Three to four APA double-spaced page essay in length (not including the title and reference pages)

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Chapter 1

Strategic Management

iStockphoto/Thinkstock

Learning Objectives

By the time you have completed this chapter, you should be able to do the following:

Appreciate the complexity of strategic management and how it is critical to achieving ongoing and future corporate success. Understand the role of strategy and strategic planning in strategic management. Understand the basic framework of a strategic analysis used to determine what strategy a company should pursue. Appreciate that a corporation—or any organization—doesn't exist in a vacuum but in the context of its operating and larger environment. Appreciate that in a capitalist society with free markets, competition governs what products are produced (the ones people are willing to buy). Understand how �irms compete for customers. Understand the �ine distinction between a strategy and a business model. Get a feel for what constitutes "success" in business. Understand the range of stakeholders to whom the corporation owes some duty.

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You are about to embark on a journey where you will learn what managing a large or small company is all about and how to plan and manage a company to realize its long-term vision, purpose, strategy, and objectives. To be successful, the company must continually become a stronger competitor and constantly seek new opportunities, because the world is changing rapidly. Leading and managing a company for long- term success is really what strategic management is all about.

Chapter 1 sets the stage for understanding the topic of strategic management and the key concepts that underlie it. You will need to become familiar with many new terms that are vital to understanding concepts in later chapters.

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Strategically managing a corporate business year after year is dif�icult to do, as demonstrated by corporate failures such as Enron.

Associated Press/Pat Sullivan

1.1 What Is Strategic Management?

Strategic management is nothing less than steering and managing a company to be successful over time—not just for the next quarter or year, but for the long term. It involves deciding the direction in which the company should go, what the company should produce, and hence in what industry it competes. It requires identifying who are its competitors and how it might beat them. It means knowing who its customers are and what they want. It entails determining whether it can produce the kinds of products customers want to buy, whether it has the people and organization to make it all happen, and, most important, how to make a pro�it when all is said and done.

The corporate graveyard is littered with notable failures —Enron, Pan Am, Tyco, Arthur Andersen, Circuit City, and Adelphia to name a few—demonstrating that managing strategically is very dif�icult to do year after year. And how does strategic management differ from just ordinary management? If one were suddenly called in to manage a company that continued to do what it had been doing and all one had to do was make sure it was done well, we might say that would constitute "managing." However, if one worried about external challenges—emerging low-cost foreign competition, changing customer tastes, impending legislation, rising material costs, and a slowing economy, to name a few—and began to look at how the company might have to change, what that change would cost, and where the money would come from for it to remain in business and be successful, then that would constitute "managing strategically."

The Strategic Management Model

Although strategic management is complex and dif�icult, it can be understood and learned. Just as you need a diagram and instructions and tools to assemble certain purchases in kit form, so too do you need a process or model for strategic management. Most writings on strategic management are based on a model, which can be de�ined as a device for codifying a complex activity that is at once easy to explain, understand, and learn providing the reader with a "road map" as to how everything �its together. While the model enables the components of such a complex activity to be examined separately and in detail, it cannot begin to describe the dif�iculties that constantly arise in the real world as companies try to implement everything.

Figure 1.1 presents the strategic-management model on which this text is based. The model is aligned with the approach espoused by the Association for Strategic Planning (ASP), whose slogan is "Think—Plan —Act." In other words, it prescribes strategic thinking, strategic planning, and strategic implementation.

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This catchphrase is also the subtitle of this text, which you should look at again now that you know what it means.

Figure 1.1: The strategic-management model

Elements of Strategic Management

To appreciate and understand the totality of strategic management, you have to understand all its elements and how they affect each other. Training in strategic management and the real-world experience you obtain will help further your career, perhaps one day even to the position of chief executive of�icer. It is at this level with a view of the entire organization and its environment that the responsibility for managing a company strategically lies.

Strategy Formulation

Strategic management involves both strategy formulation and implementation. Strategy formulation, also known as strategic planning, is a complex process in its own right involving �ive discrete steps: (1) strategic thinking including external analysis, (2) internal analysis, (3) identifying key strategic issues, (4) developing viable strategic alternatives, and (5) choosing the best strategy using as criteria whatever the company de�ines as "success."

Strategic thinking is a continual activity that seeks to �ind whether a better strategy and business model exist, and seeking a market space that is not currently served and has few competitors. This cannot be

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Chris Clinton/Digital Vision/Thinkstock

done without external analysis, which entails observing, analyzing, and understanding what is changing in a company's external environment to anticipate what the future might hold.

Internal analysis means knowing, analyzing, and understanding everything about the company itself, especially what makes it a strong competitor or why it isn't as strong as it could be. Does it have a core competence, an enabling culture, strong leadership, adequate �inancial resources, and a good understanding of its customers?

Key strategic issues are a synthesis of both the external and internal analyses that focus the management's attention on the most important issues the company faces. Viable strategic alternatives are bona �ide strategic options or alternative futures from which a company can choose the best one. They consist of strategies, strategic intent, programs, and methods of �inancing.

Strategy Implementation

Some experts suggest that strategy implementation comprises as much as 90% of strategic management. It is all about successfully executing the strategies developed, thereby enabling the company to achieve the vision and meet the objectives set by management. The �irst step is operational and budget planning to determine who will do what to implement the strategy and to ensure that the company has the resources—money, people, and know-how—to do these things. A consideration in this planning stage must be how progress will be measured. The actual performance of the myriad tasks involved in implementing the strategy is called operations. An information system to collect and analyze operational data must be devised and constructed. Actual performance must be measured at regular intervals and the data entered into the system to compare against planned estimates. When things don't go according to plan or resources are being wasted, corrective action should be taken immediately. Lastly, the strategic- planning process itself must be managed and improved on an ongoing basis.

Figure 1.1 shows in which chapters the various parts of the process are presented. It also shows that the adjustments a company must make in response to challenges and changing conditions as it implements the strategy in turn affect the assessment of the company the following year. A strategically managed company is constantly updating its information and mental models to take into account the changes occurring both outside and inside the company.

People have their own ideas about things in the world around them. Sometimes they know very little about something and sometimes they know a lot. What we know or think we know about something forms our mental model of it. For example, our mental models about pollution may not be well formed. It's a complex topic with many facets, and our motivation for learning more about it and what needs to be done may be low. Most people were probably not aware that ships had for years

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The Association for Strategic Planning has a strategic-management model, whose slogan is "Think—Plan—Act."

been dumping plastic waste into the Paci�ic Ocean on the probable assumptions that, in the vastness of the ocean, this would go unnoticed and no harm done. Their mental model of marine pollution was likely not based on

personal observation but limited to what they might have occasionally read in newspapers. For many, that mental model must have been radically updated when a series of articles about ocean pollution revealed the existence of the Paci�ic Trash Vortex consisting of non-biodegradable plastics �loating in the "western garbage patch" off the coast of Hawaii and the "eastern garbage patch" off the United States continental coast. The latter was estimated to be twice the size of Texas (Weiss, 2006). In another example, we are all familiar with newspapers and bookstores and no doubt think we have pretty good mental models of those businesses. But can you imagine a world without either of them, at least in their current form? There's a good chance that might happen in the next few years. If that happens, we will have two more mental models to update (Olivarez-Giles, 2011).

Strategic planning and strategic management are best explained while examining a company that is in only one business. This approach is used in the �irst 10 chapters. Chapter 11 explains how diversi�ied (multi-business) companies, international companies, and global companies operate and why they are considerably more complex to plan for and to manage. Companies in very fast-moving industries, as with most high-tech businesses, are also dif�icult to manage because keeping abreast of rapid changes often requires a technology strategy in addition to a company strategy and requires a higher level of investment.

The coming sections in this introductory chapter explain the context of business, what is meant by "success," the meaning of strategy and strategic planning (among the most misused and misunderstood words in business), what business models are and why every business has one, and the importance of stakeholders in business decision making. The remaining chapters in the book explore in greater detail each of the major elements of strategic management and clarify them. In the end, you will have a conceptual grasp of how everything �its and works together. To manage strategically well takes years of practice and accumulated experience, often people's entire careers.

Discussion Questions

1. The Association for Strategic Planning's motto of "think—plan—act" also forms the foundation of this book. Are these three basic elements enough?

2. What are the principal elements of the strategic-management process? How are they interrelated?

3. How does strategic planning differ from strategic management? 4. What part of doing strategic planning appears, in your opinion, to be the most dif�icult to do? Which part, if not done well, would be most likely to lead to poor strategic decisions?

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Market share is the percentage of a �irm's annual sales based on the annual sales of the entire industry.

Gunnar Pippel/iStockphoto/Thinkstock

1.2 About Competition

In this section, we'll begin to examine the different kinds of competition at various stages and levels of business.

Free Versus Regulated Markets

Capitalism allows a free market to exist and promotes competition. The United States is a mixed economy, which means that some markets are freely competitive with almost no state intervention, and some are highly regulated, making competition very dif�icult. It is convenient to assume initially that a market is not regulated until the nature and degree of the regulation can be identi�ied and understood. An example of a regulated market is public utilities, regarded as a public good and which require regulation to maintain high levels of accessibility, affordability, and safety that otherwise might be jeopardized in pursuit of pro�it. Other regulated markets include communications, energy, food production, trucking, workplace safety, and airlines, to name a few. All involve public-safety issues and the need to balance the public interest with what's good just for a particular company.

Industries Versus Markets

The terms market and industry are often used interchangeably in everyday usage, but they have quite distinct meanings. The collection of �irms that provides similar products or services to the same customers is called an industry. The buyers for those products or services are collectively called the market. To an economist, the industry is the "supply" side of the equation and the market is the "demand" side, which is illustrated in Figure 1.2 below. When demand is greater than supply and people can't get enough of what they want, they become willing to pay more. The price will go up until the point where demand again equals supply and prices stabilize. Conversely, when companies can't sell all that they have produced, supply is greater than demand. Producers will try to reduce accumulated inventories and the price will go down until supply again equals demand and prices stabilize.

Thus, it is more accurate to talk about industries—not markets—being regulated (or not). The exception is the term market share, which means a �irm's annual sales as a percentage of the annual sales of the entire industry. Given this de�inition, "industry share" is more accurate than "market share," because that is how it is calculated. However, using the term market share to mean this is so ingrained in the business lexicon that we will go along with the norm and call it market share in this book (even though we mean industry share). At least you will know what it really means when you read about companies and their market shares.

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Figure 1.2: Industries vs. markets

How Firms Compete in an Industry

In any industry regardless of the degree of regulation, �irms compete with each other to sell more products or services to customers; their purpose being to "capture more of the customer's dollar." Firms are free at any time to offer whatever products they think people need at any price they believe people would be willing to pay. If they succeed, customers will buy their product; if not, they won't. That's the nature of competition. Ultimately, consumers, whether individuals or businesses, communicate through their buying behavior exactly what goods and services they need. Companies that fail to deliver products that satisfy customers' needs will soon go out of business.

In one extreme situation in which a particular �irm is the only company in an industry, then it has a monopoly. It can charge any price it likes since customers cannot get the product from any other source. At the other end of the scale, when many �irms in an industry all produce essentially the same product (such as paper clips or fertilizer), they compete on the basis of price. In such a market, customers' perceptions that products are all the same will base purchase decisions on price alone. This is called price or "perfect" competition. Another example of this is that people who believe that supermarkets are all the same will buy from any one, especially the one that reduces their overall grocery bill the most.

Differentiation

Companies can also compete by being differentiated, that is, have a strong and distinctive brand, along with unique or different products. In that instance they can charge more for their products because in the

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consumer's mind, they are offering something that no one else is offering. Examples of this are a designer perfume or a Porsche automobile. Differentiation can, depending on the product, be achieved by offering customers superior quality, product features, technology, convenience, selection, style, performance, safety, comfort, reliability, cost savings, warranties, return policy, customer service, and so on. The key is to differentiate based on the customers' needs, not what the �irm thinks they need. When consumers perceive that your product alone best meets their need, they will buy it and be willing to pay more for it.

Companies can compete based on many other factors beyond attributes of the product or service. They may offer customers on-time delivery or shipment without spoilage or damage for products such as fresh produce. Ef�icient distribution such as Net�lix provides, automated warehouse operations, and excellent management of the supply chain all may provide a competitive advantage that a company can use to attract customers. The list is endless. As with product differentiation, the point is to address the needs of the customer.

Case Study Case of Mistaken Differentiation

A watch manufacturer once made a very average watch that sold just well enough to keep the company going as it did not offer customers any distinct advantages over competing products. The company was forced to compete on price, thus returning thin margins. The CEO lamented that the company's watch was never the "best" in any dimension, so he couldn't charge more for it. This changed when his chief engineer observed that he could make the watch accurate to within a fraction of a second per year for only a $10 increase in price. The CEO concluded that with the most accurate watch in the world he could raise the price by more than $10. He gave the go-ahead.

The marketing department created a new ad campaign touting the watch's accuracy and doubled the advertising budget. Soon, the watches were distributed to retailers, and the campaign blitzed the media.

To the dismay of the CEO, sales never picked up. He instructed his VP of marketing to �ind out what was going on. The report was troubling. Potential watch buyers weren't interested in accuracy. In fact, losing or gaining minutes a year was not a concern for them. What they really wanted was for the watch to be more of a fashion accessory with interchangeable snap-on covers in different designs and colors.

The CEO realized too late that, while the company's watch could actually be differentiated from the competition, it had to be perceived by customers to be differentiated along some dimension that they valued. Differentiation strategies must be preceded by market research to determine what customer need is not being met and then move quickly to meet it. Only then will customers be willing to pay more for the product and the company command higher margins.

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Today, many companies are increasingly cooperating through partnerships, agreements, and joint ventures rather than competing with each other. A recent example of this is the cooperation of aircraft companies Grumman and Boeing to build the U.S. Air Force's KC-135 tanker planes.

Associated Press/Azamat Imanaliev

Cooperation

Companies are increasingly cooperating with other �irms in an industry rather than competing, or doing both. They do this through partnerships, agreements, and joint ventures. Is cooperating really competing? In certain industries, the answer is yes. For instance, companies in the defense-aerospace industry used to prepare proposals on their own to bid on large military contracts. As military hardware has become increasingly complex and expensive, the cost to vendors of preparing such proposals has over time soared to many millions of dollars, exposing them to greater risk. This in turn effectively raised the cost of such contracts to the military. In response, pairs or consortia of competitors got

together to bid together on such contracts to lower the risk and costs. The military allowed such cooperation as it also reduced its own costs. The Boeing Company and Northrop Grumman Corporation have collaborated on many large military contracts that would be prohibitively expensive for a single company such as the Ground-Based Midcourse Defense (GMD) component of the United States ballistic missile defense system. Such an instance of cooperation is described as an agreement or strategic alliance, where two �irms partner for their mutual bene�it but retain their distinct corporate identity. There are other kinds of strategic alliance, discussed in Section 1.6, including simple contracts for services rendered at one end of the scale (minimum commitment) to minority ownership of another �irm or joint venture at the other (heavy commitment).

Discussion Questions

1. You own a small �irm selling grass seed. Who might your competitors be? (Think about factors other than other �irms selling grass seed.) How might you cope with some of these competitive threats?

2. Competitors are usually thought of as other companies like yours producing similar products for the same market. Would any factor that reduced overall demand for your product also be viewed as a competitor? Why or why not?

3. Over the last 10 years or so, do you believe more companies are cooperating with one another? Why or why not?

4. Why do you pay exorbitant prices for concessions at movie theaters and sports venues?

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Globalization is the process by which regional economies, cultures, and societies become integrated in a global network of political and economic ideas through communication, trade, and transportation.

Robert Humberman/SuperStock

1.3 The Globalization of Business

The world today is a lot different than it was just a decade ago. The global human population has surpassed 7 billion people (U.S. Census Bureau, 2011), and technological advances have profoundly affected our daily lives. New York Times columnist Thomas Friedman describes the arrival and spread of the Internet as "�lattening the world," meaning that the reach of every individual has become global and the power of consumers equalized (Friedman, 2007). We have all heard the expression, "the world is shrinking," alluding to the fact that international travel is easier, and we have instant access to news about events in just about every corner of the earth.

A de�inition of globalization as it is commonly used is "the development of an increasingly integrated global economy marked especially by free trade, free �low of capital, and the tapping of cheaper foreign labor markets" (Merriam-Webster's Collegiate Dictionary, 2004, p. 532). A more comprehensive de�inition for the purposes of this discussion is an amalgam from two sources. "Globalization describes the process by which regional economies, societies, and cultures have become integrated through a global network of political ideas through communication, transportation, and trade" (Bhagwati, 2004). Globalization is typically identi�ied as being propelled by a combination of economic, technological, sociocultural, political, and biological factors. The term can also refer to the transmission of ideas, languages, or popular culture across national boundaries. Some facet of life that has undergone this process can be considered to be globalized (Croucher, 2004).

What does all this mean with respect to strategic management? Not too long ago, companies might have asked themselves whether they should globalize; today, they should instead ask why they shouldn't (Yip, 2003). Consider the following scenarios and the challenges they pose to businesses.

If you managed a local or regional company, you might think that you would be competing just locally or regionally. This assumption is no longer true. It's highly likely that foreign competitors would be getting a foothold in your market. You or your competitors would almost certainly be buying parts or materials from foreign companies to make your products at lower costs. You could even be outsourcing your entire manufacturing to a foreign company; lately it seems that everything one buys is made in China. You may well be employing people from other countries. Without question you would be using equipment, from machines to cell phones to cars, made by foreign companies. So even an American company competing in the United States experiences globalization in every facet of its business.

If you directed an American company and your domestic market had matured or become saturated, meaning that sales had leveled off and no unserved demand exists, you would want to �ind new avenues

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Free trade agreements resulted in a transformation of the Mexican textile industry. When cotton imports �looded the market, many textile plants like

Associated Press/Eduardo Verdugo

for growth. If you believed that consumers in other countries buy your product, you would want to expand to one or more foreign countries to continue growing and making a pro�it. Globalization means doing just that, but you can expect to face tough foreign competition from other companies chasing the same customers. To succeed, you will have to do this in a country whose laws, culture, currency, customs, and even language are unfamiliar. You will have to make critical decisions such as whether to make the product in the United States and ship it to those countries or manufacture the product there. As you can imagine, this gets complicated very quickly.

While even the most global of companies must have their headquarters in one country, that aside, they are truly global. They have operations all over the world with employees from each of the countries in which they are located. Research and development centers may be established on several continents. Manufacturing is conducted in many locations, typically located near suppliers and customers to minimize transportation costs. Sales of�ices are found everywhere the company sells its products. It may be that products have to be tailored to a particular country, for example, cars out�itted with steering on the right for countries that drive on the left or appliances that operate on different voltages depending on the country. An enormous challenge is that a company must comply with the laws of each country in which it does business. An example of a company in this scenario is Volkswagen, a German auto company that sells cars in the United States that are manufactured in Mexico.

Today, anyone starting a company in the proverbial garage can �ind customers all over the world through the Internet. Imagine, a craftsman or rug maker in Northern India with access to an Internet connection can now sell his products globally. Conversely, a consumer in the United States shopping for a particular product can now choose from suppliers or retailers anywhere in the world. Of course, this ability also brings with it new considerations for the consumer. The reliability of buying from an Internet retailer, the security of making payment, and return policies would all factor into the purchase decision.

Case Study Globalization at Work in San Miguel

In San Miguel de Allende, a colonial town in Central Mexico and World Heritage Site, a collection of upscale art and furniture galleries occupies what was once a textile factory. Negociación Fabril de la Aurora was a company that once supplied manta, or unbleached muslin, to all of Mexico.

Constructed in 1902 by an English company, the factory was equipped with cylinders, spindles, and looms to process the bales of raw cotton from the central part of Mexico and from Sinaloa and Sonora states. The raw �iber was cleaned, ginned, carded,

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Negociación Fabril de la Aurora were forced to close their doors.

and spun into yarn or thread and �inally woven into manta. The Aurora manta was of high quality and used to make indigenous clothing and home linens. By the 1970s, production included heavy canvas used for making tennis shoes.

In the mid-1950s, most of the English machinery was replaced with later models from Germany and Switzerland. Until the time of its closing, La Aurora was the largest employer in San Miguel de Allende with a work force of over 300 and an integral part of the daily lives of its workers and the community. It sponsored soccer and baseball teams, held picnics for families on Sundays with a live band on the grounds, and even arranged an altar inside the factory for a local priest to deliver Mass.

"Free trade agreements brought many changes to the Mexican textile industry and La Aurora was not an exception. Cotton imports began �looding the market and domestic production was greatly affected. As a result, the steam-generated whistle which signaled the start and �inish of each shift and was a notable sound in San Miguel for almost 90 years blew for the last time on March 11, 1991." (Fabrica La Aurora, para. 7)

Source: Fabrica La Aurora. History of Negociación Fabril de La Aurora (1902–1991), framed at the entrance to La Aurora, photographed on March 26, 2011.

Discussion Questions

1. Can a company today survive in its domestic market by remaining entirely domestic? How would you rank order the threats it faces from nondomestic companies?

2. How can a company determine where else in the world its products might be in demand and how tough the competition might be in those markets?

3. Name some of the most global businesses in the world. What do they produce, and how did they get to be so big and expansive?

4. In the case of La Aurora, the company appeared to have been suddenly overwhelmed by events that led to its demise. Could it have foreseen any of these events? If so, what might it have done to counter them?

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While most industries have regulations in place, corruption and con�licts of interest still exist in U.S. businesses.

Comstock/Thinkstock

1.4 The Inexorable Pace of Change

The world today is changing at an ever-faster pace compared even to a few years or a decade ago. Given the rate of change, it's easy to get lost in just how far technology has advanced in such a short time. For instance, Facebook didn't exist until 2004, YouTube until 2005, and the iPhone, which has gone through numerous updates, wasn't unveiled until 2007. Kodak, for decades the producer of the most popular photographic �ilm in the world, stopped marketing �ilm cameras in January 2004 in the United States, Canada, and Western Europe. By 2007 it neither manufactured nor licensed any �ilm camera with the Kodak name. The world had truly gone digital. In early 2012, this company, which had been a prominent entry in the Fortune 500 list since that ranking �irst appeared, was facing bankruptcy.

It is easy to observe how rapidly technologies are advancing and the products they spawn are being developed. High-tech industries in which such rapid changes are occurring and where changes in market share are temporary are termed hypercompetitive. Profound changes are occurring all the time in other areas as well. The political maps of Eastern Europe, the Middle East, and Africa have all changed radically over the past 20 years. The so-called Arab Spring of 2011 saw popular uprisings overthrow autocratic regimes in Tunisia, Egypt, and Libya that had brutally oppressed their citizens for decades. Many observers and participants cite the use of Twitter and Facebook, tools that did not exist even �ive years

before, with facilitating the wave of revolutions. Political upheavals, even in distant parts of the world, can bring both threats such as the disruption of oil supplies and the rise in the price of gasoline in all countries, and opportunities like the opening of new markets and sources of materials. Businesses must be attentive to seemingly unrelated events happening in faraway places.

Many legislative and regulatory changes affect business. Building codes get updated so that buildings might withstand earthquakes or hurricanes. Environmental safety regulations mandate reduction in non- biodegradable plastics, new limits on air and water pollution, and promote an increase in recycling. The pace of such change is increasing.

Ethical behaviors by both individuals and businesses are also changing, but perhaps in the wrong direction. It appears that corruption, bribery and kickbacks, con�licts of interest, and greed are rampant in the United States and, regrettably, becoming more like the norm than the exception (Fisman, 2009). It has infected politics at every level, the highest echelons of business, and industries like pharmaceuticals, real- estate development, health care insurance, and banking and �inancial services. People are far more motivated now by money (gained legally or covertly) than what's good for the company, the public good,

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or other people. This trend, unsettling as it is, has profound implications as to how companies are run and even how they compete.

Discussion Questions

1. Discuss elements in your own life that have changed faster than you would have imagined. How did the changes happen?

2. What things can or do you buy now that did not exist �ive years ago? Three years ago? 3. What are some things that will become available in the next 3–5 years that are not now available? What do companies have to do to make them happen (besides, of course, having the necessary technology)?

4. How can a company's strategic-planning process take into account very rapid changes in its environment?

5. In which areas do you think the most profound and rapid changes are occurring? Why?

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A company does not know its true worth or market value until it is bought.

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1.5 What Is "Success"?

Most companies have one or more purposes they are trying to achieve, even though their purpose may never be expressed in writing or conveyed to the employees. These purposes can be construed to represent what the companies consider "being successful."

The most common purposes are to survive, to increase shareholder value, and to make a pro�it. Surviving means enduring. While survival cannot be measured, it is at the back of all executives' minds, simply because many companies don't survive.

Shareholder Value

Shareholder value is a computed value based on a company's projected cash �lows for the next 10 years, discounted to the present time using discounted-cash- �low (DCF) analysis and an appropriate discount rate. From that computed value is subtracted all current debt. If computed exactly the same way, even using different discount rates over time, one can keep track of shareholder value and use it as a criterion in decision making and investing (Rappaport, 1997).

Michael Raynor, who came to prominence for his contribution to the idea of disruptive innovation, believes that companies should adopt as their main purpose survival rather than shareholder value (Raynor, 2009). His thesis questions the choice of shareholder as the most important stakeholder because they are "owners" of the corporation and therefore deserve to have their investment maximized. Instead, as he says, "A stock certi�icate is a particular sort of claim on corporate wealth . . . not a deed of ownership" (Raynor, 2009, p. 5 ). More accurately, as suppliers of capital to the corporation, stockholders deserve to be paid enough to keep them investing, just as employees deserve enough payment to keep them motivated. Rather than maximizing stockholders' returns at the expense of returns to other stakeholders, Raynor advocates being fair to all suppliers of inputs at a level that guarantees their continuation to ensure the corporation's survival.

Net Worth

Calculating the net worth or value of a privately held company is more dif�icult but becomes necessary if a company wants to be acquired or if it wants to issue shares to investors. What is typically done is that a valuation consultant is engaged and uses several (usually 3–5) valuation methods, eventually taking an average. Not until a company is actually bought is its true worth or market value established. Market value is distinct from book value, which is what is re�lected on the company's balance sheet and takes

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into account its depreciated and amortized assets, inventory, and goodwill. Market value represents the value an asset might fetch if sold on the open market. For example, a customer list (part of goodwill) has one value to an accountant and perhaps far more value to an acquirer.

Pro�it

Pro�it is a popular reason why companies stay in business, but, as said in various ways in the �inancial sector, "Cash is fact, pro�it is opinion." Certainly, it's complicated. In the sense used here, we mean net pro�it after taxes (NIAT) or "the bottom line." It is what is left after all allowable expenses have been deducted over a speci�ied period. There are other kinds of pro�it: gross pro�it; operating pro�it; earnings before interest, taxes, depreciation, and amortization (EBITDA); earnings before interest and taxes (EBIT); and net income before taxes (NIBT). Just look at any income statement.

NIAT is an accounting artifact, approved by the American Institute of Certi�ied Public Accountants (AICPA) and conforming to widely accepted accounting rules called GAAP (Generally Accepted Accounting Principles). The �inal value depends on depreciation and amortization of assets on arti�icial schedules created by accountants. Some equipment, for example, may be fully depreciated, having zero value, yet continue to be used for years.

As if to support the previous point, a company can spend cash but not pro�its. Nor can it spend retained earnings, which is a balance-sheet account that accumulates pro�its or losses from previous years. It can spend only cash. At some point, pro�its show up as operating cash, loans are an in�lux of cash, investment gains result in cash, and even selling stock results in cash in�low. So it's cash that is king, not pro�its. Having said that, NIAT is so pervasively used in business as an indicator of success that companies continue to use it widely.

Highly related to NIAT are several �inancial ratios that use NIAT, like net pro�it margin (NPM), which is NIAT divided by revenues, and return on equity (ROE), which is NIAT divided by total stockholders' equity. NPM is a measure of a �irm's pro�itability relative to its revenues, and ROE is a proxy for the net pro�its that are, in a sense, generated by stockholders' investment in the company.

Market Share

Another measure of success is market share. Every company wants to be the market leader, but only one can be. What is not so obvious, especially to companies that publicly avow to increase market share, is that to do so, their revenues have to grow faster than total industry revenues. They will maintain their market share if they grow as fast as the industry, and actually lose market share if their growth lags behind the industry's.

Some years ago, a graduate student prepared a report on the company he worked for, a defense-aerospace contractor in Los Angeles. He was tired of hearing the CEO constantly telling everyone he wanted the company to gain market share. His study revealed that the company would have had to invest about $1.5 billion over the next three years to do so, and simply did not have that amount of money, either in cash or

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Nordstrom's excellent customer service has become its core competence and its brand. If employees do not maintain a high level of customer service, the brand's worth will decline.

Mario Tama/Getty Images

borrowed funds, to invest. When he showed his results to the CEO, the CEO changed his tune about wanting to gain market share.

Often, market share cannot be measured, whether because there are simply too many competitors or because many competitors are privately held. In addition, it may not be possible to know how fast the industry's total sales are growing against which a company could compare its own rate of revenue growth. In these circumstances, market share is not a good indicator of success. A closely related indicator is the company's own revenue growth, which can be measured.

Another indicator of success is whether the company has a core competence, a capability that gives it a strategic or competitive advantage over its competitors. This will be discussed in more detail in Chapter 4.

Brand Equity

Having a strong reputation, strong brand, or strong brand equity are also indicators of competitive success. These signify a successful differentiation strategy and, more than likely, a sizable market share, strong revenue growth, and healthy pro�its. A company is doing well on this criterion when customers buy its product because its brand is the primary reason for their purchase decision. Many people when they are thirsty go for a Coke, because Coca-Cola has such a strong brand and they have developed a habit of buying that brand. McDonald's has a similar grip on many people wanting a quick hamburger. In the auto industry, Mercedes, BMW, Porsche, Lexus, Volvo, Toyota, and Honda all conjure up speci�ic brands— a unique set of promises—that attract loyal customers.

They have strong brands and meet the needs of people who buy their cars.

Brand equity or brand strength refers to the power of a brand to in�luence purchases and loyalty. Brands and reputations can increase, remain the same, or erode over time if efforts to maintain them aren't made. The main reasons for brand erosion are competitors duplicating the quality of a brand so that it is no longer unique or a company failing to perform in ways that the brand promises. Nordstrom's department store offers an illustration of a successful differentiation strategy. More than the strategy, Nordstrom's legendary customer service has become its core competence and its brand. However, if other department stores provided similar outstanding service or Nordstrom's own employees failed to live up to the company's reputation, its brand equity could begin to decline. People would then stop shopping there because its brand had eroded, thereby adversely affecting its performance on other measures like revenues and pro�its

Discussion Questions

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1. Imagine you are a country's minister for health. What measures of success might you adopt in order to judge whether health expenditures are being made wisely?

2. What measures might you look at personally to assess how happy you are? 3. Imagine you have just graduated and are in the job market. What criteria might you use to help you land the best job, assuming you got more than one offer?

4. It is widely held that it is enough for a �irm to be pro�itable. Is it? What other measures might you consider using to help ensure that the company would still be in business �ive years from now?

5. Imagine you are on the verge of retiring. Looking back on your career, how would you gauge how successful it was?

6. Imagine you have only a few days to live. What criteria would you use to indicate to yourself how good a life you have lived?

7. How might you tell that your company is the technological leader in its industry?

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Innovation strategy is a product-development strategy that requires research and development to focus on introducing

JupiterImages/Creatas/Thinkstock

1.6 What Is Strategy?

Strategy is how a company actually competes (Abraham, 2006). This simple de�inition is not only true but also effective because it tacitly recognizes that companies could have a bad or ineffective strategy and hence not be able to compete well. Typical de�initions of strategy are, in fact, de�initions of a good or ideal strategy (see Appendix A for 77 such de�initions). While these are commonly accepted terms, there is no agreement on a single de�inition of good or ideal strategy. In this section the most common strategies are introduced, grouped for convenience into seven categories: concentration strategies, product- development strategies, market-development strategies, conglomerate-diversi�ication strategies, innovation strategies, technology strategies, and generic strategies

Concentration Strategies

A concentration strategy is some combination of producing an existing, improved, or new product or service for an existing, expanded, or new market. It's useful to think of them as being one of the following types.

Product-Development Strategies

Product-development strategies entail continuing to produce an existing product or service, improving them over time, and introducing new ones, all for the same market. The best examples are the auto companies that bring out improved versions of every model every year and, usually every four years, redesign every model. They periodically also introduce completely new models, like Honda's Element, Toyota's Scion line, and Nissan's Leaf. Likewise, software companies bring out successively improved versions of their product by labeling them Version 2.0, 2.1, 2.2, 3.0, and so on. Microsoft has introduced successive versions of its ubiquitous Windows operating system, from 1.0 through the famous XP and the infamous Vista to the current Windows 7, a remarkable feat of constant improvement.

Market-Development Strategies

Market-development strategies involve penetrating an existing market, expanding into related markets, or �inding new markets for the existing products or services a company produces. A jeans manufacturer targeting young men could target older men or children. Banks expand their presence by opening of�ices in supermarkets. If a company does business in only one state, expanding to other states and eventually nationally is �inding new markets, as is a domestic company expanding internationally.

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technologically advanced processes or products.

A combination of product- and market-development strategies is employed when expanding a market or �inding a new market requires modifying the product. Examples of this are jeans for men having to be redesigned for women, or cars having to be modi�ied for countries where drivers drive on the other side of the road. Sometimes modifying a product is the only way of expanding the market. Increasing a car's performance to appeal to younger male buyers, adjusting its size and �lexibility to appeal to families, expanding its range of colors to appeal to women buyers, or adding luxury features and status to attract higher-income and older people all illustrate this approach. Most concentration strategies fall into this category.

Conglomerate-Diversi�ication Strategy

A conglomerate-diversi�ication strategy is one in which a company introduces a brand new product or service for a new market. In business, this is rare because of the high risk, and few if any companies use it. If a company really wants to do this, it would instead purchase another company in the industry it wants to enter, which would drastically reduces its risk.

Innovation and Technology Strategies

Innovation strategy is a product-development strategy that deserves discussion on its own. Innovation strategy requires research and development (R&D) and focuses on introducing technologically advanced products or processes. The "R" of R&D involves both basic and applied research. Basic research focuses on discovering new things and processes unimagined before and is very costly with uncertain outcomes. Applied research takes existing knowledge and concentrates on commercializing it. The "D" of R&D is highly applied and focuses on improving existing products.

Figure 1.3 shows the basic types of innovation strategy, varying from short-term, relatively inexpensive, and low-risk in the bottom-right corner of the �igure to long-term, requiring considerable investment, and high-risk in the top left. As the degree of change increases along either dimension, the likelihood that the project will require more time and resources also increases. The ideal situation for a company pursuing an innovation strategy is to have a balanced portfolio including projects ready without much investment in the near term, some requiring more investment and time ready in the medium term, and some more risky, long-term projects requiring more research and advanced development.

Figure 1.3: Degrees of innovation strategy

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permission.

Technology strategy, another facet of an innovation strategy, instead focuses on developing new or improving existing technologies and becomes the domain of companies whose products or whose very existence depends on winning the technological race. Technology refers to both abstract and concrete tools—such as knowledge, skills, and artifacts—that can be used to create, produce, and deliver products.

Generic Strategies

Michael Porter (1985) discovered in his research that a lack of a competitive advantage was the reason companies generated below-industry-average pro�its. He proposed that the way to obtaining a competitive advantage was through one of three generic strategies, so called because they applied to any industry. Those generic strategies are differentiation, low-cost leadership, and focus.

Differentiation

A differentiation strategy involves developing a product that is unique from or superior to the product offered by the competition. There are myriad ways of doing this as was discussed when differentiation was introduced (Section 1.2). The dif�iculty of competing in this way is that customers must perceive the product as being differentiated. It does not matter how differentiated you think your product is, if customers don't perceive it, they won't buy your product. An attraction of this strategy is that if your product is differentiated, you can charge more for it because customers will be willing to pay more. When companies "play a different game" and leave competitors behind, they take differentiation to a new level.

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One special case of differentiation is a blue-ocean strategy, which is a way of competing that requires �inding a market that is not being served at all. In other words, identifying a market where you are the only provider and have no competitors. Such a market space is called a blue ocean. The name comes from an analogy where a "red ocean" represents a bloody shark-feeding frenzy all going after some prey, meaning there is too much competition. A blue ocean, on the other hand, is free of any predator except you—no competition, no blood.

Having a strong brand is another form of differentiation but is singled out because the basis of the differentiation is reputation. Companies with strong brands have strong reputations and are highly differentiated from each other. The reputation is built over time and represents the degree to which a company has met or exceeded its promises to customers. The more a company delivers on or exceeds its promises, the stronger will be its reputation. In turn, more people will have con�idence buying from the company. For example, if a company promises great customer service and consistently treats every customer like a VIP, it will become known for customer service—just as with Nordstrom's department stores—and people will shop there because of that great customer service. Reputations and brands can, if a company is not careful, erode with time, either because a company is not so assiduous doing what it promised or because competitors are successfully imitating it. If all department stores improved their customer service to the level of Nordstrom's, would customers still make a point of shopping there? Curiously, though it isn't rocket science, no other department store has been able to match Nordstrom's customer service for a long time and diminish its brand.

Low-Cost Leadership

A low-cost leadership strategy is completely invisible; neither competitors nor customers know what a company's costs are. Yet, if a price war were ever started, the company with the lowest costs in the industry would be the one standing at the end. This strategy isn't about just reducing costs but rather reducing them to be the lowest in the industry. Thus, through subtle and not-so-subtle signals that are put out to other industry players, a company can tell its competitors, "Don't mess with me, because I have the lowest costs." This is one reason that makes Walmart the most formidable of competitors.

Focus

A specialization or focus strategy targets a very small market (often called a niche) and, in so doing, reduces greatly the number of competitors in the arena. Big competitors won't be interested in a niche market with a relatively few customers. For example, instead of being a publisher or even a textbook publisher, be a medical-textbook publisher with only medical students as customers. You will have a chance to dominate the niche as not many other publishers will want to specialize in that niche and even charge enough to cover higher unit costs because of the lower volume.

Strategic Alliances

Strategic alliances are basically agreements between two companies, ranging from simple contracts (minimal integration and collaboration) to joint ventures and minority ownership (heavy integration and

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collaboration), but where each company remains separate. Figure 1.4 shows various kinds of strategic alliances and where along the spectrum they lie. The following discussion elaborates on the �igure beginning at the left-hand end.

Outsourcing and Simple Contracts

Into this category fall simple purchase agreements for products or services, like engaging consultants that often spell out terms such as deliverables and payments. Companies need protection in case products delivered are faulty, services are unsatisfactory, or even payment is late or not paid. Agreements take care of these eventualities.

Licensing

Companies that own a patent or desirable trademark make extra money through licensing use of it to other companies. In this way, they control use of that asset, how much they are compensated, and the extent to which their brand is strengthened. Harley-Davidson, the global motorcycle manufacturer, licenses its name and logo on clothing, mugs, and telephones, while Disney makes a fortune licensing use of its proprietary characters such as Superman, Spiderman, and Mickey Mouse on all kinds of products made by others. Have you ever wondered why clothing and caps from your alma mater are so expensive? About half the price goes toward the university itself as a licensing fee.

Licensing works both ways. Not only do owners of patents and trademarks bene�it but companies on the other end are happy to pay the licensing fees and royalties for using someone else's intellectual property since they are spared the years and expense of developing that product themselves. For example, just about every company in the world making inkjet printers licenses the basic technology from Canon.

Shared Resources and Competences

Companies may share the cost of R&D to develop technologies that require large amounts of capital and risk. A consortium of semiconductor manufacturers did this in the 1980s and '90s when they created Sematech. Companies may negotiate exclusive cross-distribution agreements whereby two companies in different countries agree to market each other's products in their own country. Joint R&D projects between companies and universities for the bene�it of both is becoming increasingly common. Sharing resources is common in the auto industry—Ford, for example, had Mazda develop a new transmission for the Ford Probe when the two companies decided that Mazda's transmission was better than Ford's.

Partial Acquisitions (50%)

Sometimes small, high-tech startup companies come up with new technologies and products that revolutionize industries or take them by storm. They desperately need capital for additional R&D or to take the product to market. Some entrepreneurs feel that venture capitalists often take too large a chunk of equity for the capital they provide, earning the nickname "vulture capitalists." An alternate source of capital can be large companies looking for new ideas and technologies that would bene�it them. In fact, many have "venture divisions" for just that purpose—to �ind and invest in promising new companies and

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When British Airways merged with Spanish air carrier Iberia, they were adopting a strategy that would make them more competitive in the marketplace.

Associated Press/Ian Nicholson/PA Wire

technologies. To be sure, they want an equity stake, but the equity demands are typically more reasonable since they are more interested in �irst rights to the technology when it is developed, giving them a competitive advantage. These investments typically result in 10–30% equity stakes in these companies in exchange for investments of $1–10 million. Such investor companies also may acquire a controlling interest in the small company later for an additional investment.

Joint Ventures

Whereas two companies forming a strategic alliance still remain separate entities, forming a joint venture (JV) requires the formation of a new corporate entity jointly owned by the two companies. An apt analogy often used in the literature is two parents giving birth to a child. The JV is governed by a detailed and encompassing agreement that speci�ies what each parent will contribute to the child, how much of the risk each parent incurs and the percentage of pro�it each is due, how long the agreement will endure, under what circumstances the agreement can be terminated, and how the remaining assets are distributed. Initial contributions take the form of capital, management, technology and patents, facilities, and so on. Research has shown that JVs tend to be more successful when the management team comes from one parent—usually the dominant one—rather than both parents, especially in international JVs (Killing, 1983).

In the 1950s, Fujitsu and TRW formed a JV called TRW-Fujitsu, based in Los Angeles, for the express purpose of marketing Fujitsu products in the United States. Fujitsu contributed technology, products, and capital, while TRW contributed management and staff, facilities, and capital. Ultimately, it was terminated a few years later because sales did not meet expectations.

Acquisitions and Mergers

An acquisition strategy is one in which a company buys another to take full control of it. It may purchase anywhere from a majority 51% stake to an outright 100% ownership. "Full control" means that the acquirer makes all subsequent decisions, and its board of directors and management survive intact; the acquired companies do not. However, if it is doing well, it may make sense to retain the full management of the acquired company and simply invest in it so that it can grow and do even better. Acquisitions are paid for with cash, a combination of cash and debt and stock, or entirely with stock. In an all-stock acquisition, shares of stock in the acquired company would be exchanged for a negotiated number in the

combined company. In any acquisition the �inal price and method of payment is, of course, negotiated by both boards of directors.

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The principal reason to acquire another company is because it �its with the overall strategy, but other reasons are also common, such as for �inancial gain or appreciation, to prevent a competitor from doing so. Acquisitions are often risky, because the value it was expected to add is seldom realized. In many cases this happens because the acquirer overpaid. Additionally, problems can arise if the cultures of the acquired company and the acquirer clash and key personnel in the acquired company leave (Ackatcherian, 2001).

Figure 1.4: Continuum of strategic alliances

A merger strategy also combines two companies, but the combined entity makes joint decisions and literally merges its operations carefully—some members of the board, senior management, and operational management stay on in the combined company. Often the CEO is from one company and the president from the other. Mergers succeed only when the cultures of the two entities are similar and both parties feel that merging would be in their mutual interest. In common usage the term merger is loosely used to refer to an acquisition, which is a very different arrangement.

Diversi�ication

A diversi�ication strategy signals a move to enter another industry, which could be related to the industry it's in or unrelated. It is often misused when companies call the broadening or extending of their product line "diversi�ication." There are two principal ways to enter another industry or segment. The �irst approach is through internal R&D, as when, for example, a new technology or product has application in another industry. A company that invented a �low meter to measure more accurately gas �low in an automobile was able to implement this strategy when it learned that this same �low meter could, in a much smaller design, be used to measure blood �low in a human being.

The second route to diversi�ication is through acquisition, particularly in an industry in which no one in the company has any experience. The idea is to not only become an instant player in that industry but also minimize the risk by having managers and employees already experienced in that industry. The strategy works particularly well when a growth industry is targeted and all the company needs to grow and succeed is capital. Mattel, Inc., the toy company, sought to diversify into the electronic segment of

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children's games and acquired The Learning Company for $3.6 billion, badly overpaying for it (Mattel, Inc., 2000).

Retrenchment and Divestiture

A retrenchment strategy is a conscious decision to become smaller. This could be a response to a declining industry or declining level of funding such as some defense companies had to do when military budgets were slashed. In other situations a company will divest itself of some assets by selling off a division or closing poorly performing stores. When revenues suddenly decline, companies have to trim expenses and payroll accordingly to �it their new reality. Selling off a division or major assets is also called a divestiture strategy.

Continuing the Mattel story, after paying too much for The Learning Company, it ran into �inancial trouble. Instead of increasing pro�its by $50 million the next year, it subsequently incurred $300 million in losses and resulted in $7 billion lopped off the company's valuation—a 61% plunge in its stock price, costing CEO Jill Barad her job. The new CEO immediately divested The Learning Company for a fraction of its purchase price (many said "given away") in October 2000 (Mattel, Inc., 2000).

Being acquired, or selling the company, is a special case of a divestiture strategy where the whole company is divested, that is, sold to another company or person. It is the opposite of an acquisition strategy. Are there circumstances when any company would actually want to do this? The answer is Yes. Selling a company represents a change in ownership, but in most cases the company continues to exist. In some cases, however, it does get "folded into" the acquiring company and for all intents and purposes disappears. The reasons for selling a company may include an owner wanting to cash out and retire or receiving an offer that is simply too good to pass up. Alternatively, a company might be doing so poorly that the only strategy left is to sell it–but this should be a last resort, as it would get only cents on the dollar in this scenario.

Discussion Questions

1. What are the risks of forming a strategic alliance with a foreign company? Consider things like selling through a distributor based in a particular country, outsourcing to a factory in a particular country, a cross-distribution alliance, and so forth.

2. What strategies might you consider using against established competitors with low costs and signi�icant market share? Which of these might be best and why?

3. Imagine a �irm 100% owned by a family whose wealth derives entirely from the �irm's operations. The family has so far refused requests to go public or sell any equity position to outside investors. Would such a �irm be likely to continue its current successful ways, pursue a related-diversi�ication strategy, or pursue an unrelated-diversi�ication strategy?

4. In 1984, General Motors (GM) and Toyota created and operated a joint venture (JV) in California called NUMMI—New United Motor Manufacturing, Inc.—to produce vehicles that would be sold by both companies. In June 2009 GM withdrew from the venture, and in March 2010, Toyota transferred the remaining production to its other plants. In forming the JV, GM was interested in learning how to manufacture high-quality small cars from

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Toyota, and Toyota was interested in gaining access to GM's U.S. distribution network and in reducing the political liability associated with local content laws. Which of the two �irms, in your opinion, might have derived most bene�it from the JV while it lasted? Why?

5. Strategic alliances are often thought of as a way of getting help to compete instead of going it alone. In what ways might one be better than the other?

6. A recent newspaper article about Apple, Inc., said, in part: "The company . . . is increasingly evolving from a computer maker into a multi-product international powerhouse and a major force in the entertainment and publishing industries" (Puzzanghera & Sarno, 2011). How do you think it could have transformed itself in such a short time? In other words, what strategies do you think it used—either simultaneously or not—in the process?

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In some companies, only the CEO does strategic planning. Others use a selected top- management team to implement the plan to lower management.

Flirt/Superstock

1.7 The Strategic-Planning Process and Strategic Decision Making

First and foremost, strategic planning is a process. A company collectively tries to agree on where it is going (its vision) and how it's going to get there (its strategy). Those are the two principal purposes of strategic planning. Other valid purposes include achieving "success" as the company de�ines it, such as increasing its shareholder value, market share, or long-term pro�itability. Yet another purpose could be to develop a core competence and sustainable competitive advantage. Consequently, identifying the purpose or purposes to be achieved is an integral part of the process. How and whether those purposes are achieved in reality is the job of the strategy (and management in implementing it). So choosing the right strategy is crucial. This is another answer to the question, "Why have a strategy?" It also answers the question, "Why engage in strategic planning?"

Participants in Strategic Planning

A critical dimension of strategic planning is who gets to participate in the process. In a few companies, only the CEO participates with the mindset that whatever he or she says goes. In others, the top-management team participates, which is better, and then relays what has been decided to lower management levels and employees in general. In still others, the participants include those who will help implement the plan, that is, middle managers and key other people in addition to top management. This last inclusive approach is the best. Section 8.6 outlines a suggested strategic-planning process and elaborates on the importance of involving the right people in the process.

Because the outcomes of strategic planning are so dependent on who participates, the particular process used, and the information on which decisions are based, it is clear that doing strategic planning remains very much an art. It is a highly creative yet disciplined process that draws on the individuals' and group's intuition, experience, know-how, and powers of persuasion.

While the strategic-planning process is relatively straightforward, actually doing it is much more dif�icult for a number of reasons. People seldom agree on where the company stands right now and how it is performing, whether because they have a limited perspective, don't have access to the same data, or have personal or hidden agendas. Sometimes politics gets in the way of candor and truth. The information that the company and its people possess, for example on customers and competitors, may be incomplete, dated, inaccurate, or irrelevant, while the information they most need is often unavailable. Lastly, the

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planning horizon is typically three to �ive years in the future, a future that is unknown, ambiguous, and changing before our very eyes.

Strategic Decisions

Besides deciding on a vision and the best strategy for achieving it, strategic planning is often used to make other strategic decisions. Strategic decisions differ from operational or tactical decisions primarily in that their complexity and consequences are more consequential for the organization. For this reason strategic decisions tend to get made only after appreciable analysis, discussion, and debate, and typically involve a number of people in the decision. Examples of strategic decisions include selecting a strategy, deciding which company to acquire or merge with, choosing which technology to adopt, deciding whether to form a strategic alliance and with whom, to franchise rather than expand with owned facilities, which new CEO to hire, whether to sell the business, whether to enter another industry or segment.

Operational decisions are not made during the strategic-planning process, but subsequent to it. The reason is that operational decisions and plans �low from the strategic decisions made, and so the latter must precede the former. Operational decisions are made when doing operational planning (discussed in Chapter 7) and involve deciding what has to be done (programs, activities, tasks, projects), who will do it, who is accountable, what amount of budget is allocated, and a deadline for completing it. Examples of operational decisions include upgrading the accounting system, installing a new production process, changing an advertising campaign, offering discounts or other promotional incentives, lobbying for tariffs, hiring anyone other than the CEO, reducing costs, �inancing a particular initiative, investing surplus cash, and so on.

Discussion Questions

1. Some corporations, like manufacturers of aircraft and nuclear plants, have to look 20–30 years into the future when making decisions. How might strategic planning be different for them with such long planning horizons? What other information or analysis might they require to help them make more robust decisions?

2. We know that operational decisions �low from strategic decisions, and must be made subsequently. Are they less important? Why or why not?

3. Managers who are used to making and following operational and tactical decisions are often promoted to VP or C-level executive positions. Explain what dif�iculties they might encounter as they transition from making operational decisions to making strategic ones.

4. The CEO of a small company has been making all the decisions for the past 20 years, and the company is doing well. What can you say about the manager's decision making? On the face of it, one might conclude that no strategic planning is taking place. Would you agree?

5. Why is hiring a CEO a strategic decision but hiring anyone else isn't? Hiring what other position might be strategic and under what conditions?

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Reed Hastings got tired of video rental late fees and established Net�lix. With this new business model, customers would receive their movies in the mail and there would never be a late fee.

Associated Press/Paul Sakuma

1.8 About Business Models

Business models are different from strategies, but in some people's eyes the distinction is �ine. Earlier, we de�ined strategy as "how a company actually competes." A business model describes the way in which a �irm does what it does to deliver customer value (Abraham, 2006, pp. 10–11). For example, a hospital's strategy would be concentration (both market and product development) and possibly acquisition. Its business model should answer some basic questions:

How to get people to come to the hospital for services? Will it attract patients by delivering high quality services, offering low prices to insurance companies, training courteous staff, promoting wellness, etc.? How to make money? Will it control costs by streamlining processes and removing wasteful steps, seeking volume discounts from suppliers, selling more wellness products, etc.? How to grow? Will it produce growth by expanding services that can be ef�iciently served by existing facilities, acquiring physician practices, etc.?

Three well-known instances of companies transforming an industry by successfully using a different business model are Dell, Inc., Progressive Insurance, and Net�lix. These examples will illustrate why business models are important and how they can be so easily confused with strategy.

Prior to Dell's 1985 debut, businesses buying computers for their employees relied on a system in which they purchased a large number of identical computers at a generous discount. Dell provided a fresh option to corporations, in which employees could personalize their computer orders at the same low price point. Because employees such as engineers, accountants, and sales staff all used computers in different ways, this provided the option to purchase a computer based on speci�ic features and functionality. Dell pioneered this "con�igure to order" style of manufacturing by using a JIT assembly process, in which standard components are used to create custom products. In the �irst year alone, Dell made more than $73 million. The JIT process minimized its inventory costs, another critical part of its business model in an industry

where components depreciate very rapidly (Fortune 500, n.d.). Although Dell did not radically change the way that computers are produced, the way it sold computers—its business model—was vastly different from industry competitors.

During the 1980s the state of California required rollbacks in auto-insurance premiums and the process of utilizing auto -insurance was complicated and tedious. A company called Progressive Insurance created a new policy in the 1990s to make the process more bene�icial to its customers. Instead of taking weeks to

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McDonalds is leading the pack in innovation execution. It's all about the ability to personalize its products in the global marketplace. The company keeps its brand individual while local markets are given latitude to appeal to their speci�ic customers.

McDonalds: Decentralization of Business Model

process insurance claims, Progressive began settling them immediately, often before competitors were even aware there had been an accident. In quoting rates to customers, it quoted competitors' rates as well, even if they were lower. Also, it based its rates more on where and when a car was driven rather than on age, a driver's record, and other established criteria. The result was that it grew six times faster than the industry and achieved a net pro�it margin of 8% compared to the underwriting losses experienced by its competitors at the time (Abraham & Knight, 2001). Although Progressive Insurance, like its competitors, provided auto insurance for drivers, the way it did it—its business model—was radically different.

For years, Blockbuster dominated the video rental industry, possessing over 9,000 stores in 2002 (over 5,000 in the United States) and boasting $6.1 billion in sales (Blockbuster Inc., 2005). No true competition existed. Reed Hastings was a Blockbuster customer who had formerly been successful in selling his own software company for $750 million. After becoming frustrated with the late fees Blockbuster charged, Hastings decided to start his own company: Net�lix. He envisioned renting movies using proprietary Cinematch software, whereby customers could save money by renting online, avoid late fees, and receive access to reviews and recommendations—all services that Blockbuster did not offer.

Customers could go to the Net�lix website, choose from several subscription plans, and have access to its library of movies, which he kept expanding every month by making deals with producers. Net�lix's business model also included a mail service, whereby each DVD sent to the customer included a built-in return envelope. Using a large set of distribution centers, movies were delivered quickly, often by the "next business day." By 2003, the popular company soon had over 3 million subscribers. Today, customers now have the option of streaming movies directly to their computer or TV.

McDonalds: Decentralization of Business Model From Title: The Execution Plan (https://fod.infobase.com/PortalPlaylists.aspx?

wID=100753&xtid=39954)

https://fod.infobase.com/PortalPlaylists.aspx?wID=100753&xtid=39954

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As with Dell and Progressive Insurance, even though Net�lix was ultimately providing the same service— movie rentals—as its competitors, it did so using a brand new business model. Despite Blockbuster's eventual efforts to copy Net�lix, it was unable to do so and ultimately �iled for bankruptcy in September 2010. In April 2011, it was auctioned to Dish Network for $320 million (Fritz, 2011).

Discussion Questions

1. What is the business model for a typical university? And for the university you are currently taking this course from? Does such a business model have anything to do with strategy?

2. If you are currently working for a company—even a branch or division of it—try to articulate its business model. If you found this exercise dif�icult to do, why do you think it was dif�icult?

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Stakeholders are groups or individuals who can effect and be affected by the organization's performance. Shareholders are the largest of these groups.

Jürgen Schwarz/Getty images

1.9 Importance of Stakeholders

Stakeholders are "the individuals and groups who can affect, and are affected by, the strategic outcomes achieved by and who have enforceable claims on a �irm's performance" (Hitt, Ireland, & Hoskisson, 2007, p. 21)—stated somewhat more simply, those to whom a company owes any duty or obligation. Several groups of people or companies can be de�ined as stakeholders, including investors in the corporation, creditors, employees, customers, host communities, and even the environment. While the role of each body may differ in its involvement, each is nonetheless a participant and/or has a stake in the company and its welfare.

Investors

Investors in the corporation, called stockholders or shareholders, are the stakeholders that �irst come to most people's minds. Investors have taken a risk by investing in the company and expect to be appropriately rewarded. Rewards come in two forms: stock appreciation and dividends. It is conventional wisdom that unless companies provide such returns, investors will withdraw their money and invest elsewhere; that is, they will sell their stock in the company and �ind a more lucrative investment. Investors in privately held companies are not called stockholders or shareholders, but simply investors. In too many cases, however, top managements endeavor to keep the stock price high, not so much to reward the �irm's investors but rather to line their own pockets, as a large portion of their compensation comes in the form of stock.

Creditors

Creditors are another form of stakeholder. These are banks, other �inancial institutions, or individuals that loan the company money. If the company does not repay its loans as agreed, it may �ind it dif�icult to continue getting new loans when it needs capital and could damage its credit rating, thus raising the interest rate on future loans. Creditors also include anyone to whom the company owes money, for example, a supplier that has sold goods to the company for which payment has not yet been made or employee wages that have not been paid.

Employees

As they are the ones providing the good or service, it goes without saying that employees are also one of the �irm's most vital stakeholders. If the business fails, investors lose just their investment and banks just

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their loans, but employees lose their jobs and put their families in jeopardy. Companies vary greatly in how they treat their employees. At one end of the spectrum, employees are highly valued and sometimes are co-owners of the company. Ocean Spray Cranberries and, at one time, United Airlines include employees in the ownership structure. Companies invest in them, train them, and provide long-term bene�its. At the other end of the continuum, employees are treated as commodities or objects, hired and let go at will, even being replaced by part-timers to "save" the cost of having real employees. In Mexican maquiladoras, duty-free zones along the U.S.-Mexico border are low-cost-labor-manufacturing plants owned by U.S. and Japanese companies. For every employee hired, another 10–20 wait to take their place. The incentive to give them opportunity, career paths, and even stock in the company is zero. Likewise in China, some workers are forced to work in almost inhumane conditions around the clock until they burn out. This is not considered a problem because, again, many others are ready to take their place. Cultures differ on this, but valuing the employee stakeholder can have its own rewards.

Many companies believe, however, that they owe no duty to employees other than simply employing them. With this attitude, employees are considered a "cost" and neither a resource nor stakeholder. Companies feel proud to outsource a lot of their operations for "cost-effective reasons," laying off employees without a second thought. They also try to automate their processes, particularly expanding the use of information technology (IT) and justify the cost-effectiveness of the changes by laying off workers. A company that valued employee stakeholders might be more likely to use IT to free up workers to do other valuable work for the company.

Customers

Customers are another body with a stake in the company, but are they really stakeholders? In truth, every company makes promises to its customers, either explicit or implicit, that when they buy a product or service, it will perform as advertised, will not harm them, and will not break down in the �irst few days or months. Companies that consider customers as stakeholders want them to believe that any product it sells will keep or exceed its promises. Such companies have strong brand reputations. Other companies' products break down often or harm buyers and eventually cause customers to buy elsewhere; for such companies, customers are not stakeholders, but rather nothing more than a source of revenues.

Other Stakeholders

Host communities, which are towns or cities where a company is based, are considered to have a stake in the company as well. While some companies feel the most they owe to a host community is to provide employment, other companies take a more active role in the community. Providing employment does indeed support many other businesses and services in the town, and many towns in turn exist because of a single large employer. Company towns, although at �irst owned by their only employer, sometimes became regular public cities and towns as they grew. Sometimes, a single corporation employs most of a town's inhabitants, resulting in a physical and economic setting much like a company town. Usually, company towns are detached from neighbors and centered around a manufacturing setting such as lumber or steel mills or an automobile plant. Locals will typically work for the company or be related to

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those who do. When a company is unsuccessful or fails, the �inancial toll on the town can be disastrous (Green, 2010). Beyond providing employment, a more active company might contribute works of art for public display and sponsor many community and educational activities. Is this corporate social responsibility or valuing a host community as a stakeholder? It doesn't matter. What matters is that the environment in which employees live is valued as much as the employees themselves. Generally speaking, a happy employee is more inclined to be productive at work and loyal to the company.

But things can turn ugly when a large corporation decides, for economic or competitive reasons, to close a factory in a small town where it is the largest or even its only employer. Clearly, cost savings and pro�its dominate the decision. What happens to the employees that lose their job and the other myriad small businesses that depend on them are rarely factored into the decision. These companies clearly do not consider the host community a stakeholder.

Lastly, but important nonetheless, is the role of the environment as a stakeholder in a company. What duty do companies owe the environment? In the past, the answer to that question would be, None. For years, companies' factories would belch forth smoke and soot or dump contaminants into running streams and rivers just because they could. In Mexico, pollution from maquiladoras continues unabated, and exhaust from cars make Mexico City the most polluted city in the world (Energy Information Agency, n.d.). This is what economists call "externalizing the costs of doing business."

In the past, some workers were forced to work in hazardous environments without adequate protection, breathing in dangerous fumes for hours and days on end, and contracting all manner of illnesses. If not for regulations that protect the general and workplace environments, such practices would continue. Regulations are another way of saying, "Treat the environment as a stakeholder"; the public interest and the future of our planet is worth protecting and trumps the private interests of one company. To comply with regulations, companies have to build air–treatment systems that release only pure air into the environment, dispose of toxic byproducts of production in approved ways instead of dumping them into the nearby river or sewer, and give employees protective masks to �ilter unhealthy fumes. These increase a company's cost of doing business and may even make it uncompetitive with foreign companies whose behavior is unregulated; but in this country, it's the law.

Recently, in an effort to slow climate change, companies are being required to "reduce their carbon footprint," that is, to minimize or cease emission of greenhouse gases (carbon dioxide equivalent) into the atmosphere. Although there is no law as yet in the area of being eco-friendly, many companies are "going green" not only because they believe in not wasting or degrading precious resources but also because it has become a value embraced by their employees and even their customers. Thus, in many ways, the environment, thought of on many different levels, is becoming an important stakeholder.

Discussion Questions

1. Who are the stakeholders in your life? Which of them are important, and which have you never thought about until now?

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2. Who are the stakeholders in a politician's life? Do you believe that the most important stakeholder—the voter—is often ignored? Why might this be so? Which stakeholders are given most attention? Why?

3. Investment brokers, by their very nature, invest their clients' money where they believe returns will be greatest given the risk involved. Who are their stakeholders? Is it just the clients they serve? If not, are all of them equally served? If not, why not?

4. Health-insurance companies have come under �ire recently for raising premiums of their subscribers by substantial amounts. They are accused, especially by those whose premiums have been raised, of catering to only themselves and their stockholders. Do they serve other stakeholders? If so, why aren't they perceived as serving other stakeholders?

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Summary

Strategic management is a complex process that is fundamental to a company's ongoing and future success. It includes both strategic formulation (planning) and implementation. Successful companies use feedback from their planning and operations to improve the decisions they make the next time around.

Strategic planning is the way of deciding what strategy the company should pursue in order to be more successful in the future. Some companies, especially small companies or those run by a founder or autocratic CEO, typically don't do strategic planning. In a changing world, making decisions without good data, analysis, and the inputs of those who will have to implement the strategy is foolhardy. Strategic planning is a structured and proven process for choosing the best strategy for a company to follow and making good strategic decisions. Without competitors, a company wouldn't need a strategy.

Competition is a capitalist society's way for consumers to tell producers what they need and want to buy. A company and its competitors comprise an industry and serve markets comprised of groups of customers. Markets are often confused with industries yet are very different: the former buy products and services while the latter produce them.

Companies compete in many ways—on price, through differentiating by making it easier for customers to buy, or through partnering with other companies. Competition has now become global; many foreign companies have the advantage of very low manufacturing costs and are increasingly taking over the manufacturing function of domestic companies.

Strategic thinking is a fundamental driver of good strategic planning and decision making. Strategic thinking involves having as accurate a perception as possible of a company's external environment. The extraordinary pace of change is making the job of strategic thinking more dif�icult and urgent. Doing strategic planning without strategic thinking leads to poor strategies and strategic decisions.

The outputs of strategic thinking, coupled with a candid assessment of the company itself and the resources at its disposal, form the basis for arriving at strategic issues—the most pressing issues facing the company at that time—and what strategic alternatives (or alternative futures) the company should consider before deciding on the strategies it should pursue over the next three or so years. It's the logical framework of a strategic analysis and of strategic planning for determining the best strategy a company should pursue.

The strategies that companies follow to compete effectively include concentration, innovation, differentiation, low–cost leadership, focus or specialization, �inding a "blue ocean," acquiring or merging with another company, forming strategic alliances, diversifying into another industry or segment, retrenchment, and divesting.

Although similar on the surface, strategies differ from business models; a strategy is how a company actually competes, whereas a business model states how a company attracts customers, how it expects to

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make money, and how it will grow and includes its strategy.

"Success" means doing well on a set of performance–related measures and is different for every company. Success criteria include revenues, NIAT, pro�it ratios, shareholder value, market share, developing a competitive advantage, brand value and, for some companies going through hard times, their very survival.

A corporation owes some measure of duty to its stakeholders. These include stockholders and investors, creditors, employees, customers, host communities, and the environment. Ideally, a corporation should ful�ill its duty to all its stakeholders; in practice this is rarely the case. Employees, customers, host communities, and the environment are the stakeholders most likely to have their interests ignored.

Concept Check

Key Terms

acquisition strategy Involves buying another company to take full control of it (anywhere from a majority 51% stake to an outright 100% ownership).

applied research Takes something already discovered and patented and �inds ways of commercializing it (part of the "R" in R&D).

basic research Focuses on discovering new things and processes unimagined before and is very costly with uncertain outcomes (part of the "R" in R&D).

being acquired strategy A special case of a divestiture strategy where the whole company is divested (i.e., sold to another company or person). It is the opposite of an acquisition strategy.

blue ocean An unserved market. The name stems from an analogy where a "red ocean" represents a bloody shark–feeding frenzy all going after some prey (too much competition), whereas a "blue ocean" is free of any predators except you—no competition, no blood.

blue–ocean strategy A strategy that involves �inding a market space that is not served at all, where the company is the only provider of a product or service and has no competitors; such a market space is called a blue ocean.

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book value The value of a company asset shown on its balance sheet (which might have been depreciated or amortized); this may differ from what the same asset might fetch if sold on the open market (market value).

brand Represents a unique set of promises that a company warrants to its customers and that customers in turn expect from a company. Carefully crafted, a brand is used to position a company in the consumer's mind (safety, taste, performance, power, reliability, etc.). A strong brand is an indication of a successful differentiation strategy.

brand equity Refers to the power of a brand to in�luence purchases and loyalty. It can increase, remain the same, or decline over time. The main reasons for its erosion are competitors duplicating the quality of a brand so that it is no longer unique or a company failing to perform in ways that the brand promises.

business model Describes the way in which a company does what it does to deliver customer value. It should describe how it gets customers, how it will make money, and how it will grow.

concentration strategy Involves some combination of producing an existing, improved, or new product or service for an existing, expanded, or new market. Includes an innovation strategy and a technology strategy (both geared toward new–product development).

conglomerate–diversi�ication strategy Producing a brand new product or service for a brand new market. A seldom–used form of a concentration strategy.

core competence A capability that gives a company a strategic or competitive advantage over its competitors.

differentiation Developing a product that is unique from or superior to the product offered by the competition, and, as a consequence, having a strong and distinctive brand, which enables companies to charge more for their products because, in the consumer's mind, they are offering something no one else is offering (one of Michael Porter's three generic strategies).

differentiation strategy The development of a product that is unique from or superior to the product offered by the competition.

diversi�ication strategy A strategy to enter another industry or segment, which could be related or unrelated to a company's current industry. Companies can do this through internal R&D or through acquisition of a company already in the new industry.

divestiture strategy A strategy to sell off a division or major assets of the �irm.

focus strategy Targets a very small market (often called a niche market) and, in so doing, avoids competing with large competitors that are not interested in serving such a small market.

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free market A market in which the state does not regulate or interfere with the economy, apart from overseeing property ownership and private contracts.

generic strategies First introduced by Michael Porter in the early 1980s as ways for a company to achieve a competitive advantage and above–industry–average pro�its. They are differentiation, low–cost leadership, and focus or niche strategies.

globalization Describes the process by which regional economies, societies, and cultures have become integrated through communication, transportation, and trade. It is typically identi�ied as being propelled by a combination of economic, technological, sociocultural, political, and biological factors. The term can also refer to the transmission of ideas, languages, or popular culture across national boundaries. Any facet of life that has undergone this process can be considered to be globalized.

hypercompetitive industries Industries in which technological changes are occurring so rapidly that changes in market share are �leeting and temporary.

innovation strategy A product–development strategy that requires research and development (R&D) and focuses on introducing technologically advanced products or processes.

industry A collection of �irms that provides similar products or services to the same customers.

internal analysis Knowing, analyzing, and understanding everything about the company itself, especially what makes it a strong competitor.

joint venture (JV) Requires the formation of a new corporate entity (referred to in the literature as a "child") jointly owned by two companies (referred to as "the parents"). It is a kind of strategic alliance that enables the two parents to accomplish more than just having an agreement between them.

key strategic issues A synthesis of both the external and internal analyses that focuses the company's attention on the most important issues it faces.

low–cost leadership A strategy that gives a company the lowest costs in its industry. One of Porter's three generic strategies.

maquiladoras Duty–free zones in large cities along the U.S.–Mexico border that contain low-cost-labor- manufacturing plants owned mostly by U.S. and Japanese companies.

market The collective name given to the buyers of the products or services produced by an industry.

market–development strategies Penetrating an existing market, expanding into related markets, or �inding new markets. Part of a concentration strategy.

market share A �irm's annual sales as a percentage of the annual sales of its industry or segment (really "industry share" but universally known as "market share").

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market value The value that any company asset might fetch if sold on the open market; this value may differ from that carried on the company's books (book value).

mental model What we know or think we know about something, which can be modi�ied or updated as we come to learn more about it over time. Everyone has a mental model about everything but may not realize it.

merger strategy This strategy combines two companies, but through making joint decisions. Mergers succeed only when the cultures of the two entities are similar and both parties feel that merging would be in their mutual interest. A merger strategy is often used synonymously with an acquisition strategy, which is very different.

mixed economy A free market but where substantial state intervention (regulation) exists to protect the public interest.

model A way of codifying a complex activity in a way that is at once easy to explain, understand, and learn —and gives someone a "road map" as to how everything �its together.

monopoly When a particular �irm is the only company in an industry and can charge any outcomes price it likes, since customers cannot get the product from anyone else.

net pro�it after taxes (NIAT) On the income statement, the amount that is left after all allowable expenses (including depreciation and amortization, which are accounting artifacts and not real expenses) have been deducted (often also referred to as "the bottom line"). Income statements are typically produced quarterly or annually.

net pro�it margin (NPM) A �inancial ratio calculated by dividing NIAT by revenues.

niche market A small subset of a larger market that has particular needs and which large competitors avoid because it is too small to be worth their time to serve.

operational decisions Made when doing operational planning and involve deciding what has to be done (programs, activities, tasks, projects), who will do it, who is accountable, what amount of budget is allocated, and a deadline for completing it.

product–development strategy Continuing to produce existing products or services, improving them over time, or introducing new products, all for the same market. Part of a concentration strategy.

retrenchment strategy A strategy re�lecting a conscious decision to become a smaller competitor in the industry.

return on equity (ROE) A �inancial ratio calculated by dividing NIAT by total stockholders' equity.

shareholder value A computed value based on a company's projected cash �lows for the next 10 years, discounted to the present time using discounted–cash–�low (DCF) analysis and an appropriate discount

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rate, and subtracting from the result all current debt.

stakeholders Individuals and groups that can impact a company's strategic outcomes and who have a vested interest in and power over a company's performance. Or groups of people to whom a company owes some form of duty, including investors, creditors, employees, customers, host communities, and the environment (the public interest and the future of the planet).

strategic alliance Two �irms partnering for their mutual bene�it but retaining their distinct corporate identity. Strategic alliances vary in their level of integration and commitment, ranging from simple contracts to joint ventures and owning minority stakes in other companies.

strategic alternatives Bona �ide strategic options (more like alternative futures) from which a company can choose the best one. They consist of strategies, strategic intent, programs, and how they might be �inanced.

strategic decisions These differ from operational or tactical decisions primarily in their complexity and consequences, which are more substantial for the organization.

strategic management Steering and managing a company to be successful over time—not just for one year, but also year after year. Strategic management involves both strategy formulation and strategy implementation.

strategic-management model A reproducible series of activities that if followed would enable a company to formulate and implement strategies (i.e., do strategic management). The one used in this book is shown in Figure 1.1.

strategic planning The process by which a company develops a strategy to achieve certain purposes (what it considers "success").

strategic thinking A continual activity that seeks to �ind a better strategy and business model, including a market space that is not currently served and has no competitors (blue ocean). This cannot be done without knowing and understanding what is changing in a company's external environment and what the future might hold.

strategy How a company actually competes.

strategy formulation Otherwise known as strategic planningand a complex process in its own right, involves (1) strategic thinking(which includes external analysis), (2) internal analysis, (3) determining key strategic issues, (4) developing viable strategic alternatives, and (5) choosing the best strategy using as criteria whatever the company de�ines as "success."

strategy implementation Involves executing the strategies successfully and enabling the company to achieve its vision and meet its objectives.

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supply chain Includes all companies from whom the �irm buys parts or materials in order to make or assemble their product and the companies that supply those companies, and so on back to the raw material. Includes only the part of the value chain "upstream" of the company (toward the raw materials).

technology Both the abstract and concrete tools—such as knowledge, skills, and artifacts—that can be used to create, produce, and deliver products.

technology strategy Focuses on developing new, or improving existing, technologies.

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Chapter 2

Leadership, Governance, Values, and Culture

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Learning Objectives

By the time you have completed this chapter, you should be able to do the following:

Understand the differences and similarities between leaders and managers. Know why strategic success depends on �inding, developing, and evaluating capable leaders. Appreciate the value and necessity of creating a corporate vision. Appreciate the value of having an overarching purpose for any organization. Compare the roles and responsibilities of top management and the board of directors. Appreciate that how a company is organized depends on the strategy it is pursuing. Realize the importance of corporate values and culture and the extent to which they can enable or hinder strategy implementation.

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Understand that organizational change is inevitable and desirable if a corporation wants to improve its competitiveness and performance.

This chapter will focus on the roles of power, leadership, organizational culture, and attitudes toward innovation as they relate to strategic planning and management. The importance of leadership, the roles of top management and the board of directors, values and culture, and organizational change all affect the quality of strategic planning and are in turn affected by it.

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All types of executives have the power to coerce others into doing what they want. True leaders often use in�luence rather than authority to get people to do what they want them to do.

