rights to another firm in another country or market to produce and/or sell a product. The licensee pays compensation to the licensing firm in return for technical expertise. Licensing is an especially useful strategy if the trademark or brand name is well known but the MNC does not have sufficient funds to finance its entering the country directly. For example, Yum! Brands successfully used franchising and licensing to establish its KFC, Pizza Hut, Taco Bell, Long John Silvers, and A&W restaurants throughout the world. In 2007 alone, it opened 471 restaurants in China alone plus 852 more across six continents.74 This strategy also becomes important if the country makes entry via investment either difficult or impossible. The danger always exists, however, that the licensee might develop its competence to the point that it becomes a competitor to the licensing firm. Therefore, a company should never license its distinctive competence, even for some short-run advantage.

Value-Chain Partnerships. A value-chain partnership is a strong and close alliance in which one company or unit forms a long-term arrangement with a key supplier or distributor for mutual advantage. For example, P&G, the maker of Folgers and Millstone coffee, worked with coffee appliance makers Mr. Coffee, Krups, and Hamilton Beach to use technology licensed from Black & Decker to market a pressurized, single-serve coffee-making system called Home Cafe. This was an attempt to reverse declining at-home coffee consumption at a time when coffeehouse sales were rising.75

To improve the quality of parts it purchases, companies in the U.S. auto industry, for ex- ample, have decided to work more closely with fewer suppliers and to involve them more in product design decisions. Activities that had previously been done internally by an automaker are being outsourced to suppliers specializing in those activities. The benefits of such relation- ships do not just accrue to the purchasing firm. Research suggests that suppliers that engage in long-term relationships are more profitable than suppliers with multiple short-term contracts.76

All forms of strategic alliances involve uncertainty. Many issues need to be dealt with when an alliance is initially formed, and others, which emerge later. Many problems revolve around the fact that a firm’s alliance partners may also be its competitors, either immediately or in the future. According to Peter Lorange, an authority in strategy, one thorny issue in any strategic alliance is how to cooperate without giving away the company or business unit’s core

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 199

TABLE 6–4

Strategic Alliance Success Factors

� Have a clear strategic purpose. Integrate the alliance with each partner’s strategy. Ensure that mutual value is created for all partners.

� Find a fitting partner with compatible goals and complementary capabilities. � Identify likely partnering risks and deal with them when the alliance is formed. � Allocate tasks and responsibilities so that each partner can specialize in what it does best. � Create incentives for cooperation to minimize differences in corporate culture or organization fit. � Minimize conflicts among the partners by clarifying objectives and avoiding direct competition

in the marketplace. � In an international alliance, ensure that those managing it have comprehensive cross-cultural

knowledge. � Exchange human resources to maintain communication and trust. Don’t allow individual egos to

dominate. � Operate with long-term time horizons. The expectation of future gains can minimize short-term

conflicts. � Develop multiple joint projects so that any failures are counterbalanced by successes. � Agree on a monitoring process. Share information to build trust and keep projects on target.

Monitor customer responses and service complaints. � Be flexible in terms of willingness to renegotiate the relationship in terms of environmental

changes and new opportunities. � Agree on an exit strategy for when the partners’ objectives are achieved or the alliance is judged

a failure.

SOURCE: Compiled from B. Gomes-Casseres, “Do You Really Have an Alliance Strategy?” Strategy & Leadership (September/October 1998), pp. 6–11; L. Segil, “Strategic Alliances for the 21st Century,” Strategy & Leadership (September/October 1998), pp. 12–16; and A. C. Inkpen and K-Q Li, “Joint Venture Formation: Planning and Knowledge Gathering for Success,” Organizational Dynamics (Spring 1999), pp. 33–47. Inkpen and Li provide a checklist of 17 questions on p. 46.

competence: “Particularly when advanced technology is involved, it can be difficult for part- ners in an alliance to cooperate and openly share strategic know-how, but it is mandatory if the joint venture is to succeed.”77 It is therefore important that a company or business unit that is interested in joining or forming a strategic alliance consider the strategic alliance success fac- tors listed in Table 6–4.

End of Chapter S U M M A R Y Once environmental scanning is completed, situational analysis calls for the integration of this information. SWOT analysis is the most popular method for examining external and in- ternal information. We recommend using the SFAS Matrix as one way to identify a corpo- ration’s strategic factors. Using the TOWS Matrix to identify a propitious niche is one way to develop a sustainable competitive advantage using those strategic factors.

Business strategy is composed of both competitive and cooperative strategy. As the ex- ternal environment becomes more uncertain, an increasing number of corporations are choosing to simultaneously compete and cooperate with their competitors. These firms may cooperate to obtain efficiency in some areas, while each firm simultaneously tries to differentiate itself for competitive purposes. Raymond Noorda, Novell’s founder and

200 PA RT 3 Strategy Formulation

E C O - B I T S � Target became a certified organic produce retailer in

2006 and now offers more than 500 choices of organic certified food. The company reduces waste by giving away 7 million pounds of food annually.

� Home Depot offers more than 2,500 environmentally friendly products, ranging from all-natural insect repel-

lants to front-loading washing machines, specially tagged as Eco Options.

� Vowing to become “carbon neutral” by 2010, Timber- land introduced Green Index tags, which rate its prod- ucts on the use of greenhouse gas emissions, solvents, and organic materials.81

D I S C U S S I O N Q U E S T I O N S 1. What industry forces might cause a propitious niche to

disappear?

2. Is it possible for a company or business unit to follow a cost leadership strategy and a differentiation strategy si- multaneously? Why or why not?

3. Is it possible for a company to have a sustainable com- petitive advantage when its industry becomes hyper- competitive?

4. What are the advantages and disadvantages of being a first mover in an industry? Give some examples of first mover and late mover firms. Were they successful?

5. Why are many strategic alliances temporary?

S T R A T E G I C P R A C T I C E E X E R C I S E Select an industry to analyze. Identify companies for each of Porter’s four competitive strategies. How many different kinds of differentiation strategies can you find?

INDUSTRY: ___________________________________________________________________________________________

Cost Leadership: ________________________________________________________________________________________

Differentiation: _________________________________________________________________________________________

Cost Focus: ____________________________________________________________________________________________

Differentiation Focus: ____________________________________________________________________________________

former CEO, coined the term co-opetition to describe such simultaneous competition and cooperation among firms.78 One example is the collaboration between competitors DHL and UPS in the express delivery market. DHL’s American delivery business was losing money and UPS’ costly airfreight network had excess capacity. Under the terms of a 10- year agreement signed in 2008, UPS carried DHL packages in its American airfreight net- work for a fee. The agreement covered only air freight, leaving both firms free to compete in the rest of the express-parcel business.79 A careful balancing act, co-opetition involves the careful management of alliance partners so that each partner obtains sufficient benefits to keep the alliance together. A long-term view is crucial. An unintended transfer of knowl- edge could be enough to provide one partner a significant competitive advantage over the others.80 Unless that company forebears from using that knowledge against its partners, the alliance will be doomed.

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 201

K E Y T E R M S business strategy (p. 183) collusion (p. 195) common thread (p. 182) competitive scope (p. 185) competitive strategy (p. 183) consolidated industry (p. 190) cooperative strategy (p. 195) cost focus (p. 187) cost leadership (p. 186) differentiation (p. 186)

differentiation focus (p. 188) differentiation strategy (p. 185) first mover (p. 193) fragmented industry (p. 190) joint venture (p. 197) late mover (p. 193) licensing arrangement (p. 198) lower cost strategy (p. 185) market location tactics (p. 193) mutual service consortium (p. 197)

propitious niche (p. 177) SFAS (Strategic Factors Analysis

Summary) Matrix (p. 176) strategic alliance (p. 196) strategy formulation (p. 176) SWOT (p. 176) tactic (p. 192) timing tactic (p. 193) TOWS Matrix (p. 182) value-chain partnership (p. 198)

N O T E S 1. A. Fitzgerald, “Cedar Rapids Export Company Serves Muslims

Worldwide,” Des Moines Register (October 26, 2003), pp. 1M–2M. See also corporate Web site at www.midamar.com.

2. J. Choi, D. Lovallo, and A. Tarasova, “Better Strategy for Busi- ness Units: A McKinsey Global Survey,” McKinsey Quarterly Online (July 2007).

3. D. Fehringer, “Six Steps to Better SWOTs,” Competitive Intel- ligence Magazine (January–February, 2007), p. 54.

4. T. Brown, “The Essence of Strategy,” Management Review (April 1997), pp. 8–13.

5. T. Hill and R. Westbrook, “SWOT Analysis: It’s Time for a Product Recall,” Long Range Planning (February 1997), pp. 46–52.

6. W. H. Newman, “Shaping the Master Strategy of Your Firm,” California Management Review, Vol. 9, No. 3 (1967), pp. 77–88.

7. D. J. Collis and M. G. Rukstad, “Can You Say What Your Strat- egy Is?” Harvard Business Review (April 2008), pp. 82–90.

8. D. J. Collis and M. G. Rukstad, “Can You Say What Your Strat- egy Is?” Harvard Business Review (April 2008), p. 86.

9. V. F. Misangyi, H. Elms, T. Greckhamer, and J. A Lepine, “A New Perspective on a Fundamental Debate: A Multilevel Ap- proach to Industry, Corporate, and Business Unit Effects,” Strategic Management Journal (June 2006), pp. 571–590.

10. M. E. Porter, Competitive Strategy (New York: The Free Press, 1980), pp. 34–41 as revised in M. E. Porter, The Competitive Advantage of Nations (New York: The Free Press, 1990), pp. 37–40.

11. J. O. DeCastro and J. J. Chrisman, “Narrow-Scope Strategies and Firm Performance: An Empirical Investigation,” Journal of Business Strategies (Spring 1998), pp. 1–16; T. M. Stearns, N. M. Carter, P. D. Reynolds, and M. L. Williams, “New Firm Survival: Industry, Strategy, and Location,” Journal of Business Venturing (January 1995), pp. 23–42.

12. Porter, Competitive Strategy (New York: The Free Press, 1980), p. 35.

13. M. Arndt, “Built for the Long Haul,” Business Week (January 30, 2006), p. 66.

14. R. E. Caves, and P. Ghemawat, “Identifying Mobility Barriers,” Strategic Management Journal (January 1992), pp. 1–12.

15. N. K. Geranios, “Potlach Aims to Squeeze Toilet Tissue Lead- ers,” Des Moines Register (October 22, 2003), p. 3D.

16. “Company Targets ‘Orphan Drugs,’” St. Cloud (MN) Times (May 9, 2007), p. 2A.

17. M. Arndt, “Deere’s Revolution on Wheels,” Business Week (July 2, 2007), pp. 78–79.

18. S. Thornhill and R. E. White, “Strategic Purity: A Multi- Industry Evaluation of Pure Vs. Hybrid Business Strategies,” Strategic Management Journal (May 2007), pp. 553–561; M. Delmas, M. V. Russo, and M. J. Montes-Sancho, “Deregu- lation and Environmental Differentiation in the Electric Utility Industry,” Strategic Management Journal (February 2007), pp. 189–209.

19. C. Campbell-Hunt, “What Have We Learned About Generic Competitive Strategy? A Meta Analysis,” Strategic Manage- ment Journal (February 2000), pp. 127–154.

20. M. Kroll, P. Wright, and R. A. Heiens, “The Contribution of Product Quality to Competitive Advantage: Impacts on System- atic Variance and Unexplained Variance in Returns,” Strategic Management Journal (April 1999), pp. 375–384.

21. R. M. Hodgetts, “A Conversation with Michael E. Porter: A ‘Significant Extension’ Toward Operational Improvement and Positioning,” Organizational Dynamics (Summer 1999), pp. 24–33.

22. M. Rushlo, “P. F. Chang’s Plans Succeed Where Others Have Failed,” Des Moines Register (May 18, 2004), pp. 1D, 6D.

23. P. F. Kocourek, S. Y. Chung, and M. G. McKenna, “Strategic Rollups: Overhauling the Multi-Merger Machine,” Strategy � Business (2nd Quarter 2000), pp. 45–53.

24. J. A. Tannenbaum, “Acquisitive Companies Set Out to ‘Roll Up’ Fragmented Industries,” Wall Street Journal (March 3, 1997), pp. A1, A6; 2007 Form 10-K and Quarterly Report (July 2008), VCA Antech, Inc.

25. A. Pressman, “Upwardly Mobile Stationary,” Business Week (March 17, 2008), pp. 60–61.

26. P. Gogoi, “Mickey D’s McMakeover,” Business Week (May 15, 2006), pp. 42–43.

27. N. Kumar, “Strategies to Fight Low-Cost Rivals,” Harvard Business Review (December 2006), pp. 104–112.

28. J. C. Bou and A. Satorra, “The Presistence of Abnormal Returns at Industry and Firm Levels: Evidence from Spain,” Strategic Management Journal (July 2007), pp. 707–722.

29. R. A. D’Aveni, Hypercompetition (New York: The Free Press, 1994), pp. xiii–xiv.

30. R. R. Wiggins and T. W. Ruefli, “Schumpeter’s Ghost: Is Hy- percompetition Making the Best of Times Shorter?” Strategic Management Journal (October 2005), pp. 887–911.

31. P. C. Nutt, “Surprising But True: Half the Decisions in Organi- zations Fail,” Academy of Management Executive (November 1999), pp. 75–90.

32. Some refer to this as the economic concept of “increasing re- turns.” Instead of the curve leveling off when the company reaches a point of diminishing returns when a product saturates a market, the curve continues to go up as the company takes ad- vantage of setting the standard to spin off new products that use the new standard to achieve higher performance than competi- tors. See J. Alley, “The Theory That Made Microsoft,” Fortune (April 29, 1996), pp. 65–66.

33. H. Lee, K. G. Smith, C. M. Grimm and A. Schomburg, “Tim- ing, Order and Durability of New Product Advantages with Im- itation,” Strategic Management Journal (January 2000), pp. 23–30; Y. Pan and P. C. K. Chi, “Financial Performance and Survival of Multinational Corporations in China,” Strategic Management Journal (April 1999), pp. 359–374; R. Makadok, “Can First-Mover and Early-Mover Advantages Be Sustained in an Industry with Low Barriers to Entry/Imitation?” Strategic Management Journal (July 1998), pp. 683–696); B. Mascaren- has, “The Order and Size of Entry into International Markets,” Journal of Business Venturing (July 1997), pp. 287–299.

34. At these respective points, cost disadvantages vis-à-vis later en- trants fully eroded the earlier returns to first movers. See W. Boulding and M. Christen, “Idea—First Mover Disadvan- tage,” Harvard Business Review, Vol. 79, No. 9 (2001), pp. 20–21 as reported by D. J. Ketchen, Jr., C. C. Snow, and V. L. Hoover, “Research on Competitive Dynamics: Recent Ac- complishments and Future Challenges,” Journal of Manage- ment, Vol. 30, No. 6 (2004), pp. 779–804.

35. M. B. Lieberman and D. B. Montgomery, “First-Mover (Dis) Advantages: Retrospective and Link with the Resource-Based View,” Strategic Management Journal (December, 1998), pp. 1111–1125; G. J. Tellis and P. N. Golder, “First to Market, First to Fail? Real Causes of Enduring Market Leadership,” Sloan Management Review (Winter 1996), pp. 65–75.

36. J. Pope, “Schick Entry May Work Industry into a Lather,” Des Moines Register (May 15, 2003), p. 6D.

37. S. K. Ethiraj and D. H. Zhu, “Performance Effects of Imitative Entry,” Strategic Management Journal (August 2008), pp. 797–817; G. Dowell and A. Swaminathan, “Entry Timing, Exploration, and Firm Survival in the Early U.S. Bicycle Indus- try,” Strategic Management Journal (December 2006), pp. 1159–1182. For an in-depth discussion of first and late mover advantages and disadvantages, see D. S. Cho, D. J. Kim, and D. K. Rhee, “Latecomer Strategies: Evidence from the Semiconductor Industry in Japan and Korea,” Organization Science (July–August 1998), pp. 489–505.

38. J. Shamsie, C. Phelps, and J. Kuperman, “Better Late Than Never: A Study of Late Entrants in Household Electrical Equipment,” Strategic Management Journal (January 2004), pp. 69–84.

39. T. S. Schoenecker and A. C. Cooper, “The Role of Firm Re- sources and Organizational Attributes in Determining Entry Timing: A Cross-Industry Study,” Strategic Management Jour- nal (December 1998), pp. 1127–1143.

40. Summarized from various articles by L. Fahey in The Strategic Management Reader, edited by L. Fahey (Englewood Cliffs, NJ: Prentice Hall, 1989), pp. 178–205.

41. M. Boyle, “Dueling Diapers,” Fortune (February 17, 2003), pp. 115–116.

42. C. Edwards, “To See Where Tech Is Headed, Watch TI,” Business Week (November 6, 2006), p. 74.

43. P. Burrows, “Show Time,” Business Week (February 2, 2004), pp. 56–64.

44. A. Serwer, “Happy Birthday, Steinway,” Fortune (March 17, 2003), pp. 94–97.

45. “Programmed for a Fight,” The Economist (October 20, 2007), p. 85.

46. This information on defensive tactics is summarized from M. E. Porter, Competitive Advantage (New York: The Free Press, 1985), pp. 482–512.

47. H. D. Hopkins, “The Response Strategies of Dominant U.S. Firms to Japanese Challengers,” Journal of Management, Vol. 29, No. 1 (2003), pp. 5–25.

48. For additional information on defensive competitive tactics, see G. Stalk, “Curveball Strategies to Fool the Competition,” Harvard Business Review (September 2006), pp. 115–122.

49. T. M. Burton, “Archer-Daniels Faces a Potential Blow As Three Firms Admit Price-Fixing Plot,” Wall Street Journal (August 28, 1996), pp. A3, A6; R. Henkoff, “The ADM Tale Gets Even Stranger,” Fortune (May 13, 1996), pp. 113–120.

50. B. Gordon, “Qwest Defends Pacts with Competitors,” Des Moines Register (April 30, 2002), p. 1D.

51. Much of the content on cooperative strategies was summarized from J. B. Barney, Gaining and Sustaining Competitive Advan- tage (Reading, MA: Addison-Wesley, 1997), pp. 255–278.

52. A. C. Inkpen and E. W. K. Tsang, “Learning and Strategic Al- liances,” Academy of Management Annals, Vol. 1, edited by J. F. Walsh and A. F. Brief (December 2007), pp. 479–511.

53. D. Lavie, “Alliance Portfolios and Firm Performance: A Study of Value Creation and Appropriation in the U.S. Software In- dustry.” Strategic Management Journal (December 2007), pp. 1187–1212.

54. R. D. Ireland, M. A. Hitt, and D. Vaidyanath, “Alliance Man- agement as a Source of Competitive Advantage,” Journal of Management, Vol. 28, No. 3 (2002), pp. 413–446.

55. S. H. Park and G. R. Ungson, “Interfirm Rivalry and Manage- rial Complexity: A Conceptual Framework of Alliance Failure,” Organization Science (January–February 2001), pp. 37–53.; D. C. Hambrick, J. Li, K. Xin, and A. S. Tsui, “Compositional Gaps and Downward Spirals in International Joint Venture Management Groups,” Strategic Management Journal (November 2001), pp. 1033–1053; T. K. Das and B. S. Teng, “Instabilities of Strategic Alliances: An Internal Tensions Per- spective,” Organization Science (January–February 2000), pp. 77–101; J. F. Hennart, D. J. Kim, and M. Zeng, “The Impact of Joint Venture Status on the Longevity of Japanese Stakes in U.S. Manufacturing Affiliates,” Organization Science (May–June 1998), pp. 382–395.

56. N. K. Park, J. M. Mezias, and J. Song, “A Resource-based View of Strategic Alliances and Firm Value in the Electronic Market- place,” Journal of Management, Vol. 30, No. 1 (2004), pp. 7–27; T. Khanna and J. W. Rivkin, “Estimating the Perfor- mance Effects of Business Groups in Emerging Markets,” Strategic Management Journal (January 2001), pp. 45–74; G. Garai, “Leveraging the Rewards of Strategic Alliances,” Journal of Business Strategy (March–April 1999), pp. 40–43.

57. L. Segil, “Strategic Alliances for the 21st Century,” Strategy & Leadership (September/October 1998), pp. 12–16.

202 PA RT 3 Strategy Formulation

C H A P T E R 6 Strategy Formulation: Situation Analysis and Business Strategy 203

58. R. C. Sampson, “Experience Effects and Collaborative Returns in R&D Alliances,” Strategic Management Journal (November 2005), pp. 1009–1031; J. Draulans, A-P deMan, and H. W. Vol- berda, “Building Alliance Capability: Management Techniques for Superior Alliance Performance,” Long Range Planning (April 2003), pp. 151–166; P. Kale, J. H. Dyer, and H. Singh, “Alliance Capability, Stock Market Response, and Long-Term Alliance Success: The Role of the Alliance Function,” Strategic Management Journal (August 2002), pp. 747–767.

59. H. Hoang and F. T. Rothaermel, “The Effect of General and Partner-Specific Alliance Experience on Joint R&D Project Performance,” Academy of Management Journal (April 2005), pp. 332–345; A. Goerzen, “Alliance Networks and Firm Perfor- mance: The Impact of Repeated Partnerships,” Strategic Man- agement Journal (May 2007), pp. 487–509.

60. A. MacCormack and T. Forbath, “Learning the Fine Art of Global Collaboration,” Harvard Business Review (January 2008), pp. 24–26.

61. J. Porretto, “Rival Automakers Team Up to Catch Up,” Des Moines Register (December 14, 2004), pp. 1D–2D.

62. H. Bapuji and M. Crossan, “Knowledge Types and Knowledge Management Strategies,” in Strategic Networks: Learning to Compete, M. Gibbert and T. Durand, eds. (Malden, MA: Black- well Publishing, 2007), pp. 8–25; F. T. Rothaermel and W. Boeker, “Old Technology Meets New Technology: Comple- mentarities, Similarities, and Alliance Formation,” Strategic Management Journal (January 2008), pp. 47–77.

63. M. M. Bear, “How Japanese Partners Help U.S. Manufacturers to Raise Productivity,” Long Range Planning (December 1998), pp. 919–926.

64. According to M. J. Thome of Rockwell Collins in a June 26, 2008, e-mail, these are called “international offsets.”

65. P. Anslinger and J. Jenk, “Creating Successful Alliances,” Journal of Business Strategy, Vol. 25, No. 2 (2004), p. 18.

66. X. Yin and M. Shanley, “Industry Determinants of the ‘Merger Versus Alliance’ Decision,” Academy of Management Review (April 2008), pp. 473–491.

67. J. W. Lu and P. W. Beamish, “The Internationalization and Per- formance of SMEs,” Strategic Management Journal (June–July 2001), pp. 565–586.

68. R. M. Kanter, “Collaborative Advantage: The Art of Alliances,” Harvard Business Review (July–August 1994), pp. 96–108.

69. “The Cell of the New Machine,” The Economist (February 12, 2005), pp. 77–78.

70. R. P. Lynch, The Practical Guide to Joint Ventures and Corpo- rate Alliances (New York: John Wiley and Sons, 1989), p. 7.

71. “Will She, Won’t She? The Economist (August 11, 2007), pp. 61–63.

72. Y Gong, O Shenkar, Y. Luo, and M-K Nyaw, “Do Multiple Par- ents Help or Hinder International Joint Venture Performance? The Mediating Roles of Contract Completeness and Partner Co- operation,” Strategic Management Journal (October 2007), pp. 1021–1034.

73. L. L. Blodgett, “Factors in the Instability of International Joint Ventures: An Event History Analysis,” Strategic Management Journal (September 1992), pp. 475–481; J. Bleeke and D. Ernst, “The Way to Win in Cross-Border Alliances,” Harvard Business Review (November–December 1991), pp. 127–135; J. M. Geringer, “Partner Selection Criteria for De- veloped Country Joint Ventures,” in International Management Behavior, 2nd ed., edited by H. W. Lane and J. J. DiStephano (Boston: PWS-Kent, 1992), pp. 206–216.

74. 2007 Annual Report, Yum! Brands. 75. B. Horovitz, “New Coffee Maker May Jolt Industry,” USA To-

day (February 18, 2004), pp. 1E–2E. 76. K. Z. Andrews, “Manufacturer/Supplier Relationships: The

Supplier Payoff,” Harvard Business Review (September– October 1995), pp. 14–15.

77. P. Lorange, “Black-Box Protection of Your Core Competencies in Strategic Alliances,” in Cooperative Strategies: European Perspectives, edited by P. W. Beamish and J. P. Killing (San Francisco: The New Lexington Press, 1997), pp. 59–99.

78. E. P. Gee, “Co-opetition: The New Market Milieu,” Journal of Healthcare Management, Vol. 45 (2000), pp. 359–363.

79. “Make Love—and War,” The Economist (August 9, 2008), pp. 57–58.

80. D. J. Ketchen, Jr., C. C. Snow, and V. L. Hoover, “Research on Competitive Dynamics: Recent Accomplishments and Future Challenges,” Journal of Management, Vol. 30, No. 6 (2004), pp. 779–804.

81. J. O’Donnell and C. Dugas, “More Retailers Go for Green—the Eco Kind,” USA Today (April 18, 2007), p. 3B.

What is the best way for a company to grow if its primary business is ma-

turing? A study of 1,850 companies by Zook and Allen revealed two conclusions:

First, the most sustained profitable growth occurs when a corporation pushes out

of the boundary around its core business into adjacent businesses. Second, corpo-

rations that consistently outgrow their rivals do so by developing a formula for ex-

panding those boundaries in a predicable, repeatable manner.1

Nike is a classic example of this process. Despite its success in athletic shoes, no one expected

Nike to be successful when it diversified in 1995 from shoes into golf apparel, balls, and equip-

ment. Only a few years later, it was acknowledged to be a major player in the new business. Ac-

cording to researchers Zook and Allen, the key to Nike’s success was a formula for growth that

the company had applied and adapted successfully in a series of entries into sports markets,

from jogging to volleyball to tennis to basketball to soccer and, most recently, to golf. First, Nike

established a leading position in athletic shoes in the target market, in this case, golf shoes. Sec-

ond, Nike launched a clothing line endorsed by the sports’ top athletes—in this case, Tiger

Woods. Third, the company formed new distribution channels and contracts with key suppliers

in the new business. Nike’s reputation as a strong marketer of new products gave it credibility.

Fourth, the company introduced higher-margin equipment into the new market. In the case of

golf clubs, it started with irons and then moved to drivers. Once it had captured a significant

share in the U.S. market, Nike’s next step was global distribution.

Zook and Allen propose that this formula was the reason Nike moved past Reebok in the

sporting goods industry. In 1987, Nike’s operating profits were only $164 million compared to

Reebok’s much larger $309 million. Fifteen years later, Nike’s operating profits had grown to

$1.1 billion while Reebok’s had declined to $247 million.2 Reebok was subsequently acquired by

Adidas in 2005 while Nike went on to generate operating profits of $2.4 billion in 2008.

C H A P T E R 7 strategy formulation: corporate Strategy

205

� Understand the three aspects of corporate strategy

� Apply the directional strategies of growth, stability, and retrenchment

� Understand the differences between vertical and horizontal growth as well as concentric and conglomerate diversification

Learning Objectives

Gathering Information

Putting Strategy into Action

Monitoring Performance

Societal Environment: General forces

Natural Environment: Resources and

climate

Task Environment:

Industry analysis

Internal: Strengths and Weaknesses

Structure: Chain of command

Culture: Beliefs, expectations,

values

Resources: Assets, skills, competencies,

knowledge

Programs

Activities needed to accomplish a plan

Budgets

Cost of the programs Procedures

Sequence of steps needed to do the job

Performance

Actual results

External: Opportunities

and Threats

Developing Long-range Plans

Mission

Reason for existence Objectives

What results to accomplish by when

Strategies

Plan to achieve the mission & objectives

Policies

Broad guidelines for decision making

Environmental Scanning:

Strategy Formulation:

Strategy Implementation:

Evaluation and Control:

Feedback/Learning: Make corrections as needed

After reading this chapter, you should be able to:

� Identify strategic options to enter a foreign country

� Apply portfolio analysis to guide decisions in companies with multiple products and businesses

� Develop a parenting strategy for a multiple-business corporation

206 PA RT 3 Strategy Formulation

7.1 Corporate Strategy The vignette about Nike illustrates the importance of corporate strategy to a firm’s survival and success. Corporate strategy deals with three key issues facing the corporation as a whole:

1. The firm’s overall orientation toward growth, stability, or retrenchment (directional strategy)

2. The industries or markets in which the firm competes through its products and business units (portfolio analysis)

3. The manner in which management coordinates activities and transfers resources and cul- tivates capabilities among product lines and business units (parenting strategy)

Corporate strategy is primarily about the choice of direction for a firm as a whole and the man- agement of its business or product portfolio.3 This is true whether the firm is a small company or a large multinational corporation (MNC). In a large multiple-business company, in particu- lar, corporate strategy is concerned with managing various product lines and business units for maximum value. In this instance, corporate headquarters must play the role of the organizational “parent,” in that it must deal with various product and business unit “children.” Even though each product line or business unit has its own competitive or cooperative strategy that it uses to obtain its own competitive advantage in the marketplace, the corporation must coordinate these different business strategies so that the corporation as a whole succeeds as a “family.”4

Corporate strategy, therefore, includes decisions regarding the flow of financial and other resources to and from a company’s product lines and business units. Through a series of coor- dinating devices, a company transfers skills and capabilities developed in one unit to other units that need such resources. In this way, it attempts to obtain synergy among numerous product lines and business units so that the corporate whole is greater than the sum of its indi- vidual business unit parts.5 All corporations, from the smallest company offering one product in only one industry to the largest conglomerate operating in many industries with many prod- ucts, must at one time or another consider one or more of these issues.

To deal with each of the key issues, this chapter is organized into three parts that examine corporate strategy in terms of directional strategy (orientation toward growth), portfolio analysis (coordination of cash flow among units), and corporate parenting (the building of corporate synergies through resource sharing and development).6

7.2 Directional Strategy Just as every product or business unit must follow a business strategy to improve its compet- itive position, every corporation must decide its orientation toward growth by asking the fol- lowing three questions:

1. Should we expand, cut back, or continue our operations unchanged?

2. Should we concentrate our activities within our current industry, or should we diversify into other industries?

3. If we want to grow and expand nationally and/or globally, should we do so through inter- nal development or through external acquisitions, mergers, or strategic alliances?

GROWTH STRATEGIES

C H A P T E R 7 Strategy Formulation: Corporate Strategy 207

By far the most widely pursued corporate directional strategies are those designed to achieve growth in sales, assets, profits, or some combination. Companies that do business in expand- ing industries must grow to survive. Continuing growth means increasing sales and a chance to take advantage of the experience curve to reduce the per-unit cost of products sold, thereby increasing profits. This cost reduction becomes extremely important if a corporation’s indus- try is growing quickly or consolidating and if competitors are engaging in price wars in at- tempts to increase their shares of the market. Firms that have not reached “critical mass” (that is, gained the necessary economy of large-scale production) face large losses unless they can find and fill a small, but profitable, niche where higher prices can be offset by special product or service features. That is why Oracle acquired PeopleSoft, a rival software firm, in 2005. Al- though still growing, the software industry was maturing around a handful of large firms. Ac- cording to CEO Larry Ellison, Oracle needed to double or even triple in size by buying smaller and weaker rivals if it was to compete with SAP and Microsoft.7 Growth is a popular strategy because larger businesses tend to survive longer than smaller companies due to the greater availability of financial resources, organizational routines, and external ties.8

A corporation can grow internally by expanding its operations both globally and domes- tically, or it can grow externally through mergers, acquisitions, and strategic alliances. A merger is a transaction involving two or more corporations in which stock is exchanged but in which only one corporation survives. Mergers usually occur between firms of somewhat similar size and are usually “friendly.” The resulting firm is likely to have a name derived from its composite firms. One example is the merging of Allied Corporation and Signal Companies

Concentration Vertical Growth Horizontal Growth Diversification Concentric Conglomerate

Pause/Proceed with Caution No Change Profit

Turnaround Captive Company Sell-Out/Divestment Bankruptcy/Liquidation

GROWTH STABILITY RETRENCHMENT FIGURE 7–1 Corporate

Directional Strategies

A corporation’s directional strategy is composed of three general orientations (some- times called grand strategies):

� Growth strategies expand the company’s activities. � Stability strategies make no change to the company’s current activities. � Retrenchment strategies reduce the company’s level of activities.

Having chosen the general orientation (such as growth), a company’s managers can select from several more specific corporate strategies such as concentration within one product line/industry or diversification into other products/industries. (See Figure 7–1.) These strate- gies are useful both to corporations operating in only one industry with one product line and to those operating in many industries with many product lines.

to form Allied Signal. An acquisition is the purchase of a company that is completely absorbed as an operating subsidiary or division of the acquiring corporation. Procter & Gamble’s (P&G’s) purchase of Gillette is an example of a recent acquisition. Acquisitions usually occur between firms of different sizes and can be either friendly or hostile. Hostile acquisitions are often called takeovers.

Growth is a very attractive strategy for two key reasons:

� Growth based on increasing market demand may mask flaws in a company—flaws that would be immediately evident in a stable or declining market. A growing flow of revenue into a highly leveraged corporation can create a large amount of organization slack (un- used resources) that can be used to quickly resolve problems and conflicts between de- partments and divisions. Growth also provides a big cushion for turnaround in case a strategic error is made. Larger firms also have more bargaining power than do small firms and are more likely to obtain support from key stakeholders in case of difficulty.

� A growing firm offers more opportunities for advancement, promotion, and interesting jobs. Growth itself is exciting and ego-enhancing for CEOs. The marketplace and poten- tial investors tend to view a growing corporation as a “winner” or “on the move.” Exec- utive compensation tends to get bigger as an organization increases in size. Large firms are also more difficult to acquire than are smaller ones; thus an executive’s job in a large firm is more secure.

The two basic growth strategies are concentration on the current product line(s) in one industry and diversification into other product lines in other industries.

Concentration If a company’s current product lines have real growth potential, concentration of resources on those product lines makes sense as a strategy for growth. The two basic concentration strate- gies are vertical growth and horizontal growth. Growing firms in a growing industry tend to choose these strategies before they try diversification.

Vertical Growth. Vertical growth can be achieved by taking over a function previously provided by a supplier or by a distributor. The company, in effect, grows by making its own supplies and/or by distributing its own products. This may be done in order to reduce costs, gain control over a scarce resource, guarantee quality of a key input, or obtain access to potential customers. This growth can be achieved either internally by expanding current operations or externally through acquisitions. Henry Ford, for example, used internal company resources to build his River Rouge plant outside Detroit. The manufacturing process was integrated to the point that iron ore entered one end of the long plant, and finished automobiles rolled out the other end, into a huge parking lot. In contrast, Cisco Systems, a maker of Internet hardware, chose the external route to vertical growth by purchasing Scientific-Atlanta Inc., a maker of set-top boxes for television programs and movies-on-demand. This acquisition gave Cisco access to technology for distributing television to living rooms through the Internet.9

Vertical growth results in vertical integration—the degree to which a firm operates ver- tically in multiple locations on an industry’s value chain from extracting raw materials to man- ufacturing to retailing. More specifically, assuming a function previously provided by a supplier is called backward integration (going backward on an industry’s value chain). The purchase of Carroll’s Foods for its hog-growing facilities by Smithfield Foods, the world’s largest pork processor, is an example of backward integration.10 Assuming a function previ- ously provided by a distributor is labeled forward integration (going forward on an industry’s value chain). FedEx, for example, used forward integration when it purchased Kinko’s in order to provide store-front package drop-off and delivery services for the small-business market.11

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C H A P T E R 7 Strategy Formulation: Corporate Strategy 209

Vertical growth is a logical strategy for a corporation or business unit with a strong com- petitive position in a highly attractive industry—especially when technology is predictable and markets are growing.12 To keep and even improve its competitive position, a company may use backward integration to minimize resource acquisition costs and inefficient operations as well as forward integration to gain more control over product distribution. The firm, in effect, builds on its distinctive competence by expanding along the industry’s value chain to gain greater competitive advantage.

Although backward integration is often more profitable than forward integration (because of typical low margins in retailing), it can reduce a corporation’s strategic flexibility. The re- sulting encumbrance of expensive assets that might be hard to sell could create an exit barrier, preventing the corporation from leaving that particular industry. Examples of single-use assets are blast furnaces and breweries. When demand drops in either of these industries (steel or beer), these assets have no alternative use, but continue to cost money in terms of debt pay- ments, property taxes, and security expenses.

Transaction cost economics proposes that vertical integration is more efficient than con- tracting for goods and services in the marketplace when the transaction costs of buying goods on the open market become too great. When highly vertically integrated firms become exces- sively large and bureaucratic, however, the costs of managing the internal transactions may be- come greater than simply purchasing the needed goods externally—thus justifying outsourcing over vertical integration. This is why vertical integration and outsourcing are sit- uation specific. Neither approach is best for all companies in all situations.13 See the Strategy Highlight 7.1 feature on how transaction cost economics helps explain why firms vertically integrate or outsource important activities. Research thus far provides mixed support for the predictions of transaction cost economics.14

Harrigan proposes that a company’s degree of vertical integration can range from total ownership of the value chain needed to make and sell a product to no ownership at all.15 (See Figure 7–2.) Under full integration, a firm internally makes 100% of its key supplies and com- pletely controls its distributors. Large oil companies, such as British Petroleum and Royal Dutch Shell, are fully integrated. They own the oil rigs that pump the oil out of the ground, the ships and pipelines that transport the oil, the refineries that convert the oil to gasoline, and the trucks that deliver the gasoline to company-owned and franchised gas stations. Sherwin-Williams Company, which not only manufacturers paint, but also sells it in its own chain of 3,000 retail stores, is another example of a fully-integrated firm.16 If a corporation does not want the disad- vantages of full vertical integration, it may choose either taper or quasi-integration strategies.

With taper integration (also called concurrent sourcing), a firm internally produces less than half of its own requirements and buys the rest from outside suppliers (backward taper in- tegration).17 In the case of Smithfield Foods, its purchase of Carroll’s allowed it to produce 27% of the hogs it needed to process into pork. In terms of forward taper integration, a firm sells part of its goods through company-owned stores and the rest through general wholesalers. Although Apple had 216 of its own retain stores in 2008, much of the company’s sales continued to be through national chains such as Best Buy and through independent local and regional dealers.

With quasi-integration, a company does not make any of its key supplies but purchases most of its requirements from outside suppliers that are under its partial control (backward

Full Integration

Taper Integration

Quasi- Integration

Long-Term Contract

FIGURE 7–2 Vertical

Integration Continuum

SOURCE: Suggested by K. R. Harrigan, Strategies for Vertical Integration (Lexington, Mass.: Lexington Books, D.C. Health, 1983), pp. 16–21.

Why do corporations use ver- tical growth to permanently

own suppliers or distributors when they could simply purchase in-

dividual items when needed on the open market? Transac- tion cost economics is a branch of institutional economics that attempts to answer this question. Transaction cost eco- nomics proposes that owning resources through vertical growth is more efficient than contracting for goods and services in the marketplace when the transaction costs of buying goods on the open market become too great. Trans- action costs include the basic costs of drafting, negotiating, and safeguarding a market agreement (a contract) as well as the later managerial costs when the agreement is creat- ing problems (goods aren’t being delivered on time or qual- ity is lower than needed), renegotiation costs (e.g., costs of meetings and phone calls), and the costs of settling dis- putes (e.g., lawyers’ fees and court costs).

According to Williamson, three conditions must be met before a corporation will prefer internalizing a vertical transaction through ownership over contracting for the transaction in the marketplace: (1) a high level of uncer- tainty must surround the transaction, (2) assets involved in the transaction must be highly specialized to the transac- tion, and (3) the transaction must occur frequently. If there is a high level of uncertainty, it will be impossible to write a contract covering all contingencies, and it is likely that the contractor will act opportunistically to exploit any gaps in the written agreement—thus creating problems and in- creasing costs. If the assets being contracted for are highly

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STRATEGY highlight 7.1 TRANSACTION COST ECONOMICS ANALYZES VERTICAL GROWTH STRATEGY

specialized (e.g., goods or services with few alternate uses), there are likely to be few alternative suppliers—thus allowing the contractor to take advantage of the situation and increase costs. The more frequent the transactions, the more opportunity for the contractor to demand special treatment and thus increase costs further.

Vertical integration is not always more efficient than the marketplace, however. When highly vertically integrated firms become excessively large and bureaucratic, the costs of managing the internal transactions may become greater than simply purchasing the needed goods externally—thus justifying outsourcing over ownership. The usually hidden management costs (e.g., excessive layers of management, endless committee meetings needed for interdepartmental coordination, and delayed decision making due to exces- sively detailed rules and policies) add to the internal trans- action costs—thus reducing the effectiveness and efficiency of vertical integration. The decision to own or to outsource is, therefore, based on the particular situation surrounding the transaction and the ability of the corpora- tion to manage the transaction internally both effectively and efficiently.

SOURCES: O. E. Williamson and S. G. Winter, eds., The Nature of the Firm: Origins, Evolution, and Development (New York: Oxford University Press, 1991); E. Mosakowski, “Organizational Bound- aries and Economic Performance: An Empirical Study of Entrepre- neurial Computer Firms,” Strategic Management Journal (February 1991), pp. 115–133; P. S. Ring and A. H. Van de Ven, “Structuring Cooperative Relationships Between Organizations,” Strategic Management Journal (October 1992), pp. 483–498.

quasi-integration). A company may not want to purchase outright a supplier or distributor, but it still may want to guarantee access to needed supplies, new products, technologies, or distri- bution channels. For example, the pharmaceutical company Bristol-Myers Squibb purchased 17% of the common stock of ImClone in order to gain access to new drug products being de- veloped through biotechnology. An example of forward quasi-integration would be a paper company acquiring part interest in an office products chain in order to guarantee that its prod- ucts had access to the distribution channel. Purchasing part interest in another company usu- ally provides a company with a seat on the other firm’s board of directors, thus guaranteeing the acquiring firm both information and control. As in the case of Bristol-Myers Squibb and ImClone, a quasi-integrated firm may later decide to buy the rest of a key supplier that it did not already own.18

Long-term contracts are agreements between two firms to provide agreed-upon goods and services to each other for a specified period of time. This cannot really be considered to be vertical integration unless it is an exclusive contract that specifies that the supplier or dis- tributor cannot have a similar relationship with a competitive firm. In that case, the supplier

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or distributor is really a captive company that, although officially independent, does most of its business with the contracted firm and is formally tied to the other company through a long- term contract.

Recently there has been a movement away from vertical growth strategies (and thus ver- tical integration) toward cooperative contractual relationships with suppliers and even with competitors.19 These relationships range from outsourcing, in which resources are purchased from outsiders through long-term contracts instead of being made in-house (for example, Hewlett-Packard bought its laser engines from Canon for HP’s laser jet printers), to strategic alliances, in which partnerships, technology licensing agreements, and joint ventures supple- ment a firm’s capabilities (for example, Toshiba has used strategic alliances with GE, Siemens, Motorola, and Ericsson to become one of the world’s leading electronic companies).20

Horizontal Growth. A firm can achieve horizontal growth by expanding its operations into other geographic locations and/or by increasing the range of products and services offered to current markets. Research indicates that firms that grow horizontally by broadening their product lines have high survival rates.21 Horizontal growth results in horizontal integration—the degree to which a firm operates in multiple geographic locations at the same point on an industry’s value chain. For example, Procter & Gamble (P&G) continually adds additional sizes and multiple variations to its existing product lines to reduce possible niches competitors may enter. In addition, it introduces successful products from one part of the world to other regions. P&G has been introducing into China a steady stream of popular American brands, such as Head & Shoulders, Crest, Olay, Tide, Pampers, and Whisper. By 2007, it had 6,300 employees in China and the extensive distribution network it needed to prosper in the world’s fastest growing market.22

Horizontal growth can be achieved through internal development or externally through acquisitions and strategic alliances with other firms in the same industry. For example, Delta Airlines acquired Northwest Airlines in 2008 to obtain access to Northwest’s Asian markets and those American markets that Delta was not then serving. In contrast, many small com- muter airlines engage in long-term contracts with major airlines in order to offer a complete arrangement for travelers. For example, the regional carrier Mesa Airlines arranged contrac- tual agreements with United Airlines, U.S. Airways, and America West to be listed on their computer reservations, respectively, as United Express, U.S. Airways Express, and America West Express.

Horizontal growth is increasingly being achieved in today’s world through international expansion. American’s Wal-Mart, France’s Carrefour, and Britain’s Tesco are examples of na- tional supermarket discount chains expanding horizontally throughout the world. This type of growth can be achieved internationally through many different strategies.

International Entry Options for Horizontal Growth Research indicates that growing internationally is positively associated with firm profitability.23

A corporation can select from several strategic options the most appropriate method for entering a foreign market or establishing manufacturing facilities in another country. The options vary from simple exporting to acquisitions to management contracts. See the Global Issue feature to see how U.S.-based firms are using international entry options in a horizontal growth strategy to expand throughout the world.

Some of the most popular options for international entry are as follows:

� Exporting: A good way to minimize risk and experiment with a specific product is exporting, shipping goods produced in the company’s home country to other countries for marketing. The company could choose to handle all critical functions itself, or it could con- tract these functions to an export management company. Exporting is becoming increasingly

What do Wal-Mart, Star- bucks, and International Pa-

per have in common? For one thing, they are successful U.S.

companies that grew to the point that eventually their products saturated the domestic market— resulting in slower growth in domestic sales and profits. For another, all are companies that have chosen the corporate growth strategy of concentrating in one industry. A third thing in common is that all of them are using international markets as a key growth opportunity.

From its humble beginnings in Bentonville, Arkansas, Wal-Mart has successfully grown such that its discount stores can now be found in most every corner of the nation. Knowing that Wal-Mart had fewer locations left in the United States on which to build stores, the company’s man- agement knew that the company’s domestic growth could not be sustained past 2007. Consequently, the company be- gan acquiring retail chains in other countries to eventually become the largest company in the world in terms of sales.

Growing from its base in Seattle, Washington, Star- bucks expanded its coffee shops to every city in the coun-

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GLOBAL issue COMPANIES LOOK TO INTERNATIONAL MARKETS FOR HORIZONTAL GROWTH

try in only a few years. Soon imitators began opening their own versions until the U.S. market was completely satu- rated with coffee shops. Facing slow growth in its domes- tic market, Starbucks’ management made the strategic decision to add fewer U.S. stores and to make international expansion its top priority.

Until recently, International Paper (IP) was international in name only. Founded in 1898, the company had once supplied 60% of the newsprint for American newspapers. After years of slow growth and weak financial perfor- mance, IP’s management decided to divest unrelated busi- nesses and to branch out from its North American roots to developing international markets. Acquisitions in Russia and green-field development in Brazil now positioned the company within low-cost, high-growth markets. IP’s man- agement hoped to soon control about half the office pa- per market in Latin America.

SOURCES: B. Helm and J. McGregor, “Howard Schultz’s Grande Challenge,” Business Week (January 21, 2008), p. 28; J. Bush, “Now It’s Really International Paper,” Business Week (December 17, 2007).

popular for small businesses because of the Internet, fax machines, toll-free numbers, and overnight express services, which reduce the once-formidable costs of going international.

� Licensing: Under a licensing agreement, the licensing firm grants rights to another firm in the host country to produce and/or sell a product. The licensee pays compensation to the licensing firm in return for technical expertise. This is an especially useful strategy if the trademark or brand name is well known, but the company does not have sufficient funds to finance its entering the country directly. Anheuser-Busch used this strategy to produce and market Budweiser beer in the United Kingdom, Japan, Israel, Australia, Korea, and the Philippines. This strategy is also important if the country makes entry via investment either difficult or impossible.