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2.1 Strategic Leadership and Developing a Vision

In articles in the business press and the literature, the words manager, leader, executive, and administrator are often used interchangeably. Consider, however, the implied judgments in the descriptions of a person as "a real leader" versus "just a manager," and it becomes evident that the terms are different. Ackoff and Pourdehnad (2009) try to capture the differences as follows:

An administrator is one who manages others in the attempt to accomplish a goal by the use of certain methods, both of which are speci�ied by a third party. A manager is one who oversees others in the attempt to accomplish a goal by the use of certain methods speci�ied by the manager. A leader is one who conducts and directs others in the voluntary attempt to accomplish a goal by the use of certain methods, both of which are chosen or approved of by the leader's followers.

Although all types of executives have the authority to coerce others into doing what they want done, leaders more often use in�luence rather than authority to get others to do what they want them to do and rely more extensively on interpersonal communication and the strength of their relationships with others to effect change.

From this, one might assume that the only person who creates a vision is the individual at the apex of an organization, such as CEO of the company or the president of a country. This is certainly not the case. At any level and in any sphere of life, anyone who can visualize a better state of affairs and can persuade others that such a vision makes sense has demonstrated leadership qualities. Anyone who has suggestions for change and improvement demonstrates leadership qualities to the extent that they are able to persuade others involved of the merits and bene�its of such changes. By contrast, managers charged with just implementing change and achieving a set of performance objectives don't need to be leaders even though what they do is nonetheless critical to a company's success.

Earlier, we used the phrase strategic leadership, but what makes leadership "strategic"? Recall from Chapter 1 that a strategy is required only to combat competition. In the same way, "strategic leadership" involves developing an outlook and strategy that will position the company to become a stronger competitor, in both the short term and the long term. Whereas leadership may be required in implementing changes or improvements to parts of the organization, strategic leadership determines the long-run survival and success of the entire company.

Power in an Organization

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Leaders often use communication to exact a range of pro-social in�luence tactics to gain others' compliance. Leaders have the power to in�luence or affect the people around or under them. This is true regardless of whether they have been appointed to leadership positions. There are �ive types of power in an organization.

Legitimate power is the authority obtained through the occupation of a position in the company. The higher the position an individual occupies, the more authority and legitimate power he or she holds. Expert power is based on the unique experience, competence, and expertise possessed by a leader. For example, a group surviving a crash on a mountainside would willingly follow the member with survival knowledge and skills. Referent power is derived from the appreciation, high regard, and loyalty of a leader's followers and is a direct result of the leader's character. Leaders who have the ability to give or withhold meaningful incentives hold reward power. These can take the form of tangible rewards such as pay raises, bonuses, or preferred job assignments or intangible rewards like verbal praise or respect. A leader or manager to who is in a position to punish a subordinate is said to have coercive power. This could take the form of �iring someone, denying a raise or bonus, or reassigning the person to an undesirable location (Jones & George, 2007).

Mission and Vision Statements

Companies—indeed any kind of organization—need mission and vision statements. Like many terms in the business lexicon, these too are misunderstood and often misused.

Mission Statements

A mission statement is a concise statement of a company's reason for being, what it actually does, and for whom. It should contain what products and services the company produces for which target market, as well as how it considers itself different or unique. It should not contain statements of values, strategies, or objectives (although many companies make this error), but could contain the company's customer value proposition.

A mission statement answers the questions, "What do you do?" and "What is your raison d'être (reason for being)?" For many companies, the answer doesn't change over many years, while for others in fast-moving industries when the strategies themselves are changing, it does. Periodically, therefore, a company needs to check that its mission statement is still valid. The ideal time to do this is at the end of the annual strategic-planning process.

When crafting a mission statement, care should be taken in how broadly or narrowly the company might be characterized. For example, a business could conceive of itself as a real-estate company or as a residential real-estate company, the latter precluding any work or involvement in commercial or industrial real estate. It could be an apparel store or a casual-apparel or sporting-apparel store, the former being broader and the latter ones more restrictive in the kind of apparel sold.

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If in the course of conducting the strategic analysis, a company was to decide to go national from being a regional retailer and if the existing mission statement characterized it as being regional in scope, then clearly the mission statement would need to be modi�ied and aligned with the new reality. It is for this reason that attention to both the mission and vision statements is paid at the end of the strategic-planning process.

The following two examples illustrate poor mission statements:

"Pro�itably expand through a commitment to customer service, superior quality, and creative solutions."

You would never guess that this is the mission statement for a company that manufactures and distributes agricultural equipment. Missing from the mission statement is what the company does, for whom, its geographic scope, and so on.

"Be considered the best by customers, employees, and stakeholders."

This mission belongs to a producer of car parts. The mission statement is troubling because it is very generic. Many, if not most, companies strive to be the best; thus, the mission does not differentiate the company from other �irms.

The following is an example of a good mission statement, taken from an insurance company:

"Our mission is to equip individuals and organizations to manage �inancial risk. We provide products and services that are designed to speci�ically target the ever-changing risk exposures our clients face. We increase value for our stakeholders through superior customer service and consistent operating results."

Vision Statements

Does a strategic leader simply conjure up in isolation a vision for the company? Do effective leaders rely on others in the organization to support the development of a realistic vision? Let's examine the nature of vision statements and the strategies organizations utilize to create them. A vision statement is a concise expression of where the organization would like to see itself in the next 5 or 10 years. What makes an effective vision statement rather than one that just sounds good? In order to know whether the vision has been achieved, it makes sense to use some quantitative measure in the statement. For example, it could include "become a billion-dollar company by 2017," or "be doing business in 25 countries by 2017." It is imperative that the strategy and vision must be completely aligned, which is why an organization should review and, if necessary, revise the vision statement after deciding on the strategy and strategic direction in case the latter has been changed. Ideally, the vision statement should be concise, inspiring, memorable, and achievable—a tall order, but not impossible.

Leaders who are visionary can, through collaborating with other top managers and their board of directors, craft a good vision statement that embodies their vision and makes sense to all of the company's

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stakeholders. Getting everyone's agreement takes time; however, it is as a result of such collaboration that the vision becomes truly shared and owned by everyone.

Discussion Questions

1. Imagine a leader that is visionary but has no followers—is the person still a leader? How are followers recruited?

2. Consider the following leaders. For each one, state the source or sources of their power, and explain the reasons for your choice:

Mahatma Gandhi John F. Kennedy Queen Elizabeth of England Bill Gates, Chairman of Microsoft The professor of your strategic-management course

3. Are most CEOs and presidents today "strategic" leaders? Why or why not? 4. Why do organizations �ind it dif�icult to develop a good vision statement? 5. Vision statements typically look 5 or 10 years into the future. Name an organization (or an industry) where a vision statement might be developed for 20 or more years, and one where less than a year might make sense.

6. Many companies have vision statements purely for PR purposes—they sound really good. How can you tell the difference between the PR kind and the genuine thing?

7. If a company has a good vision statement, why is a mission statement necessary? 8. Should every employee in the company be able to recite the mission statement? The vision statement? Both? Why?

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Leaders may create change, but managers implement change. Managers adopt the leader's vision as their own.

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2.2 Leaders Versus Managers

Warren Bennis, a pioneer in the contemporary study of leadership, once said, "Managers do things right; leaders do the right thing" (Bennis & Nanus, 1985, front of book jacket). Bennis's words echo a common saying in business that "leaders create change while managers implement change." The way that leaders create change is by creating a vision for the corporation (or indeed, any organization) and then "selling" the bene�its of that vision to the rest of the organization. To the extent that they succeed, they create followers and motivate or in�luence them to put their best efforts to making the vision a reality. The leader's vision then becomes their vision. One test of leadership is whether, in fact, the leader has any

followers. Who, indeed, has the leader succeeded in in�luencing?

Robert Allio has written on the differences between leaders and managers. The key differences he describes are summarized in Table 2.1. He further provides �ive prescriptions for improving the quality of leadership. Allio contends that good leaders must have good character. Integrity is an essential leadership virtue. While there's no single best way to lead, leaders must develop a personal style that balances managing with leading. Leaders win when they commit to collaboration. They cannot go it alone. Adaptability makes longevity possible, so leadership entails adroit adaptation. Lastly, leaders are self- made, and good leadership requires constant practice (Allio, 2009).

Table 2.1: Leaders vs. managers

Leaders Managers

Take the long view Take the short view

Formulate visions Make plans and budgets

Take risks Avoid risks

Explore new territory Maintain existing patterns

Initiate change Stabilize

Transform Transact

Empower Control

Encourage diversity Enforce uniformity

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Invoke passion Invoke rationality

Act morally Act amorally

Source: Robert J. Allio. (2009). Leadership—the �ive big ideas. Strategy & Leadership, 37(2).

Is it dif�icult to be a leader? The list of attributes in Table 2.1 might appear daunting to a junior person in the organization. To someone who seeks out challenges, learns from experience, works well with others, takes the initiative, and in other ways "practices" leadership, it's a natural progression to positions of leadership with ever-increasing responsibility and visibility.

Communication and Effective Leadership

Although personality, business acumen, legitimate power and authority, and expertise may all be factors in leadership ability, communication competence is central to the practice of in�luence and leadership in organizations. Without the ability to relate to others at work through interactions, in�luence and leadership are virtually impossible. A foundation of strong relational and communication skills is critical to the ability to inspire motivation within others and to encourage the pursuit of organizational vision.

Impression Management

Leadership effectiveness and communication satisfaction within organizations rely heavily on perceptions of individuals in formal or informal leadership positions. Thus, strong leaders are able to manage others' perceptions and have a heightened degree of self-awareness. They must be aware of what is appropriate and expected in a given situation, possess the skills to deliver it, and demonstrate the motivation for accomplishing excellence.

Effective Message Content

Good leaders pay a great deal of attention to the content of their messages. They approach their leadership communication as a goal-directed activity, rather than mindlessly. They craft their messages strategically so as to provide others with a clear, concrete sense of their vision. The content of their formal and informal messages should be motivational and inspirational and succeed in convincing others that behaving consistently with the leader's (or organization's) vision is truly in their own best interests. Needless to say, leaders must also have unquestionable ethics and engage in this type of in�luence carefully and thoughtfully.

Strong Message Delivery

Effective message delivery, often referred to as charisma, is central to leadership effectiveness. Numerous research studies point to the importance of message exchanges that foster a sense of "connectedness" among communicators. Although connection can be dif�icult to de�ine, studies have isolated factors such as smiling, appropriate touch and diminished physical distance, making eye contact, removal of physical barriers (for example, sitting on the same side of a table or desk with the other communicator and avoiding the use of lecterns during public presentations or meetings), engaging in some degree of self-

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disclosure, and using animated facial expressions as important to reducing the psychological distance between people.

Communicator Style

Communication researcher Robert Norton identi�ied nine primary communicator styles that nearly 30 years of research have consistently supported. When applied to leadership, they give some insight into the repertoire of communication behaviors available to foster leadership and encourage in�luence. As you read about each, consider the situations in which they would be most appropriate. Remember, although an individual may have a primary communicator style, people can "borrow" habits from each of the styles. The most competent communicators are �lexible and adaptive in their approaches to different situations.

Types of Leaders

An animated leader relies primarily on nonverbal behaviors such as gestures, eye contact, and facial expressions to motivate others. An individual who �its this pro�ile but is not able to draw on behaviors associated with the other styles will lack in�luence in contexts other than face-to- face communication.

An attentive leader relies primarily on listening skills in his/her relationships with others to exert in�luence. Through both verbal (asking questions, paraphrasing, and validating others' positions) and nonverbal (eye contact, head-nodding, and leaning forward) means, attentive communicators illustrate that they value individuals and their ideas. Attentive leaders must be careful to not only listen to others but also actually incorporate their perspectives into organizational strategies and plans to maximize the leader's credibility and impact with others.

Contentious leaders are argumentative and challenging in their communication with others. They may enjoy playing the "devil's advocate" and will often challenge others to prove or support their positions. Although the contentious communicator can be challenging to work with, this style can be used to enable transformation and to encourage others to think "outside the box." Their style and interactions with others focus on asking questions, raising the bar, and being intellectually stimulating.

Similar to the contentious leader is the dominant one. However, instead of questioning and challenging others, dominant leaders take charge of conversations and speak in a strong manner. They tend to communicate more frequently than others in meetings and conversations. This style suits the transactional, authoritative leader, but can be dangerous for leaders operating in more democratic environments.

Dramatic leaders make their points both verbally and nonverbally in "�lowery" and exaggerated ways. They will use narratives and expressive language to convey their positions. They may even rely on poetry or literature and dramatic quotes from others to drive home their point.

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The friendly leader in�luences others through the frequent delivery of positive feedback and praise.

Open communicators express emotion and self-disclose their own experiences (both positive and negative) as a way of inspiring and in�luencing others.

The impression leaving communicator �inds ways to deliver memorable messages that others think about after the conversation is over.

And �inally, relaxed leaders are calm and understated in their approach. They will rarely reveal anxiety or nervousness and react un�lappably under pressure. They exude con�idence and calm.

Summary

Effective leaders understand that impression management, strong message content, and effective delivery are central to their ability to in�luence others. Further, they recognize that there is not one perfect communicator style for a leader. Strong leaders are adept at analyzing people and situations and selecting a message, a delivery style, and a personal style that best �its the circumstances.

Questions for Critical Thinking and Engagement

1. What are some strategies leaders can use for managing others' impressions of them? What are some speci�ic ways you already practice these impression-management strategies in your personal and professional life?

2. Consider each of Norton's communicator styles as they relate to leaders and leadership. Identify at least two situations in which each style would be appropriate, and two situations in which each style would probably be ineffective. Explain.

3. What is the difference between a goal-directed message and a mindless message? Explain your perspective. Why is goal-directed communication more desirable for leaders than mindless communication?

While experience is certainly a valuable contributor in the development of a leader, some key personality traits can typically be found in those in leadership positions at various levels. The �irst of these is vision— the ability to see the "big picture," imagine likely futures, and infuse that vision with passion. Integrity is a requisite trait because it is impossible to in�luence others without gaining their trust. Communication skills, compassion, and charisma are needed to articulate the vision and persuade others to embrace it. Leaders demonstrate strong moral and ethical principles, giving attention to all stakeholders, not some at the expense of others. A commitment to collaboration encourages everyone to work together to achieve a vision. A less obvious trait of leaders is humility. Effective leaders typically give others credit for an organization's success but will accept responsibility for poor results.

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Max de Pree, the longtime chairman and CEO of the Herman Miller of�ice-furniture company, personi�ied the concept of servant leadership. He characterized the art of leadership as "liberating people to do what is required of them in the most effective and humane way possible." This puts the leader as the "servant" of his followers by removing obstacles that prevent them from doing their jobs, thus enabling them to realize their full potential (O'Toole, 1989, xviii–xvix).

The importance of humility also �igures prominently in the concept of Level 5 leadership developed by Jim Collins. His research examined how companies were able to transition from being merely "good" to "great." He concluded that a leader builds "enduring greatness through a paradoxical blend of personal humility and professional will" (Collins, 2001, p. 20). Table 2.2 further elaborates on humility and will as they pertain to leadership. Many CEOs are egocentric, however, and may take every opportunity to be the face of the company and be quoted in the press. Ironically, the companies they lead often don't perform as well as their bluster might indicate. So where might you �ind a Level 5 leader? "Look for situations where extraordinary results exist but where no individual steps forth to claim excess credit. You will likely �ind a potential Level 5 leader at work" (Collins, 2001, p. 37).

Table 2.2: Summary of the two sides of level 5 leadership

Professional Will Personal Humility

Creates superb results, a clear catalyst in the transition from good to great.

Demonstrates a compelling modesty, shunning public adulation; never boastful.

Demonstrates an unwavering resolve to do whatever must be done to produce the best long-term results, no matter how dif�icult.

Acts with quiet, calm determination; relies principally on inspired standards, not inspiring charisma, to motivate.

Sets the standard for building an enduring great company; will settle for nothing less.

Channels ambition into the company, not the self; sets up successors for even greater success in the next generation.

Looks in the mirror, not out the window, to apportion responsibility for poor results, never blaming other people, external factors, or luck.

Looks out the window, not in the mirror, to apportion credit for the success of the company—to other people, external factors, and good luck.

Source: Jim Collins. (2001). Good to great: Why some companies make the leap . . . and others don't. HarperCollins Publishers.

Discussion Questions

1. Managers are often promoted to more senior positions with substantial leadership mandates. What problems might they encounter in their �irst year in the new position?

2. Do you have what it takes to be a Level 5 leader? Why or why not? 3. Recount an experience you may have had that leads you to believe that you have leadership potential.

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4. What do you think a company should do to develop potential leaders when it has no budget for it?

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There are considerable advantages derived from developing leaders internally. Hiring a candidate externally can often come at a higher cost than promoting internally.

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2.3 Developing and Evaluating Leaders

Studies have shown that there are considerable advantages to developing leaders internally instead of hiring from outside (Brant, Dooley, & Iman, 2008). While the talent pool of applicants can be impressive, external hires for leadership positions often fail. By the end of �ive years, two-thirds have failed. By contrast, the leaders of 10 out of 11 "good-to-great" companies studied by Collins in his book of the same name came from inside the company. The companies he examined in comparison turned to outsiders six times as often yet failed to produce sustained great results.

In addition to having a higher risk of failure, recruiting external candidates for leadership positions is more costly. Direct costs include search fees, interview costs, signing bonuses, relocation, and severance packages among others. By contrast, internal-development costs are far lower, comprising training, education, program administration, and relocation costs involved with rotating assignments.

Finally, an organization that practices internal promotion is more likely to retain high-potential talent. Executive retention is positively correlated with formalized succession programs. In companies having an executive turnover rate of 1–5% annually, 84% had formal development programs. At those companies reporting turnover rates of 6–10%, 24% had succession programs. Of businesses experiencing turnover rates of 11–20%, only 11% had succession programs.

Developing the next generation of leaders is one of the most dif�icult challenges for a company. Companies committed to promoting from within can take certain measures to increase the prospects of success (Allio, 2009). First, they must have a good talent pool, which means hiring people with leadership potential in the �irst place. The organization must have a leadership-developmental program that intentionally puts these people in challenging situations and as members of crossfunctional teams. A good development program obtains feedback about them and their performance from those that see them in action (Fulmer, Stumpf, & Bleak, 2009). For example, GE is known for its strong entry-level leadership development, which offers experience in communications, engineering, �inance, information technology, manufacturing/operations, and sales/marketing, as well as a range of programs speci�ic to GE's various brands (GE, n.d.).

While there are clear advantages to promoting from within and signaling to current managers that the career path in the company goes right to the top, there are circumstances in which hiring a CEO from outside makes more sense. For instance, there are occasions when a business requires a transformational leader to shake up a structured, risk-averse enterprise, as was the case with aerospace

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conglomerate Allied-Signal, or to revitalize a company by taking it in a completely different direction, as IBM recruited Louis Gerstner to do.

Hiring People with Leadership Potential

Multinational producer of polymer products W. L. Gore & Associates valued people who showed initiative and leadership and were team players. To select suitable candidates it employed a novel recruiting system. Applicants for a job came to the company expecting to undergo several interviews before being selected or turned down. Instead, they were told on arrival to "look around." Those who were nonplussed, kept looking at the clock, and asking who was going to interview them were shown the door. Others who were curious and got up to walk around and see what was happening, then offered to help and rolled up their sleeves, were immediately hired (Hamel & Breen, 2007).

Hiring future leaders is not as easy as it sounds. Imagine you are interviewing someone for a middle- management job, such as a project manager. The person could be very well quali�ied for the position, but how do you assess his or her leadership potential? There are a few things that almost every employer looks for in an applicant when recruiting potential leaders.

An obvious indicator is experiences in the applicant's resume where he or she made a difference. As important to having achieved something tangible is the way it was accomplished, such as taking initiative, leading a group, or otherwise demonstrating leadership qualities. References can provide information about the extent to which the person was assigned to do something important and delivered results that met or surpassed expectations. They can also reveal whether teammates would work with that person again. In other words, a reference is a source that can help ascertain if the candidate has a record of successfully completing assignments and being unafraid to take on more challenging ones. During the formal interview, some employers put applicants into various calculated situations to see how they would respond. Such "mock simulations" can be very revealing. Finally, following the old adage, "it takes one to know one," several people currently in leadership roles should interview the applicant to provide a balanced and complete picture before actually hiring the person. Allio advises that candidates for future leaders possess three attributes: (1) motivation and a need to achieve, (2) attitude and the ability to inspire, to evince optimism in the face of adversity, and (3) morality—the possession of positive values and benevolent motives (Allio, 2009).

By no means should all hiring decisions take into account leadership potential. Some people, as a result of their temperament, interests, and experience, are more interested in playing a supporting role on the team; they lack the motivation or even interest to lead. There are many roles within an organization that do not require leadership competency. One important purpose of recruiting, however, is to keep the potential-leadership pipeline full.

Developing Leaders

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Good leadership depends primarily on what leaders do; thus, it is imperative that managers with leadership aspirations �ind ways to demonstrate their leadership abilities and actually practice what they've read in books. No amount of listening to lectures or attending leadership courses can realistically be expected to transform people into leaders. The only way to do so, it would appear, is to create opportunities in which people can practice being leaders.

Effective Leadership Development

Some companies know how to develop leaders. General Electric Co. (GE) has for years been considered one of the best incubators of leadership talent because its alumni have gone on to lead many other companies. The �irst step is to develop a short list of individuals with the most potential as future leaders. Their development is then carefully monitored as they are given one challenging assignment after another. Each assignment is documented (including team composition, objectives, timeframe, and budget) and formal feedback sought from group members and others that might have interacted with the group. The feedback is then examined and discussed with the individual, with special emphasis on what was done well and lessons learned. Because of this kind of attention to detail and the number of individuals involved, leadership development is managed as a program, with an experienced manager in charge. Individuals who build on their experience in this way and increase their stature with the organization become automatic candidates for senior management positions as they open up.

In another example, Nike implemented Kouzes and Posner's Leadership Challenge (Kouzes & Posner, 2008) to develop senior managers for the apparel side of its business. This model involves modeling behavior, inspiring a shared vision, challenging the current process, enabling and empowering others, and encouraging the "human" aspects of leadership (such as celebrating community and recognizing individual accomplishments).

There are two more ways to develop leaders that complement a formal development program: Current leaders should be careful to model the behavior they expect potential leaders to emulate. Potential leaders should try to �ind a mentor, either in the same company or outside it, to help their development. Following model examples and having a mentor are immeasurably useful but are often overlooked aids to leadership development.

Leadership-Development Pitfalls

Not all leadership-development programs produce desired results. According to Douglas A. Ready, a researcher on leadership-development efforts, organizations that experience dif�iculties implementing a successful development program or fail entirely manifest three "pathologies" (Ready & Conger, 2003).

Some companies display a control, ownership, and power mentality. This is characterized by a reluctance of those in positions of authority to give up control, to relinquish ownership of resources, or to share information. Identifying potential candidates and the right opportunities to develop them is seen by these kinds of managers as threatening, especially in large, complex organizations. This leads to reluctant or even zero cooperation with leadership-development programs.

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CBS Corporation's CEO Leslie Moonves received $111.6 million in compensation in 2010. During his tenure, CBS share price nearly doubled and its revenue grew by 8%.

Associated Press/Reed Saxon

Another pitfall is the "productization" of leadership development. This means creating a new program based on the latest management fad or the magical new offering promoted by a management-consulting �irm, without regard to whether it has anything to do with the corporation's strategy or future needs. To make matters worse, in tough economic times the leadership-development program is viewed as a cost and often curtailed. Over time, the disjointed efforts produce nothing of value.

Some organizations make the mistake of applying the wrong metrics. When the human-resources department promises an increased ability to deliver leadership-development programs at lower-than- expected costs, perhaps by using more e-learning technologies and new methodologies, the touted results sound impressive. In this situation it's likely that the right questions aren't being asked. In order to measure the value of a leadership-development program, one needs metrics that can provide answers to questions such as, "Are we better able to �ill key jobs when they arise?" "To what extent are potential leaders knowledgeable about and committed to our strategic direction?" Short-term savings may have long-term costs.

Evaluating Leaders and Succession Planning

The most common measure to judge the effectiveness of leadership for a corporation, and in particular the CEO, is the company's performance. Measures include beating its revenue and NIAT forecasts and achieving an increase in the corporation's stock price. How do we know this? The CEO's compensation package is designed to motivate achieving such performance for the corporation. Raises and bonuses are awarded only when the corporation performs at levels that meet or exceed expectations. Performance objectives and incentives are speci�ied in the contract when the CEO is hired.

A recent case con�irms the above measures and also illustrates the fragility of using such measures. In 2010, CBS Corporation's CEO Leslie Moonves received a total compensation package worth an extraordinary $57.7 million. Beyond his base salary of $3.5 million, he was awarded a $27.5 million bonus and nearly $23 million in stock and option awards. The company also provided an additional $3.4 million for his pension fund and reimbursement for taxes paid in New York. CBS justi�ied the nearly 34% increase in compensation from 2009 saying that Moonves's leadership resulted in extraordinary growth in shareholder value and outpaced both the industry and the

company's internal targets. CBS's share price nearly doubled during 2010, and its revenue climbed 8% (James, 2011).

Viewed in isolation these performance metrics indeed appear impressive; however, the resurgence of advertising revenue in 2010 simply lifted the company to where it had been three years earlier. Its total

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revenues of $14 billion were largely unchanged when compared to 2007, before the recession. Moreover the company's operating income of $1.8 billion was much less than the $2.6 billion in 2007. Shareholders may question whether such lavish compensation is warranted for only one year of performance.

Time and again, CEOs receive generous rewards for upsurges in company performance but are rarely penalized when corporate performance declines or cannot be sustained. For example, Robert Nardelli, CEO of Home Depot, stepped down in January 2007 and took with him a $210 million severance package amid shareholder criticism about his "generous" compensation package relative to the stock's weak performance, slowing pro�its, and a regulatory probe about its options practices. On the announcement of Nardelli's resignation, the company's share price actually jumped 3% (Kavilanz, 2007). At the company's �inal shareholder meeting before he resigned, he was the only director present, revealed no information, and allowed shareholders to speak for only one minute each (Nocera, 2006).

These examples illustrate that one measure to evaluate CEOs should be corporate success over an extended period of time. Another is the state and condition of a company at the end of a CEO's tenure. For example, when CEO Carly Fiorina was forced out at Hewlett-Packard in 2005, the company's stock price had declined by 50% during her tenure, and HP was still trying to digest the 2002 acquisition of its biggest competitor, Compaq, a move that was widely seen as a failure (Portfolio's Worst, n.d.).

When long-time CEO Michael Eisner resigned in March 2005, a year before his contract was due to expire at Disney, the company's performance had deteriorated on several fronts. Broadcast network ABC, acquired by Eisner, had lost market share over seven years. Disney had failed in a highly publicized attempt to build a historic American theme park near a civil-war battle�ield. The company was widely criticized for the disastrous hiring of Michael Ovitz as his designated successor, who lasted just 16 months and cost the company $90 million in addition to stock options. Uncharacteristically, Disney had experienced a string of box-of�ice movie �lops starting in 2000, while over that same �ive-year period the board of directors had approved compensation packages for him totaling $737 million (Gross, 2002).

In contrast, Steve Jobs, who relinquished operational control of Apple Inc. shortly before his death in 2011, left behind a company that he had led from near marginality in 1997 to being the largest high-tech company in the world. In place at the time of his departure were a successor and an innovative-design culture that will endure well into the future. The robust state in which he left the company re�lects his performance as a leader and stands in stark contrast to Fiorina's and Eisner's leadership performances. A leader's legacy really is important.

Succession Planning

The quality of a leader's successor also re�lects on how people judge the leader. Is there a smooth transition at the top? Succession planning, especially at the top of an organization, is vital. It is too late to think about it when a CEO announces his resignation, even when the transition date is a few months away. The time to think about succession planning is years before the actual event. In other words, it should be done on an ongoing basis.

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Good succession planning requires that a leadership pipeline be full at all times. This can be quite challenging especially for large corporations that employ over 10,000 people. There are four principal reasons why it is dif�icult to maintain a leadership pipeline (Brant, Dooley, & Iman, 2008):

Inadequate criteria. When asked to recommend individuals in their unit who had leadership potential, managers' recommendations may be based on criteria that re�lect local values but do not match standards used in other functions or parts of the company.

Assessing potential vs. performance. Sometimes leaders �ind it dif�icult to distinguish between current performance and evidence of perceived ability to handle a more responsible role.

Inadequate data to make an informed decision. Decisions about leadership potential may rely too heavily on performance-appraisal scores that are high and fail to distinguish between candidates. The assessments suffer from "leniency" and have less to do with raters' ability to make accurate judgments than with their willingness to be candid.

Over-reliance on traditional training. Leaders felt that traditional training methods, such as membership in cross-functional teams, were inadequate.

To ensure that potential leaders and successors are being developed, leaders should establish criteria for identifying talent throughout the corporation. Standard terminology is important so that everyone knows what is meant and what one is looking for and why. Identifying promising candidates for a leadership- development program should be company-wide and begin with recruiting. A system needs to be developed that formalizes feedback data about a particular person after a given assignment so that multiple evaluations can be aggregated. This process will help identify the employee best suited to a particular position from among all the potential candidates. Finally, an aggressive schedule of assignments consistent with the company's strategy options and business model should be devised to test these talented people for their developmental bene�it as well as the company's interests. If a company's management doesn't have the skills to create such a leadership pipeline, it should engage consultants with the necessary experience and expertise.

Discussion Questions

1. What would you do to discover whether an applicant for a job in your company had leadership potential before hiring that person?

2. If you were asked to develop a score sheet for interviewing managerial candidates to assess leadership potential, what would it look like?

3. Why do many companies persist in hiring senior and executive positions from outside despite research �indings that people promoted from within do better and are less costly?

4. Are formal leadership-development programs a cost or an investment? If the latter, how might you calculate a return on that investment?

5. When obtaining feedback on an individual already in a leadership-development program, whose feedback is more important—that of the person's supervisor, teammates, direct report, or customers?

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6. Design a feedback form to capture information you would �ind useful in assessing and developing someone's leadership potential.

7. What principal elements of a potential leader's performance in a developmental assignment should the company really look for?

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2.4 Purposes of Organizations

Section 1.5 discussed a number of measures of "success" for a corporation. This section examines how it is important for an organization to have an overarching purpose, something that goes beyond the "bottom line," shareholder value, and other traditional measures of success. While companies can certainly function without one, the publicly stated underlying purpose motivates employees, attracts people to work at such companies, and generates positive public relations.

Consider the following examples of companies' purpose statements. Notice that they are brief, catchy, and to the point.

Theme Park: Our purpose is to bring people joy.

Consumer Products Company: Our purpose is to �ind creative solutions.

Electronics Company: Our purpose is to improve others' lives through technology.

Pet Products Company: Our purpose is to better the lives of both pets and those who love them.

Some purpose statements are included in companies' mission statements, while other organizations' statements of purpose are their vision statements.

Notice that these overarching purposes don't mention pro�it, shareholder value, market share, or even the products the companies produce. They are bigger than that. They motivate employees because they express values with which employees identify. Statements of purpose differ from vision statements in that they convey core values of the company now and in the future, whereas vision statements describe a future state that companies are trying to achieve 5–10 years into the future.

Purposeful Behavior

Organizations that have a clear, overarching purpose are more likely to appeal to all their stakeholders and not just a subset. Purposeful behavior is performed by an organization consistent or aligned with a common purpose that is meaningful and important to that organization's stakeholder groups. For example, to specify "increasing shareholder value" as the company's purpose aligns primarily with the interests of management and investors and not with those of employees (unless they happen to participate in an Employee Stock Ownership Plan). According to Paul Ratoff (2007), four conditions must be present for an organization to demonstrate purposeful behavior:

The larger purpose must be clearly stated. Stakeholder interests must be aligned with that purpose. The company's strategies must be aligned with its purpose. The results achieved must be measured and stakeholders informed of progress.

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Not only is having a larger purpose good for any company but also if more companies would consciously choose to achieve something larger than their mission statements would suggest, businesses might then be better corporate citizens. More people would be passionate about their work, and organizations could become more productive as a result and make contributions to the betterment of society.

Discussion Questions

1. Develop an overall purpose for a high school and one for a college/university. What would be their similarities or differences?

2. Can any organization have a purpose? Can different levels in an organization each have a purpose (e.g., a department or functional unit within a corporation)?

3. Where do overarching purposes come from? If you had to develop one for an organization, how would you go about it? How would you know when you had the "right" purpose?

4. Many companies have mission and vision statements and strategies. Does having an overarching purpose make a difference? In what way?

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When a company "goes public," it means that the general public can purchase, sell, and trade shares on

Scott Barrow, Inc./SuperStock

2.5 Governance and the Role of the Board of Directors

Privately held and publicly held companies are governed differently. They do share one similarity and that is that all decisions made and actions taken bene�it the owner(s) of the company. We now take a closer look at the main differences.

Privately Held Companies

Privately held companies are governed or run by either one person, as in the case of a startup entrepreneurial venture, or a group of people in a larger company, like a top-management group. An autocratic CEO will make all decisions of consequence for the company whether the top-management group is consulted or not. A democratic or participative leader will make decisions only with the consensus of the other top managers. Typically, in privately held companies, the CEO and often some key managers are the owners of the company, so decisions that bene�it the company also automatically bene�it them as owners.

In cases where outsiders have invested capital in the company, the investor receives a negotiated percentage share of the equity in return as well as a seat on the board of directors. This gives the investor a say in making strategic decisions as a way to safeguard the investment. In these cases, such a board shares the governance of the company with the CEO and the top-management team. The CEO makes decisions only after consulting with such a board.

Publicly Held Companies

To explain how publicly held companies are governed differently, one has to appreciate what being a public company means. A public company is one whose shares can be publicly traded on a U.S. stock exchange and that is regulated by the United States Securities and Exchange Commission (SEC) to ensure accurate and responsible �inancial reporting. The SEC was formed to protect investors, maintain fair, orderly, and ef�icient markets, and facilitate capital formation. An organizing principle is that every investor, ranging from a big corporation to a private individual, deserves to be informed about each investment they purchase or possess. To this end, the SEC mandates that public companies share important �inancial and business-related information with the public. Only when equipped with prompt, thorough, and accurate information can people undertake wise investment decisions (U.S. Securities and Exchange Commission).

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several stock exchanges, like the New York Stock Exchange and NASDAQ.

The SEC is responsible for monitoring important participants in the securities arena, including securities exchanges, securities brokers and dealers, investment advisors, and mutual funds. The SEC's

foremost priorities are to advocate for the transparency of market-related information, promote honest business, and prevent fraud.

Once a company "goes public," it means that the public can purchase and trade its shares on one of several stock exchanges such as the NYSE or NASDAQ. In carrying out its responsibilities, the SEC also oversees the public-accounting profession and the rules it creates, the generally accepted accounting principles (GAAP) to promote honest and uniform reporting by public companies as a basis for investors to buy or sell shares. In fact, the SEC requires that the �inancial statements and computer systems of public companies be audited by a CPA �irm every year to guarantee the information as a basis for decision making (Abraham, 1978).

In addition, the SEC requires all publicly held companies in the United States to have a board of directors to ful�ill a �iduciary duty to the company's shareholders. That duty is to act solely on behalf of the shareholders and in their best interest. Why was this found to be necessary when a capable CEO and management team exist to make the key strategic and operational decisions for the company?

The truth is that publicly held companies typically have shareholders that number in the hundreds of thousands or millions, and the visceral connection that owners, managers, and investors enjoy in a small company is lost. People buy shares in a public company for monetary gain, nothing else. Their objective is to receive either regular dividends for current income or capital gains when the value of the company rises over time. As a result, top managements of companies have come to make decisions and take actions that bene�it themselves more and not the larger group of shareholders. For example, they pay themselves high salaries, high bonuses, and high severance packages, oftentimes without regard to the way the company performs. They have come to behave sel�ishly in this way not out of any ill will toward shareholders, but rather because they can.

According to a New York Times study of executive pay, the median pay in 2010 for CEOs was $10.8 million, a 23% gain from 2009 (Joshi, 2011), 343 times the median pay of American workers in nonsupervisory positions (AFL/CIO, n.d.). One view for this disparity is that few people have the talent and ability to lead large, often global public companies successfully, which means they are in short supply and so command generous compensation packages.

While it may be true that capable leaders are in high demand, one of the insidious reasons for CEOs' large compensation packages is the reinforcing cycle that sets and approves such pay. A board's compensation committee often engages a human-resources-consulting �irm to determine whether the salary and compensation proposed is in line with what is paid other CEOs. The response in virtually all cases is that it is. The board is thus supported with evidence when it gives the CEO the salary and compensation package negotiated. The CEO contract often includes a de�ined employment period like �ive years, stock, bonuses,

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Boards of Directors are required to have three standing committees: an Audit Committee, a Compensation and Bene�its Committee, and a Nominating and Corporate Governance Committee. These committees will report directly to the board.

Kablonk/SuperStock

severance packages, and other bene�its. The next time a CEO is hired, the cycle is repeated, the one certainty being that the size of the total compensation package always increases and never decreases.

The SEC must have recognized this tendency to reward insiders a long time ago, and so requires public companies to have a board of directors elected by the shareholders at their annual meeting. The role of the board is to represent shareholder interests and oversee the strategic decisions that the CEO and management team take and, when necessary, to reclaim decision-making power and make the crucial decisions itself. This is most evident when the company is trying to acquire another company or fend off an unwanted takeover attempt. In both situations it is the board that takes the lead in deciding what to do.

Boards of directors are comprised of three types of directors (Hitt, Ireland, & Hoskisson, 2007):

Insiders—the �irm's CEO and other top-level executives Related outsiders—individuals not involved with the �irm's day-to-day operations but who have a relationship with the company such as a major stockholder Outsiders or independents—individuals who have no relationship to the �irm at all

Boards of directors are required to have three standing committees to help them to ful�ill their obligations: The Audit Committee is responsible for hiring and reviewing the performance of the independent public accountants that audit the company's �inancial systems and reports. The committee safeguards the reliability of the accounting operations and monitors and inspects any notable changes in accounting policies. In addition, it helps the company comply with the requirements of the Sarbanes-Oxley Act of 2002. The Compensation and Bene�its Committee is responsible for determining compensation packages for the CEO, president, key top managers, and board members. In addition, it oversees pension and other welfare policies for all employees. The Nominating and Corporate Governance Committee is responsible for recommending candidates for the board, overseeing the performance of the board and its committees, and reviewing the organization's plans for executive succession. These three standing committees are legally required of all public companies.

Corporate boards of directors may choose to establish other committees. A strategic-planning committee is not mandated but may be created by some boards. Its role is to keep the board informed about strategic decisions the company might take and to make sure that the board's input is taken into account in the company's strategic- planning process. A public-policy committee is not a legal requirement but many boards choose to have one. These bodies oversee the company's efforts at protecting the environment, promoting health issues, and other public policies that might affect the company.

The Sarbanes-Oxley Act (SOX) introduced new standards of accountability for the boards of publicly traded

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companies. Under the Act, directors are directly responsible for internal control, and penalties, including large �ines and even prison sentences, are enforced for accounting crimes. After the Sarbanes-Oxley Act was passed, the New York Stock Exchange and the American Exchange required independent directors to head the major standing committees (Petra, 2005). Today, boards of directors of companies trading on those exchanges are required to have a majority of the board be independent and the audit committee to be composed entirely of independent directors (Hitt, Ireland, & Hoskisson, 2007). Even so, in some cases, the CEO is powerful enough to offset the independence of the board. Some companies have countered this with efforts to prevent the same person being chairman of the board and CEO concurrently (Lorsch & Zelleke, 2005).

The downside to having more independent directors is that they have, by de�inition, less information about the day-to-day operations of the company. But the issue is a red herring; they can get all the information they need from interactions with and requests of the insider directors, who are on the board because they can share with the board all the strategic, �inancial, and operational information the board needs.

With all of these committees and regulatory bodies in place, it's easy to see how governing a publicly held company is more complicated than, and substantially different from, governing a privately held company. In later chapters, the strategic-management process will be described in more detail in a way that applies equally well to both kinds of company. The emphasis will be placed on what the management team must do to make and act on its strategic decisions. Bear in mind that, for public companies, the board plays a critical role in overseeing and sometimes taking control of what management does.

Discussion Questions

1. Discuss some ways in which a board of directors might maintain its independence from management.

2. Sometimes, stockholders are not satis�ied with a company's �inancial performance, how the company is being managed, and even how effective the board is. What can they do about the situation, especially when some stockholders hold few shares in the company?

3. In the case of very large corporations, institutional stockholders hold substantial blocs of stock in the company. Is it possible that they wield too much in�luence in stockholder voting? Should this be cause for concern on the part of a small stockholder?

4. Shareholder "activists" who hold stock in many companies are particularly vocal about "keeping corporations honest" and ethical and making sure they represent all stockholders' interests. Often, such dissatisfaction takes the form of coming up with an alternative slate of directors to be voted on at the annual general meeting, thus making the process very political. Is this a good thing for corporations and their stockholders?

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Functional organizations are usually led by a CEO, with positions for a VP of Finance, VP of Marketing, VP of Production, VP of Human Resources, VP of Research and Development, and possibly a VP of Engineering.

Comstock/Getty Images

2.6 Organizational Designs and Strategy

The process of organization involves deploying resources to achieve strategic objectives. It entails dividing the workforce into speci�ic departments and jobs, identifying formal lines of authority, and creating mechanisms for coordinating diverse organizational tasks. Organizational design is thus a major determinant of whether the strategy can be implemented effectively. Strategy execution depends on competent people who have the resources and the knowledge, and who know what to do and how their jobs relate to everyone else's. Additionally they require information where and when they need it. How the company is staffed and organized becomes critical. Over time, as the organization grows, the dif�iculties of implementing the strategy increase. For example, as it grows to become an international organization, or broadens its product line, or acquires other companies, of necessity will its organizational design evolve. While details about executing strategies come later in the book, this section introduces the different kinds of organizational design and the reasons each one is effective.

Functional Organizational Design

The functional organizational design is the most common design used by business single-companies (Figure 2.1). It groups employees together according to discrete functional activities in the belief that the work will be done more effectively. Employees of small companies organized this way generally aren't aware they are using a speci�ic "design" because it happens to be so common.

Functional organization designs are variants of the following structure. At the top of the hierarchy sits the CEO or president. In public companies this includes the chairman of the board of directors and of�ice of legal counsel. Below the CEO are a number of vice presidents, each responsible for one or more functional areas. Some companies have a chief operating of�icer (COO) or executive VP, who has the authority to act as CEO in the latter's absence. That executive sometimes oversees the functional vice presidents. Reporting to most vice presidents are C-level of�icers, with responsibilities for their functional area. Examples include the CFO (chief �inancial of�icer), CMO (chief marketing of�icer), CTO (chief technology of�icer), and newer ones like CIO (chief information of�icer) and CSO (chief strategy of�icer). Figure 2.1 illustrates the basic functional organization design.

Figure 2.1: Functional organization design

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Associated Press/Mark Lennihan

The principal disadvantage of this form of organizational design is that it discourages horizontal communication, that is, across functions. For example, a situation might arise in which a company's marketing department advertises the bene�its of a particular product and delivers a dramatic sales increase only to discover it could not ful�ill the new orders because production wasn't prepared to keep up with demand. In another scenario, efforts to cut manufacturing costs might dictate automating part of the production process, but if the �inance department had not been informed of this possibility and set aside funds accordingly, the company might not have the money to fund the initiative. To get around this, a company might form cross-functional teams composed of members from each affected functional area. Special task forces might also be established to tackle a problem that only occurs once such as business- process reengineering. Cross-functional teams are rarely fulltime activities, but must be done in addition to members' regular jobs and responsibilities.

Matrix Organizational Design

Whereas a functional organizational design is the most common design used by companies, matrix organizational designs are preferred when a company encounters a more speci�ic set of circumstances or challenges. Companies that serve the functions described in the following sections may consider using a matrix organizational design.

Many Projects for Clients

Companies that provide consulting services or perform research for multiple clients may choose a matrix organizational structure. An example of this is the RAND Corporation, a "think tank" in Santa Monica, California, that undertakes research and policy projects for all

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A matrix organizational design is usually preferred when a company produces distinct brands or product lines. For example, Proctor & Gamble has 96 brands of products, including Tide detergent —one of its most popular brands.

agencies of the federal government, especially the military, as well as state and local government. RAND is organized by intellectual discipline and by project teams that propose, carry out, and report on particular contracts for individual clients. In effect, any member of the professional staff working there has a "home"—say, in the economics or computer-science group—and works on one or more projects. Most individuals have two or more overseers; but the department head is more of a resource than a manager, thus removing a potential con�lict. Figure 2.2 represents a simple matrix organizational structure.

Producing Distinct Brands or Product Lines

A large enterprise that produces many established brands for discrete markets may be suited to a matrix design. Proctor & Gamble, one of the largest and most innovative consumer-product corporations in the world, produces no fewer than 52 brands of beauty and grooming products such as Tampax, Gillette, Oral B, Crest, and Pert, and 46 brands of household-care products such as Tide, Bounty, Pampers, and Comet (Proctor & Gamble, n.d.). Organizationally, every brand is called a global business unit (GBU), which exclusively targets consumers, brands, and competitors worldwide. The GBU is also in charge of the innovation pipeline, pro�itability, and shareholder returns. Market-development organizations (MDOs) are responsible for being aware of the buyers and sellers in every market area Proctor & Gamble competes in, as well as incorporating new GBU-driven work�lows into the individual business plans operating in each country. Lastly, Global Business Services (GBS) manages Proctor & Gamble talent and expert partners with the goal of providing business-support services at the lowest costs possible.

Figure 2.2: RAND Corporation matrix organization

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Managing International Operations

Large multinational corporations with business interests in many countries may be organized in a matrix structure. The organizational matrix could be two-dimensional; think of a spreadsheet in which product managers are column headings and country managers are row headings, or even three-dimensional with the third dimension being disciplines like chemists, engineers, statisticians, computer scientists, and so forth. Proctor & Gamble has re�ined an incredible organizational design for what is a very complex organization, but most such organizations experience many dif�iculties. Even simple organizations that market only a few products internationally have con�licts with country managers. It is not uncommon for managers employed by international corporations to complain that, although they know their own domestic market and how to run the local of�ice better than the executives at the home of�ice, they still get told how to do their job.

Divisional Organizational Design

Much like functional and matrix organizational designs, the divisional organizational design works better for some companies and industries than others. A divisional organization is most effective when a company is in several businesses. A company with a broad product line or that serves several vertical

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markets could still be in one business. Honeywell International is an example of a business with a divisional organizational design. Honeywell is an enormous conglomerate that has evolved through numerous mergers and acquisitions. It does business in a variety of industries ranging from defense contracting to consumer products with divisions dedicated to aerospace, automotive products, specialized materials, and research and development among others.

The test to determine if a divisional organizational structure is the best choice for a company is whether each of the businesses has quite different customers, competitors, and strategies and therefore needs to be run by a separate manager. In such a case, one would �ind many functions such as engineering, sales, and manufacturing duplicated in each business. In a diversi�ied or multi-business company (discussed in Chapter 11), its different businesses can be divisions that still retain the corporate name and have developed organically or "subsidiaries" that have different names as a result of having been acquired.

The divisions or subsidiaries are considered "line departments" as they continue the chain of command up to the CEO and overall board of directors. Staff departments such as human resources, labor-relations, �inance, and legal counsel exist at the corporate of�ice and serve all divisions and subsidiaries. An international department would coordinate the operations of each division in different countries, allowing for contacts that one division had developed to be accessed by the other divisions. As you may well imagine, divisional organizations, while simple in concept, can become complex in an international corporation.

Figure 2.3: Divisional organization

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Discussion Questions

1. Describe how a small company's organization might change from a functional organizational design to one that might better support a new product it had just developed for a new market.

2. Imagine you are working for a company that had a matrix form of organization, and you had progressed to being one of the project managers. The client for your project suddenly changed the terms of your project, and you needed more support in computer modeling as a result. The department head for computer science claims that the person already on your project could handle the extra load, but you feel you need an additional person. How might you resolve this con�lict?

3. As an international company expands to a particular country, would you hire someone from that country to run the of�ice there but train them in the company's culture and products, or have someone set up shop in that country from the home country and have him learn about the market in that country? Discuss the reasons for your choice.

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2.7 The Role of Top Management

As the name implies, a corporation's top management is the group that runs the company under the guidance of the CEO. Depending on the management style of the CEO, the relationship could be highly participative and democratic, so strategic decisions are made jointly. However, if the CEO is more dogmatic or autocratic, top managers may be asked for their input but would not be involved in making any strategic decisions.

Composition and Authority

In a functional organization, the top-management team typically comprises all of the vice presidents and C-level executives. In a matrix organization, it would include the department heads and key staff directors and sometimes the managers of large and critically important projects. In a divisional organization, it would comprise key staff directors and all divisional and subsidiary presidents. The same would hold true in international organizations. Country managers are usually not members of the top-management team. Having said that, some global organizations are extremely complex, conducting purchasing, manufacturing, R&D, and sales and marketing in different countries. For these corporations, like the Proctor & Gamble example cited earlier, the key executives in their top-management teams could be located in different countries.

The degree of decision-making authority varies also with the kind of organizational design followed. For example, in a functional organization, a vice president or C-level executive has authority only in the functional area in question. A vice president of marketing can decide tactical questions only in areas including marketing, customer relations, sales, advertising and promotions, and market research. On the other hand, a divisional president acts like a CEO within the division in question, overseeing all business activities of the division. In that structure, however, all functional areas of the division must be compatible with their corporate counterparts.

Building Capability

Decisions are not easily compartmentalized into "strategic" and "tactical" or non-strategic. Implementing a strategy doesn't mean just doing the tasks that have always been done and in the same way as before. Strategy implementation over time becomes more demanding as competition intensi�ies. For that reason, top management must do more than simply keep the company running.

To build the necessary capabilities required for effective strategy implementation, the company must continually recruit the kinds of people it needs and train others in newer systems, processes, products, and technologies. It must develop and keep full a pipeline of potential management and leadership talent that can �ill higher-level positions as they become available. It must strive to develop a core competence if it doesn't have one already or strengthen the one it has. If it does not, the business will erode over time.

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General Electric develops future management by cross-training employees—sending new hires and longtime managers to their Leadership Development Center for executive training.

Associated Press/Paul Sakuma

Part of building capability is to push decision-making authority down to lower-level managers so they can prove themselves worthy of taking on more responsibility (Thompson, Strickland, & Gamble, 2004).

Top management must also be effective at evaluating and developing managers and supervisors at lower levels. It becomes a top-management issue in larger companies where internal demand for good managers and leaders is high and the positions varied. In such a corporation, potential leaders need to be cross- trained in different functional areas or different brands, product lines, or countries as well as develop their problem-�inding and -solving capabilities.

Case Study How GE Develops Its Future Management Needs

General Electric (GE), a highly diversi�ied global corporation, is one of the best managed companies in the world judging by the results it, along with its divisions and subsidiaries, has achieved over time. It has pioneered leadership-development methods that have been widely emulated. The critical �irst step is to recruit people with high leadership potential. The corporation then goes to great lengths to develop that potential. GE's leadership development includes cross-training for sustained periods of time, not only to provide managers with broad experience, but also to develop relationships and learn best practices.

When �illing key positions, the selection criteria include "the four Es": enormous personal energy, the ability to motivate and energize others, edge (a GE code meaning the ability to make tough decisions quickly—yes or no, not maybe), and execution or carrying things to fruition. One trait executives look for when assessing managers is pro�iciency at what GE calls "workout" by which is meant an ability to confront issues as they come up, diagnose the root causes, and bring about resolution so that the company can move forward.

Each year roughly 10,000 newly hired and longtime managers are sent to GE's Leadership Development Center, one of the world’s top corporate training centers, for a three-week course on six-sigma quality. Six-sigma quality training, which focuses on removing the causes of errors and defects, improving cycle times, and decreasing expenditures, is a prerequisite for promotion to any professional and managerial position at GE and any stock-option award.

Finally, GE has developed a grading system for evaluating its 85,000 managers and professionals every year, placing them into one of �ive tiers: the top 10%, the next 15%, the middle 50%, the next 15%, and the bottom 10%. Everyone in the top tier gets stock options, no

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one in the fourth tier gets any, and those in the bottom 10% are weeded out of the company. The CEO personally reviews the performance of the top 3,000 managers. According to Jack Welch, GE's CEO from 1980 to 2001, "The reality is, we simply cannot afford to �ield anything but teams of ‘A' players" (Thompson, Strickland, & Gamble, 2004).

Discussion Questions

1. What steps might be taken if one or more members of the top-management team were suspected of withholding information or pursuing a hidden personal agenda?

2. Members of the top-management team were appointed to their positions because of their leadership and take-charge abilities yet must behave more like team players when helping to make strategic decisions. How might such a seeming disparity be handled?

3. As CEO of a company, how would you handle high turnover in your top-management team? How could you or should you in�luence such change?

4. Would a top-management team be better if its members had experiences with other companies before having been promoted internally? Why or why not?

5. Sometimes, a former CEO becomes a member of the top-management team by way of his company having been acquired. Is adjusting to this new role easy? What problems, if any, might it present for existing team members?

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Amgen's list of corporate values includes being science-based and intensely competitive, while ensuring quality, encouraging patient creation, team spirit, and trust and respect for each other.

Associated Press/Reed Saxon

2.8 Organizational Values

According to authors Thompson, Strickland, and Gamble (2004, p. 27), a company's values are "the beliefs, traits, and behavioral norms that company personnel are expected to display in conducting the company's business and pursuing its strategic vision and strategy." In some organizations, such norms are democratically derived and clearly stated, if not rigorously followed. In many other organizations, no explicit values statement exists. Does it matter? In today's business world, whether a formal statement of organizational values exists, individual executives may feel at liberty to behave any way they want. It is more the rule than the exception that money and greed are what drive such behavior.

The corporate graveyard is littered with companies whose executives acted unethically and when caught brought the company down with them. The high pro�ile cases of Enron, Arthur Andersen, WorldCom, Adelphia Communications, Qwest, and Tyco International, are but a few examples. Enron, for example, had publicly stated values of respect, integrity, communication, and excellence; yet its executives violated every one of them. The values were not suf�iciently ingrained to prevent the unethical, even criminal, behaviors that were eventually exposed. In fact, corporate corruption is widespread. According to a 2011 survey conducted by the Ethics Resource Center (2011), 45% of U.S. employees observed

wrongdoing within their organizations. We can assume that public exposure of these incidents would erode consumer perceptions of credibility and trust in those companies—and that would be disastrous for brand reputation.

Stop and think for a moment about all the places where you shop or do business and why you do. Which ones get your patronage because of how they treat you? Do you buy their products because of their generous return policy? Is it the company's commitment to preserving the environment that attracts you? Companies that actually hold themselves to meaningful norms and values derive signi�icant bene�its from how their customers and the world at large regard them.

What should a statement of values contain? Ideally it should summarize the culture and state how the company wants everyone to behave. For instance, Yahoo! pursues values of excellence, innovation, customer respect, teamwork, community, and fun. Curiously, at the end of its list of values, there is another list of 54 things it doesn't value, including "bureaucracy, losing, good enough, arrogance, the status quo, following, formality, quick �ixes, passing the buck, micro managing, 20/20 hindsight, missing the boat, playing catch-up, punching the clock, and ‘shoulda coulda woulda'" (Thompson, Strickland, & Gamble, 2004, p. 30).

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The values statement should state as accurately as possible what the values are and what is meant in observing them. This is hard to do if the company wants buy-in from all the employees. The language should be concise and clear. Typically the key values are fewer than 10 in number; a longer list would fail to get people's attention and would intimidate rather than motivate them to model the behaviors. More importantly, everyone from the CEO on down should model the behaviors and attitudes set forth. People should not only be accountable to the company but also to themselves. This means that the company should be extremely careful in hiring people. Fortunately, companies do exist that "do well by doing good."

Commonly Held Corporate Values

The following are commonly held company values:

Accountability Celebrating company and personal achievements Citizenship Community Compassion Continual improvement Continual learning Creating shareholder value Credibility Customer service Doing the "right" thing Embracing change Empowerment Entrepreneurial spirit and innovation Environmental stewardship Excellence Getting it right the �irst time Passion Personal renewal Quality Respect for people and self Safety Taking care of people Teamwork The customer is always right Tolerance for risk Trust Uncompromising integrity

Which values should be on your company's statement? Which ones match its vision, strategy, and brand and should therefore be adopted? Which ones are paramount? Which ones does everyone agree on?

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Discussion Questions

1. Can a company be successful without a formal values statement? Discuss. 2. Describe a process you would use to develop a statement of values to which everyone in the company subscribes.

3. What would you do—indeed, what can you do—if you notice someone in the company violating a strongly held company value (anything from padding an expense report to overbilling a customer to lying)?

4. Is the initial employee contract an individual signs on joining the company enough to guarantee honest behavior? How might a company monitor employee behavior and become aware of violations?

5. How can you ensure that all employees really understand and accept the company's values statement? Would they know what "integrity" and "accountability" mean in this context, and how might you explain these?

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2.9 Organizational Culture

The values statement sets forth what is expected of employees, and in turn, what they can expect from the company. When observed, the shared values contribute to the organizational culture of a workplace. Much has been written about what corporate culture is. Kilmann, Saxton, and Serpa state that culture "is de�ined as the set of key values, beliefs, understandings, and norms shared by members of an organization" (1986, p. 87). Because of this last characteristic, norms, it is incumbent on top managers to have a thorough understanding of the company's culture and evaluate the extent to which the culture can become a strategic enabler or hindrance (Prahalad, 2010). Consider, for example, Microsoft and Apple or United Airlines and Southwest airlines—two sets of organizations with vastly different cultures rooted in different values. Apple and Southwest are two organizations that have differentiated themselves from their competitors. Their cultural differences in the areas of values, beliefs, and vision are evident in their business practices, products, and services.

Culture has the ability to enhance or impede the implementation of a particular strategy. Just as form follows function, so also does structure follow strategy. Changing the structure involves changing the culture (Schein, 2010). Many failures in corporate strategy can be traced to a new strategy being imposed on the organization without considering whether the culture should also be changed. Sometimes a new strategy proves impossible to implement because the culture will not change. As an example of this, for years before General Motors actually went bankrupt, it resisted manufacturing and selling smaller, more fuel-ef�icient cars primarily because executives' bonuses were still based on selling the large gas-guzzlers that commanded high pro�it margins.

Jerome Want has laid out a hierarchy of corporate cultures, in order of least desirable to most desirable (Table 2.3). The last two, Service and New Age, are considered high-performing cultures.

Table 2.3: Hierarchy of corporate cultures

Culture Characteristics Some Examples

Predatory Punitive, alienating, exploitive WorldCom, Enron, Global Crossing, HMOs

Frozen Gridlock, denial, authoritarian, unresponsive to change

Telecoms, airlines, Kmart, cable companies, steel industry

Chaotic Fragmented, unfocused, no mission AOL, advertising, software industry

Political Balkanized, retaliatory Universities, large partnerships, law �irms

Bureaucratic Procedural, rigid, regimented, authoritarian, demands conformity

Utilities, government agencies, insurance companies, banks

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Southwest Airlines' corporate culture is considered New Age because it creates change and is innovative, customer oriented, and has a long-term focus.

Bill Cobb/Superstock

Service Customer focus, quality, authoritative focus, responsive to change

Harley-Davidson, Edward Jones, Jet Blue, Target, Westin Hotels

New Age Creates change, innovative, egalitarian, consensual, long-term focus, entrepreneurial

Southwest Air, Nucor, Google, Johnson Controls, Patagonia

Source: Jerome Want. (2006, p. 86). Corporate culture: Illuminating the black hole—Key strategies of high-performing business culture. New York, NY: St. Martin's Press.

At times, strategic changes implemented by top management can have an effect on the organizational culture as a whole. There are many common strategic changes that companies undergo that require the corporate culture also to change. High-growth companies will eventually make a transition to maturity and slower growth. The primary emphases of the organization then shifts from market share and sales commissions to cost cutting and cost savings. Companies that have declining or �lat pro�its may be obliged to turn to lowering costs in all phases of their operations and develop a low-cost mentality. When a company is in the midst of a turnaround, losses have �inally been stemmed, operations stabilized, and the new strategy has begun to take effect, a new culture will be vital to sustaining the progress.

Some companies may make a strategic decision to be innovative as a way of keeping up with the competition. This transition can be dif�icult because an innovative culture demands a different style of managing—one that rewards failure instead of punishing it (Sutton, 2009).

Unless done carefully, people in organizations, and especially cultures that have evolved over time, resist change. The way to succeed is to get those who must change involved in the change process from the very beginning. They should be told what the problem is or why the change is necessary and be given an opportunity to come up with solutions. Any change forced on them will produce resistance, either overt or tacit. The change

process should be planned carefully with participation by all affected. Implementation should take place in stages and be accompanied by any necessary education or training and support. The process may be smoothed with the assistance of a skilled consultant.

The extent to which a strategic alternative �its with the existing corporate culture, or the extent to which a company's culture might be required to change, are key criteria in choosing the best strategy. Changing the culture is very dif�icult to do and so should be taken into account when making strategic choices. This is discussed in Chapter 6, when we consider how to decide which of several strategic alternative choices to adopt.

Case Study

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Culture Change at the Paci�ica Corporation

Some years ago during a strong real estate market, the Paci�ica Corporation acquired a real estate development company through a leveraged buyout where most of the purchase price was �inanced through debt. For this reason, the CEO was under intense pressure to repay much of the debt very quickly. To do so would require doubling the company's sales the very next year.

This would be quite a challenge under the best of circumstances, but was this company that had been acquired prepared to deliver the results needed? In the preceding three years it had purchased no new land on which to build homes and was coasting on money made from selling houses built on existing lots. Employees were in the habit of arriving late, taking long lunch breaks, and leaving early. The acquisitions manager responsible for �inding new parcels of land to buy was routinely out of the of�ice �ive days a week. When confronted, he could not produce a list of parcels on which the company might bid, had no records of contacts or meetings attended, and had never held debrie�ing meetings to recommend parcels to bid on at what price. No one had held him accountable. "Country club" would best describe the culture existing when the company was acquired. The CEO engaged a consultant to help him change the culture in a hurry and get the company to double sales in one year.

The consultant held a series of meetings with the staff to lay out the problem and to discuss possible solutions. These meetings and an accompanying survey revealed the following attitudes:

Company operating nowhere near its potential (average assessment 46%) An absence of trust No incentives in place No strategy or direction No one cares (so why bother?) An absence of information about economic changes

As a consequence of having been asked, the employees' attitude toward attending workshops and changing the way work was done markedly improved. Land parcels were identi�ied, bids placed, and several bought. The process of getting permits and utilities to the parcels was accelerated. An economic expert was brought in, and the group became educated about how to obtain forecasts and assess what they meant for the business. Alternative strategies were debated and decided and reward systems put in place. The culture was now decidedly collaborative. By mid-year, solid progress had been made, and everyone knew what was expected of them.

Before the transition was complete, however, �ive original managers, including the acquisitions manager, were replaced. The CFO was let go when it was discovered he had no idea how to budget. For six entire months, he had fooled the CEO into believing that everything was on track. Whenever he was asked if expenses were "on budget," the CFO would say, "Yes," and

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people believed him. After about six months, the consultant remarked that costs had skyrocketed and asked, "Is everything still on track with the original budget that was set?" The real answer was "no": Every month, as costs had outpaced the set budget, the CFO had simply raised the budget to match expenses. Rather than taking action to decrease costs, he had consistently told everyone that things were "on budget."

Paci�ica did double its sales that �irst year of new ownership, primarily because its culture was turned around. The footnote to the story is that the CEO shrewdly sold the company a few years later, shortly before the real-estate market took a downturn.

Discussion Questions

1. Every four years, Americans vote for who gets to be president of the United States. In cases where a new president represents a change in political party, what sort of culture change has to take place in the Executive Branch of government? How is it done?

2. Can an organization with a bureaucratic culture ever change? Why or why not? 3. Some companies replace their CEO as a way of changing their culture quickly. Is this a good idea? Why or why not?

4. How exactly does an organization realize that its culture is the reason its strategy is not working? If you, as someone working in the company, noticed this, what would you do?

5. A company needs to change its culture. Which is better—replacing enough people to sever continuity with the old culture, or going through a culture-change process?

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Car manufacturer Toyota started a suggestion box for employees to generate ideas. Toyota reads every employee suggestion and thanks them, encouraging them to suggest another.

Associated Press/Ed Reinke

2.10 Managing Organizational Change

Change management is "a systematic approach to dealing with change, both from the perspective of an organization and on the individual level . . . proactively addressing adapting to change, controlling change, and effecting change" (Change-Management-Coach.Com, n.d.a.). It is "the coordination of a structured period of transition from situation A to situation B in order to achieve lasting change within an organization" (Change- Management-Coach.Com, n.d.b). These are two of many de�initions; together, they effectively and concisely de�ine a complex process.

To keep pace with external changes going on and to compete effectively, organizations must embrace change. Given the complexity of today's large and international corporations, managing such continual change is dif�icult. Not to do so, however, would be to lose competitive viability and market share, thus corporations have no option but to accept the need to change. Section 1.4 discussed the accelerating pace of change to which all organizations are subject. More than being reactive, corporations need to change proactively to get ahead of their competitors and survive competitive pressures in the long term.

Why Organizational Change Is Necessary

Organizational change is dif�icult because, unless handled properly, it poses a threat to the status quo and creates immediate resistance. Changes can impact every aspect of organizational life including strategies, culture, structure, control systems, and groups and teams. Vital processes such as communications, motivation, and leadership are also affected. Resistance to change can take many forms, both passive and active, such as blaming others, poisoning the culture, and so on.

Prerequisites to change include recognizing that there is a problem, identifying it correctly, and �iguring out how to resolve it. The problem might be something simple such as taking too long to pay vendors, or it could be more complex and dangerous like losing one's lead in innovation. Perhaps something is not happening the way it should or performance is deteriorating in some way. The need to improve performance and lower costs is unrelenting. The more urgent motivation for change stems from a strategic consideration. A company might need to develop a new technology, adopt a new production process, enter a new market, develop a core competence, or take other vital actions to improve the company's position in the market, its market share, and performance on other key indicators. In such cases, the status quo is not an option; change is inevitable.

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Companies that can manage change, therefore, are ahead of the game. Researchers believe that the highest-performing organizations are those that are constantly changing and have become experienced at doing so (Jones & George, 2007). These organizations' cultures are either innovative, adaptive, or both. They have learned to identify goals and ways of achieving those goals as a result of participative discussions and then pursued them enthusiastically. Any attempt to force doing something or how to do it on a work group will be met with resistance thereby jeopardizing the change process or even preventing it.

Implementing Change

Managers introduce and implement change from either the top down or the bottom up. Top-down change is autocratic; the need for change and how it is to be implemented is decided at the top of the organization and relayed to those lower down in the hierarchy to implement. Top-down change is valuable when the company needs to act quickly and decisively. It is typically instigated by the CEO. It works because managers at each level of the hierarchy have the authority to tell their staffs what to do and what results are expected. For example, the Transportation Security Administration (TSA) is widely recognized as an autocratic, top-down style organization. Airport TSA of�icers must react and carry out mandates from the agency's top leaders and have very little to no involvement in change (Jamieson, 2011).

Bottom-up change is more gradual, complex, and evolutionary, but no less effective. More than top-down change, it gets everyone involved, con�irms to workers that the "higher-ups" are listening to their ideas and sometimes acting on them. This sense of being a participant in the process minimizes resistance to change. Who else is in a better position to see the need for change or how something can be done better or more ef�iciently than front-line workers? Bottom-up change can originate anywhere in the organization. For example, Google gives its staff freedom, time, and resources to work on their own ideas and innovations that might be of interest to consumers. In fact, the company reports that about 50% of its new products and features are the outcome of "personal project" time. Instead of change and innovation being created at the top, with lower level employees carrying out the plan, new ideas emanate from the ground up. In some traditional organizations that encourage bottom-up innovation, progress is critically evaluated at each stage of development through a "stage-gate" process where progress is critically evaluated and the project may be terminated at any stage (Cooper, 1993).

Monetary rewards for coming up with ideas, especially in innovative companies, are relatively uncommon because such behavior is expected as part of a person's job. Moreover, if the idea results in a successful product line or business within the company, there is the potential for the creator of the idea to be put in charge of that product line or division. In other words, it can be a fast track to promotion (Block & MacMillan, 1993).

Many companies also have suggestion schemes. If no one reads the suggestions and gets back to the idea- generator, however, people will eventually stop suggesting ideas. Suggestion boxes have been known to gather dust from disuse. Toyota, on the other hand, has become famous for reading every single

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suggestion and replying one way or the other to the senders, thanking them for submitting the idea and encouraging them to submit others.

Managing change demands a high degree of communication and coordination among all organizational units. A new technology may require a change in product design, production, and other functional areas. All activities related to the adoption of the new technology must be coordinated, as must all the other change processes that may be ongoing. Change can quickly become a way of life in organizations that embrace change and want to become stronger competitors. As Hiroshi Okuda, Chairman of Toyota Motor Corporation, has said, "Failure to change is a vice" (Miller, 2003).

Case Study Bottom-Up Suggestions at Toyota

Toyota implements more than 700,000 improvement ideas each year worldwide. That number is incredible, considering that Toyota has been pursuing its mission of decreasing cost and increasing quality for almost 50 years. If every idea were to save Toyota a mere $100, the total would result in a staggering $70 million.

As Toyota cuts production costs by implementing ef�icient practices on the shop �loor and beyond, customers bene�it from the savings via price reduction. Between 2000 and 2003, the company proved itself a �ierce industry competitor by adding even more features to popular vehicle models while simultaneously reducing prices.

For every idea that saves the company money, Toyota rewards the employee in cash. The greater the cost savings, the greater the employee reward, with bonuses ranging from $5 to $2,000 per idea. After the employee submits a form outlining the idea, a supervisor assesses it, the reward is calculated, and money is added to the employee’s paycheck. This process has been honed over 50 years.

Most employee rewards are in the $5 range. Bonus funds are taken from the training budget, since Toyota believes that self-generated improvement is more effective than traditional classroom training or lectures. Because the money is not taken from the improvement budget, pressure to generate high savings is absent. Toyota’s philosophy is that with quality training and education, good ideas and savings will automatically result.

Because employee ideas are generated and submitted during breaks and after work, rather than “on the clock,” the bonuses provide Toyota a way to appreciate employees who spend their personal time on company advancement.

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Discussion Questions

1. You are in charge of a small company and want to institute many changes. Compare the approaches of telling your employees what you want them to do versus asking them for their ideas before deciding on what to do.

2. You are interviewing for a job in a company. How would you discover whether it had an innovative or adaptive culture? If it didn't, would that be a deal breaker for you? Why or why not?

3. A company is considering whether to install a new technology into its production process. Top management wants to do this because of large savings estimated to accrue in future years, but the functional departments of engineering and production say the dif�iculties of doing so are huge, and it should not be done. Suggest a way out of this impasse.

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This video summarizes many of the main themes and concepts of the chapter, most notably the difference between various leadership styles.

Different Leadership Styles

Summary

An understanding of the human side of corporations is essential to managing strategically. Strategic planning and strategic management are the principal drivers of change.

Leaders create change; managers implement change. Leaders are visionary, while managers get things done through other people. Both are responsible for getting things done, but leaders see where change is needed and the direction in which the company should go. Companies run leadership-development programs to identify, develop, and evaluate potential leaders and ensure that a quali�ied person will be available to �ill a leadership role when needed. Leaders are best trained in the crucible of experience rather than by attending courses.

Leaders' power stems from legitimate authority due to their positions in the company, specialized knowledge, respect and charisma, and the ability to bestow or deny rewards. Strategic leaders are most concerned with the company's long-term ability to endure and prosper. They take the lead in creating a vision statement that articulates where the company should be 5 to 10 years in the future and are responsible for motivating the company to achieve the vision. Vision statements should be concise, inspiring, memorable, and achievable.

The effectiveness of a CEO is measured by corporate success over an extended period, the state of the company at the end of the CEO's tenure, and the preparedness of the CEO's successor and succession plan. CEO's compensation packages tend to emphasize short-term results except for the stock they are given.

Organizations need an overarching purpose other than pro�its, market share, shareholder value, or traditional measure of corporate success. A purpose statement can motivate employees by expressing values with which employees readily identify (e.g., to save and enhance lives). Employees are more inspired to work for a company whose raison d'etre expresses their own values than they are to achieve traditional measures.

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Companies are governed by CEOs and their top-management teams. Public companies are required to elect a board of directors to represent the interests of stockholders. Boards of public companies are further required to have an audit committee composed of independent directors, a compensation and bene�its committee, and a nominating and corporate governance committee. Boards are comprised of inside members (the CEO and key executives), related outsiders, and independent members. Keeping the board informed and being responsive to its wishes regarding strategic direction is a challenge for the chairman and CEO.

As a company evolves and expands, its organizational design also evolves. In other words, structure follows strategy. Unless the company is organized appropriately, it will not be able to execute its strategies effectively. There are three basic forms of organizational design. Functional organization is the most common for single-business companies. A matrix organization may be suitable when a company handles many projects or brands and may conduct business in several countries. Divisional organization is primarily for diversi�ied companies and conglomerates.

Besides the CEO and president, top-management teams in a functional organizational design typically consist of all vice presidents and C-level of�icers. In a matrix organization, top management includes department heads and key staff directors. In a divisional organization, key staff directors and all divisional and subsidiary presidents are members of the management team.

Top-management teams are involved in strategic planning and making strategic decisions for the whole corporation. In addition, as the company's leadership pipeline is a resource for top executives, they have an obligation to keep it full and give those in it as much cross training as possible.

How people behave in a company and how they treat customers and suppliers is of the utmost importance. Company compliance with all laws and regulations is imperative. Not doing so could be fatal to the enterprise. The company has to treat people fairly, motivate them to be good and to do good. Thus promoting values and making them explicit and modeling them are critical. A culture based on good values will endure, because it will attract people who share those values.

Organizational cultures are built values or "how we do things around here." Once established, cultures are self-perpetuating and therefore hard to change. When a new strategy is chosen or changing times demand different goals, implementation is hindered if the culture doesn't change appropriately. Innovative and adaptive cultures are, by their nature, used to constant change and are the kind of cultures companies should strive to develop when their environment and competition is changing rapidly.

In order for a company to transition from its current state to a desired new state, myriad changes may be necessary, and they have to be managed well. The single biggest mistake is not giving those who will be most affected by the change an opportunity to participate in effecting the change. Excluding front-line workers from the process leads to resistance, both passive and overt, making the change process more costly and even impossible. If there's a problem, it must �irst be identi�ied before a solution can be crafted.

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If change is required that is not a direct response to a problem, the reason for the change must be clearly explained before being implemented.

Sometimes change is dictated from the top down. This is particularly true if the issue is urgent, as top- down change can be implemented rapidly. Bottom-up changes take longer but involve those most affected by the change, thus minimizing resistance and increasing the chances of successful implementation. Suggestion schemes can be useful but only if suggestions are read and contributors receive a response.