� Franchising: Under a franchising agreement, the franchiser grants rights to another company to open a retail store using the franchiser’s name and operating system. In ex- change, the franchisee pays the franchiser a percentage of its sales as a royalty. Franchis- ing provides an opportunity for a firm to establish a presence in countries where the population or per capita spending is not sufficient for a major expansion effort.24 Fran- chising accounts for 40% of total U.S. retail sales. Close to half of U.S. franchisers, such as Yum! Brands, franchise internationally.25

� Joint Ventures: Forming a joint venture between a foreign corporation and a domestic company is the most popular strategy used to enter a new country.26 Companies often form joint ventures to combine the resources and expertise needed to develop new products or technologies. A joint venture may be an association between a company and a firm in the host country or a government agency in that country. A quick method of obtaining local

C H A P T E R 7 Strategy Formulation: Corporate Strategy 213

management, it also reduces the risks of expropriation and harassment by host country of- ficials. A joint venture may also enable a firm to enter a country that restricts foreign own- ership. The corporation can enter another country with fewer assets at stake and thus lower risk. Under Indian law, for example, foreign retailers are permitted to own no more than 51% of shops selling single-brand products, or to sell to others on a wholesale basis. These and other restrictions deterred supermarket giants Tesco and Carrefour from entering In- dia. As a result, 97% of Indian retailing is composed of small, family-run stores. Eager to enter India, Wal-Mart’s management formed an equal partnership joint venture in 2007 with Bharti Enterprises to start wholesale operations. Under the name Bharti-Mart, the new company planned to open a dozen small retail stores by 2015.27

� Acquisitions: A relatively quick way to move into an international area is through acquisi- tions—purchasing another company already operating in that area. Synergistic benefits can result if the company acquires a firm with strong complementary product lines and a good distribution network. For example, Belgium’s InBev purchased Anheuser-Busch in 2008 for $52 billion to obtain a solid position in the profitable North American beer market. Be- fore the acquisition, InBev had only a small presence in the U.S., but a strong one in Europe and Latin American, where Anheuser-Busch was weak.28 Research suggests that wholly owned subsidiaries are more successful in international undertakings than are strategic al- liances, such as joint ventures.29 This is one reason why firms more experienced in interna- tional markets take a higher ownership position when making a foreign investment.30

Cross-border acquisitions now account for 19% of all acquisitions in the United States—up from only 6% in 1985.31 In some countries, however, acquisitions can be difficult to arrange because of a lack of available information about potential candidates. Government restric- tions on ownership, such as the U.S. requirement that limits foreign ownership of U.S. air- lines to 49% of nonvoting and 25% of voting stock, can also discourage acquisitions.

� Green-Field Development: If a company doesn’t want to purchase another company’s problems along with its assets, it may choose green-field development and build its own manufacturing plant and distribution system. Research indicates that firms possessing high levels of technology, multinational experience, and diverse product lines prefer green-field development to acquisitions.32 This is usually a far more complicated and ex- pensive operation than acquisition, but it allows a company more freedom in designing the plant, choosing suppliers, and hiring a workforce. For example, Nissan, Honda, and Toyota built auto factories in rural areas of Great Britain and then hired a young work- force with no experience in the industry. BMW did the same thing when it built its auto plant in Spartanburg, South Carolina, to make its Z3 and Z4 sports cars.

� Production Sharing: Coined by Peter Drucker, the term production sharing means the process of combining the higher labor skills and technology available in developed coun- tries with the lower-cost labor available in developing countries. Often called outsourcing, one example is Maytag’s moving some of its refrigeration production to a new plant in Reynosa, Mexico, in order to reduce labor costs. Many companies have moved data pro- cessing, programming, and customer service activities “offshore” to Ireland, India, Barba- dos, Jamaica, the Philippines, and Singapore, where wages are lower, English is spoken, and telecommunications are in place. As the number of technology services employees in India grew to be 15% of IBM’s total tech services employees by 2007, the company has been able to eliminate 20,000 jobs in high-cost locations in the U.S., Europe, and Japan.33

� Turnkey Operations: Turnkey operations are typically contracts for the construction of operating facilities in exchange for a fee. The facilities are transferred to the host country or firm when they are complete. The customer is usually a government agency of, for ex- ample, a Middle Eastern country that has decreed that a particular product must be pro- duced locally and under its control. For example, Fiat built an auto plant in Tagliatti,

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Russia, for the Soviet Union in the late 1960s to produce an older model of Fiat under the brand name of Lada. MNCs that perform turnkey operations are frequently industrial equipment manufacturers that supply some of their own equipment for the project and that commonly sell replacement parts and maintenance services to the host country. They thereby create customers as well as future competitors. Interestingly, Renault purchased in 2008 a 25% stake in the same Tagliatti factory built by Fiat to help the Russian carmaker modernize, using Renault’s low cost Logan as the base for the plant’s new Lada model.34

� BOT Concept: The BOT (Build, Operate, Transfer) concept is a variation of the turnkey operation. Instead of turning the facility (usually a power plant or toll road) over to the host country when completed, the company operates the facility for a fixed period of time during which it earns back its investment plus a profit. It then turns the facility over to the government at little or no cost to the host country.35

� Management Contracts: A large corporation operating throughout the world is likely to have a large amount of management talent at its disposal. Management contracts offer a means through which a corporation can use some of its personnel to assist a firm in a host country for a specified fee and period of time. Management contracts are common when a host government expropriates part or all of a foreign-owned company’s holdings in its country. The contracts allow the firm to continue to earn some income from its in- vestment and keep the operations going until local management is trained.36

Diversification Strategies According to strategist Richard Rumelt, companies begin thinking about diversification when their growth has plateaued and opportunities for growth in the original business have been de- pleted.37 This often occurs when an industry consolidates, becomes mature, and most of the surviving firms have reached the limits of growth using vertical and horizontal growth strate- gies. Unless the competitors are able to expand internationally into less mature markets, they may have no choice but to diversify into different industries if they want to continue growing. The two basic diversification strategies are concentric and conglomerate.

Concentric (Related) Diversification. Growth through concentric diversification into a related industry may be a very appropriate corporate strategy when a firm has a strong competitive position but industry attractiveness is low.

Research indicates that the probability of succeeding by moving into a related business is a function of a company’s position in its core business. For companies in leadership positions, the chances for success are nearly three times higher than those for followers.38 By focusing on the characteristics that have given the company its distinctive competence, the company uses those very strengths as its means of diversification. The firm attempts to secure strategic fit in a new industry where the firm’s product knowledge, its manufacturing capabilities, and the marketing skills it used so effectively in the original industry can be put to good use.39 The corporation’s products or processes are related in some way: they possess some common thread.

The search is for synergy, the concept that two businesses will generate more profits to- gether than they could separately. The point of commonality may be similar technology, cus- tomer usage, distribution, managerial skills, or product similarity. This is the rationale taken by Quebec-based Bombardier, the world’s third-largest aircraft manufacturer. In the 1980s, the company expanded beyond snowmobiles into making light rail equipment. Defining itself as a transportation company, it entered the aircraft business in 1986, with its purchase of Canadair, then best known for its fire-fighting airplanes. It later bought Learjet, a well-known maker of business jets. Over a 14-year period, Bombardier launched 14 new aircraft. In July 2008, the company announced its C Series Aircraft Program to manufacture a 110–130-seat “green” single-aisle family of airplanes to directly compete with Airbus and Boeing.40

Market Attractiveness

1. Is the market large enough to be attractive?

2. Is the market growing faster than the economy?

3. Does it offer the potential to increase revenue from current customers?

4. Does it provide the ability to sell existing services to new customers?

5. Does it create a recurring revenue stream?

6. Are average earnings in the industry/market higher than in current businesses?

7. Is the market already taken by strong competitors?

8. Does it strengthen relationships with existing value- chain players?

C H A P T E R 7 Strategy Formulation: Corporate Strategy 215

A firm may choose to diversify concentrically through either internal or external means. Bombardier, for example, diversified externally through acquisitions. Toro, in contrast, grew internally in North America by using its current manufacturing processes and distributors to make and market snow blowers in addition to lawn mowers. When considering concentric di- versification alternatives, see the criteria presented in Strategy Highlight 7.2.

Conglomerate (Unrelated) Diversification. When management realizes that the current industry is unattractive and that the firm lacks outstanding abilities or skills that it could easily transfer to related products or services in other industries, the most likely strategy is conglomerate diversification—diversifying into an industry unrelated to its current one. Rather than maintaining a common thread throughout their organization, strategic managers who adopt this strategy are primarily concerned with financial considerations of cash flow or risk reduction. This is also a good strategy for a firm that is able to transfer its own excellent management system into less-well-managed acquired firms. General Electric and Berkshire Hathaway are examples of companies that have used conglomerate diversification to grow successfully. Managed by Warren Buffet, Berkshire Hathaway has interests in furniture retailing, razor blades, airlines, paper, broadcasting, soft drinks, and publishing.41

The emphasis in conglomerate diversification is on sound investment and value-oriented management rather than on the product-market synergy common to concentric diversifica- tion. A cash-rich company with few opportunities for growth in its industry might, for exam- ple, move into another industry where opportunities are great but cash is hard to find. Another instance of conglomerate diversification might be when a company with a seasonal and,

STRATEGY highlight 7.2 SCREENING CRITERIA FOR CONCENTRIC DIVERSIFICATION

Market Feasibility

1. Can the company enter the market within a year?

2. Are there any synergies in the geographic region where the market is located?

3. Can existing capabilities be leveraged for market entry?

4. Can existing assets be leveraged for market entry?

5. Can existing employees be used to support this opportunity?

6. Will current and future laws and regulations affect entry?

7. Is there a need for a strong brand in the new market?

8. If there is a need for partners, can the company secure and manage partner relationships?

SOURCE: Summarized from N. J. Kaplan, “Surviving and Thriving When Your Customers Contract,” Journal of Business Strategy (January/February, 2003), p. 20.

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therefore, uneven cash flow purchases a firm in an unrelated industry with complementing seasonal sales that will level out the cash flow. CSX management considered the purchase of a natural gas transmission business (Texas Gas Resources) by CSX Corporation (a railroad- dominated transportation company) to be a good fit because most of the gas transmission rev- enue was realized in the winter months—the lean period in the railroad business.

CONTROVERSIES IN DIRECTIONAL GROWTH STRATEGIES Is vertical growth better than horizontal growth? Is concentration better than diversifica- tion? Is concentric diversification better than conglomerate diversification? Research re- veals that companies following a related diversification strategy appear to be higher performers and survive longer than do companies with narrower scope following a pure con- centration strategy.42 Although the research is not in complete agreement, growth into areas related to a company’s current product lines is generally more successful than is growth into completely unrelated areas.43 For example, one study of various growth projects examined how many were considered successful, that is, still in existence after 22 years. The results were vertical growth, 80%; horizontal growth, 50%; concentric diversification, 35%; and conglomerate diversification, 28%.44 This supports the conclusion from a study of 40 suc- cessful European companies that companies should first exploit their existing assets and ca- pabilities before exploring for new ones, but that they should also diversify their portfolio of products.45

In terms of diversification strategies, research suggests that the relationship between re- latedness and performance is curvilinear in the shape of an inverted U-shaped curve. If a new business is very similar to that of the acquiring firm, it adds little new to the corporation and only marginally improves performance. If the new business is completely different from the acquiring company’s businesses, there may be very little potential for any synergy. If, how- ever, the new business provides new resources and capabilities in a different, but similar, busi- ness, the likelihood of a significant performance improvement is high.46

Is internal growth better than external growth? Corporations can follow the growth strate- gies of either concentration or diversification through the internal development of new products and services, or through external acquisitions, mergers, and strategic alliances. The value of global acquisitions and mergers has steadily increased from less than $1 trillion in 1990 to $3.5 trillion in 2000.47 According to a McKinsey & Company survey, managers are primarily motivated to purchase other companies in order to add capabilities, expand geographically, and buy growth.48 Research generally concludes, however, that firms growing through acquisitions do not perform financially as well as firms that grow through internal means.49 For example, on September 3, 2001, the day before HP announced that it was purchasing Compaq, HP’s stock was selling at $23.11. After the announcement, the stock price fell to $18.87. Three years later, on September 21, 2004, the shares sold at $18.70.50 One reason for this poor performance may be that acquiring firms tend to spend less on R&D than do other firms.51 Another reason may be the typically high price of the acquisition itself. Studies reveal that over half to two-thirds of acquisitions are failures primarily because the premiums paid were too high for them to earn their cost of capital.52 Another reason for the poor stock performance is that 50% of the cus- tomers of a merged firm are less satisfied with the combined company’s service two years af- ter the merger.53 It is likely that neither strategy is best by itself and that some combination of internal and external growth strategies is better than using one or the other.54

What can improve acquisition performance? For one thing, the acquisition should be linked to strategic objectives and support corporate strategy. In addition, a corporation must be prepared to identify roughly 100 candidates and conduct due diligence investigation on around 40 companies in order to ultimately purchase 10 companies. This kind of effort requires

C H A P T E R 7 Strategy Formulation: Corporate Strategy 217

the capacity to sift through many candidates while simultaneously integrating previous acqui- sitions.55 A study by Bain & Company of more than 11,000 acquisitions by companies throughout the world concluded that successful acquirers make small, low-risk acquisitions before moving on to larger ones.56 Previous experience between an acquirer and a target firm in terms of R&D, manufacturing, or marketing alliances improves the likelihood of a success- ful acquisition.57 Realizing that an acquired company must be carefully assimilated into the acquiring firm’s operations, Cisco uses three criteria to judge whether a company is a suitable candidate for takeover:

� It must be relatively small.

� It must be comparable in organizational culture.

� It must be physically close to one of the existing affiliates.58

STABILITY STRATEGIES A corporation may choose stability over growth by continuing its current activities without any significant change in direction. Although sometimes viewed as a lack of strategy, the stability family of corporate strategies can be appropriate for a successful corporation operating in a reasonably predictable environment.59 They are very popular with small business owners who have found a niche and are happy with their success and the manageable size of their firms. Stability strategies can be very useful in the short run, but they can be dangerous if followed for too long. Some of the more popular of these strategies are the pause/proceed-with-caution, no-change, and profit strategies.

Pause/Proceed with Caution Strategy A pause/proceed-with-caution strategy is, in effect, a timeout—an opportunity to rest be- fore continuing a growth or retrenchment strategy. It is a very deliberate attempt to make only incremental improvements until a particular environmental situation changes. It is typ- ically conceived as a temporary strategy to be used until the environment becomes more hos- pitable or to enable a company to consolidate its resources after prolonged rapid growth. This was the strategy Dell followed after its growth strategy had resulted in more growth than it could handle. Explained CEO Michael Dell, “We grew 285% in two years, and we’re hav- ing some growing pains.” Selling personal computers by mail enabled Dell to underprice competitors, but it could not keep up with the needs of a $2 billion, 5,600-employee com- pany selling PCs in 95 countries. Dell did not give up on its growth strategy; it merely put it temporarily in limbo until the company was able to hire new managers, improve the struc- ture, and build new facilities.60 This was a popular strategy in late-2008 during a U.S. finan- cial crisis when banks were freezing their lending and awaiting a rescue package from the federal government.

No-Change Strategy A no-change strategy is a decision to do nothing new—a choice to continue current opera- tions and policies for the foreseeable future. Rarely articulated as a definite strategy, a no- change strategy’s success depends on a lack of significant change in a corporation’s situation. The relative stability created by the firm’s modest competitive position in an industry facing little or no growth encourages the company to continue on its current course, making only small adjustments for inflation in its sales and profit objectives. There are no obvious oppor- tunities or threats, nor is there much in the way of significant strengths or weaknesses. Few ag- gressive new competitors are likely to enter such an industry. The corporation has probably

218 PA RT 3 Strategy Formulation

found a reasonably profitable and stable niche for its products. Unless the industry is under- going consolidation, the relative comfort a company in this situation experiences is likely to encourage the company to follow a no-change strategy in which the future is expected to con- tinue as an extension of the present. Many small-town businesses followed this strategy before Wal-Mart moved into their areas and forced them to rethink their strategy.

Profit Strategy A profit strategy is a decision to do nothing new in a worsening situation but instead to act as though the company’s problems are only temporary. The profit strategy is an attempt to artifi- cially support profits when a company’s sales are declining by reducing investment and short- term discretionary expenditures. Rather than announce the company’s poor position to shareholders and the investment community at large, top management may be tempted to fol- low this very seductive strategy. Blaming the company’s problems on a hostile environment (such as anti-business government policies, unethical competitors, finicky customers, and/or greedy lenders), management defers investments and/or cuts expenses (such as R&D, mainte- nance, and advertising) to stabilize profits during this period. It may even sell one of its prod- uct lines for the cash-flow benefits.

The profit strategy is useful only to help a company get through a temporary difficulty. It may also be a way to boost the value of a company in preparation for going public via an ini- tial public offering (IPO). Unfortunately, the strategy is seductive and if continued long enough it will lead to a serious deterioration in a corporation’s competitive position. The profit strategy is typically top management’s passive, short-term, and often self-serving response to a difficult situation. In such situations, it is often better to face the problem directly by choos- ing a retrenchment strategy.

RETRENCHMENT STRATEGIES A company may pursue retrenchment strategies when it has a weak competitive position in some or all of its product lines resulting in poor performance—sales are down and profits are becoming losses. These strategies impose a great deal of pressure to improve performance. In an attempt to eliminate the weaknesses that are dragging the company down, management may follow one of several retrenchment strategies, ranging from turnaround or becoming a captive company to selling out, bankruptcy, or liquidation.

Turnaround Strategy Turnaround strategy emphasizes the improvement of operational efficiency and is probably most appropriate when a corporation’s problems are pervasive but not yet critical. Research shows that poorly performing firms in mature industries have been able to improve their per- formance by cutting costs and expenses and by selling off assets.61 Analogous to a weight- reduction diet, the two basic phases of a turnaround strategy are contraction and consolidation.62

Contraction is the initial effort to quickly “stop the bleeding” with a general, across-the- board cutback in size and costs. For example, when Howard Stringer was selected to be CEO of Sony Corporation in 2005, he immediately implemented the first stage of a turnaround plan by eliminating 10,000 jobs, closing 11 of 65 plants, and divesting many unprofitable electron- ics businesses. 63 The second phase, consolidation, implements a program to stabilize the now- leaner corporation. To streamline the company, plans are developed to reduce unnecessary overhead and to make functional activities cost-justified. This is a crucial time for the organiza- tion. If the consolidation phase is not conducted in a positive manner, many of the best people leave the organization. An overemphasis on downsizing and cutting costs coupled with a heavy

C H A P T E R 7 Strategy Formulation: Corporate Strategy 219

hand by top management is usually counterproductive and can actually hurt performance.64 If, however, all employees are encouraged to get involved in productivity improvements, the firm is likely to emerge from this retrenchment period a much stronger and better-organized com- pany. It has improved its competitive position and is able once again to expand the business.65

Captive Company Strategy A captive company strategy involves giving up independence in exchange for security. A com- pany with a weak competitive position may not be able to engage in a full-blown turnaround strat- egy. The industry may not be sufficiently attractive to justify such an effort from either the current management or investors. Nevertheless, a company in this situation faces poor sales and increas- ing losses unless it takes some action. Management desperately searches for an “angel” by offer- ing to be a captive company to one of its larger customers in order to guarantee the company’s continued existence with a long-term contract. In this way, the corporation may be able to reduce the scope of some of its functional activities, such as marketing, thus significantly reducing costs. The weaker company gains certainty of sales and production in return for becoming heavily de- pendent on another firm for at least 75% of its sales. For example, to become the sole supplier of an auto part to General Motors, Simpson Industries of Birmingham, Michigan, agreed to let a special team from GM inspect its engine parts facilities and books and interview its employees. In return, nearly 80% of the company’s production was sold to GM through long-term contracts.66

Sell-Out/Divestment Strategy If a corporation with a weak competitive position in an industry is unable either to pull itself up by its bootstraps or to find a customer to which it can become a captive company, it may have no choice but to sell out. The sell-out strategy makes sense if management can still obtain a good price for its shareholders and the employees can keep their jobs by selling the entire com- pany to another firm. The hope is that another company will have the necessary resources and determination to return the company to profitability. Marginal performance in a troubled indus- try was one reason Northwest Airlines was willing to be acquired by Delta Airlines in 2008.

If the corporation has multiple business lines and it chooses to sell off a division with low growth potential, this is called divestment. This was the strategy Ford used when it sold its struggling Jaguar and Land Rover units to Tata Motors in 2008 for $2 billion. Ford had spent $10 billion trying to turn around Jaguar after spending $2.5 billion to buy it in 1990. In addi- tion, Ford had paid $2.8 billion for Land Rover in 2000. Ford’s management hoped to use the proceeds of the sale to help the company reach profitability in 2009.67 General Electric’s man- agement used the same reasoning when it decided to sell or spin off its slow-growth appliance business in 2008.

Divestment is often used after a corporation acquires a multi-unit corporation in order to shed the units that do not fit with the corporation’s new strategy. This is why Whirlpool sold Maytag’s Hoover vacuum cleaner unit after Whirlpool purchased Maytag. Divestment was also a key part of Lego’s turnaround strategy when management decided to divest its theme parks to concentrate more on its core business of making toys.68

Bankruptcy/Liquidation Strategy When a company finds itself in the worst possible situation with a poor competitive position in an industry with few prospects, management has only a few alternatives—all of them dis- tasteful. Because no one is interested in buying a weak company in an unattractive industry, the firm must pursue a bankruptcy or liquidation strategy. Bankruptcy involves giving up management of the firm to the courts in return for some settlement of the corporation’s obli- gations. Top management hopes that once the court decides the claims on the company, the

220 PA RT 3 Strategy Formulation

company will be stronger and better able to compete in a more attractive industry. Faced with a recessionary economy and falling market demand for casual dining, restaurants like Benni- gan’s Grill & Tavern and Steak & Ale, that once thrived by offering mid-priced menus with po- tato skins and thick hamburgers, filed for bankruptcy in July 2008. Within the troubled airline industry, at least 30 airlines went bankrupt during just the first half of 2008 with 30 more bank- ruptcies expected by the end of the year.69 A controversial approach was used by Delphi Cor- poration when it filed for Chapter 11 bankruptcy only for its U.S. operations, which employed 32,000 high-wage union workers, but not for its foreign factories in low-wage countries.70

In contrast to bankruptcy, which seeks to perpetuate a corporation, liquidation is the ter- mination of the firm. When the industry is unattractive and the company too weak to be sold as a going concern, management may choose to convert as many saleable assets as possible to cash, which is then distributed to the shareholders after all obligations are paid. Liquidation is a prudent strategy for distressed firms with a small number of choices, all of which are prob- lematic.71 This was Circuit City’s situation in 2008, when it liquidated its retail stores. The ben- efit of liquidation over bankruptcy is that the board of directors, as representatives of the shareholders, together with top management make the decisions instead of turning them over to the bankruptcy court, which may choose to ignore shareholders completely.

At times, top management must be willing to select one of these less desirable retrench- ment strategies. Unfortunately, many top managers are unwilling to admit that their company has serious weaknesses for fear that they may be personally blamed. Even worse, top manage- ment may not even perceive that crises are developing. When these top managers eventually notice trouble, they are prone to attribute the problems to temporary environmental distur- bances and tend to follow profit strategies. Even when things are going terribly wrong, top management is greatly tempted to avoid liquidation in the hope of a miracle. Top management enters a cycle of decline, in which it goes through a process of secrecy and denial, followed by blame and scorn, avoidance and turf protection, ending with passivity and helplessness.72

Thus, a corporation needs a strong board of directors who, to safeguard shareholders’ inter- ests, can tell top management when to quit.

7.3 Portfolio Analysis Chapter 6 dealt with how individual product lines and business units can gain competitive ad- vantage in the marketplace by using competitive and cooperative strategies. Companies with multiple product lines or business units must also ask themselves how these various products and business units should be managed to boost overall corporate performance:

� How much of our time and money should we spend on our best products and business units to ensure that they continue to be successful?

� How much of our time and money should we spend developing new costly products, most of which will never be successful?

One of the most popular aids to developing corporate strategy in a multiple-business cor- poration is portfolio analysis. Although its popularity has dropped since the 1970s and 1980s, when more than half of the largest business corporations used portfolio analysis, it is still used by around 27% of Fortune 500 firms in corporate strategy formulation.73 Portfolio analysis puts corporate headquarters into the role of an internal banker. In portfolio analysis, top man- agement views its product lines and business units as a series of investments from which it ex- pects a profitable return. The product lines/business units form a portfolio of investments that top management must constantly juggle to ensure the best return on the corporation’s invested money. A McKinsey & Company study of the performance of the 200 largest U.S. corporations

C H A P T E R 7 Strategy Formulation: Corporate Strategy 221

BCG GROWTH-SHARE MATRIX Using the BCG (Boston Consulting Group) Growth-Share Matrix depicted in Figure 7–3 is the simplest way to portray a corporation’s portfolio of investments. Each of the corpora- tion’s product lines or business units is plotted on the matrix according to both the growth rate of the industry in which it competes and its relative market share. A unit’s relative competitive position is defined as its market share in the industry divided by that of the largest other com- petitor. By this calculation, a relative market share above 1.0 belongs to the market leader. The business growth rate is the percentage of market growth, that is, the percentage by which sales of a particular business unit classification of products have increased. The matrix assumes that, other things being equal, a growing market is attractive.

The line separating areas of high and low relative competitive position is set at 1.5 times. A product line or business unit must have relative strengths of this magnitude to ensure that it will have the dominant position needed to be a “star” or “cash cow.” On the other hand, a prod- uct line or unit having a relative competitive position less than 1.0 has “dog” status.75 Each product or unit is represented in Figure 7–3 by a circle. The area of the circle represents the relative significance of each business unit or product line to the corporation in terms of assets used or sales generated.

found that companies that actively managed their business portfolios through acquisitions and divestitures created substantially more shareholder value than those companies that passively held their businesses.74 Given the increasing number of strategic alliances in today’s corpora- tions, portfolio analysis is also being used to evaluate the contribution of alliances to corpo- rate and business unit objectives.

Two of the most popular portfolio techniques are the BCG Growth-Share Matrix and GE Business Screen.

Stars

Cash Cows Dogs

22

20

18

16

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12

10

8

6

4

2

0

1 0 x

4 x

Relative Competitive Position (Market Share)

B u

s in

e s s G

ro w

th R

a te

(P e rc

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2 x

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0 .5

x 0 .4

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x

0 .1

x

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x

Question Marks FIGURE 7–3

BCG Growth- Share Matrix

SOURCE: Reprinted from Long Range Planning, Vol. 10, No. 2, 1977, Hedley, “Strategy and the Business Portfolio,” p. 12. Copyright © 1977 with permission from Elsevier.

In 2003, top management at General Motors (GM) de-

cided to discontinue further work on its EV1 electric auto-

mobile. Working versions of the car had been leased to a limited number

of people, but never sold. Environmentalists protested that GM stopped making the car just to send a message to gov- ernment policy makers that an electric car was bad busi- ness. Management responded by stating that the car would never have made a profit.

In an April 2005 meeting of GM’s top management team, Vice Chairman Robert Lutz suggested that it might be time to build another electric car. He noted that Toyota’s Prius hybrid had made Toyota look environmentally sensi- tive; whereas, GM was viewed as making gas “hogs.” The response was negative. Lutz recalled one executive saying, “We lost $1 billion on the last one. Do you want to lose $1 billion on the next one?”

Even though worldwide car ownership was growing 5% annually, rising fuel prices in 2005 reduced sales of GM’s profitable SUVs—resulting in a loss of $11 billion. Board members began signaling that it was time for man- agement to take some riskier bets to get the company out of financial trouble. In February 2006, management reluc- tantly approved developmental work on another electric car. At the time, no one in GM knew if batteries could be made small enough to power a car, but they knew that

222 PA RT 3 Strategy Formulation

The BCG Growth-Share Matrix has a lot in common with the product life cycle. As a product moves through its life cycle, it is categorized into one of four types for the purpose of funding decisions:

� Question marks (sometimes called “problem children” or “wildcats”) are new products with the potential for success, but they need a lot of cash for development. If such a prod- uct is to gain enough market share to become a market leader and thus a star, money must be taken from more mature products and spent on the question mark. This is a “fish or cut bait” decision in which management must decide if the business is worth the investment needed. For example, after years of fruitlessly experimenting with an electric car, General Motors finally decided in 2006 to take a chance on developing the Chevrolet Volt.76 To learn more of GM’s decision to build the electric car, see the Environmental Sustainabil- ity Issue feature.

� Stars are market leaders that are typically at the peak of their product life cycle and are able to generate enough cash to maintain their high share of the market and usually con- tribute to the company’s profits. HP’s printer business has been called HP’s “crown jewel” because of its 41% market share in printers and its control of the replacement cartridge

GENERAL MOTORS AND THE ELECTRIC CAR

ENVIRONMENTAL sustainability issue

choices were limited. According to Larry Burns, Vice Presi- dent of R&D and Strategic Planning, “This industry is 98% dependent on petroleum. GM has concluded that that’s not sustainable.”

Chairman and CEO Richard Wagoner, Jr. surprised the world at the January 2007 Detroit Auto Show with a vow to start developing an electric car called the Chevrolet Volt. It would plug into a regular electric outlet, leapfrog the competition, and be on sale in 2010. The company not only needed to build a radical new car, but had to convert as much as 75% of its current fleet to hybrid engines to meet fuel economy rules taking effect in 2017.

Management created a new team dedicated to getting hybrid and electric cars to market. The R&D budget was in- creased from $6.6 billion in 2006 to $8.1 billion in 2007. Several new models were canceled to free resources. The battery lab was under pressure to design batteries that could propel the Volt 40 miles before a small gasoline en- gine would re-charge the battery and extend the range to 600 miles. Douglas Drauch, battery lab manager, promised that the batteries would be ready on schedule. “We’re making history,” he said. “Fifty years from now, people will remember the Volt—like they remember a ‘53 Corvette.”

SOURCES: D. Welch, “GM: Live Green or Die,” Business Week (May 26, 2008), pp. 36–41; “The Drive for Low Emissions,” The Economist’s Special Report on Business and Climate Change (June 2, 2007), pp. 26–28.

C H A P T E R 7 Strategy Formulation: Corporate Strategy 223

market. On its own, it accounted for more than half of HP’s operating profit.77 When a star’s market growth rate slows, it becomes a cash cow.

� Cash cows typically bring in far more money than is needed to maintain their market share. In this declining stage of their life cycle, these products are “milked” for cash that will be invested in new question marks. Expenses such as advertising and R&D are re- duced. Panasonic’s video cassette recorders (VCRs) moved to this category when sales declined and DVD player/recorders replaced them. Question marks unable to obtain dom- inant market share (and thus become stars) by the time the industry growth rate inevitably slows become dogs.

� Dogs have low market share and do not have the potential (because they are in an unat- tractive industry) to bring in much cash. According to the BCG Growth-Share Matrix, dogs should be either sold off or managed carefully for the small amount of cash they can generate. For example, DuPont, the inventor of nylon, sold its textiles unit in 2003 be- cause the company wanted to eliminate its low-margin products and focus more on its growing biotech business.78 The same was true of IBM when it sold its PC business to China’s Lenovo Group in order to emphasize its growing services business.

Underlying the BCG Growth-Share Matrix is the concept of the experience curve (dis- cussed in Chapter 5). The key to success is assumed to be market share. Firms with the high- est market share tend to have a cost leadership position based on economies of scale, among other things. If a company is able to use the experience curve to its advantage, it should be able to manufacture and sell new products at a price low enough to garner early market share lead- ership (assuming no successful imitation by competitors). Once the product becomes a star, it is destined to be very profitable, considering its inevitable future as a cash cow.

Having plotted the current positions of its product lines or business units on a matrix, a company can project its future positions, assuming no change in strategy. Present and pro- jected matrixes can thus be used to help identify major strategic issues facing the organization. The goal of any company is to maintain a balanced portfolio so it can be self-sufficient in cash and always working to harvest mature products in declining industries to support new ones in growing industries.

The BCG Growth-Share Matrix is a very well-known portfolio concept with some clear advantages. It is quantifiable and easy to use. Cash cow, dog, question mark, and star are easy- to-remember terms for referring to a corporation’s business units or products. Unfortunately, the BCG Growth-Share Matrix also has some serious limitations:

� The use of highs and lows to form four categories is too simplistic.

� The link between market share and profitability is questionable.79 Low-share businesses can also be profitable.80 For example, Olivetti is still profitably selling manual typewrit- ers through mail-order catalogs.

� Growth rate is only one aspect of industry attractiveness.

� Product lines or business units are considered only in relation to one competitor: the mar- ket leader. Small competitors with fast-growing market shares are ignored.

� Market share is only one aspect of overall competitive position.

GE BUSINESS SCREEN General Electric, with the assistance of the McKinsey & Company consulting firm, developed a more complicated matrix. As depicted in Figure 7–4, the GE Business Screen includes nine cells based on long-term industry attractiveness and business strength competitive position. The GE Business Screen, in contrast to the BCG Growth-Share Matrix, includes much more

224 PA RT 3 Strategy Formulation

Winners A

Winners

B

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AverageStrong

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FIGURE 7–4 General Electric’s

Business Screen

data in its two key factors than just business growth rate and comparable market share. For ex- ample, at GE, industry attractiveness includes market growth rate, industry profitability, size, and pricing practices, among other possible opportunities and threats. Business strength or competitive position includes market share as well as technological position, profitability, and size, among other possible strengths and weaknesses.81

The individual product lines or business units are identified by a letter and plotted as cir- cles on the GE Business Screen. The area of each circle is in proportion to the size of the in- dustry in terms of sales. The pie slices within the circles depict the market shares of the product lines or business units.

To plot product lines or business units on the GE Business Screen, follow these four steps:

1. Select criteria to rate the industry for each product line or business unit. Assess overall in- dustry attractiveness for each product line or business unit on a scale from 1 (very unat- tractive) to 5 (very attractive).

2. Select the key factors needed for success in each product line or business unit. Assess business strength/competitive position for each product line or business unit on a scale of 1 (very weak) to 5 (very strong).

3. Plot each product line’s or business unit’s current position on a matrix as that depicted in Figure 7–4.

4. Plot the firm’s future portfolio, assuming that present corporate and business strategies re- main unchanged. Is there a performance gap between projected and desired portfolios? If so, this gap should serve as a stimulus to seriously review the corporation’s current mis- sion, objectives, strategies, and policies.

Overall, the nine-cell GE Business Screen is an improvement over the BCG Growth- Share Matrix. The GE Business Screen considers many more variables and does not lead to

SOURCE: Adapted from Strategic Management in GE, Corporate Planning and Development, General Electric Corporation, Reprinted by permission of General Electric Company.

C H A P T E R 7 Strategy Formulation: Corporate Strategy 225

such simplistic conclusions. It recognizes, for example, that the attractiveness of an industry can be assessed in many different ways (other than simply using growth rate), and it thus al- lows users to select whatever criteria they feel are most appropriate to their situation. This port- folio matrix, however, does have some shortcomings:

� It can get quite complicated and cumbersome.

� The numerical estimates of industry attractiveness and business strength/competitive po- sition give the appearance of objectivity, but they are in reality subjective judgments that may vary from one person to another.

� It cannot effectively depict the positions of new products or business units in developing industries.

ADVANTAGES AND LIMITATIONS OF PORTFOLIO ANALYSIS Portfolio analysis is commonly used in strategy formulation because it offers certain advantages:

� It encourages top management to evaluate each of the corporation’s businesses individu- ally and to set objectives and allocate resources for each.

� It stimulates the use of externally oriented data to supplement management’s judgment.

� It raises the issue of cash-flow availability for use in expansion and growth.

� Its graphic depiction facilitates communication.

Portfolio analysis does, however, have some very real limitations that have caused some companies to reduce their use of this approach:

� Defining product/market segments is difficult.

� It suggests the use of standard strategies that can miss opportunities or be impractical.

� It provides an illusion of scientific rigor when in reality positions are based on subjective judgments.

� Its value-laden terms such as cash cow and dog can lead to self-fulfilling prophecies.

� It is not always clear what makes an industry attractive or where a product is in its life cycle.

� Naively following the prescriptions of a portfolio model may actually reduce corporate profits if they are used inappropriately. For example, General Mills’ Chief Executive H. Brewster Atwater cited his company’s Bisquick brand of baking mix as a product that would have been written off years ago based on portfolio analysis. “This product is 57 years old. By all rights it should have been overtaken by newer products. But with the proper research to improve the product and promotion to keep customers excited, it’s do- ing very well.”82

MANAGING A STRATEGIC ALLIANCE PORTFOLIO Just as product lines/business units form a portfolio of investments that top management must constantly juggle to ensure the best return on the corporation’s invested money, strategic al- liances can also be viewed as a portfolio of investments—investments of money, time, and en- ergy. The way a company manages these intertwined relationships can significantly influence corporate competitiveness. Alliances are thus recognized as an important source of competi- tive advantage and superior performance.83

Managing groups of strategic alliances is primarily the job of the business unit. Its deci- sions may escalate, however, to the corporate level. Toman Corporation, for example, has

226 PA RT 3 Strategy Formulation

7.4 Corporate Parenting Campbell, Goold, and Alexander, authors of Corporate-Level Strategy: Creating Value in the Multibusiness Company, contend that corporate strategists must address two crucial questions:

� What businesses should this company own and why?

� What organizational structure, management processes, and philosophy will foster supe- rior performance from the company’s business units?86

195 international joint ventures containing 422 alliance partners. According to a Toman exec- utive, “If headquarters is trying to bring us and some other company closer together, they should understand not only our business unit, but also other business units. Sometimes the whole of our company may benefit (from an alliance) but it may not be good for one of our business units. And if it proceeds, headquarters must give some credit to our business unit so that we can agree. But it is not acceptable if they say to us that we are to lose something as a result of the alliance and now we have to make up the difference in one of our other busi- nesses.” In this instance the stage is set for negotiations across business units at the corporate level to achieve a broadly supported alliance network management system.84

A study of 25 leading European corporations found four tasks of multi-alliance manage- ment that are necessary for successful alliance portfolio management:

1. Developing and implementing a portfolio strategy for each business unit and a cor- porate policy for managing all the alliances of the entire company: Alliances are pri- marily determined by business units. The corporate level develops general rules concerning when, how, and with whom to cooperate. The task of alliance policy is to strategically align all of the corporation’s alliance activities with corporate strategy and corporate values. Every new alliance is thus checked against corporate policy before it is approved.

2. Monitoring the alliance portfolio in terms of implementing business unit strategies and corporate strategy and policies: Each alliance is measured in terms of achievement of objectives (e.g., market share), financial measures (e.g., profits and cash flow), con- tributed resource quality and quantity, and the overall relationship. The more a firm is di- versified, the less the need for monitoring at the corporate level.

3. Coordinating the portfolio to obtain synergies and avoid conflicts among alliances: Because the interdependencies among alliances within a business unit are usually greater than among different businesses, the need for coordination is greater at the business level than at the corporate level. The need for coordination increases as the number of alliances in one business unit and the company as a whole increases, the average number of part- ners per alliance increases, and/or the overlap of the alliances increases.

4. Establishing an alliance management system to support other tasks of multi-alliance management: This infrastructure consists of formalized processes, standardized tools and specialized organizational units. All but two of the 25 companies established centers of competence for alliance management. The centers were often part of a department for corporate development or a department of alliance management at the corporate level. In other corporations, specialized positions for alliance management were created at both the corporate and business unit levels or only at the business unit level. Most corporations prefer a system in which the corporate level provides the methods and tools to support alliances centrally, but decentralizes day-to-day alliance management to the business units.85

C H A P T E R 7 Strategy Formulation: Corporate Strategy 227

Portfolio analysis typically attempts to answer these questions by examining the at- tractiveness of various industries and by managing business units for cash flow, that is, by using cash generated from mature units to build new product lines. Unfortunately, portfo- lio analysis fails to deal with the question of what industries a corporation should enter or with how a corporation can attain synergy among its product lines and business units. As suggested by its name, portfolio analysis tends to primarily view matters financially, re- garding business units and product lines as separate and independent investments.

Corporate parenting, in contrast, views a corporation in terms of resources and ca- pabilities that can be used to build business unit value as well as generate synergies across business units. According to Campbell, Goold, and Alexander:

Multibusiness companies create value by influencing—or parenting—the businesses they own. The best parent companies create more value than any of their rivals would if they owned the same businesses. Those companies have what we call parenting advantage.87

Corporate parenting generates corporate strategy by focusing on the core competen- cies of the parent corporation and on the value created from the relationship between the parent and its businesses. In the form of corporate headquarters, the parent has a great deal of power in this relationship. According to Campbell, Goold, and Alexander, if there is a good fit between the parent’s skills and resources and the needs and opportunities of the business units, the corporation is likely to create value. If, however, there is not a good fit, the corporation is likely to destroy value.88 Research indicates that companies that have a good fit between their strategy and their parenting roles are better performers than those companies that do not have a good fit.89 This approach to corporate strategy is use- ful not only in deciding what new businesses to acquire but also in choosing how each existing business unit should be best managed. This appears to have been the secret to the success of General Electric under CEO Jack Welch. According to one analyst in 2000, “He and his managers really add value by imposing tough standards of profitability and by disseminating knowledge and best practice quickly around the GE empire. If some manufacturing trick cuts costs in GE’s aero-engine repair shops in Wales, he insists it be applied across the group.”90

The primary job of corporate headquarters is, therefore, to obtain synergy among the business units by providing needed resources to units, transferring skills and capabilities among the units, and coordinating the activities of shared unit functions to attain economies of scope (as in centralized purchasing).91 This is in agreement with the con- cept of the learning organization discussed in Chapter 1 in which the role of a large firm is to facilitate and transfer the knowledge assets and services throughout the corporation.92 This is especially important given that 75% or more of a modern com- pany’s market value stems from its intangible assets—the organization’s knowledge and capabilities.93 At Proctor & Gamble, for example, the various business units are expected to work together to develop innovative products. Crest Whitestrips, which controls 68% of the at-home tooth-whitening market, was based on the P&G laundry division’s knowl- edge of whitening agents.94

DEVELOPING A CORPORATE PARENTING STRATEGY Campbell, Goold, and Alexander recommend that the search for appropriate corporate strat- egy involves three analytical steps:

1. Examine each business unit (or target firm in the case of acquisition) in terms of its strategic factors: People in the business units probably identified the strategic factors when they were generating business strategies for their units. One popular approach is to

228 PA RT 3 Strategy Formulation

HORIZONTAL STRATEGY AND MULTIPOINT COMPETITION A horizontal strategy is a corporate strategy that cuts across business unit boundaries to build synergy across business units and to improve the competitive position of one or more business units.96 When used to build synergy, it acts like a parenting strategy. When used to improve the competitive position of one or more business units, it can be thought of as a corporate compet- itive strategy. In multipoint competition, large multi-business corporations compete against other large multi-business firms in a number of markets. These multipoint competitors are firms that compete with each other not only in one business unit, but also in a number of business units. At one time or another, a cash-rich competitor may choose to build its own market share in a particular market to the disadvantage of another corporation’s business unit. Although each business unit has primary responsibility for its own business strategy, it may sometimes need some help from its corporate parent, especially if the competitor business unit is getting heavy financial support from its corporate parent. In this instance, corporate headquarters develops a horizontal strategy to coordinate the various goals and strategies of related business units.

For example, P&G, Kimberly-Clark, Scott Paper, and Johnson & Johnson (J&J) compete with one another in varying combinations of consumer paper products, from disposable dia- pers to facial tissue. If (purely hypothetically) J&J had just developed a toilet tissue with which it chose to challenge Procter & Gamble’s high-share Charmin brand in a particular district, it might charge a low price for its new brand to build sales quickly. P&G might not choose to re- spond to this attack on its share by cutting prices on Charmin. Because of Charmin’s high mar- ket share, P&G would lose significantly more sales dollars in a price war than J&J would with its initially low-share brand. To retaliate, P&G might thus challenge J&J’s high-share baby

establish centers of excellence throughout the corporation. According to Frost, Birkin- shaw, and Ensign, a center of excellence is “an organizational unit that embodies a set of capabilities that has been explicitly recognized by the firm as an important source of value creation, with the intention that these capabilities be leveraged by and/or disseminated to other parts of the firm.”95

2. Examine each business unit (or target firm) in terms of areas in which performance can be improved: These are considered to be parenting opportunities. For example, two business units might be able to gain economies of scope by combining their sales forces. In another instance, a unit may have good, but not great, manufacturing and logistics skills. A parent company having world-class expertise in these areas could improve that unit’s performance. The corporate parent could also transfer some people from one busi- ness unit who have the desired skills to another unit that is in need of those skills. People at corporate headquarters may, because of their experience in many industries, spot areas where improvements are possible that even people in the business unit may not have no- ticed. Unless specific areas are significantly weaker than the competition, people in the business units may not even be aware that these areas could be improved, especially if each business unit monitors only its own particular industry.

3. Analyze how well the parent corporation fits with the business unit (or target firm): Corporate headquarters must be aware of its own strengths and weaknesses in terms of re- sources, skills, and capabilities. To do this, the corporate parent must ask whether it has the characteristics that fit the parenting opportunities in each business unit. It must also ask whether there is a misfit between the parent’s characteristics and the critical success factors of each business unit.

C H A P T E R 7 Strategy Formulation: Corporate Strategy 229

shampoo with P&G’s own low-share brand of baby shampoo in a different district. Once J&J had perceived P&G’s response, it might choose to stop challenging Charmin so that P&G would stop challenging J&J’s baby shampoo.

Multipoint competition and the resulting use of horizontal strategy may actually slow the development of hypercompetition in an industry. The realization that an attack on a market leader’s position could result in a response in another market leads to mutual forbearance in which managers behave more conservatively toward multimarket rivals and competitive ri- valry is reduced.97 In one industry, for example, multipoint competition resulted in firms be- ing less likely to exit a market. “Live and let live” replaced strong competitive rivalry.98

Multipoint competition is likely to become even more prevalent in the future, as corporations become global competitors and expand into more markets through strategic alliances.99

End of Chapter S U M M A R Y Corporate strategy is primarily about the choice of direction for the firm as a whole. It deals with three key issues that a corporation faces: (1) the firm’s overall orientation toward growth, stability, or retrenchment; (2) the industries or markets in which the firm competes through its products and business units; and (3) the manner in which management coordi- nates activities and transfers resources and cultivates capabilities among product lines and business units. These issues are dealt with through directional strategy, portfolio analysis, and corporate parenting.