Concept Check

Key Terms

administrator One who directs others in the pursuit of ends by the use of means, both of which are determined by a third party.

audit committee A standing committee of the board of directors responsible for hiring and reviewing the performance of the independent public accountants that audit the company's �inancial systems and reports, for ensuring the integrity of its accounting practices and controls, and for reviewing signi�icant changes in accounting policies. In addition, it helps the company comply with the Sarbanes-Oxley Act of 2002.

bottom-up change A change process that can begin with anyone in the company (and need not travel upward more than one or two levels), gets results gradually over time, and involves employees, thus minimizing their resistance to change.

change management A structured approach to rearranging and transforming individuals, teams, and organizations from a present state to a desirable future state. This organizational process aims to cultivate a business environment in which employees can accept and welcome workplace changes.

C-level of�icers Executives that are on a par with vice presidents in the organizational hierarchy. "C-level" is shorthand for CFO (chief �inancial of�icer), CMO (chief marketing of�icer), CIO (chief information of�icer), CSO (chief strategy of�icer), and so on.

coercive power The ability of a leader or manager to punish a subordinate; this could take the form of �iring someone, denying a raise or bonus, or reassigning the person to an undesirable location.

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Compensation and Bene�its Committee A standing committee of the board of directors responsible for determining compensation packages for the CEO, president, and key top managers and board members, and pension and other welfare policies for all employees.

corporate culture The framework of core ideals, beliefs, and standards shared by members of an organization.

division A strategic business unit of the company that nevertheless does business using the corporate name.

divisional organizational design A design that is most common in diversi�ied companies, where each division or subsidiary has its own president and functional organization but reports up the chain of command to the CEO.

expert power Power attributed to the unique experience, competence, and expertise possessed by a leader.

functional organizational design A design that groups employees together according to discrete functional activities in the belief that by so doing the work will be done more effectively.

governance The mechanism by which a company is steered, managed, and safeguarded. Public companies must be governed by a board of directors as well as by a CEO and top management.

insider A member of the board of directors with substantial day-to-day experience of running the company, like the CEO and certain other top-level executives appointed by the board.

leader One who conducts and directs others in the voluntary attempt to accomplish a goal by the use of certain methods, both of which are chosen or approved of by the leader's followers.

leadership pipeline A cadre of highly developed potential leaders capable of �illing slots in the organizational hierarchy as and when they become vacant; ideally, this pipeline should be "full" at all times.

legitimate power The authority obtained through the occupation of a position in the company; the higher the position, the more power and authority the individual holds.

level-5 leadership A leader that builds enduring greatness (for the company) through a paradoxical blend of personal humility and professional will.

manager One who oversees others in the attempt to accomplish a goal by the use of certain methods speci�ied by the manager. (A more general de�inition is someone that gets work done through others.)

matrix organizational design A design with both vertical (skills or disciplines) and horizontal chains of command (such as projects, distinct brands or product lines, or countries).

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Nominating and Corporate Governance Committee A standing committee of the board of directors responsible for reviewing possible candidates to join the board and recommending nominees for election, overseeing the process for performance evaluations of the board and its committees, and reviewing the company's executive-succession plans.

organizing The deployment of organizational resources to achieve strategic objectives.

outsider or independent A member of the board of directors that has no relationship to the company at all.

overarching purpose A statement that is bigger than pro�it or shareholder value or market share, or even the products the company produces. It motivates employees because it expresses values with which employees identify.

public company A company whose shares can be publicly traded on a U.S. stock exchange and that is regulated by the SEC to ensure accurate and responsible �inancial reporting.

public-policy committee An optional committee of the board of directors responsible for overseeing the company's efforts at protecting the environment, health issues, and other public policies that might affect the company.

referent power Power that is derived from the appreciation, high regard, and loyalty of a leader's followers and is a direct result of the leader's character.

related outsider A member of the board of directors not involved with the �irm's day-today operations but who may have a relationship with the company (for example, a major stockholder).

reward power Based on the ability to give or withhold tangible rewards (like pay raises, bonuses, preferred job assignments) or intangible rewards (like verbal praise or respect).

Securities and Exchange Commission (SEC) A United States federal agency that enforces federal securities laws and oversees key participants in the securities world, including stock brokers and dealers, investment advisors, and mutual funds.

servant leadership A form of leadership that focuses on removing obstacles that prevent employees from doing their jobs, thus enabling them to realize their full potential.

stock exchange An independently run exchange that enables the stock of public companies to be bought or sold at a price dictated by demand and the performance of those companies.

strategic leadership Involves developing an outlook and strategy that will position the company to become a stronger competitor, in both the short term and the long term.

strategic-planning committee An optional committee of the board of directors responsible for keeping the board informed about strategic decisions the company might take and for making sure that the board's

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input is taken into account (for example, in the company's annual strategic-planning process).

top management Typically comprises all the vice presidents and C-level executives in a functional organization, the department heads and key staff directors in a matrix organization, and key staff directors and all divisional and subsidiary presidents in a divisional organization.

top-down change Change instigated by the CEO when the company needs to act quickly and decisively.

transformational leader A leader that satis�ies the higher needs of the followers and who interacts with followers to raise the organization to a higher moral plane.

vision statement A concise statement of where the organization would like to see itself 5 or 10 years (sometimes longer) in the future.

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Chapter 3

Strategic Thinking

gerenme/istock/Thinkstock

Learning Objectives

By the time you have completed this chapter, you should be able to do the following:

Understand how complex strategic thinking is, and appreciate why one cannot do strategic planning without it. Learn how to go about �inding a better strategy through identifying viable opportunities. Identify situational monopolies or unique market spaces with no competitors. Learn how to create viable scenarios so that strategic decisions might be made taking into account alternative likely futures. Learn how to go about �inding a better business model.

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Strategic thinking is part of the strategic-planning process, which itself is part of the strategic- management process. This chapter describes what is involved in doing strategic thinking and why it should be done year round, not just when doing strategic planning. It includes many tools and techniques useful in �inding and evaluating opportunities as well as trying to understand which of several futures might unfold.

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3.1 Purpose of Strategic Thinking

Company and business owners need a clear picture of the next few years in the life of the company in order to make decisions so that the company can continue to prosper. Not surprisingly, the further into the future one looks, the more potential outcomes have to be considered.

What does strategic thinking really mean? To be sure, it implies thinking outside the box and not limiting oneself to conventional ideas. One pioneering approach to creativity developed by Edward De Bono is called lateral thinking.

Edward De Bono likens the process to a game of chess, which uses a standard set of pieces on a standard grid. He argues that, in life, the pieces are not a given even though we may perceive them as such. To engage in lateral thinking the object is not to play with the existing pieces but to change the actual pieces themselves. Strategic thinking may also have something to do with "seeing the big picture," or being able to distinguish between "the forest and the trees." Some strategy consultants use the analogy of a helicopter ride that takes one up to a suf�icient height to see the big picture, the road beyond the turns, and the hills that, from ground level, are not visible. Some even take managers through lateral thinking and creativity exercises to "free up" people's thinking, implying that to do these things is to think strategically. While these activities may be useful, they are not suf�icient, and they do not constitute strategic thinking. (To learn more about lateral thinking, see De Bono, 1970, 1971, and 1992.)

Earlier, it was noted that a company could operate with a plan rather than with a strategy if it did not have to compete. The term strategy signi�ies the need to contend with and outwit competition. Therefore, strategic thinking involves �inding unique ways to compete and provide customer value. In other words, strategic thinking entails coming up with better strategies and business models.

The Origin of "Thinking Outside the Box"

A phrase we often hear used casually in everyday speech in business, "thinking outside the box" is a useful metaphor for communicating how ordinary people can actually create extraordinary value when working together in organizations. The phrase comes from a famous puzzle in mathematics known as the nine-dot problem. Visualize a page with nine dots arrayed in three rows of three dots each. The objective is to draw four straight lines that connect all of the dots, without lifting your pencil from the paper.

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The puzzle seems intractable because we immediately assume we are bound by the imaginary square in which the nine dots are arrayed. Of course the puzzle is impossible to solve with that constraint, but the instructions never mentioned any restriction. Most people simply assume this boundary and thus are limited by their perceptions or mental model. The solution requires that three of the four lines extend outside the space de�ined by the outmost dots (see below). Hence, the metaphor "thinking outside the box" refers to thinking outside of the normal mental models that in�luence the way we view the world.

For example, consider Starbucks. In a March 2011 interview, CEO Howard Schultz admitted that the rapid growth of the chain had become a "carcinogen" on its overall health. He re�lected:

"Growth should not be, and is not, a strategy. It's a tactic." He recalled visiting a Starbucks store and �inding a table of teddy bears for sale. Concerned that this type of merchandise had nothing to do with coffee, he queried the manager of the store who explained that the bears were boosting the store's monthly sales. Schultz realized that the coffee chain had strayed far from its mission and values in its

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emphasis on this sales metric, which is but one way to measure the health of an organization. In response, Schultz and his team had to engage in a new line of strategic thinking to create better strategies that would deliver customer value and satisfaction and bring the chain back to its roots (Webb, 2011).

It is not possible to create a strategy without using strategic thinking. The quest to �ind workable alternative strategies—one component of the strategic-planning process—is essentially strategic thinking in action. Discovering the strategy that is "right" for a company can result in a higher market share, a new competitive edge, or discovery of an uncontested market space, all of which is accomplished through strategic thinking. In the Starbucks example, after a period of strategic thinking, Schultz announced the end of monthly comparative sales reporting, and the chain shifted its merchandising to products that were tied to coffee, such as the now-popular "Via" instant coffee. Shultz and his team strategically �igured that if they could "integrate Via and other products into the emotional connection we have with customers in our stores," they could launch a new model that would still feed the bottom line but in a way that is consistent with the organization's mission. Even being able to choose the industry or to dictate the rules of competition, should the company be so fortunate, are legitimate outcomes of strategic thinking (Webb, 2011).

Strategic thinking is not just "thinking" or "blue-skying," but trying to �ind different and better ways of competing, of delivering customer value, and of growing—that is, thinking with some purpose in mind. Without such thinking and absent many years of experience, coming up with alternative strategies or business models and choosing a preferred or "best" one becomes considerably more dif�icult. The following sections go into more detail about how to engage in strategic thinking.

Discussion Questions

1. Chatting with a guest over dinner, you learn that he manages a small business and that, as this is a new experience for him, he feels somewhat overwhelmed. How might your knowledge of strategic thinking help him?

2. Is being highly creative the same as being a good strategic thinker? Why or why not? 3. What might be an apt analogy for trying to do strategic planning without doing any strategic thinking?

4. If a company did only strategic thinking, would it need to do strategic planning? Discuss.

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3.2 Finding Better Strategies

Having discussed the range of potential business strategies in Chapter 1, we shall next examine how companies can make decisions about which strategy or strategies work best for them. Searching for a better strategy could simply mean "look at strategies we aren't currently pursuing and see whether adopting any of them makes any sense for us." In meaningful terms, however, the challenge is more complex. In this section, we explore three ways of thinking that would yield better results:

Play a different game Be entrepreneurial Find more opportunities

Play a Different Game

Strategy is all about standing out from the competition by �inding a unique way to dominate the industry. To paraphrase Michael Porter of the Harvard Business School and leading scholar in the �ield of strategy, improving the way you do business is desirable, but will not produce long-term bene�its if it is something that your competitors can replicate (Porter, 1996). If competitors can easily copy your strategies, you will have to rethink them as you will not be about to maintain your advantage for long.

Consider concentration, a recognized strategy by which a company continues to better its product and broaden its market share. If the competition imitates this success by playing the same game, at best a company may gain a limited or momentary edge by developing a new product or powerful advertisement. Porter would say that this is achieving greater operational effectiveness, not strategy (Porter, 1996). The difference comes when a company can successfully differentiate itself in a way that is dif�icult or impossible for competitors to imitate. Differentiation is a form of playing a different game—a game which ideally only your company is positioned to win.

For example, TOMS Shoes founder Blake Mycoskie has created a unique business model that's a win for the company, its customers, and the hundreds of thousands of impoverished children in Argentina, Africa, Ethiopia, and the United States who receive a free pair of shoes for every pair purchased (Cook, 2009). There is nothing particularly special or unique about selling shoes, or the design of the TOMS model. Consumers have hundreds, if not thousands, of choices when it comes to casual, affordable footwear. But Mycoskie's differentiation strategy of introducing a social message of "doing good" into his business has resulted in a recognizable and pro�itable brand.

Gary Hamel and C. K. Prahalad, who formulated the "core competencies" business model, made a similar point when they said that �irms should not be too concerned about competing with their current competitors. Focusing on the actions of competitors puts a company in the position of simply making attempts to "catch up," by which time the industry leaders would have lengthened their lead again. Instead, they suggest that companies should prepare to compete in a future market, one that only they know about and for which, therefore, they would have the greatest lead time preparing to serve. When a

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Trader Joe's stores differentiate themselves from other grocery stores by having fast turnaround; selective and privately labeled products; small, intimate environments; great customer service; and extraordinary value.

Associated Press/Ric Francis

company comes up with the right products to serve that market, it will, by de�inition, be the leader and have all others scrambling to follow and catch up (Hamel & Prahalad, 1994). These are valuable points, but identifying such a market is no trivial feat. Preparing to compete in a future market requires an intimate knowledge of industry and market trends as well as what is changing in the general external environment. These are, in fact, the requisite elements for strategic thinking when it is done properly, all the time, year round.

One clear example of successful differentiation is the grocery store chain Trader Joe's. The chain began as a small group of stores based in Southern California and by 2011 grew to become a nationwide chain with 365 stores and an estimated $8.5 billion in revenue (Supermarket News, n.d.). Joe Coulombe, the chain's founder, quickly realized that he could not compete against traditional convenience stores such as 7-Eleven or well-known grocery store chains like Safeway. In order to be different, he drew on his love of traveling to France for food and wine, turning trips abroad into business trips to purchase for his stores. Today, Trader Joe's differentiates itself in �ive distinct ways:

Selective products. Trader Joe's has a limited assortment of about 3,200 SKUs (stock-keeping units), a relatively small number for a grocery store. In contrast, a large supermarket would have on the order of 50,000 SKUs. The items turn over quickly. Private-labeled unique products. About 70% of the items in the stores are unusual items that were found on international buying trips and immediately repackaged with the Trader Joe's brand label. The stores do not stock commodities. Because most of the items are unique, customers can buy them only from Trader Joe's. Small, intimate feel of each store. The stores are kept intentionally small and very intimate. A Trader Joe's market is on average about 10,000 square feet. Safeway by comparison has an average store size of 55,000 square feet. If a store gets too crowded, another one is opened. Giving each location a neighborhood-store atmosphere that is not slick or chainlike turns it into a unique social experience for the customer. The Trader Joe's brand is, in fact, the store. Fanatical attention to customers. Everything Trader Joe's does centers on the customer. Its whole philosophy of buying and offering products is predicated on choosing those products that customers will and do buy. The products are selected and tested with the customer in mind. This forges a bond with its customers and gets them to come back time and time again. Extraordinary value. Trader Joe's buying target is a product with signi�icant value, comprising taste, quality, private labeling, and price. Each product has to pass a number of tests in the tasting process. Trader Joe's thus ensures that the products taste good, meet rigorous standards of quality, and are priced competitively. That spells value from the customer's point of view. If Trader Joe's cannot �ind the best price for a product, the item is not carried in its stores (Abraham, 2002).

Trader Joe's is a model of what it means to play by your own rules and win. The chain's business model is unrivaled, with popular products and a trusted brand name. Customer loyalty is what sets Trader Joe's

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Nike used a concentration strategy to develop a whole new line of athletic apparel in addition to its athletic shoes.

Associated Press/Rick Bowmer

apart from competing grocers. After all, isn't one supermarket much like another? Finally, Trader Joe's selects the items it stocks and sells, whereas chain supermarkets all stock the same selection of brand- name products that manufacturers supply to all supermarkets. Because the grocery chains stock a common selection of name brands, manufacturers have bargaining power over them. That is why Trader Joe's is also more pro�itable.

Be Entrepreneurial

Those with an entrepreneurial mindset are "different" from everyone else. They see opportunity where others do not. They seem to have a special knack for discovering opportunities and thinking outside the box. Entrepreneurs are extremely mindful of value generation and tirelessly seek new ways to produce and deliver value. When something takes a long time to accomplish, they look for a faster way. If something keeps breaking down while using it, they look for a more reliable way. If something is too complex, they �ind a simpler solution.

The entrepreneur's ability to see opportunity depends �irst on a level of dissatisfaction with what exists today and a clear conception of the problem. After that, they generate ideas and possible solutions until arriving at a resolution to the problem, which they then develop into a product or service with commercial potential. In each instance, it is the customer's needs and level of perceived satisfaction that drive the changes pursued. The customer base is considered the number one concern, and the entrepreneur must constantly attempt to "walk in the customers' shoes" in order to determine what will ful�ill their needs.

Dustin Moskovitz and Justin Rosenstein were two of the founders of Facebook. In their experiences at the growing giant, they frequently became frustrated with the dif�iculty of project management in an organization with layers of management, hundreds of employees, and a seemingly endless stream of innovations and new ideas. Realizing that their struggles to streamline collaborative work and communication were common to many professionals, they eventually left Facebook to create Asana, a workplace-productivity-software company. Because Moskovitz and Rosenstein had walked in the customer's shoes, they had a great foundation for launching a business that would help other professionals solve common workplace-collaboration and project- management problems (Vance & MacMillan, 2011).

To be able to take advantage of strategic opportunities that they are missing, strategists, organizational leaders, and marketing professionals must learn to look at the world with entrepreneurial eyes and see it from the customer's perspective. Strategic thinking is concerned not simply with how to be different but with generating alternative possibilities of creating customer value that the organization can deliver.

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Figure 3.1 shows a matrix of products and markets. All companies in business are, by de�inition, in the top-left cell, selling existing products or services to an existing market. The bottom-right cell—coming up with a new product for a new market—is not common because of the huge risk such a move entails. Its technical term is conglomerate diversi�ication. Companies that must enter a brand new market with a brand new product should do so either through acquisition or one or more strategic alliances if they are to mitigate the high risk. When product- or market-development strategies are implemented, it is rare that only one of the components is affected. Improving the product is likely to expand the market, and expanding the market usually entails improving the product. Improving or modifying the product often attracts new customers, for example when a sedan is modi�ied to be sportier or even into a convertible. Expanding a market usually involves modifying the product in some way. For instance, selling cars in England that are made in the United States or the European Community requires putting the steering wheel and driver controls on the right-hand side.

Figure 3.1: Concentration strategies

Find More Opportunities

In terms of improving the product or introducing a new one, where do ideas come from besides the customer? Several approaches might be helpful: a system for innovation, Abell's three-dimensional

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business-de�inition model, an experience-based opportunity-search method, structured brainstorming, and strategic frontiers.

System for Innovation

The system for innovation is most useful for coming up with new product ideas rather than changes to an existing product line. In its most basic form, employees are asked to submit ideas for new products to a new-product-development committee. Employees would be given guidelines and some incentive to propose projects and should always have their efforts acknowledged. They would be instructed to give just enough information to enable the committee to determine whether it should follow up on the idea or not. If the idea has merit, the contributor would be asked to provide more detailed information, such as market demand and likely customers, manufacturing process, costs, additional development needed, and likely volume. If the committee then believes that the idea has market potential, it would decide to allocate resources to develop the proposal further, possibly to a prototype stage, along with detailed market and competitive analyses. This would continue until the product was approved for full-scale manufacturing and marketing. Under such a system, the committee would meet as often as there were projects to consider.

Abell's Three-Dimensional Business-De�inition Model

Derek Abell (1980, pp. 29–30) proposed that the mission of a corporation is determined by three dimensions. These are (1) customer groups, or who the company serves; (2) customer needs; and (3) capabilities and technologies, or how the company will meet the customer needs. This analysis is known as Abell's three-dimensional business-de�inition model. Abell maintained that mission statements should contain all three elements. In addition to de�ining a company's mission statement, this model can also be very effective in searching for new opportunities.

The �irst step is to brainstorm different kinds of customers or customer groups that might use or buy the product. Then brainstorm different products that could be made using the company's skills, capabilities, and technologies. For example, a furniture company that makes the upholstery for all its furniture and whose business was declining, produced an idea in a brainstorming session to manufacture sails for boats —the same skills employed in making upholstery, but using different designs and different materials. Lastly, brainstorm other products your customers need or buy that you might provide.

With respect to this last dimension, consider Reader's Digest Association, publisher of Reader's Digest, the largest-circulation magazine in the world in 1992 (around 28 million readers). As famous and as popular as its magazine and brand were at the time, the real value to the company is the huge database of subscribers that it had (about 50 million households in the United States and an equal number spread across other countries). It has used that database to sell various products such as condensed books and other publications, videos, CDs, and so on. In 1992, 66.7% of its revenues and 91.8% of its operating pro�its came from selling products through mail order (its "database-distribution channel"), far higher percentages than its �lagship magazine (Kopp and Lois Shufeldt, 1994). Using Abell's model, what other

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products could it send down this distribution channel (that would be amenable to mail order and that would appeal to its subscriber base)?

Remember that what you are doing when brainstorming is drawing up a menu of opportunities, not the �inal ones you are going to adopt. You might think of it as creating a wish list, without regard to how many items get on that list. Later, prune the list down to those that appear feasible and relevant to the company's business. While you will now have a much smaller number, you may still have too many to adopt. As a guideline, aim for 10 real opportunities, with 4–6 as a more typical range. Investigating the feasibility of more than a handful of opportunities is prohibitively expensive for all but the largest companies. Most, if not all, of these will appear later as strategic issues to be evaluated as to whether it makes sense for the company to pursue them.

An Experience-Based Opportunity-Search Method

A few years ago a multidisciplinary team of students at California State Polytechnic University undertook a yearlong project to identify commercial opportunities for a large aerospace company in the Los Angeles area. The company had a system for innovation, which in the past three years or so had yielded over 80 ideas, of which only three had been pursued and implemented. All three had subsequently been sold to other companies, because the company did not consider them to be integral to their core business. In terms of ongoing products and revenue streams, the company was still searching for opportunities to pursue. Clearly, the company's system for innovation was not working. Furthermore, �inding new opportunities took on particular urgency because the defense industry was in the midst of a long-term decline.

In explaining how it went about the process of seeking opportunities, the company showed the team a triangular diagram that was used to depict the company's strategic options (Figure 3.2). The points of the triangle each represented one of three variables, one or more of which could be adjusted to stimulate ideas for new business opportunities. These parameters de�ined the project, which was essentially to �ind a number of concrete opportunities the company could pursue.

Figure 3.2: Opportunity-search method

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In simple terms, the options consisted of some combination of �inding new markets, developing new technologies, and modifying the existing business systems. For example, the company could try to �ind new customers without changing either its technical capabilities or its business system. This constraint limited potential customers to large billion-dollar companies or the federal government. Another option would be to update its technical capabilities to develop products for existing markets while maintaining its present business systems. A third possibility would be to innovate with its business system, while keeping the others constant. At a deeper level of complexity the company could change any two sets of variables while keeping the third constant, or it could change all three at once. Clearly, the more variables that are changed simultaneously, the riskier the strategy. Initially, the team was asked to con�ine its search for opportunities to �inding new customers while keeping the other two variables constant. Later, because that constraint was found to be too restrictive, it was relaxed to include acquiring a new technology or core capability if the opportunity in question was signi�icantly large and worth pursuing, and even include changing its business system.

The actual method this team used was a combination inside-outside approach. The inside-out part involved �irst gaining an understanding of the company's products, technologies, capabilities, and business systems, and then trying to �ind new markets and applications that might �it the company. The outside-in part involved �irst looking at competitors, markets, industries, and application areas to �ind opportunities, and then comparing them against the company's technical capabilities and business process to see which were feasible. The project team came up with 28 ideas but quickly discarded half of them because of obvious de�iciencies or mismatches with the company's capabilities. The remaining ideas were then pruned to seven candidates, from which the company selected four for further study. The team �inally recommended three solid opportunities that met all criteria. The project showed that gearing up to �ind opportunities is time-consuming and costly and really should be done year round. In this way, a company will have time to act on those it �inds that have real potential.

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Tyson Foods reached more customers by offering different kinds of chicken products.

Associated Press/Paul Sakuma

Opportunities are the lifeblood of any organization and one of the primary sources for key strategic issues for the company. Many strategic issues entail making choices between opportunities a company could pursue and, in fact, the key ones �ind their way into one strategic alternative or another. That is when the decision is made as to which opportunity or opportunities should be pursued, particularly in the typical case where the company cannot afford to pursue more than one at a time.

Structured Brainstorming

Thinking outside the box helps businesspeople seek solutions to problems in ways that are neither mundane nor predictable. The following opportunity-seeking questions may serve to facilitate a structured brainstorming process to develop potential opportunities:

Are there other customers who might bene�it from our product, even if the product is used differently? Hughes Aircraft was a major aerospace and defense contractor that faced shrinking markets for its products when defense budgets began declining in the early 1990s. One of its divisions focused on selling and servicing satellites for government and industrial clients. To reduce its dependence on government contracts, it created a different business model directed at a consumer market. The technology that it had developed for the military and large corporate customers was repurposed to enable the beaming of television channels and movies off satellites to home-mounted satellite-dish receivers. By 2001, the division, now called DirecTV, accounted for 77% of Hughes' pro�its at the time (Tucker, 2001). What other products could we produce for the same customers? Tyson Foods provides a good example of a company �inding new opportunities by expanding its product offerings to existing customers. In 1967, Tyson was doing very well, with $53 million in annual revenues from selling raw chickens, mainly to grocery stores in Arkansas and neighboring states. Growth options at the time were either to truck the chickens to more states or come up with new products. The �irst new product was a chicken patty for sandwiches. In due course, as a result of trying to �igure out how to "do more with chicken" (Tyson's motto), it began offering chicken pieces, marinated chicken, frozen prepared-chicken dinners, chicken tenders, chicken nuggets, and ready-to-eat chicken "buffalo wings." Along with these product innovations, Tyson explored different distribution channels. Instead of selling chicken products only to food shoppers through grocery stores, it set out to reach consumers even when they went out to eat, and expanded its markets to include fast-food outlets, restaurants, airlines, and hospitals. In the early 1980s, it worked with McDonald's to add chicken to its menu. In the decade that followed as Chicken McNuggets became popular, Tyson experienced a 7-fold increase in revenues and 19-fold increase in earnings per share (EPS) (Tucker, 2001). What other types of products might we create, for any customers that have need of our expertise, technologies, and ability? Matsushita Corporation is a conglomerate that produces products for many markets worldwide. At one point, it was faced with the maturing of its rice-cooker, toaster- oven, and food-processor product lines. Using technologies contained in each of them (computer- controlled heating from the rice cooker, heating devices from the toaster, and motors from food

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processors), it created a new consumer product, a bread machine, that produced a variety of breads reliably and simply every single time. The product produced outstanding sales the �irst year it was introduced (Abraham & Knight, 2001). In contrast, Motorola, which had been producing amazing touch-screen cell phones in its labs in China for the Chinese market, failed to move that technology from China to the United States and other markets. Why? There was no innovation process, or standardized-pipeline mechanism that focused on bringing out a steady stream of innovative products (Nussbaum, 2008). How might we reinvent our business model in order to gain a competitive advantage? Thomas Weisel Partners Group was a leading force in taking dot-com-era �irms public in the late 1990s. Weisel, for example, ushered many small start-ups under the Yahoo! umbrella. But when the dot-com bubble burst in 2000, he was forced to either reinvent the company or take up golf prematurely—probably on a public course. Like many other �irms that survived the crash of the tech market, Weisel now focuses on easily pro�itable social-media and social-networking sites. Because these sites rely on relatively inexpensive technology, they tend to make money quickly. Similarly, Sandy Robertson, a technology-oriented private-equity banker, describes the critical business-model shift from "old" tech to social media: "Social media is the new frontier." Like those �irms that survived the �irst bubble bust, these are aware that the social-media craze might not last forever, either, and remain dynamic and �lexible in their models and practices (Craig, 2001). Apple provides another good example. While not the �irst to bring digital music to market, it simply took over that market when it launched the iPod. Apple's true innovation was making downloading music easy and convenient by adopting a business model that combined hardware, software, and service. Looking to the future, can we predict which industries will have the highest growth? This is a variant of the previous question and involves diversifying into a business in which the company has little experience or know-how. At �irst glance some people might say that pursuing such a strategy would be irresponsible and a recipe for disaster. There are, however, ways of entering a new business area intelligently and while minimizing the inherent risk of a diversi�ication strategy. A company could always hire someone having a great amount of experience and know-how in the proposed industry to head up the effort. It could also acquire a company already in that business whose management had the necessary experience and expertise. Assuming that these steps could take care of the inherent initial risk, the issue here is identifying which industries are growing rapidly.

While �inding opportunities for growth should always be a top priority for a company, there is an endless list of companies that have allowed themselves to become distracted from their main business, whether through an acquisition, integrating vertically backwards, diversifying, or searching for other opportunities. A company must continue to perform optimally at its core business while the search for new opportunities takes place simultaneously. When the current business stops growing, two things happen: pressure to maintain pro�its and the stock price leads to cost-cutting, including programs for new-product development, and the cash available for developing new sources of revenue dries up (Fisher, 2001). Putting a manager or small group permanently in charge of the opportunity-�inding process will enable the company to keep its focus on its present business, the growth of which must be maintained. Losing that focus can be fatal to a business (Reis, 1996).

Strategic Frontiers

In their book, The Power of Strategy Innovation, Robert Johnston and Douglas Bate propose that companies adopt a process called "strategy innovation" which is the term they use for strategic thinking

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(2003). One important concept put forth is exploring a strategic frontier, which they describe as anything a company might do in the future that it is not currently doing or that could be an extension of its current strategy. That might involve targeting a new market, entering another business, merging with another company, forming a strategic alliance, broadening the product line, adopting a new technology, and so on. The authors de�ine strategic frontier as "that unexplored area of potential growth that lies between today's business and tomorrow's opportunities," (113). Table 3.1 presents some examples of strategic frontiers.

Their method advocates �irst getting top-management agreement or alignment as to which strategic frontier is to be explored, but this unnecessarily limits the person or group and runs the risk of the chosen frontier not being the correct one. It is better for the exploration to be open-ended and to inform it with information about how industries, competitors, and markets change.

Table 3.1: Some strategic frontiers

Company-Speci�ic Company-Generic Marketplace

New product Franchising Arti�icial intelligence

New product category Globalization Biotechnology

New distribution channel JIT manufacturing Genomics

New manufacturing process Mass customization Internet

New positioning Outsourcing Nanotechnology

New sourcing strategy Partnerships Smart materials

New technology Patent exploration Wireless communications

Services Automation

Source: Reprinted from The power of strategy innovation: A new way of linking creativity and strategic planning to discover great business opportunities (p. 177), by R. E. Johnston Jr. and J. D. Bate, 2003, New York: AMACOM. Reprinted with permission.

One of the best models for sustained growth that embodies some concepts discussed earlier comes from a book written by three partners at McKinsey & Company, a well-known global management- consulting �irm. They call the model the "three horizons of growth":

Horizon 1 constitutes the company's core business and accounts for the lion's share of pro�its and cash �low. The Horizon 1 business must be successful for initiatives in Horizons 2 and 3 to be viable. Horizon 2 comprises businesses or lines of business on the rise that could transform the company but not without considerable investment. They might be described as the emerging stars of the company. Though pro�its are still several years away, they show strong revenue growth and a growing customer base. They are entrepreneurial in nature and focus on increased revenues and

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market share. They could be extensions of the �irm's current business or moves into new directions. Horizon 2 emphasizes building new streams of revenue for the �irm that could in time become Horizon 1 businesses. Horizon 3 businesses are options on future opportunities, but they are not simply ephemeral ideas. Rather, they are real activities and investments, however small, such as research projects, minority stakes, pilot projects, etc. These might never show a pro�it or conversely they could be successes that eventually end up as Horizon 1 businesses (Baghai, Coley, & White, 2000).

The key is to manage all three horizons concurrently. Putting off Horizon 2 or 3 businesses is tantamount to closing down the company's future. While these may be new terms for short-, medium-, and long-range projects, the principle is the same. To ensure long-term growth, the company has to "�ill the pipeline" and then nurture Horizon 2 and 3 projects into Horizon 1 successes. A company's vision has to encompass all three horizons, not just Horizon 1. Using earlier constructs, this describes a formal opportunity-�inding mechanism operating all the time, producing a "portfolio" of products or businesses with growth potential. These opportunities then have to be managed and brought into the mainstream of what the company does, its Horizon 1 businesses. Identifying and starting Horizon 3 businesses, for example, takes a very different entrepreneurial mindset and approach from managing the current core Horizon 1 business successfully. The difference is opportunity-�inding and strategic thinking.

The new opportunity or �ledgling business should be run as a separate enterprise, primarily because it might require a business model very different from the company's current one. Trying to create and implement a new business model while operating the existing one is dif�icult at best. Christensen proposed the concept of a disruptive strategy, that is, one that will disrupt the market but at the same time broaden the customer base and help the company grow. He cites the example of Teradyne, a company that made sophisticated integrated-circuit-testing equipment. In the mid-1990s, it sensed that competitors were about to introduce a cheaper, simpler version of the product that could test simple circuits at the low end of the market. Rather than wait, Teradyne decided to beat them to it. Because creating such a product would also disrupt Teradyne's current product, it needed to be handled by an independent group within the company. By keeping very tight control on costs and a separate focus, the venture achieved $150 million in annual sales within 18 months of its release in 1998 (Christensen, Johnson, & Darrell, 2002).

Discussion Questions

1. If playing a "different game" makes so much sense strategically, why doesn't every company follow that advice?

2. Is it possible for established companies—even ones in mature industries—to think entrepreneurially?

3. Consider a company that had an "opportunity-�inding" process it followed throughout the year. Presumably its opportunity "pipeline" would be full and it would constantly be deciding which ones to pursue, an enviable position to be in. What could go wrong with such a process? Why might it not produce envisioned results?

4. Might following a rigid process for identifying and analyzing opportunities sti�le creativity? Doesn't creativity �lourish better in a freewheeling environment? Discuss.

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5. A company has, over time, succeeded in differentiating itself and raising its pro�its. What must it do to capture those bene�its over an extended period? Can a differentiated edge erode? Discuss.

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3.3 Finding Unique Market Spaces and Situational Monopolies

Section 1.6 introduced Kim and Mauborgne's concept of a blue ocean and why it made so much sense to look for one (Kim & Mauborgne, 2005). This section explains two related techniques that are central to strategic thinking: �inding a blue ocean, and how to �ind a situational monopoly, a related concept proposed by Milind Lele of the University of Chicago Graduate School of Business (2005).

Value innovation is at the core of a blue-ocean strategy, which places as much emphasis on value as it does on innovation. Instead of having to make a trade-off between differentiation and cost, as most strategies require, value innovation seeks to pursue differentiation and low cost simultaneously, which is easier to do when you are in a market space with no competition.

Kim and Mauborgne's two analytic techniques for beginning to think about how to �ind a blue ocean, namely the strategy canvas and the four-action framework, are summarized in the following sections.

The Strategy Canvas

The strategy canvas technique takes the form of a graphical two-dimensional representation. The x-axis comprises a list of the factors on which the industry currently competes, such as price, features, promotion, distribution, service, and so forth. The y-axis represents the offering level that buyers receive across all these competing factors.

When the offering levels of each competing factor, whether for an industry, a segment of it, or a company, are connected, the resulting plot or strategic pro�ile is called a value curve. For a company, its value curve is a depiction of its relative performance across the key competitive factors of its industry. Figure 3.3 shows a depiction of the strategy canvas for the personal-computer industry.

Figure 3.3: The strategy canvas for the personal computer industry

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Value curves can depict performance of an industry or its segments. Creating value curves can be based on extant knowledge of an industry or company, or a melding of the opinions of a group. The fact that what results isn't as accurate as if done through extensive research doesn't matter. The important thing is to ask the right questions and focus on the right issues. Greater skill comes through more practice.

Value curves of segments and companies may or may not intersect. In parts where they overlap, a company is not differentiated on those competitive factors. Where the company's value curve is higher than the industry's, the company is clearly differentiated on those issues. In a situation where a company uses issues on which the industry doesn't even register such, as using unique competitive factors, the company can be said to have found a blue ocean.

From the founding of Apple Computer in 1976, Steve Jobs envisioned the PC as a personal-information device. The Microsoft-Intel alliance, euphemistically called WinTel, appropriated this notion and made the PC business that of an industrial computer, sold in quantities to large corporations. By 2001, the PC market had degenerated into a "red ocean" of price/performance competition where ever-faster computers with ever-greater memory and storage were being offered at ever-decreasing prices.

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With Apple computers, Steve Jobs implemented a strategy that turned the personal computer into a personal accessory that the consumers could be identi�ied with.

Associated Press/Paul Sakuma

Jobs saw an opportunity to refocus the PC on people, not corporations. Jobs' vision of the PC was not so much a personal computer as it was a personal accessory, much like the automobile had become by the 1950s. He envisaged the computer as something that people would use as a tool while at the same time being something to which they attached their identity, much as they might a designer handbag. Jobs realized this vision by designing Apple's computer to be visually beautiful, so it became almost a fashion statement. In manufacturing Apple incorporated industry-leading screen technology and superior case materials such as titanium rather than the plastics used by competitors. Apple set the industry standard for customer service, and reintroduced the concept of branded retail stores. The Apple Stores are about brand building, not sales; for the �irst two or three years, Apple lost money on every computer sold in its stores. Apple deliberately raised prices of its products to cover the advanced visual appeal of its machines and the high level of customer support, aware such prices would reduce the price/performance metrics of its products.

Although there will always be a corporate industrial market for PCs, by 2008, with mobs of excited customers �illing its branded retail stores, Apple had created a blue ocean marketplace where the other

PC competitors were no longer relevant. By August 2010, Apple had become the most valuable technology stock in the world and then became the company with the biggest market capitalization in the world (Crum, n.d.).

The Four-Action Framework

A �irst attempt at plotting a company's value curve might disappoint if the curve is too similar to that of the industry. This means, of course, that the company is not at all or not suf�iciently differentiated. The four-action framework is designed to stimulate thinking to �ind ways to differentiate the company and even ways of competing that have not been contemplated by the industry, which is to say, a blue ocean.

Situational Monopoly

The conventional mental model of a monopoly is a company that accounts for 100% of sales in a given industry; that is the de�inition taught in every introductory economics course. Governments created the majority of such monopolies. In Britain, for example, in the past the state ran the railroads, telecommunications, airlines, health care, and other major industries. Most have since been privatized, except for the National Health System (Abraham, 1974).

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Notwithstanding the traditional de�inition, a form of monopoly exists that most successful companies operate at different phases of their operation. Lele termed this a situational monopoly or monopoly space, and it exists because a company either creates or takes advantage of a situation to charge monopoly prices. It is "an ownable space for a useful period of time" and is natural, legal, and surprisingly common (2005, p. 25). Consider the high concessions prices at movie theaters and sports arenas. Vendors are able to charge in�lated prices because the facilities allow only food and drink that was purchased there to be consumed on the premises. Similarly, consumers are forced to pay high prices for brand-name replacement-ink cartridges for printers if the warranty is not to be voided. In the personal-care-products business one can see this same situation with replacement-razor blades.

Companies can create a situational monopoly through innovative business practices. Dell was able to enjoy a 10-year monopoly when it was the only computer manufacturer selling made-to-order PCs for the corporate market. Enterprise Rent-A-Car grew to be the largest car-rental company in the United States because it is the only car-rental company that caters to people for local, nontravel-related needs such as renting a car when their own car is being serviced or repaired, and it will pick you up and drop you off at the end (Lele, 2005).

To discover where your company's next monopoly space might be, look for a pattern and a situation where customers want something that existing competitors can't or won't provide. In other words, look for an emerging need, incumbent inertia, and new capability. All three conditions must be present for a monopoly space to be opening up (Lele, 2005).

Because owning a monopoly space is legal and produces high pro�its, every company should want to look for one and hang on to it as long as possible. In fact, Lele says, a company's chief responsibility should be to �ind its next monopoly space. That should be the goal, and how to get there should be the strategy (2005).

Case Study The Merger of Whole Foods and Wild Oats: Shattering the Situational Monopoly

In early 2007, the premium organic and natural-foods grocer Whole Foods proposed a purchase of competitor Wild Oats' 190 stores. Subsequently, the Federal Trade Commission challenged the deal, claiming that because Whole Foods and Wild Oats were the "only two nationwide operators of premium natural and organic supermarkets in the United States," the purchase would enable the creation of a monopoly in this market.

In his ruling against the FTC, United States District Judge Paul L. Friedman highlighted the ways in which contemporary market dynamics shatter monopolies. Essentially, although Whole Foods and Wild Oats were the only supermarkets dedicated to the sale of natural and organic products, Friedman pointed out that other national supermarket chains such as Wegmans,

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Safeway, Publix, Kroger, Supervalu (and subsequently, even Walmart) have invested heavily to compete in this market. Court documents even referred to statements made by Whole Foods that the chain had reduced prices in order to be competitive with some of these other mainstream supermarkets' natural and organic offerings.

Although Whole Foods and Wild Oats together at one point had a monopoly space on premium natural and organic groceries, other supermarkets had realigned their strategies to enter and compete in this market. "To put it colloquially," Friedman wrote, "this train has already left the station" (Federal Trade Commission v. Whole Foods Market, Inc., and Wild Oats Markets, Inc., p. 37).

The Whole Foods/Wild Oats merger calls into question the staying power of monopolies and situational monopolies. The current economy, enabled by globalization, quick and �lexible decision making (often facilitated by digital media), and the need to be adaptive and dynamic in business practices may extinguish these notions. What do you think?

Questions for Critical Thinking and Engagement

1. In our contemporary era of business and organizing, is it possible for a true monopoly to develop? If yes, in what industries and why? If no, why not? What about a situational monopoly?

2. What factors made it desirable and easier for mainstream supermarkets to enter the domain of Whole Foods/Wild Oats than in the past?

3. Can the creation of a situational monopoly be strategic, or a byproduct of circumstances? 4. Do organizations with situational monopolies spend resources to keep others out of the market? Why or why not?

5. Identify another example of a once situational monopoly that now splits market share or that has exited the market entirely. Describe the circumstances either in writing or during class discussion, as directed by your instructor.

Discussion Questions

1. Which concept is more useful, in your opinion, in trying to �ind a unique market space with no competitors—the strategy canvas and four-action framework or a situational monopoly? Give reasons for your answer.

2. Do you think there are differences between the bene�its of a highly differentiated strategy and being in a monopoly space? If so, what are they? If not, why not?

3. "Monopoly" still has an unfortunate and illegal connotation, yet owning a monopoly space is perfectly legal, highly pro�itable, and quite common. If you had to come up with another name for it, what would it be?

4. Can you use the four-action framework without a comprehensive knowledge of the industry in which your company is competing?

5. Must one use the strategy-canvas tool together with the four-action framework, or can they yield bene�its when used alone? Discuss.

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3.4 Creating Future Scenarios

The consequences of any decision made today play out in the future. Likewise, the product of every decision made during the strategic-planning process, including the strategy itself, happens in the future. It is important then that strategists and key organizational managers should feel comfortable in thinking about the future, because that is where they are going to live and work, implement plans and achieve results, and take the company to where it is going.

Some managers are not comfortable thinking about or dealing with the future, adopting an attitude that it is beyond their purview and is instead the burden of the executives. Many view it as "beyond their control." They feel that nothing they can do can change the inexorable momentum that carries us into the future. That is a fatalistic attitude.

One cannot change other people or their behavior, but one can control how one responds to other people and what one does oneself. Most of all, it is a deep-down belief that what you do does make a difference and can affect how things turn out in the future. This is called a normative attitude. People with a normative attitude do not extrapolate everything. While certain industries that are stable for a number of years lend themselves to short-term extrapolation, others are more volatile or unstable and are likely to be discontinuous; the future will be unlike the past.

How does thinking about the future relate to strategic thinking? First, any kind of strategic thinking is going to be set in the future, so learning some ways of forecasting or anticipating the future can serve you very well. Secondly, trying to do strategic thinking with a fatalistic or naıv̈e attitude about the future will adversely affect the results achieved. Instead, a normative attitude asks, of all possible futures, what can be done to bring about a desired future. Finally, being comfortable about the future means being comfortable with ambiguity, uncertainty, incompleteness, and subjectivity. This is easier said than done. For example, most accountants, used to dealing only with historical information, �ind dealing with the future very dif�icult. In fact, they have resisted auditing forecast information for public companies for years, unwilling to take responsibility because of the uncertainty (Abraham, 1978).

Futures Research

Methods of looking at or analyzing the future are called futures-research methods. One of the most relevant methods that would enhance strategic thinking is scenario planning. Despite the fact that scenario planning requires weeks to months of time, training, and expertise, companies often bene�it greatly from the shared learning process as well as from the end result. Such planning can serve to position and hone employee skills as well as change set thinking habits.

Doug Randall (2009), managing partner of Monitor 360 and a partner at the strategic-consulting �irm Monitor, believes that the future should be explored in order to understand more fully options that might be considered today. He offers the �ive following recommendations:

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Futures-research methods are a way to analyze the future, enhancing strategic thinking through scenario planning and future mapping.

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Create scenarios that are plausible, not necessarily probable. Determine what it would take to be successful in each scenario; give your creativity free rein. Assess current capabilities and be painfully realistic. Identify gaps between current capabilities and what it would take to be successful in each scenario. Be honest in your analysis. Make choices considering all your options.

Scenario Planning

Scenarios are detailed descriptions that attempt to predict or project the way that something might happen in the future. Engaging in scenario planning fosters preparedness; it allows managers to imagine a range of potential futures and get ready for them before they occur, should they occur. Further, it allows enough time for a management team to consider what the company might do for each scenario should it materialize (Fahey, 2003).

Scenario planning begins with issues deemed critical to the future of the company and about which suf�icient information is unavailable to determine how the issue will turn out. For example, a critical issue for the automobile industry in the United States might be energy prices, or more speci�ically gasoline prices. For the housing, construction, and lumber industry, as well as homebuyers, the critical issue is interest rates, a principal driver and inhibitor of demand. A critical issue for the movie-theater industry and its suppliers today is digital technology. In what form and when will digital-transmission and -projection systems be introduced; and what will persuade movie theaters to invest in and switch to that technology? Some economists, business leaders, scientists, and geopolitical strategists are convinced that water is the new oil; that is, water is rapidly becoming the "blue gold" and is in short supply. Does this represent an opportunity or a threat? (Ebb without Flow, 2009). It is around such critical issues that two to three scenarios are devised, so that they may be compared and contrasted. Potential strategies are not only possible responses to a scenario about the future but also to what different players are likely to face and do within each scenario. These actions in turn may in�luence which strategy may be more appropriate (Wells, 1998).

To begin forming scenarios, one needs to collect information about key forces impinging on that critical issue and driving forces in the macro environment. This is very research-intensive and could cover markets, new technology, political factors, economic trends, demographic changes, and so on. Peter Schwartz says that in this phase one should look for major trends and trend breaks. Next, the key factors and driving forces are ranked on the basis of two criteria: (1) how important they are in determining the success or outcome of the critical issue identi�ied in the beginning, and (2) the degree of uncertainty surrounding them. One is looking for the most important and the most uncertain. The factors that are most important and most uncertain will now form the axes along which the eventual scenarios will differ.

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The purpose is to end up with just a few scenarios whose distinctions make a real difference to decision makers. These sets of issues must be reshaped and regrouped in such a way that a logic for each one emerges and a story (the scenario) can be told. As Stuart Wells says, "The essence of this process is writing stories about the future as if we were viewing the past" (Wells, 1998).

Perhaps a bene�it of equal importance to the value of the insights gained from developing scenarios is the learning that takes place during the process. This learning should be integrated into the strategic-thinking and decision-making processes. Liam Fahey (2003) suggests the following scenario-learning principles:

Scenarios are only a means to an end and should primarily inform decision makers and in�luence decision making. Scenarios should be used to carefully form questions about the present and the future and guide how they might be answered. Each step must aim to identify, challenge, and re�ine manager mindsets and expertise, rather than attempt to perfect scenario content. Scenarios bring to light information that enables managers to track and monitor how the future is developing. In this way, the learning process is ongoing.

Discussion Questions

1. Because there is more than one possible future, we don't know how things are going to turn out; that is, we don't have a crystal ball. Explain why going through scenario planning might provide more useful information than just getting the latest forecast from the Wall St. Journal or New York Times.

2. In your opinion, is the cost of engaging an expert on scenario planning and all the management time involved worth the bene�it? Give reasons for your answer, particularly with respect to what bene�its might be produced.

3. Scenario planning is a complex, time-consuming activity. Can you think of another way to generate similar results at much less cost?

4. Can strategic thinking be done without some form of scenario planning? 5. Are scenario planning and other similar methods only possible for large corporations? Can you think of any way in which small companies might access those bene�its?

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3.5 Finding a Better Business Model

Section 1.8 introduced the concept of a business model as having elements that describe how a company goes about attracting more customers, making money, and growing. A more detailed model of the �irm can be more helpful when doing strategic thinking concerning how to improve one's business model or �ind a better one.

This model, shown as a "business-model canvas" in Figure 3.4, has nine building blocks (Osterwalder & Pigneur, 2010):

Key partnerships (KP)—the outsourced activities and resources acquired outside the company Key activities (KA)—the activities required to deliver the above elements Value propositions (VP)—why do customers buy from the company? Customer relationships (CR)—the relationships established and maintained with each customer segment Customer segments (CS)—which ones does the company serve? Key resources (KR)—assets required to offer and deliver the above elements Channels (CH)—communication, distribution, and sales channels used Cost structure (CS)—the cost structure of the elements of the business model Revenue streams (RS)—revenue streams that result from the value propositions successfully offered to customers

Figure 3.4: The business model canvas

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Using the same business-model canvas, Figure 3.5 shows how Skype's business model disrupted the telecommunications providers. In its �irst �ive years, Skype had over 400 million users, experienced over 100 billion free calls, and in 2008, generated $550 million in U.S. revenues.

As a strategic-thinking exercise, �irst use the business-model canvas to describe the company's current business model (keep entries very brief). Regard each of the nine elements as a source for business-model innovation; elements can be changed one at a time or several at a time.

As you can see, it requires a great deal of creativity and strategic thinking to come up with feasible and purposeful ways of improving the business model to help the company be more successful.

Figure 3.5: Skype vs. Telco

Source: Reprinted from Business Model Generation: A Handbook for Visionaries, Game Changers, and Challengers (p. 99), by A. Osterwalder and Y. Pigneur, 2010, Hoboken, NJ: John Wiley & Sons. Reprinted with permission.

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Summary

In Chapter 1, you learned that strategic planning is a process designed to choose the best strategy a company can follow, as well as decide on its purpose, vision, and objectives. Because strategic thinking, done well, produces potential strategies to follow and suggestions for innovating its business model, it is an indispensable prerequisite to doing strategic planning.

This chapter explored the complex concept of strategic thinking—what it is and how to do it. Strategic thinking includes the constant search for a better strategy, a better business model, and a "blue ocean," situational monopoly, or uncontested market space. It also includes developing alternative futures or scenarios to reduce future risk and guide strategic choice.

Searching for a better strategy involves playing a different game—not being like your competitors, being entrepreneurial (looking at things from a customer's perspective and looking for opportunities all the time), and �inding more opportunities. The chapter presents a number of useful techniques for coming up with opportunities, like Abell's three-dimensional business-de�inition model, structured brainstorming, and identifying strategic frontiers.

Finding a "blue ocean" is made easier using two related techniques—the strategy canvas and the four- action framework, both created by the authors of the book Blue Ocean Strategy. Finding a situational monopoly is easier and, ironically, upends our mental model of a monopoly (illegal in the United States, although the situational monopolies described here are quite legal).

The chapter presents the most useful technique for developing alternative futures—scenario planning. To derive the full bene�its, a company wanting to use it should get expert consultation because of its complexity.

The chapter concludes with the business-model canvas, a tool comprising nine building blocks that facilitates improving the company's business model either incrementally (changing any one of the building blocks at a time) or more radically (changing two or more building blocks simultaneously). Such moves have to be analyzed for feasibility and effect before being considered seriously.

Concept Check

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Key Terms

entrepreneurial mindset Seeing opportunities everywhere.

four-action framework A tool designed to stimulate thinking to �ind ways to differentiate the company and of competing that have not so far been contemplated by the industry (a blue ocean).

futures-research methods Techniques for looking at or analyzing the future.

normative attitude A deep-down belief that what you do does make a difference and can affect how things turn out in the future.

monopoly space or situational monopoly Exists because a company either created or took advantage of a situation to charge monopoly prices. It is an ownable space for a useful period of time.

scenario planning A planning tool designed to create a small number of plausible futures constructed around critical issues for the company about which suf�icient information is unavailable to determine how the issue will turn out.

strategic frontier Essentially anything a company might do in the future that it is not currently doing or that could be considered an extension of its current strategy.

strategy canvas A graphical two-dimensional representation: The x-axis comprises a list of the factors the industry currently competes on, such as price, features, promotion, distribution, service, etc., and the y- axis represents the offering level that buyers receive across all these competing factors.

thinking outside the box A metaphor for thinking outside of the normal mental models that in�luence the way we view the world.

value curve A depiction of a company's relative performance (its strategic pro�ile) across the key competitive factors of its industry on a strategy canvas.

value innovation Seeks to pursue strategies of differentiation and low-cost leadership simultaneously.

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Chapter 4

External Environmental Analysis

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Learning Objectives

By the time you have completed this chapter, you should be able to do the following:

Conduct an industry and competitive analysis and understand why it is important. Conduct a market analysis and understand why it is important. Scan the general environment for any changes or trends that might favor or adversely affect the company.

An analysis of the external environment covers the industry or segment in which the company competes, its competitors, markets, and other relevant environmental trends and changes. The purpose is to understand how the environment relevant to the company is changing and might change in the future --in this sense, "relevant" means anything the company might affect or could be affected by. Without such an understanding, doing strategic planning becomes much more dif�icult.

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Assembling a group of knowledgeable people can be very helpful when performing an industry analysis.

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4.1 Industry and Competitive Analysis

An industry analysis is the study of a �irm's industry and the forces that might be causing it to change. It involves using a number of standard but indispensable tools, including Porter's �ive-forces model, industry attractiveness (part of the GE Matrix), driving forces, critical-success factor analysis, and strategic groups, all discussed in this chapter. Because the ways in which an industry changes can dramatically affect the decisions a company makes, an industry analysis has become a key element in strategic planning.

The word industry in "industry analysis" can mean a segment of a larger industry or the industry itself. If a company manufactures disk drives for personal computers, for example, it could say that it competes in the disk-drive industry for purposes of doing a strategic analysis, even though that is really a segment of the computer industry. What we are really analyzing is the arena in which the company competes.

One thing to keep in mind when conducting an industry analysis is to write down what is true for the industry, not for the company under analysis. Sometimes industry data are easy to obtain because they are regularly published or because trade groups or consulting �irms keep tabs on industry statistics. However, many industries are not tracked by any group, or they consist largely of privately held �irms. This makes it dif�icult to get industry data and complete an industry analysis.

To minimize errors when using inadequate data or relying on one person's estimates, it is advisable to assemble a group of people to share perspectives and use shared estimates in the analysis. If the group is fairly knowledgeable about the industry, the perceptions gathered about the industry will be more useful and make the understanding more complete. Group members who have differing estimates and opinions will be forced to explain their views and, in the process, either convince others they are correct or be persuaded to change their own views or estimates. In this way, a shared perspective leads to greater understanding.

Doing an Industry Analysis

The purpose of doing an industry analysis is to answer the following kinds of questions:

What are the dominant economic characteristics of the industry? In what ways is the industry changing, and why? Do buyers and/or suppliers have greater bargaining power? How steep are entry barriers?

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Is the industry concentrated or fragmented? What must one do well in order to succeed in this industry? How appealing is the industry?

Dominant Economic Characteristics of an Industry

Economic characteristics can vary by industry but generally are applicable throughout business and include the following:

Industry size—total dollar sales of all �irms in the industry. Industry growth rate—percentage increase or decrease over the previous year. Scope of competitive rivalry—local, regional, national, international. Number of competitors—if known. Stage in the industry's lifecycle:

emerging—must be a brand-new industry with total industry sales less than 5%. growth—total industry sales growing at over 5% per year. shakeout—a transitional period between growth and maturity where some competitors fail, others are acquired, and the total number of competitors shrinks. mature—total industry sales of between 0–5% declining—the growth rate must be negative for several years in a row.

The customers or buyers—Who are they? Where are they? How many are there? Degree of vertical integration—How many companies in the industry are vertically integrated forward? How many are vertically integrated backward? How many are vertically integrated in both directions? Rate of technological innovation—How dependent is the industry on technological innovation? How much innovation is taking place? Product characteristics—Are the products commodity-like or differentiated? This determines to a large extent the bargaining power the industry has with respect to buyers. Are the products high- or low-tech? Economies of scale—for example in purchasing, production, shipping, distribution, or advertising. Capacity utilization—Is capacity utilization in the industry high or low? How sensitive are variations in capacity utilization to pro�its? In commodity-like industries, pro�its are very sensitive to capacity utilization. Industry pro�itability—If pro�itability in the industry is not high, what are some causes? Commodity-like industries are low-pro�it, while those with differentiated companies command higher pro�its.

Forces Driving Industry Change

To understand how an industry is changing, identify the driving forces causing those changes. The following are examples of driving forces:

Changes in the industry growth rate Changes in who buys the product and how customers use it Product or marketing innovations Changes in technology Exit or entry of major �irms Circulation of technical knowledge

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Increasing global scope of the industry Changes in cost and ef�iciency, for example, in process innovations Emerging buyer preferences for differentiation Changes in governmental or economic policy Deregulation or increasing regulation of an industry Changes in societal attitudes, concerns, and lifestyles Reductions or increases in uncertainty and business risk Likelihood that this and one or more other industries will merge or converge

It is one thing to ascertain that an industry has been and is changing, but quite another to gauge the way it will change in the future. That is, however, the challenge managers must face. If one can come to understand how an industry is changing and what is causing it to change, the chances are good that future changes can be predicted and possibly anticipated. In many industries today, rapidly advancing technology is changing everything about the industry—the product itself, how it is made, how it is distributed, and how it is used. The examples provided of driving forces may provide a starting point for an examination of a particular industry and how it may be changing. Of course, it is important to keep in mind that every industry is unique and may have driving forces other than those listed here.

Bargaining Power

What exactly is bargaining power? In simple terms, it comes down to who dictates the terms such as price, delivery, quality, and the like in a negotiation. Consider the example of someone trying to sell a used car. There is a certain "Blue Book" price for a car of a certain model, age, mileage, condition, and options. If the make and model is in high demand, the car at issue has low mileage, and is in good condition, then the price will be higher. It is possible that several potential buyers may actually bid up the price. The seller in that situation may demand full payment in cash and other conditions, and will probably have those demands met. In this case, the seller has bargaining power and will end up making a favorable deal. On the other hand, if the seller is desperate to sell the car, or it is not in very good condition, perhaps needing major repairs, and the seller has to incur costs to advertise extensively, he may have to accept the �irst offer that comes along, even at some fraction of his asking price. In this case, the buyer would have all the bargaining power and the seller none.

Sometimes both buyers and suppliers have bargaining power. In that situation it is likely that the industry in question has low pro�itability, the product is viewed as a commodity, rivalry among competitors is �ierce, and innovation is relatively low. On the other hand, if companies in the industry have more bargaining power than both buyers and suppliers, the chances are that it is pro�itable, the products and competitors are differentiated and have strong brands, competition is controlled as it is in monopolistic competition, and innovation may be fairly rapid.

For another example of bargaining power, consider the unfortunate predicament of a California tool manufacturer. About 90% of the company's production was going to one customer. Pro�it margin was understandably low. One day the customer demanded a price reduction of 10% and delivery in small quantities at frequent intervals, thus forcing the tool manufacturer to carry even more inventory and

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increase its costs. If the company had not been so dependent on this one customer, it might have refused to supply it but it could not. Instead, it got squeezed. It's not dif�icult to tell who had the bargaining power here.

This example is true and, while unfortunate, illustrates how shortsighted companies can be. The customer in this case did not appear to care that it might drive one of its principal suppliers out of business. Walmart is another example of a company that, because of its size and in�luence with its customers, retains the bargaining power when negotiating with its suppliers. It, too, appears to run many of its suppliers into the ground in its drive for ever-lower costs.

In contrast, Toyota and other companies practice Kaizen, a system in which independent suppliers sign long-term agreements with the manufacturer, practically collocate with the manufacturer, earn fair pro�its, and are given help and training to supply products and parts at the desired level of quality and delivery.

If a company has many suppliers all competing for the contract to supply it, the company has bargaining power. If it has to purchase a component, however, and only one company can supply it, that supplier will have bargaining power. One strategy that suppliers have for retaining bargaining power is to raise the switching costs of the buyer, that is, make it so expensive for a buyer to switch to a competing supplier that it will not do so. Consider a supplier that provides its customer's procurement staff with computer terminals that are tied in with its own system, enabling the customer to order at any time, track the status of delivery of any order, and so on. The service could be so convenient, and the purchasing company's people so well trained and comfortable in using the ordering system, that it might not change suppliers even if a lower-cost competitor came along.

Porter's Five-Forces Model

In 1980, Michael E. Porter of the Harvard Business School developed what is probably the most in�luential tool for assessing the structure and competitive threats of an industry. Porter proposed a framework that in a given industry, �ive forces determine the degree of competitiveness in that industry. Competitiveness, in turn establishes the attractiveness or pro�itability of the industry. This model can be used by organizations considering a wide range of strategic plans, including entry into the industry and beyond. The �ive forces described by Porter are

Rivalry among existing competitors Bargaining power of buyers Bargaining power of suppliers Threat of new entrants Threat of substitutes

Figure 4.1 depicts Porter's �ive-forces model in diagrammatic form. The �ive main boxes in the shape of a cross constitute the actual model. The four "analysis" boxes in each corner add

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meaning to the model and enhance the industry analysis.

In the model, the terms buyers and suppliers are self-evident; these are the customers of the industry and the �irms that supply the raw materials, respectively. Rivals are all of the companies presently competing in the industry. New entrants are �irms not currently engaged in the industry but which could potentially compete in the future. For example, British supermarket chain Tesco PLC entered the U.S. grocery industry in 2007 under the brand Fresh and Easy, with an aggressive growth plan, concentrating primarily on the Southwest states. Although Tesco did not open Fresh and Easy locations in all U.S. markets, or even in all Southwestern communities, existing grocers were wise to be aware of the Fresh and Easy threat.

Figure 4.1: Porter's �ive-forces model

Substitutes are products in other industries that have the potential to draw customers away and are, in effect, also competitors. The concept of substitutes is sometimes hard to grasp; accordingly, the following example may help. The founder of a for-pro�it theater company in a moderately sized California town believed he had no competition as there was no other theater company in the town. Yet when his season tickets went on sale in the fall, they did not sell out. In fact, far from selling out, many tickets remained unsold all season long. He remained puzzled by this until someone asked him what a person in the town could do with $20 on a Friday or Saturday night. Well, he replied, that person could go to the movies, out to dinner, watch TV, go for a walk, go to a ballgame, go shopping, or visit with friends, among many other options. It turned out that "going to the theater" ranked quite low on this list, accounting for the dearth of

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ticket sales. This impressed on the theater owner that his real competition came from substitutes.

To perform an industry analysis for a particular company using Porter's model, one would begin by listing the company name as well as those of its principal competitors in the Rivals box. Next, write a description of the buyers and suppliers of the industry (not the company under study) in the respective boxes. Be careful not to list distributors or retail channels as buyers, even though they may purchase the products for resale. Porter intended that buyers for companies that make frames for glasses be listed as people, not optometrists. The names of any �irms that could possibly enter the industry are entered in the New Entrants box. If no potential new entrants can be identi�ied, the box should be marked "unknown." Finally any substitutes to what the industry produces are written in the box so labeled.

Once the �ive boxes have been �illed in on the model, then write a brief assessment of the intensity of rivalry (low, medium, or high, and why), bargaining power of buyers and suppliers (low, medium, or high, and why), entry barriers (low, medium, or high, and what they are), and threat of substitutes (low, medium, or high, and why) in each of the corner analysis boxes.

Porter's model provides a clear, straightforward way to assess the nature of competition in any industry. Users should take care not to be misled by the seemingly simplistic nature of this tool. Strategic thinkers must be thorough and wide-ranging in their thinking when analyzing each element within the context of their business, industry, and environment. As the theater owner's case illustrates, shortsighted or narrow thinking may lead to an inaccurate assessment of the elements and potentially negative implications for pro�it, public relations, employee morale, and more.

Barriers to Entry

High entry barriers keep potential entrants out of an industry. This is a good thing for a company that is already in the industry, but a bad thing for a company trying to enter the industry. Barriers to entry could take any of several forms. An industry that requires a signi�icant capital investment to enter has a high barrier to entry, particularly to smaller �irms. Another type of barrier is the need for expertise in a certain technology or manufacturing process, a core competence, or proprietary technology, which could cost a lot or take a long time to develop. Electronics and biotechnology industries have this barrier. An established brand name and customer loyalty, both of which take time to develop, may also provide a deterrent to would-be entrants. When an industry includes competitors with signi�icant market share and market power or competitors with low costs that realize signi�icant economies of scale, prospective entrants would probably view this as a barrier.

What if the potential entrant is a much larger corporation with more than adequate �inancial resources and possibly also a strong brand identity in a related market? The results of this assessment might turn

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Beauty salons are an example of a fragmented industry.

Inga Ivanova/iStock/Thinkstock

out quite differently. The issue is to try to imagine (a) who the likely potential entrant might be; (b) why it might want to enter this industry now; and (c) make as best an assessment as you can. What is perceived by one �irm to be a high barrier to entry may not present a deterrent to another.

Also, in some industries it may be easy to enter the industry but dif�icult to compete effectively on a national or global scale once having entered. For example, in the donut industry, anyone can open a single donut shop that serves local customers ("easy to enter"). Yet such an entrant would unlikely compete with the large national chains like Dunkin Donuts, Winchell's, and Krispy Kreme, and so would not present a threat at all ("hard to compete with").

Industry Concentration

A concentrated industry is one in which a few �irms in the industry account for a large portion of total industry sales. Examples are commercial aircraft manufacturing, in which only two �irms compete (Boeing and Airbus), or the business of auditing public companies in the United States, in which 96% of the work is shared among the "Big Four" certi�ied public accounting (CPA) �irms. Even six to eight �irms, accounting for upwards of 40% of an industry's sales, would qualify to be called concentrated.

A fragmented industry is one in which no one �irm has more than a fraction of a percent in market share. Examples are beauty salons and the auditing of privately held businesses. Bookstores and fast-food restaurants

used to be fragmented industries, but now are fairly concentrated due to franchising and the emergence of dominant chains.

For a company in a fragmented industry, it is dif�icult to increase market share unless you clone or standardize the business and duplicate or franchise it (Porter, 1982). This is what some fast-food companies did and what enabled them to become global giants such as McDonald's, KFC, Burger King, and so on.

Critical Success Factors

When a potential company is assessing an industry, it often needs to identify the industry's critical success factors (CSFs). Think of them as constituting the rules of the industry. Just as every sport has its own set of unique rules, there is no way that one can "play" in an industry, let alone dominate it, without knowing and playing by those rules. CSFs attach to an industry, not to a company, and every industry has a different set. Ideally, a �irm should be able to identify six to eight CSFs. One way is to come up with a much larger number �irst and then edit them down to those that are really essential to succeeding in its particular industry.

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The value of identifying the industry's critical success factors becomes evident when they are used to compare a company with its key competitors. A CSF analysis allows a company to compare itself with its principal competitors using CSFs as the dimensions to do so (Table 4.1).

After choosing six appropriate CSFs for the industry, the example company was rated along the dimensions of the listed CSFs on a scale of 0–10, 10 being highest. The same was done for each competitor in the table.

Table 4.1: Critical-success-factor analysis

Critical-Success Factor

Company Competitor A

Competitor B

Competitor C

Competitor D

Strength of brand 10 8 9 8 10

Distribution channels 6 10 9 8 7

New-product development

8 5 10 7 8

Financial strength 9 6 10 8 9

Customer service 8 7 8 9 5

Low costs 5 6 5 6 9

Totals 46 39 51 46 48

In the example shown, the company under analysis rated a total of 46 out of a possible 60. Comparing the scores gives a rough idea of how the company "stacks up" against its competitors, as well as how each of the key competitors stacks up against the others. To the extent that your ratings of a company and those of its competitors are accurate or realistic, the analysis provides useful information regarding whether or not the company has competitive advantages or vulnerabilities and which competitors are most dangerous.

Looking across the rows, the table reveals where there may be a competitive advantage or competitive vulnerability. In this example, the company's strong brand may constitute a competitive advantage. Competitor A may have one in its extensive distribution system, and Competitor B one in its ability to generate new products rapidly. Any rating of 5 in the table would signify a competitive vulnerability, something that should be addressed in that company's short-term plans (like the company's and Competitor B's costs).

Looking down the columns, the analysis identi�ies which competitors are more dangerous than others. In the table, judging from the totals at the bottom, the company lies in the middle of the pack, with Competitors B and D to be more feared than the other two competitors. Competitive analysis includes how the company might react to attacks, especially from strong competitors (Coyne & Horn, 2009).

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Industry Attractiveness

Can one measure industry "attractiveness," and is it important? The answers to these questions are yes and yes, but the measurement is highly subjective and the result is more useful in some situations than others. Industry attractiveness is based on of a number of attributes or characteristics. To discover them, imagine what an ideal industry would look like. It would, for example, have a huge market (potential customer base), be growing rapidly, be hugely pro�itable, have few competitors, be unregulated, have high entry barriers, and not need technological expertise. This would yield the following initial list of factors for an industry-attractiveness analysis:

Size of the potential market Industry growth rate Intensity of competition Degree of regulation Entry barriers Degree of technological innovation

These factors, of course, constitute an incomplete list; they may be changed or ampli�ied. Notice also that the factors are stated in a neutral way: "size of the potential market," not "large market."

To perform an industry-attractiveness analysis, �irst assign a weight to each of these factors as a percentage according to their perceived importance. Next rate each factor from the point of view of the company doing the analysis on a scale of 0–1.0. Finally, multiply the weight by the rating for each factor. Be careful in two instances: (a) If degree of competition is high, the rating should be low because it makes the industry less attractive, and (b) if degree of regulation is low, the rating should be high as it makes the industry more attractive. Remember that the rating should be high for any factor that makes the industry more attractive, and low if the opposite. Add up the products to yield a percentage �igure.

Table 4.2 below shows an industry-attractive matrix, which is a weighted technique based on a number of factors to determine how attractive an industry is. The industry-attractiveness (I.A.) index of 75.6 shows this to be an attractive industry, attractive enough to stay in it and invest in improving the company's position. When such an analysis yields a result of less than 50%, then the company might well ask the fateful question, "Should we continue to be in this industry, or should we exit?"

Table 4.2: Industry-attractiveness matrix

Factor Weight Rating Product

Industry growth rate 24 0.8 19.2

Pro�itability 20 0.7 14.0

Size of potential market 18 1.0 18.0

Intensity of competition 16 0.3 4.8

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Budweiser is in the same strategic group as Miller Brewing company, but in a different group than microbrewers.

Daniel Acker/Bloomberg via Getty Images

Entry barriers 12 0.8 9.6

Degree of regulation 10 1.0 10.0

Totals 100 I.A. Index 75.6

Strategic-Group Map

In industries that contain disparate competitors, a strategic-group map is a useful technique to cluster and identify strategically similar competitors. Competitors can show differences—and similarities—to each other on various factors (Porter, 1982). Those that are similar to each other belong to the same strategic group; the more distant one strategic group is from another re�lects the extent to which they are dissimilar and therefore, not direct competitors.

An industry often consists of a small number of distinct strategic groups. A strategic-group map is a two-dimensional representation of an industry's strategic groups. To create one, choose two strategic dimensions that are not correlated with each other, as are price and quality, and that have the capacity to separate the competitors in the industry. For example, if all companies in the industry have broad product lines, choosing this dimension as one of the axes will not work—all the competitors would be bunched up at one end. On the other hand, positioning might be a useful dimension to use if there are some companies at the high end, some at the midlevel, and some at the low end of the industry. Other than the two guidelines given previously, there is no rule for choosing strategic dimensions that would serve as axes for the strategic-group map. The dimensions chosen as axes for a strategic-group map should embody strategic variables, not performance. Try several and see which two separate the competitors or rivals into clusters on the map. When you have several clusters that make sense and can articulate the strategy of each cluster, you have a useful strategic-group map. Naturally, using the technique presupposes a good working knowledge of competitors in a particular industry.

Figures 4.2 and 4.3 show examples of strategic-group maps. Figure 4.2 is a simple strategic-group map that represents the pharmaceutical industry. Figure 4.3 shows a slightly more complex strategic-group map of selected retail chains. The �igures display different strategic dimensions in use and underscore the fact that companies in the same strategic group compete more intensely with each other, while competition between distant groups is virtually nonexistent.

Figure 4.2: Simple strategic-group map of the pharmaceutical industry

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Figure 4.3: Strategic-group map of selected retail chains

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Zefa/SuperStock

Source: Adapted from Arthur A. Thompson, Jr., John E. Gamble, and A. J Strickland III, Strategy: Core Concepts, Analytical Tools, Readings, p. 68. Copyright © 2004 Irwin McGraw-Hill. Reprinted with permission.

What can be learned from a strategic-group map? First, the companies in a particular strategic group are strategically similar and constitute the group's key competitors. Those in a nearby group form the next tier of competitors. In all likelihood, companies in a distant strategic group are not really competitors although they are in the same industry. For example, in the U.S. beer industry, Anheuser Busch competes with Miller Brewing in the same strategic group, but not with the many microbrewers and some of the imported high-end beers, which are in distant strategic groups. In another example, this time in the hospitality industry, Days Inn (low end) does not compete with Ritz Carlton (high end) because they are strategically dissimilar and in different strategic groups; their markets are quite different.

Secondly, the implications of Porter's �ive-forces model are different for different strategic groups. Entry barriers vary among the groups, as does bargaining power with suppliers and customers, the threat of substitutes, and the intensity of intra-group rivalry. Thus, it could be more desirable to be in one strategic group than another (there could be more opportunities and fewer threats) (Hill & Jones, 2001). For example, in retailing, a recession would adversely affect high-end department stores but actually increase demand for discounters and mass merchandisers. Because of such differences, it may be worthwhile for a company to move consciously from one strategic

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It is imperative to know as much about your competitors as possible.

group to another. The ease of doing so depends on the size of mobility barriers between the groups (factors that inhibit both entry into and exit from a group). For example, in Figure 4.2, Greenstone is a generic pharmaceutical company that competes with others in its strategic

group; it would �ind it very dif�icult to move into the proprietary strategic group with companies like Valeant Pharmaceutical and Merck. This is because Greenstone lacks the necessary R&D skills and resources that would take time and a great deal of capital to acquire.

Thirdly, one could discover some unserved demand in an area of a strategic-group map not occupied by any strategic group. In creating a strategic-group map of the automobile industry, using pricing and safety as the two strategic dimensions, a group of business students found that no company was offering a low- priced, high-safety automobile. Such a car might appeal to parents with teenagers and possibly older drivers (Harrison, 2003).

Finally, it is possible for a company to belong to more than one strategic group. In the hospitality industry, Hilton Hotels and Marriott compete in both the high end and affordable ends, through the lower-rate Hampton Inns and Courtyards by Marriott, respectively. In this illustration, each company, rather than surmount mobility barriers by moving to another strategic group, has penetrated another strategic group through internal diversi�ication and acquisition.

Competitive Analysis

Strategy began as a military concept. Before going into battle, and during the battle itself, generals would try to �ind out everything they could about the enemy: their strength in numbers, their weaponry, supplies, communications capability, precise locations, intents, and strategies. To go into a battle with no information about the enemy would be to put an army at considerable risk and its chances of success at virtually zero. It is only with good intelligence about the enemy—their movements, resources, and strategies—that a general or leader can plan strategy and deploy resources to win the battle or achieve a military objective.

The same imperative exists in business today. In virtually every business, companies must be aware of and know how to deal with their competitors. The �irst step is to ask, "How much do I know about my competitors?" One should know—or try to obtain—at least the following information about one's competitors:

Market share—Many industries have publications that track these data, but companies will occasionally have to determine a competitor's market, or industry, share on their own. Geographic scope—Are your competitors local, regional, national, or international/global competitors? Diversi�ication—Are your competitors conglomerates with a portfolio of businesses in unrelated industries, companies with many related businesses, companies with many strategic alliances, or companies in only one business? Vertical integration—The degree to which competitors are vertically integrated, especially backwards along the supply chain, may give them cost and competitive advantages that can be

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dif�icult to overcome. Competitive advantage—Do your competitors possess a competitive advantage? What is it? How large is it? How have they sustained it? Core competence—What are the core competences that underlie your competitors' strategies? Strategic intent—How are your competitors trying to position themselves in the industry? Are they aggressively trying to overtake rivals on their way to market dominance, or are they more concerned with defending their ranking and maintaining market share? Strategy—What strategies are your competitors following? In most cases, they can be inferred from other information known about the companies and what they are actually doing. Have the strategies been working, or are they about to be changed? Are mergers among key competitors likely? Are any of them looking to be acquired? If in a high-tech industry, what is their investment in R&D as a percent of sales? Resources and capabilities—How strong �inancially and technologically are each of your competitors? How �lexible are they to adapting to the changing environment? How well managed? How fast do they bring new products to market? Do they have innovative cultures and a record of innovation? Which one just got a new CEO?

Trying to get this kind of information about key competitors also reveals how much or how little a company knows about them.

Discussion Questions

1. What additional information might an industry analysis provide that simply monitoring a company's competitors does not? After all, isn't the industry just an aggregate of all competitors?

2. Porter's �ive-forces model is a useful tool to analyze the competitive forces and structural characteristics of an industry. But isn't this, at best, a snapshot at a point in time? How could one get a more dynamic perspective?

3. Suppose a company has very little bargaining power with suppliers; in fact, its industry also is plagued with weak bargaining power. What are some ways of gaining more bargaining power?

4. What might be a method for identifying an industry's driving forces other than simply brainstorming?

5. Can a company be more pro�itable in a concentrated industry (not one of the industry leaders) or a fragmented one? Give your reasons either way.

6. The industry-attractiveness matrix is a highly subjective exercise. So what are the bene�its of doing one despite the subjectivity?

7. A strategic-group map groups together strategically similar companies in an industry on a two-dimensional space. Yet, movement from one strategic group to another could experience mobility or entry barriers, different competitors, and signi�icant investment. Does that make each strategic group an industry segment? Explain.

8. Once an industry's dominant economic characteristics and driving forces have been identi�ied and Porter's �ive-forces analysis has been performed, how can the rules of the game for this industry and the critical success factors be discerned? Explain the steps this would take.

9. A critical-success-factor analysis can be very useful to a company in analyzing how it stacks up to its competitors. How might you tell if the numbers used in that analysis are realistic?

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Is there another kind of analysis you could do that would also yield good comparative data with your competitors?

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4.2 Market Analysis

We now turn to an examination of a company's customers, which could be companies in another industry, like the auto industry, or individual consumers. A market analysis is an umbrella term covering the collection and analysis of data and information about a company's customers, which could be companies in another industry or individuals (consumers). While it is relatively straightforward to get information about a customer industry, getting useful information about consumers is more dif�icult. The demographic or socioeconomic groups of some consumers make them harder to analyze and understand. It is important to keep in mind the target market and degree of market penetration, changing customer needs, and distribution channels and pricing, as discussed in the following sections.

Target Market and Market Penetration

First consider the target market. For example, if banks buy your product, your market is banks. But are you targeting all banks worldwide (which is the overall market), only the large banks, only neighborhood banks, only banks with over $2.0 billion in deposits or over 500 branches, or middle-market banks nationally? Very few companies can target the entire population of their markets although there are exceptions such as Coca-Cola, Microsoft, and so forth. So a company needs to de�ine its target market— what is it, how large is it, and how fast is it growing? It also must decide who is the served market, or that portion of the target market that is either currently served by the company or its current focus.

Another factor to establish is the degree of market penetration. How far have all the companies in the industry penetrated the market? In other words, what proportion of the target market has bought a product/service from your industry? If the answer is 60%, the market is said to be 60% penetrated, leaving 40% that is unserved or underserved among them. When a market is 100% penetrated, it is considered saturated.

The degree of penetration is, however, more complex than the illustration discussed here. For example, not all of the target market may purchase a product from the industry for various reasons— they cannot afford to, don't need to, and the like. So the target market is often reduced to what is called a served market made up of viable customers who could buy the product or service. Also, though rare, it is possible for markets to be more than 100% penetrated, as when households own more than one TV or car.

Changing Customer Needs

What are customers' current needs? From what is known of a company's customers and industry, can their needs be inferred? And can the degree to which such needs are currently satis�ied be assessed? When we speak of "needs," we mean bene�its or what we now term value propositions. Companies that are constantly listening to their customers will know their needs and how they are changing (Ulwick & Bettencourt, 2008).

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What will the customer need in the future? This is a chicken-and-egg situation. New products and services often affect customers and satisfy needs they never knew they had, and sometimes unsatis�ied needs are the spark that causes new products and services to be introduced. Try to address the question "How are customers' needs changing?" The extent to which this proves dif�icult to answer indicates whether the company is in touch with its customers or doesn't know enough about them.

Distribution Channels and Pricing

The next stage of the market analysis is a consideration of the company's distribution channels. This means learning how the industry's products reach the market. One must �ind out whether the industry typically supplies products to wholesalers, distributors or retail outlets. In some industries it is standard practice to employ salespersons to make direct sales calls, while in other industries, catalogs and direct mail are the norm. The extent to which the Internet is used as a distribution channel is increasingly important. Note any differences between the distribution channels the company uses and those used by the industry in general. Another way of looking at this is to ask how customers buy the products. What is the decision process they go through before they decide to buy (Court, Elzinga, Mulder, & Vetvik, 2009)?

An analysis of the distribution channels would not be complete without determining the size of channel markups. That is, for each stage in the distribution channel, what price is paid by the wholesaler, the distributor, the retailer, and what price is paid by the �inal customer? If volume discounts are expected and offered at each stage, the quantities at which these become applicable and the amount of the discount are key data points. While a company's pro�its depend on the price it receives for the product, its competitiveness depends on what the customer will pay.

One also needs to establish the degree to which customers are price-sensitive in the target market. Price sensitivity is critical with respect to how prices are set and changed and, indeed, which distribution channels are used. The following example of the law �irm illustrates the importance of knowing how price- sensitive customers are (see Case Study: Price Sensitivity and a Law Firm).

Any current trends in customer behavior are vital to an understanding of how the target market may be changing. Are customers buying differently? Are they becoming more demanding? Any other aspect of industry customers not covered elsewhere should be covered here. For example, increasingly, customers of brick-and-mortar bookstores like Barnes & Noble are actually buying their books on Amazon.com.

If a company does business in several markets, such as different countries, this type of detailed market analysis should be completed for each of those markets. Companies that target business customers (B2B) would do well to analyze the value chain of their major customers in order to discover which part of it is unserved and take advantage of the opportunity to move in to �ill that need (Crain & Abraham, 2008).

Case Study Price Sensitivity and a Law Firm

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A patent-law �irm once held a retreat to go through a strategic-planning process. During the process, the partners in attendance maintained that it was the best �irm of its kind in the large metropolitan region it served. A review of its �inances revealed that its billings (i.e., sales) were �lat, a situation that prompted the retreat in the �irst place. During the competitive-analysis phase, the �irm acknowledged that it had about �ive principal competitors, all of which charged higher hourly rates than it did. Reluctantly, the partners �inally admitted that hourly rates generally correlated with reputation; the higher the fee charged, the better the �irm was perceived to be. Worse, it turned out that several of the �irm's partners were offering discounted rates to clients for fear that they would not even get their business. They expressed the fear that if they raised their rates, the �irm would suffer a drastic decline in business. They felt hamstrung. The answer, of course, was that they were either serving the wrong kinds of clients, or they were not as good as they claimed to be. The latter conclusion was perhaps closer to the truth given their discounting behavior. Certainly, the market was not nearly as price- sensitive as they thought it was, as evidenced by the fees its competitors were charging—and getting.

Discussion Questions

1. Why is de�ining your target market so dif�icult? If you agree, suggest how it can be made easier and yield accurate results at the same time.

2. Is distinguishing between "market," "target market," and "served market" useful? In what ways?

3. How might you discover that your target market would welcome opportunities to co- create value with your company?

4. What surveys would you take of your customers that would help guide what products to produce and how to persuade them to buy?

5. If you were designing a customer-relationship-management (CRM) system, what elements would you include and why?

6. Why is it that customers of highly differentiated companies are not that price-sensitive? 7. Customers buy products because, for the most part, the products satisfy their needs. (The exceptions are impulse buys.) Are "needs" and the "bene�its" they receive from using the product the same thing?

8. List the bene�its you might experience from buying each of the following: A movie ticket A logo t-shirt A novel A car An iPod A vacation cruise Flowers for your spouse or date

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Analyzing environmental trends involves looking at what is changing and its potential impact on the company.

Wavebreakmedia Ltd/Thinkstock

4.3 Environmental-Trend Analysis

The almost dizzying pace of change going on in technology and business requires companies to plan differently than they have in the past. In order to keep pace with the rapidly changing environment, companies should divide the environment into categories or manageable pieces and, in each category, try to articulate (a) what is changing and in which direction, and (b) with what impact on the company. If the change has no relevance for the company or for what it might do in the future, then it deserves to be ignored. If a trend cannot be clearly de�ined in terms of direction (for example, something getting larger or smaller, increasing or decreasing), then it should be omitted. Saying, for example, that the "economy is in a recession" is not useful as a trend.

Environmental scanning is a common name given to identifying and analyzing trends that are external to the business (Fahey & Narayanan, 1986). People who engage in it have found that it is easy to get caught up in what they are discovering. Before they know it, they are collecting information for its own sake. Most companies cannot afford that luxury. Again, the search should be con�ined to trends that are relevant to the company, speci�ically any trend that affects the company or that may affect it in the future.

The currency of the collected data in environmental scanning is a valuable resource. Typically, one can �ind information on trends using historical data. However, the milieu in which strategic planning takes place, or the period during which the consequences of present decisions play out, is the future. A trend noticed during the 2004–2009 time frame, for example, may have limited value or even none at all in the 2012–2017 time frame. However, if the trend can be extrapolated or extended in a justi�iable manner to the future time frame in question, then it becomes valuable. Nevertheless, �irms must be cautious, because some trends are discontinuous, meaning that behavior in the future is different from behavior in the past. While simple extrapolations can be performed by almost anyone, more complex forecasting, such as technological forecasting, must be done by an expert and may require consulting assistance. For such projects, the organization must have the requisite time and resources. The tradeoff between spending resources to do something properly and taking educated guesses when such resources are unavailable is something that the company will have to consider carefully.

In many cases, rather than doing the forecasting internally, a �irm can �ind estimated or projected data on trends to �it its future time frame. For example, demographic data taken from census data contain projections for at least 30 years into the future. Whenever using such projections, it is important to know how reliable the source is and, preferably, how the projections were derived. The more critical such data are to the company, the more care the company should exercise to ensure that reliable data and analyses

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are being used. Economic forecasts, for example, are particularly dif�icult to verify as to quality; economists can be wrong even for short-term forecasts.

Finally, the environmental scan should cover a geographic scope that matches the arena in which the company competes. For example, a distribution company operating and competing only in New England should pay more attention to what is happening in the New England economy rather than what may be happening nationally. Figure 4.4, for instance, shows the strategic group for the wholesale lumber industry. A large multinational company would have to extend its scan into every country in which it does business (buying, manufacturing, or selling) as well as include exchange rates between those countries and how events or trends in one of the countries might affect any of the others. The international environment is far more complex than dealing with just one country. For example, managers in each country are typically asked to complete an environmental analysis in their own country along with other analyses and projections required for strategic planning.

Figure 4.4: Strategic group map of the wholesale lumber industry

Source: Reprinted by permission from the Case

When conducting an environmental-trend analysis, there are seven common categories that the company should consider: economic, regulatory/legislative, political, demographic, sociocultural, attitude/lifestyle, and technological. No one category is more important than another per se, though certain categories can be more relevant to a particular company and so demand more of its attention.

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Economic Trends

Of the seven categories of trends, we are �looded with opinions and doom-and-gloom prognostications about the economy the most. The news media thrive on stories about how stocks are being buffeted by economic forecasts and events such as bank bailouts or even bailouts of countries like Greece. Unless one has a direct �inancial stake, a lot of such news is just "noise." Economic data look very different and can provide a more solid feel as to how a country's economy is faring and how its currency is faring with respect to the world's major currencies. Economists monitor a number of principal indicators to identify trends:

"Structural shift" is a term that describes a trend from an industrial economy to a service economy, or from a predominantly manufacturing to a knowledge-based economy. Structural variables are factors such as energy costs rising faster than raw material costs, or general or minimum wage rates changing. In�lation and unemployment rates have historically tended to have an inverse relationship; as one goes up, the other typically goes down, and vice versa. Both are affected by �iscal policy controlled by the government and monetary policy controlled by the Federal Reserve Board, which also controls interest rates. Interest rates are the most watched economic indicator. These re�lect the cost of loans, mortgages, and credit, as well as how much savings and certi�icates of deposit (CDs) can earn. The consumer price index (CPI) is a relative indicator of how far and how fast prices have risen compared to a base year. Housing starts are a leading indicator of whether the economy might turn down or up. Balance of trade is the net difference in value between a country's exports and imports. A positive �igure re�lects a trade surplus while a negative �igure indicates a trade de�icit. For decades, the United States has run an annual trade de�icit. Exchange rates re�lect the value of one country's currency against another. A declining value of the U.S. dollar, for example, means that U.S. exports will be more competitive in world markets and imports more expensive, while a rising value of the dollar means that imports will become cheaper and U.S. goods in world markets more expensive. Personal disposable income is often associated with income data (demographic) and very useful when combined with demographic data such as geographic data, age, and ethnicity.

Regulatory/Legislative Trends

Regulations differ from laws in that they are made and enforced by city, state, and federal regulatory agencies whereas legislation refers to laws enacted by state assemblies and Congress. For both laws and regulations, indications of impending changes can be discerned by close observation of the political process at the appropriate level of government. Also, rules are made according to well-de�ined processes that include opportunities for rebuttals by industry or interested parties.

The volume of regulations enacted each year keeps increasing as re�lected in the number of pages in the Federal Register devoted to them. It behooves a company to monitor potential changes to regulations governing the industry in which it competes. Some industries, such as railroads and airlines, are so heavily regulated that they are called "regulated industries."

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Many regulations cut across all industries. Examples of these include tax regulations, workplace safety, insider trading, bargaining in good faith in labor negotiations, anticompetitive practices, and price-�ixing. All industries encounter some form of regulation, even those not considered "regulated." Deregulation of an industry can have an enormous impact. Examples of deregulated industries are telecommunications and electric power. Other industries such as airlines, banking, and transportation have seen a degree of deregulation. The merging of industries can have enormous implications for companies in each. An example of this trend has been the convergence of the banking, insurance, and brokerage industries into what is now called �inancial services. The standards set by regulation in an industry may change. In the automobile industry, for example, this can be seen in the standards for crash resistance, fuel economy, and exhaust emissions. Other industries are affected by environmental standards for allowable concentrations of contaminants or impurities in air and water. Labeling requirements on all packaged and processed foods is another such example. Trade regulations at the international level may impose tariffs or set quotas to limit imports into a country or make imported goods more costly. Regulations may also prohibit the importation of certain agricultural products or require the quarantining of animals to prevent diseases or invasive species from entering the country. All the preceding regulatory trends affecting an industry may occur at both state and federal levels, as well as in many foreign countries.

Political Trends

Politics is not just for politicians. Politics is about power, the powerless, and the actions and activities people take to redress perceived inequities. The "Occupy" movement that spread from Wall St. to Main Street in many cities across the country is a stunning example of this. Such trends could have a signi�icant effect on some companies and their perceived public reputation.

The relative in�luence and power of interest groups in every sphere of economic and social activity in the United States is a matter of growing debate. From professional organizations such as the American Medical Association, to industry groups like the National Association of Manufacturers and demographic collectives exempli�ied by the American Association of Retired Persons (AARP), interest groups are more organized and more in�luential than ever before. The term lobbyist is used in some circles as a pejorative term, giving some indication as to the controversial nature of this trend. Fighting against or demanding enforcement of regulations or laws is a trend observed in the nation's courtrooms. The United States has always been a highly litigious society and that trend is only increasing.

Demographic Trends

This category is important only to companies that market directly to consumers. Because many companies' products target speci�ic demographic groups, monitoring trends in this category is imperative. Demographic trends are by de�inition concerned with groups identi�iable by speci�ic common characteristics such as age, gender, income, national heritage, and many others.

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A country's population growth (or decline) is a demographic trend with implications for most industries. The growth rate of a particular age group such as the 25–39 or over-65 age group gives clues as to whether the population of a country is aging or getting younger, or has a "demographic bulge" moving through it. The geographic distribution of population reveals migration patterns affecting local markets. Signi�icant trends concerning gender, particularly gender differences, or in conjunction with one or more other demographic characteristics such as age, ethnicity, education, income levels, and others have critical strategic implications in a wide range of industries. Changes in ethnic mix reveal the extent to which regions or cities are growing more diverse or becoming dominated by one ethnicity. Data on income levels show patterns of wealth distribution and indicate relative purchasing power, especially in combination with geographic data concerning average individual income and household income. Literacy rates re�lect the extent to which a population has received basic education and can read its own language.

Attitude/Lifestyle Trends

This category of trends also concerns only companies targeting consumers. These shed light on how people live—their patterns of living—making the trends highly interrelated with one another as well as with demographic information. These are also an outward manifestation of people's attitudes and values.

Household formation includes the family structure one chooses to establish such as married-couple families, one-parent families with either female or male head of household, couples with no children, and gay or lesbian couples. Also of interest is the average number of persons per household. Trends in the type of work and who is working are important to consumer-oriented industries. For example, the rise of women in the workforce, especially in professional and technical jobs, and the increase of two-income households have had a tremendous effect on spending patterns and the types of products brought to market. Similarly the tendency of more elderly people delaying retirement and continuing to work is a growing trend. Trends in the type and level of education achieved are signi�icant, particularly when the data are combined with ethnicity, race, and sex demographic variables. Companies producing for consumers need to be aware of changes in the consumption patterns of goods and services, especially homes, durable goods, furnishings, automobiles, clothes, beverages, and personal services and shifts in patterns within each category. Consumer choices with respect to leisure activities are constantly changing. This includes all types of sports and physical-�itness activities, cultural events, movie attendance, travel, and home- centered activities such as watching network and cable television and videos, reading, gardening— anything people choose to do in their free time.

Sociocultural Trends

This category focuses on broader changes in society and the extant culture and becomes important only if societal or cultural changes might affect the business. For example, producing a movie that may not be

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suitable for young people and therefore is rated NC-17, could in turn translate to lower revenues at the box of�ice.

Changes in social regulations—such as increases in consumer and environmental protection, changes in Supreme Court rulings, trends of the courts deciding issues that the political process cannot. Changing social expectations are constantly in �lux. Businesses need to be aware of and prepared to respond to evolving consumer values across a wide range of issues. Examples include changing attitudes toward work, rising consumer demands, greater acceptance of sex and violence in popular culture, a growing emphasis on personal health and physical �itness, and increasing activism among women and minority groups. Changes in economic values have recently come to the forefront, most evident in the genesis of the Tea Party and Occupy movements. Many people have expressed increasing concern with how economic bene�its are distributed in society and how people are taxed. It can be argued that there is less acceptance of economic growth today as an unquali�ied bene�it to society. Changes in political priorities affect entire industries and even regions of the country. For example, choices made between defense versus nondefense appropriations will be of tremendous concern to any business that supplies the military or is located in regions where aerospace contractors or military bases are located.

Technological Trends

This category covers the entire swath of technology, from new energy sources, communication technologies, health care modalities and cures, food, agriculture, product and process innovations, and so on. Clearly, high-tech or technology-based companies must be current on technological developments in their �ields and how those advances affect people, businesses, and society. In rapidly changing �ields, it is possible to detect early signs of new technologies by going to professional-society meetings and listening to presentations on new processes and techniques, which often precede their introduction by several years.

The pace of change of basic science or research is manifested in the number and nature of new patents applied for and issued. The number and location of new companies formed to exploit new technologies and products based on new technologies are indicators of technology trends. Changes in the average percentage of sales spent on research and development (R&D) in a particular high-technology industry and for particular competitors, if publicly held are critical trends for companies to monitor. Trends in technology diffusion describe changes in the time required for a new technology to become accepted in general use. Innovation lag indicates the period between when the scienti�ic solution to a technological need is �irst recognized and the emergence of the �irst viable product using the solution technology and its successor.

A careful analysis of all relevant environmental trends will provide a company with an indication of strategic opportunities, that is, trends that might have a strong positive impact on the company, and looming threats or trends that might have a strong negative impact on the company. Environmental scanning should not be limited only to the period immediately preceding a strategic-planning session.

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Ideally, environmental scanning should be an ongoing, year-round activity done by many people throughout the organization. If done year-round, it would be unlikely that the company would be blindsided by any changes in its environment—and it would also be one of the �irst to notice opportunities as they arise. This last point is worth emphasizing, because the earlier an opportunity is noticed, the more lead time the company would have to exploit it.

Clearly, trends that have an immediate impact within the planning horizon—whether the impact is positive or negative—should receive the greatest attention. Trends that require a longer time to affect the company beyond the planning horizon are correspondingly less important but should nevertheless be monitored. Trends that have no impact on the company should be ignored.

Discussion Questions

1. Which environmental categories most need scanning if your company: Produces cell phones? Is a mass merchandiser? Produces steel tubing? Supplies lumber for the construction industry? Is a four-year university? Publishes books? Sells nutritional supplements online?

2. List some sources of information for each category of environmental scanning. 3. We know why environmental scanning is considered part of strategic planning, but why is it part of strategic thinking?

4. Economic and demographic data are often quantitative, which makes it easier to identify trends and their impact on the company. But attitude, lifestyle and sociocultural trends are "soft," subjective, and elusive. How can one understand better what's going on in these areas?

5. Scanning the technological environment is dif�icult for anyone but scientists or engineers in the �ield. Realizing what's happening today in this environment is too late, because developing technology takes years. How can one �ind out now what might be developing several years from now?

6. Assessing threats is a critical part of an external analysis that should precede, or be a part of, the strategic-planning process. But the world is not "convenient" in this respect. Forces that may adversely affect the company are constantly changing. How can a company monitor these so that it is never caught unawares?

7. What happens when threats are underestimated? Whose fault is it? Discuss.

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Summary

This chapter explored the importance of and tools to help in analyzing a company's external environment —its industry, competitors, markets, and general environment.

Several useful tools for doing an industry and competitive analysis were presented and discussed, including Porter's �ive-forces model, industry-attractiveness matrix, strategic-group maps, and critical- success-factor analysis. In addition, identifying the industry's dominant economic characteristics and driving forces add to one's knowledge about the industry and how it might be changing—critical knowledge when deciding what strategy to pursue.

An industry sells its products or services to customers, so a key part of the external analysis is �inding out all one can about a company's customers (market). Included in a market analysis is distinguishing between a market, target market, and served market (which could be a niche), determining the size of it and whether it is growing (not to be confused with industry growth rate), how far the market is penetrated, what customers' needs are and whether these are changing, the distribution channels used, whether the market is price-sensitive, and any relevant trends, for example, in buying habits.

The chapter then provides a discussion and pointers to scan the general environment for any changes or trends that might favor (opportunities) or adversely affect (threats) the company. The general environment includes seven categories, not all of which are relevant to any one company: economic, regulatory/legislative, political/legal, demographic, attitude/lifestyle, sociocultural, and technological.

Concept Check

Key Terms

bargaining power An ability to dictate the terms—price, delivery, quality, and the like—in a trading negotiation.

concentrated industry One in which a few �irms in the industry account for a large portion of total industry sales (opposite of fragmented industry).

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critical success factors (CSFs) What a company must do well in order to succeed in the industry; however, they attach to an industry, not a company (think of them as constituting "rules of the industry").

distribution channel How a product �inally reaches the customer (can include directly via salespeople, wholesalers, distributors, retailers, mail order, and the Internet).

driving forces Trends responsible for how an industry is changing.

entry barriers Factors that could, if suf�iciently high (like capital required, distribution channels, brand reputation, technological knowhow, etc.), prevent a company from entering an industry.

fragmented industry One in which no one �irm has more than a fraction of a percent in market share (opposite of concentrated industry).

industry attractiveness matrix A weighted technique based on a number of factors to determine how attractive an industry is.

industry attractiveness (I.A.) index The �inal result achieved from using the industry-attractiveness matrix, usually expressed as a percentage.

market analysis An umbrella term covering the collection and analysis of data and information about a company's customers, which could be companies in another industry or individuals (consumers).

market penetration The proportion of a market that has bought a product/service from the industry (can vary from 0 for a brand new market to 100% and beyond, as when people own more than one car or TV).

Porter's �ive-forces model An analytical tool developed by and named after Michael E. Porter to assess the �ive sources of competitive threat extant in an industry and causes of industry pro�itability.

price sensitivity How sensitive buyers are to variations in price. If a slight drop in price causes customers to buy, they are very price-sensitive; if price goes up a lot and customers still buy, they are not at all price- sensitive.

served market That portion of the target market that is currently served by the company or is the focus of the company.

strategic-group map A technique to cluster, in a two-dimensional space, strategically similar competitors in industries, especially useful when industries contain disparate competitors.

target market The group of customers targeted by a company (could be companies or consumers, domestic or international).

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Chapter 5

Assessing the Company Itself

Robert Harding Picture Library/SuperStock

Learning Objectives

By the time you have completed this chapter, you should be able to do the following:

Understand what is involved in a thorough �inancial analysis of a company and how to make sense of the data. Perform an analysis of a company's strengths, weaknesses, opportunities, and threats (SWOT analysis). Determine whether a company has a core competence and a competitive advantage. Understand a company's internal and external value chains. Determine the customer-value proposition and how strong it is. Understand the signi�icance of brand reputation, how strong it is, and how to manage it.

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Analyzing and assessing the internal environment of the company is a key part of the strategic-planning process. The recent �inancial performance and current �inancial condition is an obvious place to start using quantitative data with which to reach an objective conclusion. There are also more subjective measures including an examination of a company's competitive strengths and weaknesses, its capabilities, and determining which, if any of them, might be core competencies that would give the company a competitive advantage. The value of a company's brand and the effectiveness of its management are also taken into consideration.

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5.1 Analysis of Financial Performance and Condition

Any analysis of an organization usually begins with careful evaluation of its �inancial position. To assess the recent �inancial performance and current �inancial condition of the company, you need three to �ive years of historical �inancial data—income statements and balance sheets (see box on �inancial statements for generic templates)—including the most recent year for which complete data are available.

Financial statements: Generic templates

Income-statement Balance sheet Total revenues (sales) Assets Cost of goods sold (COGS) Cash & cash equivalents Operating income (gross pro�it) Accounts receivable (A/R) Selling expenses Inventory General & administrative (G&A) Other current assets Earnings before interest & taxes & depreciation & amortization (EBITDA)

Total current assets Total �ixed assets

Depreciation & amortization Total assets

Earnings before interest & taxes (EBIT) Total liabilities and stockholders' equity

Net interest expense Accounts payable Other expense (income) Accrued liabilities Net income before taxes (NIBT) Other current liabilities Income tax expense Total current liabilities Net income after taxes (NIAT) Long-term debt

Total liabilities Common stock Retained earnings Paid-in capital Other equity Total stockholders' equity Total liabilities and stockholders' equity

Each subtotal in bold is equal to the previous bold subtotal minus the items in between. For example, NIAT = NIBT – income tax expense.

Each subtotal is the sum of elements above it Total assets = current assets + �ixed assets Total liabilities = current liabilities + L-T debt Total assets = total liabilities + stockholders' equity

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To properly assess the �inancial state of a company, you need three to �ive years of historical �inancial data in the form of income statements and balance sheets.

Igor Mazej/iStock/Thinkstock

An annual income statement presents a �inancial picture of a company's operations over the previous 12 months. A balance sheet is a "snapshot" at a point in time (usually at the close of a company's �iscal year) that presents a �inancial picture of its assets and the proportion in which those assets are �inanced through debt and equity. In a balance sheet, the total assets equal the total liabilities (debt) and stockholders' equity—the two sides must "balance."

A convenient way of analyzing several years' worth of �inancial data is to create a spreadsheet and enter the data for each year in a different column (Tables 5.1 and 5.2). Doing so enables annual changes in line items and ratios to be computed. More speci�ically, a thorough analysis of multiyear �inancial statements consists of the following elements (Bangs & Pellecchia, 1999):

Computing all liquidity, activity, leverage, and pro�itability ratios for all years. Computing year-to-year changes for all line items (in both the income statement and balance sheet) and all ratios for all years. Computing average annual changes over all years for line items and �inancial ratios. Computing common-size income statements for all years (everything on the income statement expressed as a percent of revenues). Computing a Z- or Z2-score for each year (Calandro, 2007). This computation involves �inancial ratios (see box on Z- and Z2-scores). Forming a conclusion about how the company has been performing �inancially (from the income statements—revenue and NIAT performance) and about its current �inancial condition (from the balance sheets—�inancial structure, cash �low, degree of debt, liquidity), and its overall �inancial health (Z- or Z2-scores).

Table 5.1: Multiyear income statements for Net�lix

In $ Thousands 2000 2001 2002 2003 2004

Subscriptions 35,894 74,255 150,818 270,410 500,611

Sales - 1,657 1,988 1,833 5,617

Total Revenues or Sales 35,894 75,912 152,806 272,243 506,228

Cost of Goods Sold 24,861 49,907 78,136 148,360 276,458

Operating Income 11,033 26,005 74,670 123,883 229,770

Operating Expenses 62,511 59,138 78,606 109,826 194,129

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General & Administrative 6,990 4,658 6,737 9,585 16,287

Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA)

(58,468) (37,791) (10,673) 4,472 19,354

Depreciation and Amortization - - - - -

Earnings Before Interest & Taxes (EBIT)

(58,468) (37,791) (10,673) 4,472 19,354

Interest and other income (1,645) (461) (1,697) (2,457) (2,592)

Interest and other expense 1,451 1,852 11,972 417 170

Net Income Before Taxes (NIBT) (58,274) (39,182) (20,948) 6,512 21,776

Provision for income taxes - - - - -

Net Income After Taxes (NIAT) (58,274) (39,182) (20,948) 6,512 21,595

Source: Maddox, B., & Thompson, A. A., Jr. (2007). Net�lix versus Blockbuster versus Video-on-Demand. A case in Thompson, A. A., Jr., Strickland III, A. J., & Gamble, J. E. (Eds.), Crafting and Executing Strategy: Concepts and Cases (15th ed.; pp. C-148 to C-161). New York, NY: McGraw-Hill.

Table 5.2: Multiyear balance sheets for Net�lix

2000 2001 2002 2003 2004

Assets

Cash & cash equivalents 14,895 16,131 59,814 89,894 174,461

Short-term investments - - 43,796 45,297 -

Other current assets - 3,421 3,465 3,755 12,885

Total Current Assets 14,895 19,552 107,075 138,946 187,346

Net investment in DVD library - 3,633 9,972 22,238 42,158

Other �ixed assets 37,593 18,445 13,483 14,828 22,289

Total Fixed Assets 37,593 22,078 23,455 37,066 64,447

Total Assets 52,488 41,630 130,530 176,012 251,793

Liabilities & Stockholders' Equity

Liabilities

Current liabilities 16,550 26,208 40,426 63,019 94,910

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Total Current Liabilities 16,550 26,208 40,426 63,019 94,910

Notes & sub notes payable 1,843 2,799 - - -

Other LT debt 107,362 103,127 748 285 600

Total Liabilities 125,755 132,134 41,174 63,304 95,510

Stockholders' Equity

Red. conv. preferred stock 101,830 101,830 - - -

Other equity (175,097) (192,334) 89,356 112,708 156,283

Total Stockholders' Equity (73,267) (90,504) 89,356 112,708 156,283

Total Liabilities & Stockholders' Equity

52,488 41,630 130,530 176,012 251,793

Financial Ratios

Liquidity Ratios

Current ratio (CR) = Current assets / current liabilities

(When this ratio > 1.0, working capital (current assets – current liabilities) is positive, which is desirable.)

Quick ratio (QR) = (Current assets – inventory) / current liabilities

Inventory-to-net-working-capital ratio (INV/NWC) = Inventory / (current assets – current liabilities)

Activity Ratios

Inventory turnover (INV Turns) = Revenues / inventory

Total-asset turnover (TAT) = Revenues / total assets

Average collection period (ACP) (days) = Accounts receivable (A/R) / average daily sales or revenues/365

Leverage Ratios

Debt-to-equity ratio (D/E) = Total liabilities / total equity

(When this ratio > 2.0, debt is too high and needs to be reduced; when it is negative, debt is so high as to exceed the assets of the �irm and cause stockholders' equity to go negative, a serious problem.)

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Debt-to-assets ratio (D/A) = Total liabilities / total assets

(When this ratio > 0.67, debt is too high and needs to be reduced; when > 1.0, debt is so high as to exceed the assets of the �irm and cause stockholders' equity to go negative indicating a serious problem. Either D/E or D/A ratio is used, not both.)

Times interest earned (TIE) or coverage ratio = EBIT / interest expense

(When this ratio < 1.0, the company doesn't have enough money to pay the interest on the debt, a serious condition only experienced with very high debt.)

Pro�itability Ratios

Net pro�it margin (NPM) or Net return on sales (NROS) = Net income after taxes (NIAT) / revenues

Return on equity (ROE) = NIAT / total stockholders' equity

Return on assets (ROA) = NIAT / total assets

Two ratios reveal how productive assets are—TAT and ROA; when these are declining, increasing one's assets is problematical. Cash �low is made up of operational, �inancial, and investing cash �lows; when overall cash is increasing from year to year, cash �low is positive, otherwise it is negative.

Z- and Z2-Scores

Z- and Z2-scores are bankruptcy predictors, or indicators, developed by Edward I. Altman, a professor of

�inance at New York University. The Z-Score is based on data from manufacturing companies, while the Z2-

score is based on data for nonmanufacturing companies. Each is a very important indicator of a company's �inancial health or imminent bankruptcy. Both indicators take the form of a regression equation:

Z-Score = 1.21X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5

Z2-Score = 6.5X1 + 3.26X2 + 6.72X3 + 1.05X4

Where X1 = Net Working Capital / Total Assets

X2 = Retained Earnings / Total Assets X3 = Earnings Before Interest & Taxes (EBIT) / Total Assets X4 = Total Stockholders' Equity / Total Liabilities X5 = Sales / Total Assets

Note that four of the �inancial ratios have total assets in the denominator and the other has total debt in the denominator. Thus, increasing assets through borrowing is not a good idea �inancially (unless performance improves), while one of the �irst things to do when a company is in �inancial trouble is to sell

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off some assets and use the proceeds to pay down debt. The �inal scores are compared to the following cutoffs to assess their signi�icance:

Criteria Safe Region

Gray Region

Bankrupt Region

(Financially healthy) (In serious trouble)

Z-Score > 2.99 1.81 – 2.99

< 1.81

Z2-Score > 2.59 1.11 – 2.59

< 1.11

The last step in the analysis is the most important. What sense can be made of the numbers? What picture do they paint of the company's performance over the past several years and current condition? You could draw any one of the following conclusions:

1. The company is very well managed, has been performing extremely well, and is in strong �inancial condition and overall �inancial health (all key indicators are good and none is bad).

2. The company is very well managed, has been performing extremely well, and is in strong �inancial condition and overall �inancial health except for one major bad thing, for example, having very high debt or declining total-asset turnover (a predominance of good indicators with one or possibly two bad ones).

3. The company turned in a mixed performance over this period and is neither performing well nor in serious trouble. The results are, in fact, inconclusive (an equal or roughly equal number of good and bad indicators).

4. The company's performance and �inancial condition is poor and key result indicators were declining steadily (or precipitously) over time; the company is or should be in serious �inancial trouble except for one major good thing, such as increasing revenues (a predominance of bad indicators with one or possibly two good ones).

5. The company's performance is poor, and key result indicators were declining steadily (or precipitously) over time; the company has not been managed well and is in serious �inancial trouble (all indicators of performance and condition are bad and none is good).

After completing the �inancial analysis, only one of the preceding �ive conclusions is possible. Whichever one is selected, it must be supported with selected statistics that summarize the current �inancial performance, condition, and health of the company, or the conclusion isn't valid. Because the principal ways for a company to �inance any strategic initiative are through cash or debt (or in the case of a public company, stock), the �inancial analysis provides essential information to top management as to the company's ability to fund a proposed strategy. As an example, an analysis of the �inancial data for Net�lix presented in the multiyear income statement (Table 5.1) and multiyear balance sheets (Table 5.2) produces the conclusion summarized in the following section.

Example of a Financial-Analysis Conclusion

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Based on the income statements and balance sheets to 2004, Net�lix has performed very well �inancially, is in strong �inancial condition, and �inancially healthy.

In 2004:

Revenues increased 86% (for the fourth straight year) NIAT increased 231.6% (also for the fourth straight year) Current ratio is 1.97 (good working capital) D/E ratio is 0.61 (low debt, excellent �inancial leverage) Cash �low is positive, and increased 94.1% to $174.46 million.

This conclusion is #1, where all the indicators are good and none are bad. When the conclusion is supported by data—particularly from the most recent year—it becomes hard to refute.

Discussion Questions

1. What can you tell about a company's operations from looking at the past few years of income statements?

2. How much pro�it a company makes after all its expenses are deducted (NIAT) is shown on the income statement. Yet, a company cannot "spend" the pro�its it makes—it can spend only cash, which is a balance-sheet item. How do you explain this?

3. In a balance sheet, total assets must equal or balance total liabilities + total stockholders' equity. In what other ways is this principle of "balancing" useful?

4. In the newspapers, one often reads about companies that are "not managed well �inancially." Given what you have learned in this section (and perhaps in a previous course on �inance), what do you think this means?

5. The Z- and Z2-scores contain similar �inancial ratios as terms in their regression equations. From this, the two scores would go up with increasing working capital, retained earnings, EBIT, equity, and sales, and with decreasing assets and debt. However, all but EBIT and sales are balance-sheet items. Why do you think such bankruptcy indicators focus on balance-sheet items so heavily?

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Evaluating an organization's strengths based on its competitors can provide a more accurate assessment of the organization.

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5.2 Conducting a SWOT Analysis

Once a company has a �irm understanding of where it stands �inancially, the next part of the internal assessment is conducting a SWOT analysis, which stands for a company's strengths, weaknesses, opportunities, and threats. To be sure, opportunities and threats are more appropriately part of an external analysis, but doing a SWOT analysis is so widespread as part of a strategic analysis that they are discussed together here for convenience. As was discussed in Section 3.2, the search for opportunities is an integral part of strategic thinking.

Strengths

Strengths and weaknesses are the "internal" aspects of the traditional SWOT analysis. Whenever something—or someone—is reviewed or assessed, it makes sense to point out the good points or what was done well, as well as the areas that need improvement. They are two sides of the same coin. This assessment is easy to do super�icially, which is often the case, but dif�icult to do candidly and realistically. It is nearly always subjective, but less so if done by a group with multiple perspectives, which is why companies sometimes hire outside consulting �irms to help them analyze their strengths and weaknesses. Regardless of who conducts it, the strength analysis should compare the �irm to itself at some previous point in its history, perhaps 2–4 years ago, and determine what it is doing better and what has not improved.

It might also be useful to think of strengths as special capabilities or expertise. These are things a company does well that have enabled it to be successful to this point, and how it has prepared itself to compete in the future. Comparing a company's strengths against those of its competitors and identifying the industry's critical success factors (Section 4.1) also provides a useful assessment. Typical strengths that companies have might include the following:

Adequate �inancial resources to implement any likely strategy Strong cash �low Strong brand recognition Effective differentiation Effective advertising and promotion Consistent high quality in products/services Effective distribution Economies of scale

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When the top management of struggling companies meets, it is quite common for one department to blame the other for the company's poor performance.

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Insulation from competition Proprietary technology and patents Low-cost leader Product-innovation skills Proven management Visionary CEO, strong leader Productive corporate culture that supports the strategy

The problem is that it can be easy to classify what a company does "well," but what exactly constitutes a "strength"? The answer is subjective; it depends on how high a company's internal standards are and how widely they are shared. For this reason, it should also compare strengths (and weaknesses) with its closest competitors. In assessing whether their company's brand is a strength or a weakness, executives at Wendy's must compare the brand to those of McDonald's and Burger King. Similarly, the athletic apparel offered by Adidas must be compared to the products offered by Nike. Because Wendy's and Adidas are established and successful companies, it is tempting to consider Wendy's and Adidas to possess strengths in terms of brand and apparel. These �irms' standing relative to their closest rivals, however, would suggest that these areas are in fact weaknesses.

Weaknesses

Much like the strengths that a company may possess, weaknesses are also internal. They include problems that need to be corrected, de�iciencies recognized through a comparison with competitors, or de�iciencies relative to proposed strategies such as lacking the resources to grow. Whether or not what is identi�ied is an actual weakness, it is the perception of a weakness that counts.

Some managers have no problem admitting to weaknesses when they are self-evident, while others �ind them hard to own up to in the belief that doing so casts them in a bad light as an ineffective manager. Sometimes, if a company is having problems and the top management team is meeting to discuss them, it is not unheard of for

one department to �ind a way of blaming another department for the company's problems. The production manager might blame human resources for inadequate training resulting in low quality. Marketing might complain that engineering and R&D failed to act on its good market intelligence to create new products. Or R&D could complain about a cut in its budget for something far less important. In all these examples, grappling with weaknesses is not about �inding who is at fault or who is to blame. It is about gaining a realistic understanding of the company's weaknesses so that steps can be taken to alleviate or correct them.

Weaknesses can take many forms, including the following:

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When Ford Motor Company bought Jaguar, Ford's company executives found multiple weaknesses and wondered how Jaguar had survived.

Bill Pugliano/Getty Images

Obsolete facilities Key skills and competences missing or obsolete No core competence, hence no competitive advantage Internal operating problems and inef�iciencies Too narrow a product line Long cycle time to get product out Poor marketing skills A culture that hasn't changed with the strategy Weak or eroding brand image Poor or negative cash �low from operations, including low or negative pro�its, resulting in an inability to service debt or fund needed programs

Weaknesses become real when compared to other companies in the industry. For example, you might think your company has low costs and believe that to be a strength only to discover that your costs are among the highest in the industry. Suddenly, that supposed strength becomes a weakness. A new CEO participating in a SWOT analysis with his or her new management for the �irst time will have a different frame of reference and a different set of standards from the managers, so the CEO might have dif�iculty agreeing with them on what strengths and weaknesses the company has. As noted previously, it is the perception that is important.

These illustrations show that when making any assessment, even a seemingly casual one like identifying a strength or weakness, you are using an implicit standard or reference in making it. More experienced people will tend to be more critical because they may once have worked in organizations where they have observed things done better, thus raising their own standards. Again, the goal here is not to be "right" at the expense of someone else being "wrong." Rather, it is to reach consensus on what is real and problematic so that it can be attended to and the �irm's future prospects improved.

Opportunities

An analysis of strengths and weaknesses covers what is internal to the �irm, but that is only half the story as it pertains to assessing a company's potential success or failure. In order to stay competitive in an industry, one has to go looking for opportunities that would improve the company's situation. An opportunity has a speci�ic technical de�inition; it is a product-market issue. It must include a product or service the �irm offers, including the existing ones, and a de�ined customer group at which that product or service is targeted, including the existing ones. The following are examples of real opportunities (and concentration strategies):

Staying with an existing product and existing market and penetrating the market further.

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Improving the product for an existing market; that is, implementing a product-development strategy. Examples include automobile companies producing new models annually, and software companies releasing upgraded versions of their software. Creating a new product for an existing market, which is also a product-development strategy. Examples include Nike offering athletic apparel in addition to athletic shoes for the same market, Microsoft creating application software for users of its Windows operating system, and Calvin Klein selling perfumes as well as clothes. Expanding the market for an existing product by implementing a market-development strategy, such as promoting the product to appeal to young adults in addition to teenagers or lowering the price so that more people can afford to buy the product. Facebook, for example, has gradually expanded its market from young people to people of all ages. Finding a new market for an existing product, which is another market-development strategy. Examples abound of companies going regional from being just local or a regional company going national or entering a new country, all without changing the product or service. For example, Indian automobile manufacturer Mahindra & Mahindra is planning to start selling pick-up trucks in the United States by 2016 (Hamprecht, 2011).

If a company goes to the trouble of identifying opportunities, it does so only when doing strategic planning, usually once a year. But why not institute and formalize an opportunity-�inding mechanism that would operate all the time, generating ideas and proposals on a continuous basis? This is what is truly meant by "being opportunistic."

Many companies have instituted new-product-development committees that are responsible for evaluating new-product proposals. For promising proposals, the committee asks for more information or requests a prototype demonstration. Proposals that indicate potential for commercial success are provided with necessary support and development (Cooper, 1993). While such new products could form the basis for a future revenue stream, the probabilities for most companies are distressingly small.

By its very nature, the process can be likened to a funnel, where a large number of items are successively narrowed to a small number: only a few of the many ideas for new projects are researched further, even fewer are found to be feasible, fewer in turn are �inally adopted, and fewer still achieve success. Indeed, many �ields experience a similar, narrowing effect. Consider the example of the game of baseball. Each year more than 2 million youngsters worldwide play on Little League teams, many with dreams of one day making it to the "big leagues." Players who actually reach the minor league level number a few thousand while the active rosters in Major League Baseball include only 750 players.

Contrast such a system to another where the number of ideas vastly increases, and sifting through them becomes a fulltime job for several people. Avenues for involvement include asking customers for suggestions, reaching out beyond engineers to all company employees, and accepting ideas for improvement of all shapes and sizes—not just product innovation. In such an environment, a company can focus on opportunity-recognition, and rejuvenate its revenue model on an ongoing basis.

New technology, or more accurately newer technology brought to market faster, is a rich source of new opportunities. It is a risky business, however, especially when the pace of technological change is very fast. The key thing that separates the good opportunities from the bad ones is how well margins can be

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maintained over time or how well the resulting product can resist imitation or obsolescence over time. In a hypercompetitive industry, that is dif�icult to accomplish; companies should expect only temporary advantages at best (D'Aveni, 1995).

Change produces both threats and opportunities. Many companies, however, worry only about the threats and do not undertake systematic or frequent enough searches for opportunities. When an opportunity is found, it can take several years to take advantage of it, especially if it requires acquiring and adapting to new technology, understanding a new market, or changing the corporate culture to do it. The earlier it is found the better, thus the search for an opportunity should ideally be ongoing.

Threats

Threats are external to the company. Any "internal" threat is classi�ied as a weakness. Threats are external trends or forces that adversely affect the company. Left unaddressed or even ignored, some threats can wipe out a company. While threats derive from an external-environment scan and analysis, they are discussed here because they are typically included as part of a SWOT analysis. Threats can take many forms:

Low-cost foreign competition Slower industry growth Costly regulatory requirements Adverse effects of a recession or business cycle Growing bargaining power of customers and suppliers Changing buyer tastes and needs Demographic changes that adversely affect the company Increasing interest rates Raw-material shortages

Implicit in recognizing a threat is the fact that it is a trend moving in a certain direction. Yet at what point —at what value of a trend—does a particular threat become real? For example, companies in the real- estate industry would consider interest rates slowly inching upward as a threat. Or when the price of a critical raw material rises, precisely when does it begin to threaten the company and prompt it to take offsetting action? One way to deal with this problem is to classify threats on a two-dimensional grid (Figure 5.1). The purpose of doing so is to sort out which threats to pay attention to and do something about, and which to continue monitoring. To plot a threat on the grid you will have to decide on the severity of the likely impact of the threat on the company. Using the preceding interest-rate example, a just-rising interest rate would not have a high negative impact on the company; so it would go into the short-term, low-impact quadrant. However, a fast-rising, high-interest rate would represent a short-term, high-impact threat so would be placed in the upper-right quadrant. It is a judgment call; but again, if done by a group of people, the assessment will be more reliable.

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Figure 5.1: Classifying threats grid

Those threats in the top-left quadrant, that is, having a high negative impact in the short term, should receive priority attention by the company. Those in the top-right and bottom-left quadrants should both receive second priority, with individual threats being handled in appropriate priority order. The least pressing group is that in the bottom-right quadrant, which may need just steady monitoring but no action. For high-priority threats, a company should begin at once to gather more data about them; assign a committee or task force to track, study, and report on them; and, most importantly, come up with contingency plans for dealing with them. These threats, along with selected threats from the top-right quadrant, should probably be treated as strategic issues.

Discussion Questions

1. Imagine you are part of a top-management team at a strategic-planning meeting. The discussion eventually gets round to listing the organization's strengths and weaknesses. People shout out what they believe are strengths and weaknesses to populate each list. Very seldom is there any discussion that challenges any of the items suggested. What would you suggest to delve a little deeper to ferret out real strengths and weaknesses from those on the list (or even not on the list)?

2. Which carries more weight as a source of strengths: a comparison with the company's own past, its current competitors, or its future strategies? Give reasons for your point of view.

3. Admitting to shortcomings by people in positions of authority is considered by many to be a sign of weakness or inadequacy. How could such managers be persuaded that it is, in fact, a sign of strength?

4. Is the reluctance to admit mistakes or recognize weaknesses more of an individual failing or an aspect of the prevailing culture? How could this be determined? If the latter, is it easy to change?

5. A company identi�ied "lack of �inancial resources" as a weakness. If this were true only in the event of implementing a certain strategy, then shouldn't the strategy be determined

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�irst and then the weakness? Or would such a weakness preempt choosing a strategy that required greater �inancial resources? Discuss.

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A company's core competence and competitive advantage have become increasingly important concepts.

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5.3 Core Competence and Competitive Advantage

Core competence and competitive advantage are important concepts in the strategy literature, but the terms are often confused. The following should clarify their meaning:

Capability—the ability to do something (Capability, n.d.); capabilities may or may not be strengths. Core competence—a strategic capability that is simultaneously valuable, rare, costly to imitate, and nonsubstitutable, and one that underpins a company's strategy (Hitt, Ireland, & Hoskisson, 2005). Core competences are the assets and capabilities that can distinguish a company from its rivals. Competitive advantage—a signi�icant edge over competitors. This is often measured in developmental lead time, such as an 18-month lead over the nearest competitor in software. It may otherwise be something an organization can do that competitors can't (e.g., integrate systems ef�iciently) or that an organization has (e.g., patents, a core competence) that competitors lack. Sustainable competitive advantage—the ability to maintain or increase the edge that an organization has over its competitors over time. Given that a competitive advantage erodes over time, sustaining it takes focused effort and considerable resources (Grol, Schoch, & Roger, 1998). It involves "raising the bar" regularly; as soon as a competitor thinks it has caught up, the company in question must have developed something new that maintains the original lead. As Kevin P. Coyne (1986) writes, "The most important condition for sustainability is that existing and potential competitors either cannot or will not take the actions required to close the gap."

Addressing these competencies can allow a company to gain a competitive advantage, and this has been the case for successful companies in various industries. IKEA, a well-known seller of Swedish furniture worldwide, is a prime example of this. When it began operations in the United States in 1985, it used a business model that was unique in the industry. Customers were taken to the top �loor of a large three-story showroom and made to walk a prescribed route through dozens of �inished living room, of�ice, and bedroom, etc. sets, from the third �loor to the second and then to the �irst, where purchases were picked up before paying for them. No matter what the customer came into the store to buy in the �irst place, the idea was to expose the customer to other ideas for every room in the house, thereby selling more. The designs were simple, elegant, and modern, and the prices were low. Also, all furniture was sold unassembled, saving huge costs at the factory and store locations and passing the savings (and delivery and assembly) on to the customer. Clearly, the company has grown and is highly successful. Yet no one has been able to duplicate its business model or operations. Its competitive advantages have been sustained.

Case Study Sustainable Competitive Advantage: Southwest Airlines

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Southwest Airlines began as a small intrastate operation serving the state of Texas in 1971 with three aircraft (Southwest.com, n.d.). From that limited beginning, Southwest has expanded into the largest airline in the United States (IATA, 2011), �lying to 72 cities in 37 states. While every other major U.S. airline has �iled for bankruptcy protection and consistently reported losses, Southwest has sustained a pro�it for nearly 40 consecutive years. What has made the difference? We have de�ined sustainable competitive advantage as "the ability to maintain or increase the edge that an organization has over its competitors over time." Clearly, Southwest has been able to create and sustain its competitive advantage. Let's take a look at one of the factors that has contributed to this.

Customer Service

By numerous metrics, Southwest Airline's strength appears to exist in its ability to consistently provide superior customer service. According to numerous customer-satisfaction surveys, Southwest ranks �irst among U.S. carriers on customer experience; the airline was ranked #1 by Consumer Reports in 2011 for customer service; and in 2011, MSN Money ranked Southwest in the top ten of all companies for its Customer Service Hall of Fame. In an era marked by high-pro�ile stories of passengers stuck on airport tarmacs in aircraft with no food, beverages, or working bathrooms for many hours and little sympathy from airline personnel (Katrandjian & Schabner, 2011), Southwest has continued to stand out as the airline "with a heart." From small gestures like the continued service of free snacks to the savings afforded passengers by free baggage handling (when all other U.S. carriers are now charging for checked bags), Southwest continues to illustrate that it is a customer-focused operation. Entire websites are dedicated to consumer complaints about major U.S. airlines that range from cancelled and oversold �lights; lost, vandalized, and stolen luggage; to ground holds that approach or exceed federal regulations. Although none of these problems is new to the airline industry (including Southwest), what appears to frustrate passengers the most is the apathetic attitude that airline personnel take toward customer frustration and inconvenience. In other words, the perceived rudeness of airline employees and the feeling that passenger problems are "just numbers," often processed by off-shore call centers, contribute to more customer negativity than the original problems themselves. Common customer-service problems that unfold to nightmares for passengers on most airlines are merely inconveniences for Southwest customers who typically leave the negative experiences feeling validated and "whole." When one �light in 2006 was stuck on the tarmac due to deicing delays and a federally mandated crew change, the pilot walked the aisles updating passengers on the delay and accommodations for connecting �lights. Within a few days, passengers received letters of apology and vouchers for the full price of a future trip on the airline (Customer service champs, 2007).

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This type of response is standard operating procedure for Southwest—not an anomaly or the charity of one particularly sensitive employee or crewmember—and accounts for a large part of the airline's sustained competitive advantage over other carriers perceived as uncaring about their customers. Customers are even compensated for inconvenience associated with major storm delays—a condition for which no other major airline bears any responsibility. Customer service like this is not an accident; it's a coordinated effort that involves the entire company from top management to the front lines and that is rewarded and valued. Customer service is a way that Southwest Airlines distinguishes itself.

Questions for Critical Thinking and Engagement

1. Although customer service is a well-known and important contributor to Southwest Airline's competitive advantage, it is just one ingredient. Spend some time researching this classic example of a well-managed and well-led organization, and identify other elements that may contribute to its sustained competitive advantage.

2. What perceived barriers prevent other organizations from distinguishing themselves through the kind of service exempli�ied by Southwest?

3. Identify factors contributing to sustained competitive advantage for an organization you are familiar with. What speci�ic strategies does the organization use to continue upping its game and maintaining its edge over its competitors?

4. What role does strategic management play in developing and sustaining competitive advantage? Identify and explain.

McDonald's is another well-known company that has crafted a sustained competitive advantage over time. McDonald's success has been built around providing consistent products in a speedy fashion. Travelers have con�idence that when they enter a McDonald's in Seattle, the Big Mac and French fries that they purchase will taste the same as if they were purchased in Los Angeles or Dallas. Firms such as Burger King have tried to copy McDonald's formula, but no company has been able to duplicate McDonald's success. Importantly, McDonald's executives have been willing to change with the times in order to preserve the �irm's competitive advantage. Although McDonald's business emphasized hamburgers and other high- calorie foods for several decades, the company now offers an array of healthy options such as salads and fruit smoothies that appeal to today's customers.

The four criteria that distinguish capabilities from core competencies are related to competitive advantage and �irm performance. Valuable capabilities are those that add or create value for a �irm. Rare capabilities are those possessed by no known current or potential competitor. Costly-to-imitate capabilities are those that other �irms cannot develop easily, quickly, or inexpensively. Nonsubstitutable capabilities are those that do not have strategic equivalents. The owners of certain movie franchises have developed signi�icant competitive advantages by building �ilms around compelling characters that are valuable, rare, costly (and perhaps impossible) to imitate, and nonsubstitutable. The Harry Potter, James Bond, and Star Wars series have all earned more than $4 billion at the box of�ice. Toys, video games, and other complementary products built around these franchises have earned signi�icant revenue too.

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The following is a list of typical capabilities:

Design and production skills yielding reliable products Product and design quality Technological capability Integrating different technologies to produce a desired system or product for the customer Swift conversion of technology into new goods and procedures Effective promotion of brand-name products Strong brand (well known, high value) Strong customer service Innovative merchandising Excellent training (Hitt, Ireland, & Hoskisson, 2005)

While these criteria appear straightforward, applying them is dif�icult. Take any of the capabilities in the preceding list, for example, and try to apply these criteria. It may take some research to evaluate them. For �irms without a core competence, or with capabilities that meet two or fewer criteria, the strategic- planning imperative is clear. A company must work to develop a core competence that meets all the criteria and that produces a sustainable competitive advantage. On the downside, a core competence can be outdated by environmental change, replaced by substitution, or eroded through imitation and competitive action. In 2011, American Airlines �iled for bankruptcy protection. Like most airlines, American has struggled to create a competitive advantage. It tried to do so by creating the world's �irst frequent-�lier program to reward repeat customers. Unfortunately, its rivals such as Delta quickly introduced their own frequent-�lier programs. Imitation had prevented American from carving out a competitive advantage in the airline industry.

Discussion Questions

1. The phrase "competitive advantage" is often tossed around loosely in the business press. CEOs will label seemingly anything they do—whether the training they give their people to how they talk to customers to their prices—a competitive advantage. What might be the motivation for why they do this?

2. The concepts of core competence and sustainable competitive advantages are discussed as part of an internal analysis. Yet without an in-depth knowledge of a �irm's competitors, these concepts cannot be realized. Does this mean that an external analysis should always be done before an internal analysis? Discuss.

3. How many capabilities should be included in a search for a core competence? Explain the number you suggest as your answer.

4. Which of the four criteria for determining a core competence is the most dif�icult to answer? Why?

5. List the ways in which a core competence or competitive advantage can erode. 6. Is it more dif�icult to prevent erosion of an existing core competence or develop a new one?

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5.4 Competitive Strength

How competitive is your company? To �ind out, do an analysis very similar to the one done to assess industry attractiveness, except with different factors (see the illustration shown in Table 5.3). As with the industry-attractiveness matrix, assign a weight to each of these factors according to their perceived importance, then rate each factor from the point of view of the company doing the analysis on a scale of 0– 1.0, 1.0 being highest, and �inally multiply the weight by the rating for each factor. Here, the factors should re�lect what it takes to be competitive in an industry. When you have �inished, you will have a resultant competitive-strength (C.S.) index at the bottom. The higher the percentage �igure, the more competitive your company is considered to be in the industry, assuming realistic ratings. (While this technique is also highly subjective, it becomes less so when done by a group of people with knowledge of the company.)

Table 5.3: Competitive-strength matrix

Factor Weight Rating Product

Brand reputation 24 0.9 21.6

Customer service 22 0.9 19.8

Cost control 18 0.9 16.2

Innovative capability 14 0.5 7.0

Financial strength 12 0.8 9.6

Management 10 0.8 8.0

Totals 100 C.S. Index 82.2

In Table 5.3, the competitive-strength (C.S.) index of 82.2 shows that the company being analyzed is a strong competitor, given that the factors meaningfully describe its competitive characteristics.

Both indices are used to place the company on the G.E. Matrix, which plots industry attractiveness against competitive strength (Figure 5.2). Notice that the grid is divided into nine cells. If a company were to end up in any of the three cells in the top-right corner of the grid (pink squares), the strategy would be to "grow, invest, and build." If it were to end up in any of the three cells in the bottom-left comer of the grid (blue squares), the strategy would be to "harvest or exit" from the industry. (What else can a weak, uncompetitive company do in an unattractive industry?) The remaining three cells are more dif�icult to assess, and strategies should be developed in these situations on a case-by-case basis. The value of plotting a company on this grid is to get an early "take" on the strategy it should follow. Based on the indexes arrived at for the industry-attractiveness and competitive-strength matrices (Table 5.3), the example company would be plotted in a pink square as shown.

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Figure 5.2: G.E. matrix

Is the Current Strategy Working?

First of all, what is the company's current strategy? Once it can be articulated (and there could be more than one—see Section 1.6), three questions should be asked to tell you whether it has been working: (1) Has the company made progress toward achieving, or has it achieved, its vision and strategic intent? (2) Have its stated objectives been attained? (3) Is its �inancial performance and condition good or at least meeting expectations? A public company's stock price depends heavily on this last question.

In 2011, Net�lix faced a �irestorm of criticism about a new strategy. Net�lix executives announced a plan to split the company's video service into two services. Streaming video would continue to carry the Net�lix name. Customers wishing to rent DVDs, however, would have to subscribe to a new service called Qwikster. After thousands of customers abandoned Net�lix, the company quickly changed course and announced that the services would both remain under the Net�lix banner. But the damage had been done. Net�lix stocked lost 60% of its value between July and October of 2011 (Woo, 2011).

Table 5.4: Questions to challenge the current strategy

Questions about scope Questions about choices Questions about process

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What assumptions about market trends, competitor behavior, new entrants, changes in technology and customer needs have you made? If those assumptions were wrong, how would the strategy be affected?

What strategic choices are you making, and what are you rejecting? What is the rationale? Are there circumstances or situations that would cause you to choose differently?

How many customers did you interview? How many noncustomers?

Are there trends that could force you to change the way you do business now?

Are you pursuing growth aggressively enough? Are you compromising growth by failing to provide adequate resources?

How did you involve different markets from around the world?

If you had to triple your growth, what new business would you enter?

Can you reverse a basic assumption held in the industry? How, and what would be the bene�it?

What approaches did you use to develop creative or breakthrough strategies?

What is the de�inition of the market you are in, and what is the logic behind that de�inition?

How are your plans the same as or different from those of your competitors? How will you ensure that you have a different value proposition? What actions have your competitors taken in the last three years to upset global market dynamics? What are the most dangerous things they could do in the next three years?

Have you committed suf�icient resources to your strategic initiatives? Are they linked to your �inancial and HR plans?

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What new uses for your products and technologies have you explored?

What have you done to affect global dynamics over that period, and what are the most effective things you could do in the next three years?

Source: From Sarah Kaplan and Eric D. Beinhocker, The real value of strategic planning. MIT Sloan Management Review, 44(2), 73. Reprinted by permission of MIT Press.

In other cases, whether or not a strategy is working is far less clear. Consider the questions shown in Table 5.4. If you �ind that objectives have not been met, resist jumping to the conclusion that the strategy has not been working. The strategy could be appropriate in the circumstances, but the execution of it may be poor; or the company may have underestimated how quickly the objectives could be achieved. However, if the execution was good, then it is likely that the strategy was not working and should be changed. Also, if the company has been making satisfactory progress toward achieving its vision and strategic intent but not achieving its objectives, it could be that the objectives were set too high or were otherwise unreasonable. And a �inancial review of the past three to �ive years' data could also surface some problems. Thus, such a review ought to be done carefully, because what you conclude could set the stage for what strategic alternatives you come up with later in the process.

Discussion Questions

1. The matrix that is used to determine a competitive-strength index, like the one that determines an industry-attractiveness index, is subjective. The �inal result depends on the kind and number of factors used in the analysis, how they are weighted, and how the company itself is rated on each of those factors. Discuss some ways of reducing the amount of subjectivity present.

2. Are there certain factors, independent of industry, that are perennially more important than others? Which ones and why?

3. Why do managers and executives �ind it dif�icult to tell an outsider what strategy a �irm is pursuing? Given that they are able to do so, why are their answers different from each other? How might you address this problem?

4. Should a company's strategies be con�idential? Why or why not? 5. Many strategies don't have core competence as an element; yet having a core competence is central to earning above-industry-average pro�its. How do you reconcile this seeming anomaly?

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5.5 Value-Chain Analysis

A value chain can be described in two ways: (1) within a company, the term encompasses the different value-added phases from buying materials to distributing, selling, and servicing the �inal product (Porter, 1985), and (2) outside of the company, it describes the value-added phases from raw material to end-user as a product is produced and distributed, with each phase representing an industry (Abraham, 2006). For simplicity, these two de�initions will be referred to as "internal" and "external" value chains.

The concept of the internal value chain is critical in the �ield of strategic management and has been well examined. While the concept of the external value chain is less explored, it is equally valuable as it entails elements such as upstream/supply and downstream/distribution processes. While such processes may occur outside the walls of a corporation, they hold many strategic opportunities. Consider the following:

Outsourcing—involves moving speci�ic primary or support functions from the internal value chain to the external value chain. Vertical integration—involves absorbing one or more stages of the external value chain and making them internal. Horizontal expansion—involves developing fresh product lines or broadening channels of distribution, including geographic growth. Strategic alliances with suppliers—involves monitoring external suppliers as if they were part of the internal value chain, while not actually owning them. For example, in Toyota's Kaizen system, key suppliers are based close to a factory and provided with signi�icant guidance and training from Toyota to ensure ef�icient production.

Wayne McPhee and David Wheeler (2006) have extended Porter’s concept of internal value-chain analysis in order to look at value-chain operations outside the realm of the company (Figure 5.3). The �igure shows both Porter's initial concept of an internal value chain and the "external" additions set forth by McPhee and Wheeler, in bold. The introduction of value-chain analysis has proven extremely bene�icial in three key areas: cost analysis and reduction, differentiation, and product development.

Walmart provides a good example of an internal and external value chain (Figures 5.4 and 5.5). Depicting these initial stages is relatively easy. Achieving a full and detailed understanding would be possible by speaking with Walmart executives and monitoring the company’s operations over time.

Figure 5.3: Porter's internal value chain extended

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Source: Wayne McPhee and David Wheeler, "Making the case for the value-added chain," Strategy and Leadership, Vol 24 No. 4 (2008) Exhibit 1.41. Copyright © Emerald Group Publishing Limited. Reprinted by

permission.

Figure 5.4: Walmart's internal value chain

Source: David W. Crain and Stan Abraham, "Using value-chain analysis to discover customers' strategic needs," Strategy and Leadership, Vol 36, No. 4 (2008), Exhibit 3, 31. Copyright © Emerald Group Publishing Limited.

Reprinted by permission.

Figure 5.5: Walmart's external value chain

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Walmart's internal value chain includes the latest in technological logistics and regional distribution centers worldwide. Suppliers establish satellite of�ices near these centers to reduce costs.

Tim Boyle/Bloomberg News via Getty Images

Reprinted by permission.

A more detailed examination of Walmart's internal value chain might illuminate the company's aggressive strategy where technology is concerned (one of the support activities). Walmart was not only the �irst retailer to use bar codes, but it also uses satellite communication between stores. It has integrated its POS, RFID, inventory- control, and additional technologies that serve to decrease delivery time, bolster security (including merchandise shrinkage), and lower costs. It has created regional procurement centers to supplement its well- known center in Bentonville, Arkansas (known as "Vendorville"), including a center near Shenzhen, China. Suppliers base their satellite of�ices near well-placed procurement centers—such as Walmart's largest supplier Procter & Gamble, which has 300 fulltime employees in Bentonville. Finally, Walmart's hallmark involves focusing on the complete "customer experience," such as personally welcoming customers as they enter the store, helping to locate items, process returns, and transport purchases to the customer's car (Crain & Abraham, 2008).

Since Walmart is just a retailer and not a manufacturer, its external value chain is quite simple. It works with numerous vendors and sells to customers. But despite this outward simplicity, Walmart's secrets of success lie in analyzing its internal value chain.

Discussion Questions

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1. Should value chains be a part of a company's external or internal analysis, or both? Discuss. 2. Porter's Five-Forces Model includes the immediate portion of the company's external value chain (the three horizontal boxes—suppliers, rivals, and buyers). Isn't this enough? Why might doing a more detailed value-chain analysis be more bene�icial?

3. The external value chain has two main aspects: "upstream" of the company (its supply chain) and "downstream" (its distribution system). Of course, if the company is a retailer, there is no downstream part because it sells directly to its customers. Can you think of any situation where the supply chain affects distribution or vice-versa?

4. Can you think of any reason why it might be worth a company's time to analyze any of its suppliers' or customers' value chains?

5. To what extent might pursuing a strategy of low-cost leadership involve a company's internal or external value chain?

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Company brands involve a name, term, design, symbol, or any other feature that identi�ies the product as distinct from other products.

age fotostock/SuperStock

5.6 Brand Reputation, Equity, and Loyalty

The American Marketing Association de�ines a brand as a "name, term, design, symbol, or any other feature that identi�ies one seller's good or service as distinct from those of other sellers" (Brand, n.d.). A brand is also a reputational asset, the result of pursuing a differentiation strategy for a considerable number of years (see Section 3.2) that creates very loyal customers. Unfortunately, as an intangible resource, it remains largely invisible in a company's balance sheet. A major reason why companies' stock- market valuations are higher than their balance-sheet valuations (book value) is the value of their brand (Grant, 2008).

Companies can choose to develop a separate brand for each of their products as in the case of Proctor & Gamble, with its 52 brands of beauty and grooming products and 46 brands of household-care products or, if the same promise covers all products, for the entire company like Sony, Amazon.com, or Apple. Promoting individual brands under brand managers, a system of managing them developed by P&G, is like running separate businesses, each having a budget, target customers, and speci�ic competitors. Promoting the whole company as a brand bene�its its whole product line and means that whatever product a customer buys from that company will be "protected" by the same brand promise.

Brand equity is a measure of the value of a brand and can be computed by taking the price premium attributable to the brand, multiplying it by the brand's annual sales volume over a number of years, and calculating the net present value of this revenue stream (Grant, 2008). Given this formula, it is easy to see how brand equity or strength can erode over time. Either the price premium or total sales of the brand declines as a result of competition, or because the discount rate used in the net present value computation increases as a re�lection of a more dif�icult business climate in the future.

Not only is there a tangible �inancial reason to have a strong brand but also the effect on its target customers is real. Brand loyalty is customers' repeated preference for either particular branded products or for any product of a branded company (Jones & George, 2007). If rivals in an industry are all branded and enjoy considerable brand loyalty, then new entrants will �ind it a major barrier to entry, requiring huge advertising costs and considerable time to build customer awareness and, �inally, loyalty. Trader Joe's, discussed in Section 3.2, has a brand trusted by consumers who have become loyal customers; anything it sells under its own private label is immediately trusted and tried by its customers.

Customer-Value Proposition

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A customer-value proposition is a succinct statement summarizing why customers you are targeting should buy from you and not your competitors. The unique value offered includes a mix of elements that could be quantitative (like price or speed of service) or qualitative (like design or customer experience). The stronger or more persuasive the company's customer-value proposition is, the stronger will be its brand and the more loyal its customers.

The following are some possible ways in which a company could create value for its customers (Osterwalder & Pigneur, 2010):

Newness—for example, new technology such as a product that is the �irst of its kind, like the iPad. Performance—in products such as cars, computers, or smartphones. These kinds of customer-value propositions quickly erode because competitors catch up. Customization—including recent trends like mass-customization or tailoring offerings to match customers' needs and time available (Ott, 2010). Reliability—like Rolls-Royce jet engines where the probability of failure has to be zero. Design—hard to measure, products nevertheless succeed because their design appeals to customers. Examples include the iPod and the Aeron chair. Brand/status—from wearing a Rolex watch or driving a Porsche or BMW to wearing a logo T-shirt from your university. Price—although this aspect of a transaction is what the customer sees, it is low costs that companies have to worry about. Anyone can lower prices, but making a pro�it at the same time is more dif�icult. This element of customer value works only with price-sensitive customers (like no- frills Southwest Airlines and Ryanair airfares). Cost-reduction—customers, particularly business customers, will buy products that can help them lower their costs; for instance, if they can realize signi�icant savings for bulk purchases or via a hosted CRM application like salesforce.com. Risk-reduction—the role played by warranties, service guarantees, and return policies. These often make the difference in a purchase decision, contributing to the success of companies like Nordstrom and Costco. Accessibility—being able to access a product or service hitherto inaccessible, like NetJets, enabling customers who could never otherwise afford it rent private jets. Convenience—making it easy to buy and use, like iTunes, or Enterprise rent-a-car, which will pick you up and drop you off when you rent a car.

In conclusion, some major outcomes of a successful differentiation strategy are to enhance a company's brand image, increase its brand equity, create strong brand loyalty, and help the company achieve above- industry-average pro�its. The challenge in assessing brand reputation, equity, and loyalty is to get customers' input as well as top management's, and to have in place a system for tracking brand equity and brand loyalty so that they don't erode. It is also impossible to have a strong brand without a compelling customer-value proposition.

Discussion Questions

1. Some companies believe they will retain their "brand leadership" for many years, a dangerous assumption. Increasingly, consumers are �inding it dif�icult to distinguish

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among competing products. What type of resources are brands? Could a brand ever be the ultimate competitive weapon for a company?

2. Could a brand ever be a company weakness? 3. Customer loyalty is more than just repeat purchases. Do you agree? Why? 4. Enterprise Rent-A-Car asks customers two questions: What is the customer's rental experience, and how likely is the customer to rent from the company again? Are these questions enough, or could you think of others in order to determine the extent of customers' loyalty?

5. What organizational capabilities are needed to develop customer loyalty? 6. To what extent does customer loyalty materially add to the value of a company's brand? 7. Brand identity is how a company wants its customers to perceive the product or company, while brand image is the customer's mental image of the brand. If they are different, how can the company reconcile them?

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Strategic decisions cannot be made without a conclusive assessment of the company's resources and capabilities.

Flirt/SuperStock

5.7 Assessing Management and Leadership

The �inal aspect of a company analysis is an assessment of its management and leadership capability. Section 2.2 discussed the differences between leaders and managers.