Managers must constantly examine their corporation’s entire portfolio of products, busi- nesses, and opportunities as if they were planning to reinvest all of its capital.100 One example is Cummins, Inc. in 2003 when management decided to invest heavily in the firm’s power gen- eration business. Management realized at the time that the global appetite for power was grow- ing far faster than local power grids could provide, especially in the fast-growing developing countries. Unfortunately, power generation was the only one of Cummins’ four business units to lose money. Tom Linebarger, Cummins’ CFO, took over the power generation unit, cut costs, and reorganized the division around product lines rather than territories. Over the next four years, sales of the company’s power generators, ranging from portables for RVs to house- sized machines for factories, more than tripled to $3 billion—20% of the company’s total sales. Cummins achieved second place, behind Caterpillar, in the global power generator mar- ket. Management decided to grow horizontally by building plants in China and India and mak- ing small home generators to sell through mass merchandisers.101

E C O - B I T S � Bosch Appliances, the German multinational corpora-

tion, was the only U.S. appliance manufacturer whose entire line of major appliances in 2008 was Energy Star qualified in the categories that the program rates. Ac- cording to Bosch, if the more than 8 million U.S. con- sumers who purchased a new dishwasher in 2007 had

bought a Bosch 800 model instead of a conventional unit, the lifetime energy savings would be equal to pre- venting 21 billion pounds of CO2 emissions.102

� The green building industry is projected to grow from $2.2 billion in 2006 to $4.7 billion by 2011.103

230 PA RT 3 Strategy Formulation

S T R A T E G I C P R A C T I C E E X E R C I S E On March 14, 2000, Stephen King, the horror writer, published his new book, Riding the Bullet, on the Internet before it ap- peared in print. Within 24 hours, around 400,000 people had downloaded the book—even though most of them needed to download software in order to read the book. The unexpected demand crashed servers. According to Jack Romanos, presi- dent of Simon & Schuster, “I don’t think anybody could have anticipated how many people were out there who are willing to accept the written word in a paperless format.” To many, this announced the coming of the electronic novel. Environmental- ists applauded that e-books would soon replace paper books and newspapers, thus reducing pollution coming from paper mills and landfills. The King book was easy to download and took less time than a trip to the bookstore. Critics argued that the King book used the Internet because at 66 pages, it was too short to be a standard printed novel. It was also free, so there was nothing to discourage natural curiosity. Some people in the industry estimated that 75% of those who downloaded the book did not read it.104

By 2008, HarperCollins and Random House were offer- ing free online book content. Amazon was selling a $399 Kin- dle e-book reader for downloadable books costing $10 each, but Apple CEO Steve Jobs described the Kindle as something that filled no void and would “go nowhere.” Sales in electronic trade books increased from $5.8 million in 2002 to $20 million in 2006 compared to total 2006 book sales of $25–$30 billion. Borders was market testing the downloading of digital pur- chases. Tim O’Reilly, coiner of the term Web 2.0, had been urging publishers to go digital since the early 1980s, but pub-

lishers and authors were still concerned with how they would be paid for the intellectual property they created. Om Malik, senior writer for Business 2.0 magazine reported that the money earned from advertising clicks related to their blog con- tent was barely enough to cover the costs of blogging. Flat World Knowledge, a new entrepreneurial digital textbook pub- lisher, announced that in 2009 it planned to offer free online textbooks with the hope that the firm would make money sell- ing supplementary materials like study guides. Publishers wondered how an industry built on a 15th century paper tech- nology could make a profitable transition to a 21st century pa- perless electronic technology.105

1. Form into small groups in the class to discuss the future of Internet publishing.

2. Consider the following questions as discussion guides: � What are the pros and cons of electronic publishing? � What is the impact of electronic publishing on the

environment? � Should newspaper and book publishers completely

convert to electronic publishing over paper? (The Wall Street Journal and others publish in both paper and electronic formats. Is this a success?)

� Would you prefer this textbook and others in an elec- tronic format? How would you prefer to read the book?

� What business model should publishers use to make money publishing on the Internet?

3. Present your group’s conclusions to the class.

D I S C U S S I O N Q U E S T I O N S 1. How does horizontal growth differ from vertical growth

as a corporate strategy? From concentric diversification?

2. What are the tradeoffs between an internal and an exter- nal growth strategy? Which approach is best as an inter- national entry strategy?

3. Is stability really a strategy or just a term for no strategy?

4. Compare and contrast SWOT analysis with portfolio analysis.

5. How is corporate parenting different from portfolio analysis? How is it alike? Is it a useful concept in a global industry?

C H A P T E R 7 Strategy Formulation: Corporate Strategy 231

K E Y T E R M S acquisition (p. 208) backward integration (p. 208) bankruptcy (p. 219) BCG (Boston Consulting Group)

Growth-Share Matrix (p. 221) BOT (Build, Operate, Transfer)

concept (p. 214) captive company strategy (p. 219) cash cows (p. 223) concentration (p. 208) concentric diversification (p. 214) conglomerate diversification (p. 215) corporate parenting (p. 227) corporate strategy (p. 206) directional strategy (p. 207) diversification (p. 208) divestment (p. 219) dogs (p. 223) exporting (p. 211)

forward integration (p. 208) franchising (p. 212) full integration (p. 209) GE business screen (p. 223) green-field development (p. 213) growth strategy (p. 207) horizontal growth (p. 211) horizontal integration (p. 211) horizontal strategy (p. 228) joint venture (p. 212) licensing (p. 212) liquidation (p. 220) long-term contracts (p. 210) management contracts (p. 214) merger (p. 207) multipoint competition (p. 228) no-change strategy (p. 217) parenting strategy (p. 206)

pause/proceed with caution strategy (p. 217)

portfolio analysis (p. 220) production sharing (p. 213) profit strategy (p. 218) quasi-integration (p. 209) question marks (p. 222) retrenchment strategies (p. 207) sell-out strategy (p. 219) stability strategy (p. 207) stars (p. 222) synergy (p. 214) taper integration (p. 209) transaction cost economics (p. 209) turnaround strategy (p. 218) turnkey operations (p. 213) vertical growth (p. 208) vertical integration (p. 208)

N O T E S 1. C. Zook and J. Allen, “Growth Outside the Core,” Harvard

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4. This analogy of corporate parent and business unit children was initially proposed by A. Campbell, M. Goold, and M. Alexander. See “Corporate Strategy: The Quest for Parenting Advantage,” Harvard Business Review (March–April, 1995), pp. 120–132.

5. M. E. Porter, “From Competitive Strategy to Corporate Strategy,” in International Review of Strategic Management, Vol. 1, edited by D. E. Husey (Chicester, UK: John Wiley & Sons, 1990), p. 29.

6. This is in agreement with Toyohiro Kono when he proposes that corporate headquarters has three main functions: formulate cor- porate strategy, identify and develop the company’s core com- petencies, and provide central resources. See T. Kono, “A

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7. “Larry Ups the Ante,” Economist (February 7, 2004), pp. 59–60. 8. J. Bercovitz and W. Mitchell, “When Is More Better? The Impact

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232 PA RT 3 Strategy Formulation

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81. R. G. Hamermesh, Making Strategy Work (New York: John Wiley & Sons, 1986), p. 14.

82. J. J. Curran, “Companies That Rob the Future,” Fortune (July 4, 1988), p. 84.

83. W. H. Hoffmann, “Strategies for Managing a Portfolio of Alliances,” Strategic Management Journal (August 2007), pp. 827–856; D. Lavie, “Alliance Portfolios and Firm Perfor- mance: A Study of Value Creation and Appropriation in the U.S. Software Industry,” Strategic Management Journal (December 2007), pp. 1187–1212.

84. A. Goerzen, “Managing Alliance Networks: Emerging Prac- tices of Multinational Corporations,” Academy of Management Executive (May 2005), pp. 94–107; S. Lazzarini, “The Impact of Membership in Competing Alliance Constellations: Evi- dence on the Operational Performance of Global Airlines,” Strategic Management Journal (April 2007), pp. 345–367.

85. W. H. Hoffmann, “How to Manage a Portfolio of Alliances,” Long Range Planning (April 2005), pp. 121–143.

86. A. Campbell, M. Goold, and M. Alexander, Corporate-Level Strategy: Creating Value in the Multibusiness Company (New York: John Wiley & Sons, 1994). See also M. Goold, A. Campbell, and M. Alexander, “Corporate Strategy and Parent- ing Theory,” Long Range Planning (April 1998), pp. 308–318, and M. Goold and A. Campbell, “Parenting in Complex Struc- tures,” Long Range Planning (June 2002), pp. 219–243.

87. A. Campbell, M. Goold, and M. Alexander, “Corporate Strat- egy: The Quest for Parenting Advantage,” Harvard Business Review (March–April 1995), p. 121.

88. Ibid., p. 122. 89. A. van Oijen and S. Douma, “Diversification Strategy and the

Roles of the Centre,” Long Range Planning (August 2000), pp. 560–578.

90. “Jack’s Gamble,” The Economist (October 28, 2000), pp. 13–14. 91. D. J. Collis, “Corporate Strategy in Multibusiness Firms,” Long

Range Planning (June 1996), pp. 416–418; D. Lei, M. A. Hitt, and R. Bettis, “Dynamic Core Competencies Through Meta- Learning and Strategic Context,” Journal of Management, Vol. 22, No. 4 (1996), pp. 549–569.

92. D. J. Teece, “Strategies for Managing Knowledge Assets: The Role of Firm Structure and Industrial Context,” Long Range Planning (February 2000), pp. 35–54.

93. R. S. Kaplan and D. P. Norton, “The Strategy Map: Guide to Aligning Intangible Assets,” Strategy & Leadership, Vol. 32, No. 5 (2004), pp. 10–17; L. Edvinsson, “The New Knowledge Economics,” Business Strategy Review (September 2002), pp. 72–76; C. Havens and E. Knapp, “Easing into Knowledge Management,” Strategy & Leadership (March/April 1999), pp. 4–9.

94. J. Scanlon, “Cross-Pollinators,” Business Week’s Inside Innova- tion (September 2007), pp. 8–11.

95. T. S. Frost, J. M. Birkinshaw, and P. C. Ensign, “Centers of Ex- cellence in Multinational Corporations,” Strategic Management Journal (November 2002), pp. 997–1018.

96. M. E. Porter, Competitive Advantage (New York: The Free Press, 1985), pp. 317–382.

97. H. R. Greve, “Multimarket Contact and Sales Growth: Evi- dence from Insurance,” Strategic Management Journal (March 2008), pp. 229–249; L. Fuentelsaz and J. Gomez, “Multipoint Competition, Strategic Similarity and Entry Into Geographic Markets,” Strategic Management Journal (May 2006), pp. 477–499; J. Gimeno, “Reciprocal Threats in Multi- market Rivalry: Staking Out ‘Spheres of Influence’ in the U.S. Airline Industry,” Strategic Management Journal (February 1999), pp. 101–128; J. Baum and H. J. Korn, “Dynamics of Dyadic Competitive Interaction,” Strategic Management Journal (March 1999), pp. 251–278; J. Gimeno and C. Y. Woo, “Hypercompetition in a Multimarket Environment: The Role of Strategic Similarity and Multimarket Contact in Com- petitive De-escalation,” Organization Science (May/June 1996), pp. 322–341.

98. W. Boeker, J. Goodstein, J. Stephan, and J. P. Murmann, “Com- petition in a Multimarket Environment: The Case of Market Exit,” Organization Science (March/April 1997), pp. 126–142.

C H A P T E R 7 Strategy Formulation: Corporate Strategy 235

99. J. Gimeno and C. Y. Woo, “Multimarket Contact, Economies of Scope, and Firm Performance,” Academy of Management Jour- nal (June 1999), pp. 239–259.

100. L. Carlesi, B. Verster, and F. Wenger, “The New Dynamics of Managing the Corporate Portfolio,” McKinsey Quarterly On- line (April 2007).

101. B. Hindo, “Generating Power for Cummins,” Business Week (September 24, 2007), p. 90.

102. “Energy Efficiency Update,” Appliance Magazine Online (April 2008).

103. “Sustainability Living Grows Up,” St. Cloud (MN) Times (July 11, 2008), p. 5C.

104. “Learning to E-Read,” The Economist Survey E-Entertainment (October 7, 2000), p. 22.

105. P. Tucker, “The 21st-Century Writer,” The Futurist (July– August 2008), pp. 25–31; M. J. Perenson, “Amazon Kindles Interest in E-Books,” PC World (February 2008), p. 64; M. R. Nelson, “E-Books in Higher Education: Nearing the End of the Era of Hype?” EDUCAUSE Review (March/April 2008), pp. 40–56.

For almost 150 years, the Church & Dwight Company has been building

market share on a brand name whose products are in 95% of all U.S.

households. Yet if you asked the average person what products this company

makes, few would know. Although Church & Dwight may not be a household

name, the company’s ubiquitous orange box of Arm & Hammer1 brand baking

soda is common throughout North America. Church & Dwight provides a classic

example of a marketing functional strategy called market development—finding new uses/

markets for an existing product. Shortly after its introduction in 1878, Arm & Hammer Baking

Soda became a fundamental item on the pantry shelf as people found many uses for sodium

bicarbonate other than baking, such as cleaning, deodorizing, and tooth brushing. Hearing of

the many uses people were finding for its product, the company advertised that its baking soda

was good not only for baking but also for deodorizing refrigerators—simply by leaving an open

box in the refrigerator. In a brilliant marketing move, the firm then suggested that consumers

buy the product and throw it away—deodorize a kitchen sink by dumping Arm & Hammer

baking soda down the drain!

The company did not stop there. It initiated a product development strategy by looking for

other uses of its sodium bicarbonate in new products. Church & Dwight has achieved consistent

growth in sales and earnings through the use of brand extensions, putting the Arm & Hammer

brand first on baking soda and then on laundry detergents, toothpaste, and deodorants. By the

beginning of the 21st century, Church & Dwight had become a significant competitor in mar-

kets previously dominated only by giants such as Procter & Gamble, Unilever, and Colgate-

Palmolive—using only one brand name. Was there a limit to this growth? Was there a point at

which these continuous line extensions would begin to eat away at the integrity of the Arm &

Hammer name?

strategy formulation: functional strategy and Strategic Choice

C H A P T E R 8

237

� Identify a variety of functional strategies that can be used to achieve organizational goals and objectives

� Understand what activities and functions are appropriate to outsource in order to gain or strengthen competitive advantage

� Recognize strategies to avoid and understand why they are dangerous

� Construct corporate scenarios to evaluate strategic options

� Use a stakeholder priority matrix to aid in strategic decision making

� Develop policies to implement corporate, business, and functional strategies

Learning Objectives

Gathering Information

Putting Strategy into Action

Monitoring Performance

Societal Environment: General forces

Natural Environment: Resources and

climate

Task Environment:

Industry analysis

Internal: Strengths and Weaknesses

Structure: Chain of command

Culture: Beliefs, expectations,

values

Resources: Assets, skills, competencies,

knowledge

Programs

Activities needed to accomplish a plan

Budgets

Cost of the programs Procedures

Sequence of steps needed to do the job

Performance

Actual results

External: Opportunities

and Threats

Developing Long-range Plans

Mission

Reason for existence Objectives

What results to accomplish by when

Strategies

Plan to achieve the mission & objectives

Policies

Broad guidelines for decision making

Environmental Scanning:

Strategy Formulation:

Strategy Implementation:

Evaluation and Control:

Feedback/Learning: Make corrections as needed

After reading this chapter, you should be able to:

238 PA RT 3 Strategy Formulation

8.1 Functional Strategy Functional strategy is the approach a functional area takes to achieve corporate and business unit objectives and strategies by maximizing resource productivity. It is concerned with devel- oping and nurturing a distinctive competence to provide a company or business unit with a competitive advantage. Just as a multidivisional corporation has several business units, each with its own business strategy, each business unit has its own set of departments, each with its own functional strategy.

The orientation of a functional strategy is dictated by its parent business unit’s strategy.2

For example, a business unit following a competitive strategy of differentiation through high quality needs a manufacturing functional strategy that emphasizes expensive quality assurance processes over cheaper, high-volume production; a human resource functional strategy that emphasizes the hiring and training of a highly skilled, but costly, workforce; and a marketing functional strategy that emphasizes distribution channel “pull,” using advertising to increase consumer demand, over “push,” using promotional allowances to retailers. If a business unit were to follow a low-cost competitive strategy, however, a different set of functional strategies would be needed to support the business strategy.

Just as competitive strategies may need to vary from one region of the world to another, functional strategies may need to vary from region to region. When Mr. Donut expanded into Japan, for example, it had to market donuts not as breakfast, but as snack food. Because the Japanese had no breakfast coffee-and-donut custom, they preferred to eat the donuts in the af- ternoon or evening. Mr. Donut restaurants were thus located near railroad stations and super- markets. All signs were in English to appeal to the Western interests of the Japanese.

MARKETING STRATEGY Marketing strategy deals with pricing, selling, and distributing a product. Using a market development strategy, a company or business unit can (1) capture a larger share of an existing market for current products through market saturation and market penetration or (2) develop new uses and/or markets for current products. Consumer product giants such as P&G, Colgate- Palmolive, and Unilever are experts at using advertising and promotion to implement a mar- ket saturation/penetration strategy to gain the dominant market share in a product category. As seeming masters of the product life cycle, these companies are able to extend product life al- most indefinitely through “new and improved” variations of product and packaging that ap- peal to most market niches. A company, such as Arm & Hammer, follows the second market development strategy by finding new uses for its successful current product, baking soda.

Using the product development strategy, a company or unit can (1) develop new prod- ucts for existing markets or (2) develop new products for new markets. Church & Dwight has had great success by following the first product development strategy developing new prod- ucts to sell to its current customers in its existing markets. Acknowledging the widespread ap- peal of its Arm & Hammer brand baking soda, the company has generated new uses for its sodium bicarbonate by reformulating it as toothpaste, deodorant, and detergent. In another ex- ample, Ocean Spray developed craisans, mock berries, light cranberry juices, and juice boxes in order to market its cranberries to current customers.3 Using a successful brand name to mar- ket other products is called brand extension, and it is a good way to appeal to a company’s cur- rent customers. Smith & Wesson, famous for its handguns, has taken this approach by using licensing to put its name on men’s cologne and other products like the Smith & Wesson 357 Magnum Wood Pellet Smoker (for smoking meats).4 Arm & Hammer has successfully followed the second product development strategy (new products for new markets) by

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 239

developing new pollution-reduction products (using sodium bicarbonate compounds) for sale to coal-fired electric utility plants—a very different market from grocery stores.

There are numerous other marketing strategies. For advertising and promotion, for exam- ple, a company or business unit can choose between “push” and “pull” marketing strategies. Many large food and consumer products companies in the United States and Canada follow a push strategy by spending a large amount of money on trade promotion in order to gain or hold shelf space in retail outlets. Trade promotion includes discounts, in-store special offers, and ad- vertising allowances designed to “push” products through the distribution system. The Kellogg Company decided a few years ago to change its emphasis from a push to a pull strategy, in which advertising “pulls” the products through the distribution channels. The company now spends more money on consumer advertising designed to build brand awareness so that shoppers will ask for the products. Research has found that a high level of advertising (a key part of a pull strat- egy) is beneficial to leading brands in a market.5 Strong brands provide a competitive advantage to a firm because they act as entry barriers and usually generate high market share.6

Other marketing strategies deal with distribution and pricing. Should a company use distrib- utors and dealers to sell its products, or should it sell directly to mass merchandisers or use the direct marketing model by selling straight to the consumers via the Internet? Using multiple chan- nels simultaneously can lead to problems. In order to increase the sales of its lawn tractors and mowers, for example, John Deere decided to sell the products not only through its current dealer network but also through mass merchandisers such as Home Depot. Deere’s dealers, however, were furious. They considered Home Depot to be a key competitor. The dealers were concerned that Home Depot’s ability to underprice them would eventually lead to their becoming little more than repair facilities for their competition and left with insufficient sales to stay in business.7

When pricing a new product, a company or business unit can follow one of two strategies. For new-product pioneers, skim pricing offers the opportunity to “skim the cream” from the top of the demand curve with a high price while the product is novel and competitors are few. Penetration pricing, in contrast, attempts to hasten market development and offers the pioneer the opportunity to use the experience curve to gain market share with a low price and then dominate the industry. Depending on corporate and business unit objectives and strategies, ei- ther of these choices may be desirable to a particular company or unit. Penetration pricing is, however, more likely than skim pricing to raise a unit’s operating profit in the long term.8 The use of the Internet to market goods directly to consumers allows a company to use dynamic pricing, a practice in which prices vary frequently based upon demand, market segment, and product availability.9

FINANCIAL STRATEGY Financial strategy examines the financial implications of corporate and business-level strate- gic options and identifies the best financial course of action. It can also provide competitive advantage through a lower cost of funds and a flexible ability to raise capital to support a busi- ness strategy. Financial strategy usually attempts to maximize the financial value of a firm.

The trade-off between achieving the desired debt-to-equity ratio and relying on internal long-term financing via cash flow is a key issue in financial strategy. Many small- and medium- sized family-owned companies such as Urschel Laboratories try to avoid all external sources of funds in order to avoid outside entanglements and to keep control of the company within the family. Few large publicly-held firms have no long-term debt and instead keep a large amount of money in cash and short-term investments. One of these is Apple, Inc. According to Apple’s Chief Financial Officer, Peter Oppenheimer, “Our preference is to maintain a strong balance sheet in order to preserve our flexibility.”10 Many financial analysts believe, however, that only by financing through long-term debt can a corporation use financial leverage to boost earnings

240 PA RT 3 Strategy Formulation

per share—thus raising stock price and the overall value of the company. Research indicates that higher debt levels not only deter takeover by other firms (by making the company less at- tractive) but also lead to improved productivity and improved cash flows by forcing manage- ment to focus on core businesses.11 High debt can be a problem, however, when the economy falters and a company’s cash flow drops.

Research reveals that a firm’s financial strategy is influenced by its corporate diversifica- tion strategy. Equity financing, for example, is preferred for related diversification, whereas debt financing is preferred for unrelated diversification.12 The trend away from unrelated to re- lated acquisitions explains why the number of acquisitions being paid for entirely with stock increased from only 2% in 1988 to 50% in 1998.13

A very popular financial strategy is the leveraged buyout (LBO). During 2006 and 2007, for example, the total value of LBOs was $1.4 trillion, about one-third of all the buyouts ever done.14

In a leveraged buyout, a company is acquired in a transaction financed largely by debt, usually obtained from a third party, such as an insurance company or an investment banker. Ultimately the debt is paid with money generated from the acquired company’s operations or by sales of its assets. The acquired company, in effect, pays for its own acquisition. Management of the LBO is then under tremendous pressure to keep the highly leveraged company profitable. Unfortunately, the huge amount of debt on the acquired company’s books may actually cause its eventual de- cline by focusing management’s attention on short-term matters. For example, one year after the buyout, the cash flow of eight of the largest LBOs made during 2006–2007 was barely enough to cover interest payments.15 One study of LBOs (also called MBOs—Management BuyOuts) revealed that the financial performance of the typical LBO usually falls below the industry aver- age in the fourth year after the buyout. The firm declines because of inflated expectations, uti- lization of all slack, management burnout, and a lack of strategic management.16 Often the only solutions are to sell the company or to again go public by selling stock to finance growth.17

The management of dividends and stock price is an important part of a corporation’s fi- nancial strategy. Corporations in fast-growing industries such as computers and computer soft- ware often do not declare dividends. They use the money they might have spent on dividends to finance rapid growth. If the company is successful, its growth in sales and profits is reflected in a higher stock price, eventually resulting in a hefty capital gain when shareholders sell their common stock. Other corporations, such as Whirlpool Corporation, that do not face rapid growth, must support the value of their stock by offering consistent dividends. Instead of rais- ing dividends when profits are high, a popular financial strategy is to use excess cash (or even use debt) to buy back a company’s own shares of stock. During 2005, for example, 1,012 U.S.- based publicly traded companies declared $446 billion worth of stock repurchase plans. Be- cause stock buybacks increase earnings per share, they typically increase a firm’s stock price and make unwanted takeover attempts more difficult. Such buybacks do signal, however, that either management may not have been able to find any profitable investment opportunities for the company or that it is anticipating reduced future earnings.18

A number of firms have been supporting the price of their stock by using reverse stock splits. Contrasted with a typical forward 2-for-1 stock split in which an investor receives an additional share for every share owned (with each share being worth only half as much), in a reverse 1-for-2 stock split, an investor’s shares are split in half for the same total amount of money (with each share now being worth twice as much). Thus, 100 shares of stock worth $10 each are exchanged for 50 shares worth $20 each. A reverse stock split may successfully raise a company’s stock price, but it does not solve underlying problems. A study by Credit Suisse First Boston revealed that almost all 800 companies that had reverse stock splits in a five-year period underperformed their peers over the long term.19

A rather novel financial strategy is the selling of a company’s patents. Companies such as AT&T, Bellsouth, American Express, Kimberly Clark, and 3Com have been selling patents for products that they no longer wish to commercialize or are not a part of their core business.

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 241

TABLE 8–1 Technological Leadership Technological Followership

Research and Development Strategy and Competitive Advantage

Cost Advantage Pioneer the lowest-cost production design. Be the first down the learning curve. Create low cost ways of performing value activities.

Lower the cost of the product or value activities by learning from the leader’s experience. Avoid R & D costs through imitation.

Differentiation Pioneer a unique product that increases buyer value. Innovate in other activities to increase buyer value.

Adapt the product or delivery system more closely to buyer needs by learning from the leader’s experience.

SOURCE: Reprinted with the permission of The Free Press, a Division of Simon & Schuster, from COMPETITIVE ADVANTAGE. Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1988 by The Free Press. All rights reserved.

They use an intermediary, like Chicago-based Ocean Tomo, to group the patents into lots re- lated to a common area and sell them to the highest bidder.20

RESEARCH AND DEVELOPMENT (R&D) STRATEGY R&D strategy deals with product and process innovation and improvement. It also deals with the appropriate mix of different types of R&D (basic, product, or process) and with the ques- tion of how new technology should be accessed—through internal development, external ac- quisition, or strategic alliances.

One of the R&D choices is to be either a technological leader, pioneering an innovation, or a technological follower, imitating the products of competitors. Porter suggests that decid- ing to become a technological leader or follower can be a way of achieving either overall low cost or differentiation. (See Table 8–1.)

One example of an effective use of the leader R&D functional strategy to achieve a dif- ferentiation competitive advantage is Nike, Inc. Nike spends more than most in the industry on R&D to differentiate the performance of its athletic shoes from that of its competitors. As a result, its products have become the favorite of serious athletes. An example of the use of the follower R&D functional strategy to achieve a low-cost competitive advantage is Dean Foods Company. “We’re able to have the customer come to us and say, ‘If you can produce X, Y, and Z product for the same quality and service, but at a lower price and without that expensive la- bel on it, you can have the business,’” says Howard Dean, president of the company.21

An increasing number of companies are working with their suppliers to help them keep up with changing technology. They are beginning to realize that a firm cannot be competitive tech- nologically only through internal development. For example, Chrysler Corporation’s skillful use of parts suppliers to design everything from car seats to drive shafts has enabled it to spend consistently less money than its competitors to develop new car models. Using strategic tech- nology alliances is one way to combine the R&D capabilities of two companies. Maytag Com- pany worked with one of its suppliers to apply fuzzy logic technology to its IntelliSense™ dishwasher. The partnership enabled Maytag to complete the project in a shorter amount of time than if it had tried to do it alone.22 One UK study found that 93% of UK auto assemblers and component manufacturers use their suppliers as technology suppliers.23

A new approach to R&D is open innovation, in which a firm uses alliances and connec- tions with corporate, government, academic labs, and even consumers to develop new prod- ucts and processes. For example, Intel opened four small-scale research facilities adjacent to universities to promote the cross-pollination of ideas. Thirteen U.S. university labs engaging

242 PA RT 3 Strategy Formulation

in nanotechnology research have formed the National Nanotechnology Infrastructure Network in order to offer their resources to businesses for a fee.24 Mattel, Wal-Mart, and other toy man- ufacturers and retailers use idea brokers such as Big Idea Group to scout for new toy ideas. Big Idea Group invites inventors to submit ideas to its Web site (www.bigideagroup.net). It then refines and promotes to its clients the most promising ideas.25 IBM adopted the open operat- ing system Linux for some of its computer products and systems, drawing on a core code base that is continually improved and enhanced by a massive global community of software devel- opers, of whom only a fraction work for IBM.26 To open its own labs to ideas being generated elsewhere, P&G’s CEO Art Lafley decreed that half of the company’s ideas must come from outside, up from 10% in 2000. P&G instituted the use of technology scouts to search beyond the company for promising innovations. By 2007, the objective was achieved: 50% of the company’s innovations originated outside P&G.27

A slightly different approach to technology development is for a large firm such as IBM or Microsoft to purchase minority stakes in relatively new high-tech entrepreneurial ventures that need capital to continue operation. Investing corporate venture capital is one way to gain access to promising innovations at a lower cost than by developing them internally.28

OPERATIONS STRATEGY Operations strategy determines how and where a product or service is to be manufactured, the level of vertical integration in the production process, the deployment of physical re- sources, and relationships with suppliers. It should also deal with the optimum level of tech- nology the firm should use in its operations processes. See the Global Issue feature to see how differences in national conditions can lead to differences in product design and manufacturing facilities from one country to another.

Advanced Manufacturing Technology (AMT) is revolutionizing operations worldwide and should continue to have a major impact as corporations strive to integrate diverse busi- ness activities by using computer assisted design and manufacturing (CAD/CAM) principles. The use of CAD/CAM, flexible manufacturing systems, computer numerically controlled sys- tems, automatically guided vehicles, robotics, manufacturing resource planning (MRP II), op- timized production technology, and just-in-time techniques contribute to increased flexibility, quick response time, and higher productivity. Such investments also act to increase the com- pany’s fixed costs and could cause significant problems if the company is unable to achieve economies of scale or scope. Baldor Electric Company, the largest maker of industrial electric motors in the United States, built a new factory by using the new technology to eliminate undesirable jobs with high employee turnover. With one-tenth the employees of its foreign plants, the plant was cost-competitive with motors produced in Mexico or China.29

A firm’s manufacturing strategy is often affected by a product’s life cycle. As the sales of a product increase, there will be an increase in production volume ranging from lot sizes as low as one in a job shop (one-of-a-kind production using skilled labor) through connected line batch flow (components are standardized; each machine functions such as a job shop but is po- sitioned in the same order as the parts are processed) to lot sizes as high as 100,000 or more per year for flexible manufacturing systems (parts are grouped into manufacturing families to produce a wide variety of mass-produced items) and dedicated transfer lines (highly auto- mated assembly lines making one mass-produced product using little human labor). Accord- ing to this concept, the product becomes standardized into a commodity over time in conjunction with increasing demand. Flexibility thus gives way to efficiency.30

Increasing competitive intensity in many industries has forced companies to switch from traditional mass production using dedicated transfer lines to a continuous improvement pro- duction strategy. A mass-production system was an excellent method to produce a large num- ber of low-cost, standard goods and services. Employees worked on narrowly defined,

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 243

SOURCE: WHEELEN, TOM; HUNGER, J. DAVID, STRATEGIC MAN- AGEMENT AND BUSINESS POLICY, 9th Edition, © 2004, p. 172. Reprinted by permission of Pearson Education, Inc. Upper Saddle River, NJ.

ple, material costs may run as much as 200% to 800% higher than elsewhere, while labor and overhead costs are comparatively minimal,” added Kremer. Another consider- ation was the garments to be washed in each country. For example, saris—the 18-foot lengths of cotton or silk with which Indian women drape themselves—needed special treatment in an Indian washing machine, forcing addi- tional modifications.

Manufacturing facilities also varied from country to country. Brastemp, Whirlpool’s Brazilian partner, built its plant of precast concrete to address the problems of high humidity. In India, however, the construction crew cast the concrete, allowed it to cure, and then using chain, block, and tackle, five or six men raised each three-ton slab into place. Instead of using one building, Mexican operations used two, one housing the flexible assembly lines and stamping operations, and an adjacent facility housing the injection molding and extrusion processes.

INTERNATIONAL DIFFERENCES ALTER WHIRLPOOL’S OPERATIONS STRATEGY

To better penetrate the growing markets in develop-

ing nations, Whirlpool decided to build a “world washer.” This

new type of washing machine was to be produced in Brazil, Mexico, and India. Lightweight, with substantially fewer parts than its U.S. counterpart, its per- formance was to be equal to or better than anything on the world market while being competitive in price with the most popular models in these markets. The goal was to de- velop a complete product, process, and facility design package that could be used in different countries with low initial investment. Originally the plan had been to make the same low-cost washer in identical plants in each of the three countries.

Significant differences in each of the three countries forced Whirlpool to change its product design to adapt to each nation’s situation. According to Lawrence Kremer, Se- nior Vice President of Global Technology and Operations, “Our Mexican affiliate, Vitromatic, has porcelain and glass- making capabilities. Porcelain baskets made sense for them. Stainless steel became the preferred material for the others.” Costs also affected decisions. “In India, for exam-

GLOBAL issue

repetitious tasks under close supervision in a bureaucratic and hierarchical structure. Quality, however, often tended to be fairly low. Learning how to do something better was the preroga- tive of management; workers were expected only to learn what was assigned to them. This sys- tem tended to dominate manufacturing until the 1970s. Under the continuous improvement system developed by Japanese firms, empowered cross-functional teams strive constantly to improve production processes. Managers are more like coaches than like bosses. The result is a large quantity of low-cost, standard goods and services, but with high quality. The key to continuous improvement is the acknowledgment that workers’ experience and knowledge can help managers solve production problems and contribute to tightening variances and reducing errors. Because continuous improvement enables firms to use the same low-cost competitive strategy as do mass-production firms but at a significantly higher level of quality, it is rapidly replacing mass production as an operations strategy.

The automobile industry is currently experimenting with the strategy of modular manu- facturing in which preassembled subassemblies are delivered as they are needed (i.e., Just- in-Time) to a company’s assembly-line workers, who quickly piece the modules together into a finished product. For example, General Motors built a new automotive complex in Brazil to make its new subcompact, the Celta. Sixteen of the 17 buildings were occupied by suppli- ers, including Delphi, Lear, and Goodyear. These suppliers delivered preassembled modules (which comprised 85% of the final value of each car) to GM’s building for assembly. In a process new to the industry, the suppliers acted as a team to build a single module compris- ing the motor, transmission, fuel lines, rear axle, brake-fluid lines, and exhaust system, which was then installed as one piece. GM hoped that this manufacturing strategy would enable it

244 PA RT 3 Strategy Formulation

to produce 100 vehicles annually per worker compared to the standard rate of 30 to 50 autos per worker.31 Ford and Chrysler have also opened similar modular facilities in Brazil.

The concept of a product’s life cycle eventually leading to one-size-fits-all mass produc- tion is being increasingly challenged by the new concept of mass customization. Appropriate for an ever-changing environment, mass customization requires that people, processes, units, and technology reconfigure themselves to give customers exactly what they want, when they want it. In the case of Dell Computer, customers use the Internet to design their own comput- ers. In contrast to continuous improvement, mass customization requires flexibility and quick responsiveness. Managers coordinate independent, capable individuals. An efficient linkage system is crucial. The result is low-cost, high-quality, customized goods and services appro- priate for a large number of market niches.

A contentious issue for manufacturing companies throughout the world is the availability of resources needed to operate a modern factory. The increasing cost of oil during 2007 and 2008 drastically boosted costs, only some of which could be passed on to the customers in a competitive environment. The likelihood that fresh water could become an equally scarce re- source is causing many companies to rethink water-intensive manufacturing processes. To learn how companies are beginning to deal with increasing fresh water scarcity, see the Environmental Sustainability Issue feature.

PURCHASING STRATEGY Purchasing strategy deals with obtaining the raw materials, parts, and supplies needed to per- form the operations function. Purchasing strategy is important because materials and compo- nents purchased from suppliers comprise 50% of total manufacturing costs of manufacturing companies in the United Kingdom, United States, Australia, Belgium, and Finland.32 The ba- sic purchasing choices are multiple, sole, and parallel sourcing. Under multiple sourcing, the purchasing company orders a particular part from several vendors. Multiple sourcing has tra- ditionally been considered superior to other purchasing approaches because (1) it forces sup- pliers to compete for the business of an important buyer, thus reducing purchasing costs, and (2) if one supplier cannot deliver, another usually can, thus guaranteeing that parts and sup- plies are always on hand when needed. Multiple sourcing has been one way for a purchasing firm to control the relationship with its suppliers. So long as suppliers can provide evidence that they can meet the product specifications, they are kept on the purchaser’s list of accept- able vendors for specific parts and supplies. Unfortunately, the common practice of accepting the lowest bid often compromises quality.

W. Edward Deming, a well-known management consultant, strongly recommended sole sourcing as the only manageable way to obtain high supplier quality. Sole sourcing relies on only one supplier for a particular part. Given his concern with designing quality into a product in its early stages of development, Deming argued that the buyer should work closely with the sup- plier at all stages. This reduces both cost and time spent on product design and it also improves quality. It can also simplify the purchasing company’s production process by using the Just-In- Time (JIT) concept of having the purchased parts arrive at the plant just when they are needed rather than keeping inventories. The concept of sole sourcing is taken one step further in JIT II, in which vendor sales representatives actually have desks next to the purchasing company’s fac- tory floor, attend production status meetings, visit the R&D lab, and analyze the purchasing com- pany’s sales forecasts. These in-house suppliers then write sales orders for which the purchasing company is billed. Developed by Lance Dixon at Bose Corporation, JIT II is also being used at IBM, Honeywell, and Ingersoll-Rand. Karen Dale, purchasing manager for Honeywell’s office supplies, said she was very concerned about confidentiality when JIT II was first suggested to her. Soon she had five suppliers working with her 20 buyers and reported few problems.33

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 245

Sole sourcing reduces transaction costs and builds quality by having the purchaser and supplier work together as partners rather than as adversaries. With sole sourcing, more com- panies will have longer relationships with fewer suppliers. Research has found that buyer- supplier collaboration and joint problem solving with both parties dependent upon the other results in the development of competitive capabilities, higher quality, lower costs, and better scheduling.34 Sole sourcing does, however, have limitations. If a supplier is unable to deliver a part, the purchaser has no alternative but to delay production. Multiple suppliers can provide the purchaser with better information about new technology and performance capabilities. The limitations of sole sourcing have led to the development of parallel sourcing. In parallel sourc- ing, two suppliers are the sole suppliers of two different parts, but they are also backup sup- pliers for each other’s parts. If one vendor cannot supply all of its parts on time, the other vendor is asked to make up the difference.35

SOURCE: K. Kube, “Into the Wild Brown Yonder,” Trains (Novem- ber 2008), pp. 68–73; “Running Dry,” The Economist (August 23, 2008), pp. 53–54.

“Water is the oil of the 21st century,” contends Andrew Liveris, CEO of the chemical company Dow. Like oil, sup- plies of clean, easily accessible fresh water are under a growing strain because of the growing population and widespread improvements in living standards. Industrial- ization in developing nations is contaminating rivers and aquifers. Climate change is altering the patterns of fresh water availability so that droughts are more likely in many parts of the world. According to a survey by the Marsh Center for Risk Insights, 40% of Fortune 1000 companies stated that the impact of a water shortage on their busi- ness would be “severe” or “catastrophic,” but only 17% said that they were prepared for such a crisis. Of Nestlé’s 481 factories worldwide, 49 are located in water-scarce re- gions. Environmental activists have attacked PepsiCo and Coca-Cola for allegedly depleting groundwater in India to make bottled drinks.

There are a number of companies that are taking action to protect their future supply of freshwater. Dow has re- duced the amount of water it uses by over a third since 1995. During 1997–2006, when Nestle almost doubled the volume of food it produced, it reduced the amount of water used by 29%. By 2008, Coca-Cola had achieved 85% of its objective to clean all of the wastewater gener- ated at its bottling plants by 2010. China’s Elion Chemical is working with General Electric to recycle 90% of its wastewater to comply with the government’s new “zero- liquid” discharge rules.

The U.S. Department of En- ergy (DOE) plans to build a rail

line more than 300 miles long through the Nevada wilderness

to move spent nuclear fuel from 121 sites in 39 states to a geologic repos-

itory at Yucca Mountain. One of the biggest issues to over- come will be water supply. The DOE estimates that the construction phase would require 5,500 acre feet of water for earthwork compaction, 370 acre-feet for construction personnel, 200 acre-feet for dust control along access roads, and 30 acre-feet for quarry operations, totaling 6,100 acre- feet, or two billion gallons, of water to support a four-year construction period. To meet this need, DOE wants to drill 150 to 176 new wells. The state of Nevada, however, has re- jected a permit request to use water for drilling on the Yucca Mountain site, stating that water has to be used for the ben- efit of the public. Negotiations continue.

This is just one of the ways that organizations need fresh water for their operations. Nestlé, Unilever, Coca- Cola, Anheuser-Busch, and Danone consume almost 575 billion liters of water a year, enough to satisfy the daily water needs of every person on the planet. It takes about 13 cubic meters of freshwater to produce a single 200 mm semiconductor wafer. As a result, chip making is believed to account for 25% of the water consumption in Silicon Valley. According to Jose Lopez, Nestlé’s COO, it takes four liters of water to make one liter of product in Nestlé’s factories, but 3,000 liters of water are needed to grow the agricultural produce that supplies them. Each year, around 40% of the freshwater withdrawn from lakes and aquifers in America is used to cool power plants. Separating one liter of oil from Canada’s tar sands requires up to five liters of water!

OPERATIONS NEED FRESH WATER AND LOTS OF IT!

ENVIRONMENTAL sustainability issue

246 PA RT 3 Strategy Formulation

The Internet is being increasingly used both to find new sources of supply and to keep in- ventories replenished. For example, Hewlett-Packard introduced a Web-based procurement system to enable its 84,000 employees to buy office supplies from a standard set of suppliers. The new system enabled the company to save $60 to $100 million annually in purchasing costs.36 Research indicates that companies using Internet-based technologies are able to lower administrative costs and purchase prices.37

LOGISTICS STRATEGY Logistics strategy deals with the flow of products into and out of the manufacturing process. Three trends related to this strategy are evident: centralization, outsourcing, and the use of the Internet. To gain logistical synergies across business units, corporations began centralizing lo- gistics in the headquarters group. This centralized logistics group usually contains specialists with expertise in different transportation modes such as rail or trucking. They work to aggregate shipping volumes across the entire corporation to gain better contracts with shippers. Compa- nies such as Georgia-Pacific, Marriott, and Union Carbide view the logistics function as an im- portant way to differentiate themselves from the competition, to add value, and to reduce costs.

Many companies have found that outsourcing logistics reduces costs and improves deliv- ery time. For example, HP contracted with Roadway Logistics to manage its inbound raw ma- terials warehousing in Vancouver, Canada. Nearly 140 Roadway employees replaced 250 HP workers, who were transferred to other HP activities.38

Many companies are using the Internet to simplify their logistical system. For example, Ace Hardware created an online system for its retailers and suppliers. An individual hardware store can now see on the Web site that ordering 210 cases of wrenches is cheaper than order- ing 200 cases. Because a full pallet is composed of 210 cases of wrenches, an order for a full pallet means that the supplier doesn’t have to pull 10 cases off a pallet and repackage them for storage. There is less chance that loose cases will be lost in delivery, and the paperwork doesn’t have to be redone. As a result, Ace’s transportation costs are down 18%, and ware- house costs have been cut 28%.39

HUMAN RESOURCE MANAGEMENT (HRM) STRATEGY HRM strategy, among other things, addresses the issue of whether a company or business unit should hire a large number of low-skilled employees who receive low pay, perform repetitive jobs, and are most likely quit after a short time (the McDonald’s restaurant strategy) or hire skilled employees who receive relatively high pay and are cross-trained to participate in self- managing work teams. As work increases in complexity, the more suited it is for teams, espe- cially in the case of innovative product development efforts. Multinational corporations are increasingly using self-managing work teams in their foreign affiliates as well as in home- country operations.40 Research indicates that the use of work teams leads to increased quality and productivity as well as to higher employee satisfaction and commitment.41

Companies following a competitive strategy of differentiation through high quality use in- put from subordinates and peers in performance appraisals to a greater extent than do firms following other business strategies.42 A complete 360-degree appraisal, in which input is gath- ered from multiple sources, is now being used by more than 10% of U.S. corporations and has become one of the most popular and effective tools in developing employees and new man- agers.43 One Indian company, HCL Technologies, publishes the appraisal ratings for the top 20 managers on the company’s intranet for all to see.44

Companies are finding that having a diverse workforce can be a competitive advantage. Research reveals that firms with a high degree of racial diversity following a growth strategy

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 247

have higher productivity than do firms with less racial diversity.45 Avon Company, for exam- ple, was able to turn around its unprofitable inner-city markets by putting African-American and Hispanic managers in charge of marketing to these markets.46 Diversity in terms of age and national origin also offers benefits. DuPont’s use of multinational teams has helped the company develop and market products internationally. McDonald’s has discovered that older workers perform as well as, if not better than, younger employees. According to Edward Rensi, CEO of McDonald’s USA, “We find these people to be particularly well motivated, with a sort of discipline and work habits hard to find in younger employees.”47

INFORMATION TECHNOLOGY STRATEGY Corporations are increasingly using information technology strategy to provide business units with competitive advantage. When FedEx first provided its customers with PowerShip computer software to store addresses, print shipping labels, and track package location, its sales jumped significantly. UPS soon followed with its own MaxiShips software. Viewing its information sys- tem as a distinctive competency, FedEx continued to push for further advantage over UPS by us- ing its Web site to enable customers to track their packages. FedEx uses this competency in its advertisements by showing how customers can track the progress of their shipments. Soon there- after, UPS provided the same service. Although it can be argued that information technology has now become so pervasive that it no longer offers companies a competitive advantage, corpora- tions worldwide continue to spend over $2 trillion annually on information technology.48

Multinational corporations are finding that having a sophisticated intranet allows employ- ees to practice follow-the-sun management, in which project team members living in one coun- try can pass their work to team members in another country in which the work day is just beginning. Thus, night shifts are no longer needed.49 The development of instant translation software is also enabling workers to have online communication with co-workers in other countries who use a different language.50 For example, Mattel has cut the time it takes to de- velop new products by 10% by enabling designers and licensees in other countries to collabo- rate on toy design. IBM uses its intranet to allow its employees to collaborate and improve their skills, thus reducing its training and travel expenses.51

Many companies, such as Lockheed Martin, General Electric, and Whirlpool, use informa- tion technology to form closer relationships with both their customers and suppliers through so- phisticated extranets. For example, General Electric’s Trading Process Network allows suppliers to electronically download GE’s requests for proposals, view diagrams of parts specifications, and communicate with GE purchasing managers. According to Robert Livingston, GE’s head of worldwide sourcing for the Lighting Division, going on the Web reduces processing time by one-third.52 Thus, the use of information technology through extranets makes it easier for a com- pany to buy from others (outsource) rather than make it themselves (vertically integrate).53

8.2 The Sourcing Decision: Location of Functions For a functional strategy to have the best chance of success, it should be built on a distinc- tive competency residing within that functional area. If a corporation does not have a distinc- tive competency in a particular functional area, that functional area could be a candidate for outsourcing.

Outsourcing is purchasing from someone else a product or service that had been previously provided internally. Thus, it is the reverse of vertical integration. Outsourcing is becoming an in- creasingly important part of strategic decision making and an important way to increase effi- ciency and often quality. In a study of 30 firms, outsourcing resulted on average in a 9% reduction

248 PA RT 3 Strategy Formulation

in costs and a 15% increase in capacity and quality.54 For example, Boeing used outsourcing as a way to reduce the cost of designing and manufacturing its new 787 Dreamliner. Up to 70% of the plane was outsourced. In a break from past practice, suppliers make large parts of the fuse- lage, including plumbing, electrical, and computer systems, and ship them to Seattle for assem- bly by Boeing. Outsourcing enabled Boeing to build a 787 in 4 months instead of the usual 12.55

According to an American Management Association survey of member companies, 94% of the responding firms outsource at least one activity. The outsourced activities are general and administrative (78%), human resources (77%), transportation and distribution (66%), in- formation systems (63%), manufacturing (56%), marketing (51%), and finance and account- ing (18%). The survey also reveals that 25% of the respondents have been disappointed in their outsourcing results. Fifty-one percent of the firms reported bringing an outsourced activity back in-house. Nevertheless, authorities not only expect the number of companies engaging in outsourcing to increase, they also expect companies to outsource an increasing number of functions, especially those in customer service, bookkeeping, financial/clerical, sales/telemar- keting, and the mailroom.56 It is estimated that 50% of U.S. manufacturing will be outsourced to firms in 28 developing countries by 2015.57

Offshoring is the outsourcing of an activity or a function to a wholly owned company or an independent provider in another country. Offshoring is a global phenomenon that has been supported by advances in information and communication technologies, the development of stable, secure, and high-speed data transmission systems, and logistical advances like con- tainerized shipping. According to Bain & Company, 51% of large firms in North America, Europe, and Asia outsource offshore.58 Although India currently has 70% of the offshoring market, countries such as Brazil, China, Russia, the Phillipines, Malaysia, Hungary, the Czech Republic, and Israel are growing in importance. These countries have low-cost qualified la- bor and an educated workforce. These are important considerations because more than 93% of offshoring companies do so to reduce costs.59 For example, Mexican assembly line work- ers average $3.50 an hour plus benefits compared to $27 an hour plus benefits at a GM or Ford plant in the U.S. Less skilled Mexican workers at auto parts makers earn as little as $1.50 per hour with fewer benefits.60

Software programming and customer service, in particular, are being outsourced to India. For example, General Electric’s back-office services unit, GE Capital International Services, is one of the oldest and biggest of India’s outsourcing companies. From only $26 million in 1999, its annual revenues grew to over $420 million by 2004.61 As part of this trend, IBM acquired Daksh eServices Ltd., one of India’s biggest suppliers of remote busi- ness services.62

Outsourcing, including offshoring, has significant disadvantages. For example, mount- ing complaints forced Dell Computer to stop routing corporate customers to a technical sup- port call center in Bangalore, India.63 GE’s introduction of a new washing machine was delayed three weeks because of production problems at a supplier’s company to which it had contracted out key work. Some companies have found themselves locked into long-term con- tracts with outside suppliers that were no longer competitive.64 Some authorities propose that the cumulative effects of continued outsourcing steadily reduces a firm’s ability to learn new skills and to develop new core competencies.65 One survey of 129 outsourcing firms revealed that half the outsourcing projects undertaken in one year failed to deliver anticipated savings. This is in agreement with a survey by Bain & Company in which 51% of large North Amer- ican, European, and Asian firms stated that outsourcing (including offshoring) did not meet their expectations.66 Another survey of software projects, by MIT, found that the median In- dian project had 10% more software bugs than did comparable U.S. projects.67 During 2007–2008, tainted goods made by Chinese manufacturers, ranging from lead paint on toys, contaminated heparin, and melamine-laced milk caused their customers to reevaluate the

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 249

manner in which they engaged in offshore outsourcing.68 The increasing cost of oil was mak- ing offshoring less economical. Since 2003, crude oil increased in price from $28 to over $100 a barrel in 2008, causing the cost to ship a standard 40-foot container to triple. By 2008 it cost about $100 to ship a ton of iron from Brazil to China, more than the cost of the min- eral itself.69

A study of 91 outsourcing efforts conducted by European and North American firms found seven major errors that should be avoided:

1. Outsourcing activities that should not be outsourced: Companies failed to keep core activities in-house.

2. Selecting the wrong vendor: Vendors were not trustworthy or lacked state-of-the-art processes.

3. Writing a poor contract: Companies failed to establish a balance of power in the relationship.

4. Overlooking personnel issues: Employees lost commitment to the firm.

5. Losing control over the outsourced activity: Qualified managers failed to manage the outsourced activity.70

6. Overlooking the hidden costs of outsourcing: Transaction costs overwhelmed other savings.

7. Failing to plan an exit strategy: Companies failed to build reversibility clauses into the contract.71

The key to outsourcing is to purchase from outside only those activities that are not key to the company’s distinctive competencies. Otherwise, the company may give up the very ca- pabilities that made it successful in the first place—thus putting itself on the road to eventual decline. This is supported by research reporting that companies that have more experience with a particular manufacturing technology tend to keep manufacturing in-house.72 J. P. Morgan Chase & Company terminated a seven-year technology outsourcing agreement with IBM be- cause the bank’s management realized that information technology (IT) was too important strategically to be outsourced.73

In determining functional strategy, the strategist must:

� Identify the company’s or business unit’s core competencies

� Ensure that the competencies are continually being strengthened

� Manage the competencies in such a way that best preserves the competitive advantage they create

An outsourcing decision depends on the fraction of total value added that the activity un- der consideration represents and on the amount of potential competitive advantage in that ac- tivity for the company or business unit. See the outsourcing matrix in Figure 8–1. A firm should consider outsourcing any activity or function that has low potential for competitive ad- vantage. If that activity constitutes only a small part of the total value of the firm’s products or services, it should be purchased on the open market (assuming that quality providers of the ac- tivity are plentiful). If, however, the activity contributes highly to the company’s products or services, the firm should purchase it through long-term contracts with trusted suppliers or dis- tributors. A firm should always produce at least some of the activity or function (i.e., taper ver- tical integration) if that activity has the potential for providing the company some competitive advantage. However, full vertical integration should be considered only when that activity or function adds significant value to the company’s products or services in addition to providing competitive advantage.74

250 PA RT 3 Strategy Formulation

Activity’s Total Value-Added to Firm’s Products and Services

A c ti

v it

y ’s

P o

te n

ti a l fo

r C

o m

p e ti

ti v e A

d v a n

ta g

e

Low

Taper Vertical Integration:

Produce Some Internally

Full Vertical Integration:

Produce All Internally

Outsource Completely:

Buy on Open Market

Outsource Completely:

Purchase with Long-Term Contracts

L o w

High

H ig

h

FIGURE 8–1 Proposed

Outsourcing Matrix

8.3 Strategies to Avoid Several strategies, that could be considered corporate, business, or functional are very danger- ous. Managers who have made poor analyses or lack creativity may be trapped into consider- ing some of the following strategies to avoid:

� Follow the leader: Imitating a leading competitor’s strategy might seem to be a good idea, but it ignores a firm’s particular strengths and weaknesses and the possibility that the leader may be wrong. Fujitsu Ltd., the world’s second-largest computer maker, had been driven since the 1960s by the sole ambition of catching up to IBM. Like IBM, Fujitsu competed primarily as a mainframe computer maker. So devoted was it to catching IBM, however, that it failed to notice that the mainframe business had reached maturity by 1990 and was no longer growing.

� Hit another home run: If a company is successful because it pioneered an extremely suc- cessful product, it tends to search for another super product that will ensure growth and prosperity. As in betting on long shots in horse races, the probability of finding a second winner is slight. Polaroid spent a lot of money developing an “instant” movie camera, but the public ignored it in favor of the camcorder.

� Arms race: Entering into a spirited battle with another firm for increased market share might increase sales revenue, but that increase will probably be more than offset by in- creases in advertising, promotion, R&D, and manufacturing costs. Since the deregula- tion of airlines, price wars and rate specials have contributed to the low profit margins and bankruptcies of many major airlines, such as Eastern, Pan American, TWA, and United.

� Do everything: When faced with several interesting opportunities, management might tend to leap at all of them. At first, a corporation might have enough resources to develop

SOURCE: J. D. Hunger and T. L. Wheelen, “Proposed Outsourcing Matrix.” Copyright © 1996 and 2005 by Wheelen and Hunger Associates. Reprinted by permission.

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 251

each idea into a project, but money, time, and energy are soon exhausted as the many proj- ects demand large infusions of resources. The Walt Disney Company’s expertise in the en- tertainment industry led it to acquire the ABC network. As the company churned out new motion pictures and television programs such as Who Wants to Be a Millionaire? it spent $750 million to build new theme parks and buy a cruise line and a hockey team. By 2000, even though corporate sales had continued to increase, net income was falling.75

� Losing hand: A corporation might have invested so much in a particular strategy that top management is unwilling to accept its failure. Believing that it has too much invested to quit, management may continue to throw “good money after bad.” Pan American Airlines, for example, chose to sell its Pan Am Building and Intercontinental Hotels, the most prof- itable parts of the corporation, to keep its money-losing airline flying. Continuing to suf- fer losses, the company followed this profit strategy of shedding assets for cash until it had sold off everything and went bankrupt.

8.4 Strategic Choice: Selecting the Best Strategy After the pros and cons of the potential strategic alternatives have been identified and evalu- ated, one must be selected for implementation. By now, it is likely that many feasible alterna- tives will have emerged. How is the best strategy determined?

Perhaps the most important criterion is the capability of the proposed strategy to deal with the specific strategic factors developed earlier, in the SWOT analysis. If the alternative doesn’t take advantage of environmental opportunities and corporate strengths/competencies, and lead away from environmental threats and corporate weaknesses, it will probably fail.

Another important consideration in the selection of a strategy is the ability of each alter- native to satisfy agreed-on objectives with the least resources and the fewest negative side ef- fects. It is, therefore, important to develop a tentative implementation plan in order to address the difficulties that management is likely to face. This should be done in light of societal trends, the industry, and the company’s situation based on the construction of scenarios.

CONSTRUCTING CORPORATE SCENARIOS Corporate scenarios are pro forma (estimated future) balance sheets and income statements that forecast the effect each alternative strategy and its various programs will likely have on division and corporate return on investment. (Pro forma financial statements are discussed in Chapter 12.) In a survey of Fortune 500 firms, 84% reported using computer simulation mod- els in strategic planning. Most of these were simply spreadsheet-based simulation models dealing with what-if questions.76

The recommended scenarios are simply extensions of the industry scenarios discussed in Chapter 4. If, for example, industry scenarios suggest the probable emergence of a strong market demand in a specific country for certain products, a series of alternative strategy sce- narios can be developed. The alternative of acquiring another firm having these products in that country can be compared with the alternative of a green-field development (e.g., building new operations in that country). Using three sets of estimated sales figures (Optimistic, Pes- simistic, and Most Likely) for the new products over the next five years, the two alternatives can be evaluated in terms of their effect on future company performance as reflected in the company’s probable future financial statements. Pro forma balance sheets and income state- ments can be generated with spreadsheet software, such as Excel, on a personal computer. Pro forma statements are based on financial and economic scenarios.

252 PA RT 3 Strategy Formulation

TABLE 8–2 Scenario Box for Use in Generating Financial Pro Forma Statements

Projections1

200– 200– 200–

Factor Last Year

Historical Average

Trend Analysis O P ML O P ML O P ML Comments

GDP CPI Other Sales units Dollars COGS Advertising and marketing Interest expense Plant expansion Dividends Net profits EPS ROI ROE Other

NOTE 1: O � Optimistic; P � Pessimistic; ML � Most Likely.

SOURCE: T. L. Wheelen and J. D. Hunger. Copyright © 1987, 1988, 1989, 1990, 1992, 2005, and 2009 by T. L. Wheelen. Copyright © 1993 and 2005 by Wheelen and Hunger Associates. Reprinted with permission.

To construct a corporate scenario, follow these steps:

1. Use industry scenarios (as discussed in Chapter 4) to develop a set of assumptions about the task environment (in the specific country under consideration). For example, 3M re- quires the general manager of each business unit to describe annually what his or her in- dustry will look like in 15 years. List optimistic, pessimistic, and most likely assumptions for key economic factors such as the GDP (Gross Domestic Product), CPI (Consumer Price Index), and prime interest rate and for other key external strategic factors such as governmental regulation and industry trends. This should be done for every country/ region in which the corporation has significant operations that will be affected by each strategic alternative. These same underlying assumptions should be listed for each of the alternative scenarios to be developed.

2. Develop common-size financial statements (as discussed in Chapter 12) for the com- pany’s or business unit’s previous years, to serve as the basis for the trend analysis projec- tions of pro forma financial statements. Use the Scenario Box form shown in Table 8–2: a. Use the historical common-size percentages to estimate the level of revenues, ex-

penses, and other categories in estimated pro forma statements for future years. b. Develop for each strategic alternative a set of Optimistic(O), Pessimistic(P), and Most

Likely(ML) assumptions about the impact of key variables on the company’s future fi- nancial statements.

c. Forecast three sets of sales and cost of goods sold figures for at least five years into the future.

d. Analyze historical data and make adjustments based on the environmental assump- tions listed earlier. Do the same for other figures that can vary significantly.

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 253

e. Assume for other figures that they will continue in their historical relationship to sales or some other key determining factor. Plug in expected inventory levels, accounts re- ceivable, accounts payable, R&D expenses, advertising and promotion expenses, cap- ital expenditures, and debt payments (assuming that debt is used to finance the strategy), among others.

f. Consider not only historical trends but also programs that might be needed to imple- ment each alternative strategy (such as building a new manufacturing facility or ex- panding the sales force).

3. Construct detailed pro forma financial statements for each strategic alternative: a. List the actual figures from this year’s financial statements in the left column of the

spreadsheet. b. List to the right of this column the optimistic figures for years 1 through 5. c. Go through this same process with the same strategic alternative, but now list the pes-

simistic figures for the next five years. d. Do the same with the most likely figures. e. Develop a similar set of optimistic (O), pessimistic (P), and most likely (ML) pro

forma statements for the second strategic alternative. This process generates six dif- ferent pro forma scenarios reflecting three different situations (O, P, and ML) for two strategic alternatives.

f. Calculate financial ratios and common-size income statements, and create balance sheets to accompany the pro forma statements.

g. Compare the assumptions underlying the scenarios with the financial statements and ratios to determine the feasibility of the scenarios. For example, if cost of goods sold drops from 70% to 50% of total sales revenue in the pro forma income statements, this drop should result from a change in the production process or a shift to cheaper raw materials or labor costs rather than from a failure to keep the cost of goods sold in its usual percentage relationship to sales revenue when the predicted statement was developed.

The result of this detailed scenario construction should be anticipated net profits, cash flow, and net working capital for each of three versions of the two alternatives for five years into the future. A strategist might want to go further into the future if the strategy is expected to have a major impact on the company’s financial statements beyond five years. The result of this work should provide sufficient information on which forecasts of the likely feasibility and probable profitability of each of the strategic alternatives could be based.

Obviously, these scenarios can quickly become very complicated, especially if three sets of acquisition prices and development costs are calculated. Nevertheless, this sort of detailed what-if analysis is needed to realistically compare the projected outcome of each reasonable alternative strategy and its attendant programs, budgets, and procedures. Regardless of the quantifiable pros and cons of each alternative, the actual decision will probably be influenced by several subjective factors such as those described in the following sections.

Management’s Attitude Toward Risk The attractiveness of a particular strategic alternative is partially a function of the amount of risk it entails. Risk is composed not only of the probability that the strategy will be effective but also of the amount of assets the corporation must allocate to that strategy and the length of time the assets will be unavailable for other uses. Because of variation among countries in terms of customs, regulations, and resources, companies operating in global industries must deal with a greater amount of risk than firms operating only in one country.77 The greater the assets in- volved and the longer they are committed, the more likely top management is to demand a high probability of success. Managers with no ownership position in a company are unlikely to have

254 PA RT 3 Strategy Formulation

much interest in putting their jobs in danger with risky decisions. Research indicates that man- agers who own a significant amount of stock in their firms are more likely to engage in risk- taking actions than are managers with no stock.78

A high level of risk was why Intel’s board of directors found it difficult to vote for a pro- posal in the early 1990s to commit $5 billion to making the Pentium microprocessor chip— five times the amount of money needed for its previous chip. In looking back on that board meeting, then-CEO Andy Grove remarked, “I remember people’s eyes looking at that chart and getting big. I wasn’t even sure I believed those numbers at the time.” The proposal com- mitted the company to building new factories—something Intel had been reluctant to do. A wrong decision would mean that the company would end up with a killing amount of overca- pacity. Based on Grove’s presentation, the board decided to take the gamble. Intel’s resulting manufacturing expansion eventually cost $10 billion but resulted in Intel’s obtaining 75% of the microprocessor business and huge cash profits.79

Risk might be one reason that significant innovations occur more often in small firms than in large, established corporations. A small firm managed by an entrepreneur is often willing to accept greater risk than is a large firm of diversified ownership run by professional managers.80

It is one thing to take a chance if you are the primary shareholder and are not concerned with periodic changes in the value of the company’s common stock. It is something else if the cor- poration’s stock is widely held and acquisition-hungry competitors or takeover artists surround the company like sharks every time the company’s stock price falls below some external as- sessment of the firm’s value.

A new approach to evaluating alternatives under conditions of high environmental uncertainty is to use real-options theory. According to the real-options approach, when the future is highly uncertain, it pays to have a broad range of options open. This is in contrast to using net present value (NPV) to calculate the value of a project by predicting its payouts, adjusting them for risk, and subtracting the amount invested. By boiling everything down to one scenario, NPV doesn’t provide any flexibility in case circumstances change. NPV is also difficult to apply to projects in which the potential payoffs are currently unknown. The real-options approach, however, deals with these issues by breaking the investment into stages. Management allocates a small amount of funding to initiate multiple projects, monitors their development, and then cancels the projects that aren’t suc- cessful and funds those that are doing well.81 This approach is very similar to the way venture cap- italists fund an entrepreneurial venture in stages of funding based on the venture’s performance.

A survey of 4,000 CFOs found that 27% of them always or almost always used some sort of options approach to evaluating and deciding upon growth opportunities.82 Research indi- cates that the use of the real-options approach does improve organizational performance.83

Some of the corporations using the real-options approach are Chevron for bidding on petro- leum reserves, Airbus for calculating the costs of airlines changing their orders at the last minute, and the Tennessee Valley Authority for outsourcing electricity generation instead of building its own plant. Because of its complexity, the real-options approach is not worthwhile for minor decisions or for projects requiring a full commitment at the beginning.84

Pressures from Stakeholders The attractiveness of a strategic alternative is affected by its perceived compatibility with the key stakeholders in a corporation’s task environment. Creditors want to be paid on time. Unions exert pressure for comparable wage and employment security. Governments and inter- est groups demand social responsibility. Shareholders want dividends. All these pressures must be given some consideration in the selection of the best alternative.

Stakeholders can be categorized in terms of their (1) interest in the corporation’s activities and (2) relative power to influence the corporation’s activities. As shown in Figure 8–2, each stake- holder group can be shown graphically based on its level of interest (from low to high) in a corpo- ration’s activities and on its relative power (from low to high) to influence a corporation’s activities.

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 255

High

Local Communities

Creditors

Shareholders

S ta

k eh

ol d

er I

n te

re st

i n

C or

p or

at e

A ct

iv it

ie s

Customers

Greenpeace Federal

Government

Low Low High

Relative Power of Stakeholder

FIGURE 8–2 Stakeholder

Priority Matrix

Strategic managers should ask four questions to assess the importance of stakeholder con- cerns in a particular decision:

1. How will this decision affect each stakeholder, especially those given high and medium priority?

2. How much of what each stakeholder wants is he or she likely to get under this alternative?

3. What are the stakeholders likely to do if they don’t get what they want?

4. What is the probability that they will do it?

Strategy makers should choose strategic alternatives that minimize external pressures and maximize the probability of gaining stakeholder support. Managers may, however, ignore or take some stakeholders for granted—leading to serious problems later. The Tata Group, for ex- ample, failed to consider the unwillingness of farmers in Singur, India, to accept the West Ben- gal government’s compensation for expropriating their land so that Tata could build its Nano auto plant. Farmers formed rallies against the plant, blocked roads, and even assaulted an em- ployee of a Tata supplier.86

Top management can also propose a political strategy to influence its key stakeholders. A political strategy is a plan to bring stakeholders into agreement with a corporation’s actions. Some of the most commonly used political strategies are constituency building, political ac- tion committee contributions, advocacy advertising, lobbying, and coalition building. Re- search reveals that large firms, those operating in concentrated industries, and firms that are highly dependent upon government regulation are more politically active.87 Political support can be critical in entering a new international market, especially in transition economies where free market competition did not previously exist.88

Pressures from the Corporate Culture If a strategy is incompatible with a company’s corporate culture, the likelihood of its success is very low. Foot-dragging and even sabotage will result as employees fight to resist a radical

SOURCE: Based on C. Anderson, “Values-Based Management,” Academy of Management Executive (November 1997), pp. 25–46.

256 PA RT 3 Strategy Formulation

change in corporate philosophy. Precedents from the past tend to restrict the kinds of objectives and strategies that are seriously considered.89 The “aura” of the founders of a corporation can linger long past their lifetimes because their values are imprinted on a corporation’s members.

In evaluating a strategic alternative, strategy makers must consider pressures from the cor- porate culture and assess a strategy’s compatibility with that culture. If there is little fit, man- agement must decide if it should:

� Take a chance on ignoring the culture

� Manage around the culture and change the implementation plan

� Try to change the culture to fit the strategy

� Change the strategy to fit the culture

Further, a decision to proceed with a particular strategy without a commitment to change the culture or manage around the culture (both very tricky and time consuming) is dangerous. Nevertheless, restricting a corporation to only those strategies that are completely compatible with its culture might eliminate from consideration the most profitable alternatives. (See Chapter 10 for more information on managing corporate culture.)

Needs and Desires of Key Managers Even the most attractive alternative might not be selected if it is contrary to the needs and desires of important top managers. Personal characteristics and experience affect a person’s assessment of an alternative’s attractiveness.90 For example, one study found that narcissistic (self-absorbed and arrogant) CEOs favor bold actions that attract attention, like many large acquisitions—re- sulting in either big wins or big losses.91 A person’s ego may be tied to a particular proposal to the extent that all other alternatives are strongly lobbied against. As a result, the person may have unfavorable forecasts altered so that they are more in agreement with the desired alternative.92

In a study by McKinsey & Company of 2,507 executives from around the world, 36% responded that managers hide, restrict, or misrepresent information at least “somewhat” frequently when submitting capital-investment proposals. In addition, an executive might influence other people in top management to favor a particular alternative so that objections to it are overruled. In the same McKinsey study of global executives, more than 60% of the managers reported that busi- ness unit and divisional heads form alliances with peers or lobby someone more senior in the or- ganization at least “somewhat” frequently when resource allocation decisions are being made.93

Industry and cultural backgrounds affect strategic choice. For example, executives with strong ties within an industry tend to choose strategies commonly used in that industry. Other executives who have come to the firm from another industry and have strong ties outside the industry tend to choose different strategies from what is being currently used in their industry.94 Country of origin often affects preferences. For example, Japanese managers pre- fer a cost-leadership strategy more than do United States managers.95 Research reveals that ex- ecutives from Korea, the U.S., Japan, and Germany tend to make different strategic choices in similar situations because they use different decision criteria and weights. For example, Ko- rean executives emphasize industry attractiveness, sales, and market share in their decisions; whereas, U.S. executives emphasize projected demand, discounted cash flow, and ROI.96

There is a tendency to maintain the status quo, which means that decision makers con- tinue with existing goals and plans beyond the point when an objective observer would rec- ommend a change in course.97 Some executives show a self-serving tendency to attribute the firm’s problems not to their own poor decisions but to environmental events out of their con- trol, such as government policies or a poor economic climate.98 For example, a CEO is more likely to divest a poorly performing unit when its poor performance does not incriminate that same CEO who had acquired it.99 Negative information about a particular course of action to which a person is committed may be ignored because of a desire to appear competent or

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 257

PROCESS OF STRATEGIC CHOICE There is an old story told at General Motors:

At a meeting with his key executives, CEO Alfred Sloan proposed a controversial strategic deci- sion. When asked for comments, each executive responded with supportive comments and praise. After announcing that they were all in apparent agreement, Sloan stated that they were not going to proceed with the decision. Either his executives didn’t know enough to point out potential down- sides of the decision, or they were agreeing to avoid upsetting the boss and disrupting the cohe- sion of the group. The decision was delayed until a debate could occur over the pros and cons.101

Strategic choice is the evaluation of alternative strategies and selection of the best alterna- tive. According to Paul Nutt, an authority in decision making, half of the decisions made by man- agers are failures.102 After analyzing 400 decisions, Nutt found that failure almost always stems from the actions of the decision maker, not from bad luck or situational limitations. In these in- stances, managers commit one or more key blunders: (1) their desire for speedy actions leads to a rush to judgment, (2) they apply failure-prone decision-making practices such as adopting the claim of an influential stakeholder, and (3) they make poor use of resources by investigating only one or two options. These three blunders cause executives to limit their search for feasible alternatives and look for quick consensus. Only 4% of the 400 managers set an objective and considered several alternatives. The search for innovative options was attempted in only 24% of the decisions studied.103 Another study of 68 divestiture decisions found a strong tendency for managers to rely heavily on past experience when developing strategic alternatives.104

There is mounting evidence that when an organization is facing a dynamic environment, the best strategic decisions are not arrived at through consensus when everyone agrees on one alternative. They actually involve a certain amount of heated disagreement, and even conflict.105 Many diverse opinions are presented, participants trust in one another’s abilities and competences, and conflict is task-oriented, not personal.106 This is certainly the case for firms operating in global industries. Because unmanaged conflict often carries a high emotional cost, authorities in decision making propose that strategic managers use “programmed conflict” to raise different opinions, regardless of the personal feelings of the people involved.107 Two tech- niques help strategic managers avoid the consensus trap that Alfred Sloan found:

1. Devil’s advocate: The idea of the devil’s advocate originated in the medieval Roman Catholic Church as a way of ensuring that impostors were not canonized as saints. One trusted person was selected to find and present all the reasons why a person should not be canonized. When this process is applied to strategic decision making, a devil’s advocate (who may be an individual or a group) is assigned to identify potential pitfalls and prob- lems with a proposed alternative strategy in a formal presentation.

2. Dialectical inquiry: The dialectical philosophy, which can be traced back to Plato and Aristotle and more recently to Hegel, involves combining two conflicting views—the thesis and the antithesis—into a synthesis. When applied to strategic decision making, dialectical inquiry requires that two proposals using different assumptions be generated for each alternative strategy under consideration. After advocates of each position present and debate the merits of their arguments before key decision makers, either one of the al- ternatives or a new compromise alternative is selected as the strategy to be implemented.

because of strongly held values regarding consistency. It may take a crisis or an unlikely event to cause strategic decision makers to seriously consider an alternative they had previously ig- nored or discounted.100 For example, it wasn’t until the CEO of ConAgra, a multinational food products company, had a heart attack that ConAgra started producing the Healthy Choice line of low-fat, low-cholesterol, low-sodium frozen-food entrees.

258 PA RT 3 Strategy Formulation

Research generally supports the conclusion that the devil’s advocate and dialectical in- quiry methods are equally superior to consensus in decision making, especially when the firm’s environment is dynamic. The debate itself, rather than its particular format, appears to improve the quality of decisions by formalizing and legitimizing constructive conflict and by encouraging critical evaluation. Both lead to better assumptions and recommendations and to a higher level of critical thinking among the people involved.108

Regardless of the process used to generate strategic alternatives, each resulting alternative must be rigorously evaluated in terms of its ability to meet four criteria:

1. Mutual Exclusivity: Doing any one alternative would preclude doing any other.

2. Success: It must be feasible and have a good probability of success.

3. Completeness: It must take into account all the key strategic issues.

4. Internal Consistency: It must make sense on its own as a strategic decision for the entire firm and not contradict key goals, policies, and strategies currently being pursued by the firm or its units.109

8.5 Developing Policies The selection of the best strategic alternative is not the end of strategy formulation. The orga- nization must then engage in developing policies. Policies define the broad guidelines for im- plementation. Flowing from the selected strategy, policies provide guidance for decision making and actions throughout the organization. They are the principles under which the cor- poration operates on a day-to-day basis. At General Electric, for example, Chairman Jack Welch initiated the policy that any GE business unit must be Number One or Number Two in whatever market it competes. This policy gave clear guidance to managers throughout the or- ganization. Another example of such a policy is Casey’s General Stores’ policy that a new ser- vice or product line may be added to its stores only when the product or service can be justified in terms of increasing store traffic.

When crafted correctly, an effective policy accomplishes three things:

� It forces trade-offs between competing resource demands.

� It tests the strategic soundness of a particular action.

� It sets clear boundaries within which employees must operate while granting them free- dom to experiment within those constraints.110

Policies tend to be rather long lived and can even outlast the particular strategy that cre- ated them. These general policies—such as “The customer is always right” (Nordstrom) or “Low prices, every day” (Wal-Mart)—can become, in time, part of a corporation’s culture. Such policies can make the implementation of specific strategies easier. They can also restrict top management’s strategic options in the future. Thus a change in strategy should be fol- lowed quickly by a change in policies. Managing policy is one way to manage the corporate culture.

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 259

This chapter completes the part of this book on strategy formulation and sets the stage for strat- egy implementation. Functional strategies must be formulated to support business and corpo- rate strategies; otherwise, the company will move in multiple directions and eventually pull itself apart. For a functional strategy to have the best chance of success, it should be built on a distinctive competency residing within that functional area. If a corporation does not have a distinctive competency in a particular functional area, that functional area could be a candi- date for outsourcing.

When evaluating a strategic alternative, the most important criterion is the ability of the proposed strategy to deal with the specific strategic factors developed earlier, in the SWOT analysis. If the alternative doesn’t take advantage of environmental opportunities and corpo- rate strengths/competencies, and lead away from environmental threats and corporate weak- nesses, it will probably fail. Developing corporate scenarios and pro forma projections for each alternative are rational aids for strategic decision making. This logical approach fits Mintzberg’s planning mode of strategic decision making, as discussed earlier in Chapter 1. Nevertheless, some strategic decisions are inherently risky and may be resolved on the basis of one person’s “gut feel.” This is an aspect of the entrepreneurial mode and may be used in large established corporations as well as in new venture startups. Various management studies have found that executives routinely rely on their intuition to solve complex problems. The ef- fective use of intuition has been found to differentiate successful top executives and board members from lower-level managers and dysfunctional boards.111 According to Ralph Larsen, Chair and CEO of Johnson & Johnson, “Often there is absolutely no way that you could have the time to thoroughly analyze every one of the options or alternatives available to you. So you have to rely on your business judgment.”112 For managerial intuition to be effective, however, it requires years of experience in problem solving and is founded upon a complete understand- ing of the details of the business.113

For example, when Bob Lutz, President of Chrysler Corporation, was enjoying a fast drive in his Cobra roadster one weekend in 1988, he wondered why Chrysler’s cars were so dull. “I felt guilty: there I was, the president of Chrysler, driving this great car that had such a strong Ford association,” said Lutz, referring to the original Cobra’s Ford V-8 engine. That Monday, Lutz enlisted allies at Chrysler to develop a muscular, outrageous sports car that would turn heads and stop traffic. Others in management argued that the $80 million investment would be better spent elsewhere. The sales force warned that no U.S. auto maker had ever succeeded in selling a $50,000 car. With only his gut instincts to support him, he pushed the project forward with unwavering commitment. The result was the Dodge Viper—a car that single-handedly changed the public’s perception of Chrysler. Years later, Lutz had trouble describing exactly how he had made this critical decision. “It was this subconscious, visceral feeling. And it just felt right,” explained Lutz.114

End of Chapter S U M M A R Y

260 PA RT 3 Strategy Formulation

D I S C U S S I O N Q U E S T I O N S 1. Are functional strategies interdependent, or can they be

formulated independently of other functions?

2. Why is penetration pricing more likely than skim pricing to raise a company’s or a business unit’s operating profit in the long run?

3. How does mass customization support a business unit’s competitive strategy?

4. When should a corporation or business unit outsource a function or an activity?

5. What is the relationship of policies to strategies?

S T R A T E G I C P R A C T I C E E X E R C I S E Pierre Omidyar founded a sole proprietorship in September 1995 called Auction Web to allow people to buy and sell goods over the Internet. The new venture was based on the idea of de- veloping a community-driven process, where an organic, evolving, self-organizing web of individual relationships, formed around shared interests, would handle tasks that other companies handle with customer service operations. By May 1996, Omidyar had added Jeff Skoll as a partner and the ven- ture was incorporated as eBay. Two years later, Omidyar asked Meg Whitman to direct corporate strategy to continue the ac- celerated growth rate of the company. Whitman brought to the company global management and marketing experience and soon became President and CEO. In almost no time, the com- pany became one of the Web’s most successful sites, with 233 million registered users. By 2007, the average eBay user spent nearly two hours a month on the site—more than five times the time spent on Amazon.com.117

Whitman expanded the company’s operations and spent more than $6 billion to acquire companies, such as Internet- phone operation Skype, online payments service PayPal, ticket reseller StubHub, property rental and roommate search firm Rent.com, comparison shopping site Shopping.com, Web site recommender Stumbleupon, and 25% interest in Craigslist. Expansion and diversification provided revenue and profit growth plus stock price appreciation. Although fi- nancial analysts wondered how all these businesses would fit together, Whitman argued that she wanted eBay to be every- where users wanted to be. At developer conferences, com- pany representatives unveiled new services that let buyers

shop for and purchase eBay items outside of the core eBay.com site.

By 2008, eBay was in trouble. Its stock price had lost half its value over the past three years. The core auction and retail businesses, which accounted for the majority of revenue, were showing signs of weakness. The number of active users had been flat for three quarters, at 83 million. The number of new products listed on the site had increased only 4% from the pre- vious year. The number of stores selling goods at fixed prices on eBay declined from a year earlier to 532,000. The company had not done a good job of integrating Skype with its main business. Since its acquisition, Skype’s service had actually deteriorated.118 Competition had increased as rival Web sites, particularly Amazon, now provided similar Web services and eroded eBay’s competitive advantage.

On January 23, 2008, CEO Whitman announced that John Donahoe would take over as the company’s CEO. Dona- hoe stated that his first priority would be to revitalize eBay’s core business, even at the expense of investors. “We need to aggressively change our product, our customer approach, and our business model,” announced the new CEO.119

1. What is eBay’s problem?

2. Which marketing strategy was eBay following: market de- velopment or product development? Do you agree with it?

3. What decision-making process should CEO Donahoe uti- lize to make the decisions necessary to change the com- pany’s product, customer approach, and business model?

E C O - B I T S � In the two-day period after joining the U.S. Environ-

mental Protection Agency’s voluntary Climate Leader’s initiative, which requires members to reduce or offset emissions over the next 5 to 10 years, the average com- pany’s stock price dropped 0.9% more than it would have from normal market factors.115

� General Motors states that its facilities recycle 89% of the waste they generate and that GM is one of the world’s largest industrial users of solar power.116

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 261

K E Y T E R M S consensus (p. 257) corporate scenarios (p. 251) devil’s advocate (p. 257) dialectical inquiry (p. 257) financial strategy (p. 239) functional strategy (p. 238) HRM strategy (p. 246) information technology strategy (p. 247) leveraged buyout (p. 240)

logistics strategy (p. 246) market development (p. 238) marketing strategy (p. 238) offshoring (p. 248) operations strategy (p. 242) outsourcing (p. 247) political strategy (p. 255) product development (p. 238) purchasing strategy (p. 244)

R&D strategy (p. 241) real-options (p. 254) risk (p. 253) Stakeholder Priority Matrix (p. 255) strategic choice (p. 257) technological follower (p. 241) technological leader (p. 241)

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49. J. Greco, “Good Day Sunshine,” Journal of Business Strategy (July/August 1998), pp. 4–5.

50. W. Howard, “Translate Now,” PC Magazine (September 19, 2000), p. 81.

51. H. Green, “The Web Smart 50,” Business Week (November 24, 2003), p. 84.

52. T. Smart, “Jack Welch’s Cyber-Czar,” Business Week (August 5, 1996), p. 83.

53. S. M. Kim and J. T. Mahoney, “Mutual Commitment to Support Exchange: Relation-Specific IT System as a Substitute for Managerial Hierarchy,” Strategic Management Journal (May 2006), pp. 401–423.

54. B. Kelley, “Outsourcing Marches On,” Journal of Business Strategy (July/August 1995), p. 40.

55. S. Holmes and M. Arndt, “A Plane that Could Change the Game,” Business Week (August 9, 2004), p. 33.

56. J. Greco, “Outsourcing: The New Partnership,” Journal of Busi- ness Strategy (July/August 1997), pp. 48–54.

57. W. M. Fitzpatrick and S. A. DiLullo, “Outsourcing and the Per- sonnel Paradox,” SAM Advanced Management Journal (Sum- mer 2007), pp. 4–12.

58. Outsourcing: Time to Bring It Back Home?” The Economist (March 5, 2005), p. 63.

262 PA RT 3 Strategy Formulation

59. A. Y. Lewin and C. Peeters, “Offshoring Work: Business Hype or the Onset of Fundamental Transformation?” Long Range Planning (June 2006), pp. 221–239; A. Y. Lewing and C. Peeters, “The Top-Line Allure of Offshoring,” Harvard Business Review (March 2006), pp. 22–24.

60. G. Smith, “Factories Go South; So Does Pay,” Business Week (April 9, 2007), p. 76.

61. “Out of Captivity,” Economist (November 13, 2004), p. 68. 62. “IBM’s Plan to Buy India Firm Points to Demand for Outsourc-

ing,” Des Moines Register (April 11, 2004), p. 2D. 63. A. Castro, “Complaints Push Dell to Use U.S. Call Centers,”

Des Moines Register (November 25, 2003), p. 1D. 64. J. A. Byrne, “Has Outsourcing Gone Too Far?” Business Week

(April 1, 1996), pp. 26–28. 65. R. C. Insinga and M. J. Werle, “Linking Outsourcing to Busi-

ness Strategy,” Academy of Management Executive (November 2000), pp. 58–70; D. Lei and M. A. Hitt, “Strategic Restructur- ing and Outsourcing: The Effect of Mergers and Acquisitions and LBOs on Building Firm Skills and Capabilities,” Journal of Management, Vol. 21, No. 5 (1995), pp. 835–859.

66. “Outsourcing: Time to Bring It Back Home?” The Economist (May 5, 2005), p. 63.

67. S. E. Ante, “Shifting Work Offshore? Outsourcer Beware,” Business Week (January 12, 2004), pp. 36–37.

68. J. Carey, “Not Made in China,” Business Week (July 30, 2007), pp. 41–43; “The Poison Spreads,” The Economist (September 27, 2008), pp. 77–78; “Plenty of Blame to Go Around,” The Economist (September 29, 2007), pp. 68–70; J. Schmit, “He- parin Plant in China Passed ‘In-Depth’ Review,” USA Today (April 30, 2008), p. B1.

69. A. Goel, N. Moussavi, and V. N. Srivatsan, “Time to Rethink Offshoring?” McKinsey Quarterly (September 2008), pp. 1–5.

70. A. Takeishi, “Bridging Inter- and Intra-Firm Boundaries: Man- agement of Supplier Involvement in Automobile Product De- velopment,” Strategic Management Journal (May 2001), pp. 403–433.

71. J. Barthelemy, “The Seven Deadly Sins of Outsourcing,” Academy of Management Executive (May 2003), pp. 87–98.

72. M. J. Leiblein and D. J. Miller, “An Empirical Examination of Transaction and Firm-Level Influences on the Vertical Bound- aries of the Firm,” Strategic Management Journal (September 2003), pp. 839–859.

73. S. Hamm, “Is Outsourcing on the Outs?” Business Week (October 4, 2004), p. 42.

74. For further information on effective offshoring, see R. Aron and J. V. Singh, “Getting Offshoring Right,” Harvard Business Re- view (December 2005), pp. 135–143.

75. R. Grover and D. Polek, “Millionaire Buys Disney Time,” Business Week (June 26, 2000), pp. 141–144.

76. D. K. Sinha, “Strategic Planning in the Fortune 500,” Handbook of Business Strategy, 1991/1992 Yearbook, edited by H. E. Glass and M. A. Hovde (Boston: Warren, Gorham & Lamont, 1991), pp. 9.6–9.8.

77. N. Checa, J. Maguire, and J. Berry, “The New World Disorder,” Harvard Business Review (August 2003), pp. 70–79.

78. T. B. Palmer and R. M. Wiseman, “Decoupling Risk Taking from Income Stream Uncertainty: A Holistic Model of Risk,” Strategic Management Journal (November 1999), pp. 1037–1062; W. G. Sanders and D. C. Hambrick, “Swinging for the Fences: The Ef- fects of CEO Stock Options on Company Risk Taking and Per- formance,” Academy of Management Journal (October 2007), pp. 1055–1078.

79. D. Clark, “All the Chips: A Big Bet Made Intel What It Is To- day; Now It Wagers Again,” Wall Street Journal (June 6, 1995), pp. A1, A5.

80. L. W. Busenitz and J. B. Barney, “Differences Between Entre- preneurs and Managers in Large Organizations: Biases and Heuristics in Strategic Decision-Making,” Journal of Business Venturing (January 1997), pp. 9–30.

81. J. J. Janney and G. G. Dess, “Can Real-Options Analysis Improve Decision-Making? Promises and Pitfalls,” Academy of Manage- ment Executive (November 2004), pp. 60–75; S. Maklan, S. Knox, and L. Ryals, “Using Real Options to Help Build the Business Case for CRM Investment,” Long Range Planning (August 2005), pp. 393–410.

82. T. Copeland and P. Tufano, “A Real-World Way to Manage Real Options,” Harvard Business Review (March 2004), pp. 90–99.

83. J. Rosenberger and K. Eisenhardt, “What Are Real Options: A Review of Empirical Research,” Paper presented to annual meet- ing of the Academy of Management, Seattle, WA (August 2003).

84. P. Coy, “Exploiting Uncertainty,” Business Week (June 7, 1999), pp. 118–124. For further information on real options, see M. Amram and N. Kulatilaka, Real Options (Boston, Harvard University Press, 1999). For a simpler summary, see R. M. Grant, Contemporary Strategy Analysis, 5th edition (Malden, MA: Blackwell Publishing, 2005), pp. 48–50.

85. C. Anderson, “Values-Based Management,” Academy of Man- agement Executive (November 1997), pp. 25–46.

86. “Nano Wars,” The Economist (August 30, 2008), p. 63. 87. J-P. Bonardi, A. J. Hillman, and G. D. Keim, “The Attractive-

ness of Political Markets: Implications for Firm Strategy,” Academy of Management Review (April 2005), pp. 397–413.

88. J. G. Frynas, K. Mellahi, and G. A. Pigman, “First Mover Advantages in International Business and Firm-Specific Polit- ical Resources,” Strategic Management Journal (April 2006), pp. 321–345. For additional information about political strate- gies, see C. Oliver and I. Holzinger, “The Effectiveness of Strategic Political Management: A Dynamic Capabilities Framework,” Academy of Management Review (April 2008), pp. 496–520.

89. H. M. O’Neill, R. W. Pouder, and A. K. Buchholtz, “Patterns in the Diffusion of Strategies Across Organizations: Insights from the Innovation Diffusion Literature,” Academy of Management Exec- utive (January 1998), pp. 98–114; C. G. Gilbert, “Unbundling the Structure of Inertia: Resource Versus Routine Rigidity,” Academy of Management Journal (October 2005), pp. 741–763.

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 263

90. B. B. Tyler and H. K. Steensma. “Evaluating Technological Collaborative Opportunities: A Cognitive Modeling Perspec- tive,” Strategic Management Journal (Summer 1995), pp. 43–70; D. Duchan, D. P. Ashman, and M. Nathan, “Mavericks, Vision- aries, Protestors, and Sages: Toward a Typology of Cognitive Structures for Decision Making in Organizations,” Journal of Business Strategies (Fall 1997), pp. 106–125; P. Chattopad- hyay, W. H. Glick, C. C. Miller, and G. P. Huber, “Determinants of Executive Beliefs: Comparing Functional Conditioning and Social Influence,” Strategic Management Journal (August 1999), pp. 763–789; B. Katey and G. G. Meredith, “Relation- ship Among Owner/Manager Personal Values, Business Strate- gies, and Enterprise Performance,” Journal of Small Business Management (April 1997), pp. 37–64.

91. A. Chatterjee and D. C. Hambrick, “It’s All About Me: Narcis- sistic Executive Officers and Their Effects on Company Strat- egy and Performance,” Administrative Science Quarterly (September 2007), pp. 351–386.

92. C. S. Galbraith and G. B. Merrill, “The Politics of Forecasting: Managing the Truth,” California Management Review (Winter 1996), pp. 29–43.

93. M. Garbuio, D. Lovallo, and P. Viguerie, “How Companies Spend Their Money: A McKinsey Global Survey,” McKinsey Quarterly Online (June 2007).

94. M. A. Geletkanycz and D. C. Hambrick, “The External Ties of Top Executives: Implications for Strategic Choice and Perfor- mance,” Administrative Science Quarterly (December 1997), pp. 654–681.

95. M. Song, R. J. Calantone, and C. A. Di Benedetto, “Competi- tive Forces and Strategic Choice Decisions: An Experimental Investigation in the United States and Japan,” Strategic Man- agement Journal (October 2002), pp. 969–978.

96. M. A. Hitt, M. T. Dacin, B. B. Tyler, and D. Park, “Understand- ing the Differences in Korean and U.S. Executives’ Strategic Orientation,” Strategic Management Journal (February 1997), pp. 159–167; L. G. Thomas III and G. Waring, “Competing Capitalisms: Capital Investment in American, German, and Jap- anese Firms,” Strategic Management Journal (August 1999), pp. 729–748.

97. M. H. Bazerman and D. Chugh, “Decisions Without Blinders,” Harvard Business Review (January 2006), pp. 88–97.

98. J. A. Wagner III and R. Z. Gooding, “Equivocal Information and Attribution: An Investigation of Patterns of Managerial Sensemaking,” Strategic Management Journal (April 1997), pp. 275–286; K. Shimizu and M. A. Hitt, “Strategic Flexibility: Organizational Preparedness to Reverse Ineffective Strategic Decisions,” Academy of Management Executive (November 2004), pp. 44–59.

99. M. L. A. Hayward and K. Shimizu, “De-Commitment to Los- ing Strategic Action: Evidence from the Divestiture of Poorly Performing Acquisitions,” Strategic Management Journal (June 2006), pp. 541–557.

100. J. Ross and B. M. Staw, “Organizational Escalation and Exit: Lessons from the Shoreham Nuclear Power Plant,” Academy of

Management Journal (August 1993), pp. 701–732; P. W. Mulvey, J. F. Veiga, and P. M. Elsass, “When Teammates Raise a White Flag,” Academy of Management Executive (February 1996), pp. 40–49.

101. R. A. Cosier and C. R. Schwenk, “Agreement and Thinking Alike: Ingredients for Poor Decisions,” Academy of Manage- ment Executive (February 1990), p. 69.

102. P. C. Nutt, Why Decisions Fail (San Francisco: Berrett-Koehler, 2002).

103. P. C. Nutt, “Expanding the Search for Alternatives During Strategic Decision-Making,” Academy of Management Execu- tive (November 2004), pp. 13–28.

104. K. Shimizu, “Prospect Theory, Behavioral Theory, and the Threat-Rigidity Thesis: Combinative Effects on Organizational Decisions to Divest Formerly Acquired Units,” Academy of Management Journal (December 2007), pp. 1495–1514.

105. G. P. West III and G. D. Meyer, “To Agree or Not to Agree? Consensus and Performance in New Ventures,” Journal of Busi- ness Venturing (September 1998), pp. 395–422; L. Markoczy, “Consensus Formation During Strategic Change,” Strategic Management Journal (November 2001), pp. 1013–1031.

106. B. J. Olson, S. Parayitam, and Y. Bao, “Strategic Decision Mak- ing: The Effects of Cognitive Diversity, Conflict, and Trust on Decision Outcomes,” Journal of Management (April 2007), pp. 196–222.

107. A. C. Amason, “Distinguishing the Effects of Functional and Dysfunctional Conflict on Strategic Decision Making: Resolv- ing a Paradox for Top Management Teams,” Academy of Man- agement Journal (February 1996), pp. 123–148; A. C. Amason and H. J. Sapienza, “The Effects of Top Management Team Size and Interaction Norms on Cognitive and Affective Con- flict,” Journal of Management, Vol. 23, No. 4 (1997), pp. 495–516.