One of the most dif�icult imperatives for a company is to develop the next wave of leaders. This is particularly important for companies that are committed to promoting from within. First, they have to have a good talent pool, which means hiring carefully people with leadership potential. Then, there has to be a conscious developmental program of putting these people into challenging situations and cross-functional teams and obtaining feedback about them and their performance from those that see them in action (Fulmer, Stumpf, & Bleak, 2009). Finally, it may be possible to groom certain individuals for speci�ic higher-management positions to ensure smooth succession when the time is right, particularly to C-level and vice-president positions.

Evaluating managers and leaders is never done as part of a strategic-planning process, for obvious reasons. C-level and vice-president executives, middle managers, and supervisors are evaluated individually every year by their immediate superior, direct reports, and any groups they have worked with. The CEO and president are evaluated by the board of directors, usually with input from their direct reports.

The following are some key areas that should be included in any evaluation of a company's leadership:

In what regard do their peers and direct reports hold them? Do they command respect? Are they easy to approach and communicate with? How open are they to new ideas and new ways of doing things? Do they learn from past mistakes or tend to repeat them (Pfeffer, 2008)? What ethical standards and values do they espouse? Are they good role models, leading by example? Do they put a high priority on developing the people they supervise? Are they good motivators? Do the people they develop often get promoted? Are they critical and demanding—that is, do they have high standards and espouse ambitious goals? Do they put the organization's goals ahead of their own? Are they empathetic and compassionate?

Discussion Questions

1. Is it possible for a top-management team to do a good job of assessing the state of its own management and leadership? Why or why not?

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2. Aside from its value as part of an internal assessment of the company, what other bene�its might accrue from a detailed assessment of the state of management and leadership in the company?

3. Given that the assessment just described is quite detailed, do you believe it should be done annually in every strategic-planning meeting? Biannually? Once every three years? Give reasons for your answers.

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Summary

An internal analysis of a company entails arriving at a shared understanding among the strategic-planning team. An essential �irst step is assessing a company's �inancial performance and condition to see whether the company has any �inancial problems that might impact its ability to fund its strategic initiatives in the near future. This requires an examination of its recent history by way of multiyear income statements and multiyear balance sheets.

Conducting a SWOT analysis takes into account the company's strengths, weaknesses, opportunities, and threats. It's bene�icial to determine strengths and weaknesses compared to the previous year and also with current competitors.

The internal analysis must also include an assessment of the company's breadth of capabilities in an effort to see whether any of them give the company a strategic advantage. Each has to be tested against criteria of being valuable, rare, costly to imitate, and nonsubstitutable (having no strategic equivalent) to be considered a core competence and hence give the company a sustainable competitive advantage. To be a strong competitor in its industry, a core competence is highly desirable. If companies don't have a core competence, they should try to acquire one. If they do have one, they should make great efforts to make sure it doesn't erode.

A value-chain analysis provides knowledge of a �irm's internal primary and support activities. Primary activities depict the process of creating a product or service from raw materials or ideas to �inished product. Value-chain analysis informs decisions whether to outsource any primary activities as well as whether to bring into the company any part of the external value chain (the chain of activities that covers a company's upstream supply chain and its downstream distribution channels).

Brand reputation is the customer's perception of what the company is promising. Dimensions of that are its brand equity, which should be preserved or increased, and how loyal its customers are. This should be assessed for each individual brand or for the brand for the company as a whole. The customer-value proposition is a statement of why customers should buy products or services from the company instead of from its competitors.

The �inal consideration is of the �irm's management and leadership: Is this team experienced and suf�iciently knowledgeable to implement any strategy that might be chosen? Are they properly evaluated every year?

Concept Check

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Key Terms

average collection period (ACP) The average number of days it takes a company to collect money owed to it, calculated by dividing accounts receivable (A/R) by the company's average daily sales (revenues/365).

balance sheet A "snapshot" at a point in time (usually midnight on December 31 or whenever a company's �iscal year ends) that presents a �inancial picture of its assets and the proportion in which those assets are �inanced through debt and equity (prepared according to GAAP).

brand loyalty Customers' repeated preference for either particular branded products or for any product of a branded company.

capability The ability to perform actions; requires both expertise and the capacity to deploy resources.

common-size income statement A computation where every line on the income statement is expressed as a percent of revenues.

coverage ratio See TIE ratio.

current ratio (CR) Current assets divided by current liabilities; a value < 1.0 signi�ies negative working capital.

customer-value proposition A succinct statement summarizing why customers you are targeting should buy from you and not your competitors.

debt-to-assets ratio (D/A) Total liabilities divided by total assets.

debt-to-equity ratio (D/E) Total liabilities divided by total stockholders' equity.

�inancial statements Required of public companies both quarterly and annually, and consist of an income statement, balance sheet, and cash-�low statement, along with notes to the �inancial statements.

G.E. (General Electric) matrix A two-dimensional diagram of industry attractiveness against competitive strength that forms a guide as to whether to invest and build or harvest and exit an industry.

income statement A �inancial summary of a company's operations over the previous 12 months, prepared according to GAAP.

inventory-to-net-working-capital ratio (INV/NWC) Inventory divided by working capital.

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inventory turnover (INV Turns) Total revenues divided by inventory; the larger this ratio is, the better.

outsourcing involves moving speci�ic primary or support functions from the internal value chain to the external value chain.

quick ratio (QR) Current assets minus inventory divided by current liabilities.

return on assets (ROA) NIAT divided by total assets.

strengths Strengths are special capabilities or expertise, things a company does well that has enabled it to be successful to this point, and how it has prepared itself to compete in the future. Comparing a company's strengths against competitors' provides a more realistic assessment of them.

sustainable competitive advantage The key condition for sustainability is a state in which current and potential competitors either cannot or will not take steps to close the (advantage) gap.

times interest earned (TIE) ratio Earnings before interest and taxes (EBIT) divided by interest expense; if this value < 1.0, it means that the company doesn't have enough money even to pay the interest owed on the debt it has.

total asset turnover (TAT) Total revenues divided by total assets.

vertical integration involves absorbing one or more stages of the external value chain and making them internal.

weaknesses Weaknesses are internal. They include problems that need to be corrected, de�iciencies recognized through a comparison with competitors, or de�iciencies relative to proposed strategies (e.g., not enough resources to grow).

Z-Score A bankruptcy indicator for manufacturing companies.

Z2-Score A bankruptcy indicator for nonmanufacturing companies.

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Chapter 6

Creating Strategic-Alternative Bundles

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Learning Objectives

By the time you have completed this chapter, you should be able to do the following:

Develop strategic issues from having done a full situational analysis. Understand what it means to develop strategic alternatives and why many companies don't do it. Develop strategic alternatives from the list of key strategic issues. Create strategic-alternative bundles that meet certain criteria. Understand why the key strategic issues and bundle elements should match.

This chapter shows how to develop a set of key strategic issues that summarize the most critical elements of the entire situation analysis, and from such issues create a small number of viable strategic alternatives, or bundles, for the company to seriously consider.

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6.1 Key Strategic Issues

Identifying key strategic issues is an act of synthesis, that is, taking what you know about the organization and its changing environment (the situation analysis) and pinpointing the key questions and concerns the organization must address in its strategic plan. Strategic issues derive from both external and internal sources. The former includes the company's industry, competitors, customers, suppliers, opportunities and threats, and other environmental forces. The latter includes key organizational resources, culture, technology, or strategic decisions that the company must address. For example, consider a medium-sized private university based in the United States. Some critical external strategic issues may include the nature of private higher education in the United States; the attitude toward it of the surrounding community; legislation and policy governing higher education; the pool of graduating PhDs, which represents potential faculty; economic forces in�luencing education in general and private education more speci�ically; the comparable universities that prospective students consider; and the pro�ile of students the university attracts. Some internal issues may include the size of the university's �inancial endowment, scholarship monies available, aspects of the university's history and culture, the relationship between faculty and administration, resources available for faculty research and teaching, and technologies available to students and faculty.

Together, these strategic issues form the basis for generating the strategic alternatives. Too often, alternatives are generated from only a subset of these categories, which means leaving out a lot of information that is probably known and should be considered.

External issues may take the form of a trend, for example, likely increases in the interest rate, price of a critical raw material, or the frequency and severity of terrorist acts. Another form of external issue is an impending event such as legislation that is about to be enacted or a large competitor about to enter the competitive arena, perhaps with strategic consequences for the �irm. Internal issues may present as a strategic decision or choice, something that will have a dramatic impact on the �irm and the way it does business. For example, a company may need to decide whether to merge or acquire another �irm, go public, form strategic alliances, go international, vertically integrate, change its vision and core character, and so on.

Even after identifying a strategic issue, determining whether it is really critical is still dif�icult. It is useful to think of a strategic issue as something that keeps the CEO up at night.

Andy Grove is the author of Only the Paranoid Survive and former chairman and CEO of Intel. In the book's preface, Grove describes himself as a worrier who was concerned with everything from manufacturing issues and competition to the ability to attract and maintain talented employees. While such concerns kept him awake at night, he believed strongly in the "value of paranoia." So when reviewing a list of strategic issues, use this imagery as a way of pruning from the list those that do not merit such obsessive attention. Try also looking at a particular strategic issue in relation to others on the list; is it as important or less important? Ultimately, the �inal decision is subjective; what one person might consider critical another

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might cross off the list. More to the point, a CEO or top manager should rely on gut instincts when creating the list of strategic issues: What are the real issues, problems, or dilemmas facing the �irm (Roberto, 2009)?

Case Study Riverbank University

We have just described how the list of strategic issues used by an organization to formulate a plan may be either too limiting or too broad and that to inform strategy effectively, the issues must be thoughtfully generated and edited. The following brief case study summarizes how a recently hired university chancellor and her cabinet wrestled with the strategic issues needing to be faced by a small, private liberal arts college in the Northwest United States. (The identity of both the university and the individuals has been masked.)

Riverbank University was situated in a metropolitan area with many public and private higher education institutions. It had a long tradition of excellent undergraduate teaching that primarily attracted local and in-state students. Professors were known for the long hours they spent advising students on both course-related and personal issues, and for their strong mentoring skills. Research was not part of the landscape for either professors or students at this undergraduate-only institution. Faculty at Riverdale regularly invited students to their homes for meals and participated in on-campus events that afforded them informal opportunities to meet and get to know students. Most Riverbank faculty had spent their entire careers there, and turnover among professors and administration was very low.

In the late 1990s, as Riverbank's board of trustees and administration designed a strategic plan for the new millennium, there was talk about the desire to become a nationally, rather than regionally, known and respected university. Of�icials reasoned that attracting a more diverse pool of students as well as benefactors would enhance the university's pro�ile and set the stage for continued growth and competitiveness into the 2000s. With this goal in motion, a search ensued for a quali�ied chancellor (chief academic of�icer) that had experience in leading the transformation from a regionally to nationally recognized institution and eventually, one was selected.

When Dr. Irene Carson arrived on campus to begin assessing the climate and identifying the critical issues at hand, she quickly became overwhelmed with the internal and external factors that both inhibited and encouraged growth. Professor satisfaction and morale were huge issues: Faculty at Riverbank liked things the way they were and had no experience with an "outside" administrator being hired and setting the agenda for them. University relationships with key stakeholders—donors, board members, and other "friends" of the school—were delicate and needed to be carefully managed. The city where the school was located was resistant to growth of the physical size of the university. The structure of the university's

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academic schools and departments seemed unbalanced and illogical. Many professors were using outdated and outmoded teaching methods. The university offered no online courses in an era when all other schools did. Physical infrastructure, such as technology and lab space, was lacking. Moreover, Dr. Carson knew that universities don't rise to national prominence based on excellent teaching. She knew that she needed the resources to attract some star researchers.

So, Dr. Carson set about having strategic conversations with key constituents: members of faculty senate, deans, board members, students, community members, and other university of�icials. Through these private meetings, informal conversations, and public town hall events, Dr. Carson and her team began to clarify, prune, and prioritize the list of strategic issues into manageable, realistic, and relevant order. This bundle of strategic issues allowed Riverbank to move forward toward its goal of national recognition.

First, Dr. Carson identi�ied structural problems and corrected them by moving some academic departments to different schools within the university where they made more sense and stood a better chance of becoming accredited. For example, a School of Performing Arts was created to house theatre and dance, because Riverbank's dance department's primary barrier to national accreditation was the lack of such a school. Next, the chancellor leveraged important and longstanding relationships with key benefactors and the board of trustees to gain commitments toward new facilities that would enhance the university's goal of attracting high- pro�ile, high-achieving research faculty. With these two critical strategic issues covered, the new chancellor and her team then focused on recruiting "stars."

Within �ive years, Riverbank was home to a growing number of graduate programs, a Nobel laureate, numerous prestigious faculty members recruited from well-known research universities, and a student body that, for the �irst time, represented all 50 states in the United States. All concerned acknowledged that the university's strategy was working.

Questions for Critical Thinking and Engagement

1. When you consider Riverbank's history and the case presented, do you believe that Dr. Carson's eventual list of priorities (key strategic issues) was appropriate? Why or why not? (Note that the question uses the term "appropriate" rather than "successful.")

2. Based on your reading and analysis of this brief case, was the list of critical issues thorough enough? Was anything left off the list that should have been there?

3. Without any additional personal knowledge of this institution, continue writing the case study. The case ends on a note of success, but what "fallout" might you expect based on the background you were given? Be as speci�ic as possible.

4. Comment on Dr. Carson's practice of strategic conversations with key constituents. Based on your reading of this chapter to this point and your own experience, did she do the right thing? Why or why not?

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One informal strategic planning process involves "HERs"—hallways, elevators and restrooms. These informal meetings can be where the most interesting conversations take place.

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The strategy development process is not a time to pull punches or shy away from the truth. As Dennis Rheault, former vice president responsible for corporate strategy and development at Motorola, wrote, "The purpose of an effective strategy-development process is not to avoid but to confront uncertainty: to pose the really tough questions that you do not have the answers to—the issues and opportunities that can make or break the business" (Rheault, 2003, p. 33). This is not a time to parrot what the CEO wants to hear. Unless these issues are real and phrased in plain terms, the resulting strategic alternatives that are designed will likely not be in the company's best interest. Having strategic conversations with colleagues or outside experts over the course of a year will help to unearth the real issues that the company must confront. As has been emphasized earlier, this process is most fruitful if it is undertaken on an ongoing basis rather than as an annual exercise.

Strategic Conversations

A strategic conversation is a free-ranging discussion on a topic of strategic interest to an organization. Because of its characteristic "no- holds-barred" freedom to say whatever needs to be said, it invariably produces ideas and thinking that are ultimately useful in the strategic- planning process and that might not be captured in any formal process.

All major strategic planning, according to Peter Schwartz, cofounder of the Global Business Network, does not, in fact, take place during the strategic-planning process (Abraham, 2003). What goes on in a formal process is almost always a rati�ication of what has already happened. A strategic conversation is an attempt to understand the real strategic-planning process and often takes place entirely informally. Schwartz's colleagues at Bell South used to call it the HERs process—hallways, elevators, and restrooms— because that's where the most interesting conversations take place. While real decisions got made, real issues got confronted, real knowledge was developed, almost all of it took place in this conversational mode. And that is how real learning also takes place. If you are going to have good strategy, it involves good learning—learning about new realities, new facts, new competition, new opportunities, new directions—and challenging old

knowledge. Simply writing a strategic plan as an act of listing a set of new objectives for the coming year as if nothing had changed is pointless. The problem is that if everything has changed and you need to come up with a plan, how are you going to learn about those changes?

Furthermore, again paraphrasing Schwartz, it is one thing to do this for an individual, but how do you get a group of decision makers, who almost always have to act together, to acquire that knowledge and to develop and implement strategic plans? He maintains that the only way you learn together is through conversations (Abraham, 2003). Whether formal or informal, a strategic conversation is the learning

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When considering strategic issues, lists of 12 items or more should be reduced to 8–10 items by the CEO and/or the top management team.

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vehicle through which the group adjusts to a new worldview to enable strategic plans to be developed and implemented. The steps in the process often follow this sequence: shared conversations, shared learning, change one's mental models, then develop better strategic plans. Tony Manning echoes Schwartz in endorsing the value of informal dialogue:

Strategic conversation is far more than just an occasional practice that can be adopted or abandoned at will: it is without doubt the central and most important executive tool. . . . What senior managers talk about—clearly, passionately, and consistently—tells me what they pay attention to and how sure they are of what they must do. (Manning, 2002)

The viewpoint of most strategic analyses is assumed to be that of the CEO or leader of the organization and may include the top-management team. When examined from the viewpoint of a board of directors, other variables could be added to the list of strategic issues, such as whether to go public, and even whether it is time to replace the CEO.

There is one �inal check on whether you are dealing with the proper set of strategic issues. Because they constitute the critical questions and issues a company should address, they should all be taken into account explicitly when forming strategic alternatives. In the event that the alternatives fail to take into account one of the strategic issues, it could mean that either (a) the strategic alternatives have not been properly formulated and should be further modi�ied to take it into account, or (b) the issue in question is not as important as was initially assumed, and thus could be deleted.

While it is possible that a �irm could have any number of strategic issues at a given point, the larger the number of issues proposed, the higher the chances are that some of them are not as critical as others. Long lists of over 12 items should be pruned down, eliminating those that are not so critical or combining some of them. If the list cannot be reduced at this stage, another chance to do so will be when the strategic alternatives have been created if it is found that they have still not taken into account every issue.

Strategic issues are typically expressed in one of two forms: either as a statement or as a question. For example:

Whether the company should acquire XYZ Corporation. Should the company acquire XYZ Corporation?

The second is phrased as a question and is the recommended form because, if the outcome is known with certainty—"Yes, the company should acquire XYZ Corporation"—then the issue is not a strategic issue; it is a decision the company has already taken. It is not suf�icient, however, that one simply pose a question on a matter of strategic concern. Consider the following:

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Should the company try to lower costs? How can the company lower its costs?

The strategic issue is not whether to lower costs; the answer to that question is that of course it should. Rather, the strategic issue might be "How can the company lower its costs?" because that answer may be uncertain, so it could be included as a bona �ide strategic issue.

Thus, one criterion for a strategic issue is that the answer to the issue is uncertain. The way in which that uncertainty is resolved is through the design of strategic alternatives and choosing a preferred one. Given a strategic issue, "Should the company broaden its product line?" one alternative could say, "Broaden it" and another, leave it out altogether (not broaden it). Thus, through deciding which alternative is preferred, the one that is chosen automatically "resolves" the uncertainty inherent in the issue.

Discussion Questions

1. Having done a thorough situation analysis—both external and internal—do you agree that it makes sense to synthesize the results? Explain your answer.

2. In your view, would the external analysis previously done be more useful in scenario planning than in forming strategic issues? Why or why not?

3. It's possible that managers don't go through a process of coming up with strategic issues because it involves phrasing questions to which the answers are unclear. Could there be any truth to such a view?

4. Suggest ways of shortening a list of 20 strategic issues to a more manageable number of about 12.

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6.2 Strategic Alternatives

An ordinary alternative is one of several means by which a goal is attained or a problem solved. A strategic alternative is one of many routes a company might take to gain market advantage, realize its goals, or, if no speci�ic goal has been declared, decide where it might go and what it might accomplish. Notice two things about the de�inition: (a) The designation "strategic" is necessary because alternatives are fashioned in a competitive environment, where actions and retaliations of competitors must be taken into account; and (b) the alternatives are created at the level of the whole �irm and not any one of its functions or units. In addition, they provide choices about marketplace strategy or about con�iguring the organization, address issues of central importance to the organization, have uncertain outcomes, and require resources to develop before action can be taken (Lyles, 1994).

Alternatives are of three general types. "Obvious" alternatives arise from current strategies or simple extrapolations of what the organization is currently doing. For example, utilizing Facebook, Twitter, and a blog to communicate with consumers represents an obvious strategic alternative. "Creative" alternatives take different conceptual approaches than existing strategies do and break away, to some extent, from the assumptions and beliefs underlying current strategies. A training-and-development organization specializing in the creation and facilitation of live, face-to-face, trainer-led instruction might pursue a creative alternative by entering the e-learning market.

"Unthinkable" alternatives re�lect a radical departure from the organization's historic mindset (Lyles, 1994). For instance, as a result of the organization's organizational culture and values, alcoholic beverages have never been made available for sale within Disney theme parks. The idea that the sale of liquor could enhance pro�it or attract new customers would represent an unthinkable strategic alternative. As in the Disney example, an unthinkable alternative might be appropriately labeled as such because it violates some demonstrated, effective core value of the organization. However, sometimes alternatives are unthinkable simply because no one before has bothered to break the rules of what is appropriate for how an organization does business—even when experimenting with such alternatives might be the right move. Typically, such alternatives have little chance of being accepted by management unless arguments for their adoption are persuasive and made by someone who commands respect in the organization. Unthinkable alternatives illuminate the current situation in a radically different light and inspire other managers to propose creative solutions. However, this typology, while insightful, is typically not advocated as a framework to generate alternatives.

For some companies, the decision-making about their future may involve tweaking their present strategy slightly. This might be something as simple as adding a distribution channel or starting to advertise on television. Although the company might claim that this represents a change in strategy, it is, in fact, simply a change in implementation. Dutch digital-navigation-equipment developer TomTom recently announced that it would scale back the personal-navigation-device division that had made it famous and shift focus to its built-in automotive-navigation systems. TomTom had consistently lost pro�it on the small personal- navigation devices since consumers began relying on free or low cost mapping applications on

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Pep Boys, an auto-service �irm in Southern California, created a strategic alternative to their business strategy when they decided to start advertising on television.

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smartphones and tablets. Conversely, �inancial reports suggested the strategy shift: The built-in- automotive systems is the fastest growing division in the company (TomTom shares, 2011).

For other companies, the strategy itself may remain unaltered, but the objectives may change, such as from 10% per year to 15% per year growth in revenues or pro�its. Companies may mistakenly characterize this as a change in strategy; however, if the basic way in which the company competes has not changed, then this is not a change in strategy.

Obstacles to Creating Strategic Alternatives

What many companies do when planning ahead, it would appear, involves simpleminded extrapolations of past accomplishments involving no change in strategy, or they make the �irst change that occurs to them that makes sense at the time. Sometimes it works or works only for a short time, but more often it does not. As naıv̈e as this analysis sounds, how else can we account for so many poor decisions made by various companies over the years? Even the best decision made at a given time can lead to a poor result because of unforeseen events and actions. Poor results are notoriously the inevitable byproduct of poor execution, even with an otherwise sound strategy in place.

In each of these cases, is the strategy the company chose the best one it could have adopted in the circumstances? The only way to tell, really, is to have analyzed the subset of all plausible alternative strategies and chosen one for very good, defensible reasons. If this is done, then any challenge or question about what else might have been done can be preempted because one can argue convincingly why the chosen strategy is superior or at least preferable to any other that might be proposed.

Focus on Perceived Costs

Why don't companies develop alternative strategies routinely? Many companies forego developing strategic alternatives because they perceive obstacles, real or imagined. An excuse commonly heard is that it takes a lot of effort and time: "We're in a hurry and can't afford to wait." In fact, to do something well does require time and effort, so claiming to be in a hurry is just a convenient excuse. True, circumstances sometimes demand a quick decision, but even so, making a decision without considering alternatives is foolhardy. Besides, to make any decision at all, one needs at least two alternatives.

Another reason offered for not constructing strategic alternatives is that the exercise doesn't guarantee the "right" answer, so it may be a waste of time and resources. It is true that no one can guarantee the correctness of a decision whose consequences play out in the future, but by considering the signi�icant

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Small groups of managers sometimes brainstorm ideas that later become strategic alternatives. This process must begin with framing a problem and identifying a list of alternatives.

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trends and impacts, including the relevant variables, assessing the �it with the company's capabilities and resources, and considering plausible strategic alternatives, the chances of making the "right" decision for the company are substantially enhanced. Only when 3, 5, or even 10 years have passed, can you look back in hindsight and know whether a strategic decision was good or not. Otherwise, one has to make the decision while not knowing how things will actually turn out. All one can do in the circumstances is one's best. But companies that skip the process entirely for lack of certainty do not give themselves a �ighting chance to make the best decision they can; they short-change themselves.

Focus on the Past

Many managers are more comfortable thinking about and analyzing the past than the future. They seem to �ind nothing wrong about examining past data and then making a decision that will play out in the future. The past is certain; the future is not. In these days of rapid, even discontinuous change, past data are often irrelevant. What we need to examine are trends about everything that is changing and likely future moves of competitors. How are industries changing? What will merging industries become? How will technology affect our lives, what we buy, how we use products, how we think, how we do business? People are less comfortable in the future because they are unable to predict or forecast it, unable to extrapolate, and unused to ambiguity and uncertainty. An oft-repeated joke is that people would rather be certainly wrong than not sure whether they were right. The thought that they might even in�luence the outcome of future events even escapes them. Many people simply regard the future as something beyond their control.

Complacency

There are managers who don't take the responsibility for strategic planning seriously enough, or they don't devote enough time to ask themselves really tough questions that might put their companies on a stronger, albeit different course. It is much easier to keep doing what the company has been doing, particularly if the company is performing reasonably well. Setbacks can be blamed on a competitor, an unexpected piece of new legislation, a downturn in the economy, or a rise in supplier prices. True, the unexpected often happens, but in hindsight, many "unexpected' occurrences could have been anticipated and taken into account had strategic planning been properly done.

Insuf�icient Training

Many people who don't know how to do strategic planning would rather avoid admitting so to save face and will instead do what they think is strategic planning—as they have always done it. This may be a valid reason but, if that is the case, the company is at risk unless and until it has management in place that is

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trained in strategic planning. While there is no foolproof way of coming up with a good strategy, the process relies to a very large extent on strategic thinking, and the results achieved depend in large part on one's strategic-thinking ability and on experience with and commitment to the approach. Even after a company has decided on a strategy, it must be fully invested in making it succeed. It will require the leaders of the company to provide ideas, motivation, arguments, and skill at implementation that will bring the results desired. So, although it is more convenient to stay in one's comfort zone, it may not be the best way to chart the company's future course.

In many companies, staff planners and even some line managers who value the process of strategic planning �ind only lip service paid to it because of disinterest or a lack of commitment on the part of top management. This might be the product of a tradition or culture of risk avoidance or entrenched and threatened interest groups raising impediments to the process. Finally, top management's reluctance to embrace the process may stem from simple ignorance about what strategic planning really is and is supposed to do.

Myopia

Companies put a far greater emphasis on short-term �inancial results than on longer-term strategic performance. While short-term �inancial performance is important, it should never come at the expense of longer-term performance. CEOs who feel threatened with losing their jobs or whose judgment may be in�luenced by the value of their stock holdings may tend to focus on the short term. Boards of directors concerned principally with the company's stock price or the company's immediate survival also represent instances where shortterm considerations dominate. In this environment, the company's long-term future and potential are often sacri�iced, as when expenditures for R&D, new-product development, advertising, and training programs are slashed to show pro�its for the quarterly and year-end reports. Clearly, such decisions are suboptimal and not made in the long-term best interests of the company. Such decisions also adversely affect any strategic alternatives the company may consider and the strategic direction the company pursues.

Discussion Questions

1. Which of the obstacles to creating viable strategic alternatives are most easily removed? Which ones might be the most dif�icult to mitigate? Discuss.

2. Think of a personal decision you made for which you actually considered at least one other alternative. Could you have made the decision without considering the alternative? If so, why did you consider the alternative? Was your decision affected by having considered the alternative?

3. If you follow sports, try to imagine your favorite team. As hard as it may be for that team to win games, the real strategic decisions are made away from the arena and probably in the off-season. Which players to trade? Who would improve the team, and could the team acquire that person? How to lower the total payroll and still �ield a winning team? Describe which people in the organization participate in such strategic decision making and whether in your opinion they go through a systematic process of creating and weighing different alternatives.

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To unlock your imagination and visualize ideal solutions, consider the future needs of your ideal company or industry, the perfect product and packaging, and the ideal service or system for your company.

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6.3 Creating Strategic Alternatives

One typical way that strategic planning is conducted is for a small group or team of managers to brainstorm ideas that later become alternatives. Some follow a speci�ic process, some don't. Marjorie Lyles (1994), suggests a process that begins with framing a problem, identifying an initial list of alternatives, extending the list if resources and time permit, then narrowing the list through a process of evaluation and consolidation. However, who is to say that the resulting list contains good rather than mediocre or unimaginative alternatives? Clearly, a worthwhile strategy cannot come from poorly conceived alternatives. Lyles speci�ies certain criteria as to what makes a list of alternatives useful:

The variety of alternatives Differences among them compared to the present situation The costs and dif�iculties of implementation; if they are all too easy to implement, the organization is not stretching itself or being ambitious enough The degree to which they challenge existing goals, aspirations, long-held assumptions, and beliefs (Lyles, 1994)

Edward de Bono (1992) makes the distinction between choosing from alternatives that already exist, such as ties in a closet or menu choices at a restaurant, and alternatives that do not exist and need to be found. In the latter case, one cannot suggest just any alternative and have that alternative make sense. It has to be related to a reference point. For example, what alternatives are there to achieving this purpose or carrying out this function?

To help in coming up with alternatives, de Bono suggests thinking of groups, resemblances, similarities, or concepts. For example, as an alternative to an orange, do you search for other citrus fruit, domestic fruit, refreshing beverages, or colors? His technique of lateral thinking is directly concerned with changing concepts and perceptions, especially when used to come up with alternatives in solving problems (de Bono, 1992). It is a systematic way of generating new ideas and new concepts. Besides leading to a defensible strategy, coming up with suitable strategic alternatives is an excellent opportunity to explore whether the organization should be heading in another direction or doing business a different way. Of course, companies that have been operating in a certain way for years experiencing satisfactory results are not inclined to change their way of doing business, because there is no perceived need to do so. One overlooked reason for complacency is that it is almost impossible even to think about doing business in a different way or heading in a different direction when you are an intrinsic part of the organization and have become used to doing things the way you do. In fact, this is an ideal, if somewhat counterintuitive, time to explore other options. Many companies fall into the mindset of "If it ain't broke, don't �ix it," and

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they are dif�icult to persuade otherwise. They address the issue only when their strategy falters, or when competitors overtake them, or some other threat looms, by which time it's often too late. Opportunities go unrecognized because they are seldom sought or considered, which is yet another reason to be doing strategic thinking all the time. In cases like this, the organization may well bene�it from an outside facilitator and speci�ic exercises to stimulate creativity.

James Bandrowski offers one of the most powerful techniques for using creative imagination to �ind alternatives or, more accurately, breakthroughs (Bandrowski, 1990). He suggests visualizing the ideal solution and then "�illing in the feasibility" afterwards, that is, �iguring out how to achieve that ideal solution (Figure 6.1). The advantages include coming up with something radical, leapfrogging the competition instead of just catching up, getting ready for tomorrow's markets, and injecting new life into a possibly complacent and mentally tired organization.

Figure 6.1: The creative leap

Rather than just blindly searching for ideal solutions, Bandrowski offers the following suggestions for making a creative leap, all of which will improve your ability to think strategically and supplement the ideas discussed in Chapter 3:

Year 2020—Pick a date in the future such as the year 2020. Call it "Challenge 2020," a technique employed by 3M. Unlock your imagination and visualize what your industry, products, services, markets, and so on will be like then. Bandrowski says, "The future will be invented by those who see it today." Ideal company—What would the ideal company look like? Who is the best competitor in the industry? What do you most covet in this competitor? What company would you most like to

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Hyundai's cars were once considered inferior products until the company retooled its strategic intent and upgraded the quality of its cars. It paid off with increasing market share.

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acquire and why? Bandrowski quotes Lee Iacocca's description of an ideal automobile company: "It would combine German engineering, Japanese production ef�iciency, and American marketing." Ideal industry—Reconceptualize your entire industry. How could it become more pro�itable? How could technology revitalize it? Would it make sense for it to merge with another industry? How could you tilt the playing �ield in your favor? Sweeping solution—Start with a blank canvas and try to �ind a total solution, rather than trying to improve various components such as production, marketing, and distribution. Is there a completely different way of doing business that is better? Perfect product—What ideal products could be provided to either existing or new customers, assuming no �iscal or technical constraints? Customers should be included in this fantasy exploration; in fact, how might customers be persuaded to help co-create value? One place to start might be to list or collect data about all the shortcomings of existing products. Perfect package—How could packaging most bene�it the product? Could it make the product easier to use, last longer, more convenient, more transportable, and the like? Could it be combined with the product or even eliminated? Ideal service—Ask what customer needs are directly or even indirectly related to the product the customer buys. Any time you can make your product easier to use, save your customer money or time, or increase your customer's sales, it may provide an opportunity to improve your service to that customer. Ideal information—What information must you have to win? What don't you know that is hampering your efforts or causing you to be uncompetitive? Include information also about trends and the future. Rank the list in terms of importance to the company, not in terms of what is possible or what costs the least. Ideal system—Focus on new ways of increasing throughput, reducing costs, reducing cycle time, or bringing new products to market faster. This is an area in which business-process reengineering traditionally takes place. But what do you do for an encore after your reengineering has taken place?

Discussion Questions

1. De Bono talked about alternatives to an orange being other citrus fruit, domestic fruit, refreshing beverages, or colors. How would you apply this kind of lateral thinking to the problem of how customers buy? What unusual alternatives might this suggest for a company?

2. Which of Bandrowski's suggestions for brainstorming strategic alternatives appeals to you most and why? Which ones would you as a student �ind most dif�icult to do? Give your reasons.

3. Companies are often stymied in pursuing different options—even what they feel they need to do—because of some perceived insurmountable obstacle ("just can't be done"). Do you believe that trying to focus on a desirable end-state (taking a "creative leap") and working

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backward would help managers? If so, what would be most dif�icult about persuading them to do this?

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6.4 Creating Strategic-Alternative Bundles

The process proposed here starts with the list of key strategic issues discussed in the previous section. Because these strategic issues represent the most pressing and important problems and issues facing the organization, any subsequent plan or strategy that is developed should address all of them. So, starting with that list, create two to four alternatives that meet certain criteria. Most organizations manage to come up with three; identifying more than four is extremely dif�icult. You must be wondering, "Surely one can come up with many more than four?" Read on, these are not "ordinary" alternatives.

Because of the large number of possible strategies available, my students have always found it extremely dif�icult to create good strategic alternatives other than the obvious "safe" ones. Consider for a moment the full range of strategies discussed in Section 3.2, which are organizationwide "master" or "grand" strategies, and do not include functional or operational strategies, classi�ied as programs in this book. An organization could choose a particular combination of strategies to adopt, but in order to show that it is the best choice at the time, it would have to compare it to all other combinations of strategies, a Herculean and impractical task. It took several years to make the conceptual leap and ask, "What if there were only a small number, say two to four choices, available? And what if they constituted "either/or" choices such as choosing A or B or C, rather than saying that A + B together was better than A alone, or A + B was better than C + D? As the technique took shape, it seemed to make more and more sense, but making it practical proved to be elusive for a while.

What also became clear was that these alternatives did not consist solely of strategies but rather "bundles" that comprise strategies, strategic intent, core competence, programs (which are an operational component of a strategy), �inancing method, geographic scope, and any other element that would help de�ine and clarify a future course of action to an observer. The bundles would be derived in large part from the key strategic issues that, in turn, were derived from a comprehensive situation analysis of the external and internal environments. This sequence of dependencies gives the method a logic that is easy to grasp and learn.

As we shall see later, these bundles are one step away from being business models. That is why creating more than a few is extraordinarily dif�icult—companies are hard pressed to come up with one alternative business model, let alone up to four.

Strategic Intent

Most well-managed companies try to achieve an overall purpose and vision. The strategies it chooses have to be aligned with this purpose and vision. So what is strategic intent? Strategic intent is the market position and market share that a company sets as its goals. Strategic intent is, of course, related to the strategies the �irm has decided to pursue. Market position is the position in an industry that a company occupies ranked by market share; the market leader is #1, followed by #2, #3, and so on.

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It is a given in any industry that the #2 company ranked by market share has a strategic intent of overtaking the leader and becoming #1. Likewise #3 sets a goal of becoming #2. In practice this may take some years depending on the industry, relative market shares, and other factors. However, when a company is ranked #23 in market share, it doesn't set a goal of becoming #22, because at that level, it doesn't even know it's #23. In many industries, market shares are not monitored or known. In such cases, the strategic intent is expressed in terms of either increasing or maintaining market share.

What exactly is involved in gaining market share? Figure 6.2 shows a hypothetical industry in which sales are growing at a constant 7% per year. For simplicity this is assumed to grow in a straight line with no seasonal variation. In order to gain market share, a company would have to grow at a rate higher than 7% per year (as Company X in the �igure) and at an equal rate to maintain market share. And even though a company in this industry might be growing at 5% per year (Company Y in the �igure), it would actually be losing market share.

Figure 6.2: Gaining, maintaining, and losing market share

Google's Chrome browser represents a contemporary example of strategy driving market-share gain. Poised to overtake both Firefox and Internet Explorer, Chrome is a byproduct of Google's strategy to draw people into the Internet, then search the Web using Google, thus engaging with the company's pro�itable advertising system. Chrome offers Internet surfers a simple, clean interface with Google's online empire. Chrome keeps users focused on Google's products including cloud applications (Google Docs, for example) and other offerings (such as Google maps). The marketing strategy (and dollars) behind this push is resulting in the growth of Chrome's market share while Firefox and Explorer remain more static.

Again, strategic intent and strategy have to be aligned. If pursuing a particular strategy results in the company just keeping up with industry growth, then it cannot "overtake" a competitor in terms of market position, and it cannot increase market share.

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Major Programs

For purposes of developing a bundle, only the new major programs or operational tasks called for by the strategies in the bundle need be identi�ied. Later, during operational planning, which precedes implementation, the programs and objectives are �leshed out by every operating unit and department in the company. Programs in every alternative bundle can and should include successful and needed programs that the company is currently implementing, usually by inserting a catchall like "continue current programs." Without doing this, the implication is to stop doing everything the company is currently doing in favor of only what is in the bundle, clearly an unrealistic situation. In addition, the company may have to initiate new programs called for by the strategy. Programs implemented the very next year are often called tactics.

Every strategy implies a set of programs, shown in general form in Table 6.1.

Table 6.1: Program components of common strategies

Product development

Market expansion

Acquisition Turnaround Diversi�ication Differentiation

R&D programs

Market research

De�ine criteria

Control cash Choose industry

Market research

Engineering design

Hire sales force

Search broker lists

Meet with creditors

Set criteria Develop concept

Develop prototypes

Train sales staff

Analyze candidates

Talk to major customers

Acquire company

Invest capital

Testing Mount ad campaign

Conduct due diligence

Divest assets Invest capital Develop ad campaign

Quality program

Secure distribution channels

Negotiate deal Reduce staff

Negotiate objectives PR campaign

Get �inancing

Form new strategy

Redesign product

Consolidate Raise price

Other common programs include hiring a new CEO or vice president, seeking a strategic alliance with an external organization such as an international distributor, installing an integrated accounting system, or improving product quality. Remember that key programs are already included in the chosen strategic- alternative bundle.

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Bundles should also describe in speci�ic terms the method by which the strategies and associated activities would be �inanced. An organization can derive funds from three sources:

Cash—including actual cash and assets that can quickly generate cash such as marketable securities, disposing of excess inventories, factoring accounts receivable (i.e., selling them at a discount to a factoring �irm for ready cash), or selling assets no longer needed. Taking on debt or additional debt—such as extending existing lines of credit from banks or certain suppliers (paying late), taking on additional long-term debt, or in more dire circumstances, trying to get customers to prepay for goods not yet received. Getting an infusion of equity capital—such as issuing new stock if a public company, or �inding an investor.

Notice that these sources of funds are available to the �irm in cash. To fund anything it does in the future, it needs cash, either what it has or can secure through a loan or equity investment. As previously discussed, a business cannot, for example, spend "retained earnings."

It is useful to think of funds available to the business as being of two kinds. The �irst is baseline funds that are needed to support the �irm's current business and ongoing operations, that is, pay current operating expenses, maintain adequate working capital, and maintain current plant and equipment. The second is "strategic" funds that could be invested in new strategic initiatives, that is, purchase assets such as facilities, equipment, and inventory, increase working capital, increase R&D or marketing/promotion expenses, or acquire another company (Rowe, 1987). Increasing market share usually requires strategic funds, while maintaining market share needs only baseline funds. Firms are in serious trouble when they do not even have the level of baseline funds they need to maintain current operations.

Discussion Questions

1. Does trying to achieve a strategic intent complicate what a company is trying to do or does it help? Isn't trying to achieve a vision, strategy, and objectives enough? Explain your answer.

2. Increasing or maintaining market share applies only to the industry in which the company competes. What happens when it enters another industry or the boundaries of the current industry change?

3. Discuss developing a strategic intent for a company with markets in several different countries.

4. When one talks about one or two companies in an industry gaining market share over time, must others in the industry lose market share? Is it a zero-sum game?

5. In developing alternative bundles and, naturally, the winning bundle, one has to include not only the strategy that sets each bundle apart but also the major programs needed to implement the strategy. Are such programs enough to do detailed operational planning later, or should more detail be added at this stage?

6. Judging from Table 6.1, coming up with major programs seems straightforward. Would you agree? Or does it require substantial real-world experience?

7. Do you think that knowledge of the major programs in a bundle affects the decision as to which bundle to choose as "best"? Explain your answer.

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If Carmike was to go national as part of its alternative-strategy bundle, it would consider acquiring small-town theaters starting in the Southeast, then Midwest, then the Southwest and West.

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Carmike Cinemas, Inc.

The chapter concludes with a case study on Carmike Cinemas, Inc., a movie-theater chain in the Southeast United States in the mid-'80s, which forms a perfect vehicle for illustrating how bundles are formed from key strategic issues and how the strategic issues are modi�ied later to match the bundle elements.

In 1986, Carmike Cinemas was the �ifth largest movie- theater chain in the United States and the largest in the Southeast region. Carmike was being run con�idently and entrepreneurially by CEO Mike Patrick, and he believed that Carmike was not only a strong competitor but also smarter than most of the others. Revenues and NIAT were growing at an average 15.3% per year and 50.2% per year respectively between 1982 and 1985. In 1986, a year in which the major movie studios produced fewer commercially successful pictures, revenues and NIAT

dropped 11.6% and 44.4% respectively. Its debt/equity ratio in 1986 was 1.66, down from 6.66 in 1983 when it acquired another movie theater chain principally through debt. The company was well managed and growing aggressively through acquiring failed theater chains throughout the Southeast, staying mainly in small towns where often it would be the only theater; in effect, these small towns represented blue oceans. Like other chains at that time, it was rapidly multiplexing, that is, converting single-screen theaters into multiscreen theaters (Taylor, 1996).

Some strategic issues arising from a situation analysis include the following initial list.

Should Carmike:

Stay regional or expand nationally? How fast and where should it grow? ("Should Carmike grow?" is not an issue as its recent history suggested strong growth, and the CEO's style and characteristics lean toward aggressive growth.) Increase its debt or go public to secure additional capital? Invest in screen/projection/sound technology? Upgrade the quality and amenities of its theaters? Experiment with serving hot food and coffees in its theaters? Sell memorabilia associated with the movies it shows? Show foreign, classic, cult, or other types of movies? Get into domestic or foreign distribution? Stay in small towns or expand into urban areas and cities? Continue to grow through acquisition?

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If in doubt as to whether or not to include something as a strategic issue, go ahead and include it. Err on the side of having too many strategic issues. Later in the process, you will come to realize which of them are real issues and which are not important enough, so you can then delete them. With experience, you will be able to gauge which strategic issues are meaningful and �ind yourself adding very few that are later deleted. The process is iterative.

After much trial and error (adding, moving, erasing, changing items in each bundle), you can arrive at a set of strategic alternatives; at least two are required, otherwise there can be no decision. Creating two is not dif�icult—the strategy the company is currently pursuing and a different or potentially better alternative; creating three takes substantially more effort and thought, and four is extremely dif�icult. The reason is that these are not just strategic alternatives, but rather different business models with alternative visions (Collis & Rukstad, 2008).

Echoing Lyle's list, the best set of strategic alternatives should meet six criteria:

Be mutually exclusive—the bundles must be either/or choices. Contain signi�icant variety—that is, show that some creative and daring thinking has been done and are not so close to what the �irm is doing now, unless one of the bundles embodies the current strategy or the status quo. (Despite Lyle's criterion of variety, using a status quo alternative is quite understandable if the company is currently performing very well.) Be feasible—given the circumstances, resources, and capabilities of the �irm. Would all lead to success—even though the �irm might end up in a very different place with each alternative. Challenge the organization's existing goals, aspirations, long-held assumptions, and beliefs—to improve its performance, competitive position, value proposition, and economic value. Have addressed all the strategic issues.

Table 6.2 presents three "bundles" for Carmike Cinemas as an illustration. Giving each bundle a label helps distinguish it from the others and underscores how they are mutually exclusive. The �irst check is for mutual exclusivity—doing any one means not being able to do the others. Although components of one alternative might also be part of another one, the criterion refers to the whole alternative and not just particular components. The check shows the three bundles to be mutually exclusive. However, if it were to reveal that the bundles were not mutually exclusive, and if there were general agreement on that point, then the bundles would have to be recon�igured. Only when the resulting bundles meet all the criteria and do not change any more is this part of the process complete.

Do they contain suf�icient variety? Because of the subjectivity involved, the question is hard to answer. Imagine a continuum with no variety at one end (same strategy in every bundle, distinguished only by different rates of growth) and bundles quite unlike anything the company is doing at the other. The criterion of variety forces a search for strategies the company may not even be contemplating, while going out too far on a limb probably means the company is unable to implement it. So requisite variety is somewhere on the continuum and should be a balance between trying to be different and yet reasonable.

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Table 6.2: Alternative strategy bundles for Carmike Cinemas (1986)

Bundle Element

1. Go national 2. Stay regional 3. Go international

Strategic intent

Target #4 ranking near- term and #1 ranking nationally eventually

Maintain #5 ranking nationally but continue to dominate the Southeast region

Maintain #1 ranking regionally and become a major player internationally

Strategies Market expansion Market expansion and differentiation

International expansion

D/E comparison

Increase D/E ratio Lower D/E ratio Maintain D/E ratio

Contrasting purposes

Strive for market share Strive for pro�itability Strive for international recognition

Different acquisition programs

Look for acquisitions in small towns �irst in the Northeast, then Midwest, then Southwest and West

Look for acquisitions in small towns primarily in Florida but also in other Southeast and Southern states

Look for acquisitions in United Kingdom and Australia, Canada, European countires (in large cities), and also in the Southeast United States (small towns)

Whether to go public

Do not go public unless a very large acquisition is contemplated

Do not go public Go public to �inance international acquisitions

Other programs

Develop a cost-effective national marketing campaign

Experiment with serving hot foods and coffee, and selling movie memorabilia in selected theatres

Set up a matrix organizational structure to manage the international company

Facility programs

Maintain quality of theatres

Upgrade facilities and technology of the worst 1/5 of all theatres

Maintain quality of theatres

Continue to do what the company is doing

Continue current programs

How to �inance

Finance through debt and cash

Finance through cash and some debt

Finance through cash, debt, and proceeds from IPO

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You must involve key "idea people" in implementing your situational analysis. Your alternatives should challenge existing goals, aspirations, old assumptions, and beliefs.

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Are the bundles feasible? Could the company actually implement each one were it to be accepted? People in the company would be in the best position to gauge feasibility, while those analyzing a company they are unfamiliar with have to go with their best educated guess.

Would the bundles lead to success? While "success" means different things to different people and companies, assume for the moment that it means becoming a stronger competitor and realizing a strategic intent. We are not concerned yet with organizational objectives. Some �irms set objectives �irst and then �ind a strategy to meet them. The process described here does it the other way around for good reasons that will soon become clear.

Do the bundles challenge the organization's existing goals, aspirations, long-held assumptions, and beliefs? The value of this criterion becomes clear in the case of companies that have been in a rut for a few years and have a culture that is content with "satis�icing" and the status quo. However, for companies striving to become a stronger competitor, the alternative bundles it chooses should all meet this criterion. Put another way, if the existing goals, aspirations, and beliefs are challenging to begin with, then the bundles don't have to challenge them.

When analyzing a company with which you are unfamiliar, it is important to juxtapose mentally each bundle with the situation analysis and determine whether the bundle is something that the company would implement, is capable of implementing, and would bene�it from if implemented. This is why the key people who would be involved in implementing the strategy must be part of this process. They will have a better feel for whether a particular bundle is feasible and what it might take to implement it. At this point it would be premature to argue which is the best bundle; the analysis is simply to determine whether each bundle meets the six previously stated criteria. If not, then the process of tweaking them should continue until they do.

So often, particularly in cases when an executive or analyst comes up with one strong strategic bundle, coming up with a second or even third one is very dif�icult. The strong proposal has preoccupied the person who has chosen it and any other alternative gets added as an afterthought. A common pitfall is deciding on the best strategy before coming up with alternatives. Many companies are guilty of doing this when they decide on the strategy that they will pursue without contemplating or contrasting it with other alternatives. Without generating and considering good alternatives, the company has no way of knowing whether the strategy it will pursue is the best under the circumstances.

Let's examine for a moment some strategic alternatives that were suggested but later discarded:

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Vertical integration—Nothing in the case information suggests that vertically integrating backward would bene�it the company. Movie production and distribution are very different businesses and demand a level of investment and risk that is beyond the capability of the company to bear. Because it is already the "retail" arm of the movie industry, it cannot vertically integrate forward. Strategic alliances—Unfortunately, the case contains no competitive information. This is similar to the situation of a company whose competitors are privately held and about which no information is available. Only managers experienced in the industry and who can obtain information by "picking up the phone" can get around this obstacle. However, two avenues of thought should be pursued: (1) Which of all considered courses of action might bene�it more from, or be done better with, a strategic alliance? (2) What kind of strategic alliance might bene�it the company? Both considerations are an important part of strategic thinking. Diversi�ication—Related diversi�ication means getting into another segment of the entertainment industry. Even though the case gives no information about other segments, that does not mean to say that none of them contains an opportunity. (This sort of thinking comes under the heading of "unthinkable" alternatives mentioned previously. However, suggesting a course of action into another segment such as live theater, broadcasting, TV, professional sports, and the like has to be justi�ied and defended and supported with more information and research.)

As you can see, coming up with two to four alternative bundles may mean coming up with �ive or even six, determining whether they are mutually exclusive, plausible, and would lead to success, and deleting those that do not meet the criteria or combining them with others until they do. Carmike executives, with their additional knowledge of their own and related industries, are perhaps the only group that could mine the above four possibilities for yet another viable bundle. It's a creative and time-consuming process, but ultimately rewarding.

Discussion Questions

1. What is the difference between a strategic alternative and other kinds of alternative (e.g., considering alternative media for advertising, alternative ERM software)?

2. Picture a health center trying to raise funds for AIDS research. What types of strategic alternatives might such a group consider?

3. With respect to Question 2, is it possible to come up with strategic alternatives without �irst knowing what key strategic issues the nonpro�it faces? Why or why not?

4. The section argued for six criteria that strategic-alternative bundles should meet for them to be worth considering in choosing the best one. What if you, the analyst, couldn't come up with a set that met all six criteria? Would meeting �ive be acceptable? Four? If you think a fewer number would be acceptable, give your reasons.

5. Imagine developing and completing a criteria matrix. Some of your criteria would be positively and some negatively correlated. What part of rating your bundles on each criterion would you �ind most dif�icult to do? Why? What tips could you offer to cope with such a dif�iculty?

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In 2010, Carmike CFO Richard B. Hare announced a global box-of�ice sales increase of 7.6% to a record $29.9 billion in 2009.

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6.5 Closing the Loop with Strategic Issues

One last check needs to be performed before beginning to analyze the strategic alternatives and argue for a preferred one, and that is to compare the �inal bundles with the list of strategic issues. Every strategic issue should have been addressed in some way by the elements in each bundle. In our example, two strategic issues were not addressed:

Should it show foreign, classic, cult, or other types of movies? Should it get into domestic or foreign distribution?

This means that either (a) these issues are not as important as we �irst thought and can be deleted from the list; or (b) they are important and the bundles need further work to take them into account. Either solution is acceptable—there is no right or wrong answer. What matters is what is realistic and in the organization's best interest. If, for example, the �ilm-distribution business was not considered before, a great deal of research and data collection about that business—domestic and foreign—needs to be done before an intelligent analysis and decision can be made (this would come under "related diversi�ication"). For the moment, let's assume that we are satis�ied with the bundles as they are and delete those two issues from the list.

Notice also that bundle 3 contained the notion of going international. In fact, going international is the principal dimension that made it different from the other two. But whether the company should go international was never identi�ied originally as a strategic issue. Clearly, as a bona �ide bundle, the issue is important. So it should be added to the list, making the �inal list of strategic issues as follows:

Should Carmike stay regional, expand nationally, or expand internationally? How fast and where should it grow? Should it increase its debt position or go public to secure equity capital? Should it invest in screen, projection, and sound technology? Should it upgrade the quality and amenities of its theaters? Should it experiment with serving hot food and coffees in its theaters? Should it sell memorabilia associated with movies it shows? Should it stay in small towns or expand into urban areas and cities? Should it continue to grow through acquisition?

Discussion Questions

1. The sixth criterion for good bundles is to have addressed all the key strategic issues so that the �inal list "matches" the elements of all the bundles. Despite the argument for doing so

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in this section, do you think this criterion is really necessary? Explain your answer. 2. What would be the problem if they didn't match? Explain. 3. Do you feel that it's somewhat contrived to "make" them match at the end? Try to articulate your thoughts whatever your stance is.

4. Discuss one bene�it that checking back with the list of strategic issues might have on your �inal bundles.

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Summary

This chapter presented a way of developing a list of key strategic issues and why doing so is a fundamental step in creating viable strategic alternatives for the company. Such strategic issues synthesize what really matters to the company—what keeps the CEO up at night and on a "front burner" the rest of the time— and derive from a comprehensive external and internal analysis of the company. A key strategic issue should be phrased as a question whose answer is not known (if it is, for example, "Should the company reduce costs?"—Answer, yes—then the issue should be deleted from the list; it is something the company would do anyway no matter which alternative was chosen).

Before choosing the best alternative, the company must �irst go through a process of convincing itself that it is the best one, which can be done only by comparing it to other equally good alternatives. A strategic alternative as used here comprises a bundle of strategies, a strategic intent, core competence, programs, �inancing method, geographic scope, and any other element that helps �lesh out an alternative future for the company—which is why it is more aptly referred to as a bundle. And the reason the list of key strategic issues is so vital, besides summarizing all the issues that future plans should address, is that the alternative bundles are formed from them.

Creating good bundles is a creative process, and the chapter adds a few techniques to help do this in addition to those in Chapter 3 under strategic thinking. One of them is not really a technique, but rather the willingness to talk informally about what's really important to the company and external changes it should take into account; these are called strategic conversations. It's where one in�luential thinker says the real strategic planning takes place.

Unfortunately, many companies �ind excuses not to go to the trouble of creating good strategic alternatives. Excuses include being in a hurry and it taking too long, it not guaranteeing the "right" answer (so why bother?), being more comfortable thinking about and analyzing the past, not wanting to ask really tough questions (so let's keep doing the same thing), not knowing how to form viable alternatives and not admitting it to save face, disinterest or lack of commitment on the part of top management, and paying more attention to short-term �inancial results instead of long-term strategic performance.

The chapter explains in more detail why having a strategic intent is important and what it is. It is about improving or maintaining market position and also about maintaining or increasing market share. Maintaining market share happens when the company's revenue growth equals that of the industry; gaining market share is possible only when the company grows faster, and losing market share when it grows slower. Major programs are also included in a bundle to show what it is going to take to implement the bundle; every strategy implies a set of programs, though these can be different for different companies. And there must be suf�icient cash—whether from cash on hand (or what can quickly be converted to cash), a loan, or an infusion of equity capital—to �inance any bundle if it is to be feasible. A minimum of baseline funds is needed to keep the �irm operating, but additional strategic funds are required to �inance new strategic initiatives.

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Creating good, viable, worthy bundles must meet six criteria: be mutually exclusive (involve either/or decisions); contain signi�icant variety; be feasible; lead to success; challenge the organization's existing goals, aspirations, long-held assumptions, and beliefs; and have addressed all the strategic issues. With respect to the last criterion, to the extent they don't, the bundles and/or the strategic issues must be changed so that, in the end, they match. (Everything is �luid until the bundles are ready to be evaluated, so changes are OK.)

Concept Check

Key Terms

baseline funds Funds needed to support the �irm's current business and ongoing operations, that is, pay current operating expenses, maintain adequate working capital, and maintain current plant and equipment.

bundles Strategic alternatives that comprise strategies, strategic intent, core competence, programs, �inancing method, geographic scope, and any other element that would help de�ine and clarify a future course of action to an observer.

funds Cash that the company can use that is generated from three sources: cash on hand and whatever can be quickly converted to cash, taking on debt or more debt, and getting an infusion of equity capital (selling stock for a public company).

HERs process Strategic conversations that take place informally in hallways, elevators, and restrooms.

key strategic issues The critical questions and issues the organization must address in its strategic plan and that are a distillation or synthesis of the entire situation analysis.

market position The position in an industry that a company occupies ranked by market share.

program An operational component of a strategy. Every strategy implies a set of programs.

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strategic alternative One of many routes a company might take to gain market advantage, realize its goals, or, if no speci�ic goal has been declared, decide where it might go and what it might accomplish.

strategic conversation A free-ranging discussion on a topic of strategic interest to an organization. Because of its characteristic "no-holds-barred" freedom to say whatever needs to be said, it invariably produces ideas and thinking that are ultimately useful in the strategic-planning process and that might not be captured in any formal process.

strategic funds Funds invested to �inance new strategic initiatives.

strategic intent What a company intends to do with respect to market position or market share. For example, maintaining leadership in an industry or overtaking the #1, #2, or #X player in the industry are intents regarding market position. In industries where market share is easy to compute or is monitored closely, a company can aim for a particular market share. However, when this isn't possible, strategic intent devolves into either increasing or maintaining market share.

tactics Programs that are implemented the very next year.

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Chapter 7

Choosing the Best Strategy

age fotostock/SuperStock

Learning Objectives

By the time you have completed this chapter, you should be able to do the following:

Select criteria appropriate to the company and its purposes, and appreciate that a wide variety of criteria exists. Use the criteria in a criteria matrix to evaluate strategic-alternative bundles to help select the best one. Recognize the differences between company, partial, functional, and operational objectives, and among objectives, goals, and strategies. Set company-wide objectives with more con�idence. Decide on a strategic intent for the company and major programs required to implement the strategy. Understand why contingency planning is necessary and how to devise meaningful triggers and contingencies. Appreciate why the board of directors has to be kept informed and involved throughout the strategic decision-making process.

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This chapter explains how to choose the best strategy for the company from a number of viable alternatives using carefully selected criteria and how to argue persuasively for its adoption. It also shows how to arrive at the other strategic decisions and keep the board of directors involved through the process.

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One of the most important common criteria for choosing a strategy is revenue growth.

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7.1 Selecting Appropriate Criteria

Choosing among alternatives becomes a little easier when each alternative is compared one at a time against a set of criteria. Because such an analysis is often insuf�icient to decide an issue, the decision may eventually turn on more subjective analysis. What kinds of criteria are appropriate? Because one of the conditions for creating a good bundle is that if implemented, it would lead to success for the company, the criteria to evaluate the bundles should together represent what "success" means to the company and, perhaps, the overall purpose of the company. Depending on the company and its particular situation, the criteria explored in this section are possible candidates that could be used to examine a company's current standing and future outlook.

Shareholder value is a fairly common criterion, not only for choosing from among alternative strategies but also from among alternative investments. It requires the �irm to have a model for computing shareholder value so that the computation for each strategic alternative or investment uses common values of discount rates and common assumptions about the future environment. In this way, the results become comparable. Still, many managers and companies believe that one of the principal purposes of strategic planning is to increase shareholder value. So managers should know how to compute shareholder value.

Additionally, strategic management and planning is based on an understanding of the relative contribution of brands to shareholder value (Rappaport, 1997). For example, the Coca-Cola brand accounts for 51% of the value of the Coca-Cola Company, which also includes 3,500 other brands such as Dasani, Sprite, and Schweppes (Coca Cola Company, n.d.). When managers have a solid understanding of brand value, they will use this aspect of shareholder value as a key criterion in planning.

Revenue growth is one of the most common criteria, used more often when a �irm's revenue growth has been inadequate or �lat, or when issues of market share and market positioning are strategically signi�icant. A striking recent example of revenue growth is illustrated by Iluka Resources, one of 2011's best stock-market performers. Iluka posted a 53% increase in revenue between the third and fourth quarters of 2011 (Iluka grows, 2012). Such performance is often a strong predictor of takeover, a strategic decision made based on the revenue-growth criterion.

Pro�itability should be used when a �irm has insuf�icient working capital or inadequate or negative cash �low, when pro�its in recent years have been �lat or negative, or when it is highly leveraged. Leveraged buyouts (LBOs) rely on huge cash �lows and pro�its during the �irst year following the LBO, so that the huge debt can be rapidly paid down. However, as a note of caution, it is relatively easy to "mortgage the

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When a company is looking at the amount of investment money required from investors, an appropriate criterion to consider would be return on investments and how soon the investment may be recouped.

Dmitry Margolin/Hemera/Thinkstock

future" in favor of present pro�its, for example, by reducing investment in R&D or new-product development, so that, as a criterion, shareholder value may be superior, taking into account as it does a 10-year future stream of earnings.

Firms vary in their propensity to take risk. They are more inclined to take risks the more that risks have paid off for them in the past and when they have suf�icient capital so that they can afford to make mistakes. But degree of risk or riskiness as a criterion is more than this. A �irm's culture can, for example, be risk averse, in which case it will avoid risk even when the risk has odds of success that appear to favor it. Risk can be analyzed and measured, but few have the skills to perform such analyses. Instead, they prefer to make a risky decision according to instinct, or assess risk by venturing an opinion or two (guessing), or even ignoring any underlying risk. One way in which risk can be discussed among a group of people who are not risk analysts is as follows: Because all alternative bundles except "status quo" involve doing something the company has never done before, "risk" can be used as a subjective measure of the likelihood that it can implement the

bundle successfully. Some alternatives are sure to score higher or lower than others when risk is viewed this way.

Amount of investment required is a practical criterion. If a particular strategic alternative requires an amount of capital the �irm does not have or cannot secure, then it shouldn't even be considered a bona �ide alternative because it fails to meet the criterion of feasibility. Of course, the �irm could borrow more money but must be careful not to exceed some value of debt-to-equity ratio required by its creditors or increase its debt to the point where its cash �low cannot service the debt. Obtaining equity capital may be relatively easy for a public company that has been performing well, but not so for a private company. In certain circumstances, the �irm could go public and raise some equity capital; in other circumstances, that may not be possible. A �irm could �ind a partner to share some of the risk and put up some of the capital required. But in this case, pro�its resulting from the strategy must also be shared. Finally, being acquired by the right company could provide the capital needed to �inance a strategy, but this step is drastic and should be taken only in the best interests of the company, not just as a means of raising capital. For instance, SEOmoz software CEO and founder Rand Fishkin provided a detailed account in his blog of his experience negotiating an acquisition that ultimately didn't make sense for his company (Fishkin, 2011). In its most simplistic application, all other things being equal, it makes more sense to choose a bundle that requires less investment over another that requires more.

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Hemera/Thinkstock

Even when a company can come up with the investment required by a particular alternative, an appropriate criterion might be return on investment (ROI, a pro�itability measure) and how soon the investment can be recouped; a breakeven point in months is desirable. Clearly an alternative with a much shorter breakeven point is more attractive to a �irm with scarce resources, and one with a higher ROI is more attractive to a �irm for which ROI is a critical measure of performance. It may make sense to choose a bundle that requires a higher investment if that investment can be recouped more quickly and yields a higher return, but note that these are three separate criteria and the bundles are evaluated on each one in turn.

A �irm would choose an alternative that suited its existing corporate culture over one that needed a cultural change to make the strategy succeed. Just as "form follows function," so also does "culture follow strategy." This means that changing the culture to support the right strategy might be preferable to limiting a company to a strategy that �its the existing culture, or where the existing culture constrains the choice of strategy. Having said that, �irms that try to change their strategy assume their culture will also change, then �ind the strategy almost impossible to implement because the unchanged culture is impeding it. It is well known that changing a corporate culture is exceedingly dif�icult and, for large organizations, takes a lot of time (recall the discussion in Sections 2.9 and 2.10). If every alternative considered required the culture to change, the alternative that matched the existing company culture the most and would therefore require the least change should, perhaps, be chosen. If a �irm does not have a core competence or competitive advantage, it should certainly try to attain one, because competing without one results in below-average industry pro�its and a weak competitive position. Thus, the �irm should look for a strategic alternative that would, in time, help it attain a core competence and competitive advantage. If the �irm already possesses these attributes, then the alternative that increases the size or duration of the competitive advantage the most should be preferred.

If the industry in which a �irm competes has little or no bargaining power with its buyers or suppliers, its pro�itability will be low or subpar and competitive conditions very dif�icult. Clearly in such a situation, increasing its bargaining power and giving it some leverage is highly desirable. One of the most effective ways of doing this is through differentiating. So, would any of the alternatives in question increase the �irm's bargaining power with either its customers or suppliers?

There may be issues of timing to consider among the alternatives in question. Some alternatives are sensitive to when they are implemented, such as accelerating introduction of a new product or entering a particular market. If implementing an alternative now increases its likelihood of success as opposed to doing it later, this may be reason enough to choose it. Conversely, if doing it now reduces any advantage you otherwise might have, such as investing in a market push just as the economy turns down sharply or when a competitor introduces a better

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If there is an opportunity in foreign markets, it is important for a company to develop a global presence, whether it is venturing into the international market for the �irst time or increasing market share in selected countries.

and cheaper product, then that may be reason enough to reject the alternative. However, using this criterion typically requires more data.

Which alternative will most help the company maintain or increase its technological lead over its competitors? Or give it the technological lead it never had? Or help it become more innovative and technologically competitive?

As more companies realize that their biggest markets lie in foreign countries, developing a global presence could become a prime factor, whether venturing into international markets for the �irst time or increasing already substantial market shares in certain countries.

Clearly, some criteria make sense for some companies in certain situations, so should be used carefully. Others, such as revenue growth, pro�itability, degree of risk, investment required, shareholder value, degree of cultural change required, and competitive retaliation apply to almost all corporate situations.

The criteria you ultimately use in your analysis must �it the organization you are analyzing. For example, to some organizations, pro�it is the primary indicator of success. Elsewhere, success may be measured by the number of jobs provided to the community, the percentage of pro�it donated to charitable causes, or the reduction of waste produced during the course of operations. Most of the criteria discussed in this section do not �it the circumstances of a nonpro�it organization. The strategic-planning process of a state university's academic department might use the following criteria to help it choose from among several alternatives. Alternatives must accomplish the following:

Be in the best interests of the department's faculty Raise the quality of education and programs Enhance the department's reputation with employers Increase the department's �inances Make the department more competitive externally

Discussion Questions

1. Many candidates for possible criteria were presented in this section, and it makes sense that the criteria should be related to the company's purposes or what "success" means to the company. Yet "timing" is one that relates to neither. Which others of the criteria discussed have little or nothing to do with purposes?

2. Following on from question 1, why were such criteria included in the list of possibilities? 3. Which of the criteria discussed would be least likely to be useful in differentiating among alternative bundles?

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The selection of criteria and rating bundles through the criteria matrix is an opportunity to develop the arguments you can use to defend your preferred choice.

Francisco Cruz/SuperStock

7.2 The Criteria Matrix and Choosing the Best Strategy

One method that has been developed as a tool for evaluating strategy bundles is called the criteria matrix. It entails choosing �ive or six criteria most important to the �irm and assigning a numerical rating as a means of identifying the best strategy. Another bene�it of creating and using the criteria matrix is to use it as a worksheet in developing defensible and persuasive arguments for your preferred bundle.

Applying the Criteria

Experience has shown that using �ive or six criteria to evaluate the bundles makes the most sense. This range works because using too few criteria fails to capture the complexity inherent in the bundles, and using too many runs the risk of introducing con�licting criteria and would dilute the effect of each criterion on the �inal outcome.

Which criteria to choose is entirely up to your management team. "Playing" with several criteria can be a useful way to learn of the bundles' sensitivity to various combinations of criteria. Managers should supplement this analysis with detailed forecasts and analyses. For example, to assess which bundle might yield the most revenue growth were each one implemented, the team should conduct a more detailed sales forecast for each bundle over the planning horizon (three to �ive years). Similarly, pro�itability and shareholder-value analyses should be conducted, rather than guessing. Even though such projections are still estimates and based on assumptions, they require more re�lection and thought, and so should be more valuable.

Notice also that many of these criteria include purposes to doing strategic planning in the �irst place and what the �irm perceives as success. It is �itting that criteria used to chart the future direction of the company be as important to an organization as its fundamental purposes and what it views as success.

The criteria matrix is used to evaluate the bundles against multiple criteria using a scoring system that enables the results of using each criterion to be added up at the end (Table 7.1). The �irst step is to choose a set of criteria that makes sense for the company. These may include some of those criteria described in the previous section and perhaps others relevant to the company and its present circumstances.

The next step is to assign a rating to each criterion on a 10-point scale. Some criteria are positively correlated and some negatively correlated. An example of the former is revenues: an alternative that might yield high revenue growth is good for the company, but low revenue growth is bad. The two go in

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the same direction so to speak (high growth = good, low growth = bad), so the criterion "revenue growth" is positively correlated. In such instances the rating would range from 0 to plus 10. A neutral alternative would be scored 0 whereas an alternative that would be strongly favorable to the company might be a 9 or a 10. An example of a negative correlation is "size of investment required": an alternative requiring a lot of investment is "bad" for the company, but a small investment requirement is "good." The two go in opposite directions (a lot = bad, little = good). For a negatively correlated alternative, the rating would range from 0 to minus 10. Thus, an alternative that is not risky at all would get a 0 score, one that is moderately risky a score of perhaps minus 5, and an extremely risky one perhaps minus 7 to minus 10. Table 7.2 lists examples of positively or negatively correlated criteria.

The rating scores are subjective estimates; the absolute value of the rating is not as important as spacing them according to an estimate as to how close or far apart the alternatives are. It is the relative ratings that are critical. The bundles are rated against each criterion independently of any other criterion. When all the ratings are done, the scores are added up to see which alternative has the higher (if evaluating two) or highest total score.

Table 7.1: Criteria matrix for evaluating alternative bundles

Criteria Alternative A Alternative B Alternative C

Revenue growth (P) 8.0 8.0 9.0

Pro�itability (P) 7.0 7.5 8.5

Shareholder value (P) 8.0 7.0 8.0

Riskiness (N) -8.5 -8.0 -8.5

Investment required (N) -7.0 -9.0 -9.5

Change in culture required (N) -6.5 -8.0 -6.0

Totals 1.0 -2.5 1.5

Table 7.2: Positively and negatively correlated criteria

Positively correlated Negatively Correlated

Revenues or revenue growth Capital investment required

Contribution to shareholder value Change in culture required

Return on investment Time to breakeven

Adverse effect on competitors Overall riskiness

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An objective is a quantitative target to be achieved within a speci�ied time frame.

Raymond Forbes/SuperStock

Strength of value proposition

Gaining or extending a competitive advantage

Increasing its bargaining power

Table 7.3: Criteria matrix revised from Table 7.1

Criteria Alternative A Alternative B Alternative C

Revenue growth (P) 7** 8 9*

Pro�itability (P) 7** 8 9*

Shareholder value (P) 6** 7 9*

Riskiness (N) -7 -8 -9

Investment required (N) -7 -9** -8

Change in culture required (N) -7 -9** -6*

Totals -1 -3 4

*Reasons to select **Reasons to reject

Arguing Persuasively

In Table 7.1, the alternative bundle that receives the highest total is option C. However, option A's total score is so close to C's that it makes arguing for C being the best alternative open to question. This is where other considerations come into play. If market share is particularly important to the company (revenue growth), or pro�itability, or if the company is averse to changing its culture a lot, then the analysis would suggest option C. But the table also shows that option C requires the most investment, and if the �irm might be unable to raise the needed capital, that could be the one reason to reject it. Recall, however, that feasibility is one of the six criteria for creating bundles, so option C should not have been quali�ied as a bundle if the needed capital couldn't be raised.

To avoid the situation where there are two alternatives that achieve almost equal ratings, the choice of criteria and assigned ratings are revised until there is a clear winner by at least three points. While this

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appears to be "�ixing" the result, the process is still in "analysis" mode, which means that managers are free to try different criteria and ratings until they are satis�ied they have a defensible strategic bundle. After all, defending and being comfortable with the choice of strategy is what this whole exercise is about. It is that ultimate defense before top management or the board of directors that will keep anyone from "�ixing" the ratings to yield a preordained result. A preordained or poorly argued result can be spotted a mile away and will damage its proponent's credibility. So while this analysis is being done, it is important to remember to choose only that alternative that can be supported persuasively; the scoring system will help in that regard. The criteria matrix and the associated process of selecting criteria and rating bundles against them is simply an opportunity to develop arguments to defend or "sell" the preferred choice to others.

The danger with using such a quantitative yet still subjective method to choose a strategic alternative is that it invites criticism precisely because one person's criteria and ratings may not match anyone else's. The results are sensitive to the criteria chosen. Using shared or consensus ratings within a group is one way to get around this problem and to try out different combinations of criteria. The principal value of the criteria matrix, however, is to force planners to test their choice of alternatives against different criteria in case other people believe such criteria are important. In the case of disagreement, the person who has gone through this exercise will have "done their homework" and be able to discuss—and perhaps refute— another person's point of view.

Effective Presentations

In this chapter, we review a number of logical and data-based concerns you should have when presenting alternative strategic bundles to stakeholders. Undoubtedly, in order to be persuasive, you must have the data to support what you are advocating. However, how you package and present those data are critical concerns. The con�idence and competence you demonstrate in proposing a strategy will impact your listeners. Communication researchers and consultants Jennifer Waldeck, Patricia Kearney, and Timothy Plax point to a rich body of research literature that examines the dynamics of persuasion and resistance. What follows is a summary of some of that research and how it applies in your strategic-planning efforts. Employ these researchbased strategies to help you think through your oral or written presentation style and content:

1. Assess your stakeholders' willingness to change. Humans' inclination to resist change has been widely documented. Central to your persuasive effort is identifying your audience's present position. a. When they agree at the outset, your persuasive task is to reinforce their commitment and provide them with some motivation to strengthen their commitment to a strategic change. As inconsistent with a corporate communication strategy as they may seem, emotional appeals are popular and effective ways to energize and motivate others. Finally, when dealing with stakeholders who are "with" you, you will bene�it from

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being direct with those supportive individuals and telling them exactly what you believe needs to happen.

b. When dealing with a hostile or disagreeable audience, avoid direct and overt in�luence attempts. These will result in activation of an ego-protective defense that your listeners will use to guard what they are already invested in. In these cases, it's important to modify your expectations and ask for only small amounts of change and slight adjustments to thinking and behavior. For example, plan to move your audience from more to less disagreement in your initial discussions. Second, work to establish common ground and a sense of understanding. Acknowledge areas of agreement. Finally, be prepared to provide extensive amounts of the kinds of evidence and data discussed in this chapter to support your position.

c. When your audience is neutral or undecided, doesn't know much about the issues you are presenting, or is confused and overwhelmed by the facts, your �irst objective should be to establish relevance. By providing background information on the issue, you can make the issue professionally relevant to stakeholders and heighten their attention. Although evidence is important with these audiences, you must be cautious not to overwhelm or inundate them, since there is likely to be a learning curve involved.