108. D. M. Schweiger, W. R. Sandberg, and P. L. Rechner, “Ex- periential Effects of Dialectical Inquiry, Devil’s Advocacy, and Consensus Approaches to Strategic Decision Making,” Academy of Management Journal (December 1989), pp. 745–772; G. Whyte, “Decision Failures: Why They Occur and How to Prevent Them,” Academy of Management Execu- tive (August 1991), pp. 23–31; R. L. Priem, D. A. Harrison, and N. K. Muir, “Structured Conflict and Consensus Outcomes in Group Decision Making,” Journal of Management, Vol. 21, No. 4 (1995), pp. 691–710.

109. S. C. Abraham, “Using Bundles to Find the Best Strategy,” Strategy & Leadership (July/August/September 1999), pp. 53–55.

110. O. Gadiesh and J. L Gilbert, “Transforming Corner-Office Strategy into Frontline Action,” Harvard Business Review (May 2001), pp. 73–79.

111. E. Dane and M. G. Pratt, “Exploring Intuition and Its Role in Managerial Decision Making,” Academy of Management Re- view (January 2007), pp. 33–54.

112. A. M. Hayashi, “When to Trust Your Gut,” Harvard Business Review (February 2001), pp. 59–65.

264 PA RT 3 Strategy Formulation

113. E. Dane and M. G. Pratt, “Exploring Intuition and Its Role in Managerial Decision Making,” Academy of Management Re- view (January 2007), pp. 33–54.

114. A. M. Hayashi, pp. 59–60. 115. “Losing Green By Going Green,” Business Week (June 30,

2008), p. 61. 116. Advertisement by General Motors appearing in National Geo-

graphic Magazine (June 2008).

117. C. Holahan, “Going, Going...Everywhere,” Business Week (June 18, 2007), pp. 62–64.

118. “The Skype Hyper,” The Economist (October 6, 2007), p. 80. 119. C. Holahan, “EBay’s New Tough Love CEO,” Business Week

(February 4, 2008), pp. 58–59.

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 265

266 PA RT 3 Strategy Formulation

KMART AND SEARS: STILL STUCK IN THE MIDDLE?

On January 22, 2002, Kmart Corporation became the largest retailer in U.S. history to seek bankruptcy protec- tion. In Kmart’s petition for reorganization under Chapter 11 of the U.S. Bankruptcy Code, Kmart man- agement announced that they would outline a plan for repaying Kmart’s creditors, reducing its size, and re- structuring its business so that it could leave court pro- tection as a viable competitor in discount mass-market retailing. Emerging from bankruptcy in May 2003, Kmart still lacked a business strategy to succeed in an extremely competitive marketplace.

The U.S. discount department store industry had reached maturity by 2004 and Kmart no longer pos- sessed a clearly-defined position within that industry. Its primary competitors were Wal-Mart, Sears, Target, Kohl’s, and J.C. Penney, with secondary competitors in certain categories. Wal-Mart, an extremely efficient re- tailer, was known for consistently having the lowest costs (reflected in low prices) and the highest sales in the industry. Having started in rural America, Wal-Mart was now actively growing internationally. Sears, with the second-highest annual sales, had a strong position in hard goods, such as home appliances and tools. Around 40% of all major home appliance sales continued to be controlled by Sears. Nevertheless, Sears was struggling with slumping sales as customers turned from Sears mall stores to stand-alone, big-box retailers, such as Lowe’s and Home Depot, to buy their hard goods. Tar- get, third in sales but second in profits, behind Wal- Mart, had distinguished itself as a merchandiser of stylish upscale products. Along with Wal-Mart, Target had flourished to such an extent that Dayton-Hudson, its parent company, had changed its corporate name to Tar- get. Kohl’s, a relatively new entrant to the industry, op- erated 420 family-oriented stores in 32 states. J.C. Penney operated more than 1,000 stores in all 50 states. Both Kohl’s and J.C. Penney emphasized soft goods, such as clothing and related items.

Ending Case for Part Three Kmart was also challenged by “category killers”

that competed in only one or a few industry categories, but in greater depth within any category than could any department store. Some of these were Toys “R” Us, Home Depot, Lowe’s, and drug stores such as Rite Aid, CVS, Eckerd, and Walgreens.

Kmart had been established in 1962 by its parent company S.S. Kresge as a discount department store of- fering the most variety of goods at the lowest prices. Un- like Sears, the company chose not to locate in large shopping malls but to establish its discount stores in highly visible corner locations. During the 1960s, ’70s, and ’80s, Kmart prospered. By 1990, however, when Wal-Mart first surpassed Kmart in annual sales, Kmart’s stores had become dated and lost their appeal. Other well-known discount stores, such as Korvette’s, Grant’s, Woolco, Ames, Bradlees, and Montgomery Ward, had gone out of business as the industry had consolidated and reached maturity. Attempting to avoid this fate, Kmart management updated and enlarged the stores, added name brands, and hired Martha Stewart as its lifestyle consultant. None of these changes improved Kmart’s fi- nancial situation. By the time it declared bankruptcy, it had lost money in five of the past 10 years.

Out of bankruptcy, Kmart became profitable—pri- marily by closing or selling (to Sears and Home Depot) around 600 of its retail stores. Management had been un- able to invigorate sales in its stores. Declared guilty of in- sider trading, Martha Stewart went to prison just before the 2004 Christmas season. In a surprise move, Edward Lampert, Kmart’s Chairman of the Board and a control- ling shareholder of Kmart, initiated the acquisition of Sears by Kmart for $11 billion in November 2004. The new company was to be called Sears Holdings Corpora- tion. Even though management predicted that the com- bined company’s costs could be reduced by $500 million annually within three years through supplier and admin- istrative economies, analysts wondered how these two struggling firms could ever be successful.

By the end of 2007, the stock of Sears Holdings had fallen to 111 from its peak of 195 earlier in the year. Like many retailers, both Sears and Kmart struggled to attract shoppers in an overcrowded industry and a slumping economy. Sears Holdings did, however, have $1.5 bil- lion in cash, a significant advantage during lean times, and more than its rivals J.C. Penney, Kohl’s, and Macy’s combined. The company’s debt load was only 25% of

This case was written by J. David Hunger for Strategic Management and Business Policy, 12th edition and for Concepts in Strategic Management and Business Policy, 12th edition. Copyright © 2008 by J. David Hunger. Reprinted by permission. References available upon request.

C H A P T E R 8 Strategy Formulation: Functional Strategy and Strategic Choice 267

the total capital on its balance sheet, compared to 46% for Penney’s and 53% for Macy’s. It also had significant real estate assets on its balance sheet. For example, Sears owned outright 518 of its 816 locations and many of the Kmart stores were located in strip malls close to large cities. Since fewer shopping malls were now being built, it was becoming harder to find space for “big-box” retailers in metropolitan areas.

The most recent quarterly results for 2007 of Sears Holdings reported the third straight quarter of deteriorating

profit margins and same-store sales. After months of cutting the number of employees and reducing other expenses, industry analysts felt that there was little left to cut. They were also concerned that management had failed to invest in store improvements. Sears Holdings had just launched a bid in November 2007 to purchase Restoration Hardware, a home-goods retailer. Even though Restora- tion Hardware was also facing sluggish sales, it was thought that Sears’ management could use the acquisition to create an upscale boutique within its stores.

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P A R T4

Strategy

Implementation and

Control

For nearly five decades, Wal-Mart’s “everyday low prices” and low cost position

had enabled it to rapidly grow to dominate North America’s retailing landscape. By

2006, however, its U.S. division generated only 1.9% growth in its same-store sales.

By 2007, Target, Costco, Kroger, Safeway, Walgreens, CVS, and Best Buy were all

growing faster than Wal-Mart. At about the same time, Microsoft, whose software

had grown to dominate personal computers worldwide, saw its revenue growth slow to

just 8% in 2005. The company’s stock price had been flat since 2002, an indication that investors

no longer perceived Microsoft as a growth company. What had happened to these two success-

ful companies? Was this an isolated phenomenon? What could be done, if anything, to reinvig-

orate these giants?1

A research study by Matthew Olson, Derek van Bever, and Seth Verry attempts to provide

an answer. After analyzing the experiences of 500 successful companies over a 50-year period,

they found that 87% of the firms had suffered one or more serious declines in sales and prof-

its. This included a diverse set of corporations, such as Levi Strauss, 3M, Apple, Bank One, Cater-

pillar, Daimler-Benz, Toys“R”Us, and Volvo. After years of prolonged growth in sales and

profits, revenue growth at each of these firms suddenly stopped and even turned negative!

Olson, van Bever, and Verry called these long-term reversals in company growth stall points. On

average, corporations lost 74% of their market capitalization in the decade surrounding a

growth stall. Even though the CEO and other members of top management were typically re-

placed, only 46% of the firms were able to return to moderate or high growth within the

decade. When slow growth was allowed to persist for more than 10 years, the delay was usu-

ally fatal. Only 7% of this group was able to return to moderate or high growth.2

At Levi Strauss & Company, for example, sales topped $7 billion in 1996—extending growth

that had more than doubled over the previous decade. From that high-water mark, sales plum-

meted until they reached $4.6 in 2000—a 35% decline. Market share in its U.S. jeans market

dropped from 31% in 1990 to 14% by 2000. Its market value fell from $14 billion to $8 billion

during these four years. After replacing management, the company underwent a companywide

transformation, but by 2008 it had yet to return to growth.

strategy implementation: organizing for Action

C H A P T E R 9

271

� Develop programs, budgets, and procedures to implement strategic change

� Understand the importance of achieving synergy during strategy implementation

� List the stages of corporate development and the structure that characterizes each stage

� Identify the blocks to changing from one stage to another

� Construct matrix and network structures to support flexible and nimble organizational strategies

� Decide when and if programs such as reengineering, Six Sigma, and job redesign are appropriate methods of strategy implementation

� Understand the centralization versus decentralization issue in multinational corporations

Learning Objectives After reading this chapter, you should be able to:

Gathering Information

Putting Strategy into Action

Monitoring Performance

Societal Environment: General forces

Natural Environment: Resources and

climate

Task Environment:

Industry analysis

Internal: Strengths and Weaknesses

Structure: Chain of command

Culture: Beliefs, expectations,

values

Resources: Assets, skills, competencies,

knowledge

Programs

Activities needed to accomplish a plan

Budgets

Cost of the programs Procedures

Sequence of steps needed to do the job

Performance

Actual results

External: Opportunities

and Threats

Developing Long-range Plans

Mission

Reason for existence Objectives

What results to accomplish by when

Strategies

Plan to achieve the mission & objectives

Policies

Broad guidelines for decision making

Environmental Scanning:

Strategy Formulation:

Strategy Implementation:

Evaluation and Control:

Feedback/Learning: Make corrections as needed

272 PA RT 4 Strategy Implementation and Control

According to Olson, van Bever, and Verry, these stall points occurred primarily be-

cause of a poor choice in strategy or organizational design. The root causes fell into four

categories:

1. Premium position backfires: This happens to a firm that has developed a premium po-

sition in the market, but is unable to respond effectively to new, low-cost competitors

or a shift in customer valuation of product features. Management teams go through

a process of disdain, denial, and rationalization that precedes the fall.

2. Innovation management breaks down: Management processes for updating existing

products and creating new ones falter and become systemic inefficiencies.

3. Core business abandoned: Management fails to exploit growth opportunities in ex-

isting core businesses and instead engages in growth initiatives in areas remote from

existing customers, products, and distribution channels.

4. Talent and capabilities run short: Strategies are not executed properly because of a

lack of managers and staff with the skills and capabilities needed for strategy imple-

mentation. Often supported by promote-from-within policies, top management has a

narrow experience base, which too often replicates the skill set of past top managers.3

9.1 Strategy Implementation Strategy implementation is the sum total of the activities and choices required for the execu- tion of a strategic plan. It is the process by which objectives, strategies, and policies are put into action through the development of programs, budgets, and procedures. Although imple- mentation is usually considered after strategy has been formulated, implementation is a key part of strategic management. Strategy formulation and strategy implementation should thus be considered as two sides of the same coin.

Poor implementation has been blamed for a number of strategic failures. For example, studies show that half of all acquisitions fail to achieve what was expected of them, and one out of four international ventures does not succeed.4 The most-mentioned problems reported in post-merger integration were poor communication, unrealistic synergy expectations, struc- tural problems, missing master plan, lost momentum, lack of top management commitment, and unclear strategic fit. A study by A. T. Kearney found that a company has just two years in which to make an acquisition perform. After the second year, the window of opportunity for forging synergies has mostly closed. Kearney’s study was supported by further independent research by Bert, MacDonald, and Herd. Among the most successful acquirers studied, 70% to 85% of all merger synergies were realized within the first 12 months, with the remainder being realized in year two.5

To begin the implementation process, strategy makers must consider these questions:

� Who are the people who will carry out the strategic plan?

� What must be done to align the company’s operations in the new intended direction?

� How is everyone going to work together to do what is needed?

C H A P T E R 9 Strategy Implementation: Organizing for Action 273

These questions and similar ones should have been addressed initially when the pros and cons of strategic alternatives were analyzed. They must also be addressed again before appro- priate implementation plans can be made. Unless top management can answer these basic ques- tions satisfactorily, even the best planned strategy is unlikely to provide the desired outcome.

A survey of 93 Fortune 500 firms revealed that more than half of the corporations expe- rienced the following 10 problems when they attempted to implement a strategic change. These problems are listed in order of frequency:

1. Implementation took more time than originally planned.

2. Unanticipated major problems arose.

3. Activities were ineffectively coordinated.

4. Competing activities and crises took attention away from implementation.

5. The involved employees had insufficient capabilities to perform their jobs.

6. Lower-level employees were inadequately trained.

7. Uncontrollable external environmental factors created problems.

8. Departmental managers provided inadequate leadership and direction.

9. Key implementation tasks and activities were poorly defined.

10. The information system inadequately monitored activities.6

9.2 Who Implements Strategy? Depending on how a corporation is organized, those who implement strategy will probably be a much more diverse set of people than those who formulate it. In most large, multi-industry corporations, the implementers are everyone in the organization. Vice presidents of functional areas and directors of divisions or strategic business units (SBUs) work with their subordinates to put together large-scale implementation plans. Plant managers, project managers, and unit heads put together plans for their specific plants, departments, and units. Therefore, every op- erational manager down to the first-line supervisor and every employee is involved in some way in the implementation of corporate, business, and functional strategies.

Many of the people in the organization who are crucial to successful strategy implemen- tation probably had little to do with the development of the corporate and even business strat- egy. Therefore, they might be entirely ignorant of the vast amount of data and work that went into the formulation process. Unless changes in mission, objectives, strategies, and policies and their importance to the company are communicated clearly to all operational managers, there can be a lot of resistance and foot-dragging. Managers might hope to influence top man- agement into abandoning its new plans and returning to its old ways. This is one reason why involving people from all organizational levels in the formulation and implementation of strat- egy tends to result in better organizational performance.7

9.3 What Must Be Done? The managers of divisions and functional areas work with their fellow managers to develop programs, budgets, and procedures for the implementation of strategy. They also work to achieve synergy among the divisions and functional areas in order to establish and maintain a company’s distinctive competence.

274 PA RT 4 Strategy Implementation and Control

DEVELOPING PROGRAMS, BUDGETS, AND PROCEDURES Strategy implementation involves establishing programs to create a series of new organiza- tional activities, budgets to allocate funds to the new activities, and procedures to handle the day-to-day details.

Programs The purpose of a program is to make a strategy action oriented. For example, when Xerox Corporation undertook a turnaround strategy, it needed to significantly reduce its costs and ex- penses. Management introduced a program called Lean Six Sigma. This program was devel- oped to identify and improve a poorly performing process. Xerox first trained its top executives in the program and then launched around 250 individual Six Sigma projects throughout the corporation. The result was $6 million in savings in one year, with even more expected the next.8 (Six Sigma is explained later in this chapter.)

Most corporate headquarters have around 10 to 30 programs in effect at any one time.9

One of the programs initiated by Ford Motor Company was to find an organic substitute for petroleum-based foam being used in vehicle seats. For more information on Ford’s innovative soybean seat program, see the Environment Sustainability Issue feature.

One way to examine the likely impact new programs will have on an existing organiza- tion is to compare proposed programs and activities with current programs and activities. Brynjolfsson, Renshaw, and Van Alstyne proposed a matrix of change to help managers de- cide how quickly change should proceed, in what order changes should take place, whether to start at a new site, and whether the proposed systems are stable and coherent. As shown in Figure 9–1, target practices (new programs) for a manufacturing plant are drawn on the

SOURCE: “Manufacturers Turn to Soy for Cushy Seats,” St. Cloud (MN) Times (January 26, 2008), p. 3A, and Ford Motor Company Web site (www.Ford.com).

Mustang and other Ford vehicles delivered to auto show- rooms beginning August 2007.

Sears Manufacturing Company, a seat supplier to Deere and other companies, licensed the Ford technology to work with Deere in developing soy-based foam for seats on Deere’s farm and construction equipment. Deere was already using soy-based materials for parts such as hoods, side panels, and doors on some models of tractors, com- bines, cotton pickers, and backhoes. According to John Koutsky, Vice President of Product Development, Sears started commercial production of the new seats in 2009 and planned to use soy foam throughout its product line being sold to heavy truck manufacturers like Freightliner and International. “It’s good to be green,” commented Koutsky.

The Model T Ford once con- tained 60 pounds of soy-

beans in its paint and molded plastic parts. Since that time,

petroleum has become the primary ingredient in most plastic parts, including

the foam currently used in car and truck seats. Neverthe- less, today’s manufacturers are looking for ways to replace petroleum-based products with ones made from agricul- tural crops, as the political, environmental, and economic costs of oil increase. According to Larry Johnson, Director of the Center for Crops Utilization Research at Iowa State Uni- versity, soy is usually cheaper and more environmentally friendly than petroleum and comes from a renewable agri- cultural source. With this in mind, Ford’s management initi- ated a program in 2001 with seat supplier Lear Corporation to research soy-based foam as a possible substitute for petroleum-based foam. The program was a huge success. A complete seating system, including suspension systems, contains about 20% soy oil. The new seats were used in the

FORD’S SOYBEAN SEAT FOAM PROGRAM

ENVIRONMENTAL sustainability issue

C H A P T E R 9 Strategy Implementation: Organizing for Action 275

vertical axis and existing practices (current activities) are drawn on the horizontal axis. As shown, any new strategy will likely involve a sequence of new programs and activities. Any one of these may conflict with existing practices/activities—and that creates implementation problems. Use the following steps to create the matrix:

1. Compare the new programs/target practices with each other to see if they are complemen- tary (�), interfering (�), or have no effect on each other (leave blank).

2. Examine existing practices/activities for their interactions with each other using the same symbols as in step 1.

3. Compare each new program/target practice with each existing practice/activity for any in- teraction effects. Place the appropriate symbols in the cells in the lower-right part of the matrix.

4. Evaluate each program/activity in terms of its relative importance to achieving the strat- egy or getting the job accomplished.

5. Examine the overall matrix to identify problem areas where proposed programs are likely to either interfere with each other or with existing practices/activities. Note in Figure 9–1 that the proposed program of installing flexible equipment interferes with the proposed

Existing Practices

Ta rg

e t

P ra

c ti

c e s

Efficient Low-Cost Operation

Meet Product Requirements

Vertical Structure

Designated Equipment

Narrow Job Functions

Piece-Rate (Output) Pay

Several Management Layers (6)

Importance

Im p o rt

a n ce

F le

xi b le

E q u ip

m e n t

G re

a te

r R

e sp

o n si

b ili

ty

W o rk

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P a id

F la

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L o w

J IT

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ry

F e w

M a n a g e m

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rs (

3 – 4 )

L in

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Large WIP and FG Inventories

Matrix Interaction

+ Complementary Practices Weak/No Interaction – Interfering Practices

+ +

+ +

++

++

+

–

–2

+2 +2 +2 +1 +1

+

+

–

–

–

–

–

–

–

––

–

––1

+1

Importance to Job

+2 Very Important +1 Somewhat Important 0 Irrelevant –1 Somewhat Interfering –2 Significantly Interfering

E ne

rg iz

ed O

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iz at

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Z er

o N

on -C

on fo

rm an

ce

E lim

in at

io n

of N

on -

Va lu

e- A

dd in

g C

os ts

FIGURE 9–1 The Matrix of Change

SOURCE: Reprinted from The Matrix of Change by E. Brynjolfsson, A.A. Renshaw, and M. Van Alstyne. Sloan Management Review, Winter 1997, pp. 168-181. From MIT Sloan Management Review © 1997 by Massachusetts Institute of Technology. All rights reserved. Distributed by Tribune Media Services.

276 PA RT 4 Strategy Implementation and Control

program of assembly line rationalization. The two new programs need to be changed so that they no longer conflict with each other. Note also that the amount of change neces- sary to carry out the proposed implementation programs (target practices) is a function of the number of times each program interferes with existing practices/activities. That is, the more minus signs and the fewer plus signs in the matrix, the more implementation prob- lems can be expected.

The matrix of change can be used to address the following types of questions:

� Feasibility: Do the proposed programs and activities constitute a coherent, stable system? Are the current activities coherent and stable? Is the transition likely to be difficult?

� Sequence of execution: Where should the change begin? How does the sequence affect success? Are there reasonable stopping points?

� Location: Are we better off instituting the new programs at a new site, or can we reorga- nize the existing facilities at a reasonable cost?

� Pace and nature of change: Should the change be slow or fast, incremental or radical? Which blocks of current activities must be changed at the same time?

� Stakeholder evaluations: Have we overlooked any important activities or interactions? Should we get further input from interested stakeholders? Which new programs and cur- rent activities offer the greatest sources of value?

The matrix offers useful guidelines on where, when, and how fast to implement change.10

Budgets After programs have been developed, the budget process begins. Planning a budget is the last real check a corporation has on the feasibility of its selected strategy. An ideal strategy might be found to be completely impractical only after specific implementation programs are costed in detail. As an example, once Cadbury Schweppes’ management realized how dependent the company was on cocoa from Ghana to continue the company’s growth strategy, it developed a program to show cocoa farmers how to increase yields using fertilizers and by working with each other. Ghana produced 70% of Cadbury’s worldwide supply of the high-quality cocoa necessary to provide the distinctive taste of Dairy Milk, Crème Egg, and other treats. Manage- ment introduced the “Cadbury Cocoa Partnership” on January 28, 2008, and budgeted $87 mil- lion for this program over a 10-year period.11

Procedures After the program, divisional, and corporate budgets are approved, procedures must be devel- oped. Often called Standard Operating Procedures (SOPs), they typically detail the various activities that must be carried out to complete a corporation’s programs. Also known as organizational routines, procedures are the primary means by which organizations accomplish much of what they do.12 Once in place, procedures must be updated to reflect any changes in technology as well as in strategy. For example, a company following a differentiation compet- itive strategy manages its sales force more closely than does a firm following a low-cost strat- egy. Differentiation requires long-term customer relationships created out of close interaction with the sales force. An in-depth understanding of the customer’s needs provides the founda- tion for product development and improvement.13

In a retail store, procedures ensure that the day-to-day store operations will be consistent over time (that is, next week’s work activities will be the same as this week’s) and consistent among stores (that is, each store will operate in the same manner as the others). Properly planned procedures can help eliminate poor service by making sure that employees do use not

C H A P T E R 9 Strategy Implementation: Organizing for Action 277

excuses to justify poor behavior toward customers. Even though McDonald’s, the fast-food restaurant, has developed very detailed procedures to ensure that customers have high quality service, not every business is so well managed. See Strategy Highlight 9.1 for the top 10 ex- cuses for bad service.

Before a new strategy can be successfully implemented, current procedures may need to be changed. For example, in order to implement Home Depot’s strategic move into services, such as kitchen and bathroom installation, the company had to first improve its productivity. Store managers were drowning in paperwork designed for a smaller and simpler company. “We’d get a fax, an e-mail, a call, and a memo, all on the same project,” reported store man- ager Michael Jones. One executive used just three weeks of memos to wallpaper an entire con- ference room, floor to ceiling, windows included. CEO Robert Nardelli told his top managers

and up to date, but we can’t afford to follow every customer around to make sure we pick up everything, nor can we refurbish our place all the time.

#5. Customer complaint: I placed my order a while ago, why is it taking so long? Excuse: Sorry, but we are very busy right now. You came at our “busy” time and you must be patient.

#4. Customer complaint: Your server did not seem to know what he/she was doing and made a mess of my experience. Excuse: Unfortunately, with all the turnover we are having right now, we just didn’t have the time to train everyone up to our standards.

#3. Customer complaint: Your employee was rude to me and has a bad attitude. Excuse: We do apologize for the unfortunate attitude of a few employees.

#2. Customer complaint: The server didn’t seem to be interested in doing what he/she was supposed to do. Why can’t she/he do it the right way? Excuse: We are sorry. While we trained them to do it the right way, sometimes they just seem to ignore what we taught them.

#1. Customer complaint: We expected something different from your company and we are really disappointed. Excuse: You must be misinformed, as we have been successful for a long time and obviously know exactly what our customers want and need.

Corporations may have offi- cial policies stating that the

“customer is always right” or “customer is number one,” but

these quickly become meaningless platitudes unless procedures are devel-

oped and communicated to all employees for them to fol- low when confronted with a problem or a question from a customer. Beware of the top ten excuses for bad service. They can sabotage a company’s strategy and send valued customers to the competition. How many times have you heard the following excuses when you received poor ser- vice? Or even worse, how many times have you personally given one or all of these excuses?

#10. Customer complaint: Why do I have to wait so long for service? Excuse: To get service as good as ours, sometimes you have to wait; our guests expect that.

#9. Customer complaint: Why didn’t your service meet what I expected? Excuse: Nobody’s perfect; we simply can’t make every customer happy.

#8. Customer complaint: Why didn’t you let us have it “our way”? Excuse: We’re sorry, but if we did it “your way” for all our customers, we would crash our systems and overextend our already overworked employees.

#7. Customer complaint: Service wasn’t as good this time as it was the last time we were here. Excuse: Everybody has good days and bad days; we’re doing our best to please you, but we can’t always be perfect.

#6. Customer complaint: Your place is dirty, dated, and worn. Excuse: We do our best to keep it clean

THE TOP TEN EXCUSES FOR BAD SERVICE

SOURCE: D. Dickson, R. C. Ford, and B. Laval, “The Top Ten Ex- cuses for Bad Service (and How to Avoid Needing Them)” Organizational Dynamics, Vol. 34, Issue 2 (2005), pp. 168–181.

STRATEGY highlight 9.1

278 PA RT 4 Strategy Implementation and Control

ACHIEVING SYNERGY One of the goals to be achieved in strategy implementation is synergy between and among functions and business units. This is the reason corporations commonly reorganize after an ac- quisition. Synergy is said to exist for a divisional corporation if the return on investment (ROI) of each division is greater than what the return would be if each division were an independent business. According to Goold and Campbell, synergy can take place in one of six forms:

� Shared know-how: Combined units often benefit from sharing knowledge or skills. This is a leveraging of core competencies. One reason that Procter & Gamble purchased Gillette was to combine P&G’s knowledge of the female consumer with Gillette’s knowl- edge of the male consumer.

� Coordinated strategies: Aligning the business strategies of two or more business units may provide a corporation significant advantage by reducing inter-unit competition and developing a coordinated response to common competitors (horizontal strategy). The merger between Arcelor and Mittal Steel, for example, gave the combined company en- hanced R&D capabilities and wider global coverage while presenting a common face to the market.

� Shared tangible resources: Combined units can sometimes save money by sharing re- sources, such as a common manufacturing facility or R&D lab. The alliance between Renault and Nissan allowed it to build new factories that would build both Nissan and Renault vehicles.

� Economies of scale or scope: Coordinating the flow of products or services of one unit with that of another unit can reduce inventory, increase capacity utilization, and improve market access. This was a reason Delta Airlines bought Northwest Airlines.

� Pooled negotiating power: Combined units can combine their purchasing to gain bar- gaining power over common suppliers to reduce costs and improve quality. The same can be done with common distributors. The acquisitions of Macy’s and the May Company en- abled Federated Department Stores (which changed its name to Macy’s in 2007) to gain purchasing economies for all of its stores.

� New business creation: Exchanging knowledge and skills can facilitate new products or services by extracting discrete activities from various units and combining them in a new unit or by establishing joint ventures among internal business units. Oracle, for example, purchased a number of software companies in order to create a suite of software code- named “Project Fusion” to help corporations run everything from accounting and sales to customer relations and supply-chain management.15

9.4 How Is Strategy to Be Implemented? Organizing for Action

Before plans can lead to actual performance, a corporation should be appropriately organized, programs should be adequately staffed, and activities should be directed toward achieving de- sired objectives. (Organizing activities are reviewed briefly in this chapter; staffing, directing, and control activities are discussed in Chapters 10 and 11.)

to eliminate duplicate communications and streamline work projects. Directives not related to work orders had to be sent separately and only once a month. The company also spent $2 mil- lion on workload-management software.14

C H A P T E R 9 Strategy Implementation: Organizing for Action 279

STRUCTURE FOLLOWS STRATEGY In a classic study of large U.S. corporations such as DuPont, General Motors, Sears, and Stan- dard Oil, Alfred Chandler concluded that structure follows strategy—that is, changes in cor- porate strategy lead to changes in organizational structure.16 He also concluded that organizations follow a pattern of development from one kind of structural arrangement to an- other as they expand. According to Chandler, these structural changes occur because the old structure, having been pushed too far, has caused inefficiencies that have become too obvi- ously detrimental to bear. Chandler, therefore, proposed the following as the sequence of what occurs:

1. New strategy is created.

2. New administrative problems emerge.

3. Economic performance declines.

4. New appropriate structure is invented.

5. Profit returns to its previous level.

Chandler found that in their early years, corporations such as DuPont tend to have a cen- tralized functional organizational structure that is well suited to producing and selling a lim- ited range of products. As they add new product lines, purchase their own sources of supply, and create their own distribution networks, they become too complex for highly centralized structures. To remain successful, this type of organization needs to shift to a decentralized structure with several semiautonomous divisions (referred to in Chapter 5 as divisional structure).

Alfred P. Sloan, past CEO of General Motors, detailed how GM conducted such structural changes in the 1920s.17 He saw decentralization of structure as “centralized policy determina- tion coupled with decentralized operating management.” After top management had devel- oped a strategy for the total corporation, the individual divisions (Chevrolet, Buick, and so on) were free to choose how to implement that strategy. Patterned after DuPont, GM found the de- centralized multidivisional structure to be extremely effective in allowing the maximum amount of freedom for product development. Return on investment was used as a financial control. (ROI is discussed in more detail in Chapter 11.)

Research generally supports Chandler’s proposition that structure follows strategy (as well as the reverse proposition that structure influences strategy).18 As mentioned earlier, changes in the environment tend to be reflected in changes in a corporation’s strategy, thus leading to changes in a corporation’s structure. In 2008, Arctic Cat, the recreational vehicles firm, reorga- nized its ATV (all terrain vehicles), snowmobile and parts, and garments and accessories product

Any change in corporate strategy is very likely to require some sort of change in the way an organization is structured and in the kind of skills needed in particular positions. Managers must, therefore, closely examine the way their company is structured in order to decide what, if any, changes should be made in the way work is accomplished. Should activities be grouped differently? Should the authority to make key decisions be centralized at headquarters or de- centralized to managers in distant locations? Should the company be managed like a “tight ship” with many rules and controls, or “loosely” with few rules and controls? Should the cor- poration be organized into a “tall” structure with many layers of managers, each having a nar- row span of control (that is, few employees per supervisor) to better control his or her subordinates; or should it be organized into a “flat” structure with fewer layers of managers, each having a wide span of control (that is, more employees per supervisor) to give more free- dom to his or her subordinates?

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lines into three separate business units, each led by a general manager focused on expanding the business. True to Chandler’s findings, the restructuring of Arctic Cat came after seven consecu- tive years of record growth followed by its first loss in 25 years.

Strategy, structure, and the environment need to be closely aligned; otherwise, organiza- tional performance will likely suffer.19 For example, a business unit following a differentiation strategy needs more freedom from headquarters to be successful than does another unit fol- lowing a low-cost strategy.20

Although it is agreed that organizational structure must vary with different environmen- tal conditions, which, in turn, affect an organization’s strategy, there is no agreement about an optimal organizational design. What was appropriate for DuPont and General Motors in the 1920s might not be appropriate today. Firms in the same industry do, however, tend to orga- nize themselves similarly to one another. For example, automobile manufacturers tend to em- ulate General Motors’ divisional concept, whereas consumer-goods producers tend to emulate the brand-management concept (a type of matrix structure) pioneered by Procter & Gamble Company. The general conclusion seems to be that firms following similar strategies in simi- lar industries tend to adopt similar structures.

STAGES OF CORPORATE DEVELOPMENT Successful corporations tend to follow a pattern of structural development as they grow and expand. Beginning with the simple structure of the entrepreneurial firm (in which everybody does everything), successful corporations usually get larger and organize along functional lines, with marketing, production, and finance departments. With continuing success, the com- pany adds new product lines in different industries and organizes itself into interconnected di- visions. The differences among these three structural stages of corporate development in terms of typical problems, objectives, strategies, reward systems, and other characteristics are specified in detail in Table 9–1.

Stage I: Simple Structure Stage I is typified by the entrepreneur, who founds a company to promote an idea (a product or a service). The entrepreneur tends to make all the important decisions personally and is in- volved in every detail and phase of the organization. The Stage I company has little formal structure, which allows the entrepreneur to directly supervise the activities of every employee (see Figure 5–4 for an illustration of the simple, functional, and divisional structures). Plan- ning is usually short range or reactive. The typical managerial functions of planning, orga- nizing, directing, staffing, and controlling are usually performed to a very limited degree, if at all. The greatest strengths of a Stage I corporation are its flexibility and dynamism. The drive of the entrepreneur energizes the organization in its struggle for growth. Its greatest weakness is its extreme reliance on the entrepreneur to decide general strategies as well as detailed pro- cedures. If the entrepreneur falters, the company usually flounders. This is labeled by Greiner as a crisis of leadership.21

Stage I describes Oracle Corporation, the computer software firm, under the management of its co-founder and CEO Lawrence Ellison. The company adopted a pioneering approach to retrieving data, called Structured Query Language (SQL). When IBM made SQL its standard, Oracle’s success was assured. Unfortunately, Ellison’s technical wizardry was not sufficient to manage the company. Often working at home, he lost sight of details outside his technical in- terests. Although the company’s sales were rapidly increasing, its financial controls were so weak that management had to restate an entire year’s results to rectify irregularities. After the company recorded its first loss, Ellison hired a set of functional managers to run the company while he retreated to focus on new product development.

C H A P T E R 9 Strategy Implementation: Organizing for Action 281

Stage II: Functional Structure Stage II is the point when the entrepreneur is replaced by a team of managers who have func- tional specializations. The transition to this stage requires a substantial managerial style change for the chief officer of the company, especially if he or she was the Stage I entrepre- neur. He or she must learn to delegate; otherwise, having additional staff members yields no benefits to the organization. The previous example of Ellison’s retreat from top management

TABLE 9–1 Factors Differentiating Stage I, II, and III Companies

Function Stage I Stage II Stage III

1. Sizing up: Major problems

Survival and growth dealing with short-term operating problems.

Growth, rationalization, and expansion of resources, providing for adequate attention to product problems.

Trusteeship in management and investment and control of large, increasing, and diversified resources. Also, important to diagnose and take action on problems at division level.

2. Objectives Personal and subjective. Profits and meeting functionally oriented budgets and performance targets.

ROI, profits, earnings per share.

3. Strategy Implicit and personal; exploitation of immediate opportunities seen by owner-manager.

Functionally oriented moves restricted to “one product” scope; exploitation of one basic product or service field.

Growth and product diversification; exploitation of general business opportunities.

4. Organization: Major characteristic of structure

One unit, “one-man show.”

One unit, functionally specialized group.

Multiunit general staff office and decentralized operating divisions.

5. (a) Measurement and control

Personal, subjective control based on simple accounting system and daily communication and observation.

Control grows beyond one person; assessment of functional operations necessary; structured control systems evolve.

Complex formal system geared to comparative assessment of performance measures, indicating problems and opportunities and assessing management ability of division managers.

5. (b) Key performance indicators

Personal criteria, relationships with owner, operating efficiency, ability to solve operating problems.

Functional and internal criteria such as sales, performance compared to budget, size of empire, status in group, personal, relationships, etc.

More impersonal application of comparisons such as profits, ROI, P/E ratio, sales, market share, productivity, product leadership, personnel development, employee attitudes, public responsibility.

6. Reward-punishment system

Informal, personal, subjective; used to maintain control and divide small pool of resources for key performers to provide personal incentives.

More structured; usually based to a greater extent on agreed policies as opposed to personal opinion and relationships.

Allotment by “due process” of a wide variety of different rewards and punishments on a formal and systematic basis. Companywide policies usually apply to many different classes of managers and workers with few major exceptions for individual cases.

SOURCE: D.H. Thain, “Stages of Corporate Development,” Ivey Business Quarterly, Winter 1969, p. 37. © 1969 Ivey Management Services. One time Permission to reproduce granted by Ivey Management Services.

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at Oracle Corporation to new product development manager is one way that technically bril- liant founders are able to get out of the way of the newly empowered functional managers. In Stage II, the corporate strategy favors protectionism through dominance of the industry, often through vertical and horizontal growth. The great strength of a Stage II corporation lies in its concentration and specialization in one industry. Its great weakness is that all its eggs are in one basket.

By concentrating on one industry while that industry remains attractive, a Stage II com- pany, such as Oracle Corporation in computer software, can be very successful. Once a func- tionally structured firm diversifies into other products in different industries, however, the advantages of the functional structure break down. A crisis of autonomy can now develop, in which people managing diversified product lines need more decision-making freedom than top management is willing to delegate to them. The company needs to move to a different structure.

Stage III: Divisional Structure Stage III is typified by the corporation’s managing diverse product lines in numerous indus- tries; it decentralizes the decision-making authority. Stage III organizations grow by diversi- fying their product lines and expanding to cover wider geographical areas. They move to a divisional structure with a central headquarters and decentralized operating divisions—with each division or business unit a functionally organized Stage II company. They may also use a conglomerate structure if top management chooses to keep its collection of Stage II sub- sidiaries operating autonomously. A crisis of control can now develop, in which the various units act to optimize their own sales and profits without regard to the overall corporation, whose headquarters seems far away and almost irrelevant.

Recently, divisions have been evolving into SBUs to better reflect product-market consid- erations. Headquarters attempts to coordinate the activities of its operating divisions or SBUs through performance- and results-oriented control and reporting systems and by stressing cor- porate planning techniques. The units are not tightly controlled but are held responsible for their own performance results. Therefore, to be effective, the company has to have a decen- tralized decision process. The greatest strength of a Stage III corporation is its almost unlim- ited resources. Its most significant weakness is that it is usually so large and complex that it tends to become relatively inflexible. General Electric, DuPont, and General Motors are ex- amples of Stage III corporations.

Stage IV: Beyond SBUs Even with its evolution into SBUs during the 1970s and 1980s, the divisional structure is not the last word in organization structure. The use of SBUs may result in a red tape crisis in which the corporation has grown too large and complex to be managed through formal programs and rigid systems, and procedures take precedence over problem solving.22 For example, Pfizer’s acquisitions of Warner-Lambert and Pharmacia resulted in 14 layers of management between scientists and top executives and forced researchers to spend most of their time in meetings.23

Under conditions of (1) increasing environmental uncertainty, (2) greater use of sophisticated technological production methods and information systems, (3) the increasing size and scope of worldwide business corporations, (4) a greater emphasis on multi-industry competitive strat- egy, and (5) a more educated cadre of managers and employees, new advanced forms of orga- nizational structure are emerging. These structures emphasize collaboration over competition in the managing of an organization’s multiple overlapping projects and developing businesses.

The matrix and the network are two possible candidates for a fourth stage in corporate de- velopment—a stage that not only emphasizes horizontal over vertical connections between people and groups but also organizes work around temporary projects in which sophisticated

C H A P T E R 9 Strategy Implementation: Organizing for Action 283

information systems support collaborative activities. According to Greiner, it is likely that this stage of development will have its own crisis as well—a sort of pressure-cooker crisis. He pre- dicts that employees in these collaborative organizations will eventually grow emotionally and physically exhausted from the intensity of teamwork and the heavy pressure for innova- tive solutions.24

Blocks to Changing Stages Corporations often find themselves in difficulty because they are blocked from moving into the next logical stage of development. Blocks to development may be internal (such as lack of resources, lack of ability, or refusal of top management to delegate decision making to others) or external (such as economic conditions, labor shortages, and lack of market growth). For ex- ample, Chandler noted in his study that the successful founder/CEO in one stage was rarely the person who created the new structure to fit the new strategy, and as a result, the transition from one stage to another was often painful. This was true of General Motors Corporation un- der the management of William Durant, Ford Motor Company under Henry Ford I, Polaroid Corporation under Edwin Land, Apple Computer under Steven Jobs, and Sun Microsystems under Scott McNealy.

Entrepreneurs who start businesses generally have four tendencies that work very well for small new ventures but become Achilles’ heels for these same individuals when they try to manage a larger firm with diverse needs, departments, priorities, and constituencies:

� Loyalty to comrades: This is good at the beginning but soon becomes a liability as “favoritism.”

� Task oriented: Focusing on the job is critical at first but then becomes excessive atten- tion to detail.

� Single-mindedness: A grand vision is needed to introduce a new product but can become tunnel vision as the company grows into more markets and products.

� Working in isolation: This is good for a brilliant scientist but disastrous for a CEO with multiple constituencies.25

This difficulty in moving to a new stage is compounded by the founder’s tendency to ma- neuver around the need to delegate by carefully hiring, training, and grooming his or her own team of managers. The team tends to maintain the founder’s influence throughout the organi- zation long after the founder is gone. This is what happened at Walt Disney Productions when the family continued to emphasize Walt’s policies and plans long after he was dead. Although this may often be an organization’s strength, it may also be a weakness—to the extent that the culture supports the status quo and blocks needed change.

ORGANIZATIONAL LIFE CYCLE Instead of considering stages of development in terms of structure, the organizational life cy- cle approach places the primary emphasis on the dominant issue facing the corporation. Orga- nizational structure is only a secondary concern. The organizational life cycle describes how organizations grow, develop, and eventually decline. It is the organizational equivalent of the product life cycle in marketing. These stages are Birth (Stage I), Growth (Stage II), Maturity (Stage III), Decline (Stage IV), and Death (Stage V). The impact of these stages on corporate strategy and structure is summarized in Table 9–2. Note that the first three stages of the orga- nizational life cycle are similar to the three commonly accepted stages of corporate develop- ment mentioned previously. The only significant difference is the addition of the Decline and Death stages to complete the cycle. Even though a company’s strategy may still be sound, its

284 PA RT 4 Strategy Implementation and Control

aging structure, culture, and processes may be such that they prevent the strategy from being executed properly. Its core competencies become core rigidities that are no longer able to adapt to changing conditions—thus the company moves into Decline.26

Movement from Growth to Maturity to Decline and finally to Death is not, however, in- evitable. A Revival phase may occur sometime during the Maturity or Decline stages. The cor- poration’s life cycle can be extended by managerial and product innovations.27 Developing new combinations of existing resources to introduce new products or acquiring new resources through acquisitions can enable firms with declining performance to regain growth—so long as the action is valuable and difficult to imitate.28 This can occur during the implementation of a turnaround strategy.29 Nevertheless, the fact that firms in decline are less likely to search for new technologies suggests that it is difficult to revive a company in decline.30

Eastman Kodak is an example of a firm in decline that has been attempting to develop new combinations of its existing resources to introduce new products, and thus, revive the corpo- ration. When Antonio Perez left Hewlett-Packard to become Kodak’s President in 2003, Kodak was in the midst of its struggle to make the transition from chemical film technology to digital technology and digital cameras. Instead of focusing the company’s efforts on acqui- sitions to find growth, Perez looked at technologies that Kodak already owned, but was not utilizing. He noticed that Kodak scientists had developed new ink to yield photo prints with vivid colors that would last a lifetime. He suddenly realized that Kodak’s distinctive competence was not in digital photography, where other competitors led the market, but in color printing. Perez initiated project Goza to go head to head with HP in the consumer inkjet printer business. In 2007, Kodak unveiled its new line of multipurpose machines that not only handled photographs and documents, but also made copies and sent faxes. The printers were designed to print high- quality photos with ink that would stay vibrant for 100 rather than the usual 15 years. Most im- portantly, replacement ink cartridges would cost half the price of competitors’ cartridges. According to Perez, “We think it will give us the opportunity to disrupt the industry’s business model and address consumers’ key dissatisfaction: the high cost of ink.” Perez then predicted that Kodak’s inkjet printers would become a multibillion-dollar product line.31

Unless a company is able to resolve the critical issues facing it in the Decline stage, it is likely to move into Stage V, Death—also known as bankruptcy. This is what happened to Montgomery Ward, Pan American Airlines, Macy’s Department Stores, Baldwin-United, East- ern Airlines, Colt’s Manufacturing, Orion Pictures, and Wheeling-Pittsburgh Steel, as well as many other firms. As in the cases of Johns-Manville, International Harvester, Macy’s, and Kmart—all of which went bankrupt—a corporation can rise like a phoenix from its own ashes and live again under the same or a different name. The company may be reorganized or liquidated, depending on individual circumstances. For example, Kmart emerged from Chapter 11 bankruptcy in 2003 with a new CEO and a plan to sell a number of its stores to

TABLE 9–2 Organizational Life Cycle

Stage I Stage II Stage III* Stage IV Stage V

Dominant Issue Birth Growth Maturity Decline Death

Popular Strategies Concentration in a niche

Horizontal and vertical growth

Concentric and conglomerate diversification

Profit strategy followed by retrenchment

Liquidation or bankruptcy

Likely Structure Entrepreneur dominated

Functional management emphasized

Decentralization into profit or investment centers

Structural surgery Dismemberment of structure

NOTE: *An organization may enter a Revival phase either during the Maturity or Decline stages and thus extend the organization’s life.

C H A P T E R 9 Strategy Implementation: Organizing for Action 285

Home Depot and Sears. These sales earned the company close to $1 billion. Although store sales continued to erode, Kmart had sufficient cash reserves to continue with its turnaround.32

It used that money to acquire Sears in 2005. Unfortunately, however, fewer than 20% of firms entering Chapter 11 bankruptcy in the United States emerge as going concerns; the rest are forced into liquidation.33

Few corporations will move through these five stages in order. Some corporations, for ex- ample, might never move past Stage II. Others, such as General Motors, might go directly from Stage I to Stage III. A large number of entrepreneurial ventures jump from Stage I or II directly into Stage IV or V. Hayes Microcomputer Products, for example, went from the Growth to De- cline stage under its founder Dennis Hayes. The key is to be able to identify indications that a firm is in the process of changing stages and to make the appropriate strategic and structural adjustments to ensure that corporate performance is maintained or even improved.

ADVANCED TYPES OF ORGANIZATIONAL STRUCTURES The basic structures (simple, functional, divisional, and conglomerate) are discussed in Chapter 5 and summarized under the first three stages of corporate development in this chap- ter. A new strategy may require more flexible characteristics than the traditional functional or divisional structure can offer. Today’s business organizations are becoming less centralized with a greater use of cross-functional work teams. Table 9–3 depicts some of the changing structural characteristics of modern corporations. Although many variations and hybrid structures contain these characteristics, two forms stand out: the matrix structure and the network structure.

Matrix Structure Most organizations find that organizing around either functions (in the functional structure) or products and geography (in the divisional structure) provides an appropriate organiza- tional structure. The matrix structure, in contrast, may be very appropriate when organiza- tions conclude that neither functional nor divisional forms, even when combined with horizontal linking mechanisms such as SBUs, are right for their situations. In matrix structures, functional and product forms are combined simultaneously at the same level of the organization. (See Figure 9–2.) Employees have two superiors, a product or project man- ager, and a functional manager. The “home” department—that is, engineering, manufactur- ing, or sales—is usually functional and is reasonably permanent. People from these functional units are often assigned temporarily to one or more product units or projects. The product units or projects are usually temporary and act like divisions in that they are differ- entiated on a product-market basis.

TABLE 9–3 Old Organization Design New Organization Design

Changing Structural Characteristics of Modern Corporations

One large corporation Minibusiness units and cooperative relationships Vertical communication Horizontal communication Centralized, top-down decision making Decentralized participative decision making Vertical integration Outsourcing and virtual organizations Work/quality teams Autonomous work teams Functional work teams Cross-functional work teams Minimal training Extensive training Specialized job design focused on individuals Value-chain team-focused job design

SOURCE: Reprinted from RESEARCH IN ORGANIZATIONAL CHANGE AND DEVELOPMENT, Vol. 7, No. 1, 1993, Macy and Izumi, “Organizational Change, Design, and Work Innovation: A Meta-Analysis of 131 North American Field Studies—1961–1991,” p. 298. Copyright © 1993 with permission.

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Top Management

Manufacturing

Manufacturing Unit

Manager: Project A

Manager: Project B

Manager: Project C

Manager: Project D

Manufacturing Unit

Manufacturing Unit

Manufacturing Unit

Sales

Sales Unit

Sales Unit

Sales Unit

Sales Unit

Finance

Finance Unit

Finance Unit

Finance Unit

Finance Unit

Human Resources

Matrix Structure

Network Structure

Designers Suppliers

Manufacturers Distributors

Packagers

Promotion/ Advertising Agencies

Corporate Headquarters

(Broker)

Human Resources Unit

Human Resources Unit

Human Resources Unit

Human Resources Unit

FIGURE 9–2 Matrix

and Network Structures

Pioneered in the aerospace industry, the matrix structure was developed to combine the stability of the functional structure with the flexibility of the product form. The matrix struc- ture is very useful when the external environment (especially its technological and market as- pects) is very complex and changeable. It does, however, produce conflicts revolving around duties, authority, and resource allocation. To the extent that the goals to be achieved are vague and the technology used is poorly understood, a continuous battle for power between product and functional managers is likely. The matrix structure is often found in an organization or SBU when the following three conditions exist:

� Ideas need to be cross-fertilized across projects or products.

� Resources are scarce.

� Abilities to process information and to make decisions need to be improved.34

Davis and Lawrence, authorities on the matrix form of organization, propose that three distinct phases exist in the development of the matrix structure:35

1. Temporary cross-functional task forces: These are initially used when a new product line is being introduced. A project manager is in charge as the key horizontal link. J&J’s experience with cross-functional teams in its drug group led it to emphasize teams cross- ing multiple units.

2. Product/brand management: If the cross-functional task forces become more perma- nent, the project manager becomes a product or brand manager and a second phase be- gins. In this arrangement, function is still the primary organizational structure, but product or brand managers act as the integrators of semi-permanent products or brands. Consid- ered by many a key to the success of P&G, brand management has been widely imitated by other consumer products firms around the world.

3. Mature matrix: The third and final phase of matrix development involves a true dual- authority structure. Both the functional and product structures are permanent. All employ- ees are connected to both a vertical functional superior and a horizontal product manager. Functional and product managers have equal authority and must work well together to re- solve disagreements over resources and priorities. Boeing, Philips, and TRW Systems are example of companies that use a mature matrix.

Network Structure–The Virtual Organization A newer and somewhat more radical organizational design, the network structure (see Figure 9–2) is an example of what could be termed a “non-structure” because of its virtual elimination of in-house business functions. Many activities are outsourced. A corporation or- ganized in this manner is often called a virtual organization because it is composed of a se- ries of project groups or collaborations linked by constantly changing nonhierarchical, cobweb-like electronic networks.36

The network structure becomes most useful when the environment of a firm is unstable and is expected to remain so.37 Under such conditions, there is usually a strong need for innovation and quick response. Instead of having salaried employees, the company may contract with people for a specific project or length of time. Long-term contracts with suppliers and distributors replace services that the company could provide for itself through vertical integration. Electronic markets and sophisticated information systems reduce the transaction costs of the marketplace, thus justi- fying a “buy” over a “make” decision. Rather than being located in a single building or area, the organization’s business functions are scattered worldwide. The organization is, in effect, only a shell, with a small headquarters acting as a “broker,” electronically connected to some completely owned divisions, partially owned subsidiaries, and other independent companies. In its ultimate form, a network organization is a series of independent firms or business units linked together by computers in an information system that designs, produces, and markets a product or service.38

Entrepreneurial ventures often start out as network organizations. For example, Randy and Nicole Wilburn of Dorchester, Massachusetts, run real estate, consulting, design, and baby food companies out of their home. Nicole, a stay-at-home mom and graphic designer, farms out design work to freelancers and cooks her own line of organic baby food. For $300, an In- dian artist designed the logo for Nicole’s “Baby Fresh Organic Baby Foods.” A London free- lancer wrote promotional materials. Instead of hiring a secretary, Randy hired “virtual assistants” in Jerusalem to transcribe voice mail, update his Web site, and design PowerPoint graphics. Retired brokers in Virginia and Michigan deal with his real estate paperwork.39

Large companies such as Nike, Reebok, and Benetton use the network structure in their op- erations function by subcontracting (outsourcing) manufacturing to other companies in low-cost locations around the world. For control purposes, the Italian-based Benetton maintains what it calls an “umbilical cord” by assuring production planning for all its subcontractors, planning ma- terials requirements for them, and providing them with bills of labor and standard prices and costs, as well as technical assistance to make sure their quality is up to Benetton’s standards.

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The network organizational structure provides an organization with increased flexibility and adaptability to cope with rapid technological change and shifting patterns of international trade and competition. It allows a company to concentrate on its distinctive competencies, while gathering efficiencies from other firms that are concentrating their efforts in their ar- eas of expertise. The network does, however, have disadvantages. Some believe that the net- work is really only a transitional structure because it is inherently unstable and subject to tensions.40 The availability of numerous potential partners can be a source of trouble. Con- tracting out individual activities to separate suppliers/distributors may keep the firm from dis- covering any internal synergies by combining these activities. If a particular firm overspecializes on only a few functions, it runs the risk of choosing the wrong functions and thus becoming noncompetitive.

Cellular/Modular Organization: A New Type of Structure? Some authorities in the field propose that the evolution of organizational forms is leading from the matrix and the network to the cellular (also called modular) organizational form. Accord- ing to Miles and Snow et al., “a cellular organization is composed of cells (self-managing teams, autonomous business units, etc.) which can operate alone but which can interact with other cells to produce a more potent and competent business mechanism.” This combination of independence and interdependence allows the cellular/modular organizational form to gen- erate and share the knowledge and expertise needed to produce continuous innovation. The cellular/modular form includes the dispersed entrepreneurship of the divisional structure, cus- tomer responsiveness of the matrix, and self-organizing knowledge and asset sharing of the network.41 Bombardier, for example, broke up the design of its Continental business jet into 12 parts provided by internal divisions and external contractors. The cockpit, center, and for- ward fuselage were produced in-house, but other major parts were supplied by manufacturers spread around the globe. The cellular/modular structure is used when it is possible to break up a company’s products into self-contained modules or cells and where interfaces can be speci- fied such that the cells/modules work when they are joined together.42 The cellular/modular structure is similar to a current trend in industry of using internal joint ventures to temporar- ily combine specialized expertise and skills within a corporation to accomplish a task which individual units alone could not accomplish.43

The impetus for such a new structure is the pressure for a continuous process of innova- tion in all industries. Each cell/module has an entrepreneurial responsibility to the larger orga- nization. Beyond knowledge creation and sharing, the cellular/modular form adds value by keeping the firm’s total knowledge assets more fully in use than any other type of structure.44

It is beginning to appear in firms that are focused on rapid product and service innovation— providing unique or state-of-the-art offerings in industries such as automobile manufacture, bi- cycle production, consumer electronics, household appliances, power tools, computing products, and software.45

REENGINEERING AND STRATEGY IMPLEMENTATION Reengineering is the radical redesign of business processes to achieve major gains in cost, service, or time. It is not in itself a type of structure, but it is an effective program to imple- ment a turnaround strategy.

Business process reengineering strives to break away from the old rules and procedures that develop and become ingrained in every organization over the years. They may be a com- bination of policies, rules, and procedures that have never been seriously questioned because they were established years earlier. These may range from “Credit decisions are made by the credit department” to “Local inventory is needed for good customer service.” These rules of

C H A P T E R 9 Strategy Implementation: Organizing for Action 289

organization and work design may have been based on assumptions about technology, people, and organizational goals that may no longer be relevant. Rather than attempting to fix existing problems through minor adjustments and fine-tuning of existing processes, the key to reengi- neering is asking “If this were a new company, how would we run this place?”

Michael Hammer, who popularized the concept of reengineering, suggests the following principles for reengineering:

� Organize around outcomes, not tasks: Design a person’s or a department’s job around an objective or outcome instead of a single task or series of tasks.

� Have those who use the output of the process perform the process: With computer- based information systems, processes can now be reengineered so that the people who need the result of the process can do it themselves.

� Subsume information-processing work into the real work that produces the informa- tion: People or departments that produce information can also process it for use instead of just sending raw data to others in the organization to interpret.

� Treat geographically dispersed resources as though they were centralized: With mod- ern information systems, companies can provide flexible service locally while keeping the actual resources in a centralized location for coordination purposes.

� Link parallel activities instead of integrating their results: Instead of having separate units perform different activities that must eventually come together, have them commu- nicate while they work so that they can do the integrating.

� Put the decision point where the work is performed and build control into the process: The people who do the work should make the decisions and be self-controlling.

� Capture information once and at the source: Instead of having each unit develop its own database and information processing activities, the information can be put on a net- work so that all can access it.46

Studies of the performance of reengineering programs show mixed results. Several com- panies have had success with business process reengineering. For example, the Mossville En- gine Center, a business unit of Caterpillar Inc., used reengineering to decrease process cycle times by 50%, reduce the number of process steps by 45%, reduce human effort by 8%, and improve cross-divisional interactions and overall employee decision making.47

One study of North American financial firms found that “the average reengineering proj- ect took 15 months, consumed 66 person-months of effort, and delivered cost savings of 24%.”48 In a survey of 782 corporations using reengineering, 75% of the executives said their companies had succeeded in reducing operating expenses and increasing productivity.49 A study of 134 large and small Canadian companies found that reengineering programs resulted in (1) an increase in productivity and product quality, (2) cost reductions, and (3) an increase in overall organization quality, for both large and small firms.50 Other studies report, however, that anywhere from 50% to 70% of reengineering programs fail to achieve their objectives.51

Reengineering thus appears to be more useful for redesigning specific processes like order en- try, than for changing an entire organization.52

SIX SIGMA Originally conceived by Motorola as a quality improvement program in the mid-1980s, Six Sigma has become a cost-saving program for all types of manufacturers. Briefly, Six Sigma is an analytical method for achieving near-perfect results on a production line. Although the em- phasis is on reducing product variance in order to boost quality and efficiency, it is increas- ingly being applied to accounts receivable, sales, and R&D. In statistics, the Greek letter sigma

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DESIGNING JOBS TO IMPLEMENT STRATEGY Organizing a company’s activities and people to implement strategy involves more than simply redesigning a corporation’s overall structure; it also involves redesigning the way jobs are done. With the increasing emphasis on reengineering, many companies are begin- ning to rethink their work processes with an eye toward phasing unnecessary people and ac- tivities out of the process. Process steps that have traditionally been performed sequentially can be improved by performing them concurrently using cross-functional work teams. Harley-Davidson, for example, has managed to reduce total plant employment by 25% while reducing by 50% the time needed to build a motorcycle. Restructuring through need- ing fewer people requires broadening the scope of jobs and encouraging teamwork. The de- sign of jobs and subsequent job performance are, therefore, increasingly being considered as sources of competitive advantage.

Job design refers to the study of individual tasks in an attempt to make them more rele- vant to the company and to the employee(s). To minimize some of the adverse consequences of task specialization, corporations have turned to new job design techniques: job enlargement (combining tasks to give a worker more of the same type of duties to perform), job rotation (moving workers through several jobs to increase variety), and job enrichment (altering the jobs by giving the worker more autonomy and control over activities). The job characteristics

denotes variation in the standard bell-shaped curve. One sigma equals 690,000 defects per 1 million. Most companies are able to achieve only three sigma, or 66,000 errors per million. Six Sigma reduces the defects to only 3.4 per million—thus saving money by preventing waste. The process of Six Sigma encompasses five steps.

1. Define a process where results are poorer than average.

2. Measure the process to determine exact current performance.

3. Analyze the information to pinpoint where things are going wrong.

4. Improve the process and eliminate the error.

5. Establish controls to prevent future defects from occurring.53

Savings attributed to Six Sigma programs have ranged from 1.2% to 4.5% of annual revenue for a number of Fortune 500 firms. Firms that have successfully employed Six Sigma are Gen- eral Electric, Allied Signal, ABB, and Ford Motor Company.54 About 35% of U.S. companies now have a Six Sigma program in place.55 At Dow Chemical, each Six Sigma project has resulted in cost savings of $500,000 in the first year. According to Jack Welch, GE’s past CEO, Six Sigma is an appropriate change program for the entire organization.56 Six Sigma experts at 3M have been able to speed up R&D and analyze why its top sales people sold more than others. A disad- vantage of the program is that training costs in the beginning may outweigh any savings. The ex- pense of compiling and analyzing data, especially in areas where a process cannot be easily standardized, may exceed what is saved.57 Another disadvantage is that Six Sigma can lead to less-risky incremental innovation based on previous work than on riskier “blue-sky” projects.58

A new program called Lean Six Sigma is becoming increasingly popular in companies. This program incorporates the statistical approach of Six Sigma with the lean manufacturing program originally developed by Toyota. Like reengineering, it includes the removal of un- necessary steps in any process and fixing those that remain. This is the “lean” addition to Six Sigma. Xerox used Lean Six Sigma to resolve a problem with a $500,000 printing press it had just introduced. Teams from supply, manufacturing, and R&D used Lean Six Sigma to find the cause of the problem and to resolve it by working with a supplier to change the chemistry of the oil on a roller.59

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model is a good example of job enrichment. (See Strategy Highlight 9.2.) Although each of these methods has its adherents, no one method seems to work in all situations.

A good example of modern job design is the introduction of team-based production by the glass manufacturer Corning Inc., in its Blacksburg, Virginia, plant. With union approval, Corn- ing reduced job classifications from 47 to 4 to enable production workers to rotate jobs after learning new skills. The workers were divided into 14-member teams that, in effect, managed themselves. The plant had only two levels of management: Plant Manager Robert Hoover and two line leaders who only advised the teams. Employees worked demanding 12 1⁄2-hour shifts, al- ternating three-day and four-day weeks. The teams made managerial decisions, imposed disci- pline on fellow workers, and were required to learn three “skill modules” within two years or else lose their jobs. As a result of this new job design, a Blacksburg team, made up of workers with interchangeable skills, can retool a line to produce a different type of filter in only 10 minutes— six times faster than workers in a traditionally designed filter plant. The Blacksburg plant earned a $2 million profit in its first eight months of production instead of losing the $2.3 million pro- jected for the startup period. The plant performed so well that Corning’s top management acted to convert the company’s 27 other factories to team-based production.60

4. Vertically load the job by giving workers increased authority and responsibility over their activities.

5. Open feedback channels by providing workers with information on how they are performing.

Research supports the job characteristics model as a way to improve job performance through job enrichment. Although there are several other approaches to job design, practicing managers seem increasingly to follow the pre- scriptions of this model as a way of improving productivity and product quality.

The job characteristics model is an advanced approach to

job design based on the belief that tasks can be described in

terms of certain objective character- istics and that these characteristics affect

employee motivation. In order for a job to be motivating, (1) the worker needs to feel a sense of responsibility, feel the task to be meaningful, and receive useful feedback on his or her performance, and (2) the job has to satisfy needs that are important to the worker. The model proposes that managers follow five principles for redesigning work:

1. Combine tasks to increase task variety and to enable workers to identify with what they are doing.

2. Form natural work units to make a worker more responsible and accountable for the performance of the job.

3. Establish client relationships so the worker will know what performance is required and why.

DESIGNING JOBS WITH THE JOB CHARACTERISTICS MODEL

SOURCE: J. R. Hackman and G. R. Oldham, Work Redesign (Read- ing, MA: Addison-Wesley, 1980), pp. 135–141; G. Johns, J. L. Xie, and Y. Fang, “Mediating and Moderating Effects in Job Design,” Journal of Management (December 1992), pp. 657–676; R. W. Griffin, “Effects of Work Redesign on Employee Perceptions, Atti- tudes, and Behaviors: A Long-Term Investigation,” Academy of Management Journal (June 1991), pp. 425–435.

STRATEGY highlight 9.2

9.5 International Issues in Strategy Implementation An international company is one that engages in any combination of activities, from export- ing/importing to full-scale manufacturing, in foreign countries. A multinational corporation (MNC), in contrast, is a highly developed international company with a deep involvement throughout the world, plus a worldwide perspective in its management and decision making.

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INTERNATIONAL STRATEGIC ALLIANCES Strategic alliances, such as joint ventures and licensing agreements, between an MNC and a local partner in a host country are becoming increasingly popular as a means by which a cor- poration can gain entry into other countries, especially less developed countries. The key to the successful implementation of these strategies is the selection of the local partner. Each party needs to assess not only the strategic fit of each company’s project strategy but also the fit of each company’s respective resources. A successful joint venture may require as much as two years of prior contacts between the parties. A prior relationship helps to develop a level of trust, which facilitates openness in sharing knowledge and a reduced fear of opportunistic be- havior by the alliance partners. This is especially important when the environmental uncer- tainty is high.62 Research reveals that firms favor past partners when forming new alliances.63

Key drivers for strategic fit between alliance partners are the following:

� Partners must agree on fundamental values and have a shared vision about the potential for joint value creation.

� Alliance strategy must be derived from business, corporate, and functional strategy.

� The alliance must be important to both partners, especially to top management.

� Partners must be mutually dependent for achieving clear and realistic objectives.

For an MNC to be considered global, it must manage its worldwide operations as if they were totally interconnected. This approach works best when the industry has moved from being multidomestic (each country’s industry is essentially separate from the same industry in other countries) to global (each country is a part of one worldwide industry).

The global MNC faces the dual challenge of achieving scale economies through standard- ization while at the same time responding to local customer differences. According to Spulber in his book, Global Competitive Strategy, the forces pushing for standardization are:

� Convergence in customer preferences and income across target countries.

� Competition from successful global products.

� Growing customer awareness of international brands.

� Economies of scale.

� Falling trading costs across countries.

� Cultural exchange and business interactions among countries.

The forces pushing for customization to local markets are:

� Persistent differences in customer preferences.

� Persistent differences in customer incomes.

� The need to build local brand reputation.

� Competition from successful, innovative domestic companies.

� Variations in trading costs across countries.

� Local regulatory requirements.61

The design of an organization’s structure is strongly affected by the company’s stage of development in international activities and the types of industries in which the company is in- volved. Strategic alliances may complement or even substitute for an internal functional ac- tivity. The issue of centralization versus decentralization becomes especially important for an MNC operating in both multidomestic and global industries.

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� Joint activities must have added value for customers and the partners.

� The alliance must be accepted by key stakeholders.

� Partners contribute key strengths but protect core competencies.64

STAGES OF INTERNATIONAL DEVELOPMENT Corporations operating internationally tend to evolve through five common stages, both in their relationships with widely dispersed geographic markets and in the manner in which they structure their operations and programs. These stages of international development are:

� Stage 1 (Domestic company): The primarily domestic company exports some of its prod- ucts through local dealers and distributors in the foreign countries. The impact on the or- ganization’s structure is minimal because an export department at corporate headquarters handles everything.

� Stage 2 (Domestic company with export division): Success in Stage 1 leads the com- pany to establish its own sales company with offices in other countries to eliminate the middlemen and to better control marketing. Because exports have now become more im- portant, the company establishes an export division to oversee foreign sales offices.

� Stage 3 (Primarily domestic company with international division): Success in earlier stages leads the company to establish manufacturing facilities in addition to sales and ser- vice offices in key countries. The company now adds an international division with re- sponsibilities for most of the business functions conducted in other countries.

� Stage 4 (Multinational corporation with multidomestic emphasis): Now a full-fledged MNC, the company increases its investments in other countries. The company establishes a local operating division or company in the host country, such as Ford of Britain, to better serve the market. The product line is expanded, and local manufacturing capacity is established. Managerial functions (product development, finance, marketing, and so on) are organized locally. Over time, the parent company acquires other related businesses, broadening the base of the local operating division. As the subsidiary in the host country successfully develops a strong regional presence, it achieves greater autonomy and self-sufficiency. The operations in each country are, nevertheless, managed separately as if each is a domestic company.

� Stage 5 (MNC with global emphasis): The most successful MNCs move into a fifth stage in which they have worldwide human resources, R&D, and financing strategies. Typically operating in a global industry, the MNC denationalizes its operations and plans product design, manufacturing, and marketing around worldwide considerations. Global consid- erations now dominate organizational design. The global MNC structures itself in a ma- trix form around some combination of geographic areas, product lines, and functions. All managers are responsible for dealing with international as well as domestic issues.

Research provides some support for stages of international development, but it does not necessarily support the preceding sequence of stages. For example, a company may initiate production and sales in multiple countries without having gone through the steps of exporting or having local sales subsidiaries. In addition, any one corporation can be at different stages simultaneously, with different products in different markets at different levels. Firms may also leapfrog across stages to a global emphasis. In addition, most firms that are considered to be stage 5 global MNCs are actually regional. Around 88% of the world’s biggest MNCs derive at least half of their sales from their home regions. Just 2% (a total of nine firms) derive 20% or more of their sales from each of the North American, European, and Asian regions.65

Developments in information technology are changing the way business is being done inter- nationally. See the Global Issue feature for a possible sixth stage of international development, in

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which an MNC locates its headquarters and key functions at multiple locations around the world.66

Nevertheless, the stages concept provides a useful way to illustrate some of the structural changes corporations undergo when they increase their involvement in international activities.

SOURCES: S. Hamm, “Borders Are So 20th Century,” Business Week (January 22, 2003), pp. 68–70; “Globalization from the Top Down,” Futurist (November–December 2003), p. 13.

what is a multinational company. Does it have a home country? What does headquarters mean? Can you frag- ment your corporate functions globally?” Corporate head- quarters are now becoming virtual with executives and core corporate functions dispersed throughout various world regions. These primarily technology companies are using geography to obtain competitive advantage through the availability of talent or capital, low costs, or proximity to most important customers. Logitech, for example, has its manufacturing headquarters in Taiwan to capitalize on low-cost Asian manufacturing, its business-development headquarters in Switzerland where it has a series of strate- gic technology partnerships, and a third headquarters in Fremont, California.

In what could be a sixth stage of international devel-

opment, an increasing number of MNCs are relocating their head-

quarters and headquarters functions at multiple locations around the world. Of the 800 corporate headquarters established in 2002, 200 of them were in de- veloping nations. The antivirus software company Trend Micro, for example, spreads its top executives, engineers, and support staff throughout the world to improve its abil- ity to respond to new virus threats. “With the Internet, viruses became global. To fight them, we had to become a global company,” explained Chairman Steve Chang. Trend Micro’s financial headquarters is in Tokyo, where it went public. Its product development is in Taiwan, and its sales headquarters is in America’s Silicon Valley.

C. K. Prahalad, strategy professor at the University of Michigan, proposes that this is a new stage of international development. “There is a fundamental rethinking about

MULTIPLE HEADQUARTERS: A SIXTH STAGE OF INTERNATIONAL DEVELOPMENT?

GLOBAL issue

CENTRALIZATION VERSUS DECENTRALIZATION A basic dilemma an MNC faces is how to organize authority centrally so that it operates as a vast interlocking system that achieves synergy and at the same time decentralize authority so that local managers can make the decisions necessary to meet the demands of the local mar- ket or host government.67 To deal with this problem, MNCs tend to structure themselves either along product groups or geographic areas. They may even combine both in a matrix struc- ture—the design chosen by 3M Corporation, Philips, and Asea Brown Boveri (ABB), among others.68 One side of 3M’s matrix represents the company’s product divisions; the other side includes the company’s international country and regional subsidiaries.

Two examples of the usual international structure are Nestlé and American Cyanamid. Nestlé’s structure is one in which significant power and authority have been decentralized to geographic entities. This structure is similar to that depicted in Figure 9–3, in which each ge- ographic set of operating companies has a different group of products. In contrast, American Cyanamid has a series of centralized product groups with worldwide responsibilities. To de- pict Cyanamid’s structure, the geographical entities in Figure 9–3 would have to be replaced by product groups or SBUs.

C H A P T E R 9 Strategy Implementation: Organizing for Action 295

The product-group structure of American Cyanamid enables the company to intro- duce and manage a similar line of products around the world. This enables the corporation to centralize decision making along product lines and to reduce costs. The geographic-area structure of Nestlé, in contrast, allows the company to tailor products to regional differences and to achieve regional coordination. For instance, Nestlé markets 200 different varieties of its instant coffee, Nescafé. The geographic-area structure decentralizes decision making to the local subsidiaries.

As industries move from being multidomestic to more globally integrated, MNCs are in- creasingly switching from the geographic-area to the product-group structure. Nestlé, for ex- ample, has found that its decentralized area structure had become increasingly inefficient. As a result, operating margins at Nestlé have trailed those at rivals Unilever, Group Danone, and Kraft Foods by as much as 50%. CEO Peter Brabeck-Letmathe acted to eliminate country-by- country responsibilities for many functions. In one instance, he established five centers worldwide to handle most coffee and cocoa purchasing. Nevertheless, Nestlé is still using three different versions of accounting, planning, and inventory software for each of its main regions—Europe, the Americas, and Asia, Oceania, and Africa.69

Simultaneous pressures for decentralization to be locally responsive and centralization to be maximally efficient are causing interesting structural adjustments in most large corpo- rations. This is what is meant by the phrase “think globally, act locally.” Companies are at- tempting to decentralize those operations that are culturally oriented and closest to the customers—manufacturing, marketing, and human resources. At the same time, the compa- nies are consolidating less visible internal functions, such as research and development, fi- nance, and information systems, where there can be significant economies of scale.

Board of Directors

President

Operating Companies

U.S.

Operating Companies

Europe*

Operating Companies

Latin America

Operating Companies

Africa

Operating Companies

Asia*

Product Group

B

Product Group

D

Corporate Staff

Product Group

A

Product Group

B

Product Group

C

R&D

FIGURE 9–3 Geographic Area

Structure for an MNC

*NOTE: Because of space limitations, product groups for only Europe and Asia are shown here.

296 PA RT 4 Strategy Implementation and Control

End of Chapter S U M M A R Y Strategy implementation is where “the rubber hits the road.” Environmental scanning and strategy formulation are crucial to strategic management but are only the beginning of the process. The failure to carry a strategic plan into the day-to-day operations of the workplace is a major reason why strategic planning often fails to achieve its objectives. It is discour- aging to note that in one study nearly 70% of the strategic plans were never successfully implemented.70

For a strategy to be successfully implemented, it must be made action oriented. This is done through a series of programs that are funded through specific budgets and contain new detailed procedures. This is what Sergio Marchionne did when he implemented a turnaround strategy as the new Fiat Group CEO in 2004. He attacked the lethargic, bureaucratic system by flattening Fiat’s structure and giving younger managers a larger amount of authority and responsibility. He and other managers worked to reduce the number of auto platforms from 19 to six by 2012. The time from the completion of the design process to new car production was cut from 26 to 18 months. By 2008, the Fiat auto unit was again profitable. Marchionne’s next step was to revive the other two underperforming units of Lancia and Alfa Romeo.71

This chapter explains how jobs and organizational units can be designed to support a change in strategy. We will continue with staffing and directing issues in strategy implemen- tation in the next chapter.

E C O - B I T S � Only 5% of the 30 million tons of annual plastic waste

in the U.S. is currently being recycled.72

� Cargill is building the first large-scale manufacturing plant to make soybean-based “polyols,” the building

blocks of polyurethane. The company says that the use of polyols is a more sustainable option for manufactur- ers of plastic and ultimately for consumers interested in reducing their environmental footprint.73

D I S C U S S I O N Q U E S T I O N S 1. How should a corporation attempt to achieve synergy

among functions and business units?

2. How should an owner-manager prepare a company for its movement from Stage I to Stage II?

3. How can a corporation keep from sliding into the Decline stage of the organizational life cycle?

4. Is reengineering just another management fad, or does it offer something of lasting value?

5. How is the cellular/modular structure different from the network structure?

S T R A T E G I C P R A C T I C E E X E R C I S E The Synergy Game Yolanda Sarason and Catherine Banbury

Setup

Put three to five chairs on either side of a room, facing each other, in the front of the class. Put a table in the middle, with a bell in the middle of the table.

Procedure

The instructor/moderator divides the class into teams of three to five people. Each team selects a name for itself. The instructor/ moderator lists the team names on the board. The first two teams come to the front and sit in the chairs facing each other. The instructor/moderator reads a list of products or services being provided by an actual company. The winning team must

C H A P T E R 9 Strategy Implementation: Organizing for Action 297

identify (1) possible sources of synergy and (2) the actual com- pany being described. For example, if the products/services listed are family restaurants, airline catering, hotels, and retire- ment centers, the synergy is standardized food service and hospitality settings and the company is The Marriott Corpo- ration. The first team to successfully name the company and the synergy wins the round.

After one practice session, the game begins. Each of the teams is free to discuss the question with other team mem- bers. When one of the two teams thinks that it has the answer to both parts of the question, it must be the first to ring the bell in order to announce its answer. If it gives the correct answer, it is deemed the winner of round one. Both parts of the answer must be given for a team to have the correct answer. If a team correctly provides only one part, that answer is still wrong— no partial credit. The instructor/moderator does not say which part of the answer, if either, was correct. The second team then has the opportunity to state the answer. If the second team is wrong, both teams may try once more. If neither chooses to try again, the instructor/moderator may (1) declare

no round winner and both teams sit down, (2) allow the next two teams to provide the answer to round one, or (3) go on to the next round with the same two teams. Two new teams then come to the front for the next round. Once all groups have played once, the winning teams play each other. Rounds con- tinue until there is a grand champion. The instructor should provide a suitable prize, such as candy bars, for the winning team.

Note from Wheelen and Hunger The Instructors’ Manual for this book contains a list of prod- ucts and services with their synergy and the name of the com- pany. In case your instructor does not use this exercise, try the following examples:

Example 1: Motorcycles, autos, lawn mowers, generators

Example 2: Athletic footwear, Rockport shoes, Greg Norman clothing, sportswear

For each example, did you guess the company providing these products/services and the synergy obtained? The answers are printed here, upside-down:

K E Y T E R M S budget (p. 276) cellular organization (p. 288) geographic-area structure (p. 295) job design (p. 290) matrix of change (p. 274) matrix structure (p. 285) multinational corporation (MNC) (p. 291) network structure (p. 287)

organizational life cycle (p. 283) procedure (p. 276) product-group structure (p. 295) program (p. 274) reengineering (p. 288) Six Sigma (p. 289) stages of corporate development (p. 280)

stages of international development (p. 293)

strategy implementation (p. 272) structure follows strategy (p. 279) synergy (p. 278) virtual organization (p. 287)

N O T E S 1. A. Bianco, M. Der Hovanesian, L. Young, and P. Gogoi, “Wal-

Mart’s Midlife Crisis,” Business Week (April 30, 2007), pp. 46–56; “The Bulldozer of Bentonville Slows,” The Econo- mist (February 17, 2007), p. 64; D. Kirkpatrick, “Microsoft’s New Brain,” Fortune (May 1, 2006), pp. 56–68; “Spot the Di- nosaur,” The Economist (April 1, 2006), pp. 53–54; J. Greene, “Microsoft’s Midlife Crisis,” Business Week (April 19, 2004), pp. 88–98.

2. M. S. Olson, D. van Bever, and S. Verry, “When Growth Stalls,” Harvard Business Review (March 2008), pp. 50–61. This phe- nomenon was called the “burnout syndrome” by G. Probst and S. Raisch in “Organizational Crisis: The Logic of Failure,” Academy of Management Executive (February 2005), pp. 90–105.

3. Ibid. 4. J. W. Gadella, “Avoiding Expensive Mistakes in Capital Invest-

ment,” Long Range Planning (April 1994), pp. 103–110; B. Voss, “World Market Is Not for Everyone,” Journal of Business Strat- egy (July/August 1993), p. 4.

5. A. Bert, T. MacDonald, and T. Herd, “Two Merger Integration Imperatives: Urgency and Execution,” Strategy & Leadership, Vol. 31, No. 3 (2003), pp. 42–49.

6. L. D. Alexander, “Strategy Implementation: Nature of the Prob- lem,” International Review of Strategic Management, Vol. 2, No. 1, edited by D. E. Hussey (New York: John Wiley & Sons, 1991), pp. 73–113. See also L. G. Hrebiniak, “Obstacles to Effective Strat- egy Implementation,” Organizational Dynamics, Vol. 35, Issue 1 (2006), pp. 12–31 for six obstacles to implementation.

SOURCE: This exercise was developed by Professors Yolanda Sarason of Colorado State University and Catherine Banbury of St. Mary’s College and Purdue University and presented at the Organizational Behavior Teaching Conference, June 1999. Copyright © 1999 by Yolanda Sarason and Catherine Banbury. Adapted with permission.

Example 1: Engine technology by Honda

Example 2: Marketing and distribution for the athletically- oriented by Reebok

7. L. G. Hrebiniak (2006). 8. F. Arner and A. Aston, “How Xerox Got Up to Speed,” Business

Week (May 3, 2004), pp. 103–104. 9. J. Darragh and A. Campbell, “Why Corporate Initiatives Get

Stuck?” Long Range Planning (February 2001), pp. 33–52. 10. E. Brynjolfsson, A. A. Renshaw, and M. Van Alstyne, “The Ma-

trix of Change,” Sloan Management Review (Winter 1997), pp. 37–54.

11. “Cocoa Farming: Fair Enough?” The Economist (February 2, 2008), p. 74.

12. M. S. Feldman and B. T. Pentland, “Reconceptualizing Organi- zational Routines as a Source of Flexibility and Change,” Administrative Science Quarterly (March 2003), pp. 94–118.

13. S. F. Slater and E. M. Olson, “Strategy Type and Performance: The Influence of Sales Force Management,” Strategic Manage- ment Journal (August 2000), pp. 813–829.

14. B. Grow, “Thinking Outside the Box,” Business Week (October 25, 2004), pp. 70–72.

15. M. Goold and A. Campbell, “Desperately Seeking Synergy,” Harvard Business Review (September–October 1998), pp. 131–143.

16. A. D. Chandler, Strategy and Structure (Cambridge, MA: MIT Press, 1962).

17. A. P. Sloan, Jr., My Years with General Motors (Garden City, NY: Doubleday, 1964).

18. T. L. Amburgey and T. Dacin, “As the Left Foot Follows the Right? The Dynamics of Strategic and Structural Change,” Academy of Management Journal (December 1994), pp. 1427–1452; M. Ollinger, “The Limits of Growth of the Multidivisional Firm: A Case Study of the U.S. Oil Industry from 1930–90,” Strategic Man- agement Journal (September 1994), pp. 503–520.

19. D. F. Jennings and S. L. Seaman, “High and Low Levels of Or- ganizational Adaptation: An Empirical Analysis of Strategy, Structure, and Performance,” Strategic Management Journal (July 1994), pp. 459–475; L. Donaldson, “The Normal Science of Structured Contingency Theory,” in Handbook of Organiza- tion Studies, edited by S. R. Clegg, C. Hardy, and W. R. Nord (London: Sage Publications, 1996), pp. 57–76.

20. A. K. Gupta, “SBU Strategies, Corporate-SBU Relations, and SBU Effectiveness in Strategy Implementation,” Academy of Management Journal (September 1987), pp. 477–500.

21. L. E. Greiner, “Evolution and Revolution As Organizations Grow,” Harvard Business Review (May–June 1998), pp. 55–67. This is an updated version of Greiner’s classic 1972 article.

22. K. Shimizu and M. A. Hitt, “What Constrains or Facilitates Di- vestitures of Formerly Acquired Firms? The Effects of Organiza- tional Inertia,” Journal of Management (February 2005), pp. 50–72.

23. A. Weintraub, “Can Pfizer Prime the Pipeline?” Business Week (December 31, 2007), pp. 90–91.

24. Ibid, p. 64. Although Greiner simply labeled this as the “?” cri- sis, the term pressure-cooker seems apt.

25. J. Hamm, “Why Entrepreneurs Don’t Scale,” Harvard Business Review (December 2002), pp. 110–115. See also C. B. Gibson and R. M. Rottner, “The Social Foundations for Building a Company Around an Inventor,” Organizational Dynamics, Vol. 37, Issue 1 ( January–March 2008), pp. 21–34.

26. W. P. Barnett, “The Dynamics of Competitive Intensity,” Administrative Science Quarterly (March 1997), pp. 128–160; D. Miller, The Icarus Paradox: How Exceptional Companies Bring About Their Own Downfall (New York: Harper Business, 1990).

27. D. Miller and P. H. Friesen, “A Longitudinal Study of the Cor- porate Life Cycle,” Management Science (October 1984), pp. 1161–1183.

28. J. L. Morrow, Jr., D. G. Sirmon, M. A. Hitt, and T. R. Holcomb, “Creating Value in the Face of Declining Performance: Firm Strategies and Organizational Recovery,” Strategic Manage- ment Journal (March 2007), pp. 271–283; C. Zook, “Finding Your Next Core Business,” Harvard Business Review (April 2007), pp. 66–75.

29. J. P. Sheppard and S. D. Chowdhury, “Riding the Wrong Wave: Organizational Failure as a Failed Turnaround,” Long Range Planning (June 2005), pp. 239–260.

30. W-R. Chen and K. D. Miller, “Situational and Institutional De- terminants of Firms’ R&D Search Intensity,” Strategic Manage- ment Journal (April 2007), pp. 369–381.

31. S. Hamm, “Kodak’s Moment of Truth,” Business Week (February 19, 2007), pp. 42–49.

32. R. Berner, “Turning Kmart into a Cash Cow,” Business Week (July 12, 2004), p. 81.

33. H. Tavakolian, “Bankruptcy: An Emerging Corporate Strat- egy,” SAM Advanced Management Journal (Spring 1995), p. 19.

34. L. G. Hrebiniak and W. F. Joyce, Implementing Strategy (New York: Macmillan, 1984), pp. 85–86.

35. S. M. Davis and P. R. Lawrence, Matrix (Reading, MA: Addison-Wesley, 1977), pp. 11–24.

36. J. G. March, “The Future Disposable Organizations and the Rigidities of Imagination,” Organization (August/November 1995), p. 434.

37. M. A. Schilling and H. K. Steensma, “The Use of Modular Or- ganizational Forms: An Industry-Level Analysis,” Academy of Management Journal (December 2001), pp. 1149–1168.

38. M. P. Koza and A. Y. Lewin, “The Coevolution of Network Al- liances: A Longitudinal Analysis of an International Profes- sional Service Network,” Organization Science (September/ October 1999), pp. 638–653.

39. P. Engardio, “Mom-and-Pop Multinationals,” Business Week (July 14 & 21, 2008), pp. 77–78.

40. For more information on managing a network organization, see G. Lorenzoni and C Baden-Fuller, “Creating a Strategic Center to Manage a Web of Partners,” California Management Review (Spring 1995), pp. 146–163.

41. R. E. Miles, C. C. Snow, J. A. Mathews, G. Miles, and H. J. Coleman, Jr., “Organizing in the Knowledge Age: Anticipating the Cellular Form,” Academy of Management Executive (November 1997), pp. 7–24.

42. N. Anand and R. L. Daft, “What Is the Right Organization De- sign?” Organizational Dynamics, Vol. 36, No. 4 (2007), pp. 329–344.

43. J. Naylor and M. Lewis, “Internal Alliances: Using Joint Ven- tures in a Diversified Company,” Long Range Planning (October 1997), pp. 678–688.

44. G. Hoetker, “Do Modular Products Lead to Modular Organiza- tions?” Strategic Management Journal (June 2006), pp. 501–518.

45. Anand and Daft, pp. 336–338. 46. Summarized from M. Hammer, “Reengineering Work: Don’t

Automate, Obliterate,” Harvard Business Review (July–August 1990), pp. 104–112.

47. D. Paper, “BPR: Creating the Conditions for Success,” Long Range Planning (June 1998), pp. 426–435.

298 PA RT 4 Strategy Implementation and Control

C H A P T E R 9 Strategy Implementation: Organizing for Action 299

48. S. Drew, “BPR in Financial Services: Factors for Success,” Long Range Planning (October 1994), pp. 25–41.

49. “Do As I Say, Not As I Do,” Journal of Business Strategy (May/June 1997), pp. 3–4.

50. L. Raymond and S. Rivard, “Determinants of Business Process Reengineering Success in Small and Large Enterprises: An Em- pirical Study in the Canadian Context,” Journal of Small Busi- ness Management (January 1998), pp. 72–85.

51. K. Grint, “Reengineering History: Social Resonances and Busi- ness Process Reengineering,” Organization (July 1994), pp. 179–201; A. Kleiner, “Revisiting Reengineering,” Strategy � Business (3rd Quarter 2000), pp. 27–31.

52. E. A. Hall, J. Rosenthal, and J. Wade, “How to Make Reengi- neering Really Work,” McKinsey Quarterly (1994, No.2), pp. 107–128.

53. M. Arndt, “Quality Isn’t Just for Widgets,” Business Week (July 22, 2002), pp. 72–73.

54. T. M. Box, “Six Sigma Quality: Experiential Learning,” SAM Advanced Management Journal (Winter 2006), pp. 20–23.

55. R. O. Crockett, “Six Sigma Still Pays Off at Motorola,” Business Week (December 4, 2006), p. 50.

56. J. Welch and S. Welch, “The Six Sigma Shotgun,” Business Week (May 21, 2007), p. 110.

57. Arndt, p. 73. 58. B. Hindo, “At 3M, A Struggle Between Efficiency and Creativ-

ity,” Business Week IN (June 11, 2007), pp. 8–16. 59. F. Arner and A. Aston, “How Xerox Got Up to Speed,” Business

Week (May 3, 2004), pp. 103–104. 60. J. Hoerr, “Sharpening Minds for a Competitive Edge,” Business

Week (December 17, 1990), pp. 72–78. 61. D. Spulberg, Global Competitive Strategy (Cambridge, UK:

Cambridge University Press, 2007), p. 257; See also A. K. Gupta, V. Govindarajan, and H. Wang, The Quest for Global Dominance, 2nd ed. (San Francisco: Jossey-Bass, 2007) for a similar set of forces.

62. R. Krishnan, X. Martin, and N. G. Noorderhaven, “When Does Trust Matter to Alliance Performance,” Academy of Manage- ment Journal (October 2006), pp. 894–917.

63. S. X. Li and T. J. Rowley, “Inertia and Evaluation Mechanisms in Interorganizational Partner Selection: Syndicate Formation Among U.S. Investment Banks,” Academy of Management Journal (December 2002), pp. 1104–1119.

64. M. U. Douma, J. Bilderbeek, P. J. Idenburg, and J. K. Loise, “Strategic Alliances: Managing the Dynamics of Fit,” Long Range Planning (August 2000), pp. 579–598; W. Hoffmann and R. Schlosser, “Success Factors of Strategic Alliances in Small and Medium-Sized Enterprises—An Empirical Survey,” Long Range Planning (June 2001), pp. 357–381; Y. Luo, “How Im- portant Are Shared Perceptions of Procedural Justice in Coop- erative Alliances?” Academy of Management Journal (August 2005), pp. 695–709.

65. Alan M. Rugman, The Regional Multinationals (Cambridge, UK: Cambridge University Press, 2005); P. Ghemawat, “Re- gional Strategies for Global Leadership,” Harvard Business Re- view (December 2005), pp. 98–108.

66. J. Birkinshaw, P. Braunerhjelm, U. Holm, and S. Terjesen, “Why Do Some Multinational Corporations Relocate Their Headquarters Overseas?” Strategic Management Journal (July 2006), pp. 681–700.

67. J. H. Taggart, “Strategy Shifts in MNC Subsidiaries,” Strategic Management Journal (July 1998), pp. 663–681.

68. C. A. Bartlett and S. Ghoshal, “Beyond the M-Form: Toward a Managerial Theory of the Firm,” Strategic Management Jour- nal (Winter 1993), pp. 23–46.

69. C. Matlack, “Nestle Is Starting to Slim Down at Last,” Business Week (October 27, 2003), pp. 56–57; “Daring, Defying to Grow,” Economist (August 7, 2004), pp. 55–58.

70. J. Sterling, “Translating Strategy into Effective Implementa- tion: Dispelling the Myths and Highlighting What Works,” Strategy & Leadership, Vol. 31, No. 3 (2003), pp. 27–34.

71. “Rebirth of a Carmaker,” The Economist (April 26, 2008), pp. 87–89.

72. M. Der Hovanesian, “I Have One Word for You: Bioplastics,” Business Week (June 30, 2008), pp. 44–47.

73. “Cargill Begins to Build Chicago Plant,” St. Cloud (MN) Times (July 9, 2008), p. 3A.

Have you heard of Enterprise Rent-A-Car? Hertz, Avis, and National Car Rental

operations are much more visible at airports. Yet Enterprise owns more cars and op-

erates in more locations than Hertz or Avis. Enterprise began operations in St. Louis

in 1957, but didn’t locate at an airport until 1995. It is the largest rental car com-

pany in North America, but only 230 out of its 7,000 worldwide offices are at airports.

In virtually ignoring the highly competitive airport market, Enterprise has chosen a cost-

leadership competitive strategy by marketing to people in need of a spare car at neighborhood

locations. Its offices are within 15 miles of 90% of the U.S. population. Instead of locating many

cars at a few high-priced locations at airports, Enterprise sets up inexpensive offices throughout

metropolitan areas. As a result, cars are rented for 30% less than they cost at airports. As soon

as one branch office grows to about 150 cars, the company opens another rental office a few

miles away. People are increasingly renting from Enterprise even when their current car works

fine. According to CEO Andy Taylor, “We call it a ‘virtual car.’ Small-business people who have

to pick up clients call us when they want something better than their own car.” Why is this com-

petitive strategy so successful for Enterprise even though its locations are now being imitated

by Hertz and Avis?

The secret to Enterprise’s success is its well-executed strategy implementation. Clearly laid

out programs, budgets, and procedures support the company’s competitive strategy by making

Enterprise stand out in the mind of the consumer. It was ranked on Business Week’s list of “Cus-

tomer Service Champs” in both 2007 and 2008. When a new rental office opens, employees

spend time developing relationships with the service managers of every auto dealership and

body shop in the area. Enterprise employees bring pizza and doughnuts to workers at the auto

garages across the country. Enterprise forms agreements with dealers to provide replacements

for cars brought in for service. At major accounts, the company actually staffs an office at the

dealership and has cars parked outside so customers don’t have to go to an Enterprise office to

complete paperwork.