2. Avoid in�lammatory phrases. Steer clear of words and phrases that will make your stakeholders angry, cringe, or uncomfortable. These semantic barriers will distract your audience from listening effectively and evaluating alternatives fairly.

3. Use a two-sided message with refutation. A speaker is most likely to in�luence an audience by presenting both sides of an issue and taking the time to argue against the position he/she �inds undesirable. When you do this, your constituents will perceive you as well- informed, credible, and objective. Just be careful to be objective in opposing others' points of view, rather than offensive.

4. Inoculate against counterarguments. When you know there are arguments against elements of your strategy (and there always are), it's a good idea to inoculate the audience against them. Doing so involves identifying those arguments and refuting each with solid evidence, often before they are even raised (because you have anticipated them). As a result, you will arm your audience to resist them.

5. Minimize objections. Spending too much time inoculating against counterarguments detracts from the advantages of your proposal. So just as it's important to carefully consider the range of strategic alternatives as you are creating your bundle, you should identify only the top two or three critical objections to address in your proposal.

6. Repeat your message using various tactics and media. Leveraging stakeholder support for a proposed strategy is rarely accomplished in a single message. In shepherding strategy change, design a message strategy that will expose your constituents to the ideas multiple times and in multiple formats (e.g., presentation, written proposal, podcast, interactive Web-based summary).

In comparing Tables 7.1 and 7.3, note that the latter uses only whole numbers; since the ratings are "educated guesses" in the absence of any data, estimating to one place of decimals belies a level of accuracy that just isn't there. Arguments involved in the selection of a bundle consist of two parts: (1) reasons why the preferred bundle was chosen, and (2) reasons why the other two were rejected. The best

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ratings in the table are highlighted in the winning bundle. Thus, in Table 7.3, if option A were "forming new partnerships," option B were "developing new products," and option C were "expanding nationally," the argument would look like this:

"The company should expand nationally because doing so would generate the most revenue growth and pro�itability, increase shareholder value the most, and require the least culture change. Forming new partnerships would generate the least revenue growth and pro�itability and increase shareholder value the least, while developing new products would require the most investment and culture change."

A �inal comment on the bundle analysis re�lects on how well you have crafted the criteria matrix. It could be that the bundle chosen best meets all the criteria and one of the other two bundles falls short of all the criteria. This means a couple of things: (a) the winning bundle is so much better than the others and the one that falls short of all the criteria is so much worse than the others that it re�lects badly on how the bundles were created in the �irst place (they are all supposed to be good, viable bundles); and (b) the third bundle is left with no reason to reject it, which also hurts the argument. In such a case, the criteria matrix should be reworked so that the winning bundle is still the one that would prevail, but would not be better than the other two on all criteria.

Discussion Questions

1. Are the following criteria positively or negatively correlated? Brand reputation Economic value added Changing the cost structure of the �irm Cost of maintaining quality Sales per square foot Managerial turnover Weighted average cost of capital (WACC)

2. The section advises that one should use 5–6 criteria in a criteria matrix. Discuss arguments of your own concerning why using a smaller or larger number of criteria would or would not work.

3. Would using more criteria produce a different result? Would it inspire more or less con�idence in the result?

4. Assume you have developed a good criteria matrix and are now working on a convincing argument for your winning bundle. But what the criteria matrix reveals, in your opinion, doesn't make for a convincing argument. What do you do?

5. The overarching purpose of a criteria matrix is to choose a preferred "best" strategy and argue persuasively to others (perhaps even yourself) that it is the best one. Can you think of another method or process that would lead to the same result? Explain it.

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One of the steps in setting objectives is to decide on a small number of measures critical to the �irm, such as revenues, pro�it, and debt structure.

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7.3 Deciding on Objectives

The recommendations phase concludes the strategic-planning process allowing the recommendations— and the strategy—to be implemented. Recommendations include setting objectives, de�ining strategic intent, identifying key programs to achieve the objectives, and exploring triggers and contingencies if things do not go as planned. Creating or revising mission and vision statements is also part of this �inal phase if the organization's existing statements are no longer valid, or if the organization has never had them before.

An objective is a quantitative target to be achieved within a speci�ied time frame. It may seem odd to some that setting objectives comes after choosing a strategy. They may �ind it more logical to �irst set objectives and then choose a strategy to achieve them. Ideally, they should be set together, that is, iteratively until they �it with each other. But that is hard to do. Deciding on a strategy �irst makes sense for three reasons. First, it follows naturally from identifying the company's key strategic issues, which in turn follow logically from the situation-analysis phase. Second, by construing the selection of a strategic alternative bundle as creating a road map or direction for the company, one can then turn one's attention to deciding how far and how fast to go along that road (i.e., objectives). Last, deciding on the strategy �irst allows many criteria to be used, enriching the assessment and ultimately the choice of strategy. For example, examine the timeline of strategy implementation for the United and Continental airlines merger: http://www.unitedafa.org/news/merger/timeline/default.aspx (http://www.unitedafa.org/news/merger/timeline/default.aspx)

In addition, there are two problems with setting objectives �irst. Where does the objective—the quantitative target—come from? Other than the case where the current strategy is being continued, setting an objective �irst lacks a context. For example, to meet a 20% revenue growth objective in two years may be possible by expanding internationally, but not by investing more in R&D. Yet the latter may be the better strategy in the long run. Wouldn't it make more sense to ask which of the two was capable of generating more revenues over the next several years? And where did that 20% number come from?

The second problem with setting objectives �irst is that, for example, revenue growth becomes the sole criterion for picking a strategy. That is, having set an objective, a strategy is chosen that will best enable the company to meet the objective. Wouldn't it make more sense to use revenue growth in this instance as one of several important criteria? Would one be as content to achieve the revenue-growth objective if the company were also losing money?

http://www.unitedafa.org/news/merger/timeline/default.aspx

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In the end, whichever one is done �irst—the strategy or the objectives—they must both match and be consistent with one another. The strategy determines how the company will compete and where it is going, while the objectives determine the rate of growth and how fast the company can go (what it can achieve) given its resources, capabilities, and aspirations. Great care must be taken to distinguish objectives from strategies. For example, executives often talk of "high growth," "moderate growth," and "low growth" strategies. Clearly, these growth "strategies" are really objectives re�lecting a high, medium, or low increase in sales or revenues. The full range of possible business strategies was covered in Section 3.2.

Setting Objectives

While this model advocates setting objectives after deciding on a preferred strategic alternative, the two must be so well matched that an observer would imagine that they were done together. It is impossible to evaluate or judge a strategy without knowing what the objectives are, and likewise impossible to judge whether the objectives make sense without knowing how they are to be achieved (the strategy) (Collis & Rukstad, 2008).

Consider this example. A company decides to pursue an accelerated product-development strategy and at the same time, change its fairly conservative culture into an innovative one that also values quality. Is this a good strategy? It is impossible to tell unless you also know what the company is trying to achieve, that is, know its objectives. If you were now told that in three years' time the company expected sales to double and pro�its to increase by 50% and that it had the resources to carry out this preferred strategy, one now has a basis for either criticizing the strategy or believing that it will work (or even criticizing the objectives). So a strategy without objectives is meaningless.

Consider a second example. A company whose sales have been �lat and that has been losing money for two years wants to increase sales by 20% next year and at least break even. Are these good objectives? Again, it is impossible to tell unless you know how the company intends to achieve them, which means knowing its strategy and programs. Merely trying to increase sales, typically through a market-development strategy, may be insuf�icient. The company's product may be outdated and its cost structure too high. So with the competitive environment the company faces, it will take a well-thought-out strategy to give an observer con�idence that the objectives could and would be achieved. Again, objectives without a strategy are meaningless.

Setting objectives is a three-step process.

Limit the Choices

Decide on a small number of measures critical to �irm performance. These might typically include revenues, pro�it, debt structure, and the like. There is no rule as to how many objectives a �irm should have. But the more it has, the more dif�icult it becomes to achieve them all and the greater is the likelihood that some objectives will con�lict with others; that is, achieving one will result in not achieving another. About three to four companywide objectives is typical, one of which is revenues (or market share if it can

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Companies have goals because they inspire employees and external constituents to perform better.

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be accurately measured) and some kind of pro�it measure: EBIT, NIBT, NIAT, EPS, ROI, ROE, ROS, or ROA—NIAT being the most commonly used. The remaining one or two can be anything of critical importance to the company such as sales per square foot for a retailer, operating income per screen for a movie-theater chain, debt–equity ratio for a fairly leveraged company, and the like. Do not include costreduction objectives as one of them because any efforts to reduce costs will show up in improved pro�it; costreduction objectives are important only at an operational not a strategic level. Similarly, other operational or programmatic objectives, such as number of new products produced, percentage of international sales, number of retail outlets served, or increasing production capacity or throughput by X%, while important, should not be part of this set.

Set Annual Objectives

Decide on annual values for these critical measures for the next three years. This is dif�icult to do well. Theory tells us that objectives, to be effective, should be set at a "challenging" level; set too high, they de-motivate because people consider them impossible to achieve, and set too low, they also de-motivate because they are too easily achieved. How does a company �ind that perfect level? The following �ive-step process may help.

First, extrapolate from historical data to establish initial values for each objective for the next three years. This is easier to do when you have at least �ive years of historical data available. Second, make a list of external and internal forces or changes that might act to decrease these beginning values over time, such as intensifying competition, scarcity of borrowed funds, a conservative culture, rapidly accelerating technological innovation in the industry with which the �irm cannot keep up, and so on. For each item, indicate, however subjectively, the strength of the negative effect on the objective (high, medium, or low). Third, make a list of external and internal forces or changes that might act to increase these beginning values over time such as a new strategy, companywide training, a new CEO, a change to a more productive culture, new quality programs, strategic alliances, a new advertising campaign, and so on. For each item, indicate, however subjectively, the strength of the positive effect on the objective (high, medium, or low). Fourth, compare the two lists and decide, for each objective, whether the initial value deserves to be increased or decreased and by how much, depending on the extent to which the positive effects outweigh the negative effects or vice versa. In this way, create a "�irst cut" of each objective for each of the next three years.

Finally, get feedback from those who are going to be held accountable for achieving the objectives whether the "�irst-cut" objectives are challenging yet achievable in the circumstances. In fact, get these people involved in the other steps too. For some companies, deciding on strategic objectives cannot be done unless the whole range of operational objectives have been created, thought through, and approved, to make sure that the resources to achieve them are available and that they are feasible to achieve in the time

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frame speci�ied. When they have been well designed, achieving the operational objectives should result in automatically achieving the company-wide objectives.

Match Objectives to Strategy

Check that the objectives match the preferred strategy. The preferred strategy and the set of objectives must be consistent with each other. For example, if the strategy decided upon is aggressive, the objectives set should also be aggressive. If the strategy is a turnaround, the objectives should re�lect this unusual state, showing �irst stabilization at a lower level followed by growth consistent with the new strategy. If the strategy is designed to maintain market position in a highly competitive, mature market, the objectives should not show high growth, but re�lect current conditions to a high degree. If the strategy requires a period of heavy investment before it pays off, the objectives should re�lect that reality. Remember, the objectives indicate what the company considers to be successful performance over time given the changing realities of the industry, marketplace, and the company's own strategies, resources, and commitments. Thus, not achieving these objectives (indicators) means less-than-successful performance, while meeting or exceeding them indicates intended or superlative performance in the circumstances.

Types of Objectives

The preceding discussion implicitly assumes that these are company or company-wide objectives. There are also other types of limited objectives. Partial objectives cover only part of some activity, like international sales versus total sales. Functional objectives pertain only to a particular function, like a sales and marketing department increasing the number of salesmen. Operational objectives are either subsumed by higher-order objectives (like reducing costs) or are cross-functional, for example, security or systems or plant maintenance, none of which come under any "function" (Table 7.2). All of these other types of objectives will show up during implementation of a strategy. The value of understanding the differences is that at the strategic level, we need company-wide objectives, not functional or operational objectives.

Table 7.4: Partial, functional, and operational objectives

Kind of objective

Objective Explanation

Partial Increase international sales by 10%/yr Does not address domestic sales

Increase sales from new products introduced during the past three years to 40% of total sales

Does not address sales from existing products

Increase sales to mass merchandisers by 30%/yr

Does not address sales to other retail channels

Functional Double the number of retail outlets Concerns only marketing

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Increase throughput by 5%/yr Concerns only production

Redesign the product to reduce purchasing costs by 5%

Concerns only engineering

Operational Reduce costs by 12%/yr The higher-order objective of NIAT takes this into account

Improve quality by reducing the costs of quality by 30%

Insofar as quality is measured this way, it is subsumed by NIAT

Improve the sales "hit rate" from 2% to 6% at year-end

This is an operational objective for marketing

Typically, the most common company-wide objectives are revenues, NIAT (or other pro�it objective), and one or two other ratios or non�inancial measures that the company as a whole commits to achieving. These might be volunteer hours donated by employees to the community, a lowered number of quality defects, a lowered turnover rate, or improved safety and accident rates.

Objectives vs. Goals

In many companies, what we now understand to be an objective is often referred to as a goal (and vice versa). To underscore the difference as used here, a goal is de�ined as a qualitative end-state that a company tries to achieve; for example, "to become more innovative." Note that progress cannot be measured, and there is no speci�ied time frame.

Why, then, do companies have goals? Because they are intended to inspire. They should sound stirring to employees and to external constituents. The following are some examples of goals:

Become more innovative Make the customer #1 Take care of the environment Produce better products Be there for our customers We're going to grow Develop a national presence Become more ef�icient Become lean and mean Streamline our operations

At the same time, goals, precisely because they are not amenable to measurement, let management off the hook. There's no incentive to follow through. Management isn't accountable.

Objectives are written in such a fashion that organizational members will be able to answer the question "Will we know it when we see it or when it happens?" Organizational consultants and authors Beebe,

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Mottet, and Roach use four criteria for objectives (2003). First, accomplishment of the objective must be observable; we should be able to see the results. Second, objectives must be measurable; that is, some objective metric must yield useful data indicating that an objective has been met. Third, objectives must be speci�ic; a clearly written objective includes precise guidelines for describing the nature of the objective and the strategies and tactics required to accomplish it. Finally, as we've made clear in our discussions so far about strategic thinking, talking, and management, objectives must be feasible and attainable. Organizations must develop objectives based on a realistic understanding of both internal and external barriers to accomplishment.

Thus, a CEO might be well advised to run a company on objectives alone. It has been said that "you can't improve what you can't measure," and there is much truth in that. Goals imply programs (for example, "produce better products" implies more R&D, engineering, better quality control, and constant customer feedback) and operational as well as company-wide objectives. Incentives for improved performance and results are tied to achieving objectives. Settling for a goal instead implies laziness and an aversion to accountability.

Discussion Questions

1. Companies, both in their public statements and in the way they are managed, make extensive use of goals and objectives. Assuming that they are de�ined as they are in this presentation, do you think that a company could be managed using just goals? Why or why not?

2. Imagine a company whose managers collectively set objectives at a very conservative level, knowing full well the objectives would be exceeded and all of them would get hefty bonuses as a result. How could this situation be avoided?

3. Is it possible for company-wide objectives to be set last, in effect adding up all the partial and functional objectives? If it is, might that be better or worse than setting them �irst?

4. At a business school, overall objectives (things like number of courses taught by full-time faculty, ratio of full-time faculty to total faculty, total funding received, etc.) are derived from annual plans of each department (�inance, operations, accounting, HR, etc.); that is, the departmental objectives are combined to produce the school's overall objectives. Yet the school maintains that it does strategic planning. How would you explain to the school that it is mistaken?

5. Companies' reward and incentive systems are attached to attaining or exceeding certain objectives, assuming that pro�its were also achieved. But little is said or publicized about what happens when such objectives are not achieved. What kinds of penalties would you suggest for not achieving company-wide objectives and functional objectives? How would you gain everyone's agreement in the �irst place for a system of penalties as well as bonuses and other rewards?

6. If it didn't already exist in a company, would developing a system for penalizing failure to meet company objectives be worthwhile?

7. Recall an organization you were part of (needn't be a company). Did you have goals and objectives? What were they? Were they taken seriously?

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In contingency planning, companies tend to look at the short term, medium term, and long term. The standard range for "long term" used to be �ive years, but due to the rapid pace of technology, it has been reduced to three years.

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7.4 Contingency Planning

Murphy's Law states, "If anything can go wrong, it will." An extension of this is that it always seems to happen at the worst possible time. It is a good idea to contemplate what could go potentially wrong in the future, which is termed a trigger, and what the company would do differently were that to happen, referred to as a contingency.

We therefore talk about trigger-contingency pairs, typically one or two that pertain to next year— the short term—and one or two that could occur three years from now—the long term. In reality, companies may have as many as 20 triggers and contingencies "active" at any time, assuming they do contingency planning. The planning horizon, however, can vary considerably according to the size of the company and the industry. For example, a company like Boeing views the next several years as "short-term," about 10– 15 years as "medium term," and 20–30 years as "long term." Companies in the fashion business view two weeks as "short term," and a season (3–4 months) as "long term." For most companies, however, the "standard" long term of �ive years has now shrunk to three years because of the rapid pace of change, especially in high-technology industries.

Triggers

Triggers should be external, speci�ic, and quantitative. Absent these three quali�iers the company will not know when to invoke the contingency plan. It is no use saying, for example, "If pro�its decline," or "When things get tough." Decline how much? Get how tough? Even when trying to address phenomena that cannot be measured— such as a competitor in�iltrating your territory, or, for the Carmike movietheater case discussed in the previous chapter, "worse" movies being made in a certain year—try to gauge their effect on your sales. For example, if the unknown phenomena were to cause your sales to decline, would you do something differently if your sales fell below target projections by 10%, 15%, or 20%? In this way, you will monitor something you constantly measure, and so can bring into play the contingency plan at just the

right moment.

Triggers also come from assumptions you make about the future that are "soft"—that is, about which you lack con�idence and which are external to the company. For example, if you are engaged in strategic planning and your company is sensitive to interest rates, you might not know what is going to happen to interest rates next year. You may have tried to obtain information from various economic forecasts on this variable but, frustratingly, all of them differ in their predictions. So here is something you can do. Simply

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Good contingency plans depend on three guidelines: not reneging on your adopted "best strategy," not planning for something the company is already doing, and making the contingency a solution to the problem.

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make the assumption that interest rates are not going up next year (if economic indicators make that at least plausible), and base your planning on that.

However, because the assumption is "soft," create a trigger that admits the possibility that interest rates could go up: "If interest rates go up by more than X percentage points, then . . ." the contingency plan takes effect.

Triggers can also emerge from the timing of various imminent occurrences. For example, if new federal legislation is being created to nationalize health care, you may be unsure if this would take place next year or two to three years from now. So create your plans with your best assumption in mind—for example, no health care legislation will be enacted during the period of the planning horizon. However, because the assumption is "soft," create a trigger, too, that speci�ies, "If health care legislation were enacted within the next two years, then . . ." the paired contingency will be enacted. Notice that this trigger is quantitative. You can tell exactly when it happens and can therefore invoke the contingency plan. Similarly, you may want to do something differently if two competitors merge or if quota restrictions into some foreign country are imposed or lifted.

For companies focused on increasing sales or market share, it is tempting and understandable to create triggers having to do with not meeting revenue objectives. To do this once is perfectly �ine, but to have such a trigger every year gives the impression of obsessive focus in one area. Management's role is directing and coordinating the many aspects of a company to work together seamlessly to create value, and indeed things could go wrong in many areas, not just in failing to make a revenue objective. A better approach is to make a list of all the possible things that could go wrong or where your assumptions are soft, and choose the most likely of them as your triggers. Try to choose a different trigger for the long term from what is chosen for the short term. A useful training exercise is to create one trigger-contingency pair based on what might cause a revenue shortfall and one an NIAT shortfall, stating one in the short term and the other in the long term, just to practice creating realistic trigger-contingency pairs.

Contingencies

Contingencies are precursors to contingency plans. They are a response to a particular trigger; what a company should do differently if that trigger occurred. Later, when the strategic plan has been prepared for operational implementation, the contingency should be translated into a contingency plan complete with details as to who is responsible for it, its budget and schedule, and who must keep it relevant as conditions change.

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Good contingencies should follow three guidelines:

Do not renege on the adopted "best" strategy. For example, suppose the company chose a market- expansion strategic bundle, but there is reason to believe it would be dif�icult to implement and pull off. If sales were to drop more than 10% from target projections at any time, it should not set as a contingency, "Cancel the market-expansion strategy and implement a differentiation strategy." If one does that, it is in effect saying that the strategic bundle chosen was not a good choice, and its proponents will instantly lose credibility. Besides, companies cannot—and should not—be in the habit of changing their strategies at the �irst sign of adversity. Strategies typically take anywhere from two to �ive years to implement, and the organization must give the chosen strategy a chance to succeed by not changing it until there is absolute certainty it is not working. For any new or modi�ied strategy being implemented that does not seem to be working, it is advisable always to suspect �irst the execution of the strategy, not the strategy itself. That way the contingency should focus on operational changes that could be made to enable the strategy to succeed, not changing the strategy itself. The following are examples of possible operational changes:

Change the ad campaign or the advertising agency. Replace the VP Marketing (or any senior manager). Give the salespeople additional or more technical training. Do additional and speci�ic market research. Broaden the distribution channels. Increase links to your customers and increase their switching costs. Seek alternative suppliers.

Do not make something that the company is already doing the contingency. Think about it. What the company has been doing up to the time the trigger is invoked is what got the company into trouble in the �irst place. If sales are not meeting expectations, do not set as a contingency, "Continue advertising" or "Do more R&D." The company is already doing those things, and, clearly, sales are still down. So think of something it can do differently, that is, an adjustment to its operations or execution, one that can be implemented quickly, say, in a couple of months. Make the contingency a solution to the problem implied in the trigger. If inadequate pro�its are the problem, the contingency should be directed towards increasing pro�its, not sales. If market share is the problem, do not suggest lowering costs as the contingency, even if it is a matter of doing something different; the two are unrelated.

Because contingencies are in fact back-up plans, they have to be spelled out in great detail, and those responsible for developing them and carrying them out must know who they are and what they must do. Those details are added during the operational phase prior to implementation. Companies that go this extra mile of contingency planning will reap rewards in three ways. First, they will be better prepared for speci�ic uncertainties than companies that have no triggers and contingencies, especially if they work to adjust the contingencies over time as conditions change to keep them current and workable. Second, they will become more adept at anticipating what might go wrong and come up with better triggers and contingencies over time. Third, they will appreciate the need to be alert to key changes in the environment and their company and, over time, create a more �lexible company culture.

It is effective to express a trigger/contingency pair in the form of a three-part sentence. For example:

The external cause of the trigger: "If competitors lowered their prices, . . ." The quantitative trigger: "causing revenues to lag projections by 15%, . . ."

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The contingency: "then the company should increase advertising and promotions."

Stringing those three parts together—"If competitors lowered their prices, causing revenues to lag projections by 15%, then the company should increase advertising and promotions"—you will �ind that this simple sentence meets all criteria for creating a good trigger and contingency.

Discussion Questions

1. If "value" implies bene�its accruing for a certain level of costs, try to articulate the true value of contingency planning to a company.

2. Contingency planning is needed precisely because certain assumptions about the changing environment might be "soft" and uncertain. Yet, because of changing conditions both inside and outside the company, contingency plans—both triggers and contingencies—rapidly go out of date. How often should a company review its contingency planning and keep things current?

3. Triggers assume that progress toward objectives is measured constantly and that actual performance can be compared to plan performance, say, every month. In your opinion, is this true of most companies? Comment speci�ically about NIAT performance.

4. Typically, pro�its are computed quarterly at most, and are done so using accounting principles. To the extent you agree with this, should pro�its ever be used as a trigger? Discuss.

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In public companies, it is important to keep the board of directors involved in the process because they are directly responsible to the shareholders for making strategic decisions.

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7.5 Keeping the Board of Directors Involved

Strategic planning is a critical part of strategic management and singularly responsible for directing or keeping the company on the right path. In companies that do strategic planning, a topmanagement team, led by the CEO and ideally including key operational managers, is responsible for doing strategic planning and implementing the decisions made during the process.

In public companies, however, the board of directors is directly responsible to the shareholders for making strategic decisions that ultimately bene�it the company and, by extension, its stockholders. So what is the role of the board in strategic planning and decision making? The role and level of involvement ranges from almost nothing at one end of the scale to taking over completely at the other, and varies from company to company.

There are two scenarios where board involvement is nonexistent or where it "rubber stamps" executive decisions. In the �irst there is a high degree of trust between the board and the CEO and top management. In the second the board members have been handpicked by

the CEO and agree with all his decisions. In many such cases, the CEO is also the chairperson of the board, making the relationship even cozier. While some companies are fortunate to enjoy mutual trust, nothing is wrong with the latter technically or legally. Whether it is "right" is a matter of opinion.

At the other end of the scale, takeover bids and acquisitions demand full board involvement, and resultant decisions are made solely by the board. Bear in mind that the CEO, CFO, and one or two other key executives are usually also members of the board.

Most companies operate somewhere in between these two extremes. Because the ef�icacy of the board- management relationship differs so much, it is dif�icult to generalize. What would be useful instead would be to summarize some things a board could and should do to be involved in the strategic-planning process:

If at all possible, the board should nominate a strategic-planning committee whose responsibility would be to monitor the strategic decisions being made by top management and involve the whole board if circumstances warrant. In the absence of a strategic-planning committee, it may be advisable to have at least one board member present at all strategic-planning meetings as an observer. Have the director of strategic planning—or the CEO if one doesn't exist—send summaries of all reports and research done in preparation for strategic-planning meetings. Ask probing questions at board meetings of the CEO and CFO, especially during the strategic- planning process. If the board gets an inkling of the direction the CEO wants to take the company

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and it disagrees, and if each side is adamant that its direction is right, it is the CEO who gets dismissed. Above all, it is the board's �iduciary responsibility to ensure that the direction and strategy the company moves in is in its best interest and that of the stockholders; it has to do whatever it must to carry out that duty.

Discussion Questions

1. Somehow, the board of directors has to maintain good relationships with the top management of the company and yet stay at arm's length, so to speak, to properly perform its role of overseer. How can it best manage this tension?

2. Imagine yourself as a board member: You notice that all is not right between the CEO and the CFO and certain other board members. What would you do?

3. Also as a board member, you have a sudden insight as to what the company might do strategically in the future. What do you with this idea?

4. If the CEO and CFO are insider members of the board, is there any justi�ication for the board appointing a strategic-planning committee?

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Summary

This chapter described a useful method—the criteria matrix—for evaluating alternative bundles on a number of criteria in order to select the best one. However, choosing which criteria to use is subjective and could affect the outcome. They should be related to the purposes the company is trying to achieve and what "success" means to the company. It therefore makes sense that using such criteria would in fact result in the best bundle for the company. In addition, only �ive to six criteria should be used, as too few would fail to capture the complexity of a future strategic direction and too many would dilute the impact that each criterion would have on the outcome.

The criteria matrix consists of a table with the alternative bundles as columns and the criteria as rows. Putting numbers or ratings down in each cell must be done carefully. Positively correlated criteria should be rated on a scale of 0 to plus 10, 10 being best, while negatively correlated criteria should be rated on a scale of 0 to minus 10, 0 being best. The magnitude of the rating is not nearly as important as the relative ratings across bundles. Criteria for which every bundle gets the same rating should be deleted; the purpose of choosing criteria includes their ability to differentiate the bundles. Finally, the "winning" bundle must win by at least three points or there will be dif�iculty arguing for it as the best bundle. If this happens, the ratings and even the criteria need to be changed until it meets that condition.

After determining the bundle with the highest score, a persuasive argument must be created to convince others of the choice. The best argument consists of two parts: why the winning bundle was selected and why the others were rejected. Reasons for selecting the winning bundle include those criteria for which it had the best rating. Reasons for rejecting any bundle include those criteria on which it had the worst rating. If the reasons are "unbalanced" (i.e., the winning bundle was best on all the criteria and another bundle was worst on all criteria), it means that the bundles were poorly formed or badly rated in the �irst place. If all the bundles were good to begin with and the ratings are realistic, the winning bundle should be best on a subset of criteria and the others the worst on other subsets.

Besides choosing a winning strategy and bundle, the company needs to make strategic decisions that include company-wide objectives, strategic intent, major programs, and triggers and contingencies. Company-wide objectives are targets the whole company is responsible for producing, whereas functional objectives apply only to functional departments, partial objectives are subsumed under other objectives, and operational objectives are other kinds of nonstrategic objective. The latter three types of objectives are operational, not strategic. Objectives are quantitative targets to be achieved in a speci�ied time frame, whereas goals are simply qualitative endstates to be achieved in the future and, while they may sound inspirational, lack incentives and accountability.

Because things may go wrong despite the best planning, well-managed companies will do contingency planning. This involves, for each contingency, identifying an external assumption that might be "soft" or uncertain (what could go wrong), a quantitative trigger (when should the company do something different

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to correct the situation), and what the company would do if the trigger were reached. Companies who prepare themselves in this way fare better than those that don't.

Finally, the board of directors has to be kept informed and involved throughout the strategic decision- making process. While their involvement varies from hands-off to taking over the strategic decision making completely (as when responding to a takeover bid or making an acquisition offer), boards would do well to do some of the following: strengthen their relationship with the CEO and CFO (insider board members), appoint a strategic-planning committee, sit in on strategic-planning meetings, or receive summaries of all reports and research done in preparation for strategic-planning meetings.

Concept Check

Key Terms

argument The argument for selecting a preferred bundle consists of two parts: (1) reasons why the preferred bundle was chosen, and (2) reasons why the other two were rejected. The reasons are drawn from the criteria matrix.

company-wide objectives Set during the strategic-planning process that the whole company must achieve.

contingencies Back-up plans and precursors to contingency plans. They are a response to a particular trigger, what a company might do differently if that trigger occurred.

contingency planning Counteracts Murphy's Law ("If anything can go wrong, it will") by contemplating what could go wrong in the future (trigger) and what the company would do differently were that to happen (contingency).

contingency plans Differ from contingencies only in adding operational details, like who is responsible, the budget and schedule, and who must keep the plan current over time.

criteria matrix A matrix for evaluating alternative bundles using 5–6 criteria important to the �irm. Uses a scoring system that enables the results of using each criterion to be added up at the end. Absolute ratings are not important, but relative ratings are. The winning bundle must have at least three points more than any other bundle, otherwise the winning bundle cannot be defended adequately.

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criteria Conditions used to evaluate alternative bundles derived from purposes to doing strategic planning and what the �irm perceives as "success." Must be classi�ied as either positively or negatively correlated.

criteria, negatively correlated So labeled because a bundle having less of something is "good" (opposites)—like riskiness or amount of investment required. Bundles using such a criterion are rated on a scale of 0 to –10, 0 being best.

criteria, positively correlated So labeled because a bundle having more of something is "good" (reinforcing)—like revenue growth or pro�itability. Bundles using such a criterion are rated on a scale of 0 to 10, 10 being best.

functional objectives Objectives that pertain only to a particular function, like increasing the number of salespeople (marketing/sales), increasing throughput or production ef�iciency (production), reducing purchasing costs through redesign (engineering), or reducing the weighted average cost of capital (�inance).

objective A quantitative target to be achieved within a speci�ied time frame.

operational objectives Objectives that are either subsumed by higher-order objectives (like reducing costs) or concerning, for example, security or systems or plant maintenance, none of which come under any "function."

partial objectives Objectives that cover part of some activity, like international sales vs. total sales, sales from new products vs. all products, sales to mass merchandisers vs. all retail channels.

triggers Should be external, speci�ic, and quantitative.

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Chapter 8

Operational and Budget Planning

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Learning Objectives

By the time you have completed this chapter, you should be able to do the following:

Understand the differences between operational and budget planning. Learn what this planning entails and why it must be done. Appreciate broader operational issues such as systems and systems thinking, information systems, building consensus, and the role of policies. Understand who is involved in operational planning and issues involved in getting it done before the start of the new �iscal year.

No strategy is useful unless it can be implemented, and no strategy can be implemented with any degree of success without doing operational and budget planning. This chapter explains how to do such planning, why it's important, and other important process issues.

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The world is made up of systems. Systems are a set of interacting or independent components forming an integrated whole. Corporations are complex social systems.

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8.1 Some Broad Operational Issues

Some aspects of operational planning are more encompassing than just planning programs, projects, and tasks for people to do. These include systems and systems thinking, management-information systems, ensuring participation in the operational-planning process, and the need for consensus in decision making. Not only are they more encompassing but also are determinants of effective strategy execution and should therefore be taken into account.

Systems and Systems Thinking

For the most part, our world is made up of systems—from the galactic solar system of which we are a part, to the human body, which has many subsystems of its own, such as the immune, reproductive, digestive, and cardiovascular systems. A system is a set of interacting or interdependent components forming an integrated whole. Corporations are complex social systems, consisting of individuals and units that work together (or not) to produce products or services for their customers that ensure their survival. Complex systems are self-regulating systems; that is, they are self-correcting through feedback. In other words, systems must be responsive to feedback such as the company's sales �igures, turnover, and other metrics in order to ensure their competitive edge and survival.

Moreover, the systems approach to understanding organizations addresses the relationship between the operation and its environment. It does so by examining the nature of the boundaries between the organization and the outside world. The more permeable are an organization's boundaries, the more the organization is able to place its �inger on the pulse of the competition, the marketplace, and industry trends. Boundaries may be created, for instance, by employer apathy toward employee development and small travel budgets; an organization that does not send employees to conferences and training, for instance, establishes a less permeable boundary between the organization and the industry. Systems with permeable boundaries are known as open systems and are preferred to closed systems for their greater functionality and innovativeness. Viewing an organization as an open system requires strategic thinkers to consider the complex interactions the system has with its environment, as well as the ways in which the different units within the organization (known as subsystems) import and export ideas, products, and other resources.

Additionally, systems are characterized by subsystem interdependence. For example, to market a product, the marketing department must interact with the research and development team to learn what it needs to know about the product, as well as the sales team to provide the sales strategy. In too many

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organizations, functional units act as if they were isolated from the others. For example, purchasing may order parts without knowledge of production rates and inventory levels. In both strategic and operational planning, systems managers must practice systems thinking, or the realization that affecting one part of the system affects other parts and furthermore that decisions must bene�it the whole company and not just a particular functional area to the detriment of others. The performance of any system, including a company, is thus never equal to the sum of the performance of its parts considered separately, but rather the product of their interactions (Ackoff, 1986).

In operational planning, plans should be coordinated between functional units of the organization, especially those between which there is an output-input relationship. The higher one's position in the organizational hierarchy, the more emphasis must be placed on having a system-wide perspective and maintaining awareness of the purposes and goals of the entire organization. Even at a basic operational level, tremendous coordination is needed. As Russell Ackoff (1986), one of the most in�luential management thinkers of our time, says, understanding how one unit's activities affect and are affected by other corporate activities is a bene�it that "cannot be realized unless the planning is comprehensive, coordinated, and participative" (pp. 202–203).

There is a class of system models called system dynamics, a detailed discussion of which is beyond the scope of this text. In simple terms, however, dynamic systems speci�ically take into account how an organization as a complex social system behaves and changes. They are used predictively and can be used to support strategic decisions.

Not many companies employ such models, which take time to develop, calibrate, and learn to use. More important than the actual models is the thinking they require in terms of feedback loops; that is, these are positive if self-reinforcing in a positive direction or negative if self-reinforcing the other way. For example, make more product, sell more product, get more money, make more product, and so on is a positive feedback loop. When positive and negative feedback loops interact, depending on the data and kind of model created, results are often counterintuitive.

Management-Information Systems (MIS)

Every day, at every level in the organization, decisions are made. Earlier chapters focused on strategic decisions, while this chapter and the next focus on operational decisions. Simple decisions require a person's knowledge and experience or, in some organizations, an established policy may govern decisions in routine situations. Startup �irms operate with the entrepreneur making all the decisions seemingly "off the cuff" as speed is of the essence and the entrepreneur knows what he or she is doing.

The more complex decisions become, the less one person or even a group is able to act independently. Should special promotions in the Southern United States be continued for another month? That would depend on how effective the promotions had been in increasing sales, and without those data the right decision could not be made. Can production throughput be increased by 20% next year? Without knowing the plant capacity, production costs, and sales forecasts, that question also couldn't be answered. And

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An information management system must be tailored to the needs of the decision makers it serves. The usefulness of the data depends on its timeliness, quality, completeness, and relevance.

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these are operational decisions. We already know that strategic decisions need a lot of data to be analyzed and processed before they are made, and even then no one will know if the right decision was made until a couple of years later when one can see how the company performed.

With the exception of startups, no company can afford to be without a management-information system (MIS). By de�inition, it must supply the basic information needed by managers for making decisions. The extent to which it succeeds in doing this determines the quality of decisions made (Mason & Hof�lander, 1972). Even before the advent of computers, there were information systems, usually in the form of reams of paper and information stored in people's minds.

A management information system is more than a stream of unprocessed data that people can access. If it is just this, it is a databank, not an MIS. An accounting system is an example of a databank. Likewise, �inancial statements display data—the user determines what meaning they have.

A management-information system must be tailored to the needs of the decision-makers it serves. Cloud computing has made management-information systems easy to create and maintain. These networked platforms make the MIS mobile, and data accessible from laptops, smartphones, and tablets. The usefulness of the information depends on its quality, timeliness, completeness, and relevance (Jones & George, 2007). What data are needed? In what form? Collected how often? Can anyone input data into the system? Can it be trusted? Can anyone use the system? In fact, it cannot be designed properly without �irst de�ining the kinds of decisions people make and the information that would best serve those decision-makers. Unfortunately, the reverse is often the case, where the MIS is built on data that can be easily collected and stored that people think will be useful for various decision-makers (Mason & Hof�lander, 1972).

Predictive information systems permit decision-makers to draw inferences and make predictions from the data. Asking the system "what if" questions given certain assumptions gets a response in the vein of "if that were done, then this is what can be expected to occur." The system cannot evaluate the outcome, just provides the information. A �inancial-planning-simulation model is a good example; other examples are not even computer-based but nonetheless function as a predictive information system, like a market-research group that analyzes data and answers decision- makers' questions (Mason & Hof�lander, 1972).

A more advanced type of information system is a decision-making system, which embodies the organization's criteria for choice and actually makes decisions on which the organization can rely and act. A linear-program model for optimizing distribution routes to minimize costs and use available trucks is a

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good example. So-called "action" information systems automatically make the correct decisions that are acted upon immediately, like process-control applications (Mason & Hof�lander, 1972). One example is measuring the �low of a �luid and regulating a valve to maintain the �low at a predetermined level—an automatic control system.

From this brief overview, it's easy to see why management-information systems are easier to develop for operational decisions than for strategic decision making. However, integrated systems are found in many companies today that support operations, such as manufacturing resource planning II (MRPII) and its successor, enterprise resource planning (ERP) systems.

MRPII systems, used in manufacturing companies evolved from the earlier material requirements planning (MRP), which uses forecasts from sales and marketing to determine demand for raw materials (Figure 8.1). MRP and MRPII systems draw on a master-production schedule, which is a breakdown of speci�ic plans for each product on a line. While MRP coordinates the purchase of raw-materials, MRPII generates a comprehensive production schedule that takes into consideration machine and labor capacity and coordinates production runs with the arrival of materials. An MRPII output is a �inal labor and machine schedule (Monk & Wagner, 2006).

Figure 8.1: Overview of MRP II

Source: Adapted from Gunasekaran et al. (2000).

ERP is a process that aims to consolidate a company's departments and operations into one computer system that serves each department's individual needs (see Figure 8.2). The goal of ERP is to create one software solution that serves to integrate the various moving parts of a company into a uni�ied whole, through which information can be shared, acted upon, and reviewed on a company-wide basis. ERP is mainly used in large organizations that can afford the considerable initial cost. An oft–cited example of an

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Federal Express uses a communication system that allows it to coordinate handling an average of 5.2 million packages and delivering them with nearly 60,000 vehicles.

JB Reed/Bloomberg via Getty Images

ERP software is customer-ordering and delivery. A customer's order transitions seamlessly from sales, the origin point of the deal, to inventory and warehousing, where the deal is packaged and delivered, to �inance, where invoicing, billing, and payments are handled, and on to manufacturing, where the purchased product can be replaced if necessary. Most of these operations, however, involve recording and updating data, not making decisions involving judgment or prediction.

In companies with such integrated information systems, operational planning can be facilitated using data from the system and updated in real time as conditions change. For example, integrated systems in supermarkets typically include supply-chain, inventory, and �inance/accounting management based on Figure 8.2, but not human- resource management (HRM) or customer-relationship management (CRM) systems. The emphasis is squarely on cost-control, which includes not stocking items not in demand and not being stocked out of any item in demand. Used for that limited but important purpose, the system is useful since margins are quite thin overall.

Larger companies �ind they cannot operate without some sort of sophisticated information system. Federal Express (FedEx) has communication systems that allow it to coordinate nearly 60,000 vehicles handling an average of 5.2 million packages a day. Its own controllers can override the �light plans of over 650 aircraft should bad weather or other emergencies arise. Its series of e-business tools allows customers to ship and track packages online either on its own or the company's website, create address books, generate custom reports, reduce internal warehousing and inventory-management costs, purchase goods from suppliers, and respond quickly to customer demands (Thompson, Gamble, & Strickland, 2004).

Information systems often extend beyond the company to suppliers, also. Walmart is without peer in terms of managing its supply chain. For example, its computers transmit daily sales to Wrangler, a supplier of blue jeans. From the information transmitted and "married" to Wrangler's own systems, the clothing manufacturer can ship speci�ic quantities of speci�ic sizes and colors to speci�ic stores from speci�ic warehouses—lowering logistics and inventory costs for both supplier and customer and leading to fewer stockouts (Thompson, Gamble, & Strickland, 2004).

Figure 8.2: Overview of ERP

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Source: Enterprise Resource Planning, from SoftWeb Solutions. Reprinted by permission.

Building Consensus

Operational planning is, in essence, a string of decisions that have to be made quickly at whatever level that planning is done. Unless there is consensus, that is, complete agreement, on a decision by a group of people, majority rule takes over. There's nothing intrinsically wrong with that, except that it introduces the possibility that a minority is not committed to the decision. So how can consensus be built when there is a difference of opinion?

If time allows, it pays to get more data on the alternatives to aid in the decision-making process; however, that is not always possible. It may be that the lack of consensus is due not just to different opinions, but also to different positions and political ploys. It is frequently easier to get managers and people to agree �irst that consensus is desirable (as well as possible) than it is to obtain it (Ackoff, 1986). The additional time and effort it takes to achieve consensus is more than compensated for by the surge in motivation after agreement has been reached.

Spotlight on Group Decision Support Systems

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Operational planning requires the kind of consensus and buy-in that challenges even the most competent and cooperative human communicators. One solution that many organizations use to streamline this process is the Group Decision Support System (GDSS). GDSS has a long history of development and applications in team-related tasks. Although the sophistication of the interface and the platforms for these technologies have improved over the years, the documented outcomes of GDSS implementation on decision making and group communication have remained stable over close to 30 years of research. Today, most GDSS are supported by a web-based platform that collects, organizes, and interprets the thoughts and reactions of individuals participating in a group decision-making effort (Roszkiewicz, 2007). GDSS replaces whiteboards and �lipcharts with a projected image, and can tabulate rankings and evaluations (offering anonymity when desired by meeting leaders and participants) that individuals input through their keyboards, laptops, tablets, smartphones, or specialized handheld "clickers" compatible with the system.

In many ways, the GDSS helps level the playing �ield among meeting participants—the shy individual hesitant to disagree or advocate for an alternative position; the dominant, outspoken opinion leader; the fault-�inder; the devil's advocate; and so forth. Although all these roles are important to group decision making, their individual communication styles often steer meetings down the wrong course and lead to outcomes that are unrelated to the best interest of the organization. These problems and other human-communication problems, such as groupthink, interpersonal con�lict, and retaliation/retribution may be magni�ied by the popularity of web conferencing, where participants contend with apprehension about using technology, distractions, and lowered personal cues, which research has shown to be important communication outcomes (Walther, Loh, & Granka, 2005).

GDSS introduces discipline and structure into discussions that can go wrong due to human differences— without turning human participants into androids. Participants have equal opportunities to express themselves in brainstorming sessions by posting comments and thoughts to the projection screen, and vote via automated polling. But meetings supported by GDSS are far from silent; the meeting facilitator is now freed from the tasks of recording notes and votes and can facilitate more meaningful conversation. Research indicates that variables such as trust, group synergy, participation, openness, truthfulness, listening, and perceptions of cooperation are enhanced in GDSS-supported group environments (Aiken & Martin, 1994).

Further, the accuracy and ef�iciency of decision making improve when GDSS is implemented (Poole & Holmes, 1995). As agreements and consensus are reached, the facilitator can encourage the group to continue the dialogue with the sophisticated graphs and other visuals that GDSS produces quickly and seamlessly as people participate. Some studies indicate that strategic decision-making time can be cut in half when GDSS is employed. GDSS-supported meetings yield results that are reliably defensible through the patterns identi�ied and statistics

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Wendy's Hamburgers' purchasing policy allows managers to buy locally produced fresh meat and produce from local producers

Associated Press/Terry Gilliam

compiled by the system. And, because GDSS also serves as a cloud repository for meeting communication, participants can retrieve the ideas later.

In summary, research indicates that the implementation of online GDSS decreases negative interpersonal communication dynamics and enhances the ef�icacy and quality of decision making and information gathering. GDSS has applications for a wide range of organizational decision-making tasks, but can play a critical role in accurate and ef�icient strategic and operational planning where consensus is important.

Questions for Critical Thinking and Engagement

1. You may already have experience with GDSS; even the clicker-based response systems used in some classrooms represent a form of this type of technology. If you have experience with some type of GDSS, what is your reaction to it? Describe how the technology was utilized by your group, and with what outcomes.

2. Describe a group decision-making experience you have had which might have been enhanced by the use of GDSS. Describe the challenges your group encountered, and explain how GDSS might have mitigated or prevented them.

3. Although there are many bene�its to GDSS implementation, these technologies are not a panacea. What barriers to their use might exist? What unintended problems might they introduce into the group decision-making process?

The Role of Policies

A policy is a company directive designed to guide the thinking, decisions, and actions of managers and their subordinates (Pearce & Robinson, 2005). Policies play several roles and serve several purposes. First, it saves higher management from wasting time making decisions that could be as well handled lower down the hierarchy. Second, it empowers people lower in the organization to make those decisions, often where they should be made. Third, they address issues that crop up frequently, so the amount of time saved is considerable. Finally, the decisions themselves could save the company money by, for example, limiting the kinds of services offered ("Sorry, sir, our policy is to ...").

In addition, policies

establish indirect control over independent action immediately; promote uniform handling of similar activities; ensure quicker decisions through using standardized answers; institutionalize basic aspects of organizational behavior;

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rather than from company-owned sources.

clarify what is expected and facilitate smooth execution of strategy; provide predetermined answers to routine problems (Pearce & Robinson, 2005).

Examples of policies include Wendy's purchasing policy that allows local store managers to buy fresh meat and produce locally rather than from company-owned sources. IBM has a strict marketing policy of not giving free IBM PCs to any person or organization. Packaging-materials giant Crown, Cork, & Seal's R&D policy is not to do any basic research. Polaroid Corporation has longstanding �inancial policies of never taking on any debt and never making an acquisition. Electronic Data Systems (EDS) for many years had a customer-service policy of empowering any employee to drop whatever that person was doing to answer a customer's call and take care of the problem, at least by passing it to a more quali�ied person for help (Pearce & Robinson, 2005).

Policies should be developed in written form, widely distributed throughout the company, and discussed at all meetings once �inalized. In written form, employees can constantly refer to them as an authoritative source until they become second nature. Finally, policies are as useful for what they don't cover as for what they do. For instance, many banks have policies that state that a loan will not be given to a customer who is already overextended.

Discussion Questions

1. Corporations and all organizations are systems; yet they themselves contain many systems. Is this possible? Explain.

2. Following on from (1), how might one manage the smaller systems to improve the functioning of the larger one?

3. How can "systems thinking" improve operational decision making? 4. If some management-information systems are simply databanks, are they really systems? Explain.

5. Many manufacturing companies have realized signi�icant savings from using MRPII or similar systems. What would you tell them about investing to upgrade those systems into ERP or more comprehensively integrated systems? How might the additional costs be justi�ied?

6. In a public company, why is the accounting-information system the only system that must be audited? Would it make sense to audit other parts of the system? Why or why not?

7. Can an information system provide a company with a competitive advantage? If so, how? 8. The point was made that consensus in decision making means total buy-in to the decision and smoother implementation. How might you tell the difference between real consensus and several people just "going along" with the majority?

9. If consensus is desirable to achieve, whatever happened to dissent? Isn't dissent also considered a spur to better decision making? Discuss.

10. A bank has a policy of not validating a customer's parking receipt unless a transaction has been completed. One day, a customer wanted to see a bank of�icer who happened to be out of the of�ice. When he asked to have his parking permit validated, the teller refused. What should the teller do—stick to the policy and risk losing a customer or make an exception?

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General overview of the operational issues implementing a new system. System dynamics explored. Also addresses building consensus, keeping frontline employees involved in the process.

Operational Ef�iciency Case Study: General Dynamics

8.2 Operational Planning

Operational planning involves preparing detailed organizational plans for the coming �iscal year. It includes programs, projects, and activities that the company is already doing as well as new ones required by any change in strategy. Detailed plans by organizational unit are part of operational plans. Finally, it includes coordinating all these activities to make sure they support stated strategies.

The iterative nature of the operational- planning process means that, in practice, draft versions of plans could go up and down the hierarchical chain more than twice (Figure 8.3). The model depicted also combines operational and budget planning into the same process, which is what happens in most companies; however, because the two are signi�icantly different, they shall be discussed separately.

At the conclusion of the strategic-planning process, the vice presidents of the different functions, in functionally organized companies, take the strategic decisions to their department and, with their key managers, draft functional objectives to be achieved by the end of the next �iscal year. In other types of organizations, key operational units get to do the same thing. For example, in marketing, examples of operational objectives (with the addition of the quantitative element) might be to improve salespersons' "hit rate" of converting sales visits into orders, increase advertising effectiveness, increase the effectiveness of each distribution channel, and improve the effectiveness of market research. Production objectives could be built around issues of throughput, quality, cost-reduction, and even outsourcing.

The directives then go to the actual operating units that must meet those objectives—the sales supervisors or actual sales force for a smaller company, the advertising department, market research, production or plant operations, quality control, and so on. Their challenge is to decide what must be done to meet that objective by the end of the �iscal year. This may mean continuing to do what they have already been doing, changing what they have been doing, or even changing the objective if it appears to be impossible. They must develop a series of tasks and specify who will be accountable to do what, when, and for how much, with a clear output and summary of their efforts.

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Operational planning concerns detailed organizational plans for the upcoming year, including programs, activities, and projects the company is already doing or will start to do in the future.

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The operating units then submit their draft plan to their managers, who coordinate with other plans in the functional area, and modify if necessary the objectives and budgets. These then go to top management, who reviews them with knowledge of other plans from the other functional areas. Because no �irst draft is ever perfect and usually goes over budget, the plans are sent back down for revision. In practice, the revision process takes place in a succession of meetings, at the end of which planning documents are revised. After one or two more iterations, top management approves and �inalizes the operational objectives, budgets, and tasks before the �iscal year begins. Only if they have changed signi�icantly might the board get involved again.

For smaller companies, project-management software exists to help in planning projects, especially ones with lots of smaller tasks that must be done both sequentially and in parallel. Project Evaluation and Review Technique (PERT) has been around for a long time, and is an operational tool useful in planning, scheduling, costing, coordinating, and controlling complex projects such as constructing buildings, assembling a machine, and R&D projects (Siegel, Shim, & Hartman, 1992). Its most valuable use is helping project managers determine when a project will be �inished and the likelihood that it will be completed on time. Each task is mapped on a network diagram clarifying which tasks must be completed before it can be completed, and which other tasks require its completion �irst. With this information, PERT calculates and identi�ies a critical path through the network which is the path that takes the longest time to complete (Siegel, Shim, & Hartman, 1992). To avoid missing a deadline, changes could be made, and PERT would keep recalculating a new critical path until the project could be �inished on time.

Figure 8.3: Operational-planning process

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After detailed departmental plans are approved, an incentive and rewards program will help motivate employees to achieve operational objectives.

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Online project-management solutions are widely available. Most web-based project-management tools offer the same basic options, including task-allocation and tracking, resource-allocation and management, risk management, scheduling timelines and deadlines, document archives, and communication. Online project-management solutions offer users transparent, easy access to �iles and communications, which in turn enables improved teamwork, enhanced time-management, and improved task ef�iciency.

Reward Systems

One more thing that must be done and that can't be done until the detailed departmental plans are �inally approved is to put in place a reward system that will be sure to motivate the achievement of operational, and hence strategic, objectives. This is a system of rewards that incentivizes people to excel and achieve beyond expectations, often mis-termed a "reward and incentive system."

Rewards are primarily (but not exclusively) �inancial and vary by hierarchical position. The following are typical, although speci�ic company experiences can vary:

For CEOs and top executives, rewards are typically tied to companywide objectives such as growth in revenues and earnings, pro�itability ratios such as NPM, ROA, and ROE, and stock-price performance. They may include performance bonuses, stock options, increases in base pay, pro�it-sharing, and perks such as mortgage loans, use of a private jet or �irst- class travel, contribution to retirement plans, and so forth. Some incentives such as restricted stock may include provisions called golden handcuffs because they tie the executive to the company by

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prohibiting the sale of shares for a speci�ied time period; if the executive leaves before that period is up, the shares are forfeited (Pearce & Robinson, 2005). The rewards given to middle managers are typically tied to functional or operational objectives such as sales of product lines or in a particular region, quality, throughput, cost savings, new product development, weighted average cost of capital, and myriad others. These include performance bonuses, promotions, raises, pro�it sharing, and possibly stock options. Employees' and supervisors' rewards are generally tied to contributing to the achievement of functional or operational objectives as team players, and may include some combination of pro�it sharing, bonuses for exceptional and timely work, and raises.

Other rewards, while non�inancial, are nonetheless important. Intangible rewards range from frequent words of praise (or constructive criticism), to special recognition at company gatherings or in its newsletter, increased autonomy, and more challenging assignments.

The �inancial rewards are based on accurate measurements of company performance that, in turn, typically depend on a reliable and up-to-date MIS. Some companies pay out rewards quarterly, but most do so annually. In creating the system, executives have to guard against the temptation of functional departments to set their functional and operational objectives too low in order to increase their rewards for achieving those objectives. Some experts maintain that companies should never offer a promotion as a reward for two reasons: It destroys the company's carefully constructed compensation system, and promotions should be given only to individuals that are ready to assume the greater responsibility of the higher position.

The following is a useful checklist for designing an incentive-compensation (reward) system:

The performance payoff should be signi�icant—perhaps 10%–12% of base pay, while 20% will command the attention of the potential recipient. Incentives should extend to all workers, not just the top executives. The reward system should be administered with scrupulous care and fairness. All individuals should know what the reward system is at the beginning of the year or else they won't be appropriately motivated. Incentives and the performance targets on which they are based should not be impossible to achieve. Payoffs should occur as soon as possible after results have been acknowledged. Con�ine payoffs only to results achieved. Payoffs should not be made for behaviors such as putting in long hours for a long period, or even going the extra mile but coming up short. Once an exception is made for one person, they will be made for more, and the reward system will quickly get out of hand (Thompson, Gamble, & Strickland, 2004).

Payoffs should never be made when the company's pro�its are below a level to make them possible or for average or below-average performance.

Discussion Questions

1. Some organizations (like some universities, for example) are content to keep doing what they have always done. In fact, the strategy and companywide objectives eventually

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comprise their operational plans added together. How would you persuade such organizations to do planning the other way round?

2. How does an organization speci�ically bene�it from doing operational planning? (Contrast with an organization that might do no operational planning.)

3. Some smaller organizations operate "on the edge" and are forever "putting out �ires." Operational planning isn't even in their lexicon. If you had an opportunity to talk to the president of such a company, what would you say? How might the conversation go?

4. Restricted stock or "golden handcuff" awards designed to keep executives from leaving also have the effect of fostering risk-averse decision making because of the downside risk borne by the affected executives. Can you see any way of countering this effect?

5. Restricted-stock deals always bene�it executives that have them whether or not the �irm performs well. Does this way of discouraging an executive from leaving make sense to you? Why or why not?

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In corporations, the �inance department begins the process of estimating the company's �inancial resources and arriving at a budget that upper management can implement.

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8.3 Budget Planning

Budget planning is the process of matching available organizational �inancial resources (cash on hand, a line of credit or loan, and any investment) with what the organization needs to spend to implement its strategies. It includes revising requests for money from organizational units until their requests and available resources match. What each organizational unit is �inally approved to spend constitutes its budget.

The �inance department begins the process by coming up with a comfortable estimate of �inancial resources that is the sum of what the company has and could obtain (through additional borrowing or equity investment). Given knowledge of each department's current spending and the spending implied by the new strategic initiatives, it further arrives at a tentative budget total for each department or cost/pro�it center.

That budget �igure is given to each departmental vice president, who makes it available to departmental managers as they do their planning for the year. When they come up with their initial plan to meet the functional objectives, they itemize every dollar it might cost to do so. If their estimate equals or comes in under the budget �igure, there is no problem. If their estimate exceeds the budget �igure, they try to adjust as much as they can, but more often will say that the job can't be done for the budgeted amount.

As Figure 8.3 shows, the department may get their plans back from an upper-management review with a mandate to reduce spending in some way to match the budget. Either departmental members become creative and �ind a way to deliver the mandated reductions or they respond that the only way to get the two numbers to match is to modify the objectives. Of course, the latter reply must include their reasoning for the position, and their supervisor then becomes their advocate.

The revised plans are resubmitted where the CEO and top management have the bene�it of looking at all the departmental plans and budgets. At this point, they can be persuaded that implementing the strategy will indeed take more money than they thought and see whether they can raise the additional capital. If they can, then higher budgets are approved that match the estimated spending from all departments, and the budget-planning process ends. If they can't, then some or all departments are told that they must meet their objectives with the available budget. For example, if adding 10 salespeople was in the marketing plan to help marketing reach its sales objectives, then it might have to get the same objective accomplished with fewer salespeople. The process ends when departmental budgets �inally match available �inancial resources together with their commitment to achieve their functional objectives.

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Normally, operational and budget planning should be enough to enable each organizational unit and, by extension, everyone in the organization, to know what they have to do and accomplish during the coming �iscal year. However, some organizations also engage in pro�it planning, which is the process of arriving at an estimate, month by month, of the pro�it (NIBT) the whole organization intends to achieve. For each month, the total company budget is subtracted from estimated revenues; the sum of the monthly pro�its equals the overall NIBT objective for the coming year. Pro�it planning is not widely used and is considered unnecessary by some strategic planners.

Reducing Costs

The budget-planning process can also be thought of as a process for reducing costs. Not only does it ensure that spending will be covered by real �inancial resources but also is a forcing function for reducing costs. It's human nature to take the easy route or continue doing what you have always done. That will happen unless someone requires it to be done for less. The very requirement forces the consideration of alternatives.

Entrepreneurs are often faced with this problem when writing their business plan and trying to seek startup capital. Their �irst pass at a cash-�low projection often shows that the business might not make enough money, or even make any money at all, which is certainly not what the entrepreneurs or potential investors want to hear. All the assumptions must be reexamined and, with more research and thought, revised �igures are produced of both the revenue model and the expenses. If the revised business plan looks better but still doesn't come close to achieving the 20%–40% ROI required by typical investors, at this point the entrepreneur considers any and all alternatives to achieving the targeted revenues for less cost. More attractive margins, at least on paper, won't be possible until he or she is forced to consider lower-cost alternatives. Having had to put so much thought into the revised estimates also makes defending them easier.

For this reason, top management's �irst instinct in this process is to force functional and operational units to try to reduce costs. The budget-planning process is so valuable because it forces people to try to lower costs, which wouldn't happen any other way.

Discussion Questions

1. What risk is the organization running when it approves expenses that exceed available �inancial resources?

2. Departments of a city or other public entity are well known for trying to spend their entire budget allocations so that they will be funded again the following year at least at the same level. If they don't, they might be viewed as not "needing" their budget allocation and so be allocated a lesser amount. What is wrong with this process?

3. What do you think might happen when, midway through the year, expected �inancial resources fail to appear (for example, when some funding from a government agency is slashed)? What options might an organization in this position have?

4. Whose responsibility is it in the organization to reduce costs?

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5. How does an individual or departmental unit know that something that person or group is doing can, indeed, be done at lower cost?

6. Following on from (5), if there is a way of knowing, why don't all corporations avail themselves of it all the time?

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Involving all employees in the organization makes it easier to avoid things that block new initiatives or are no longer useful in helping the company be more ef�icient and productive.

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8.4 Participation in Operational Planning

Just as it's a mistake to do strategic planning only with the participation of the top-management group, so also is it a mistake to do operational planning with just middle managers. To be sure, middle managers bear the brunt of the responsibility for operational planning because they will be called upon later in the year to implement the plans. But make no mistake, everyone in the company is and ought to be involved, not only in operational planning but also in carrying out the plans.

By virtue of their size, small companies have no option but to involve everyone. Yet exceptions abound. The production manager for a small garment manufacturer complained of being left out of the planning process entirely. The company was being squeezed by its large customers who were forcing the price down to maintain their own pro�itability. The customers used the approach that if this �irm could not supply at the desired price there would be lots of other suppliers that would. The president and co-owner of the company was the one who made the bids to these large clients for future business. Time and again, he bid at a price point that was below cost, because he was convinced that he wouldn't get the business otherwise, and he never checked �irst with the production manager who could have advised him of current costs and

margins. The result was that it put enormous additional pressure on reducing manufacturing costs while margins all but eroded. This scenario was repeated many times, and this was a management team of only two people.

In large companies, it is all too common not to involve the rank and �ile in operational planning. In many companies, information is only divulged or passed down on a "need to know" basis, much as in the military or police departments. People at the bottom just do what they are told; it's part of the job.

As the discussion of organizational change in Section 2.10 made clear, however, smooth and enthusiastic implementation of any task is not possible unless those who are to do the work are involved in the planning. This is much easier said than done. It depends to a large extent on the kind of culture that exists in the company. Cultures that are command-and-control or bureaucratic are by their very nature not inclined to involve everyone as they should, mainly because, as be�its those cultures, they have been able to do what they do without such involvement. Open, adaptive, innovative, nimble organizational cultures as discussed in Section 2.9 would not be able to progress without involving everyone and seeking their input, especially in planning and suggesting new ideas. This culture of openness requires the implementation of participative leader-member behavior, which encourages supportive-relationship behavior and the open sharing of ideas during decision-making and strategic and operational planning.

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Another reason to involve everyone in the organization is to make it easier to get people to stop doing things that either get in the way of new initiatives or are no longer useful in helping the company be more ef�icient and productive. Change involves "forgetting" about and dropping old habits if new ones are to take their place. Change will stall or not take hold to the extent that people cannot or won't forget what they used to do. It is therefore wise to involve everyone; make sure they understand what they have to do and why; how their job, role, and expectations are changing; how and why they will bene�it from the changes; and have a mechanism such as muscle memory for repeating the new imperatives often until force of habit takes over, and the changes and improvements become second nature.

Discussion Questions

1. The ease with which everyone in the organization can be involved depends on its culture. Might involving everyone actually change the culture? Comment.

2. This section advocated involving everyone. Surely not everyone? Would this include the people loading boxes in the shipping dock? The janitors? The mailroom clerk? The secretaries? Comment.

3. Following on from (2), if you don't agree that everyone should be involved, where might your cutoff be? Give reasons for your answer.

4. Following on from (3), if you advocate a cutoff, explain why that might be superior to involving everyone.

5. "Muscle memory" is unquestionably valuable when a new habit must be learned. But how can one get rid of an old habit that has also been engrained in the organization's "muscles"?

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Budget preparation should take two to four weeks, depending on the size of the company.

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8.5 Getting It Done in Time The operational-planning process should be timed so that by the time the new �iscal year starts, all the strategic decisions, operational plans, and budgets have been completed. Final approval of the plans and budgets should be completed within a couple of weeks of the start of the �iscal year. Bear in mind that both strategic and operational planning take place in addition to people's regular daily activities. But how long should the strategic- and operational-planning processes take?

There is no simple answer. Consider four scenarios—among many—beginning with the best or ideal situation:

The company is used to doing strategic planning, and much of the required research is done throughout the year. It is performing well and is used to transforming strategic decisions into operational plans and can get those plans approved in one iteration. The two processes together, especially for small to mid-size companies, take no more than two months. Like the scenario just described, but for a well-performing larger company with more divisions and vertical layers, coordinating operational and budget planning takes longer but still gets done within 2-1/2 months. For a company that is not performing very well, has �inancial problems, but has some experience with strategic and operational planning. This company is constantly putting out �ires, lurching from crisis to crisis; strategic and operational planning take back seats, if done at all. If anything is done, it will probably be done badly, with changes continuing to be made after "approvals" have been given. The time frame needed for planning is impossible to estimate.

There are companies, of course, that are run autocratically, with the CEO telling everybody what to do and being the only one to approve anything. In this situation, the combined processes shouldn't take long at all, perhaps two to four weeks. This was not included as a scenario in the preceding list because, although it might take the least amount of time, it doesn't qualify as a "best" or "ideal" scenario. However, it often works in that kind of organization.

Sometimes, the process takes longer than anticipated, and the deadline of the new �iscal year is missed. What usually happens is that the full operational-planning process is aborted, and whatever stage it has reached is hurriedly approved. After all, the start of the new �iscal year can't be changed. One way around this dilemma is to shorten the approval cycle. Instead of going all the way up the hierarchy for every approval cycle, as shown in Figure 8.3, plans should only go to a higher level when they are re�ined much further. This will shorten the operational- planning cycle.

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For an organization that has not previously done operational planning, two months is a reasonable allowance for the �irst time. In each successive year, familiarity with the process and everyone's ability to produce better plans should enable the company to be more accurate in scheduling the process without any drop in quality. It is best to start strategic planning as late in the �iscal year as possible while leaving enough time for decent operational and budget planning. The time frame of three months, mentioned earlier, is a whole quarter and really, too long to devote to planning, mainly because conditions will have changed during such a long planning process. For a large organization that has many layers and planning units, operational planning does take more time than anyone would like.

Should a company ever abandon the operational-planning process if time is running out? The short answer is no. As long as management approves what should be allocated and achieved during the �irst month of the �iscal year, there will be that additional month to �inish the process properly. In the next chapter we shall consider some tools that large organizations can use to speed up both strategic and operational planning and keep the "intrusion" of planning in people's busy lives to a minimum.

Discussion Questions

1. Suggest one way in which operational and budget planning could suffer if the process were rushed.

2. Imagine that the operational-planning process was well into its third month and already extant conditions had changed. What should the company do? For example, should plans at the lowest levels be changed �irst or only those plans most affected by the changed conditions?

3. Following from (2), should just the plans be changed or budgets as well? 4. With more experience in operational and budget planning, it should be possible to get it done in less time each year. Exactly how important is getting it done quicker?

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Summary

This chapter explained the context and importance of operational and budget planning. Operational planning focuses on planning the projects, programs, tasks, and activities the company needs to implement its strategies, and includes both what it already does as well as additional programs it must do the next year. Budget planning focuses on getting all operating units to spend what they need to spend to do what they must do without exceeding the total �inancial resources that the company has or may have at its disposal for the coming year. As plans take shape for each operational or functional unit, they inevitably undergo changes until their estimated costs match the estimated �inancial resources allocated to that operational unit.

Operational planning is carried out more effectively when everyone involved in the process understands that everything is part of a larger system, that anything they do affects other parts of the system, and vice versa. That understanding, called systems thinking, is critical in operational planning. In the same vein, having access to the right information for management decision making and action is vital—companies couldn't operate without such information. Many such systems are nothing more than databanks, forcing the user to make sense of and interpret the data. Transforming them into systems such as MRP II (manufacturing resource planning II) for manufacturing companies or the more encompassing ERP (enterprise resource planning) make such data far more useful, but they require considerable investment, not only in capital, but also in transforming the way people work and learn.

Operational decisions should be based on consensus at each decision-making level, which means complete agreement. Getting a majority vote, for example, means there is a minority that disagrees with the decision, which in turn means that implementation will be that much more dif�icult.

The chapter also discussed the role of policies in an organization. These are in effect rules that guide behavior in often-encountered situations. That way, in such situations people will make the correct decision all the time. Having the policies in writing allows people to refer to them at any time and gives them the force of law (which, in the company, they are). Policies can cover, for example, how customers and the environment and suppliers are treated, as well as mundane subjects like what can and can't be included in an expense report. Operational planning must take into account the company's current policies.

Operational planning itself is the process by which objectives are translated into projects, programs, tasks, and activities that get progressively more detailed the further down in the organization the process goes. Budget planning is done at the same time. Operational units must develop their plans while staying within the budget allocated to each one, requiring �irst drafts to undergo several revisions in order to balance these two requirements and as they go up and down the organizational hierarchy. One of the unheralded bene�its of budget planning is the creativity unleashed in order to reduce costs.

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Finally, everyone in the company should be involved in operational and budget planning, not just the managers and supervisors. When this happens, new ideas have a chance to surface, consensus is more likely, and implementation goes more smoothly. Operational and budget planning have to be done fairly quickly just before the start of the new �iscal year. Doing this is dif�icult without compromising the process and because involvement is an additional burden on top of day-to-day responsibilities. The risk with taking up to three months to do operational and budget planning is that conditions will change during the process, requiring plans to be further changed as a result. Experience helps, as does revising plans �irst before submitting them up the ladder for approval.

Concept Check

Key Terms

action information systems Automatically make (the right) decisions that are acted upon immediately.

budget planning The process of matching available organizational �inancial resources (cash on hand, a line of credit or loan, and any investment) with what the organization needs to spend to implement its chosen strategies. It includes revising requests for money from organizational units until their requests and available resources match. What each organizational unit is �inally approved to spend constitutes its budget.

consensus Complete agreement.

critical path The path through the network that takes the longest time to complete.

databank A stream of unprocessed data that people can access.

decision-making system Embodies the organization's criteria for choice and actually makes decisions on which the organization can rely and act.

ERP (enterprise resource planning) A process that aims to consolidate a company's departments and operations into one computer system that serves each department’s individual needs.

management-information system (MIS) A system that must supply the basic information needed by managers for making decisions.

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manufacturing resource planning II (MRPII) A comprehensive production schedule that takes into consideration machine and labor capacity and coordinates production runs with the arrival of materials. An MRPII output is a �inal labor and machine schedule. Information about production costs, including machine time, labor time, materials used, and �inal production numbers, is delivered to accounting and �inance via the MRPII system.

muscle memory Repeating something often enough so that muscles learn what needs to be done and it becomes second nature (they can perform the activity without conscious thought). The concept is applicable to organizations.

operational planning Involves preparing detailed organizational plans for the coming �iscal year. It includes programs, projects, and activities that the company is already doing as well as new ones required by any change in strategy. It includes detailed plans by organizational unit. Finally, it includes coordinating all these activities to make sure they support stated strategies.

policy A company directive designed to guide the thinking, decisions, and actions of managers and their subordinates.

predictive information systems Permit decision-makers to draw inferences and make predictions from the data.

PERT (project evaluation and review technique) An operational tool useful in planning, scheduling, costing, coordinating, and controlling complex projects.

reward system A system of rewards that incentivizes people to excel and achieve beyond stated objectives.

system A set of interacting or interdependent components forming an integrated whole.

systems thinking The realization that affecting one part of the system affects other parts and that what is done must bene�it the whole and not just a particular part at the expense of other parts.

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Chapter 9

Implementation

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Learning Objectives

By the time you have completed this chapter, you should be able to do the following:

Recognize good operational plans and distinguish them from weak ones. Appreciate the value of tracking progress on all operational plans. Appreciate the value of face-to-face meetings with middle managers to discuss negative variances. Know why emergent strategies occur and how they might affect a company's current strategy. Manage, improve, and evaluate an existing strategic-planning process. Understand the "strategy paradox," showing how a company's strength in execution can be simultaneously its Achilles' heel.

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Implementing a strategy in the real world isn't a leisurely swim across a calm pond on a sunny day, but rather like crossing from one bank of a raging river to the other, encountering hidden eddies, fog, driving rain, lightning, and riptides along the way. While not impossible to reach the other bank (the goal), the task often becomes dif�icult and one of overcoming obstacles and making constant adjustments without losing focus or sight of the goal. Implementation is like that. Even the most brilliant strategy is worthless if it cannot be implemented.

This chapter focuses on strategy execution and its dif�iculties, and part of it is devoted to assessing, improving, and managing the strategic-planning process itself.

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Research and development is essential to a company's ability to compete. It requires new initiatives to keep up with technology and develop new products.

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9.1 Plans by Organizational Unit

When an organizational unit gets its plans and budget approved by the level it reports to and on upward, exactly what is it that gets approved? An operational plan is a document that speci�ies the projects or tasks that must be accomplished to achieve particular operational objectives. Details speci�ied in operational plans include the names of those who will be involved and the individual responsible for each one, what equipment will be needed, when each will start and end, and the estimated costs for each one. Given the level of detail required it should come as no surprise that an operational plan can run to many pages if a large number of projects must be detailed, such as manufacturing hundreds of product lines.

It takes contributions from everyone who will be involved in that unit's operations to create such plans. They will make sure that continuing current operations are included in the plans, which is easily done. What adds a level of complexity and dif�iculty is incorporating additional tasks demanded by a change in strategy.

Consider the following scenarios, which illustrate the dif�iculty in creating operational plans when asked to do more than simply repeating what was done the previous year:

Production. A speci�ic higher level of throughput is required to satisfy increased demand, which will soon require capacity expansion. Can the increased capacity requirement be met by adding additional shifts, physically expanding the size of the plant, or building a new plant? Can some of the additional production be outsourced? How many new machines must be added and of what kind? How many new people must be hired and trained, and how long might all of this take? Also, consider the scenario where a whole new product line has been designed and now has to be produced in addition to producing all the other product lines. How can this best be accomplished? In both scenarios, production capacity has to be increased. Research & Development. Technology advances are affecting the company's ability to compete. This requires new initiatives to keep up with technology as well as continue with applied research associated with developing new products. This could mean expanding staff and facilities or forging strategic alliances with particular universities that have the requisite capabilities to help the company. Another option might be �inding a company with the needed technology and licensing it. Yet another possibility might be to start a conversation with top management about possibly acquiring a small high-tech company with these capabilities and patents. What is the best way to do this? Marketing. The decision to expand from being a regional consumer-products company (B2C) to a national business presents a host of operational challenges. Should the company continue to handle its own distribution or �ind a national distributor? How many new retail outlets would it

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need to �ind to reach potential customers? Would it need to lease additional distribution centers or warehouses? Which speci�ic parts of the "rest of the country" should be targeted �irst, second, and so on until the company covers all of its targeted areas? What advertising media would be most appropriate, and does going national require television advertising? Should more emphasis be placed on online rather than brickand- mortar sales? How can this sales objective be realized most expediently? Finance. Consider two scenarios: In the �irst, the company has decided to invest in either a new integrated information system or a signi�icant development of the existing one. How many more software engineers and programmers will be required? Could part of the new system be licensed and then customized? Without intimate knowledge of the completed system, how can building it be planned for? Should a consulting �irm be engaged with the requisite experience? Will IT staff need to be hired and trained for the other functions? In the second scenario the company's cash needs for the coming year exceed what it can normally access. How can it raise more cash? Should receivables be factored? Should a larger line of credit be negotiated? Should payables be delayed? If appropriate, should some customers be asked to prepay? Is there a way to maintain negative working capital to free up the most cash?

Ideally, operating units will have been working on these kinds of changes over a much longer period, using the formal operational-planning period at the end of the �iscal year to �inalize its plans and match available resources before the new �iscal year begins. And its plans must be done in some sort of networked way or using Gantt charts to show which projects or tasks can be done independently of others and which are integral to a particular sequence.

A Gantt chart is a graphic depiction of a project schedule. Gantt charts show the beginning and end dates of each project component. Some charts also illustrate the dependency relationships between component activities, or the dependency of one activity upon the completion of another. Gantt charts may be used to provide up-to-date schedule status using percent-complete shadings (Figure 9.1). Gantt charts can also be combined with PERT software to produce a critical path of projects.

When that is done, the total plans for a particular unit should be summarized according to the review period set by the company. Typically this is each month. The review cannot begin until all the requisite data have been collected and organized, which usually takes a week after the end of the month. Actual results are then compared to plan (expected performance and budget) along the following dimensions:

For each project completed during the period, data show whether the objective was achieved, current and total costs, and whether the deadline was met. For each ongoing project, data show progress toward achieving the objective, current and cumulative costs, and a probability that the deadline will be met.

The project leader initially does such a review, with copies given to middle managers on up to functional heads. If the data are input into a computer system, then those managers will all have access to monthly summaries.

Figure 9.1: Example of a Gantt chart

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Discussion Questions

1. Clearly, it's much tougher to translate a change in strategy into operational plans than it is to continue with an established strategy. In your opinion, is it acceptable to submit a plan that's full of uncertainties? Explain your point of view.

2. Can you think of anything else that should be part of a good operational plan? 3. Now that you know more about what is involved in coming up with a good operational plan, do you believe that strategic planning should be done solely by top management?

4. To what extent, if any, does strategic-planning experience help an operational manager develop operational plans to support the company's strategies?

5. To what extent should managers be aware of what's going on in other parts (e.g., functions) of the company while preparing operational plans?

6. If quality or effectiveness of a project is important, how can these be incorporated into an operational plan? Or should a separate project be developed to assess those attributes, requiring additional expenditures?

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The manager's job is to collect and organize current project data by project.

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9.2 Tracking Performance Using Metrics

Two old adages underscore why the use of metrics is so vital in organizations:

"What gets measured gets managed." "You can't improve what you can't measure."

By way of illustration, consider the true example of a nonpro�it organization that provided educational workshops for high-school students in an effort to reduce the teen crime rate in the area around the city in which it operated. The directors were asked how they knew how the organization was performing and what information was reported to its sponsors periodically. They said they kept records of student attendance at every workshop they gave, the number of workshops each week and at which school, who gave the workshops, and the content of each workshop. In other words, what they said they were going to do and what they did was what was measured and reported. But how effective were the workshops? What was the purpose for developing and giving them? Did the teen crime rate decline over the couple of years that this organization was giving its workshops? And even if they did—which no one knew—was it because of the workshops?

In this example, the donor was as much at fault as the people in the organization for not insisting on better measures and better data. Clearly, like many other organizations, this one measured what is easy to measure, not what needed to be measured. Unfortunately, those running the programs didn't know, or had never considered, the difference. There are many ways to measure performance, but the more systematic and reliable the method is, the more credible the data will be in supporting strategic plans and their implementation.

Organizations mistakenly measure the results of their activities or effort, not progress toward achieving objectives. Although impact measurement is important, process evaluation is critical to strategic management. Evaluating progress at numerous stages throughout implementation allows the manager and his or her team to make adjustments and modi�ications to the strategy.

Operational objectives, discussed in Chapter 8, must be set carefully. Making good progress toward objectives that were set too low is of little value and won't implement the strategy properly. Setting them too high de-motivates the workforce and is just as bad. So let us assume that

"stretch" objectives—set at just the right level but that demand a little more from everyone to achieve— have been set all the way down the line, plans were devised for every unit that matched its budget allocations, and that it was these plans that are now being carried out by everyone in the organization.

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How does top management monitor whether everything is "on track" or "on plan?"

The manager's job is to collect and organize current project data for the review period, by project, in their respective areas of responsibility. The example shown in Figure 9.1 is a step in the right direction, but has to be summarized for the month. For example, the �igure shows an almost instantaneous picture for daily monitoring, a time frame and level of detail required only by the people actually doing the work. From such daily reports and the status of projects at the end of the month, a manager would need to extract and summarize information on each major project, being careful to note which projects were on schedule and under budget and which weren't and by how much. The latter could constitute a separate "exception" report of negative variances (discussed in more detail later), which are projects that have slipped their schedule or are over budget, together with additional information on how much extra it might cost to get all of them back to meeting their deadline.

The Budget as a Control System

Recall the vignette about Paci�ica Corporation recounted in a box in Section 2.9. As part of the rapid change in its culture, �ive original managers, including the CFO, were replaced. The CFO was let go when it was discovered he had no idea how to budget. For six entire months, he had fooled the CEO into believing that everything was on track. Whenever he was asked if expenses were "on budget," the CFO would say "Yes," and people believed him. After about six months, with costs clearly skyrocketing, the CFO was asked again if expenses were on track with the original budget. The real answer was no: Every month, as costs had outpaced the set budget, the CFO had simply raised the budget to match expenses. Rather than taking action to decrease costs, he had consistently told everyone that things were "on budget."

The budget is a control system in that it allows management to compare actual performance to a standard, measure the variance, take action to reduce the variance, reset or update, and test again. Another example of a control system is a packaging machine that automatically �ills boxes with a precise weight of cereal and signals the operator the moment the �illed weight exceeds or falls short by a preset small amount, enabling immediate adjustment of the machine. In the case of a budget as control system, action is taken only if expenses exceed the budget. Further, cumulative expenses are compared to cumulative budgets so that an operational unit that has overspent one month can "make up" and spend less than its budget in the following month (Figure 9.2).

One of the hallmarks of a good control system is that corrective action is taken as soon as it is found to be needed. Why wait until the end of the year to discover that you have gone over budget? At the other end of the scale, should you check every week? That makes no sense, either. Monthly checking is about right, and most information systems can provide such information monthly, either as needed onscreen or in a customized monthly report sent to all operational managers.

In large organizations that have federal contracts, for example, government auditors closely examine expense reports, time sheets, and invoices related to programs. So, for example, when a contractor requests increased funding, budget controls are in place to quickly advise regulators as to the legitimacy of

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the request. In this way, the government can determine when increased expenses are justi�ied, or when to tell its contractors to cut costs.

Addressing Negative Variances

Managers in well-run corporations make a point of meeting with their direct reports regularly to go over progress and discuss any problems. One focus of the meeting should be variances and any exception reports that detail differences between plans or standards and actual performance. A negative variance is an instance where a project's progress is delayed and could miss a deadline, or where its budget has been exceeded, or where performance comes up short of a quantitative standard or expectation.

Figure 9.2: The budget as control system

What can be accomplished in such a meeting between a manager and a direct report? First, the manager should learn about the particular circumstances surrounding negative variances of some projects, what might have caused the delays or budget overruns, and which other projects might be in jeopardy as a result. They should ask questions and listen carefully to the responses. Both the manager and direct report should note questions to which an answer could not be provided because the direct report didn't have the necessary information.

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Well-run corporations have their manager's report in every month to track progress and discuss any problems that have arisen.

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Second, the manager and direct report should discuss potential solutions to the negative variances. Some projects can be pulled back on track through either the direct report getting project personnel to acknowledge problems and solve them, helping them to �ind solutions, and trying to remove obstacles that might be delaying progress. Also, if budgets are overrun, a new lower budget that compensates for the overrun must be communicated to project personnel. The manager should focus on projects where there is a direct relationship between schedule and budget. That is, where speeding them up will cost more, and conversely, where reducing the budget results in unacceptable delays. It is in precisely such situations that any critical-path software becomes invaluable, because it lets a project leader or supervisor try out different alternatives until both parameters (project time and budget) meet expectations.

Third, the manager should insist that the direct report �ile—within the next couple of days—a revised plan containing the points that were discussed that will bring projects and budgets back in line.

Finally, meetings represent an opportunity for the manager to strengthen a relationship with the direct report. In most cases, the meeting is just between the two of them (although inviting other project managers who are in a better position to provide explanations is also common). What is the direct report most worried about? Is the communication between them as "open" as it needs to be? What's really going on? Taking the time to delve a little deeper and offer guidance and counseling is often well worth the time.

Be mindful of a couple of potential red �lags: Some managers don't like hearing or dealing with bad news and might even tell their reports they don't want to hear it. So if a supervisor is repeatedly told that "everything is okay," he or she might well suspect that it's not. The manager will have to dig deeper and even go to chat informally with the direct report's colleagues and team members. A manager also needs to be sensitive to whether a direct report is losing control of the team or his or her responsibilities. If the employee feels overwhelmed and relatively powerless to stem the tide, a real problem exists.

This kind of face-to-face meeting with a direct report goes on up and down the hierarchy. Typically, a manager might have a half dozen to a dozen direct reports, some fewer, some more. A manager should schedule all meetings with direct reports over the course of a day or two before meeting with his or her own supervisor, taking on the role of "direct report."

If this description of the organization conveys the idea that this is one massive control system, that is exactly the intent. During execution or implementation of a strategy, doing the work and controlling the work—its quality, timeliness, and adherence to a budget—is vital. And in the spirit of a good control system, actual performance is compared to a standard, the variance noted (especially negative variance), solutions developed, and a correction applied as soon as possible. Data collected about performance,

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especially as part of an information system, are essential, but a control system needs more; that's why the face-to-face meetings are imperative and why everyone in the hierarchy must follow through and put the corrections into effect to improve performance the following month.

This description also gives the impression that managers take part in many meetings, and that too is by design. With so many meetings to prepare for and attend, when do managers get time to do their real work? Perhaps this is the fallacy. Recall the de�inition of a manager as "someone who gets work done through other people." The time spent in meetings is the work. Whether that time is wasted or not is another issue and goes directly to whether the person conducting the meeting is an effective manager. Managing well is dif�icult, challenging, time-consuming, but ultimately very satisfying. The job gets done on time and within budget, and your direct reports grow and develop into productive, congenial team members.

Discussion Questions

1. It's easy to measure what training was given, to whom, by whom, how often, and whether it was within budget. What measures would you suggest to determine the effectiveness of such training? Is it important?

2. Midway through the year, all managers are told that budgets need to be slashed. What is their likely response? Do all operational managers line up to "make their case" for not cutting budgets on their projects? Do vice presidents and other senior-level managers make the decisions as to where and what to cut?

3. With each manager receiving a monthly report about project progress and budget compliance, what additional bene�it is gained from a face-to-face meeting?

4. If you were a manager who had to oversee people and projects, would you look forward to your monthly face-to-face meetings? Under what circumstances might you dread them? If you can think of any, how could you improve the situation?

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9.3 Emergent Strategies

There is one type of strategy that occurs only during operational execution. Emergent strategies, �irst proposed by Henry Mintzberg of McGill University, arise as a result of an organization's response to unexpected events as a strategy is being implemented. In Mintzberg's terms, an intended strategy is akin to the "best" strategy that was developed in Section 6.4 and chosen in Section 7.2. Such a strategy, when implemented, is then called a deliberate strategy. If it fails for whatever reason, it is considered an unrealized strategy (Figure 9.3).

As the deliberate strategy is executed, a pattern may emerge that was not intended when the strategy was �irst proposed. Actions that were taken one at a time take on a cumulative effect and become a strategy. For example, a supplier serving restaurants has an opportunity to serve a hotel, and later another hotel, and so on until it becomes clear over time that the company has diversi�ied into the related market of hotels. That is an emergent strategy that was never a part of the strategy the company set out to implement. Combined with the deliberate strategy of serving restaurants, it evolves into the realized strategy of serving the hospitality industry. This is also sometimes referred to as an umbrella strategy.

There is much validity to viewing strategy in this way, from how it's formulated to what actually happens in practice. Real life is messy and rarely do plans actually happen the way they are intended. Few strategies are purely deliberate, just as few are purely emergent; the former allows for no learning while the latter means no control (Mintzberg, Ahlstrand, & Lampel, 1998). Reality is some combination of the two.

Accepting the notion of emergent strategies allows the organization to learn from customers and to increase its capacity to experiment with new ideas. That is not to say that learning doesn't occur without an emergent strategy; one of the important byproducts of the strategic thinking and planning process is to increase strategic learning and to update everyone's mental models in a similar way. The very act of implementing a strategy involves all kinds of learning, which bene�its the next round of strategic planning.

Figure 9.3: Deliberate and emergent strategies

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Keeping one's eyes open for a pattern that signals an emergent strategy is another way for a company to stay agile and �lexible. In times of constant and rapid change, taking advantage of opportunities "on the run" as well as formally through strategic thinking is a sign of a healthy company. Should the emergent strategy become so powerful as to swamp the deliberate strategy, the company can always have an impromptu strategic-planning meeting and, with the board's approval, acknowledge what is happening and capitalize on it with full budgetary support.

Discussion Questions

1. Is it possible for a company to experience emergent strategies all the time? Is that the same as saying that it has no strategy? Explain.

2. Mintzberg and his associates characterize deliberate strategies as exhibiting control but no learning, whereas emergent strategies exhibit the opposite. Do you agree? Why or why not?

3. Do you believe that companies in general �ind it dif�icult to realize an intended strategy? If so, is it because of emergent strategies cropping up all the time or simply poor execution?

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9.4 Managing the Strategic-Planning Process

Strategic planning is usually carried out by a group of people in a company, and a formal process needs to be established to get such a group to coordinate their efforts and work as one. What follows is a set of guidelines for setting up and managing the strategic-planning process in a company, building on the discussion in previous chapters, which describe a process for doing strategic thinking and strategic planning. Insofar as the abilities of different companies to perform strategic planning and implement a formal process vary greatly, such guidelines are dif�icult to write. A few basic assumptions were made in formulating them:

Most small- to medium-sized organizations do not have a good understanding of strategic planning and therefore either do not perform it at all or do something they "think" is strategic planning. Companies that do strategic planning and use a formal process could bene�it by benchmarking their process with these guidelines. Many companies do strategic planning without re�lecting on whether it is done well or provides the organization with value. That is, they do so without the bene�it of any strategic thinking.

Before the process of strategic planning is begun, it would be a useful exercise for members of top management to assess the company's inventory of needs. One device that could accomplish this is a brief questionnaire such as the following strategy quiz.

Table 9.1: Strategy Quiz: How strategic is your organization?

Answer each question either with a Yes or No by checking the appropriate column next to it. Your answers will be scored based on the number of "No" responses.

Questions Yes No

1. Are you realizing the full potential of your company and people?

2. Do you have a �ive-year vision for your company?

3. If so, do you believe your company can achieve it?

4. Are you pleased with your company's pro�itability over the past three years?

5. Do you believe the value of your company is increasing over time?

6. Are your company's sales or revenues growing fast enough?

7. Do you have enough money (including ability to borrow) to get the job done?

8. Do you have a signi�icant advantage over your competitors?

9. Are your products or services competitive?

10. Do you know what your costs are?

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In smaller companies, the CEO usually does the strategic planning, but in larger companies the responsibility is delegated to a VP or group of individuals.

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11. Are you getting new products to market quickly enough?

12. Does your company do strategic planning every year?

13. Can you state what your company's strategy is and why it will work?

14. Do you have at least three opportunities you are deciding whether to pursue?

15. Do you know what your company's principal problems are?

16. If so, do you know what to do about them?

17. Do you have a set of measureable objectives you are trying to achieve?

18. Are you getting the most out of your people?

19. Do your employees know where the company is going and how it will get there?

20. Is your company culture collaborative, innovative, and trusting?

TOTAL

Source: Stan Abraham, www.futurebydesign.biz (http://www.futurebydesign.biz/)

Whose Responsibility Is It?

In small companies that perform strategic planning, the CEO or owner typically drives the process. Occasionally this role is acknowledged as the CEO's most valuable contribution. For example, Livescribe, a market leader in digital pens, hired a new CEO for the speci�ic task of strategic planning (Takahashi, 2012). Sometimes, he or she might use a consultant or an executive within the organization to conduct the process and help the group decide on the strategies. Most small companies and new ventures, however, do no strategic planning for the simple reason that there is only one strategy possible, and the company's energies are focused on executing it. Examples are restaurants, retail outlets, or small service businesses. Such companies address strategic planning only when faced with several choices or intense competition and, for the �irst time, are put in a position of not knowing what to do.

In midsize to large companies, the job of controlling the process is typically delegated. Ideally, there would be a director of strategic planning to manage the process. Absent such a position, responsibility would go to whoever the CEO believes can do a good job or has some experience with strategic planning such as the CFO or

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a functional vice president. If no one wants the assignment or feels able to do it, someone from outside may be brought in to do it. If manufacturing, R&D, and distribution can be outsourced, so can facilitating the strategic-planning process. However, only planning and conducting the process and achieving its purposes should be subcontracted to a consultant. The actual decisions cannot be; the CEO and managers, who alone are accountable for acting on those decisions and achieving the company's objectives, must make them. Some organizations, such as Air France (Air France, n.d.), form ad hoc or standing committees to focus on strategic planning. Others, like Mitsubishi (Mitsubishi Electric, n.d.), employ a vice president or C-level executive to direct strategic planning and related initiatives.

The person in charge should make sure all those involved understand what they have to do and give them time to do it. Part of the process is creating standard reporting formats that everyone understands and that facilitate comparisons with later years. At the outset they should establish a schedule for the process and then enforce it unless a company crisis intervenes. The individual managing the process must remember that these planning tasks are superimposed on people's regular jobs and are likely to produce negative attitudes and reactions. Only if those involved see the activity as crucial for the company and worthy of being taken seriously by everyone will they be motivated to do a good job.

Choosing the Process

Whatever process the company uses for strategic planning must meet certain criteria. Key company managers, particularly the person in charge of the process, must understand it—what it is, what is involved, who should be involved, why it is needed, and how to realize the bene�its from using it. The process must be perceived as appropriate and feasible for the company in terms of sophistication, complexity, and culture. The company must be prepared to commit to the process and its outcomes. All involved must agree to take it seriously and implement those strategies and decisions that result from the process.

The person in charge should explore several different approaches, or invite several consultants who specialize in this area to discuss their approaches.

Hiring a consultant to help with doing strategic planning the �irst time is prudent. Ceding this control (and worry) frees managers and executives to participate in the process. Furthermore, a consultant can control the quality of the discussion and strategic ideas that are proposed, as well as ensure that real data and analyses are used as much as possible rather than opinions and conjecture. Finally, a consultant can act as facilitator to make sure that all voices are heard, not just one or two people who might dominate discussions. A neutral facilitator is more likely to ensure that people are not just saying what they think the CEO wants to hear, which is a major problem in many companies. Ideally, a consultant should be trusted and one with whom the CEO is comfortable— someone who can do a good job of guiding participants in the strategic-planning process that is the best �it for the company. An effective consultant should deliver bene�its to the process that outweigh the fees charged.

A Suggested Strategic-Planning Process

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The biggest waste of a company's time and money is to pay for a top managers' meeting at a rural retreat center and no one follows up on implementing any of the business discussed.

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The following process would work with �irms of almost any size. It is generic and can be tailored to �it a particular company. The process has 10 basic steps; some of them could be broken down into sub steps (Figure 9.4). Perhaps the most crucial element in strategic planning is to involve the right people, particularly those who will be called upon to implement the plan. People— depending upon their experience, background, and role in the company—going through the same process of strategic planning will make completely different decisions and achieve completely different results. It is crucial, therefore, to consider carefully who is involved in the process. As has been discussed, it would limit the effectiveness of the process and of implementation to limit the planning group to just the top management; managers two or three levels down should also be included. If this yields a number that becomes unwieldy for simple meetings, it may be necessary to limit the number that participate or cascade the meetings from one level to the next to accommodate everyone. What is crucial is to obtain as many different perspectives in the planning process as possible as well as the involvement of people who implement the strategies. The value of a professional facilitator becomes more pronounced the larger the group of people involved in the process.

Strategic planning is only meaningful if the company fully intends to implement the decisions taken. A common waste of time and money is for a company to bear the cost of top managers meeting at a retreat, sometimes with an expensive facilitator, making important decisions, on which no one then follows up. The result is business as usual. One can only conjecture some possible reasons for why this happens. Perhaps "going through the motions" of strategic planning soothes some executives' consciences. Perhaps they believe that "doing the planning" is all there is to it, a belief that no one has bothered to correct for them. Perhaps it is the golf game at the resort where the retreat is held that has their real interest. However, it is a waste of time just to go through the motions so a commitment to the process and implementation are requisite elements.

There are a few key strategic decisions to be made, or at least revisited. The �irst is to con�irm a commitment to a vision to which the company aspires. The outcome of the process is deciding on the best strategic bundle in the circumstances. That may even happen to be what the company is currently doing. After that, overall companywide objectives are set. Finally, major programs that are to be implemented and resource allocations are developed in detail.

Follow through will be much more likely if the participants see these decisions as being the best that could be made, that they are feasible yet challenging to achieve, that some urgency attaches to getting them implemented, and that they would result in a stronger and more competitive company. Focusing on a

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small set of objectives increases the chances of them being attained and lessens the likelihood of con�lict between objectives that might occur with a larger number. A limited set of objectives would also help focus the company.

The following description of each step in the process shown in Figure 9.4 includes some pointers for making the whole process successful.

Figure 9.4: A suggested strategic-planning process

Situation Analysis (a)

Certain key categories of data need to be collected in this initial research step. Any time that data are collected it is best to obtain a copy of the source document or at least a complete citation of the source. It should be self-evident that it is best to get the most recent data possible. If forecasts can be obtained, the source should be recorded, because it has a huge bearing on the credibility of the forecast itself. Finally, key people in the company should be appointed to act as gatekeepers for particular categories of data, and everyone in the organization should know who they are. Everyone can then send items of information or leads about a particular category to these gatekeepers. If done throughout the year, this �irst step is not needed; otherwise, one must allow suf�icient time to collect and analyze the data and prepare useful

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summaries. Every month, these gatekeepers should summarize and make sense of the data collected to- date, which is then sent to everyone on the planning team.

Substantial preparation should be done for each step. Research and data collection must be based on fact or analysis, not on opinion. Where data cannot be obtained, for example, on competitors that are privately held, make assumptions and move on. Paying for critical data such as economic forecasts or competitive intelligence may be worth considering as it could be an investment. Also consider adding an economist or competitive-intelligence professional to the company's permanent staff if it turns out to be cost-effective.

Situation Analysis (b)

Each gatekeeper should make a summary presentation of what is going on in his or her particular category. Such presentations should be based on the data collected and analyzed during the previous 12 months and should include numbers, trends, graphs, and sources wherever possible. The gatekeeper should interpret all the data and conclude with the most signi�icant and relevant facts and trends that will affect the company. This is one way of educating the planning team about changes and implications arising in that particular category. The presenters should encourage questions in order for complex issues or trends to be understood or challenged. This process should appeal to companies that like structure; an alternative is a series of strategic conversations, discussed in Chapter 2.

Synthesis

This step allows the participants to list all critical uncertainties, that is, the key strategic issues that could have a positive or negative impact on the company. "Critical" means those issues that must be addressed in the ensuing strategic plan. Everyone's suggestions should be solicited �irst before combining or eliminating any issue.

Create the Strategic-Alternative Bundles

This is a creative activity well suited to an extremely diverse group of people. Ideally it would include representatives from different functional areas and levels of the company, with very different business and industrial backgrounds, newer members of the organization, and seasoned veterans. Starting with the list of strategic alternatives and working in small groups, each group should come up with its version of alternative bundles and check to see that they meet all four criteria.

When the small groups have designed the proposed bundles, these can be assesed and debated by the entire planning assemblage. The idea is to synthesize the efforts of the various subgroups into a �inal grouping of three or four really good bundles that meet the criteria. Experience has shown that this step always takes longer than expected to do well. One idea to force an intelligent critique of the alternatives is to "murder-board" them.

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After completing a situation analysis, each manager or gatekeeper should make a brief 30-minute presentation on his or her particular category.

Digital Vision/Photodisc/ThinkstockAssign a subgroup to tackle each alternative bundle, and instruct them to come up with all the reasons they possibly can as to why that alternative would not work. It is amazing how this extra step adds a humiliating dose of reality to the process, can result in important modi�ications to the bundle in question, and can even cause one bundle that was going to be considered by the group to be discarded.

Choose the Best Bundle

Select a subset of �ive to six relevant criteria. Evaluate the bundles on each criterion. The entire group of participants should reach consensus that whichever bundle is �inally selected really is the best one in the circumstances, and why. Ultimately, everyone should understand that this is how the company will compete over the next three to �ive years.

Set Companywide Objectives

As discussed earlier, this is a three-step process. Depending on the preferred key indicator, such as revenues, NIAT, market share, and D/E ratio, the company needs simply to answer the question, "How far do we want to go this next year and in each of the next two years toward implementing the chosen strategic bundle?" It will depend on the �irm's current resources and those it could additionally access, as well as the nature of the chosen strategies. In addition, it will depend on whether the competitive environment is becoming more dif�icult or any other threats are looming. Based on how the company has been doing in the recent past, the objectives should be set at a challengingly high level while still being achievable. Most importantly, those who must be accountable for achieving these objectives should agree to the level at which they are set, and that level should be challenging.

Of course, the model assumes a participative way of setting objectives; some CEOs still reserve the right to do this on their own. However, a wise CEO knows that when managers charged with implementing a strategy set their own objectives, they are more likely to achieve them.

Design Major Programs and Contingencies

Some of these major programs are included in the chosen bundle, while others may need to be added. It is this list of programs that will guide the creation of the operational plans. "Contingencies" here refer to the trigger/contingency pairs that were discussed in Section 7.4.

Prepare Detailed Operational Objectives and Plans

This is one of the more complex steps in the process, but there are many ways to create operational plans. Given the companywide objectives and major programs already identi�ied, the directors of functional units (e.g., marketing, production, �inance) and other support units (e.g., materials lab, purchasing) take these as mandates to their respective staff and get them to generate detailed operational plans that would

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One of the more complex steps in the analysis is preparing a detailed account of your operational objectives and plans.

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contribute to achieving the objectives and chosen bundle (business model). At a minimum, these plans should include the following:

A timeline of speci�ic tasks the unit will undertake during the year A proposed budget to accomplish them by task and month Speci�ic details as to who will be participating in these activities and, in particular, the person who will be responsible for each activity A list of additional resources, human and material, that will be required to complete the proposed tasks

Perform a Final Check

Once these plans have been drafted, they should be reviewed by top management and/or the director of strategic planning to check their feasibility, verify that the requested budgets do not exceed available funds, and con�irm that completing all the planned activities will, in fact, achieve the overall objectives for the company. This mixture of top-down and bottom-up planning may have to endure one or more iterations before the operational plans and budgets are �inally approved. For this reason, be sure to allow enough time to complete this process properly and break it down into components as shown in that �igure.

Assess the Process

Those who participated in the strategic-planning process should be asked to complete a detailed questionnaire about how well the process went and the quality of the decisions made. The following section discusses measures for improving the process.

Discussion Questions

1. You work for a company that has never done strategic planning. Describe the steps you would take to persuade the CEO that going to the trouble of putting a process in place would really bene�it the company.

2. In your opinion, what might be the most dif�icult part of the strategic-planning process for a company to develop competence in? Explain your answer.

3. If you had to choose from these two alternatives, which would you choose: good data but poor decision making, or untrustworthy data but good decision making? Why?

4. If a company did operational planning well but had no strategic direction, could it be successful? If it could, why bother doing strategic planning?

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9.5 Improving the Strategic-Planning Process

Strategic planning is, at its heart, a process for arriving at strategic decisions and achieving some purpose. However, unlike other processes, the output is not widgets; it is nothing less than the future of the company. Assuming that improving the process will improve the quality of strategic decision making in the future, it should be reviewed every year to see where improvements might be made. Such a review should include every aspect of the process—the quality and adequacy of the data and analyses, whether enough expertise was at hand or applied, the quality and extent of the discussions, the degree to which mental models were changed and uni�ied, whether the key strategic issues were properly identi�ied and well understood, and so on.

Questions for Improving the Process

The following questions should help in assessing the strategic-planning process and making improvements for the following year.

Situation Analysis

1. Were suf�icient data collected for various parts of the situation analysis? If not, which particular parts were shortchanged?

2. Was enough time allowed for data collection? Where would more time allowed have been bene�icial? 3. Was enough analysis performed on the data? If not, where would more analysis have been bene�icial? 4. Were credible sources used for data and forecasts? If not, for which kinds of data were they not credible?

5. For those analyses that used subjective estimates, was there consensus as to how those analyses turned out? Where particularly did the subjectivity affect the credibility of the analytic �indings? Were the opinions of some people given undue weight over those of others?

6. Would the use of outside experts have improved any part of the situation analysis (e.g., having an economist talk to the managers about economic trends for the coming year)?

7. Did the participants in general understand the terms and terminology used in the situation analysis (e.g., core competence)? Were there any terms or concepts that caused confusion?

Strategic Analysis

8. Were enough key strategic issues identi�ied? If not, what might have been added? 9. In hindsight, did the key issues identi�ied really represent the most critical issues facing the company? If not, why not? Which ones were left out? Was the omission an oversight, or were some people afraid to articulate it?

10. Did the strategic issues re�lect the kind of long-term strategic thinking that participants imagined should have occurred? If not, why not?

11. Were the strategic-alternative bundles suf�iciently creative and realistic? 12. When creating them, were participants unduly in�luenced by what the company is currently doing, by

its current strategies, or by what participants believed the CEO really wanted? If so, how could this be corrected in the future?

13. Did everyone who could have contributed usefully to the process of creating these alternative bundles actually do so? If not, how could this be corrected?

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After putting together your situation analysis, you should distribute a questionnaire to your employees to help you better assess the strategic-planning process.

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14. Were the criteria used to evaluate the alternative bundles reasonable for this company? If not, which others should have been used?

15. Did the analysis that was used comparing the alternatives against the criteria produce a believable result? Why or why not?

16. Which of the alternative bundles might the company have been advised to pursue other than the one chosen? Why? Was every point of view given fair consideration? If not, why not?

17. During the sessions choosing a preferred strategic bundle, were participants allowed ample opportunity to express their feelings, agreements, or misgivings? If not, why not?

Recommendations

18. Were the objectives that the company decided on for the next year appropriate and achievable? If not, why not?

19. Are the objectives for three years from now appropriate and reasonable? Are they unattainable as stated, "stretch" objectives (challenging yet attainable), set without much careful thought (e.g., an extrapolation of last year's), or set too low? Why or why not? What should they have been?

20. Are those who participated pleased and excited about the direction the company is taking now as a result of the strategic- planning exercise? If not, why not?

Some General Questions

21. Did the whole process take too long? Why? Where could it have been shortened?

22. Did the process stick to the original schedule? If not, where did it deviate? Might the schedule have been unrealistic?

23. If the process did not keep to the original schedule, were there any adverse effects?

24. What lessons were learned about the process this year that might be put to good use next year?

25. Has the company's knowledge of strategic planning increased? How do you know? If not, why not?

26. Was everyone who participated in the process substantially "on the same page," or did the process conclude with a number of people in signi�icant disagreement? If the latter, how might such disagreements be addressed more fully and resolved?

27. Overall, is the company better off for having been through this strategic-planning exercise? Why or why not?

The person responsible for the process should distribute a questionnaire with the preceding questions (or a similar set) to all participants in the process. The responses should be analyzed and the results presented with constructive commentary and suggestions for what should be changed the following year. The analysis and suggestions for change should be discussed at the meeting and consensus sought as to which changes should be implemented. Unless such a debrie�ing takes place, changes made to the process might be resented; in addition, it serves an educational purpose.

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Discussion Questions

1. Participating fully in a strategic-planning process is unquestionably a learning experience. Do you think that special training beforehand would make a difference? Why or why not?

2. If strategic-planning participants are sent materials ahead of the process, what should they contain?

3. After a couple of annual iterations of improving the process, an observer might be forgiven for thinking that the process was good enough not to change any more. Give some reasons why that would be wrong.

4. Why is achieving consensus at the post-planning debrie�ing meeting advisable?

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9.6 Assessing the Strategic-Planning Process

Bene�its do not accrue automatically every time a company engages in strategic planning; they are more likely to be realized if they are consciously sought. Both strategic planners and the consultant facilitators advising them should strive to ensure that these bene�its are realized. The extent to which they are realized, therefore, constitutes an excellent assessment.

The 10 Bene�its

The 10 bene�its of effective strategic planning may also be viewed as criteria for assessing whether a company is doing strategic planning effectively. The 10 bene�its are organized to follow the Association for Strategic Planning's rubric of "Think—Plan—Act."

The 10 Bene�its of Effective Strategic Planning

"Think"

1. A shared understanding of external changes 2. The ability to anticipate future external changes 3. The ability to search for a better strategy or business model

"Plan"

4. Having a strategic vision 5. Choosing the best strategy from among viable alternatives 6. A constantly improving strategic-planning process 7. Having the board of directors on the same page

"Act"

8. Becoming a stronger competitor 9. Having an adaptive, innovative culture 10. Having all programs aligned with the vision, strategy, and company objectives

Source: Abraham, S. (2010, February 23). Ten Bene�its of Effective Strategic Planning—and Why You Should Want Them All. Presentation at the 2010 ASP National Conference, Pasadena, CA.

1. A Shared Understanding of External Changes

To use a military analogy, just as con�licting accounts about an enemy's strength, position, and deployment make it dif�icult to devise a winning strategy, so too does the absence of a shared understanding of external changes and their impacts on the company make the crafting of a winning strategy extremely

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Your strategic vision should be realistic, achievable within a speci�ied time frame, inspirational, concise, and memorable.

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dif�icult. Because changes occur continuously, the only way to keep up with them and even anticipate some is to monitor them year round, and to keep the strategic planning group and board of directors informed as to key changes and developments in all areas. One person should be responsible for each area and be trained to collect and summarize data in useful form. A summary for the year with emphasis on recent trends should be prepared in advance of the annual strategic-planning meetings and be distributed to participants. To the extent this is done well the company's decision making will improve.

2. The Ability to Anticipate Future External Changes

A number of well-known techniques enable an organization to explore "soft" assumptions about the future and provide additional options for planning. These include scenario planning, forecasts, and simulations (Section 3.4). It may be that the �irm would be advised to engage a consultant that specializes in one of these areas, or pay attention to forecasts that have earned a good reputation over time. Expressed another way, the bene�it here is that the resulting information can guide the �irm toward actions that enable a preferred scenario to occur, or develop a contingency in case a hoped-for scenario does not occur.

3. The Ability to Search for a Better Strategy or Business Model

A company not actively seeking a better strategy is not doing a good job of strategic planning, and its strategic decisions will not be good ones. How else is a company to �ind a "blue ocean" or situational monopoly with no competition? How else could it guard against being disrupted by a company outside the industry or even plan a disruption itself in a proactive move? How else could it gain a competitive advantage it lacks or strengthen one it already has?

For every different strategy and business model contemplated, someone in the organization should assess its costs, feasibility, bene�its, and risks on an ongoing basis. The results of such assessments play directly into the strategic-decision-making process. Except when the �irm needs to act immediately because the decision just won't wait, the information can wait until the annual strategic-planning process comes around.

4. Having a Strategic Vision

Every organization that wants to endure should have a strategic direction and strive to become something. Succeeding is more likely if there is a clear vision and if everyone knows what it is and is motivated to help the organization get there. Visions should be realistic (achievable within a set time frame, 5 or 10 years is typical), concise, inspirational, and memorable. They sometimes include a value statement, although listing values separately is more common (Section 2.1).

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The real bene�it of a clear vision statement is to get everyone in the organization on board and wanting to achieve it; and though cumbersome, everyone in the organization should also have had a hand in creating it or at least providing feedback before it is adopted. As soon as the organization is close to achieving its vision, it should be changed, being careful to go through the same process of getting buy-in from everyone before adoption.

5. Choosing the Best Strategy from Among Viable Alternatives

Choosing from the best options available is a bene�it, as it allows people to trust the decision that was made and have faith in the direction the company is headed. This is bene�icial only if the strategic planning process generate good viable alternatives and a decision-making process for selecting the best one.

Having said that, such a "best strategy" doesn't guarantee success. It must be well executed for the �irm to succeed. It is much easier to "sell" the strategy down the line in a company and motivate a high level of execution if people know why it is the best from among the options considered.

6. A Constantly Improving Strategic-Planning Process

The bene�it of improving the process should be clear: better strategic decision making. This might entail involving different people, getting better information, stimulating more spirited discussions and encouraging diverse views, or even using computer software to include inputs from everyone quickly (Warden & Russell, 2001). Without thoughtful annual improvements, an organization is likely to allow its strategic planning to become a rote exercise that is taken ever less seriously and one that participants, for those very reasons, resist wanting to participate in.

7. Having the Board of Directors on the Same Page

For public corporations and nonpro�its—and quite a few but not all privately held companies—it is imperative to ensure that the board of directors approves of all strategic decisions before any move to implement them is made. In fact, there are instances where the strategic decision comes from the board as in resisting a takeover bid or deciding to acquire another company. In the typical case where strategic planning is done by a top-management or strategic-planning team, there has to be some mechanism for the board to be kept apprised of the process. In 2005, management consulting �irm McKinsey & Co. polled over 1,000 directors and discovered that strategy coordination between the CEO and the board was the number-one cause for the success or failure of CEO appointments (Felton & Keenan Fritz, 2005). In some companies, the CEO is also chairman of the board, and so automatically serves as the desired link.

Boards of directors may have a strategic-planning committee whose chair would attend the meetings of the management group and keep the board informed. The bene�it, of course, is knowing that the strategic decisions made are in the best interests of the stockholders in the case of a public corporation or the sponsors and clients in the case of a nonpro�it organization. Ultimately it is the board that has responsibility for the strategic direction of the organization.

8. Becoming a Stronger Competitor

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Apple Computer's culture encourages innovation and new ideas to look for the "next big thing." Apple values learning from mistakes, sharing experiences, and developing ideas, no matter what the source.

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If strategic planning is done well and the strategy properly executed, then the company will become a stronger competitor. This, of course, is the principal bene�it for doing strategic planning in the �irst place. Many things have to contribute for this bene�it to be realized. For example:

Knowing how your industry and markets are changing Anticipating and meeting customers' needs Getting more customers to buy your product or service Creating or improving a core competence Knowing what your competitors are up to and outdoing them Defending one's position against attack from competitors Looking for "blue oceans" or monopolies with no competitors Looking for opportunities to disrupt the industry before someone else does Cultivating a strong brand and staying true to it

Management knows that the company is a stronger competitor if it achieves gains in revenues and market share, and maintains high brand equity, or achieves other established measures of success the company holds dear.

9. Having an Adaptive and Innovative Culture

When a company has been following the same strategy for some time, the culture adapts to that strategy and gets it to work. However, if some major change is deemed necessary, such as pursuing a new strategy or adopting a new technology or manufacturing process, and the culture remains what it always was, then the change will not succeed. A mismatched culture is one of the principal reasons why changes and new strategies fail, and it is widely acknowledged that it is dif�icult to change a culture. The reason that it is dif�icult is that change imposed from above results in a lot of resistance. Many companies in this predicament resort to wholesale changes in personnel to change the culture.

With an adaptive culture, that draconian measure is not necessary. An adaptive culture is one that is willing to change if the reason for doing so makes sense. It is a culture that values open communication, education, teamwork, and individual initiative. Companies that have adaptive cultures make the necessary changes over time and succeed.

An innovative culture does not simply encourage innovation and new ideas and look for the next "big thing." It also puts a high value on learning from mistakes and giving people permission to make mistakes. Innovative cultures encourage the sharing of experiences and developing ideas no matter their source. Two of the best examples of innovative cultures are Apple Inc. and Google.

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It would be dif�icult to make strategic decisions and implement them if the culture were not adaptive and innovative. The converse, of course, is also true. Making good strategic decisions that call for change and smooth execution will force the culture to be adaptive and innovative. Hiring people with similar traits will ensure that this desirable culture endures.

10. Having All Programs Aligned with the Vision, Strategy, and Company Objectives

The importance of aligning everything the company does with its vision, strategy, and companywide objectives was discussed in the context of operational and budget planning (Chapter 8). The bene�it is the assurance of knowing that completing all programs, projects, and activities as planned will result in the strategy being implemented and the vision and company-wide objectives being fully realized (barring unforeseen circumstances).

In too many companies, what employees in the different functional areas and operational units actually do has little to do with the strategy that's in place, because little or no effort was expended to make sure that the two were aligned. As a result the strategy fails or "business as usual" triumphs. When operational planning is done, critical elements include performance measures (to track progress), appropriate training, and reward and incentive systems.

Discussion Questions

1. Of the 10 bene�its discussed in this section, which of them, in your opinion, are most often unrealized and why?

2. Which of these bene�its, again in your opinion, are most dif�icult to realize and why? 3. Do you believe that there are any bene�its that companies are less interested in realizing, hence probably won't?

4. In what ways are these 10 bene�its different from the annual improvement cycle recommended in Section 9.5?

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9.7 Raynor's Strategy Paradox

According to Michael E. Raynor, some traditional strategic-analysis tools that have been taught for years and are in widespread use (including some discussed in earlier chapters) are passé and could even be counterproductive. He speci�ically identi�ies Michael Porter's �inding that a commitment to competitive strategy is the single most important ingredient of any plan (Porter, 1980), and Gary Hamel and C. K. Prahalad's (1994) revelation of the power of a core competence.

These management tools are, in fact, powerful only if one can predict a future discontinuity with some certainty, which no one can, especially in an unstable economic climate, or in an environment of constant change and technological innovation. For example, consider a company such as Mozilla, which relies on open-source development for its �lagship product, the Firefox browser. Older models of forecasting the future and strategically planning with those forecasts in mind simply won't work for an organizational model such as this.

The argument is that the commitment it takes in �inancial resources and organizational adaptation to implement a strategy or develop a core competence is so signi�icant and time consuming that, when the world inevitably changes, the typical organization cannot adapt quickly. The very strategies that at one time were responsible for a company's success will then seed its destruction. That is Raynor's strategy paradox (Raynor, 2007).

The solution, according to Raynor, is not to focus on the strategy, but to manage uncertainty so that, whichever way the world changes, one can adapt, survive, and prosper. Raynor illustrates, with the ill- fated story of the failure of Sony's Betamax, what happens when a company focuses on its well- constructed strategy and fails to heed external changes and manage uncertainty (Abraham, 2007). In 1977, Sony had a choice of competing or collaborating with Matsushita, which produced the VHS recorder. Sony had a 60% share of the market, and its Betamax was the best product for recording a TV show and replaying it at a later time (''TV shift''). Then Fox Studios put 50 of its �ilms on both Beta and VHS for people to watch at home. Watching a movie at home required a simple cheap playback device, not the complexity of a TV-shift device that could also record. To its detriment Sony didn't adapt. By 1985, VHS had become the new standard and Betamax had less than a 10% market share, which continued to decline. In 1988, Sony pulled the plug on Betamax, a good product with an initially sound marketing plan, but which did not rapidly adapt to market shifts.

Microsoft, on the other hand, has the budget to pursue myriad strategic options, which it can then exercise (develop and quickly try to become the leader) or abandon as appropriate. For instance, although it may not have happened soon enough for early adopters of Microsoft's much-criticized Vista operating system, the company had the resources to put in place Windows 7 as a means of responding to the widespread problems with Vista. Call it hedging one's bets if you will, but Raynor calls it managing uncertainty.

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How, then, is this uncertainty managed, and who should do it? Here, Raynor drew on the pioneering work done by Elliott Jacques, developer of the ''requisite organization'' concept. Jacques investigated why people's pay at different organizational levels differed, and what was considered ''fair pay.'' His research showed that people who had to make decisions based on a longer time horizon were appropriately perceived as deserving higher pay. Thus, for this reason alone, people at higher levels in an organization were paid more than people at lower levels. Raynor piggybacked on this concept and developed a model of requisite uncertainty. Figure 9.5 summarizes the key levels in an organization and the time horizon over which they tend to make decisions. Raynor is not concerned, here, with compensation. Instead, the exhibit shows that the decisions made with long time horizons (about 20 years) in mind address the greatest strategic uncertainty and, he says, the board of directors should be responsible for making them. The next level down, corporate management (5- to 10-year horizon), explores new markets, technologies, and business models; their job is not to decide how to succeed, but rather that the company be positioned to succeed regardless of what the future holds. Division management (two-to �ive-year horizon) chooses the strategy and how they should be implemented. Finally, line and functional managers (with a time horizon restricted in range to less than one year) focus on implementation of strategies already decided on. Notice that from top to bottom of the exhibit, the management imperative shifts from ''uncertainty'' to ''commitment.'' A company must not only implement strategies already in play but also, by managing uncertainty, always keep itself in position to change to another strategy should changing circumstances warrant.

Figure 9.5: Raynor's model of requisite uncertainty

Source: From Stanley Abraham, "At ASP, Raynor on managing uncertainty, plus some highlights of lessons from practice," Strategy and Leadership, Vol. 35 No. 4, 2007, Exhibit 2, 46. Copyright © Emerald Group Publishing Limited. Reprinted by permission.

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Discussion Questions

1. Does Raynor's strategy paradox negate this book's premise of good strategic planning at the heart of strategic management? Why or why not?

2. Raynor says that the solution is to manage uncertainty. Isn't that the purpose of strategic thinking? Doesn't strategic thinking try to get a handle on the future and soft assumptions (uncertainties) about the future?

3. Raynor's model of requisite uncertainty, whereby the company continues to execute its strategy while upper levels of management worry about the future, advocates that the board of directors worry about the long-term future. Does this sound realistic to you? Why or why not?

4. Following on from question 3, if the board doesn't see this as within its purview, who do you think should worry about the company's long-term future?

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Summary

Some organizations don't create operational plans as they would consist of just doing whatever the company is already doing. For most companies, however, change is constant and the push to become a stronger competitor and reduce costs is never ending. Creating operational plans also involves dif�icult choices; the plan must get the job done, be within the company's technical and capacity means to do so, and be done for the lowest cost within the allocated budget. Operational plans include projects and programs the company is currently doing as well as new ones and changes in the way current projects are being done. The plan for each project should include start and end dates, equipment needed or used, people involved, who is accountable, and estimated costs for all elements by month.

It's conventional wisdom that nothing gets managed or improved that isn't measured. Tracking progress of all projects is therefore critical to keep them "on track and on budget." Care needs to be exercised to make sure that the right things are being measured. If a better trained workforce is a goal, knowing how many lectures or workshops are given and how many people attended won't help; a way has to be found of measuring increased effectiveness or capability. For many standard measures, especially in manufacturing and project management, software such as Gantt charts and PERT networks with a continually updated critical path.

Managers meet face-to-face with their direct reports regularly to discuss negative variances that have resulted from the previous month's operations. Negative variances include projects that have either missed their deadlines or have a higher probability of missing them or have exceeded their budgets. The meetings are vital for managers to understand the causes for such variances and discuss possible solutions. In addition, it's an opportunity to strengthen relationships and understand their direct reports better. Just like classical control systems that are corrected as soon as possible if untoward variances occur, so also in operational management must variances be identi�ied and then corrected as soon as possible. After having met with all direct reports, the manager later takes on the role of direct report when a similar meeting is held with his or her supervisor. Managing is getting things done (right) through people, and such meetings are a critical part of a manager's job.

While executing a strategy, changes may result in activities being done or opportunities pursued that, in retrospect, bear little resemblance to the original "intended" strategy. Such new activities could form an "emergent strategy," �irst described by Henry Mintzberg, and, together with the strategy being implemented ("deliberate" strategy), turn into the �inal "realized strategy." When intended or deliberate strategies fail, they are considered "unrealized." Agile or adaptive cultures are best able to handle such real ongoing changes in stride.

Although not an operational plan per se, the strategic-planning process must nevertheless be managed, especially as it is done in addition to managers' regular responsibilities. It is the responsibility of the CEO or possibly designated vice president but never a consultant, even though a consultant might facilitate the process. The person responsible for the process should survey all participants, analyze the responses, and

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report to a debrie�ing meeting to discuss proposed improvements. A consensus on the proposed improvements should be obtained before implementing the changes for the following year.

Finally, implementing a strategy that is working and in which considerable investment has been made might, if conditions abruptly change, also be a company's Achilles' heel, because such a company would �ind it very dif�icult to change as quickly, like a large oil tanker trying to make a quick turn. This is Raynor's strategy paradox. His solution is to manage uncertainty better, meaning to not only keep executing its successful strategy but also spend more time looking further ahead (10–20 years) in an effort to get as much lead time as possible to allow the organization to change accordingly. Planning at the CEO and board levels, according to Raynor's "model of requisite uncertainty," should exclusively be concerned with �iguring out what the company should be doing 5-20 years into the future.

Concept Check

Key Terms

control system Comparing actual performance to a standard, measuring the variance, taking action to reduce the variance, resetting or updating, and testing again. Corrective action should be taken as soon as it is found necessary.

deliberate strategy The intended strategy, operationalized and executed.

emergent strategies Strategies a company pursues during implementation that were never a part of the intended strategy.

Gantt chart A graphic depiction of a project schedule. Gantt charts show the beginning and end dates of each project component. Some charts also illustrate the dependency relationships between component activities, or the dependency of one activity upon the completion of another.

negative variance An instance where a project's progress is delayed and could miss a deadline, or where its budget has been exceeded, or where performance comes up short of a quantitative standard or expectation.

Raynor's model of requisite uncertainty The decisions made with long time horizons (about 20 years) in mind address the greatest strategic uncertainty. A company must not only implement strategies already

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in play but also, by managing uncertainty, always keep itself in position to change to another strategy should changing circumstances warrant (with the board and top management worrying about how to cope with changes that might occur over the longer term).

Raynor's strategy paradox When the world inevitably changes, the typical organization cannot adapt quickly; the very strategies that at one time were responsible for a company's success then seed its destruction. That is the strategy paradox.

realized strategy A combination of deliberate and emergent strategies. Also known as an umbrella strategy.

unrealized strategy A failed strategy.

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Chapter 10

Ethics and Corporate Social Responsibility

Cultura Limited/SuperStock

Learning Objectives

By the time you have completed this chapter, you should be able to do the following:

Understand the differences among ethics, morals, and values. Understand ethical issues and behavior. Learn about the various unethical behaviors that tempt managers and corporations. Learn about ethical dilemmas and an approach to coping with them. Ponder the extent to which ethics can be taught. Understand the nature of corporate social responsibility (CSR) and the role of corporations in being economically, legally, ethically, philanthropically, and environmentally responsible.

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Ethics and ethical behavior should be embedded into the way people are brought up and the way business students are trained. But the sad fact is that unethical behavior is more the norm in the business world than the exception. The fact that it is widespread in no way condones unethical behavior. This chapter will clarify the distinctions between ethics, morality, and values, what unethical behavior is and isn't, situations that make it dif�icult to be ethical and how to cope with them, and the degree to which ethics can be taught.

The chapter also discusses corporate social responsibility (CSR), what it is, and the extent to which corporations have a duty to be socially responsible. Finally, the physical environment (air, land, water) is— or should be—an important stakeholder for corporations. What does the responsibility to safeguard the environment mean, and what role should corporations play?

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10.1 Ethics, Morals, and Values

The terms ethics, morals and values are often confused or used interchangeably in everyday speech. Before discussing ethics in more detail, it is important to establish de�initions of what each means and the differences among them. A traditional de�inition of ethics is the art and discipline of applying principles and frameworks to analyze and resolve complex moral dilemmas (Rossy, 2011).

The Josephson Institute of Ethics, a nonpro�it organization based in Los Angeles, de�ines ethics differently but perhaps more aptly for the business world: "Ethics is about how we meet the challenge of doing the right thing when that will cost more than we want to pay."

This de�inition gets to the heart of why "doing the right thing" is sometimes so dif�icult; we are unaware of the associated cost. The Institute breaks down the de�inition into two parts: (1) the ability to discern right from wrong, good from evil, and propriety from impropriety; and (2) the commitment or will to do what is right, good, and proper (Maxwell, 2003). People and organizations need to develop a standard to follow and then the will to uphold it, an ongoing struggle for both.

A moral person knows right from wrong and chooses right; an immoral person knows the difference too but chooses wrong, while an amoral person either doesn't know the difference or doesn't care. This description includes notions of bad versus good. Both require societal and cultural norms of right and wrong and, because these evolve over time, what is "right" is far from clear.

Values are the tenets most important to people and the ways that govern how they choose to live their life. That statement also applies to organizations (see Section 2.8). Some people have been known to die for preserving a value very important to them (like freedom, or protecting another's life), and at the other end of the scale are people who think nothing of in�licting harm on others if their cause warrants it (like allegiance to a gang and killing rival gang members to defend "turf").

Virtually every company has an ethics code of behavior, which more accurately might be called a moral code. More than 85% of companies have created and circulated organizational codes of conduct. Simply having a code does not necessarily mean that employees will follow it, however; there is no proof that codes of conduct actually in�luence ethical behavior (Rossy, 2011). An example of a less-than-successful code is that of energy corporation Enron. Enron's 64-page Code of Ethics, which opened with a motivating forward by CEO Kenneth Lay, did not avert one of history's worst instances of corporate ethical failure (Rossy, 2011). Enron went bankrupt as a result of corporate of�icers' unethical accounting practices. By in�lating earnings and cash �low, and keeping liabilities off the books, Enron presented a distorted picture of �inancial health, attracting investors in the process. Among the losses were the 401K retirement accounts of Enron employees. In contrast, CEO Lay sold stock in the months before the scandal broke and pro�ited greatly (Oppel, 2001).

An unethical act is carried out with immoral intent, done with the full knowledge that it is legally and morally wrong or goes against societal or organizational norms (Rossy, 2011). It usually infringes obvious

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rules, laws, and corporate codes of ethics. An ethical "mistake," on the other hand, is an act that is not deliberately unethical, and is something an individual or group regrets afterward and desires to undo (Rossy, 2011). The following three components separate unethical actions from ethical mistakes:

Intentionality—did you harbor good or bad intention? Were you aware that you were doing something wrong? Did you attempt to hide or cover up your motives? Remorse—did you recognize and regret your unethical behavior? Or did you regret only being found out and exposed? Accountability—were you willing to own up to your mistakes and take responsibility for any unethical actions? Were you ready to try and reverse your actions and set things right? (Rossy, 2011)

The next four sections focus on ethics in business, amplifying the nature of ethical issues and dilemmas, revealing the unprecedented extent of unethical behavior, offering some guidelines for dealing with ethical dilemmas, and discussing the extent to which ethics can be taught.

Discussion Questions

1. Does obeying the law make a person "moral," and breaking it "immoral"? Discuss the reasons for your answer.

2. Can ethics vary from country to country? If you think so, provide an example of a country in which principles, norms, and standards of conduct are different from the United States, and provide as much detail as you can (even anecdotes).

3. Is a dictator moral, immoral, or amoral? Give reasons for your answer and an example that could validate your answer.

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Ethical issues arise when people succumb to pressure to achieve results. Executives manipulate stock prices to increase value, students cheat to get higher grades, and workers produce inferior products to increase production rates.

Lisette Le Bon/SuperStock

10.2 Ethical Issues and Behavior The chairman of AOL Time Warner Book Group was having dinner in New York one evening with John Maxwell, a prominent author on leadership issues from a Christian perspective, and suggested he'd be the perfect fellow to write a book on business ethics. "There's no such thing," replied Maxwell. When asked what he meant, he said, "There's only ethics." This conversation spawned the title of the book Maxwell came to write (Maxwell, 2003).

People get into trouble when one set of ethics or values governs their private life and another their working life. For example, a typical sales employee might say, "I'm an honest person, but it's OK to pad my expense report because that's what everyone in the company does." In fact, many people are ethically duplicitous without realizing it. As Maxwell says, "The same person who cheats on his taxes and steals of�ice supplies wants honesty and integrity from the corporation whose stock he buys, the politician he votes for, and the client he deals with in his own business" (Maxwell, 2003).

Ethical issues arise whenever people are tempted to behave unethically or not do the right thing. Maxwell lists the �ive most common things that give rise to unethical responses:

Pressure to achieve results when things aren't going as planned, which is why people often "cook the books," cut corners, or "bend the rules." Students often cheat to get higher grades, executives manipulate information to increase stock price, factory workers produce inferior products to reduce costs or increase throughput rate. Many of us are under pressure—in 2005, the Ethics Resource Center conducted a national survey of U.S. employees and found that 10% of them at all levels reported feeling pressure to compromise ethical standards (Treviño & Nelson). The desire for pleasure (if it feels good, do it) leads people to live beyond their means, abuse drugs (of all kinds), suffer divorce and broken homes, and so on. Executives that have achieved an elevated compensation level may do whatever they must to preserve their lifestyle. The consequences are never worth the promise of the temptation and are almost always regretted later. Abusing the power a person has been given. This, too, can act like a drug: "having power is like drinking salt water. The more you drink the thirstier you get" (Maxwell, 2003, p. 80). Powerful executives may develop a sense of entitlement. They believe that they and the institution are one, so they can take what they want when they want it (Abraham Zaleznik, as quoted in Maxwell, 2003). Those who want to keep their power at all costs are also most likely to compromise standard ethical behavior to do so. While pride itself is not a bad thing—after all, we have all been brought up to take pride in ourselves, our work, our family, and our country—having an exaggerated sense of pride and self-

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worth (hubris) is destructive. Pride is essentially competitive; one is proud only of being richer, smarter, or better looking than others. If everyone else were as rich, smart, or good looking, there would be nothing about which to be proud. If your goal is to outdo everyone else, then your focus is entirely on yourself and your own interests (Maxwell, 2003). "Pride can blind you to your own faults, to other people's needs, and to ethical pitfalls that lie in your path" (Maxwell, 2003, p. 86). Priorities. German poet and novelist Johann Wolfgang von Goethe said, "Things that matter most must never be at the mercy of things that matter least" (Quoted in Maxwell, 2003). Is being liked by others the most important thing to you? Is keeping your job more important than doing the right thing, like, blowing the whistle on some malfeasance? Do you know what your priorities are?

The following breakdown broadens our understanding of ethical issues in the corporate world:

Human-resources issues. An obvious example of this type of ethical issue is discrimination, which can lead to rampant unfairness. Sexual and other types of harassment may take the form of an individual in a hierarchy taking advantage of their position to use power to control others lower in the organizational structure. Harassment may also occur between peers and result in a hostile work environment for those who are the objects of the unwanted attention. Con�licts of interest may take many forms such as bribes and kickbacks, inappropriate in�luence, and the use of privileged information to bestow favor on special friends or interests. Customer-con�idence issues. In many business situations a person may be privy to con�idential information, which they may not reveal regardless of their position. To breach that con�identiality and divulge such information is a serious ethical violation. Product safety issues, whether the dangers to consumers were intentional or not, also fall into this category. When products are misrepresented, hyped beyond the bene�its they provide, or false claims are made, this transgresses truth in advertising ethical boundaries. In professions that handle other peoples' money, such as stockbrokers, there is an ethical obligation called �iduciary responsibility to base all actions on the best interest of the client. A stockbroker making an investment of a client's money for which the only motivation is the stockbroker's commission would be a violation of the broker's �iduciary responsibility. Issues arising from the use of corporate resources. These issues range from what may seem to be mundane to the extremely serious. Many people do not give a second thought to making personal calls from work, taking a long lunch or break, or taking stationery products from the supply room to use at home. All of these are examples of stealing company resources. Using company letterhead for personal reasons or allowing a personal view to be construed as the company's are misappropriations of the company's reputation. Most people would clearly recognize the ethical wrong in falsifying data to make a company's �inancial results look better or receive approval for a new drug (Treviño & Nelson).

The root problems in most of these instances are unfairness, lack of respect, and self-interest.

Discussion Questions

1. This section introduced the notion that people behave unethically rather than bear the costs of ethical behavior (an economic reason). Do you think this is prevalent in corporations today? Why or why not?

2. We have all heard of the Golden Rule: "Do unto others as you would they do unto you." According to John Maxwell, it is the only guide to ethics one needs. Do you agree?

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3. Assuming you do the "right" thing all or most of the time, how do you know it? Elaborate on your answer as best you can.

4. Ethics exist in law, business, medicine, and other spheres of life, even politics. Other than the settings in each sphere, would you say that the concept of ethics was the same or different in all spheres? Discuss.

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In the case of Bernie Madoff's Ponzi scheme, greed overruled all ethics. Madoff received a long-term prison sentence for bilking investors out of billions of dollars.

Stephen Chernin/Getty Images News/Getty Images

10.3 Unethical Behavior

Every day brings new reports of some new ethical violation or the disposition of a case brought against someone or a company for unethical behavior. Unethical behavior consists of conduct undertaken to bene�it a person or organization while knowingly (or being oblivious to the possibility of) harming others. Behavior is still considered unethical if the act is wrongful, whether or not it results in harm, for example, a deceitful representation even though not acted upon (Christopher D. Stone, J. Thomas McCarthy Trustee Chair in Law, University of Southern California Gould School of Law, personal communication, October 3, 2011).

Many cases involve greed, like the Ponzi scheme run by Bernard Madoff, a former chairman of the board of directors of the National Association of Securities Dealers (NASD). Madoff used money from new investors to pay "pro�its" to old ones until the situation imploded and the scam was revealed. People who trusted him with their investments lost billions of dollars. Another type of greed-induced unethical behavior is illustrated by the case of Raj Rajaratnam, founder of the Galleon Group, an international hedge fund based in New York. In 2011, Rajaratnam was convicted of securities fraud and conspiracy for insider trading and sentenced to 11 years in prison, the longest-ever term imposed for that type of offense. Unlike Madoff's Ponzi scheme, which swindled identi�iable victims directly of speci�ic amounts of money, insider trading cheats "the system" including all those investors who are not privy to the information on which pro�itable trades are made. At the heart of the prosecutors' case was an allegation that Mr. Rajaratnam gained access to con�idential information about a $5 billion investment in Goldman Sachs by Berkshire Hathaway Inc. in 2008 during the �inancial crisis. Prosecutors described an environment of rampant insider trading on Wall Street of which the defendant was only one prominent offender. In pronouncing his sentence, U.S. District Judge Richard Holwell stated that the billionaire investor's crimes "re�lect a virus in our business culture that needs to be eradicated." In addition to the prison term the judge also ordered Mr. Rajaratnam to pay a $10 million �ine and forfeit $53.8 million (Pulliam & Bray, 2011).

Not all unethical behavior can be attributed to an individual acting out of the prospect of personal gain. Companies may collectively make unethical decisions that result in harm to others. Workers on the Deepwater Horizon oil platform in the Gulf of Mexico were concerned about safety on the rig months before the oil rig exploded but feared retribution and retaliation if they reported problems. In particular, employees reported that drilling took priority over maintenance that could have ensured safety. The explosion killed 11 employees and resulted in history’s largest accidental oil spill. The oil killed large

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Company consumer contracts' �ine print allows a �irm to change the terms as they see �it at any time, initiate higher fees, and forbid consumers from �iling lawsuits.

Kai Chiang/iStockphoto/Thinkstock

numbers of wildlife, shut down crucial industries such as �isheries and tourism in large areas of the Gulf of Mexico, causing billions of dollars of economic damage and affecting untold numbers of people directly and indirectly (Urbina, 2010).

Entire industries may be tarred with the brush of unethical behavior in the interest of making pro�its. For decades the tobacco industry fought a cynical campaign to deny and discredit extensive research that demonstrated the very serious health risks of smoking. In the meantime, the tobacco companies were among the largest spenders on all forms of advertising to induce people to become addicted to smoking. As we all know, they �inally lost their protracted case, and it has been conclusively shown that executives were aware of the dangers even as they denied it publicly. Tobacco ads are no longer allowed on television, and it is now illegal to smoke in many public places such as restaurants, movie theaters, museums, aircraft, and so forth. Some states such as California have gone further, banning smoking in parks, apartment-complex balconies, and on the beach. There is now no disputing the fact that tobacco kills, yet these same tobacco companies continue to expand their markets for cigarettes around the world and get new generations addicted to smoking. The

argument often used to justify their actions is that tobacco is a legal product. Of course, if tobacco was a new product being introduced to the market today, with all the attendant proven health effects, there is no question that it would be immediately rejected by regulatory agencies as unsafe.

What about new drugs and medical products rushed to market without adequate testing or approval? In 2010, DePuy Orthopaedics, a unit of Johnson & Johnson, issued a global recall of its ASR XL Acetabular System and Hip Resurfacing System (hip implants) because of growing problems with the products and for selling them and other products without FDA approval (Kavilanz, 2011). Also in 2010, France's health regulators issued a recall of pre�illed silicone breast implants manufactured by Poly Implant Prothese (PIP), a French company, and said to affect 35,000–45,000 women worldwide. The gel used in them was unauthorized, and the implants have been associated with abnormally high rupture rates (PIP breast implant recall, 2010). In these examples, the companies involved paid for reparations to victims—and PIP was even shut down.

An ethical concern that may not be as obvious as the preceding examples because the harm is harder to identify has to do with the immensely complicated "�ine print" that we seem to confront on an increasing basis. Every time we install or update a software package we are required to accept a lengthy user agreement �illed with legalese unintelligible to (and ignored by) most people. Hidden among the verbiage often are clauses that have been described as "weasel words in contracts that allow a company to change the terms at any time, or lay the groundwork for sky-high fees, or that forbid a consumer from �iling a

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lawsuit." Web service providers such as Facebook and Google have attracted �irestorms of protest when they have decided to make unilateral changes to their privacy policies that invariably give the companies more freedom to make commercial use of the users' information or browsing habits and eroding what little is left of the individual's privacy. As Web entrepreneur David Hirsch commented in an interview on the burgeoning practice, "This �ine-print world we're living in is bad for consumers, bad for business, and bad for the country. You've got people not understanding what they're agreeing to, and they're getting clobbered" (Lazarus, 2011).

It may be glib to say that executives cheat, lie, fudge, and line their own pockets because they can, or because it's unfortunately more acceptable nowadays, or because no one will �ind out. But isn't this at the heart of ethical behavior—to do the "right" thing, even when no one is looking? Doing otherwise is unethical, and there must be many more unreported instances where people and organizations intentionally get away with such behavior, thus, in their minds, legitimizing it.

Case Study Corporate Ethics

On January 13, 2012, Carnival Corporation's Costa Concordia cruise ship ran aground a reef and capsized off the Italian coast after its captain, Francesco Schettino, steered the ship off the approved course. The ship sustained a hole in its hull greater than the length of a football �ield, causing it to take on water immediately. The chaos that ensued aboard the ship of panic- stricken passengers futilely seeking information and a disorganized evacuation was heavily reported in international news reports. Surviving passengers even reported that the ship's safety brie�ing hadn't been conducted at the time of the disaster and wasn't scheduled until the next day—three days after the ship sailed. And this is just the beginning of the ethical issues that arose in the days following the crash.

The captain's ethics were called into question when reports emerged that he had an unauthorized female companion on the ship's bridge at the time of the crash with whom he'd also shared dinner and wine just minutes before, that he was performing a close "sail-by" to show off to the residents of the Island of Giglio or to "salute" a friend living on the island. Days later, recordings of conversations between the captain and Italian Coast Guard of�icials revealed that he had abandoned ship and was aboard a lifeboat before most of the ships passengers were evacuated. The Christian Science Monitor concluded that Schettino had engaged in "a pattern of untruths and attempted coverup" (Marquand, 2012, para. 1).

Carnival's corporate ethics were called into question, as well. For example, Schettino later de�lected attention from his initial "salute" story with the claim that his corporate managers told him to take the ship close to the shore as a publicity maneuver. Surviving passengers described chaos aboard the ship as language barriers, an unskilled crew, passenger lack of knowledge about evacuation procedures, and malfunctioning lifeboats all contributed to fear

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and panic. Reports indicate that passengers were initially told that the problem was an electrical failure; in an amateur video shot by a passenger, a crew member is heard telling passengers: "The situation is under control. Go back to your cabins. We ask you that you all return to your cabins. Once the electrical problem is sorted out everything will be back to normal shortly. Everything is under control. We are resolving the problem" (Pisa, 2012). An hour passed before the Captain ordered everyone to abandon ship, plunging nearly 4,000 people into complete chaos. During evacuation, crew members appeared to have little control and offered minimal support to panicked passengers—calling into questions corporate safety procedures.

Subsequent to the disaster, the corporation's moral compass was questioned when Carnival authorized call center employees to phone survivors and offer "30% off their next voyage." News accounts and editorials have labeled the offer "insensitive" and "crass," indicating that the decision to offer the discounts was an ill-conceived strategy for promoting company loyalty that might, in fact, further damage the cruise line's reputation (Costa Concordia disaster, 2012).

Finally, the wreck posed a grave threat to the maritime environment and the health and safety of coastal residents amid fears that the ship's 17 fuel tanks might begin to leak into the sea. As National Public Radio noted, "What do you do with a 1,000-foot wreck … Remove it. Very carefully" (Neuman, 2012, para. 1). The article further noted that removing the wreck involved "logistical and environmental issues that are just as large" as the ship (Neuman, 2012, para. 5).

Question for Critical Thinking and Engagement

Assume the role of a consultant hired by Carnival Corporation. Prepare a brie�ing on the critical issues that executives, management, and other leaders should address. What recommendations would you make to the corporation relative to public concerns about employee ethics, corporate safety policies, and the impact of this disaster on the environment?

Discussion Questions

1. List as many reasons as you can why a company would wish to abide by ethical standards. Organize the reasons based on whether they are morally or economically motivated.

2. Do you think business executives, particularly CEOs, have a general public image of behaving sel�ishly and unethically? Do you think that reputation is deserved? Discuss.

3. Imagine you are looking for a job. Is the company's having an ethical culture or behavior important to you? If so, how would you go about determining this?

4. Imagine you are hiring people. Your company is proud of the fact that it makes a pro�it by being ethical. How would you ensure you are hiring people with a similar ethos?

5. Cite some examples of trust in business from your personal experience or from reading the newspapers. What happens when trust is lost?

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6. What other industries not discussed in this section have also succumbed to unethical behavior? Cite examples to justify your choices.

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The German philosopher Immanuel Kant believed that moral decisions should be based upon the one principle he called the "Categorical Imperative"–act as if the maxim of your action were to become the general law.

De Agostini Picture Library/De Agostini/Getty Images

10.4 Ethical Dilemmas and How to Approach Them

Every person will be faced with ethical dilemmas throughout life; it is inevitable. By de�inition, the "right answer" is elusive. An ethical dilemma arises when a person is presented with a choice (ordinarily of action) in which one consideration is the rightness or wrongness of the action (Christopher D. Stone, J. Thomas McCarthy Trustee Chair in Law, University of Southern California, personal communication, October 3, 2011). Some ethicists evaluate the action in itself, whatever the consequences. Consider a situation in which a person is attempting to shoot someone but realizes too late that the gun isn't loaded; the act is unethical even though the target didn't die. Others focus their evaluation on the consequences. For example, lying, which is a "bad" act, may have good consequences. Within the workplace, the "right thing to do" is usually complicated by time pressures and con�licting �inancial and political demands, and often comes with a price tag. While we never seem to have the right answer when we need it, there are �ive questions we can ask ourselves when faced with an ethical dilemma that might well help us avoid making the wrong decision:

1. What's in it for me? How will my loved ones and I bene�it, and what price will I pay in terms such as time, money, effort, and reputation? To fully understand what in�luences your self– interest in a situation, it can be helpful to ask, "Would I be comfortable sharing my real motives with the public?"

2. What decision or action would lead to the greatest good for the greatest number? This presupposes that one knows and understands the legitimate interests and values of others. John Stuart Mill's classic work on utilitarianism holds that the preferred decision is the one that will return the highest net social bene�it to all stakeholders (those people who might be affected by the outcome) (Mill, 1906). Value con�licts can make achieving such a noble outcome dif�icult; how do we de�ine the "greater good"? Many environmental and air-quality regulations, for example, are motivated by a desire to protect the general public and act in its behalf.

3. What laws, regulations, and written or unwritten social norms apply in this situation? German philosopher Immanuel Kant thought that moral decisions should be made by following a principle he called the Categorical Imperative; behave as though the maxim of your decision were to become a general law, required of all people. Patricia Werhane, Director of the Institute for Business and Professional Ethics at DePaul University, asks the following germane questions implied by such a rule-based perspective:

Does the action set positive or negative precedents? Is the action acceptable to other reasonable persons? Is it applicable to other similar situations? Does it respect, or at least not denigrate, human dignity? (Werhane, 1994)

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4. What are my obligations to others? To understand this, one has to appreciate the role of reciprocity and trust in society. Reciprocity is a universal norm common to all human cultures; it is embodied in the Golden Rule. Implicit in this view is that people have to trust one another. How do you feel when someone you've previously helped rejects your request for help? Will you ever forget when someone you have helped many times doesn't reciprocate?

5. What will the lasting impact be on me and on my key stakeholders? Informed self–interest requires looking at the big picture and assuming that one's self–interest is aligned with societal interests. That is, one's self-interest rests on doing what is right for others. For example, consider the actions of environmentalists and others who make sacri�ices for societal movements.

These �ive questions in fact constitute a framework for identifying ethical dilemmas and help think through any inherent con�licts among the values and obligations they underscore. The following three criteria will help you to choose from and resolve those con�licts:

Priority. In this instance, which questions are most applicable to the key values held by you and your company? Balance. If you must compromise among your values, which is the best tradeoff? Acceptance. How well will your decision and rationale fare if submitted to public scrutiny? (Rossy, 2011)

In conclusion, ensure that you consider all �ive questions before making a decision. Always keep in mind the pivotal role of values when assessing the implications of the issues at hand. Compare the short- and long-term consequences. Take your time and avoid the urge to give into quick solutions that may be too good to be true. Go with your instincts, but remain open to counsel and advice. And be brave—sometimes the ethical answer can be politically unpopular. As a way of thinking through the ethical criteria just presented, consider the following examples of common, everyday situations that many employees face, and answer the related questions.

Everyday Ethics

Sheryl often takes home pens, pencils, printer paper, and other small of�ice supplies for her personal use—even though she doesn't perform any work from home. Is Sheryl's behavior ethical or unethical? Why or why not? Is there any "gray area" to what Sheryl is doing? In other words, under any circumstances, is her behavior ethical? What are the potential consequences of Sheryl's behavior to others? To her organization? How about to herself?

In order to get some new business, Phil overpromised, knowing his company couldn't deliver. He told the prospect that their orders would be delivered within 14 days, when he knew that deliveries have been taking 30–45 days. He also told the client that technology platforms were updated annually. However, due to the recent economic downturn, Phil knew that the platform hadn't been updated in over three years. What are the potential consequences of Phil's distortions? Is Phil's behavior unethical, or is he just doing what it takes to stay competitive in a tough economic climate?