One key to implementation at Enterprise is staffing—hiring and promoting a certain kind

of person. Virtually every Enterprise employee is a college graduate, usually from the bottom

strategy implementation: staffing and Directing

C H A P T E R 10

301

� Understand the link between strategy and staffing decisions

� Match the appropriate manager to the strategy

� Understand how to implement an effective downsizing program

� Discuss important issues in effectively staffing and directing international expansion

� Assess and manage the corporate culture’s fit with a new strategy

� Decide when and if programs such as MBO and TQM are appropriate methods of strategy implementation

� Formulate action plans

Learning Objectives

Gathering Information

Putting Strategy into Action

Monitoring Performance

Societal Environment: General forces

Natural Environment: Resources and

climate

Task Environment:

Industry analysis

Internal: Strengths and Weaknesses

Structure: Chain of command

Culture: Beliefs, expectations,

values

Resources: Assets, skills, competencies,

knowledge

Programs

Activities needed to accomplish a plan

Budgets

Cost of the programs Procedures

Sequence of steps needed to do the job

Performance

Actual results

External: Opportunities

and Threats

Developing Long-range Plans

Mission

Reason for existence Objectives

What results to accomplish by when

Strategies

Plan to achieve the mission & objectives

Policies

Broad guidelines for decision making

Environmental Scanning:

Strategy Formulation:

Strategy Implementation:

Evaluation and Control:

Feedback/Learning: Make corrections as needed

After reading this chapter, you should be able to:

10.1 Staffing The implementation of new strategies and policies often calls for new human resource man- agement priorities and a different use of personnel. Such staffing issues can involve hiring new people with new skills, firing people with inappropriate or substandard skills, and/or training existing employees to learn new skills. Research demonstrates that companies with enlight- ened talent-management policies and programs have higher returns on sales, investments, assets, and equity.2 This is especially important given that it takes an average of 48 days for an American company to fill a job vacancy at an average cost per hire of $3,270.3

If growth strategies are to be implemented, new people may need to be hired and trained. Experienced people with the necessary skills need to be found for promotion to newly created managerial positions. When a corporation follows a growth through acquisition strategy, it may find that it needs to replace several managers in the acquired company. The percentage of an acquired company’s top management team that either quit or was asked to leave is around 25% after the first year, 35% after the second year, 48% after the third year, 55% after the fourth year, and 61% after five years.4 In addition, executives who join an acquired com- pany after the acquisition quit at significantly higher-than-normal rates beginning in their sec- ond year. Executives continue to depart at higher-than-normal rates for nine years after the

half of the class. According to COO Donald Ross, “We hire from the half of the college class

that makes the upper half possible. We want athletes, fraternity types—especially frater-

nity presidents and social directors. People people.” These new employees begin as man-

agement trainees. Instead of regular raises, their pay is tied to branch office profits.

Another key to implementation at Enterprise is leading—specifying clear perfor-

mance objectives and promoting a team-oriented corporate culture. The company stresses

promotion from within and advancement based on performance. Every Enterprise em-

ployee, including top executives, starts at the bottom. As a result, a bond of shared expe-

rience connects all employees and managers. Enterprise was included in Business Week’s

“50 Best Places to Launch a Career” three years in a row. To reinforce a cohesive culture

of camaraderie, senior executives routinely do “grunt work” at branch offices. Even Andy

Taylor, the CEO, joins the work. “We were visiting an office in Berkeley and it was mobbed,

so I started cleaning cars,” says Taylor. “As it was happening, I wondered if it was a good

use of my time, but the effect on morale was tremendous.” Because the financial results

of every branch office and every region are available to all, the collegial culture stimulates

good-natured competition. “We’re this close to beating out Middlesex,” grins Woody

Erhardt, an area manager in New Jersey. “I want to pound them into the ground. If they

lose, they have to throw a party for us, and we get to decide what they wear.”1

This example from Enterprise Rent-A-Car illustrates how a strategy must be imple-

mented with carefully considered programs in order to succeed. This chapter discusses

strategy implementation in terms of staffing and leading. Staffing focuses on the selec-

tion and use of employees. Leading emphasizes the use of programs to better align em-

ployee interests and attitudes with a new strategy.

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C H A P T E R 1 0 Strategy Implementation: Staffing and Directing 303

acquisition.5 Turnover rates of executives in firms acquired by foreign firms are significantly higher than for firms acquired by domestic firms, primarily in the fourth and fifth years after the acquisition.6

It is one thing to lose excess employees after a merger, but it is something else to lose highly skilled people who are difficult to replace. In a study of 40 mergers, 90% of the acquir- ing companies in the 15 successful mergers identified key employees and targeted them for retention within 30 days after the announcement. In contrast, this task was carried out only in one-third of the unsuccessful acquisitions.7 To deal with integration issues such as these, some companies are appointing special integration managers to shepherd companies through the im- plementation process. The job of the integrator is to prepare a competitive profile of the com- bined company in terms of its strengths and weaknesses, draft an ideal profile of what the combined company should look like, develop action plans to close the gap between the actu- ality and the ideal, and establish training programs to unite the combined company and to make it more competitive.8 To be a successful integration manager, a person should have (1) a deep knowledge of the acquiring company, (2) a flexible management style, (3) an ability to work in cross-functional project teams, (4) a willingness to work independently, and (5) sufficient emotional and cultural intelligence to work well with people from all backgrounds.9

If a corporation adopts a retrenchment strategy, however, a large number of people may need to be laid off or fired (in many instances, being laid off is the same as being fired); and top management, as well as the divisional managers, needs to specify the criteria to be used in making these personnel decisions. Should employees be fired on the basis of low seniority or on the basis of poor performance? Sometimes corporations find it easier to close or sell off an entire division than to choose which individuals to fire.

As in the case of structure, staffing requirements are likely to follow a change in strategy. For example, promotions should be based not only on current job performance but also on whether a person has the skills and abilities to do what is needed to implement the new strategy.

Changing Hiring and Training Requirements Having formulated a new strategy, a corporation may find that it needs to either hire different people or retrain current employees to implement the new strategy. Consider the introduction of team-based production at Corning’s filter plant mentioned in Chapter 9. Employee selec- tion and training were crucial to the success of the new manufacturing strategy. Plant Manager Robert Hoover sorted through 8,000 job applications before hiring 150 people with the best problem-solving ability and a willingness to work in a team setting. Those selected received extensive training in technical and interpersonal skills. During the first year of production, 25% of all hours worked were devoted to training, at a cost of $750,000.10

One way to implement a company’s business strategy, such as overall low cost, is through training and development. According to the American Society of Training and Development, the average annual expenditure per employee on corporate training and development is $1,000 per employee.11 A study of 51 corporations in the UK found that 71% of “leading” companies rated staff learning and training as important or very important compared to 62% of the other companies.12 Another study of 155 U. S. manufacturing firms revealed that those with train- ing programs had 19% higher productivity than did those without such programs. Another study found that a doubling of formal training per employee resulted in a 7% reduction in scrap.13 Training is especially important for a differentiation strategy emphasizing quality or customer service. For example, Motorola, with annual sales of $17 billion, spends 4% of its payroll on training by providing at least 40 hours of training a year to each employee. There

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is a very strong connection between strategy and training at Motorola. For example, after set- ting a goal to reduce product development cycle time, Motorola created a two-week course to teach its employees how to accomplish that goal. It brought together marketing, product de- velopment, and manufacturing managers to create an action learning format in which the man- agers worked together instead of separately. The company is especially concerned with attaining the highest quality possible in all its operations. Realizing that it couldn’t hit quality targets with poor parts, Motorola developed a class for its suppliers on statistical process con- trol. The company estimates that every $1 it spends on training delivers $30 in productivity gains within three years.14

Training is also important when implementing a retrenchment strategy. As suggested ear- lier, successful downsizing means that a company has to invest in its remaining employees. General Electric’s Aircraft Engine Group used training to maintain its share of the market even though it had cut its workforce from 42,000 to 33,000 in the 1990s.15

Matching the Manager to the Strategy Executive characteristics influence strategic outcomes for a corporation.16 It is possible that a current CEO may not be appropriate to implement a new strategy. Research indicates that there may be a career life cycle for top executives. During the early years of executives’ tenure, for example, they tend to experiment intensively with product lines to learn about their business. This is their learning stage. Later, their accumulated knowledge allows them to reduce exper- imentation and increase performance. This is their harvest stage. They enter a decline stage in their later years, when they reduce experimentation still further, and performance declines. Thus, there is an inverted U-shaped relationship between top executive tenure and the firm’s financial performance. Some executives retire before any decline occurs. Others stave off de- cline longer than their counterparts. Because the length of time spent in each stage varies among CEOs, it is up to the board to decide when a top executive should be replaced.17

The most appropriate type of general manager needed to effectively implement a new cor- porate or business strategy depends on the desired strategic direction of that firm or business unit. Executives with a particular mix of skills and experiences may be classified as an executive type and paired with a specific corporate strategy. For example, a corporation fol- lowing a concentration strategy emphasizing vertical or horizontal growth would probably want an aggressive new chief executive with a great deal of experience in that particular in- dustry—a dynamic industry expert. A diversification strategy, in contrast, might call for some- one with an analytical mind who is highly knowledgeable in other industries and can manage diverse product lines—an analytical portfolio manager. A corporation choosing to follow a stability strategy would probably want as its CEO a cautious profit planner, a person with a conservative style, a production or engineering background, and experience with controlling budgets, capital expenditures, inventories, and standardization procedures.

Weak companies in a relatively attractive industry tend to turn to a type of challenge- oriented executive known as a turnaround specialist to save the company. For example, when former IHOP (International House of Pancakes) waitress Julia Stewart left Applebee’s restau- rant chain to become CEO of IHOP, she worked to rebuild the company with better food, better ads, and better atmosphere. Six years later, a much improved IHOP acquired the strug- gling Applebee’s restaurant chain. CEO Stewart vowed to turnaround Applebee’s within a year by improving service, food quality and focusing the menu on what the restaurant does best: riblets, burgers, and salads. She wanted Applebee’s to again be the friendly, neighborhood bar and grill that it once was.18

If a company cannot be saved, a professional liquidator might be called on by a bankruptcy court to close the firm and liquidate its assets. This is what happened to Montgomery Ward, Inc., the nation’s first catalog retailer, which closed its stores for good in 2001, after declaring

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bankruptcy for the second time.19 Research tends to support the conclusion that as a firm’s en- vironment changes, it tends to change the type of top executive to implement a new strategy.20

For example, during the 1990s when the emphasis was on growth in a company’s core products/services, the most desired background for a U.S. CEO was either in marketing or in- ternational experience. With the current decade’s emphasis on mergers, acquisitions, and di- vestitures, the most desired background is finance. Currently, one out of five American and UK CEOs are former Chief Financial Officers, twice the percentage during the previous decade.21

This approach is in agreement with Chandler, who proposes (see Chapter 9) that the most appropriate CEO of a company changes as a firm moves from one stage of development to an- other. Because priorities certainly change over an organization’s life, successful corporations need to select managers who have skills and characteristics appropriate to the organization’s particular stage of development and position in its life cycle. For example, founders of firms tend to have functional backgrounds in technological specialties, whereas successors tend to have backgrounds in marketing and administration.22 A change in the environment leading to a change in a company’s strategy also leads to a change in the top management team. For ex- ample, a change in the U.S. utility industry’s environment in 1992 supporting internally fo- cused, efficiency-oriented strategies, led to top management teams being dominated by older managers with longer company and industry tenure, with efficiency-oriented backgrounds in operations, engineering, and accounting.23 Research reveals that executives having a specific personality characteristic (external locus of control) are more effective in regulated industries than are executives with a different characteristic (internal locus of control).24

Other studies have found a link between the type of CEO and a firm’s overall strategic type. (Strategic types were presented in Chapter 4). For example, successful prospector firms tended to be headed by CEOs from research/engineering and general management back- grounds. High performance defenders tended to have CEOs with accounting/finance, manu- facturing/production, and general management experience. Analyzers tended to have CEOs with a marketing/sales background.25

A study of 173 firms over a 25-year period revealed that CEOs in these companies tended to have the same functional specialization as the former CEO, especially when the past CEO’s strategy continued to be successful. This may be a pattern for successful corporations.26 In par- ticular, it explains why so many prosperous companies tend to recruit their top executives from one particular area. At Procter & Gamble (P&G)—a good example of an analyzer firm—for example, the route to the CEO’s position has traditionally been through brand management, with a strong emphasis on marketing—and more recently international experience. In other firms, the route may be through manufacturing, marketing, accounting, or finance—depend- ing on what the corporation has always considered its core capability (and its overall strategic orientation).

SELECTION AND MANAGEMENT DEVELOPMENT Selection and development are important not only to ensure that people with the right mix of skills and experiences are initially hired but also to help them grow on the job so that they might be prepared for future promotions.

Executive Succession: Insiders versus Outsiders Executive succession is the process of replacing a key top manager. The average tenure of a chief executive of a large U.S. company declined from nearly nine years in 1980 to six years in 2006.27 Given that two-thirds of all major corporations worldwide replace their CEO at least once in a five-year period, it is important that the firm plan for this eventuality.28 It is especially important for a company that usually promotes from within to prepare its current managers for

Hewlett-Packard identifies those with high potential for

executive leadership by look- ing for six broad competencies

that the company believes are necessary:

1. Practice the HP Way by building trust and respect, focusing on achievement, demonstrating integrity, being innovative with customers, contributing to the community, and developing organizational decision making.

2. Lead change and learning by recognizing and acting on signals for change, leading organizational change, learning from organizational experience, removing barriers to change, developing self, and challenging and developing others.

3. Know the internal and external environments by anticipating global trends, acting on trends, and learning from others.

STRATEGY highlight 10.1 HOW HEWLETT-PACKARD IDENTIFIES POTENTIAL EXECUTIVES

4. Lead strategy setting by inspiring breakthrough business strategy, leading the strategy-making process, committing to business vision, creating long-range strategies, building financial strategies, and defining a business-planning system.

5. Align the organization by working across boundaries, implementing competitive cost structures, developing alliances and partnerships, planning and managing core business, and designing the organization.

6. Achieve results by building a track record, establishing accountability, supporting calculated risks, making tough individual decisions, and resolving performance problems.

SOURCE: Summarized from R. M. Fulmer, P. A. Gibbs, and M. Goldsmith, “The New HP Way: Leveraging Strategy with Diver- sity, Leadership Development and Decentralization,” Strategy & Leadership (October/November/December, 1999), pp. 21–29.

promotion. For example, companies using relay executive succession, in which a candidate is groomed to take over the CEO position, have significantly higher performance than those that hire someone from the outside or hold a competition between internal candidates.29 These “heirs apparent” are provided special assignments including membership on other firms’ boards of di- rectors.30 Nevertheless, only half of large U.S. companies have CEO succession plans in place.31

Companies known for being excellent training grounds for executive talent are AlliedSig- nal, Bain & Company, Bankers Trust, Bristol Myers Squibb, Cititcorp, General Electric, Hewlett-Packard, McDonald’s, McKinsey & Company, Microsoft, Nike, PepsiCo, Pfizer, and P&G. For example, one study showed that hiring 19 GE executives into CEO positions added $24.5 billion to the share prices of the companies that hired them. One year after people from GE started their new jobs, 11 of the 19 companies they joined were outperforming their com- petitors and the overall market.32

Some of the best practices for top management succession are encouraging boards to help the CEO create a succession plan, identifying succession candidates below the top layer, mea- suring internal candidates against outside candidates to ensure the development of a comprehen- sive set of skills, and providing appropriate financial incentives.33 Succession planning has become the most important topic discussed by boards of directors.34 See Strategy Highlight 10.1 to see how Hewlett-Packard identifies those with potential for executive leadership positions.

Prosperous firms tend to look outside for CEO candidates only if they have no obvious internal candidates.35 For example, 85% of the CEOs selected to run S&P 500 companies in 2006 were insiders, according to executive search firm Spencer Stuart.36 Hiring an outsider to be a CEO is a risky gamble. CEOs from the outside tend to introduce significant change and high turnover among the current top management.37 For example, in one study, the percentage of senior executives that left a firm after a new CEO took office was 20% when the new CEO

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was an insider, but increased to 34% when the new CEO was an outsider.38 CEOs hired from outside the firm tend to have a low survival rate. According to RHR International, 40% to 60% of high-level executives brought in from outside a company failed within two years.39 A study of 392 large U.S. firms revealed that only 16.6% of them had hired outsiders to be their CEOs. The outsiders tended to perform slightly worse than insiders but had a very high vari- ance in performance. Compared to that of insiders, the performance of outsiders tended to be either very good or very poor. Although outsiders performed much better (in terms of share- holder returns) than insiders in the first half of their tenures, they did much worse in their sec- ond half. As a result, the average tenure of an outsider was significantly less than for insiders.40

Firms in trouble, however, overwhelmingly choose outsiders to lead them.41 For example, one study of 22 firms undertaking turnaround strategies over a 13-year period found that the CEO was replaced in all but two companies. Of 27 changes of CEO (several firms had more than one CEO during this period), only seven were insiders—20 were outsiders.42 The proba- bility of an outsider being chosen to lead a firm in difficulty increases if there is no internal heir apparent, if the last CEO was fired, and if the board of directors is composed of a large percent- age of outsiders.43 Boards realize that the best way to force a change in strategy is to hire a new CEO who has no connections to the current strategy.44 For example, outsiders have been found to be very effective in leading strategic change for firms in Chapter 11 bankruptcy.45

Identifying Abilities and Potential A company can identify and prepare its people for important positions in several ways. One approach is to establish a sound performance appraisal system to identify good performers with promotion potential. A survey of 34 corporate planners and human resource executives from 24 large U.S. corporations revealed that approximately 80% made some attempt to iden- tify managers’ talents and behavioral tendencies so that they could place a manager with a likely fit to a given competitive strategy.46 Companies select those people with promotion po- tential to be in their executive development training program. Approximately 10,000 of GE’s 276,000 employees take at least one class at the company’s famous Leadership Development Center in Crotonville, New York.47 Doug Pelino, chief talent officer at Xerox, keeps a list of about 100 managers in middle management and at the vice presidential levels who have been selected to receive special training, leadership experience, and mentorship to become the next generation of top management.48

A company should examine its human resource system to ensure not only that people are being hired without regard to their racial, ethnic, or religious background, but also that they are being identified for training and promotion in the same manner. Management diversity could be a competitive advantage in a multi-ethnic world. With more women in the workplace, an increasing number are moving into top management, but are demanding more flexible ca- reer ladders to allow for family responsibilities.

Many large organizations are using assessment centers to evaluate a person’s suitability for an advanced position. Corporations such as AT&T, Standard Oil, IBM, Sears, and GE have successfully used assessment centers. Because each is specifically tailored to its corporation, these assessment centers are unique. They use special interviews, management games, in-basket exercises, leaderless group discussions, case analyses, decision-making exercises, and oral presentations to assess the potential of employees for specific positions. Promotions into these positions are based on performance levels in the assessment center. Assessment centers have generally been able to accurately predict subsequent job performance and career success.49

Job rotation—moving people from one job to another—is also used in many large corpo- rations to ensure that employees are gaining the appropriate mix of experiences to prepare them for future responsibilities. Rotating people among divisions is one way that a corpora- tion can improve the level of organizational learning. General Electric, for example, routinely

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rotates its executives from one sector to a completely different one to learn the skills of man- aging in different industries. Jeffrey Immelt, who took over as CEO from Jack Welch, had managed businesses in plastics, appliances, and medical systems.50 Companies that pursue re- lated diversification strategies through internal development make greater use of interdivi- sional transfers of people than do companies that grow through unrelated acquisitions. Apparently, the companies that grow internally attempt to transfer important knowledge and skills throughout the corporation in order to achieve some sort of synergy.51

PROBLEMS IN RETRENCHMENT On January 28, 2009, Starbucks announced that it was closing 300 stores in addition to the 600 closures it had announced earlier and thus reduce its workforce by 7,000 people. Meanwhile, Hershey Foods closed six plants in the U.S. and Canada and eliminated 3,000 U.S. jobs. Like other companies at the time, both firms were experiencing declining sales and profits and at- tempting to cut costs. Due to a poor economy, more than 2.1 million U.S. workers were laid off in 2008. Downsizing (sometimes called “rightsizing” or “resizing”) refers to the planned elimination of positions or jobs. This program is often used to implement retrenchment strate- gies. Because the financial community is likely to react favorably to announcements of down- sizing from a company in difficulty, such a program may provide some short-term benefits such as raising the company’s stock price. If not done properly, however, downsizing may re- sult in less, rather than more, productivity. One study found that a 10% reduction in people re- sulted in only a 1.5% reduction in costs, profits increased in only half the firms downsizing, and the stock prices of downsized firms increased over three years, but not as much as did those of firms that did not downsize.52 Why were the results so marginal?

A study of downsizing at automobile-related U.S. industrial companies revealed that at 20 out of 30 companies, either the wrong jobs were eliminated or blanket offers of early retirement prompted managers, even those considered invaluable, to leave. After the layoffs, the remain- ing employees had to do not only their work but also the work of the people who had gone. Be- cause the survivors often didn’t know how to do the departeds’ work, morale and productivity plummeted.53 Downsizing can seriously damage the learning capacity of organizations.54 Cre- ativity drops significantly (affecting new product development), and it becomes very difficult to keep high performers from leaving the company.55 In addition, cost-conscious executives tend to defer maintenance, skimp on training, delay new product introductions, and avoid risky new businesses—all of which leads to lower sales and eventually to lower profits.56 These are some of the reasons why layoffs worry customers and have a negative effect on a firm’s reputation.57

A good retrenchment strategy can thus be implemented well in terms of organizing but poorly in terms of staffing. A situation can develop in which retrenchment feeds on itself and acts to further weaken instead of strengthen the company. Research indicates that companies undertaking cost-cutting programs are four times more likely than others to cut costs again, typically by reducing staff.58 This happened at Eastman Kodak, Xerox, Ford, and General Mo- tors during the 1990s, but 10 years later the companies were still downsizing and working to regain their profitable past performance. In contrast, successful downsizing firms undertake a strategic reorientation, not just a bloodletting of employees. Research shows that when com- panies use downsizing as part of a larger restructuring program to narrow company focus, they enjoy better performance.59

Consider the following guidelines that have been proposed for successful downsizing:

� Eliminate unnecessary work instead of making across-the-board cuts: Spend the time to research where money is going and eliminate the task, not the workers, if it doesn’t add value to what the firm is producing. Reduce the number of administrative levels rather

C H A P T E R 1 0 Strategy Implementation: Staffing and Directing 309

than the number of individual positions. Look for interdependent relationships before eliminating activities. Identify and protect core competencies.

� Contract out work that others can do cheaper: For example, Bankers Trust of New York contracted out its mailroom and printing services and some of its payroll and ac- counts payable activities to a division of Xerox. Outsourcing may be cheaper than verti- cal integration.

� Plan for long-run efficiencies: Don’t simply eliminate all postponable expenses, such as maintenance, R&D, and advertising, in the unjustifiable hope that the environment will become more supportive. Continue to hire, grow, and develop—particularly in crit- ical areas.

� Communicate the reasons for actions: Tell employees not only why the company is downsizing but also what the company is trying to achieve. Promote educational programs.

� Invest in the remaining employees: Because most “survivors” in a corporate downsizing will probably be doing different tasks from what they were doing before the change, firms need to draft new job specifications, performance standards, appraisal techniques, and compensation packages. Additional training is needed to ensure that everyone has the proper skills to deal with expanded jobs and responsibilities. Empower key individuals/ groups and emphasize team building. Identify, protect, and mentor people who have lead- ership talent.

� Develop value-added jobs to balance out job elimination: When no other jobs are cur- rently available within the organization to transfer employees to, management must con- sider other staffing alternatives. For example, Harley-Davidson worked with the company’s unions to find other work for surplus employees by moving into Harley plants work that had previously been done by suppliers.60

INTERNATIONAL ISSUES IN STAFFING Implementing a strategy of international expansion takes a lot of planning and can be very ex- pensive. Nearly 80% of midsize and larger companies send their employees abroad, and 45% plan to increase the number they have on foreign assignment. A complete package for one ex- ecutive working in another country costs from $300,000 to $1 million annually. Nevertheless, between 10% and 20% of all U.S. managers sent abroad returned early because of job dissat- isfaction or difficulties in adjusting to a foreign country. Of those who stayed for the duration of their assignment, nearly one-third did not perform as well as expected. One-fourth of those completing an assignment left their company within one year of returning home—often leav- ing to join a competitor.61 One common mistake is failing to educate the person about the cus- toms and values in other countries.

Because of cultural differences, managerial style and human resource practices must be tailored to fit the particular situations in other countries. Because only 11% of human resource managers have ever worked abroad, most have little understanding of a global assignment’s unique personal and professional challenges and thus fail to develop the training necessary for such an assignment.62 Ninety percent of companies select employees for an international as- signment based on their technical expertise while ignoring other areas.63 A lack of knowledge of national and ethnic differences can make managing an international operation extremely difficult. For example, the three ethnic groups living in Malaysia (Malay, Chinese, and Indian) share different religions, attend different schools, and do not like to work in the same factories with each other. Because of the importance of cultural distinctions such as these, multinational corporations (MNCs) are now putting more emphasis on intercultural training for managers

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being sent on an assignment to a foreign country. This type of training is one of the commonly cited reasons for the lower expatriate failure rates—6% or less—for European and Japanese MNCs, which have emphasized cross-cultural experiences, compared with a 35% failure rate for U.S.-based MNCs.64

To improve organizational learning, many MNCs are providing their managers with in- ternational assignments lasting as long as five years. Upon their return to headquarters, these expatriates have an in-depth understanding of the company’s operations in another part of the world. This has value to the extent that these employees communicate this understanding to others in decision-making positions. Research indicates that an MNC performs at a higher level when its CEO has international experience.65 Global MNCs, in particular, emphasize in- ternational experience, have a greater number of senior managers who have been expatriates, and have a strong focus on leadership development through the expatriate experience.66

Unfortunately, not all corporations appropriately manage international assignments. While out of the country, a person may be overlooked for an important promotion (out of sight, out of mind). Upon his or her return to the home country, co-workers may deprecate the out-of country experience as a waste of time. The perceived lack of organizational support for interna- tional assignments increases the likelihood that an expatriate will return home early.67

From their study of 750 U.S., Japanese, and European companies, Black and Gregersen found that the companies that do a good job of managing foreign assignments follow three general practices:

� When making international assignments, they focus on transferring knowledge and devel- oping global leadership.

� They make foreign assignments to people whose technical skills are matched or exceeded by their cross-cultural abilities.

� They end foreign assignments with a deliberate repatriation process, with career guidance and jobs where the employees can apply what they learned in their assignments.68

Once a corporation has established itself in another country, it hires and promotes people from the host country into higher-level positions. For example, most large MNCs attempt to fill managerial positions in their subsidiaries with well-qualified citizens of the host countries. Unilever and IBM have traditionally taken this approach to international staffing. This policy serves to placate nationalistic governments and to better attune management practices to the host country’s culture. The danger in using primarily foreign nationals to staff managerial po- sitions in subsidiaries is the increased likelihood of suboptimization (the local subsidiary ig- nores the needs of the larger parent corporation). This makes it difficult for an MNC to meet its long-term, worldwide objectives. To a local national in an MNC subsidiary, the corporation as a whole is an abstraction. Communication and coordination across subsidiaries become more difficult. As it becomes harder to coordinate the activities of several international sub- sidiaries, an MNC will have serious problems operating in a global industry.

Another approach to staffing the managerial positions of MNCs is to use people with an “international” orientation, regardless of their country of origin or host country assignment. This is a widespread practice among European firms. For example, Electrolux, a Swedish firm, had a French director in its Singapore factory. Using third-country “nationals” can allow for more opportunities for promotion than does Unilever’s policy of hiring local people, but it can also result in more misunderstandings and conflicts with the local employees and with the host country’s government.

Some corporations take advantage of immigrants and their children to staff key positions when negotiating entry into another country and when selecting an executive to manage the company’s new foreign operations. For example, when General Motors wanted to learn more about business opportunities in China, it turned to Shirley Young, a Vice President of Marketing

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at GM. Born in Shanghai and fluent in Chinese language and customs, Young was instrumen- tal in helping GM negotiate a $1 billion joint venture with Shanghai Automotive to build a Buick plant in China. With other Chinese-Americans, Young formed a committee to advise GM on relations with China. Although just a part of a larger team of GM employees working on the joint venture, Young coached GM employees on Chinese customs and traditions.69

MNCs with a high level of international interdependence among activities need to pro- vide their managers with significant international assignments and experiences as part of their training and development. Such assignments provide future corporate leaders with a series of valuable international contacts in additional to a better personal understanding of international issues and global linkages among corporate activities.70 Research reveals that corporations us- ing cross-national teams, whose members have international experience and communicate fre- quently with overseas managers, have greater product development capabilities than others.71

Executive recruiters report that more major corporations are now requiring candidates to have international experience.72 To increase its own top management’s global expertise, Cisco Sys- tems introduced a staffing program in 2007 with the objective of locating 20% of its senior managers at its new Bangalore, India, Globalization Center by 2010.73

Since an increasing number of multinational corporations are primarily organized around business units and product lines instead of geographic areas, product and SBU managers who are based at corporate headquarters are often traveling around the world to work personally with country managers. These managers and other mobile workers are being called stealth ex- patriates because they are either cross-border commuters (especially in the EU) or the acci- dental expatriate who goes on many business trips or temporary assignments due to offshoring and/or international joint ventures.74

10.2 Leading Implementation also involves leading through coaching people to use their abilities and skills most effectively and efficiently to achieve organizational objectives. Without direction, peo- ple tend to do their work according to their personal view of what tasks should be done, how, and in what order. They may approach their work as they have in the past or emphasize those tasks that they most enjoy—regardless of the corporation’s priorities. This can create real prob- lems, particularly if the company is operating internationally and must adjust to customs and traditions in other countries. This direction may take the form of management leadership, com- municated norms of behavior from the corporate culture, or agreements among workers in au- tonomous work groups. It may be accomplished more formally through action planning or through programs, such as Management By Objectives and Total Quality Management. Pro- cedures can be changed to provide incentives to motivate employees to align their behavior with corporate objectives. For an example of Abbott Laboratories’ new procedures to motivate employees to drive carbon neutral autos, see the Environmental Sustainability Issue feature.

MANAGING CORPORATE CULTURE Because an organization’s culture can exert a powerful influence on the behavior of all em- ployees, it can strongly affect a company’s ability to shift its strategic direction. A problem for a strong culture is that a change in mission, objectives, strategies, or policies is not likely to be successful if it is in opposition to the accepted culture of the company. Corporate culture has a strong tendency to resist change because its very reason for existence often rests on preserv- ing stable relationships and patterns of behavior. For example, when Robert Nardelli became

Abbott Laboratories, which provides its sales staff with

6,000 vehicles, has changed its procedures for mileage reimburse-

ment in order to make its car fleet more carbon neutral. Under previous rules, Abbott’s employees reimbursed the company for personal use of company cars at 17.3¢ per mile. Starting January 2009, those choosing SUVs were re-

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ABBOTT LABORATORIES’ NEW PROCEDURES FOR GREENER COMPANY CARS

ENVIRONMENTAL sustainability issue

quired to pay 72.3¢ per mile. As a result, 48% of the sales reps selected sedans compared to only 25% in 2008. Re- quests for SUVs dropped from 44% of the sales reps the previous year to 29% in 2009. Requests for hybrid autos increased from 6% in 2008 to 18% in 2009.

SOURCE: Summarized from D. Kiley, “Steering Workers into the Green Lane,” Business Week (October 27, 2008), p. 18.

CEO at Home Depot in 2000, he changed the corporate strategy to growing the company’s small professional supply business (sales to building contractors) through acquisitions and making the mature retail business cost-effective. He attempted to replace the old informal en- trepreneurial collaborative culture with one of military efficiency. Before Nardelli’s arrival, most store managers had based their decisions upon their personal knowledge of their cus- tomers’ preferences. Under Nardelli, they were instead given weekly sales and profit targets. Underperforming managers were asked to leave the company. The once-heavy ranks of full- time employees were replaced with cheaper part-timers. In this “culture of fear,” morale fell and Home Depot’s customer satisfaction score dropped to last place among major U.S. retail- ers. By 2007, Nardelli was asked to leave the company.

There is no one best corporate culture. An optimal culture is one that best supports the mission and strategy of the company of which it is a part. This means that corporate culture should support the strategy. Unless strategy is in complete agreement with the culture, any sig- nificant change in strategy should be followed by a modification of the organization’s culture. Although corporate culture can be changed, it may often take a long time, and it requires much effort. At Home Depot, for example, CEO Nardelli attempted to change the corporate culture by hiring GE veterans like himself into top management positions, hiring ex-military officers as store managers, and instituting a top-down command structure.

A key job of management involves managing corporate culture. In doing so, management must evaluate what a particular change in strategy means to the corporate culture, assess whether a change in culture is needed, and decide whether an attempt to change the culture is worth the likely costs.

Assessing Strategy-Culture Compatibility When implementing a new strategy, a company should take the time to assess strategy-culture compatibility. (See Figure 10–1.) Consider the following questions regarding a corporation’s culture:

1. Is the proposed strategy compatible with the company’s current culture? If yes, full steam ahead. Tie organizational changes into the company’s culture by identifying how the new strategy will achieve the mission better than the current strategy does. If not . . .

2. Can the culture be easily modified to make it more compatible with the new strat- egy? If yes, move forward carefully by introducing a set of culture-changing activities such as minor structural modifications, training and development activities, and/or hiring new managers who are more compatible with the new strategy. When Procter & Gamble’s

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No

No

No

Is the proposed strategy compatible with the current culture?

Tie changes into the culture.

Introduce minor culture-changing activities

Yes

Yes

No

Find a joint-venture partner or contract with another company

to carry out the strategy.

Manage around the culture by establishing a new structural unit

to implement the new strategy.

Is management willing and able to make major organizational changes and accept probable delays and a

likely increase in costs?

Yes

Yes

Is management still committed to implementing the strategy?

Formulate a different strategy.

Can the culture be easily modified to make it more compatible with the

new strategy?

FIGURE 10–1 Assessing Strategy–Culture Compatibility

top management decided to implement a strategy aimed at reducing costs, for example, it made some changes in how things were done, but it did not eliminate its brand-management system. The culture adapted to these modifications over a couple years and productivity increased. If not . . .

3. Is management willing and able to make major organizational changes and accept probable delays and a likely increase in costs? If yes, manage around the culture by es- tablishing a new structural unit to implement the new strategy. At General Motors, for ex- ample, top management realized the company had to make some radical changes to be more competitive. Because the current structure, culture, and procedures were very in- flexible, management decided to establish a completely new Saturn division (GM’s first new division since 1918) to build its new auto. In cooperation with the United Auto Work- ers, an entirely new labor agreement was developed, based on decisions reached by con- sensus. Carefully selected employees received from 100 to 750 hours of training, and a whole new culture was built, piece by piece. If not . . .

4. Is management still committed to implementing the strategy? If yes, find a joint- venture partner or contract with another company to carry out the strategy. If not, formu- late a different strategy.

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Based on Robert Nardelli’s decisions when he initially started as Home Depot’s CEO, he probably answered “no” to the first question and “yes” to the second question—thus justifying his many changes in staffing and leading. Unfortunately, these changes didn’t work very well. Instead, he should have replied “no” to the first and second questions and stopped at the third question. As suggested by this question, he should have considered a different corporate strat- egy, such as growing the professional side of the business without changing the collegial culture of the retail stores. Not surprisingly, once Nardelli was replaced by a new CEO, the company divested the professional supply companies that Nardelli had spent so much time and money ac- quiring and returned to its previous strategy of concentrating on Home Depot retail stores.

Managing Cultural Change Through Communication Communication is key to the effective management of change. A survey of 3,199 world-wide ex- ecutives by McKinsey & Company revealed that ongoing communication and involvement was the approach most used by companies that successfully transformed themselves.75 Rationale for strategic changes should be communicated to workers not only in newsletters and speeches, but also in training and development programs. This is especially important in decentralized firms where a large number of employees work in far-flung business units.76 Companies in which ma- jor cultural changes have successfully taken place had the following characteristics in common:

� The CEO and other top managers had a strategic vision of what the company could be- come and communicated that vision to employees at all levels. The current performance of the company was compared to that of its competition and constantly updated.

� The vision was translated into the key elements necessary to accomplish that vision. For ex- ample, if the vision called for the company to become a leader in quality or service, aspects of quality and service were pinpointed for improvement, and appropriate measurement sys- tems were developed to monitor them. These measures were communicated widely through contests, formal and informal recognition, and monetary rewards, among other devices.77

For example, when Pizza Hut, Taco Bell, and KFC were purchased by Tricon Global Restaurants (now Yum! Brands) from PepsiCo, the new management knew that it had to cre- ate a radically different culture than the one at PepsiCo if the company was to succeed. To be- gin, management formulated a statement of shared values—“How We Work Together” principles. They declared their differences with the “mother country” (PepsiCo) and wrote a “Declaration of Independence” stating what the new company would stand for. Restaurant managers participated in team-building activities at the corporate headquarters and finished by signing the company’s “Declaration of Independence” as “founders” of the company. Since then, “Founder’s Day” has become an annual event celebrating the culture of the company. Headquarters was renamed the “Restaurant Support Center,” signifying the cultural value that the restaurants were the central focus of the company. People measures were added to finan- cial measures and customer measures, reinforcing the “putting people first” value. In an un- precedented move in the industry, restaurant managers were given stock options and added to the list of performance incentives. The company created values-focused 360-degree perfor- mance reviews, which were eventually pushed to the restaurant manager level.78

Managing Diverse Cultures Following an Acquisition When merging with or acquiring another company, top management must give some consid- eration to a potential clash of corporate cultures. According to a Hewitt Associates survey of 218 major U.S. corporations, integrating culture was a top challenge for 69% of the reporting companies.79 Cultural differences are even more problematic when a company acquires a firm in another country. DaimlerChrysler’s purchase of a controlling interest in Mitsubishi Motors in 2001 was insufficient to overcome Mitsubishi’s resistance to change. After investing

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Integration

Equal merger of both cultures into a new corporate culture

Assimilation

Acquiring firm’s culture kept intact, but subservient to that of acquiring firm’s corporate culture

Separation

Conflicting cultures kept intact, but kept separate in different units

Deculturation

Forced replacement of conflicting acquired firm’s culture with that of the acquiring firm’s culture

FIGURE 10–2 Methods

of Managing the Culture

of an Acquired Firm

SOURCE: Based on A. R. Malezadeh and A. Nahavandi, “Making Mergers Work in Managing Cultures,” Journal of Business Strategy (May/June 1990), pp. 53–57 and “Acculturation in Mergers and Acquisitions,” Academy of Management Review (January 1988), pp. 79–90.

$2 billion to cut Mitsubishi’s costs and improve its product development, DaimlerChrysler gave up.80 It’s dangerous to assume that the firms can simply be integrated into the same re- porting structure. The greater the gap between the cultures of the acquired firm and the acquir- ing firm, the faster executives in the acquired firm quit their jobs and valuable talent is lost. Conversely, when corporate cultures are similar, performance problems are minimized.81

There are four general methods of managing two different cultures. (See Figure 10–2.) The choice of which method to use should be based on (1) how much members of the acquired firm value preserving their own culture and (2) how attractive they perceive the culture of the acquirer to be.82

1. Integration involves a relatively balanced give-and-take of cultural and managerial prac- tices between the merger partners, and no strong imposition of cultural change on either company. It merges the two cultures in such a way that the separate cultures of both firms are preserved in the resulting culture. This is what occurred when France’s Renault pur- chased a controlling interest in Japan’s Nissan Motor Company and installed Carlos Ghosn as Nissan’s new CEO to turn around the company. Ghosn was very sensitive to Nissan’s culture and allowed the company room to develop a new corporate culture based on the best elements of Japan’s national culture. His goal was to form one successful auto group from two very distinct companies.83

2. Assimilation involves the domination of one organization over the other. The domination is not forced, but it is welcomed by members of the acquired firm, who may feel for many reasons that their culture and managerial practices have not produced success. The ac- quired firm surrenders its culture and adopts the culture of the acquiring company. This was the case when Maytag Company (now part of Whirlpool) acquired Admiral. Because Admiral’s previous owners had not kept the manufacturing facilities up to date, quality had drastically fallen over the years. Admiral’s employees were willing to accept the domi- nance of Maytag’s strong quality-oriented culture because they respected it and knew that without significant changes at Admiral, they would soon be out of work. In turn, they ex- pected to be treated with some respect for their skills in refrigeration technology.

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3. Separation is characterized by a separation of the two companies’ cultures. They are struc- turally separated, without cultural exchange. When Boeing acquired McDonnell-Douglas, known for its expertise in military aircraft and missiles, Boeing created a separate unit to house both McDonnell’s operations and Boeing’s own military business. McDonnell ex- ecutives were given top posts in the new unit and other measures were taken to protect the strong McDonnell culture. On the commercial side, where Boeing had the most expertise, McDonnell’s commercial operations were combined with Boeing’s in a separate unit managed by Boeing executives.84

4. Deculturation involves the disintegration of one company’s culture resulting from unwanted and extreme pressure from the other to impose its culture and practices. This is the most common and most destructive method of dealing with two different cultures. It is often ac- companied by much confusion, conflict, resentment, and stress. This is a primary reason why so many executives tend to leave after their firm is acquired. Such a merger typically results in poor performance by the acquired company and its eventual divestment. This is what happened when AT&T acquired NCR Corporation in 1990 for its computer business. It replaced NCR managers with an AT&T management team, reorganized sales, forced em- ployees to adhere to the AT&T code of values (called the “Common Bond”), and even dropped the proud NCR name (successor to National Cash Register) in favor of a sterile GIS (Global Information Solutions) nonidentity. By 1995, AT&T was forced to take a $1.2 bil- lion loss and lay off 10,000 people.85 The NCR unit was consequently sold.

ACTION PLANNING Activities can be directed toward accomplishing strategic goals through action planning. At a minimum, an action plan states what actions are going to be taken, by whom, during what time frame, and with what expected results. After a program has been selected to implement a particular strategy, an action plan should be developed to put the program in place. Table 10–1 shows an example of an action plan for a new advertising and promotion program.

Take the example of a company choosing forward vertical integration through the acqui- sition of a retailing chain as its growth strategy. Once it owns its own retail outlets, it must in- tegrate the stores into the company. One of the many programs it would have to develop is a new advertising program for the stores. The resulting action plan to develop a new advertising program should include much of the following information:

1. Specific actions to be taken to make the program operational: One action might be to contact three reputable advertising agencies and ask them to prepare a proposal for a new radio and newspaper ad campaign based on the theme “Jones Surplus is now a part of Ajax Continental. Prices are lower. Selection is better.”

2. Dates to begin and end each action: Time would have to be allotted not only to select and contact three agencies, but to allow them sufficient time to prepare a detailed pro- posal. For example, allow one week to select and contact the agencies plus three months for them to prepare detailed proposals to present to the company’s marketing director. Also allow some time to decide which proposal to accept.

3. Person (identified by name and title) responsible for carrying out each action: List some- one—such as Jan Lewis, advertising manager—who can be put in charge of the program.

4. Person responsible for monitoring the timeliness and effectiveness of each action: Indicate that Jan Lewis is responsible for ensuring that the proposals are of good quality and are priced within the planned program budget. She will be the primary company con- tact for the ad agencies and will report on the progress of the program once a week to the company’s marketing director.

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TABLE 10–1 Example of an Action Plan

Action Plan for Jan Lewis, Advertising Manager, and Rick Carter, Advertising Assistant, Ajax Continental

Program Objective: To Run a New Advertising and Promotion Campaign for the Combined Jones Surplus/Ajax Continental Retail Stores for the Coming Christmas Season within a Budget of $XX.

Program Activities: 1. Identify Three Best Ad Agencies for New Campaign. 2. Ask Three Ad Agencies to Submit a Proposal for a New Advertising and Promotion Campaign for Combined Stores. 3. Agencies Present Proposals to Marketing Manager. 4. Select Best Proposal and Inform Agencies of Decision. 5. Agency Presents Winning Proposal to Top Management. 6. Ads Air on TV and Promotions Appear in Stores. 7. Measure Results of Campaign in Terms of Viewer Recall and Increase in Store Sales.

Action Steps Responsibility Start–End

1. A. Review previous programs B. Discuss with boss C. Decide on three agencies

Lewis & Carter Lewis & Smith Lewis

1/1–2/1 2/1–2/3 2/4

2. A. Write specifications for ad B. Assistant writes ad request C. Contact ad agencies D. Send request to three agencies E. Meet with agency acct. execs

Lewis Carter Lewis Carter Lewis & Carter

1/15–1/20 1/20–1/30 2/5–2/8 2/10 2/16–2/20

3. A. Agencies work on proposals B. Agencies present proposals

Acct. Execs Carter

2/23–5/1 5/1–5/15

4. A. Select best proposal B. Meet with winning agency C. Inform losers

Lewis Lewis Carter

5/15–5/20 5/22–5/30 6/1

5. A. Fine-tune proposal B. Presentation to management

Acct. Exec Lewis

6/1–7/1 7/1–7/3

6. A. Ads air on TV B. Floor displays in stores

Lewis Carter

9/1–12/24 8/20–8/30

7. A. Gather recall measures of ads B. Evaluate sales data C. Prepare analysis of campaign

Carter Carter Carter

9/1–12/24 1/1–1/10 1/10–2/15

5. Expected financial and physical consequences of each action: Estimate when a com- pleted ad campaign will be ready to show top management and how long it will take af- ter approval to begin to air the ads. Estimate also the expected increase in store sales over the six-month period after the ads are first aired. Indicate whether “recall” measures will be used to help assess the ad campaign’s effectiveness plus how, when, and by whom the recall data will be collected and analyzed.

6. Contingency plans: Indicate how long it will take to get an acceptable ad campaign to show top management if none of the initial proposals is acceptable.

Action plans are important for several reasons. First, action plans serve as a link between strategy formulation and evaluation and control. Second, the action plan specifies what needs to be done differently from the way operations are currently carried out. Third, during the eval- uation and control process that comes later, an action plan helps in both the appraisal of per- formance and in the identification of any remedial actions, as needed. In addition, the explicit

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assignment of responsibilities for implementing and monitoring the programs may contribute to better motivation.

MANAGEMENT BY OBJECTIVES Management By Objectives (MBO) is a technique that encourages participative decision making through shared goal setting at all organizational levels and performance assessment based on the achievement of stated objectives.86 MBO links organizational objectives and the behavior of individuals. Because it is a system that links plans with performance, it is a pow- erful implementation technique.

The MBO process involves:

1. Establishing and communicating organizational objectives.

2. Setting individual objectives (through superior-subordinate interaction) that help imple- ment organizational ones.

3. Developing an action plan of activities needed to achieve the objectives.

4. Periodically (at least quarterly) reviewing performance as it relates to the objectives and including the results in the annual performance appraisal.87

MBO provides an opportunity for the corporation to connect the objectives of people at each level to those at the next higher level. MBO, therefore, acts to tie together corporate, busi- ness, and functional objectives, as well as the strategies developed to achieve them. Although MBO originated the 1950s, 90% of surveyed practicing managers feel that MBO is applicable today.88 The principles of MBO are a part of self-managing work teams and quality circles.89

One of the real benefits of MBO is that it can reduce the amount of internal politics oper- ating within a large corporation. Political actions within a firm can cause conflict and create divisions between the very people and groups who should be working together to implement strategy. People are less likely to jockey for position if the company’s mission and objectives are clear and they know that the reward system is based not on game playing, but on achiev- ing clearly communicated, measurable objectives.

TOTAL QUALITY MANAGEMENT Total Quality Management (TQM) is an operational philosophy committed to customer sat- isfaction and continuous improvement. TQM is committed to quality/excellence and to being the best in all functions. Because TQM aims to reduce costs and improve quality, it can be used as a program to implement an overall low-cost or a differentiation business strategy. About 92% of manufacturing companies and 69% of service firms have implemented some form of quality management practices.90 Not all TQM programs have been successes. Nevertheless, a recent survey of 325 manufacturing firms in Canada, Hungary, Italy, Lebanon, Taiwan, and the United States revealed that total quality management and just-in-time were the two highest- ranked improvement programs to improve company performance. This study agreed with a 2004 Census of Manufacturing survey that identified total quality management and lean man- ufacturing as the top improvement methodologies in both the U.S. and China.91 An analysis of the successes and failures of TQM concluded that the key ingredient is top management. Suc- cessful TQM programs occur in those companies in which “top managers move beyond de- fensive and tactical orientations to embrace a developmental orientation.”92

TQM has four objectives:

1. Better, less variable quality of the product and service

2. Quicker, less variable response in processes to customer needs

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3. Greater flexibility in adjusting to customers’ shifting requirements

4. Lower cost through quality improvement and elimination of non-value-adding work93

According to TQM, faulty processes, not poorly motivated employees, are the cause of defects in quality. The program involves a significant change in corporate culture, requiring strong leadership from top management, employee training, empowerment of lower-level em- ployees (giving people more control over their work), and teamwork in order to succeed in a company. TQM emphasizes prevention, not correction. Inspection for quality still takes place, but the emphasis is on improving the process to prevent errors and deficiencies. Thus, quality circles or quality improvement teams are formed to identify problems and to suggest how to improve the processes that may be causing the problems.

TQM’s essential ingredients are:

� An intense focus on customer satisfaction: Everyone (not just people in the sales and marketing departments) understands that their jobs exist only because of customer needs. Thus all jobs must be approached in terms of how they will affect customer satisfaction.

� Internal as well as external customers: An employee in the shipping department may be the internal customer of another employee who completes the assembly of a product, just as a person who buys the product is a customer of the entire company. An employee must be just as concerned with pleasing the internal customer as in satisfying the external customer.

� Accurate measurement of every critical variable in a company’s operations: This means that employees have to be trained in what to measure, how to measure, and how to interpret the data. A rule of TQM is that you only improve what you measure.

� Continuous improvement of products and services: Everyone realizes that operations need to be continuously monitored to find ways to improve products and services.

� New work relationships based on trust and teamwork: Important is the idea of empowerment—giving employees wide latitude in how they go about achieving the company’s goals. Research indicates that the keys to TQM success lie in executive com- mitment, an open organizational culture, and employee empowerment.94

INTERNATIONAL CONSIDERATIONS IN LEADING In a study of 53 different national cultures, Hofstede found that each nation’s unique culture could be identified using five dimensions. He found that national culture is so influential that it tends to overwhelm even a strong corporate culture. (See the numerous sociocultural societal variables that compose another country’s culture that are listed in Table 4–3.) In measuring the differences among these dimensions of national culture from country to country, he was able to explain why a certain management practice might be successful in one nation but fail in another:95

1. Power distance (PD) is the extent to which a society accepts an unequal distribution of power in organizations. Malaysia and Mexico scored highest, whereas Germany and Austria scored lowest. People in those countries scoring high on this dimension tend to prefer autocratic to more participative managers.

2. Uncertainty avoidance (UA) is the extent to which a society feels threatened by uncertain and ambiguous situations. Greece and Japan scored highest on disliking ambiguity, whereas the United States and Singapore scored lowest. People in those nations scoring high on this dimension tend to want career stability, formal rules, and clear-cut measures of performance.

3. Individualism-collectivism (I-C) is the extent to which a society values individual free- dom and independence of action compared with a tight social framework and loyalty to the group. The United States and Canada scored highest on individualism, whereas Mexico

320 PA RT 4 Strategy Implementation and Control

and Guatemala scored lowest. People in nations scoring high on individualism tend to value individual success through competition, whereas people scoring low on individual- ism (thus high on collectivism) tend to value group success through collective cooperation.

4. Masculinity-femininity (M-F) is the extent to which society is oriented toward money and things (which Hofstede labels masculine) or toward people (which Hofstede labels feminine). Japan and Mexico scored highest on masculinity, whereas France and Sweden scored lowest (thus highest on femininity). People in nations scoring high on masculinity tend to value clearly defined sex roles where men dominate, and to emphasize perfor- mance and independence, whereas people scoring low on masculinity (and thus high on femininity) tend to value equality of the sexes where power is shared, and to emphasize the quality of life and interdependence.

5. Long-term orientation (LT) is the extent to which society is oriented toward the long- versus the short-term. Hong Kong and Japan scored highest on long-term orientation, whereas Pakistan scored the lowest. A long-term time orientation emphasizes the impor- tance of hard work, education, and persistence as well as the importance of thrift. Nations with a long-term time orientation tend to value strategic planning and other management techniques with a long-term payback.

Hofstede’s work was extended by Project GLOBE, a team of 150 researchers who collected data on cultural values and practices and leadership attributes from 18,000 managers in 62 coun- tries. The project studied the nine cultural dimensions of assertiveness, future orientation, gen- der differentiation, uncertainty avoidance, power distance, institutional emphasis on collectivism versus individualism, in-group collectivism, performance orientation, and humane orientation.96

The dimensions of national culture help explain why some management practices work well in some countries but not in others. For example, MBO, which originated in the United States, succeeded in Germany, according to Hofstede, because the idea of replacing the arbi- trary authority of the boss with the impersonal authority of mutually agreed-upon objectives fits the low power distance that is a dimension of the German culture. It failed in France, how- ever, because the French are used to high power distances; they are used to accepting orders from a highly personalized authority. In countries with high levels of uncertainty avoidance, such as Switzerland and Austria, communication should be clear and explicit, based on facts. Meetings should be planned in advance and have clear agendas. In contrast, in low- uncertainty-avoidance countries such as Greece or Russia, people are not used to structured communication and prefer more open-ended meetings. Because Thailand has a high level of power distance, Thai managers feel that communication should go from the top to the bottom of a corporation. As a result, 360-degree performance appraisals are seen as dysfunctional.97

Some of the difficulties experienced by U.S. companies in using Japanese-style quality circles in TQM may stem from the extremely high value U.S. culture places on individualism. The differences between the United States and Mexico in terms of the power distance (Mexico 104 vs. U.S. 46) and individualism-collectivism (U.S. 91 vs. Mexico 30) dimensions may help ex- plain why some companies operating in both countries have difficulty adapting to the differ- ences in customs.98 In addition, research has found that technology alliance formation is strongest in countries that value cooperation and avoid uncertainty.99

When one successful company in one country merges with another successful company in another country, the clash of corporate cultures is compounded by the clash of national cul- tures. For example, when two companies, one from a high-uncertainty-avoidance society and one from a low-uncertainty-avoidance country, are considering a merger, they should investi- gate each other’s management practices to determine potential areas of conflict. Given the growing number of cross-border mergers and acquisitions, the management of cultures is be- coming a key issue in strategy implementation. See the Global Issue feature to learn how

C H A P T E R 1 0 Strategy Implementation: Staffing and Directing 321

When Upjohn Pharmaceuti- cals of Kalamazoo, Michigan,

and Pharmacia AB of Stock- holm, Sweden, merged in 1995,

employees of both sides were optimistic for the newly formed Pharmacia & Upjohn, Inc. Both companies were second-tier competitors fighting for survival in a global industry. Together, the firms would create a global company that could compete scientifically with its bigger rivals.

Because Pharmacia had acquired an Italian firm in 1993, it also had a large operation in Milan. U.S. executives sched- uled meetings throughout the summer of 1996—only to cancel them when their European counterparts could not at- tend. Although it was common knowledge in Europe that most Swedes take the entire month of July for vacation and that Italians take off all of August, this was not common knowledge in Michigan. Differences in management styles became a special irritant. Swedes were used to an open sys- tem, with autonomous work teams. Executives sought the whole group’s approval before making an important deci- sion. Upjohn executives followed the more traditional Amer- ican top-down approach. Upon taking command of the newly merged firm, Dr. Zabriskie (who had been Upjohn’s CEO), divided the company into departments reporting to the new London headquarters. He required frequent reports, budgets, and staffing updates. The Swedes reacted nega- tively to this top-down management hierarchical style. “It was degrading,” said Stener Kvinnsland, head of Pharmacia’s cancer research in Italy before he quit the new company.

differences in national and corporate cultures created conflict when Upjohn Company of the United States and Pharmacia AB of Sweden merged.

MNCs must pay attention to the many differences in cultural dimensions around the world and adjust their management practices accordingly. Cultural differences can easily go unrecog- nized by a headquarters staff that may interpret these differences as personality defects, whether the people in the subsidiaries are locals or expatriates. When conducting strategic planning in an MNC, top management must be aware that the process will vary based upon the national culture where a subsidiary is located. For example, in one MNC, the French expect concepts and key questions and answers. North American managers provide heavy financial analysis. Germans give precise dates and financial analysis. Information is usually late from Spanish and Moroccan operations and quotas are typically inflated. It is up to management to adapt to the differences.100

The values embedded in his or her national culture have a profound and enduring effect on an executive’s orientation, regardless of the impact of industry experience or corporate culture.101

Hofstede and Bond conclude: “Whether they like it or not, the headquarters of multinationals are in the business of multicultural management.”102

GLOBAL issue CULTURAL DIFFERENCES CREATE IMPLEMENTATION PROBLEMS IN MERGER

The Italian operations baffled the Americans, even though the Italians felt comfortable with a hierarchical management style. Italy’s laws and unions made layoffs dif- ficult. Italian data and accounting were often inaccurate. Because the Americans didn’t trust the data, they were constantly asking for verification. In turn, the Italians were concerned that the Americans were trying to take over Ital- ian operations. At Upjohn, all workers were subject to test- ing for drug and alcohol abuse. Upjohn also banned smoking. At Pharmacia’s Italian business center, however, waiters poured wine freely every afternoon in the company dining room. Pharmacia’s boardrooms were stocked with humidors for executives who smoked cigars during long meetings. After a brief attempt to enforce Upjohn’s poli- cies, the company dropped both the no-drinking and no- smoking policies for European workers.

Although the combined company had cut annual costs by $200 million, overall costs of the merger reached $800 million, some $200 million more than projected. Never- theless, Jan Eckberg, CEO of Pharmacia before the merger, remained confident of the new company’s ability to succeed. He admitted, however, that “we have to make some smaller changes to release the full power of the two companies.”

SOURCE: Summarized from R. Frank and T. M. Burton, “Cross- Border Merger Results in Headaches for a Drug Company,” Wall Street Journal (February 4, 1997), pp. A1, A12.

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End of Chapter S U M M A R Y Strategy is implemented by modifying structure (organizing), selecting the appropriate people to carry out the strategy (staffing), and communicating clearly how the strategy can be put into action (leading). A number of programs, such as organizational and job design, reengineering, Six Sigma, MBO, TQM, and action planning, can be used to implement a new strategy. Exec- utives must manage the corporate culture and find the right mix of qualified people to put a strategy in place.

Research on executive succession reveals that it is very risky to hire new top managers from outside the corporation. Although this is often done when a company is in trouble, it can be dangerous for a successful firm. This is also true when hiring people for non-executive positions. An in-depth study of 1,052 stock analysts at 78 investment banks revealed that hir- ing a star (an outstanding performer) from another company did not improve the hiring com- pany’s performance. When a company hires a star, the star’s performance plunges, there is a sharp decline in the functioning of the team the person works with, and the company’s market value declines. Their performance dropped about 20% and did not return to the level before the job change—even after five years. Interestingly, around 36% of the stars left the invest- ment banks that hired them within 36 months. Another 29% quit in the next 24 months.

This phenomenon occurs not because a star doesn’t suddenly become less intelligent when switching firms, but because the star cannot take to the new firm the firm-specific re- sources that contributed to her or his achievements at the previous company. As a result, the star is unable to repeat the high performance in another company until he/she learns the new system. This may take years, but only if the new company has a good support system in place. Otherwise, the performance may never improve. For these reasons, companies cannot obtain competitive advantage by hiring stars from the outside. Instead, they should emphasize grow- ing their own talent and developing the infrastructure necessary for high performance.103

It is important to not ignore the 75% of the workforce who, while not being stars, are the solid performers that keep a company going over the years. An undue emphasis on attracting stars wastes money and destroys morale. The CEO of McKesson, a pharmaceutical wholesaler, calls these B players “performers in place. . . .They are happy living in Dubuque. I have more time and admiration for them than the A player who is at my desk every six months asking for the next promotion.” Coaches who try to forge a sports team composed of stars court disaster. According to Karen Freeman, former head coach of women’s basketball at Wake Forest Uni- versity, “During my coaching days, the most dysfunctional teams were the ones who had no respect for the B players.” In basketball or business, when the team goes into a slump, the stars are the first to whine, Freeman reports.104

E C O - B I T S � The U.S. Climate Action Partnership (USCAP), com-

posed of General Electric, Caterpillar, Alcoa, General Motors, Chrysler, and Duke Energy plus 21 other major corporations, endorses reducing greenhouse gas emis- sions by 10% to 30% within 15 years and 60% to 80% by 2050 to avert the severest consequences of global warming.

� General Electric, Caterpillar, and Alcoa also sit on the board of the Center for Energy & Economic Develop- ment (CEED), an organization that opposes a federal cli-

mate bill requiring a 65% reduction in emissions by 2050.

� USCAP members General Motors and Chrysler are also members of the Heartland Institute, an organization that disputes humanity’s role in global warming.

� Duke Energy, a USCAP member, is currently building two coal-burning power plants and also belongs to Americans for Balanced Energy Choices, a group that advocates expanded coal use.105

C H A P T E R 1 0 Strategy Implementation: Staffing and Directing 323

D I S C U S S I O N Q U E S T I O N S 1. What skills should a person have for managing a business

unit following a differentiation strategy? Why? What should a company do if no one is available internally and the company has a policy of promotion from within?

2. When should someone from outside a company be hired to manage the company or one of its business units?

3. What are some ways to implement a retrenchment strat- egy without creating a lot of resentment and conflict with labor unions?

4. How can corporate culture be changed?

5. Why is an understanding of national cultures important in strategic management?

S T R A T E G I C P R A C T I C E E X E R C I S E Staffing involves finding the person with the right blend of characteristics, such as personality, training, and experience, to implement a particular strategy. The Keirsey Temperament Sorter is designed to identify different kinds of personality temperament. It is similar to other instruments derived from Carl Jung’s theory of psychological types, such as the Myers- Briggs, the Singer-Loomis, and the Grey-Wheelright. The questionnaire identifies four temperament types: Guardian (SJ), Artisan (SP), Idealist (NF), and Rational (NT). Guardians have natural talent in managing goods and ser- vices. They are dependable and trustworthy. Artisans have keen senses and are at home with tools, instruments, and vehicles. They are risk-takers and like action. Idealists are concerned with growth and development and like to work with people. They prefer friendly cooperation over confrontation and con- flict. Rationalists are problem solvers who like to know how things work. They work tirelessly to accomplish their goals. Each of these four types has four variants.106

Keirsey challenges the assumption that people are basi- cally the same in the ways that they think, feel, and approach problems. Keirsey argues that it is far less desirable to attempt to change others (because it has little likelihood of success) than to attempt to understand, work with, and take advantage of normal differences. Companies can use this type of question- naire to help team members understand how each person can contribute to team performance. For example, Lucent Technol- ogy used the Myers-Briggs Type Indicator to help build trust and understanding among 500 engineers in 13 time zones and three continents in a distributed development project.

1. Access the Keirsey Temperament Sorter using your Internet browser. Type in the following URL: www.advisorteam.com

2. Complete and score the questionnaire. Print the descrip- tion of your personality type.

3. Read the information on the Web site about each person- ality type. Become familiar with each.

4. Bring to class a sheet of paper containing your name and your personality type: Guardian, Artisan, Idealist, or Rational. Your instructor will either put you into a group containing people with the same predominant style or into a group with representatives from each type. He or she may then give each group a number. The instructor will then give the teams a task to accomplish. Each group will have approximately 30 minutes to do the task. It may be to solve a problem, analyze a short case, or propose a new en- trepreneurial venture. The instructor will provide you with very little guidance other than to form and number the groups, give them a task, and keep track of time. He or she may move from group to group to sit in on each team’s progress. When the time is up, the instructor will ask a spokesperson from each group to (1) describe the process the group went through and (2) present orally each group’s ideas. After each group makes its presentation, the instruc- tor may choose one or more of the following: � On a sheet of paper, each person in the class identifies

his/her personality type and votes which team did the best on the assignment.

� The class as a whole tries to identify each group’s dominant decision-making style in terms of how they did their assignment. See how many people vote for one of the four types for each team.

� Each member of a group guesses if she/he was put into a team composed of the same personality types or in one composed of all four personality types.

K E Y T E R M S action plan (p. 316) dimensions of national culture (p. 319) downsizing (p. 308) executive succession (p. 305) executive type (p. 304) individualism-collectivism (I-C) (p. 319)

integration manager (p. 303) leading (p. 302) long-term orientation (LT) (p. 320) Management By Objectives (MBO)

(p. 318) masculinity-femininity (M-F) (p. 320)

power distance (PD) (p. 319) staffing (p. 302) Total Quality Management (TQM)

(p. 318) uncertainty avoidance (UA) (p. 319)

324 PA RT 4 Strategy Implementation and Control

N O T E S 1. B. O’Reilly, “The Rent-A-Car Jocks Who Made Enterprise #1,”

Fortune (October 28, 1996), pp. 125–128; J. Schlereth, “Putting People First,” an interview with Andrew Taylor, BizEd (July/August 2003), pp. 16–20; P. Lehman, “A Clear Road to the Top,” Business Week (September 18, 2006), p. 72; Company Web site at www.enterprise.com.

2. S. Caudron, “How HR Drives Profits,” Workforce Management (December 2001), pp. 26–31 as reported by L. L. Bryan, C. I. Joyce, and L. M. Weiss in “Making a Market in Talent,” McKinsey Quarterly (2006, No. 2), pp. 1–7.

3. “The Stat,” Business Week (October 24, 2005), p. 16. 4. The numbers are approximate averages from three separate stud-

ies of top management turnover after mergers. See M. Lubatkin, D. Schweiger, and Y. Weber, “Top Management Turnover in Related M&Ss: An Additional Test of the Theory of Relative Standing,” Journal of Management, Vol. 25, No. 1 (1999), pp. 55–73.

5. J. A. Krug, “Executive Turnover in Acquired Firms: A Longitu- dinal Analysis of Long-Term Interaction Effects,” paper pre- sented to annual meeting of Academy of Management, Seattle, WA (2003).

6. J. A. Krug and W. H. Hegarty, “Post-Acquisition Turnover Among U.S. Top Management Teams: An Analysis of the Effects of For- eign vs. Domestic Acquisitions of U.S. Targets,” Strategic Man- agement Journal (September 1997), pp. 667–675; J. A. Jrug and W. H. Hegarty, “Predicting Who Stays and Leaves After an Acqui- sition: A Study of Top Managers in Multinational Firms,” Strategic Management Journal (February 2001), pp. 185–196.

7. D. Harding and T. Rouse, “Human Due Diligence,” Harvard Business Review (April 2007), pp. 124–131.

8. A. Hinterhuber, “Making M&A Work,” Business Strategy Re- view (September 2002), pp. 7–9.

9. R. N. Ashkenas and S. C. Francis, “Integration Managers: Spe- cial Leaders for Special Times,” Harvard Business Review (November–December 2000), pp. 108–116.

10. J. Hoerr, “Sharpening Minds for a Competitive Edge,” Business Week (December 17, 1990), pp. 72–78.

11. K. Hess and N. J. Nentl, “Strategic Training for Managers,” SAM Management in Practice (2006, No. 4).

12. “Training and Human Resources,” Business Strategy News Re- view (July 2000), p. 6.

13. High Performance Work Practices and Firm Performance (Washington, DC: U.S. Department of Labor, Office of the American Workplace, 1993), pp. i, 4.

14. T. T. Baldwin, C. Danielson, and W. Wiggenhorn, “The Evolu- tion of Learning Strategies in Organizations: From Employee Development to Business Redefinition,” Academy of Manage- ment Executive (November 1997), pp. 47–58; K. Kelly, “Mo- torola: Training for the Millennium,” Business Week (March 28, 1996), pp. 158–161.

15. R. Henkoff, “Companies That Train Best,” Fortune (March 22, 1993), pp. 62–75.

16. D. C. Hambrick, “Upper Echelons Theory: An Update,” Academy of Management Review (April 2007), pp. 334–343.

17. D. Miller and J. Shamsie, “Learning Across the Life Cycle: Ex- perimentation and Performance Among the Hollywood Studio Heads,” Strategic Management Journal (August 2001), pp. 725–745). An exception to these findings may be the com- puter software industry in which CEOs are at their best when

they start their jobs and steadily decline during their tenures. See A. D. Henderson, D. Miller, and D. C. Hambrick, “How Quickly Do CEOs Become Obsolete? Industry Dynamism, CEO Tenure, and Company Performance,” Strategic Manage- ment Journal (May 2006), pp. 447–460.

18. B. Hrowvitz, “New CEO Puts Comeback on the Menu at Applebee’s,” USA Today (April 28, 2008), pp. 1B, 2B.

19. A study of former General Electric executives who became CEOs categorized them as cost controllers, growers, or cycle managers on the basis of their line experience at GE. See B. Groysberg, A. N. McLean, and N. Nohria, “Are Leaders Portable?” Harvard Business Review (May 2006), pp. 92–100.

20. D. K. Datta and N. Rajagopalan, “Industry Structure and CEO Characteristics: An Empirical Study of Succession Events,” Strategic Management Journal (September 1998), pp. 833–852; A. S. Thomas and K. Ramaswamy, “Environmen- tal Change and Management Staffing: A Comment,” Journal of Management (Winter 1993), pp. 877–887; J. P. Guthrie, C. M. Grimm, and K. G. Smith, “Environmental Change and Manage- ment Staffing: An Empirical Study,” Journal of Management (December 1991), pp. 735–748.

21. J. Greco, “The Search Goes On,” Journal of Business Strategy (September/October 1997), pp. 22–25; W. Ocasio and H. Kim, “The Circulation of Corporate Control: Selection of Func- tional Backgrounds on New CEOs in Large U.S. Manufactur- ing Firms, 1981–1992,” Administrative Science Quarterly (September 1999), pp. 532–562; R. Dobbs, D. Harris, and A. Rasmussen, “When Should CFOs Take the Helm?” McKinsey Quarterly Online (November 2006); “How to Get to the Top,” The Economist (May 31, 2008), p. 70.

22. R. Drazin and R. K. Kazanjian, “Applying the Del Technique to the Analysis of Cross-Classification Data: A Test of CEO Suc- cession and Top Management Team Development,” Academy of Management Journal (December 1993), pp. 1374–1399; W. E. Rothschild, “A Portfolio of Strategic Leaders,” Planning Re- view (January/February 1996), pp. 16–19.

23. R. Subramanian and C. M. Sanchez, “Environmental Change and Management Staffing: An Empirical Examination of the Electric Utilities Industry,” Journal of Business Strategies (Spring 1998), pp. 17–34.

24. M. A. Carpenter and B. R. Golden, “Perceived Managerial Dis- cretion: A Study of Cause and Effect,” Strategic Management Journal (March 1997), pp. 187–206.

25. J. A. Parnell, “Functional Background and Business Strategy: The Impact of Executive-Strategy Fit on Performance,” Journal of Business Strategies (Spring 1994), pp. 49–62.

26. M. Smith and M. C. White, “Strategy, CEO Specialization, and Succession,” Administrative Science Quarterly (June 1987), pp. 263–280.

27. “Making Companies Work,” Economist (October 25, 2003), p. 14; C. H. Mooney, C. M. Dalton, D. R. Dalton, and S. T. Certo, “CEO Succession as a Funnel: The Critical, and Chang- ing Role of Inside Directors,” Organizational Dynamics, Vol. 36, No. 4 (2007), pp. 418–428. Note, however, that the tenures of CEOs of family firms typically exceed 15 years. See I. Le Breton-Miller and D. Miller, “Why Do Some Family Busi- nesses Out-Compete? Governance, Long-Term Orientations, and Sustainable Capability,” Entrepreneurship Theory and Practice (November 2006), pp. 731–746.

42. C. Gopinath, “Turnaround: Recognizing Decline and Initiating Intervention,” Long Range Planning (December 1991), pp. 96–101.

43. K. B. Schwartz and K. Menon, “Executive Succession in Fail- ing Firms,” Academy of Management Journal (September 1985), pp. 680–686; A. A. Cannella Jr., and M. Lubatkin, “Suc- cession as a Sociopolitical Process: Internal Impediments to Outsider Selection,” Academy of Management Journal (August 1993), pp. 763–793; W. Boeker and J. Goodstein, “Performance and Succession Choice: The Moderating Effects of Governance and Ownership,” Academy of Management Journal (February 1993), pp. 172–186.

44. W. Boeker, “Executive Migration and Strategic Change: The Effect of Top Manager Movement on Product-Market Entry,” Administrative Science Quarterly (June 1997), pp. 213–236.

45. E. Brockmann, J. J. Hoffman, and D. Dawley, “A Contingency Theory of CEO Successor Choice and Post-Bankruptcy Strate- gic Change,” Paper presented to annual meeting of Academy of Management, Seattle, WA (2003).

46. P. Lorange, and D. Murphy, “Bringing Human Resources Into Strategic Planning: System Design Characteristics,” in Strategic Human Resource Management, edited by C. J. Fombrun, N. M. Tichy, and M. A. Devanna (New York: John Wiley & Sons, 1984), pp. 281–283.

47. M. Leuchter, “Management Farm Teams,” Journal of Business Strategy (May/June 1998), pp. 29–32.

48. S. Armour, “Playing the Succession Game,” USA Today (November 24, 2003), p. 3B.

49. D. A. Waldman and T. Korbar, “Student Assessment Center Per- formance in the Prediction of Early Career Success,” Academy of Management Learning and Education (June 2004), pp. 151–167.

50. “Coming and Going,” Survey of Corporate Leadership, Econo- mist (October 25, 2003), pp. 12–14.

51. R. A. Pitts, “Strategies and Structures for Diversification,” Academy of Management Journal (June 1997), pp. 197–208.

52. K. E. Mishra, G. M. Spreitzer, and A. K. Mishra, “Preserving Employee Morale During Downsizing,” Sloan Management Review (Winter 1998), pp. 83–95.

53. B. O’Reilly, “Is Your Company Asking Too Much?” Fortune (March 12, 1990), p. 41. For more information on the emotional reactions of survivors of downsizing, see C. R. Stoner and R. I. Hartman, “Organizational Therapy: Building Survivor Health & Competitiveness,” SAM Advanced Management Jour- nal (Summer 1997), pp. 15–31, 41.

54. S. R. Fisher and M. A. White, “Downsizing in a Learning Orga- nization: Are There Hidden Costs?” Academy of Management Review (January 2000), pp. 244–251.

55. T. M. Amabile and R. Conti, “Changes in the Work Environ- ment for Creativity During Downsizing,” Academy of Manage- ment Journal (December 1999), pp. 630–640; A. G. Bedeian and A. A. Armenakis, “The Cesspool Syndrome: How Dreck Floats to the Top of Declining Organizations,” Academy of Management Executive (February 1998), pp. 58–67.

56. For a more complete listing of the psychological and behavioral reactions to downsizing, see M. L. Marks and K. P. De Meuse, “Resizing the Organization: Maximizing the Gain While Mini- mizing the Pain of Layoffs, Divestitures, and Closings,” Organizational Dynamics, Vol. 34, No. 1 (2005), pp. 19–35.

57. D. J. Flanagan and K. C. O’Shaughnessy, “The Effect of Lay- offs on Firm Reputation,” Journal of Management (June 2005), pp. 445–463.

28. A. Bianco, L. Lavelle, J. Merrit, and A. Barrett, “The CEO Trap,” Business Week (December 11, 2000), pp. 86–92.

29. Y. Zhang and N. Rajagopalan, “When the Known Devil Is Better Than an Unknown God: An Empirical Study of the Antecedents and Consequences of Relay CEO Succession,” Academy of Management Journal (August 2004), pp. 483–500; W. Shen and A. A. Cannella, Jr., “Will Succession Planning Increase Share- holder Wealth? Evidence from Investor Reactions to Relay CEO Successions,” Strategic Management Journal (February 2003), pp. 191–198.

30. G. A. Bigley and M. F. Wiersema, “New CEOs and Corporate Strategic Refocusing: How Experience as Heir Apparent Influ- ences the Use of Power,” Administrative Science Quarterly (December 2002), pp. 707–727.

31. J. L. Bower, “Solve the Succession Crisis by Growing Inside- Outside Leaders,” Harvard Business Review (November 2007), pp. 91–96; Y. Zhang and N. Rajagopalan, “Grooming for the Top Post and Ending the CEO Succession Crisis,” Organizational Dynamics, Vol. 35, Issue 1 (2006), pp. 96–105.

32. “Coming and Going,” Survey of Corporate Leadership, Econo- mist (October 25, 2003), pp. 12–14.

33. D. C. Carey and D. Ogden, CEO Succession: A Window on How Boards Do It Right When Choosing a New Chief Executive (New York: Oxford University Press, 2000).

34. “The King Lear Syndrome,” Economist (December 13, 2003), p. 65.

35. Y. Zang and N. Rajagopalan, “Grooming for the Top Post and Ending the CEO Succession Crisis,” Organizational Dynamics, Vol. 35, Issue 1 (2006), pp. 96–105.

36. J. Weber, “The Accidental CEO,” Business Week (April 23, 2007), pp. 64–72.

37. M. S. Kraatz and J. H. Moore, “Executive Migration and Insti- tutional Change,” Academy of Management Journal (February 2002), pp. 120–143; Y. Zhang and N. Rajagopalan, “When the Known Devil Is Better Than an Unknown God: An Empirical Study of the Antecedents and Consequences of Relay CEO Suc- cession,” Academy of Management Journal (August 2004), pp. 483–500; W. Shen and A. A. Cannella, Jr., “Revisiting the Performance Consequences of CEO Succession: The Impacts of Successor Type, Post-Succession Senior Executive Turnover, and Departing CEO Tenure,” Academy of Manage- ment Journal (August 2002), pp. 717–733.

38. K. P. Coyne and E. J. Coyne, Sr., “Surviving Your New CEO,” Harvard Business Review (May 2007), pp. 62–69.

39. N. Byrnes and D. Kiley, “Hello, You Must Be Going,” Business Week (February 12, 2007), pp. 30–32.

40. C. Lucier and J. Dyer, “Hiring an Outside CEO: A Board’s Best Moves,” Directors & Boards (Winter 2004), pp. 36–38. These findings are supported by a later study by Booz Allen Hamilton in which 1,595 worldwide companies during 1995 to 2005 showed the same results. See J. Webber, “The Accidental CEO,” Business Week (April 23, 2007), pp. 64–72.

41. Q. Yue, “Antecedents of Top Management Successor Origin in China,” paper presented to the annual meeting of the Academy of Management, Seattle, WA (2003); A. A. Buchko and D. DiVerde, “Antecedents, Moderators, and Consequences of CEO Turnover: A Review and Reconceptualization,” Paper presented to Midwest Academy of Management (Lincoln, NE: 1997), p. 10; W. Ocasio, “Institutionalized Action and Corporate Governance: The Re- liance on Rules of CEO Succession,” Administrative Science Quarterly (June 1999), pp. 384–416.

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326 PA RT 4 Strategy Implementation and Control

58. Wall Street Journal (December 22, 1992), p. B1. 59. R. D. Nixon, M. A. Hitt, H. Lee, and E. Jeong, “Market Reac-

tions to Announcements of Corporate Downsizing Actions and Implementation Strategies,” Strategic Management Journal (November 2004), pp. 1121–1129; G. D. Bruton, J. K. Keels, and C. L. Shook, “Downsizing the Firm: Answering the Strate- gic Questions,” Academy of Management Executive (May 1996), pp. 38–45; E. G. Love and N. Nohria, “Reducing Slack: The Performance Consequences of Downsizing by Large In- dustrial Firms, 1977–93,” Strategic Management Journal (December 2005), pp. 1087–1108; C. D. Zatzick and R. D. Iver- son, “High-Involvement Management and Workforce Reduc- tion: Competitive Advantage or Disadvantage?” Academy of Management Journal (October 2006), pp. 999–1015.

60. M. A. Hitt, B. W. Keats, H. F. Harback, and R. D. Nixon, “Rightsizing: Building and Maintaining Strategic Leadership and Long-Term Competitiveness,” Organizational Dynamics (Autumn 1994), pp. 18–32. For additional suggestions, see W. F. Cascio, “Strategies for Responsible Restructuring,” Academy of Management Executive (August 2002), pp. 80–91, and T. Mroczkowski and M. Hanaoka, “Effective Rightsizing Strategies in Japan and America: Is There a Convergence of Employment Practices?” Academy of Management Executive (May 1997), pp. 57–67. For an excellent list of cost-reduction programs for use in short, medium, and long-term time hori- zons, see F. Gandolfi, “Cost Reductions, Downsizing-related Layoffs, and HR Practices,” SAM Advanced Management Jour- nal (Spring 2008), pp. 52–58.

61. J. S. Black and H. B. Gregersen, “The Right Way to Manage Ex- pats,” Harvard Business Review (March–April 1999), pp. 52–61.

62. Ibid, p. 54. 63. J. I. Sanchez, P. E. Spector, and C. L. Cooper, “Adapting to a

Boundaryless World: A Developmental Expatriate Model,” Academy of Management Executive (May 2000), pp. 96–106.

64. R. L. Tung, The New Expatriates (Cambridge, MA.: Ballinger, 1988); J. S. Black, M. Mendenhall, and G. Oddou, “Toward a Comprehensive Model of International Adjustment: An Inte- gration of Multiple Theoretical Perspectives,” Academy of Management Review (April 1991), pp. 291–317.

65. M. A. Carpenter, W. G. Sanders, and H. B. Gregersen, “Bundling Human Capital with Organizational Context: The Impact of International Assignment Experience on Multina- tional Firm Performance and CEO Pay,” Academy of Manage- ment Journal (June 2001), pp. 493–511.

66. P. M. Caligiuri and S. Colakoglu, “A Strategic Contingency Ap- proach to Expatriate Assignment Management,” Human Re- source Management Journal, Vol. 17, No. 4 (2007), pp. 393–410.

67. M. A. Shaffer, D. A. Harrison, K. M. Gilley, and D. M. Luk, “Struggling for Balance Amid Turbulence on International As- signments: Work-Family Conflict, Support, and Commitment,” Journal of Management, Vol. 27, No. 1 (2001), pp. 99–121.

68. J. S. Black and H. B. Gregersen, “The Right Way to Manage Ex- pats,” Harvard Business Review (March–April 1999), p. 54.

69. G. Stern, “GM Executive’s Ties to Native Country Help Auto Maker Clinch Deal in China,” Wall Street Journal (November 2, 1995), p. B7.

70. K. Roth, “Managing International Interdependence: CEO Char- acteristics in a Resource-Based Framework,” Academy of Man- agement Journal (February 1995), pp. 200–231.

71. M. Subramaniam and N. Venkatraman, “Determinants of Transnational New Product Development Capability: Testing the Influence of Transferring and Deploying Tacit Overseas Knowledge,” Strategic Management Journal (April 2001), pp. 359–378.

72. J. S. Lublin, “An Overseas Stint Can Be a Ticket to the Top,” Wall Street Journal (January 29, 1996), pp. B1, B2.

73. “Cisco Shifts Senior Executives to India,” St. Cloud (MN) Times (January 13, 2007), p. 6A.

74. “Expatriate Employees: In Search of Stealth,” The Economist (April 23, 2005), pp. 62–64.

75. M. Meaney, C. Pung, and S. Kamath, “Creating Organizational Transformations,” McKinsey Quarterly Online (September 10, 2008).

76. L. G. Love, R. L. Priem, and G. T. Lumpkin, “Explicitly Artic- ulated Strategy and Firm Performance Under Alternative Lev- els of Centralization,” Journal of Management, Vol. 28, No. 5 (2002), pp. 611–627.

77. G. G. Gordon, “The Relationship of Corporate Culture to Indus- try Sector and Corporate Performance,” in Gaining Control of the Corporate Culture, edited by R. H. Kilmann, M. J. Saxton, R. Serpa, and Associates (San Francisco: Jossey-Bass, 1985), p. 123; T. Kono, “Corporate Culture and Long-Range Plan- ning,” Long Range Planning (August 1990), pp. 9–19.

78. B. Mike and J. W. Slocum, Jr., “Changing Culture at Pizza Hut and Yum! Brands,” Organizational Dynamics, Vol. 32, No. 4 (2003), pp. 319–330.

79. T. J. Tetenbaum, “Seven Key Practices That Improve the Chance for Expected Integration and Synergies,” Organizational Dynamics (Autumn 1999), pp. 22–35.

80. B. Bremner and G. Edmondson, “Japan: A Tale of Two Merg- ers,” Business Week (May 10, 2004), p. 42.

81. P. Very, M. Lubatkin, R. Calori, and J. Veiga, “Relative Standing and the Performance of Recently Acquired European Firms,” Strategic Management Journal (September 1997), pp. 593–614.

82. A. R. Malekzadeh and A. Nahavandi, “Making Mergers Work by Managing Cultures,” Journal of Business Strategy (May/June 1990), pp. 53–57; A. Nahavandi, and A. R. Malekzadeh, “Acculturation in Mergers and Acquisitions,” Academy of Management Review (January 1988), pp. 79–90.

83. C. Ghosn, “Saving the Business Without Losing the Company,” Harvard Business Review (January 2002), pp. 37–45; B. Bremner, G. Edmondson, C. Dawson, D. Welch, and K. Kerwin, “Nissan’s Boss,” Business Week (October 4, 2004), pp. 50–60.

84. D. Harding and T. Rouse, “Human Due Diligence,” Harvard Business Review (April 2007), pp. 124–131.

85. J. J. Keller, “Why AT&T Takeover of NCR Hasn’t Been a Real Bell Ringer,” Wall Street Journal (September 19, 1995), pp. A1, A5.

86. J. W. Gibson and D. V. Tesone, “Management Fads: Emergence, Evolution, and Implications for Managers,” Academy of Man- agement Executive (November 2001), pp. 122–133.

87. For additional information, see S. J. Carroll, Jr., and M. L. Tosi, Jr., Management by Objectives: Applications and Re- search (New York: Macmillan, 1973), and A. P. Raia, Managing by Objectives (Glenview, IL: Scott, Foresman, and Company, 1974).

88. J. W. Gibson, D. V. Tesone, and C. W. Blackwell, “Management Fads: Here Yesterday, Gone Today?” SAM Advanced Manage- ment Journal (Autumn 2003), pp. 12–17.

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89. J. W. Gibson and D. V. Tesone, “Management Fads: Emergence, Evolution, and Implications fdor Managers,” Academy of Man- agement Executive (November 2001), p. 125.

90. S. S. Masterson, and M. S. Taylor, “Total Quality Management and Performance Appraisal: An Integrative Perspective,” Journal of Quality Management, Vol. 1, No. 1 (1996), pp. 67–89.

91. R. J. Vokurka, R. R. Lummus, and D. Krumwiede, “Improving Manufacturing Flexibility: The Enduring Value of JIT and TQM,” SAM Advanced Management Journal (Winter 2007), pp. 14–21.

92. T. Y. Choi and O. C. Behling, “Top Managers and TQM Suc- cess: One More Look After All These Years,” Academy of Man- agement Executive (February 1997), pp. 37–47.

93. R. J. Schonberger, “Total Quality Management Cuts a Broad Swath—Through Manufacturing and Beyond,” Organizational Dynamics (Spring 1992), pp. 16–28.

94. T. C. Powell, “Total Quality Management as Competitive Ad- vantage: A Review and Empirical Study,” Strategic Manage- ment Journal (January 1995), pp. 15–37.

95. G. Hofstede, “Culture’s Recent Consequences: Using Dimen- sional Scores in Theory and Research,” International Journal of Cross Cultural Management, Vol. 1, No. 1 (2001), pp. 11–17; G. Hofstede, Cultures and Organizations: Software of the Mind (London: McGraw-Hill, 1991); G. Hofstede and M. H. Bond, “The Confucius Connection: From Cultural Roots to Economic Growth,” Organizational Dynamics (Spring 1988), pp. 5–21; R. Hodgetts, “A Conversation with Geert Hofstede,” Organizational Dynamics (Spring 1993), pp. 53–61.

96. M. Javidan and R. J. House, “Cultural Acumen for the Global Manager: Lessons from Project GLOBE,” Organizational Dy- namics, Vol. 29, No. 4 (2001), pp. 289–305; R. J. House, P. J. Hanges, M. Javidan, P. W. Dorfman, and V. Gupta, eds.,

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97. M. Javidan and R. J. House, “Cultural Acumen for the Global Manager: Lessons from Project GLOBE,” Organizational Dy- namics, Vol. 29, No. 4 (2001), p. 303.

98. See G. Hofstede and M. H. Bond, “The Confucius Connection, From Cultural Roots to Economic Growth,” Organizational Dynamics, (Spring 1988), pp. 12–13.

99. H. K. Steensma, L. Marino, K. M. Weaver, and P. H. Dickson, “The Influence of National Culture on the Formation of Tech- nology Alliances by Entrepreneurial Firms,” Academy of Man- agement Journal (October 2000), pp. 951–973.

100. T. T. Herbert, “Multinational Strategic Planning: Matching Central Expectations to Local Realities,” Long Range Planning (February 1999), pp. 81–87.

101. M. A. Geletkancz, “The Salience of ‘Culture’s Consequences’: The Effects of Cultural Values on Top Executive Commitment to the Status Quo,” Strategic Management Journal (September 1997), pp. 615–634.

102. G. Hofstede and M. H. Bond, “The Confucius Connection, From Cultural Roots to Economic Growth,” Organizational Dynamics, (Spring 1988), p. 20.

103. B. Groysberg, A. Nanda, and N. Nohria, “The Risky Business of Hiring Stars,” Harvard Business Review (May 2004), pp. 92–100.

104. D. Jones, “Employers Learning That ‘B Players’ Hold the Cards,” USA Today (September 9, 2003), pp. 1B–2B.

105. B. Elgin, “Green—Up to a Point,” Business Week (March 3, 2008), pp. 25–26.

106. D. Keirsey, Please Understand Me II (Del Mar, CA: Prometheus Nemesis Book Co., 1998).

Nucor Corporation, one of the most successful steel firms operating in the

United States, keeps its evaluation and control process simple and easy to

manage. According to Kenneth Iverson, Chairman of the Board:

We try to keep our focus on what really matters—bottom-line performance and

long-term survival. That’s what we want our people to be thinking about. Manage-

ment takes care not to distract the company with a lot of talk about other issues. We don’t

clutter the picture with lofty vision statements or ask employees to pursue vague, interme-

diate objectives such as “excellence” or burden them with complex business strategies. Our

competitive strategy is to build manufacturing facilities economically and to operate them

efficiently. Period. Basically, we ask our employees to produce more product for less money.

Then we reward them for doing that well.1

The evaluation and control process ensures that a company is achieving what it set out to

accomplish. It compares performance with desired results and provides the feedback necessary

for management to evaluate results and take corrective action, as needed. This process can be

viewed as a five-step feedback model, as depicted in Figure 11–1.

1. Determine what to measure: Top managers and operational managers need to specify

what implementation processes and results will be monitored and evaluated. The processes

and results must be capable of being measured in a reasonably objective and consistent

manner. The focus should be on the most significant elements in a process—the ones that

account for the highest proportion of expense or the greatest number of problems. Mea-

surements must be found for all important areas, regardless of difficulty.

2. Establish standards of performance: Standards used to measure performance are detailed

expressions of strategic objectives. They are measures of acceptable performance results.

Each standard usually includes a tolerance range, which defines acceptable deviations.

Standards can be set not only for final output but also for intermediate stages of produc-

tion output.

3. Measure actual performance: Measurements must be made at predetermined times.

4. Compare actual performance with the standard: If actual performance results are within

the desired tolerance range, the measurement process stops here.

evaluation and Control

C H A P T E R 11

329

� Understand the basic control process � Choose among traditional measures, such

as ROI, and shareholder value measures, such as economic value added, to properly assess performance

� Use the balanced scorecard approach to develop key performance measures

� Apply the benchmarking process to a function or an activity

� Understand the impact of problems with measuring performance

� Develop appropriate control systems to support specific strategies

Learning Objectives

Gathering Information

Putting Strategy into Action

Monitoring Performance

Societal Environment: General forces

Natural Environment: Resources and

climate

Task Environment:

Industry analysis

Internal: Strengths and Weaknesses

Structure: Chain of command

Culture: Beliefs, expectations,

values

Resources: Assets, skills, competencies,

knowledge

Programs

Activities needed to accomplish a plan

Budgets

Cost of the programs Procedures

Sequence of steps needed to do the job

Performance

Actual results

External: Opportunities

and Threats

Developing Long-range Plans

Mission

Reason for existence Objectives

What results to accomplish by when

Strategies

Plan to achieve the mission & objectives

Policies

Broad guidelines for decision making

Environmental Scanning:

Strategy Formulation:

Strategy Implementation:

Evaluation and Control:

Feedback/Learning: Make corrections as needed

After reading this chapter, you should be able to:

330 PA RT 4 Strategy Implementation and Control

1

Determine what to

measure.

Establish predetermined

standards.

Measure performance.

No 5432

Yes

STOP

Does perfor-

mance match stan-

dards?

Take corrective

action.

FIGURE 11–1 Evaluation and Control Process

5. Take corrective action: If actual results fall outside the desired tolerance range, action

must be taken to correct the deviation. The following questions must be answered:

a. Is the deviation only a chance fluctuation?

b. Are the processes being carried out incorrectly?

c. Are the processes appropriate to the achievement of the desired standard? Action

must be taken that will not only correct the deviation but also prevent its happen-

ing again.

d. Who is the best person to take corrective action?

Top management is often better at the first two steps of the control model than it is at

the last two follow-through steps. It tends to establish a control system and then delegate

the implementation to others. This can have unfortunate results. Nucor is unusual in its

ability to deal with the entire evaluation and control process.

11.1 Evaluation and Control in Strategic Management Evaluation and control information consists of performance data and activity reports (gathered in Step 3 in Figure 11–1). If undesired performance results because the strategic management processes were inappropriately used, operational managers must know about it so that they can correct the employee activity. Top management need not be involved. If, however, undesired performance results from the processes themselves, top managers, as well as operational man- agers, must know about it so that they can develop new implementation programs or proce- dures. Evaluation and control information must be relevant to what is being monitored. One of the obstacles to effective control is the difficulty in developing appropriate measures of im- portant activities and outputs.

An application of the control process to strategic management is depicted in Figure 11–2. It provides strategic managers with a series of questions to use in evaluating an implemented strategy. Such a strategy review is usually initiated when a gap appears between a company’s financial objectives and the expected results of current activities. After answering the proposed set of questions, a manager should have a good idea of where the problem originated and what must be done to correct the situation.

C H A P T E R 1 1 Evaluation and Control 331

Issue

No

No

No

No

No

No

No

No

No

No

NoYes

Yes

YesYesYes

Yes

Yes

Yes

Yes

No

Conclusions

Yes

Did the existing strategies

produce the desired results?

Were the under- lying assumptions

and premises valid?

Were alternative scenarios defined

and assessed?

Were the current situation and

important trends properly

diagnosed?

Was strategy formulation adversely affected?

Were supporting functional stra-

tegies consistent with the business unit strategies?

Inconsistent functional plans.

Were resource allocations suffi-

cient and consistent with

the selected strategies?

Incorrect assessment of

resource requirements.

Successful strategy

and results.

Were results monitored and