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Suzanne works in management for a pet supply retail chain and is upset by some questionable corporate policies about how small animals sold by the store are cared for. For example, she is not permitted to schedule cage cleaning for the hamsters and birds as often as she believes is necessary for their optimal health and well-being. What are her options? Are there any risks to Suzanne should she decide to expose her employer's policies? Do the bene�its of blowing the whistle on corporate policy outweigh the risks?

Cathy gets to work in the morning at the required hour, and spends about 20 minutes having coffee with her friends before heading to her desk. Cathy then spends the �irst hour of her day checking her personal e-mail, Facebook account, and even online dating sites. By about 10:00, she starts working; but she keeps Facebook and her personal e-mail account open throughout the day. Is Cathy's behavior ethical or unethical? Is there any "gray area" to what Cathy is doing? In other words, is her behavior acceptable? Would the answer be different if she is able to complete her assigned tasks and meet deadlines?

Eric is a supervisor for a transportation company that has several government contracts. This work is obtained through a strict competitive bidding process regulated by the federal government. He recently discovered that a coworker responsible for preparing project bids is having an affair with an insider at the government agency. Is the activity that Eric has observed (or learned of) unethical? Why or why not? If Eric is reasonably sure that the information he's learned is accurate, would it be unethical if he chose to ignore it? Why or why not? What are Eric's options?

Discussion Questions

1. Consider the case of a highly pro�itable public company that is rewarding its stockholders with capital gains on rising stock prices and dividend payouts. It is also awarding its top management generous compensation packages with guaranteed bonuses. Its rank-and-�ile employees, however, don't get raises or bonuses or otherwise realize the effects of such impressive corporate performance. In fact, the pro�it is achieved by keeping labor and other costs down. Is this an ethical issue? Do such companies perceive it as an ethical issue? Why or why not?

2. The role of unions has been to give a voice and some power to employees as stakeholders. Have they balanced the ethical issue? Do you see the rise in power of unions as a bad thing because they constrain what management can do and increase labor costs? Discuss.

3. If a corporation did not have an ethics of�icer, to whom would someone report a breach of organizational ethics? What if the alleged perpetrator were that person's manager?

4. When are ethics and ethics standards especially important in companies? 5. Companies often require that their employees work long hours or travel extensively. If you worked for such a company but had young children or elderly relatives to care for, you might �ind that your career would be jeopardized if you declined these additional work

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pressures. Is it unethical for a manager or a company to expect so much of employees despite their needs as parents, caregivers, or other life outside work? Discuss.

6. Is employing illegal migrant workers ethical? Why or why not? What is the nature of the dilemma?

7. Why do companies do business with other companies in China or Indonesia given unsettling reports one hears concerning labor practices? Is saving a few extra dollars the most important thing? Do companies realize that by doing so, they are helping perpetuate such practices?

8. Companies don't give a second thought to outsourcing jobs to lower-cost countries. Does the end (making pro�its) always justify the means? What does it say about the companies' attitude to its workers?

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Ethics classes may teach ethics, but by the time students get to college, most have learned their personal values from their family environment.

Associated Press/Matt Houston

10.5 Can Ethics Be Taught?

Today, every business school includes courses in ethics or requires ethics to be a part of every course in its curriculum. Judging by the results, however, the regular reports of unethical practices in business suggest the requirement hasn't made much difference. An informal poll of students in a business program a few years ago posed two questions: "Would you cheat if you knew for certain you would not be found out?" and "Would you cheat if everyone else was cheating?" Sadly, over 85% of the students answered "Yes" to each question. This experience seems to be shared by many instructors in business education. College business students are more likely to practice academic dishonesty, such as plagiarizing or cheating on exams, than students who are pursuing different majors or careers (McCabe & Treviño, 1995). Based on research showing that business- school students' moral reasoning skills may be ranked lower than students in philosophy, political science, law, medicine, and dentistry, business students may require increased ethics training (McCabe & Treviño, 1993). Lester Thurow, former Dean of the Sloan School of Management at MIT, believes the foundation of ethics must begin with family, clergy, schooling, and the jobs students hold prior to business school (Treviño & Nelson, 2007).

In the mid-'90s, Joseph Badaracco, an ethics professor at Harvard Business School did some research on MBA graduates that had taken an ethics course at Harvard and faced ethical dilemmas in the business world. Fifty percent of them had been employed by companies with of�icial ethics programs. He wrote: "Corporate ethics programs, codes of conduct, mission statements, hot lines, and the like provided little help . . . the young managers resolved the dilemmas they faced largely on the basis of personal re�lection and individual values, not through reliance on corporate credos, company loyalty, the exhortations of senior executives, philosophical principles, or religious re�lection" (Badaracco & Webb, 1995, p. 9). In other words, their personal integrity came from their upbringing rather than from ethics courses.

To �ind out how students felt about the business world, another professor asked his students a series of questions, one of which was whether they would dump known carcinogens in a river. Astonishingly, the students said that they would, claiming if they did not, someone else would. When asked if such a pessimistic environment was one in which they would like to live, students made the argument that they already lived in one. Disheartened, the professor concluded that his students' attitudes had been shaped long before his course began. He decided, as others had before him, that as a society, our obsession with money and material goods was producing future generations eager to succeed at any cost (Treviño & Nelson, 2007).

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People, it turns out, are taught values early in life. If they do have a set of values that includes honesty, fairness, and sel�lessness, being around others that dismiss their values out of self-interest will quickly erode them. Parents will attest to changes that take place when their teenage children begin paying more attention to their peer group than to them. It becomes really challenging when people learn that in order to "win" (whether it's passing a test or climbing the career ladder), they have to sacri�ice their values and ethics.

Boys and girls that participate in sports in middle and high school and college are fortunate because, besides acquiring skills and stamina, they are taught the ethics of good sportsmanship and other character-building traits, such as teamwork, discipline, and sacri�icing individualism for the team. Unfortunately, there are coaches—and parents—that preach winning at any cost. In some sports such as track & �ield and cycling, we have almost reached a point where there is a presumption of guilt against those who are successful. When athletes in any sport are caught cheating, the common refrain is that "everyone else is doing it so I had to as well just to compete."

To conclude, the values and ethics ingrained in us from a very early age by our parents and family are the most reliable indicator of how we will fare when ethically tested later in our careers, no matter what those careers are. However, even people with good values and ethics can, when thrust into morally and ethically wanting corporations, behave unethically. When told by your manager to fudge some data or do something else that's wrong, do you comply in order to remain in their good graces and stay on that fast track up the corporate ladder, or do you stand your ground and risk not only your prospects but also your job? And when you are a few years from retirement, do you succumb to such demands or lose everything, knowing that getting another job at your age is highly unlikely? It is the unusual corporation that develops an ethical system and culture to make sure that employees behave ethically and want to behave ethically. One way that organizations can teach, encourage, and promote ethical behavior is by creating and modeling social responsibility and good citizenship through policies. Corporate social responsibility policies will be covered in the next section.

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Economist Milton Friedman considers a corporation's sole responsibility to society to be to make a pro�it and continue to create wealth and jobs.

George Rose/Hulton Archive/Getty Images

10.6 Corporate Social Responsibility

Perceptions of corporate social responsibility vary widely. As University of Chicago economist Milton Friedman wrote almost 50 years ago: "Few trends could so thoroughly undermine the very foundations of our free society as the acceptance by corporate of�icials of a social responsibility other than to make as much money for their stockholders as possible" (Friedman, 1962). Many people still believe, like Milton Friedman, that a corporation's sole responsibility to society is to make a pro�it so it can continue to provide jobs for people and thereby sustain communities and standards of living. To many others, corporate social responsibility (CSR) is so much more. For example, The Gap Inc. has a comprehensive social responsibility commitment that encompasses a youth development program, an environmental protection plan that addresses supply chain and in-store issues, and community investment that confronts social challenges (Gap, n.d.).

CSR is the idea that business has a duty to serve society as well as the �inancial interest of stockholders (Pierce & Robinson, 2005). CSR was conceptualized by Archie B. Carroll of the University of Georgia as a pyramid that represents various kinds of social responsibility (Figure 10.1). Economic responsibilities, at the base of the pyramid, are met by all well-managed corporations; the ones that aren't well managed fail or are acquired. The economic responsibility is to make as much pro�it as possible in order to create wealth and jobs. Then follow in order of importance legal, ethical, and philanthropic responsibilities. The pyramid is useful because it not only provides a structure for discussion but also demonstrates the complexities of the topic—different people perceive CSR to mean different things.

Legal Responsibilities

Companies are duty bound to honor the law and not break it in whichever country they do business. This is called their legal responsibilities. As was discussed earlier, many regulations and laws are enacted to protect the public and the public good, and there are a plethora of government agencies responsible for enforcing them, including the following:

The Securities and Exchange Commission for ensuring the proper functioning of the securities industry (online and stock exchanges) and the integrity of �inancial reporting for public companies Occupational Safety Health Administration for ensuring safety in the workplace The Environmental Protection Agency for protecting the environment The US CPSC, while not a government agency, still has the authority to ensure the safety of consumer products sold in the United States

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The Internal Revenue Service for collecting taxes owed the federal government The National Labor Relations Board for minimizing unfair labor practices and ideally preventing them from happening

Figure 10.1: Corporate social responsibility pyramid

Source: From A. B. Carroll, "The pyramid of corporate social responsibility: Toward the moral management of organizational stakeholders." Business Horizons, Vol. 34 No. 4, 1991, pp. 39-48. Copyright © Elsevier. Used with

permission.

These agencies came into being to enforce appropriate regulations and laws to prevent corporations from in�licting harm on particular constituencies—investors, workers, consumers, the environment, and so on. Corporations know about these laws and the consequences for breaking them; it is their obligation to the shareholders and employees to be aware of the laws. Despite this, they may commit both errors of commission (they know about the laws but still try to circumvent them) and omission (they are not aware of particular laws or their consequences or don't agree with them). But are these laws effective? Do they succeed in changing the corporate behavior that is at the root of much malfeasance?

As far back as 1975, Christopher Stone (1975) of the University of Southern California Law School explored this very topic. He found maximization of pro�its to be the dominant characteristic of corporations and that, by and large, corrective actions by the law in terms of �ines and penalties for wrongdoing had little effect on changing behavior. They were perceived as a "cost of doing business" so long as they were a relatively small percentage of pro�its, so �irms simply paid them and then went about business as usual. In 2011 United States District Court Judge Jed Rakoff took a strong stand from the bench regarding the culpability of �inancial institutions in the mortgage crisis that contributed to the recent recession. He refused to approve a boilerplate agreement between Citigroup and the Securities and Exchange Commission to settle a civil fraud case in which Citi was accused of having loaded a $1 billion mortgage fund with securities that it believed would fail. Citi sold the fund to investors and then it bet against its customers and reaped enormous pro�its when values declined. The settlement Rakoff rejected called for Citigroup to pay $285 million, which the judged described as "neither fair, nor reasonable, nor

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Corporations dislike becoming ethically responsible of their own volition. Ralph Nader and others formed Campaign GM to buy GM stock and wage a proxy �ight against GM, urging them to adopt stricter testing and environmental standards.

Vince Mannino/Bettmann/Corbis

adequate, nor in the public interest." He characterized the $285 million �igure as "pocket change to any entity as large as Citigroup," and stated that large �inancial institutions regard such penalties "as a cost of doing business." In reaching this opinion, Judge Rakoff noted that Citigroup had settled similar cases with the SEC in the past and promised not to repeat the same behavior. The judge, in rejecting the agreement referred to Citi as "a repeat offender" (Wyatt, 2011).

To make penalties so severe as to jeopardize a company's ability to continue to produce goods and possibly force it out of business would be counterproductive and perhaps viewed as overregulation. Stone made persuasive arguments in his book that the law, as part of the punishment for speci�ic kinds of wrongdoing should insert into the corporation a probation of�icer or trustee, answerable to the court, to make sure that procedures are changed and that the problem would not recur. The types of offenses for which he envisions this type of remedy include the kind where the source of the problem could be ascertained, like the poor design of a car, quality of materials purchased not checked, cooking foods to the wrong temperature, lack of quality inspections, and the like.

It seems that laws and regulations play a necessary but far from suf�icient role in trying to get corporations to behave more responsibly; so long as corporations can absorb the costs incurred when they are indicted, in all likelihood they will continue to do whatever they want in pursuit of pro�it. The best solution, as Stone surmises, is for corporations to want to behave ethically. While a good number do, that number is not nearly large enough.

Ethical Responsibilities

Notwithstanding the ethics of individuals within a company, companies themselves are often reluctant to become ethically responsible on their own. They are typically pushed to do so by critics or stockholders. Campaign GM, formed by Ralph Nader and others, bought stock in General Motors and proceeded to wage a proxy �ight to force GM to adopt stricter testing and environmental standards and to put women and representatives from minority groups on its board of directors. Corporations have found themselves trying to satisfy their critics while at the same time hoping the critics would go away. How could corporations become socially responsible if their management couldn't, even in principle, determine what their social obligations were (Wyatt, 2011)?

Corporations and researchers developed a new idea—instead of being socially responsible, why not be socially responsive? As long as a company was "responsive" to the demands of society and tried to anticipate and meet these demands, it didn't have to worry about being "responsible." In other words, it

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In U.S. culture, wealthy individuals and businesses are expected to share their good fortune. Many of the wealthiest billionaires in the United States are proli�ic philanthropists. Bill and Melinda Gates top the list, having given $24 billion to their Bill and Melinda Gates Foundation to help bridge the gap in human health between the developed and developing world.

Eric Piermont/AFP/Getty Images

would have no obligation to be moral or ethical. Corporate social responsiveness is primarily pragmatic and perverts the connection between ethics and strategy. It is simple, easy, and wrongheaded (Freeman & Gilbert, 1988). It conveniently sidesteps the true notion of responsibility.

Ethical responsibilities encompass the more general responsibility to do the right thing and avoid doing undue harm to others. Unless a company's culture and public declarations put a priority on behaving ethically, individual managers will have a hard time being true to their values—swimming against the tide, so to speak. It is much easier to "go along" if it's okay with everyone else. In the rare instance when it's not okay, that individual will tender his or her resignation and join a company whose values are aligned with the individual's own.

Philanthropic Responsibilities

Philanthropic responsibilities are voluntary and engage the corporation's participation in activities that promote human welfare and goodwill. These take the form of donations of time or money to any of a number of deserving causes, charities, and civic-related projects. However, because such activities are voluntary and discretionary, failure to be philanthropic is not considered unethical, and some don't consider it even a responsibility (Treviño & Nelson, 2007).

It was Milton Friedman who said, in not so many words, that giving corporate pro�its to charity or using them in a way that doesn't bene�it stockholders was tantamount to stealing from stockholders (Freeman & Gilbert, 1988). Wouldn't it make more sense to return excess pro�its to the stockholders and let them decide to donate the money to causes near and dear to their hearts? What right does the corporation (and its board of directors) have to give

its money away?

Fortunately, many companies feel it is their duty to "give back" to society and to contribute where the need is greatest. When the tsunami of 2004 hit Southeast Asia, companies like FedEx, Abbott Laboratories, and Coca-Cola jumped in to help. Over 100 companies are estimated to have sent $178 million worth of cash and medicine to affected countries, many doing so quietly, not announcing or advertising their contributions (Chandler, 2005). Many corporations also responded swiftly in September 2005 to help victims of hurricane Katrina after it rampaged through Louisiana, Mississippi, and Alabama. Walmart donated over $20 million to aid victims and donated 1,500 truckloads of free merchandise, food for 100,000 meals, and the promise of jobs for all displaced workers (Barbaro & Gillis, 2005). The recent earthquake, tsunami, and resultant nuclear accident that hit northern Japan on March 11, 2011, cost an

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estimated 22,000 lives and an estimated $300 billion, not counting the tens of thousands that were still homeless months later. The nuclear contamination is expected to persist for decades. The �lood of donations and assistance from countries, nongovernmental entities, corporations, and individuals has come from every region of the world. Businesses have provided donations of cash, materials, and services to help the victims. Many, such as Sony and Mitsubishi from Japan, Disney and Goldman Sachs from the United States, and Pak Suzuki Motors from Pakistan have contributed matching funds to supplement employee donations (Philanthropy News Digest, 2011). Again, these are examples of the best of human nature, coming to the aid of those less fortunate and in dire need.

In the United States, there is a tradition of philanthropy on the part of wealthy individuals and businesses. In support of this, the federal tax code includes tax incentives to do so. Many of the wealthiest individuals and families in the United States are proli�ic givers. Bill Gates tops the list, having given generously to The Bill and Melinda Gates Foundation over the years to help bridge the gap in human health that exists between the developed and developing world (Treviño & Nelson, 2007). Warren Buffet, arguably the most successful investor in recent history, has, in addition to donating in excess of $9.5 billion to the Gates Foundation alone, committed to donating the bulk of his fortune to charity on his death. Further, he has persuaded more than 40 other billionaires to pledge the majority of their fortunes to charity during or after their lifetimes. The commitments by these benefactors are expressed in personal letters from each at Giving Pledge.com, describing the role philanthropy has played in their lives.

Other forms of philanthropy support the arts (such as symphony orchestras, opera companies, and museums), city beauti�ication projects (such as commissioning a work of art or a garden), scholarships for students, research facilities at universities, hospitals, libraries, and so on. Many high-pro�ile contemporary organizations have signi�icant corporate social responsibility programs. For example, retailer Target contributes 5% of its income to programs bene�itting local communities with a Target presence (Target.com, 2008). Philanthropy goes beyond "doing the right thing," because it is something no one has a right to expect but something for which everyone is thankful.

Many of America's cities owe their greatest cultural features—museums, artwork, buildings, auditoriums, schools, and community facilities to the philanthropic efforts of corporate families such as the Carnegies, Rockefellers, Vanderbilts, and many more. Just walk around any university campus, and the names of some of those who have donated to fund education will be evident in the names of the buildings.

Environmental Responsibilities

Externalities are costs to society, such as air and water pollution, that are produced by companies but not re�lected in the company's cost structure (Kuttner, 1997). Historically, it was cheaper for such companies to pollute than not to; pro�its won out over the harm being done to society. The only way to protect society was through regulation. Thus, despite the aversion that companies have for regulations, not all are bad; some force an ethical standard on companies that otherwise would be ignored.

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For consumers, the bene�its of using nuclear power rather than fossil fuels are overshadowed by the risk of nuclear accidents, such as the one that occurred at the Fukushima nuclear facility in Japan in March of 2011.

Associated Press/Tokyo Electric Power Co.

Because environmental responsibilities was not included in the pyramid shown in Figure 10.1, one shouldn't assume that they are "less important" or of a "lower order" of responsibility than philanthropic responsibilities. On the contrary, they are a vital part of corporate social responsibility and becoming more so with each passing year.

What we are talking about here is a company accepting responsibility for and reducing the adverse environmental effects stemming from its operations. Not only are expectations rising for corporations to become more environmentally responsible but technologies are advancing even faster to make some actions possible that only a few years ago were not. Take genetically engineered crops and genetically modi�ied foods—are they safe, and what will be the effect on farmers in regions where GM crops are planted (Schwartz & Gibb, 1999)? Or consider the case of Paci�ic Gas and Electric's contamination of the water supply in a small California town popularized in the �ilm Erin Brockovich. It turns out that 20 years later, water samples indicate that PG&E has not solved the problem.

Despite this bad news, a growing number of companies are becoming more environmentally responsible — leading one scholar to label the phenomenon business's new "megatrend" (Reid, 2010). For instance, the Coca-Cola Corporation has partnered with communities to restore watersheds (Coca-Cola Company, n.d.). Apple seeks to lead the industry in "reducing or eliminating environmentally harmful substances" from its packaging and the metal and plastic in its parts (Apple and the environment, n.d.); and hotelier Marriott is focused on "integrating greater environmental sustainability . . . through architecture and construction, engineering and procurement (Marriott, n.d.).

While companies are motivated by current pressures and existing laws to "clean up after themselves" in the short term, they resist making investments in causes such as research toward long-term solutions to the adverse environmental impacts of their operations. Generally, the immediate pressures to produce pro�its prevail. Michael Porter has said that pollution is in itself a form of inef�iciency in production, creating negative externalities that until now companies have been able to shift on to the public sector (Schwartz & Gibb, 1999). Will there come a time when the accounting profession begins to include costs for safeguarding the environment as a legitimate cost of doing business? Probably not until everyone in an industry is forced to do the same thing. Of course, in some industries, such costs are much higher than in others (for example, preventing oil spills, nuclear accidents, and tainted food).

Another problem is the growing skepticism the consumers have for technological advances being risk-free. A case in point is nuclear power, where the potential bene�its over using fossil fuels are balanced by the real risks of a nuclear accident such as the one experienced in Japan in March 2011. In a cost/bene�it

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analysis of nuclear power, how do you account for the possibility of a major nuclear accident or the risk in storing irradiated spent fuel for hundreds of years?

But whom do we blame for overly high levels of mercury in seafood? For the dumping of plastic and other indecomposable garbage now swirling in the Paci�ic Ocean in two pools, each the size of Texas? For rapidly depleting the world's supply of fossil fuel? For adding to our global carbon footprint? For changing global climate patterns?

Taking care of negative externalities caused by a particular �irm's operations is one thing, but there is growing evidence of massive environmental damage that is collectively caused, making it dif�icult to pin blame and rendering the law helpless. While I don't have any solutions (nor is this the appropriate forum for delving into the full extent of the problems), becoming aware of the problems is a �irst step, followed closely by nations getting together to try to mitigate them. How bad do they have to get before we are all forced to cooperate and take responsibility for solving them?

Discussion Questions

1. In your opinion, what is the most pressing environmental problem: (a) that particular corporations are responsible for, and (b) that the global community is responsible for. Explain your choices.

2. Why is the law so far behind developments and policymakers even further behind? (Stone's book, for example, is a call for policymakers to act.) Is it because not enough facts are available, or there is too much ambiguity, or the costs of following through too high? Discuss.

3. If companies were suddenly expected to bear the costs of their negative externalities, whether or not you agree that is just, how do you think it will affect their stock prices, their prospects for the future, their investors, and their other stakeholders?

4. Following on from (3), do you believe it will spur innovation and investment in innovation? 5. What particular advantages accrue to companies who proactively take steps to safeguard the environment (like BMW), besides giving them a warm, fuzzy feeling?

6. Just from your perception over the past few years of reading the papers and listening to the news, what has accelerated interest in environmental responsibilities of corporations? Has it been the growth of environmental "watchdogs," investor activism, or consumer pressure? Discuss your thinking.

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Summary

Ethics is about how we meet the challenge of doing the right thing when it will cost more than we want to pay, which is a better de�inition for the business world than the traditional de�inition of "the art and discipline of applying principles and frameworks to analyze and resolve complex moral dilemmas." Morality is knowing the difference between right and wrong and choosing right. Someone who is immoral also knows the difference but chooses wrong. Values are tenets that are important to an individual or group and the ways that govern how they choose to live their life. An unethical act has immoral intent and is done with the full knowledge that it is legally and morally wrong or contravenes the prevailing societal or organizational culture. Unethical behavior consists of conduct undertaken to bene�it a person or organization while knowingly—or being oblivious to the possibility of—harming others. Behavior is still considered unethical if the act is wrongful, whether or not it results in harm.

Why do people behave unethically? In most instances, they are motivated by self-interest. Often they justify such behavior by claiming that other people are getting away with it. Fudging data to make quarterly results look good or to qualify for a bonus, cutting corners to meet production targets, and obeying an order by your manager to cover something up are a few examples of unethical behaviors. Organizations, particularly large ones, are so focused on meeting pro�it goals, buoying their stock price, and pleasing their stockholders that they may go to great lengths to avoid or minimize unnecessary expenditures. This includes a proclivity for externalizing whatever costs they can such as pollution. In some industries it is common for �irms to tolerate �ines and penalties for breaking the law or to settle a lawsuit so long as they are a fraction of pro�its, but continuing to do "business as usual." To some, this is simply a cost of doing business.

Ethical issues arise whenever people are tempted to behave unethically or not do the "right" thing. In the business world they include a host of issues. In the sphere of human resources, they include such matters as discrimination, sexual and other forms of harassment, and con�licts of interest. Customer-con�idence issues encompass con�identiality, product safety, truth in advertising, and �iduciary responsibilities. The use, or misuse, of corporate resources includes such behaviors as co-opting corporate reputation, stealing corporate resources, and falsifying data. The root problems in most of these instances are unfairness, lack of respect, and self-interest.

All of us face ethical dilemmas—a choice in which one consideration is the rightness or wrongness of the action—at some point in our careers. You will recognize you are facing one when you're not sure what the right thing to do is. However, asking yourself �ive questions might help you avoid making the wrong decision: (1) What is in it for me? (2) What decision or action would lead to the greatest good for the greatest number? (3) What laws, regulations, and social norms apply in this situation? (4) What are my obligations to others? (5) What will the lasting impact be on me and on my key stakeholders? Three further questions will aid in resolving con�licts you may encounter: In the current situation, which questions above relate most to your personal and organizational values? If those values must be

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jeopardized, which is the best tradeoff? How well will your decision and rationale fare if submitted to public scrutiny?

It is naive to think that ethics can be taught either in the workplace or in business school. Research has shown that such courses make little if any difference and that one's values and ethics are molded early on in life by our parents, family, church or religious group, and so on. Those values and ethics turn out to be the most reliable indicator of how we will fare when ethically tested later in our careers, no matter what those careers are. However, even people with good values and ethics can, when thrust into morally and ethically challenged cultures, behave unethically.

Corporate social responsibility (CSR) is the idea that business has a duty to serve society as well as the �inancial interests of investors. CSR can be viewed as a pyramid. At the base is economic responsibility, which is in essence the obligation of a corporation to make pro�its, provide jobs, and pay taxes. Many people believe, like economist Milton Friedman, that they are a corporation's only social responsibility.

Companies are duty bound to honor the law in whichever country they do business, which constitutes their legal responsibilities. Over the years, many government agencies have been created to enforce appropriate regulations and laws to prevent corporations from in�licting harm on particular constituencies—investors, workers, consumers, the environment, and so on. While these agencies have been, to varying degrees, effective at enforcing regulatory compliance, it is debatable whether laws and regulations have produced change in corporate ethical behavior. An eminent legal scholar, Christopher D. Stone, surmises that the best solution is for corporations to want to behave ethically.

Ethical responsibilities encompass the more general responsibility to do what's right and avoid doing undue harm to others. Many corporations are reluctant to embrace such responsibilities absent pressure from critics, stockholder groups, and lawsuits. Corporations that have tried to be socially responsive act on the belief that they have no obligation to be moral or ethical. Social responsiveness is primarily pragmatic and conveniently sidesteps the true notion of ethical responsibility.

Philanthropic responsibilities promote company involvement in causes and events that encourage human welfare and goodwill. Since such undertakings are optional, an absence of philanthropy does not mark a company as unethical, and some do not consider it a responsibility. Fortunately, many companies feel it is their duty to "give back" to society and to contribute in times of emergency or disaster, or to fund cultural and civic activities. Philanthropy goes beyond "doing the right thing," because it is something no one has a right to expect but something for which everyone is thankful.

Environmental responsibilities involve a company's accepting responsibility for and reducing the adverse environmental effects stemming from its operations. While a growing number of corporations are voluntarily becoming more environmentally responsible, others must be forced to do so by the regulations. There is also massive environmental damage that is collectively caused, making it dif�icult to assign responsibility to anyone and rendering the law helpless. The law lags behind the need, and policymaking lags behind the law; while changes are occurring, the pace is still too slow.

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Concept Check

Key Terms

amoral Not knowing the difference between right and wrong or not caring.

corporate social responsibility (CSR) The idea that business has a duty to serve society as well as the �inancial interest of stockholders.

economic responsibilities Making pro�its so that the corporation grows and endures while providing jobs and paying taxes.

environmental responsibilities A company's accepting responsibility for and reducing the adverse environmental effects stemming from its operations.

ethical "mistake" An act that is not deliberately unethical, and is something an individual or group regrets afterward and desires to undo.

ethical dilemma A choice (ordinarily of action) in which one consideration is the rightness or wrongness of the action.

ethical issues Arise whenever people are tempted to behave unethically or not do the right thing.

ethical responsibilities Encompass the more general responsibility to do the right thing and avoid doing undue harm to others.

ethics (1) The art and discipline of applying principles and frameworks to analyze and resolve complex moral dilemmas.

ethics (2) Is about how we meet the challenge of doing the right thing when it will cost more than we want to pay.

externalities Costs to society, such as air and water pollution, that are produced by companies but not re�lected in the company's cost structure.

immoral Knowing right from wrong and choosing wrong.

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legal responsibilities Where companies are duty bound to honor the law (in whichever country they do business) and not break it.

moral Knowing right from wrong and choosing right.

philanthropic responsibilities Are voluntary and promote company involvement in causes and events that encourage human welfare and goodwill.

unethical act Is carried out with immoral intent, done with the full knowledge that it is legally and morally wrong or goes against societal or organizational norms.

unethical behavior Conduct undertaken to bene�it a person or organization while knowingly (or being oblivious to the possibility of) harming others. Behavior is still considered unethical if the act is wrongful, whether or not it results in harm.

values The tenets most important to people and organizations and the ways that govern how they choose to live their life.

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Chapter 11

Diversi�ied, Global, and Other Types of Organizations

Belinda Images/SuperStock

Learning Objectives

By the time you have completed this chapter, you should be able to do the following:

Understand the added complexities involved in strategically managing both multibusiness and diversi�ied corporations. Appreciate the different strategies an international corporation can use to expand its markets and the dif�iculties involved in the strategic management of international and global corporations. Appreciate the differences between a business plan and strategic planning for startup companies. Learn how small businesses with meager resources can do strategic management (and why they don't). Understand how strategic management of nonpro�it organizations differs from that of for-pro�it corporations.

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The discussion to this point through the �irst 10 chapters has intentionally focused on single-business, single-country corporations, which are the least complex of organizations to illustrate the model of strategic management and strategic planning expounded in this book. That knowledge can help you work through the additional complexities presented by multibusiness and diversi�ied corporations, and international and global corporations.

Entrepreneurial organizations have to be focused on entering the market with a better product or service and in fact need a business plan, not a strategic plan. Small businesses, whether intent on growth or mom- 'n-pops, are handicapped by insuf�icient funds and experience of the owners. Finally, nonpro�it organizations lack a pro�it motive, are �inanced in part or wholly by third parties (principally grants or philanthropy), and are driven by causes; they present a very different strategic-management challenge.

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An excellent example of an international diversi�ied corporation is Disney, who has diversi�ied in the entertainment industry by producing movies, TV broadcasting, theme parks, cruise lines, and stores all around the world.

Yoshikazu Tsuno/AFP/Getty Images

11.1 Multibusiness and Diversi�ied Corporations

This discussion so far has focused on single-business corporations or strategic business units (SBU) that compete in a speci�ic industry with speci�ic competitors. They require unique strategies and �inancial resources to enable them, with someone, typically the CEO, accountable for what is achieved. Both multibusiness and diversi�ied corporations operate more than one business, that is, have more than one strategic business unit (SBU). By extension, a multibusiness corporation is one that owns more than one SBU or is in more than one business.

Why might a company want to operate a second SBU? It might want to pursue an opportunity in another industry or follow through on a different application of a technology it owns. Running a second SBU typically means being in a different industry or a substantially different segment of the same industry. If a men's jeans manufacturer wants to produce jeans for women, is that another business? No. If the same men's jeans manufacturer wants to produce denim jackets for men, is that another business? Again, the answer is no. However, in the latter case, it would morph from a jeans manufacturer into an apparel manufacturer to re�lect the change. Since jeans is apparel, the "business" it's in wouldn't change. But manufacturing or even distributing anything that wasn't apparel would mean getting into another business. For example, Levi's did not create

another business with the creation of its Dockers brand; the new identity still represented a presence in the apparel industry. However, Sara Lee, a frozen and prepackaged foods company, pursued a new industry when it bought Hanes—a manufacturer of hosiery and clothing.

A diversi�ied corporation also called a conglomerate owns businesses that are unrelated to each other. Take the case of Honda. It is an auto manufacturer—all its different models of cars and trucks and manufacturing plants and international markets don't change that. But it also manufactures motorcycles, power equipment (generators, lawnmowers, pumps, snowblowers, tillers, and trimmers), marine engines, and jet engines (HondaJet)—all different businesses (Honda.com, n.d.).

So it is a multibusiness company. But is it diversi�ied? No. All of its businesses have a common element— in fact its core competence—and that is engines and engine design. It doesn't produce anything that doesn't have an engine in it.

Consider another example. Disney Corp. is broadly in the entertainment industry, and is in animated and live moviemaking (and DVDs), TV broadcasting (ABC, ESPN, Disney Channel), theme parks (Walt Disney

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World and Disneyland and other resorts worldwide), cruise lines, licensing its trademarked characters to other companies, and its own stores that sell everything Disney, including books, toys, and branded merchandise (Disney, n.d.). Yes, it's a multibusiness corporation, but is it diversi�ied? To answer this question, use the de�inition as a guide, notwithstanding they are all in the "entertainment" industry. You will �ind that they are basically unrelated businesses—they have different competitors, demand different strategies and �inancial investments, and need different people to run them. Multibusiness corporations can encompass businesses that are related but still SBUs, like Wrigley's chewing gum and its acquisition of Lifesavers and Altoids from Kraft Foods. Related SBUs can bene�it from shared expertise and resources and thus have high potential to add more value to the corporation. Multibusiness corporations can also own different companies that constitute a complete value chain, like the global, 100% vertically integrated oil companies that �ind and drill for oil, transport it via pipeline or tanker to their re�ineries, re�ine the crude into many different products, and sell some of those products directly to consumers (for example, gas and home heating oil).

Management Challenges

Managing a corporation with multiple businesses involves everything we have discussed so far and more. Certainly, each business should be managed strategically and do strategic planning. One major difference is that these divisions or subsidiaries cannot go outside the corporation for �inancing, either to get a bank loan or any equity investment; they must ask the (parent) corporation for the �inancing they need. It is the parent that must make sure it has suf�icient �inancial resources for the needs of all its companies.

As we know, companies at different stages of their lifecycle vary in their need for capital. Young growing and expanding companies are voracious in their appetite for funds, while those that are mature and doing well are throwing off cash but still need funds for innovation. Knowing this about a corporation's businesses helps it to anticipate funding needs and preempts it from treating all its companies the same way. A useful way of arraying a corporation's portfolio of companies and their �inancial needs was created by the Boston Consulting Group (BCG) (Figure 11.1).

Figure 11.1: BCG portfolio matrix

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Source: Adapted from Alan J. Rowe, Richard O. Mason, Karl E. Dickel, Richard B. Mann, and Robert J. Mockler, Strategic Management: A Methodological Approach, Fourth Edition (Reading, MA: Addison-Wesley Publishing

Company, 1994) 253. Reprinted by permission of Pearson Education.

The matrix is used to array both a portfolio of products as well as a portfolio of companies. In the latter case, the "industry-growth-rate" axis applies to different industries. Both products and companies begin life as "question marks," a capital-intensive state, ideally growing in market share until they are the market leaders (relative market share 1.0) and become "stars." Over time, as the industry matures and they still retain market leadership, they become "cash cows," throwing off cash that is often used to fund new "question marks." The last quadrant, "dogs," although a nickname given by the Boston Group, is a misnomer. For example, in any mature industry, only one company can be market leader; does that make all the other companies "dogs"? Is Ford Motor Company, currently in number-two position in the automobile industry, a "dog"? While it is entirely possible for products and companies to go from "question marks" to "dogs" and still be pro�itable, BCG is really saying that companies should aim for and nurture "stars" and "cash cows."

The value for a multibusiness corporation is to use the tool to help manage the portfolio. A portfolio with too many "question marks" is going to require huge amounts of cash; however, with several cash cows to �inance those needs, the overall pressure to raise capital is reduced. Also, a portfolio heavy with cash cows has no future stars on the horizon, jeopardizing the company's long-term future. So the need is to have a balanced portfolio.

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The track record of diversi�ied corporations is dismal. Often, only corporate lawyers,

Comstock/Stockbyte/Thinkstock

There are four principal management challenges: (a) ensuring that the right person is heading up each company, (b) ensuring that each company is following the right strategy to perform to expectations, (c) getting as balanced a portfolio of companies as possible, and (d) maximizing the synergy or advantages (also called "spillover effects") created through related businesses (Saloner, Shepard, & Podolny, 2001). Even though the parent may have acquired a company with a CEO already at the helm, once the parent owns it, this becomes the parent company's responsibility. Both company performance and reports from other senior and middle managers can provide a better indication. And the only way to check on the appropriateness of the strategy is to insist the company engages in strategic planning, read its strategic plan, and then grill the CEO and the key executives on its contents. If the answers are satisfactory, the parent company need only give them the capital they need, get out of the way, and let them perform. If the answers are not satisfactory, then there is a problem and management will have to work through to a new solution.

The kinds of questions to ask should be familiar by now:

Is your current strategy working? Why or why not? How are your industry, competitors, markets, and technologies changing? How are these changes impacting the company? How are you planning to cope with these impacts? Do you have a competitive advantage? If not, are you trying to develop one? Do you have any �inancial problems, and, if so, how are you �ixing them? What are the key strategic issues facing your company? What other strategic options did you consider? Why did you reject them? What makes you believe your strategy will work? What will you need ($ amount) to implement your strategy? What could go wrong as you move ahead, and how might you cope with that?

Strategic-Management Complexities

Assuming that the SBU companies in a diversi�ied corporation's portfolio do the kind of strategic planning described in this book, what does the corporation's top management do? It cannot do strategic planning because the companies in its portfolio are in different industries. Instead, it can do two things:

Set corporate-wide annual objectives that are typically �inancial and pro�itrelated, such as 15% ROE or 10% NPM. Sell any company in its portfolio that is preventing the corporation from achieving its objectives and buy any other that is a high performer to boost achievement of the corporation's objectives. The strategic challenge becomes having the right portfolio and the portfolio's ability to achieve the required �inancial performance.

As discussed earlier, a diversi�ied corporation's �irst approach should be to "rescue" a poorly performing SBU, or give it a chance to right itself through following a

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investment bankers, and original sellers make a pro�it, rather than the shareholders.

different strategy, or even being led by a different CEO. Only if its performance cannot be improved quickly enough should the SBU be put up for sale. For example, conglomerate Sara Lee spun off Coach, a leading brand in leather goods in 2000, and sold its personal care products unit to Procter and Gamble, Unilever, and SC Johnson between 2009 and 2011 (Crown, 2006).

It is worth noting that the track record of diversi�ied corporations or conglomerates in adding value has been historically dismal, just as the track record of acquisitions being successful (around 20%) is also dismal. Michael Porter, as far back as the late ‘80s, asserted that in the 33 companies he studied, only the lawyers, investment bankers, and original sellers pro�ited from the diversi�ication acquisitions, not the shareholders (Porter, 1987). One factor against a conglomerate's ability to add value is that each acquisition is unrelated, and few synergies or economies of scale are possible. Given this record, why do �irms diversify, especially into unrelated businesses? One answer could be that it provides additional bene�its to top-level executives that stockholders do not enjoy. As �irms get larger, so does executive compensation. As �irms become more complex and dif�icult to manage, so does executive compensation increase (Hitt, Ireland, & Hoskisson, 2007). And these correlations are true whether or not each new acquisition adds value to the �irm.

Diversi�ied �irms with related businesses, either producing different products for the same consumer market nationally or internationally (like Kraft or Nestlé) or using proprietary technologies in all its products (like Canon), have a more dif�icult challenge in trying to maximize synergies and ef�iciencies among its portfolio companies. When they succeed, they perform beyond expectations; when they don't, the situation is harder to correct because of the web of relationships between and among the companies. The parent can't just "sell off" the underperforming unit. Diversi�ied �irms are often also international in scope, to which we turn in the next section.

Discussion Questions

1. Managing a diversi�ied corporation at some point becomes largely a �inancial exercise—the overall objectives for the corporation are �inancial, and the decision to buy or sell companies for the portfolio is �inancial. Do you agree with this view? Why or why not?

2. If one of the portfolio companies in a diversi�ied corporation wasn't performing up to expectations yet provided a valuable service to society and had �irst-rate people among its staff, what argument would you use to keep the company in the portfolio and get it to perform better?

3. What other kinds of expertise does a multibusiness corporation need at the top besides accounting and �inancial? Explain.

4. On what basis might staff at the corporate level be hired and �ired? 5. Before acquiring a company to add to the portfolio, how might the management team really evaluate the company, which is in another industry, besides its �inancial results?

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11.2 International Corporations

Companies, regardless of the country in which they ordinarily do business, are driven to go explore international opportunities for two principal reasons. One is the maturing of the home market and a subsequent slowing of its growth rate. The other is recognition of signi�icant growth opportunities for the company's product or service in one or more foreign countries. Either or both will impel a company to expand internationally.

Becoming an international corporation is not that simple. The biggest difference is that competing abroad is quite unlike competing at home in the United States. In each country, the rules and culture are different, the playing �ield is not level, competitors are ruthless, and prices demand that costs be lower than low. For example, in an analysis of the luxury fashion industry in Brazil, which has historically had a strong market for high-end fashion and accessories, Imran Amed (2012) wrote, "When you try to do business here, you will eventually �ind yourself stuck in a morass of government bureaucracy, corruption, and an incomprehensible system of taxation."

Stephen Rhinesmith underscores the complexity of a global organization; managers need to balance issues of "centralization vs. decentralization, global ef�iciency vs. local responsiveness, and geographic vs. functional priorities" (Rhinesmith, 1996, p. xii). Our focus at this point is on international, not global, corporations (which are discussed Section 11.3). International corporations include essentially domestic companies that export products to other countries through incountry representatives or distributors (requiring no knowledge of foreign markets), international corporations that have an international division with foreign subsidiaries or divisions, and multinational enterprises that establish mini-replicas of their domestic business in each foreign market, having foreign nationals manage those businesses. Nestlé of Switzerland is a good example of this last type. In fact, multinational corporations try to look like "multidomestic" organizations so that local regulatory authorities treat them as a local business.

Going International

In the arena of international business, the adage "know before you go" is important advice. Many countries in the world have consulate of�ices in the largest U.S. cities on both coasts, and they are well informed as to what kinds of products are most needed in their countries as well as a list of products they are trying to export to the United States. They will also provide advice on how to go about exporting products to their country.

A prospective exporter must become familiar with the laws in that particular country, particularly as they apply

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For companies venturing into the foreign market, there are management challenges involved in estimating the demand for a product.

to selling products there, paying taxes, and repatriating pro�its back to the home country. Japan, for example, is a closed market, and entering it requires a strategic alliance or partnership with a Japanese company. But the

overarching consideration, besides potential demand, is the country's political climate and stability.

It is incumbent on any company planning to do business abroad to get all the information it can about the countries before deciding to expand elsewhere. Read voraciously about them and their relationships with the United States. Generate a list of questions and then seek answers from appropriate agencies of the federal government like the U.S. State Department. Best of all, visit the countries in question, shop at the kind of retail outlets that will stock your product, chat with customers, make appointments to talk with prospective business customers and distributors, and get information on bidding for government contracts if that is your market (of course, go with a translator if you cannot speak the language). Doing anything less heightens the risk immeasurably.

Management Challenges

For a company that has never ventured abroad before, there are considerable management challenges involved in doing so. In some respects, these challenges are similar to those that startups face when they enter a market for the �irst time. The most common include the following:

Estimating demand for its product in that country (and in every country being considered for expansion). Obtaining data is vital; guesses or opinion are not the bases on which to make large �inancial decisions. Knowing the current competitors, some of whom could be familiar because they probably compete in the domestic market. And what prices and versions of the product are being sold, and why might the company's also fare well? Determining whether enough infrastructure is in place such as for transportation and telecommunications. This can be a major issue in developing countries. The dominant language spoken in that country and, if not English, how you will overcome that barrier. How long it will take to break even and make money. This involves knowing which international strategy (discussed in the following section) makes most sense, particularly in the beginning. Whether to hire staff in the foreign country and, if so, how to train them, reward them, and nurture loyalty in them.

Note again that domestic companies that outsource production or other services to another country are not considered international companies if they serve only their domestic market. However, Chinese factories, on the other hand, are international companies because most of their markets are in other countries (Midler, 2009). While companies that license their technology or trademarks to foreign companies are considered international in this discussion because their customers are located in other countries, the negotiations nevertheless take place on their home turf, and they don't have to learn about foreign cultures or business practices, or even take the risks that international companies do.

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Toyota built car-manufacturing plants in the United States when they determined it was more pro�itable to build and sell cars in the United States rather than ship them from Japan.

Associated Press/James Crisp

International Strategies

The following discussion includes different strategies that a hitherto domestic company can use to transform itself into an international company. They can be market-entry strategies as well as strategies to further its growth depending on available resources and what it might be facing competitively. They are discussed in order of increasing complexity, commitment, and cost.

Exporting and Market Expansion

Exporting doesn't require a presence in the host country, just knowledge of shipping and freight, insurance, and custom regulations. Most of all, it needs a distributor or importer in the host country that acts as the customer and places the orders. In an ideal situation, the importer would contact the company (manufacturer) to make the deal, but more typically, the company has to �ind the customer. With foreign consulates in the home country and the power of the Internet and telephone, the problem is not insurmountable. However, the domestic company will discover a great deal of pressure on prices, because it is now competing with manufacturers from all over the world.

To a large extent, how a company responds to pricing pressure depends on the country that is receiving the goods. The European Union is very different from a developing country like India. Savvy U.S. manufacturers, unless their product is unique and proprietary, might arrange to outsource manufacturing to reduce the price and then have the product shipped directly to their foreign customers, saving even more money. Of course, that introduces additional risks. There is the danger that the outsourced manufacturer has no scruples about selling the product to still other customers in other countries (Midler, 2009).

A risk that cannot be avoided (except by choosing a different foreign market) is currency-exchange �luctuations. For example, a surge of the Japanese yen against the U.S. dollar recently erased 80 billion yen ($1 billion) from Toyota's latest (2011 Q3) quarterly net income (Associated Press, 2011, Toyota pro�it drops). When a company determines that too much money is being lost bringing pro�its home, it will try to establish a manufacturing plant in the host country. That not only reduces currency-exchange losses, but also transportation costs and pressure on the home factory to produce for both markets. Keeping with the example of the auto industry, there is another bene�it to a manufacturer that decides to open a plant in different state or city. An automobile factory signi�icantly in�luences a community in diverse ways, not just as a result of local employment but also through an economic multiplier effect. Creating a factory within a community bene�its not just the local community, but also surrounding regions and even nearby states. Because the auto industry pays above– average wages and boasts a job–creation multiplier of 7.5—the highest of any United States industry—

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capital investment often has potential to reach or exceed $1 billion (McAlinden & Fulton, 2001), it is easy to see why communities battle each other to be chosen for an automotive-assembly plant. The cost to attract such an automotive investment is high; in some cases communities have offered incentive packages to car manufacturers reaching upward of $300 million per facility and over $100,000 per job (Car Research, 2003).

Market expansion, unlike exporting, does require a presence in the foreign market. Market expansion is a way of ending dependence on a foreign distributor or importer, which doesn't release any market information, and eliminating the markup it charges. Companies open sales of�ices and staff them with nationals of that country, because it's easier to train a local person about the product and company's procedures than to transplant someone from the home market and expect them to learn about the country, its culture, business practices, and market. Kenichi Ohmae (1990) believes the problem is more complex than this. Companies are held back because they cannot seem to get rid of the "headquarters" mentality. This is not just a problem of bad attitude, but rather stems from their entrenched systems, structures, and behaviors. But these are the last to get management's attention because the �irst symptoms are local (in the host country). For example, if advertising in the host country is not paying off as expected, the company may not recognize that the cause could be back at its own headquarters. Lacking cultural awareness, it may not understand what it takes to market effectively in the host country. Other possible causes for the failure to realize anticipated results include a reluctance to make long-term, front- end capital investments in new markets, or the failure to ensure that strong employees are in place at the local level. Instead the failure may be diagnosed as a local problem and the company will try to "�ix" that (Ohmae, 1990).

One of the challenges is the tension between headquarters telling the host sales of�ice what to do, and the sales of�ice—because of its proximity to the customer and knowledge of market trends in that country— telling headquarters what should be done. There is no easy solution to the problem except to choose the host sales manager with care; it should be someone headquarters can really trust and listen to. Headquarters should remind itself why it hired that person and what it is trying to do in that market, and be open to suggestions that can bene�it both. If things turn out as planned, the host sales of�ice will grow to become a major part of the international division of the home company, a pattern to be repeated with every new foreign market the company chooses to enter.

Another challenge is the realization that different countries require different versions or variations of the product. An example would be European's need of very small major appliances, like clothes washers and dryers and dishwashers, because they more commonly live in small apartments, unlike the very large appliances common in more spacious U.S. homes. Such product changes grow out of market research—the data and intelligence collected and made sense of by the of�ice that

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Eighty percent of Coca-Cola Company's revenues are outside the United States, making it perhaps the biggest global franchise in the world.

the company maintains in that country. This typi�ies a multidomestic strategy, when customer demands and needs vary substantially from country to country, forcing a company to modify any combination of product

features, packaging, advertising, servicedelivery methods, and pricing; centralized control or integration is virtually impossible (Abraham, 2006). For example, McDonald's has succeeded in France, in part, by demonstrating an understanding of the country's cultural preference for longer, more leisurely meals than U.S. customers prefer and offering table service in response. Further, because the French are not inclined to "snack" in between meals, McDonald's emphasizes meals rather than the quick-serve snack foods that are so popular in the United States. And, the company has introduced cultural favorites to the French McDonald's menu—such as baguettes (Fancourt, Lewis & Majka, 2012).

Another international-market-expansion strategy is franchising, which has been used successfully by well-known companies in the fast-food industry like McDonald's, KFC, and Subway (Hitt, Ireland, & Hoskisson, 2007). However, a host country's culture and preferences may dictate modi�ications in the menu items. For example, McDonald's in India could not serve beef because the cow is a sacred animal to Indians and Hindus; it served vegetarian and mutton burgers instead. Subway, when it �irst entered China, found the going dif�icult because the Chinese weren't used to eating with their hands; so at least one item on the menu had to be eaten with chopsticks (Hitt, Ireland, & Hoskisson, 2007).

Perhaps the most global franchise system is Coca-Cola, which derives over 80% of its revenues outside the United States. It franchises bottlers in virtually every country in the world; to manage those companies, it depends on the relationship with its bottlers and thus has to be organized geographically. For example, the Eurasian and Africa Group is responsible for 90 emerging markets, headquartered in Turkey (Holstein, 2011). Franchising is also the way in which the product turns out to be identical no matter the location.

Strategic Alliances

Forming strategic alliances has become more popular over time principally because it allows �irms to share both risks and resources as it tries to enter international markets. (Strategic alliances were introduced in Section 1.6. This section discusses the role of strategic alliances only in international expansion, sometimes called cross-border strategic alliances.) If the right partner can be found, then a strategic alliance with a �irm in the host country has distinct advantages over a simple exporting or market-expansion strategy:

The host partner is familiar with the host market, industry and competitive conditions, legal and social norms, political trends, and cultural idiosyncrasies of the country. Partnering with a local host company avoids paying tariffs and is sometimes the only way a foreign company can do business in a host country. This is true of Japan, which is otherwise closed to foreign businesses. The risks (and pro�its) are shared. Both partners learn capabilities from the other, including but not limited to technological skills, competitive/marketing skills, and a greater cultural awareness. (By the same token, each partner brings to the relationship unique knowledge and resources.)

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While many strategic alliances are formed to create a competitive advantage, the purpose in this context is to expand the market for the home company in a way that reduces the risk and raises the probability of success (Ireland, Hitt, & Valdyanath, 2002). A successful strategic alliance depends critically on doing due diligence on the prospective partner and developing a sound agreement to which both parties are committed. Many companies have expanded their markets in this way, including Fujitsu, Cisco, Dell, and Microsoft. Lockheed Martin has formed over 250 alliances with �irms in more than 30 countries (Hitt, Ireland, & Hoskisson, 2007). French automaker Renault has had a successful strategic alliance over the years with Japanese automaker Nissan because it was well managed; executives from both companies knew their companies well, understood how each partner perceived the other, and could adapt while remaining true to their own company and cultural values (Pooley, 2005). The primary reasons why strategic alliances fail include incompatible partners, often a result of rushing into the agreement without fully considering key factors, and con�lict between the partners (Robins, Tallman, & Fladmoe-Lindqvist, 2002). In addition, the very nature of cross-cultural alliances can complicate the negotiotion process and result in a lack of communication and trust between the partners. Other reasons for failure include the possibility that one partner acts opportunistically outside the terms of the agreement, a lack of trust (which cannot be overemphasized), "stealing" proprietary information and even the partner's tacit knowledge of processes and ways of doing business, misrepresenting resources and competences brought to the relationship, and lack of transparency regarding necessary disclosures (Midler, 2009).

In pursuing international expansion, host-country partners are typically distributors. Some refer to this as a vertical complementary strategic alliance because it shares resources and capabilities from different stages of the value chain (as in vertical integration), compared to a horizontal complementary strategic alliance that involves one with a competitor. Choosing the right distributor partner is not easy. It has to have a good reputation with retailers (or with companies if the market is commercial) and the physical and organizational capacity to grow. A different kind of alliance would be with a manufacturer in the host country, not a distributor, and would entail a cross-distribution alliance, which is an agreement between two companies in different countries to market and distribute each other's products in the other's country. If this possibility is appealing, then the search for a partner should include manufacturers of products that are targeting similar markets and would bene�it from this particular kind of strategic alliance.

Joint Ventures

As noted in Chapter 1, a joint venture is a strategic alliance that requires a greater level of commitment. Also governed by an agreement between the two parties, a joint venture requires the formation of a separate corporate entity jointly owned by the two parties. International joint ventures are particularly dif�icult to manage successfully for some of the same reasons that complicate strategic alliances. Care should be taken in choosing the country in the �irst place before looking for potential joint venture partners; for example, Russia appears to have signi�icant disadvantages that should be taken into account including a chronic shortage of certain raw materials and dif�iculty repatriating pro�its back to the home country, which neither Russian banks nor authorities can guarantee or facilitate. A company

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Starbuck's and China's President's Coffee formed a joint venture to open hundreds of Starbuck stores in China, creating a whole new market for what had previously been a nation of tea drinkers.

Associated Press/Long yudan/Imaginechina

contemplating this type of arrangement must also take measures to protect against government expropriation such as by limiting the circumstances in which it would be considered legal, de�ining a lump sum in U.S. dollars should expropriation occur unexpectedly, and taking out expropriation insurance before signing an agreement. American companies must also address natural- environmental issues, because Westerners often are blamed for airand water-pollution problems and habitat destruction (David, 2005).

The following are examples of well-known joint ventures:

NUMMI (New United Motor Manufacturing, Inc.), the joint venture between General Motors and Toyota formed in 1984 in Fremont, California (and recently disbanded in 2010). GM saw an opportunity to learn about lean manufacturing, and Toyota established its �irst manufacturing base in North America and the chance to implement its production system in an American labor environment (Bensinger & Strack, 2009). NUMMI produced a number of models, notably the GM brands Geo Prizm and Pontiac Vibe and Toyota brands Voltz, Corolla, and Tacoma pickup truck. GM, despite its reason for entering into the joint venture, did not apply what it learned about ef�icient Japanese manufacturing to its other manufacturing divisions. Hewlett Packard's entry into the computer market in Japan through forming a joint venture with Yokogawa Electric (Yokogawa Electric, 1999). Starbucks formed a joint venture with China's President's Coffee to open hundreds of Starbucks coffeehouses in China. Long a country of tea drinkers, Starbucks is having success in helping the Chinese develop a taste for coffee (David, 2005). The Dutch company Philips Electronics NV has over $2.5 billion worth of investment in China that includes 30 wholly owned enterprises and joint ventures that employ 18,000 people and produce everything from semiconductors and lighting to medical diagnostic imaging equipment (David, 2005).

Joint ventures can prove thorny if managers assigned to operate the venture were not involved in forming or shaping it, if customers experience poorer service, if the support from the two "parents" is unequal in important ways, or if the venture itself begins to compete with one of the parents (Hutheesing, 2001).

Acquisition

Cross-border acquisitions increased signi�icantly during the 1990s and comprised 45% of all acquisitions completed worldwide (Shimizu, Hitt, Valdyanath, & Pisano, 2004). Why should a company expand internationally by acquiring another when it could form a strategic alliance or even a joint venture? There are several reasons for preferring an acquisition strategy:

Where the business is the same, it enhances economies of scale.

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The U.S. Securities and Exchange Commission enforces the international accounting provisions through the 1977 Foreign Corrupt Practices Act.

Jim Bourg/Reuters/Corbis

In cases where technology transfer takes place, proprietary processes and other intellectual property can be more easily safeguarded. It provides the fastest and often largest initial international expansion of any of the other international strategies (Hitt & Pisano, 2003). Walmart expanded into Germany and the UK through acquiring local �irms (Levine, 2004). In most cases, the buildings and locations already exist instead of having to be built and situated, which takes considerable time in any country. While similar to a strategic-alliance strategy, in that the home company has partners in the host country to continue the expansion, only in the case of an acquisition can the acquirer control what the acquired company does. It lends itself to replication if the acquiring �irm has become adept at acquiring companies (foreign or domestic), that is to say, develops a core competence in doing this. The large companies that rely on acquisitions to grow have departments with experienced people whose sole job is to help make and help digest each acquisition.

Many references and mentions about acquisitions frequently include mergers and confuse the two, but, as Section 1.6 makes clear, the strategies are very different. As an international expansion strategy, mergers are far less common and more dif�icult to pull off, primarily because cultures from different countries must be successfully integrated.

Acquiring companies must realize that negotiations to acquire a company in another country are more complex than those for a domestic acquisition and must deal with two legal systems; only about 20% of cross-border bids lead to a completed acquisition compared to 40% of bids for domestic acquisitions (French dressing, 1999)

Ethics Challenges

Companies doing business in the international arena often �ind themselves facing ethical dilemmas. What is regarded as "unethical" at home sometimes seems to be "business as usual" in other countries. So why not, as the saying goes, "When in Rome, do as the Romans do"? If other companies are doing it and, in U.S. eyes, are "getting away with it," why not do likewise?

The Foreign Corrupt Practices Act is a federal law enacted in 1977 that prohibits the payment of bribes to foreign government of�icials and politicians as a means of establishing business in another country. The act contains two parts: an anti-bribery provision that is enforced by the Department of Justice, and an accounting provision overseen by the Securities and Exchange Commission

(World Compliance, 2011). If a U.S. company is found to have been engaging in bribery abroad or taking or giving kickbacks in order to win a contract, they can be prosecuted at home regardless of whether others engage in the practice. In the past several years, enforcement of the law has signi�icantly increased.

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Other challenges, encountered principally in international marketing, include but are not limited to the following:

Gifts/favors/entertainment—includes a variety of items such as generous gifts, personal travel opportunities funded by the company, items gifted upon completion of a business transaction, sex workers, and similar costly entertainment. Pricing—includes unfair differential pricing, inaccurate invoicing (e.g., invoices showing an amount different from the price paid by a buyer), pricing strategies that force out competitors, selling products abroad at price points far below that of the home country, and practices such as price- �ixing agreements that are legal abroad but illegal at home in the U.S. Products/technology—includes products and technology whose use is legal in the host country but illegal in the United States, and/or products deemed unacceptable or inappropriate for consumers in the host country. Tax-evasion practices—includes transfer pricing (where amounts paid between af�iliates and/or the parent company are modi�ied to bene�it pro�it allocation), the use of tax havens (where pro�its gained are recorded in a low-tax jurisdiction), adjusted interest payments on intra-�irm loans, and dubious amounts charged for management and services between af�iliates and/or the parent company. Activities considered illegal or immoral in the host country—including harm to the environment, unsafe working conditions, duplication of products and technology in places where patent protection, trademarks, or copyrights are not enforced (of particular concern in China), and short- weighting overseas shipments by charging a country an inaccurate weight. Questionable commissions to channel members—includes paying exorbitant commissions to sales agents, consultants, middlemen, dealers, importers, and other channel members. Involvement in political affairs—includes politically driven marketing activities such as the exertion of political in�luence by multinationals, conducting business while either country is at war, and illegally transferring technology. (Armstrong, 1992)

In many instances the playing �ield is not level for an international �irm, but that's why developing or acquiring skills traversing that �ield is a decided advantage.

Discussion Questions

1. How does environmental analysis differ in the international arena from the home market? Comment on the relative dif�iculty of obtaining the requisite information.

2. Choosing an international strategy is often dif�icult—is it better to open a sales of�ice, form a strategic alliance, or acquire a company in the target country? We know that country- speci�ic factors and the potential size of the opportunity signi�icantly affect the decision. But what role do �inancial considerations play? For example, how important is the size of the required investment, return on that investment (including ease of repatriating full pro�its), and time to breakeven (to recoup the investment)? Should these be more or less important? Explain.

3. Which kinds of international strategies are most appropriate for companies in the following domestic industries to use, and why?

producing movies software management consulting breakfast cereals

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school of business

4. Imagine playing a role in deciding an international strategy for a company. You decide that forming a strategic alliance with a company in Brazil is the best way to go to enter that market. But negotiations don't go well because the deal is not structured fairly and you distrust the potential partner. Do you keep looking for the right partner or decide on another strategy?

5. When competing and operating internationally, by which moral compass do you steer? To what extent are your actions governed by what you perceive to be ethical and right? Discuss.

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11.3 Global Corporations

Global corporations are designed to compete globally and serve markets in most countries of the world that have enough experience and have developed sophisticated systems to manage such a complex enterprise. They are typically in one major industry (like electronics, telecommunications, or automobiles) but may have many product lines in many segments of that industry in order to achieve a global brand and economies in many areas of the value chain.

Global vs. International Corporations

There are two principal differences between global corporations and international corporations. The �irst is that a global company has centralized strategy-making and marketing control, meaning that country- speci�ic product preferences are minimal or nonexistent, and a standardized product can be marketed and sold to all countries, generating signi�icant economies of scale in purchasing, production, and advertising. SBUs operating in each country are interdependent and coordinated and integrated by the home of�ice (MacMillan, Van Putten, & McGrath, 2003). The second difference is that global businesses have the freedom to move functions to anywhere in the world; for example, they can purchase from anywhere, produce anywhere, carry out R&D anywhere, acquire companies anywhere, and even move the headquarters anywhere in the world.

A good example is the Focus ST (Sports Technology), one car manufactured by the Ford Motor Co., which is a multinational corporation. This Focus was designed, manufactured, and marketed in several countries. Today, it can be purchased in over 40 markets including the United States, Canada, Mexico, South Africa, Australia, New Zealand, and 15 European countries. It was engineered by the Ford Global Performance Vehicles group—a strategic partnership between Europe’s Team RS and North America’s Special Vehicle Team (SVT).

Focus ST has not come around by chance. . . . What came �irst was our global performance strategy, which has been developed with North America, Europe, and Asia together. With this, the core DNA attributes—steering, driving dynamics, sound quality, and power enhancements for all ST models—have been de�ined to the extent that our engineers can take that global DNA �ingerprint and use it to create the new Focus ST. (Jost Capito, as quoted in Ford News Center, 2011)

Management Challenges

The discussion here presumes that most of the challenges that beset the various international strategies also apply to pursuing global strategies. In addition, the following should be mentioned:

Customer needs may change over time resulting in diminished demand for the global product. If the corporation is attentive, then it should take steps to phase in a transnational strategy, a name for a global strategy that capitalizes on ef�iciencies and economies of scale while being locally responsive, epitomized by the familiar saying, "Think globally, act locally."

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Global strategies are vulnerable to local catastrophes that disrupt their operations. In October of 2011, �looding at a Honda plant in Thailand caused a chronic shortage of parts, forcing Honda to cut production by 50% in the United States and Canada.

Associated Press/Sakchai Lalit

Whirlpool Corporation embarked on a global strategy in the late 1980s, anticipating that a few global players would dominate the worldwide appliance industry. It grew through acquisitions and investments in companies in Europe, India, China, and South America. However, by the mid-90s, it suffered large losses in every market, calling into question its centralized global strategy. Once the company had established itself in these countries, each center of production began developing various skills and designs tailored to that particular region —they became centers of excellence for technology and production. In fact, the Whirlpool's Duet washers and dryers now popular in the United States are engineered and made in Germany; the quality of its "kink-free German technology" justi�ies the high price and outsells the competition (Hitt, Ireland, & Hoskisson, 2007).

Global strategies are particularly vulnerable to local catastrophes that disrupt �inely tuned operations. Two recent examples involve Toyota and Honda. Toyota's plunging sales and pro�its in the summer of 2011 were caused by parts shortages from the combination earthquake and tsunami disaster in northeastern Japan in March 2011 that closed its factory for a month (Associated Press, 2011, Toyota pro�it drops). Honda also underwent an unanticipated parts shortage when they were forced to cut U.S. and Canadian factory production by half due disastrous �looding in Thailand shortly after the company had begun to recover from the March 11 earthquake and tsunami in Japan (Associated Press, 2011, Honda to cut).

Global corporations often use sophisticated modeling and analysis techniques, perhaps more than multinational corporations. They use variants of the "traveling salesman problem," which chooses an optimum route for a sales representative to visit a number of cities at least once and travel the least distance. Global corporations use approximations of the model to locate factories and assembly plants to be both close to suppliers and close to customers in order to minimize transportation costs. Such a model can at best be a guide, however, because other factors must be taken into account such as investments, laws, and labor pool in particular countries that cannot be included in a quantitative model. The insights gained from such analyses enable the corporation to derive new solutions as soon as conditions change, just as a PERT model can be recon�igured instantly to recompute a new critical path to take into account delays or overspending in completing previous tasks.

Discussion Questions

1. Why do you think only a few companies achieve a bona �ide globalization strategy? 2. Can you think of any forces that might be acting against globalization? 3. Research assignment: Go to the following companies' websites and determine whether they are pursuing a global, transnational, or multinational strategy (justify your conclusions):

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IKEA Siemens

Sony Singapore Airlines

BMW Net�lix

Cisco Google

Exxon Walmart

4. Can you come up with any social or political arguments against globalization? 5. Can a global corporation become too big? Why or why not?

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Startups need a business plan to help secure needed funding to launch new products, as well as an operational plan to guide them to their objective.

Aleksandar Stojanov/iStockphoto/ThinkStock

11.4 Startups and Small Businesses

Having considered the case of very large multinational and global companies, we now turn our attention to very small businesses. While many startups and small businesses have little or no history, have insuf�icient funds at their disposal, and don't do strategic management or strategic planning, only startups need a business plan, not a strategic plan. A startup is a company, venture, or organization that comes into being the moment money is expended in its behalf, not when revenues are achieved or when it is registered. This section discusses startups �irst and then covers small businesses, which need to do strategic planning and management, but usually don't. De�ining small business is a matter of opinion as there is no standard agreement as to how small is small. On the grand scale of things, while companies with revenues or sales of under $100 million qualify as "small," this section focuses on even smaller businesses that have sales of under $10 million.

Business Plans vs. Strategic Plans

Startups have no way of answering the following questions:

Is the current strategy working? Should the current strategy be changed? Does the company have any �inancial problems? What strategic options does the company have?

These questions are at the heart of strategic planning and require both some history to go on and the existence of strategic options to consider. Startups have neither.

Instead, startups are formed and come into being with a product or service idea of suf�icient merit to enable them to enter the industry and immediately be competitive. The startup's industry is preordained by its particular product or service or, in extremely rare cases, by creating a brand-new industry. Its strategy is to enter the market, which it does usually through innovation and differentiation strategies, but sometimes through cost leadership (as when a startup disrupts incumbents in an industry with a much lower price point).

What startups need is a business plan, for two reasons—to secure funding the company needs to launch its product or service and to develop an operating plan to guide what it needs to do. With respect to securing investors, a business plan is a document that clearly explains the concept of the business, the opportunity it is going after, its vision in the �ive-to-seven year range, how it intends to meet existing

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competition, how it will make and price the product, why there will be a demand for it, when the company will break even, how much startup capital is sought and how it will be spent, and the founder's experience, motivation, and how much of his or her own money is invested in the company.

A business plan for operational purposes needs only to have a detailed cash-�low projection for two years by month with lots of detail, notably the sales projections form revenue targets for each month and the expenses form monthly budgets. Once things get going, the plan needs constant updating to re�lect new realities. It is for this reason that some people say that it isn't worth putting together a startup business plan, because no sooner has the ink dried than everything has changed.

Securing funding is often a huge problem; it is the rare startup (other than a mom-and-pop) that can launch a business �inanced entirely by the owner. Even getting a bank loan is problematic because banks typically require three years of pro�itable operations before giving a loan without commensurate collateral. In the economic climate following the banking crisis of 2008, many lenders raised their lending requirements or stopped making small-business loans entirely. But they continued to give a loan on the basis of collateral or with a cosigner whose credit rating and net worth were suf�icient.

Business plans constitute the principal way that startups secure external equity funding, typically from venture capitalists and angel investors. Getting the right investors that are as motivated for the venture to succeed as they are to make money is not easy. What many entrepreneurs don't realize is that venture capitalists are as eager to �ind a good venture that has some likelihood of succeeding as entrepreneurs are to get funded.

Outline of a Business Plan

Executive Summary (This should be done last and summarize every section in the business plan; its purpose is to get an investor to read the plan. It precedes the table of contents, is not page-numbered, and should be one page long single-spaced.

Main Sections

The Business Concept (one page)—introduce the company or idea, tell how the company came to be, describe its history to date if it has already been started (this may take up to three pages), and provide contact information (person to contact, address, phone, e-mail, website).

Industry and Competitive Analysis (what you know about the industry in which you will compete and your competitors).

Market Analysis (everything you know about your customers—how many, whether growing, where dispersed, how they buy, price-sensitivity, needs, trends—consumer or business customers).

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Environmental Trends (in the economy, technology, regulation, sociocultural, political, etc.— what might adversely affect the startup?)

Management Team (include ownership, who is taking what management role, how the company is organized now and at the end of two years, and something about the values or culture and how these will be sustained. Principal roles are marketing, operations, �inance, and R&D/engineering for a technical product).

Marketing Plan (what activities are needed to get the intended sales and how much will they cost)

Operations Plan (include all other programs, such as training, IT, staf�ing, leasing, manufacturing, outsourcing, security, etc. not included in the marketing or �inancial plans).

R&D/Engineering Plan (include if the company is still developing its product or intends to develop a next-generation product).

Financial Projections and Investment Deal (must include two years of projections, by month, with subtotals for each year, both for a "most likely" scenario and a "worst-case" scenario; must include a section called "Assumptions" that explains every number in the projections, together with a summary of the differences between the most-likely and worst-case projections [typically 4–6 key differences]; must summarize the key results from the projections, e.g., revenues and cash surplus [loss] for each year, return on initial investment, breakeven month, and capital investment required; and if outside investment is required, then must include a section on the investment deal [not a loan, because startups can't really get loans save in exceptional circumstances or from a family member]—amount required, stock percentage offered, how proceeds will be used, and any other terms).

Risks and Contingencies (enumerate the major risks the startup will face and what will be done to cope with or ameliorate each one).

Appendices (these can be A, B, C, etc. if you have more than one; continue with the page numbering. Full résumés of all principles should be in one appendix.)

Source: Adapted from Stanley C. Abraham, handout for his course on The Business Plan, California Polytechnic University, 2011.

A venture capitalist is a person that invests in a startup or expanding business venture with potential to achieve signi�icant returns on invested capital. Venture capitalists are looking for a high rate of return, to compensate for the much higher risk involved in investing in early-stage startups. Typically they are looking for over 25% but often closer to 40% return. When a high-tech prototype, for example, has proven

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One of the most important challenges for a startup business is keeping it properly capitalized.

LdF/iStockphoto/Thinkstock

the business concept and production begins, much of the early risk has dissipated and returns are much lower.

What's the difference between a venture capitalist and an angel investor? An angel investor is a former entrepreneur that has become wealthy from prior ventures and wants to help other entrepreneurs, usually in the same �ield. For example, someone that founded and sold a software venture is inclined to invest only in software startups. Angel investors typically invest smaller amounts than venture capitalists and take a more active role with the company's management. It is not uncommon for ventures to be funded by a group of angel investors, just as very large ventures expanding nationally (like

IKEA) would be funded by several venture-capital �irms and other investors.

An oft-overlooked source of funding, particularly with high-tech companies that have developed new technology, is a strategic alliance with a large corporation. Such corporations, both domestic and foreign and in many different industries, invest in entrepreneurial companies in return for rights to make or market new products and services. The investment is considerable for the small company and, besides the aforementioned rights, might also involve a small ownership stake (Silver, 1993).

Unique Challenges Facing Startups

The biggest challenge, of course, is to produce the product successfully, establish it, get people buying it, generate positive cash �low, and continue to grow—easy to say but very hard to do. To accomplish this, other challenges need to be met almost simultaneously:

Make sure the company continues to be properly capitalized as it grows and expands, yet not relinquish too much of the founders' shares in the process. High-tech startups should consider forming a strategic alliance with a large corporation interested in its technology in exchange for the capital it needs and �irst rights to using the technology. Make sure the right people are hired who can do the job and perpetuate the culture of the founders. Be extra careful in forming a partnership; the partner might look perfect in the beginning, but it's not until the contracts have been signed and the working relationship is tested that the viability of the relationship becomes apparent. Also, choose partners with complementary skills and experience (not a clone of you) and a history that will not prove detrimental to the company (Jaffe, 1998). Adjust quickly as more is learned about the company's customers and competitors; while the business plan is a good foundation to start the business and obtain initial capital, it quickly becomes out of date.

These challenges are all business-related. However, many new entrepreneurs with ideas worth investing in have virtually no business experience. Depending upon the industry, they may be software or IT

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experts, scientists of one kind or another, or engineers that know more than anyone else about their product and why it works and, as a consequence, have a product-centered view of the business. The problem with this is that such an entrepreneur may tend to dwell on the technical aspects of the product, where they feel most comfortable, forgetting that venture capitalists are not necessarily technically inclined and are more interested in the business aspect of the startup. It is important when seeking funding to develop a customer-centered view of the business and speak the language of venture capitalists. There's nothing wrong with being the best expert in the world on the technology or product, but a startup needs to have someone on the team who knows marketing, accounting, and �inance.

Strategic Planning Challenges for Small Businesses

A small business is one that is privately owned and operated, has relatively few employees and small sales volume. Small businesses are typically privately owned corporations, partnerships, or sole proprietorships. Legally, a "small" business is de�ined as having less than 500 employees, the upper limit which governs whether business can qualify for any Small Business Administration programs. Small businesses can also be de�ined by their sales, assets, or net pro�its. This discussion excludes startups that have the bene�it of carefully conceived business plans and investor advisors and that are designed to grow quickly. It also excludes sole proprietorships, like CPAs and consultants, and independently owned mom- and-pop businesses, like convenience stores. Finally, it excludes franchisees that, although independently run, are too constrained by the corporate parent through its franchise agreement and, for the franchised business certainly, are restricted from doing strategic planning.

Very small businesses, below $1 million in revenues, focus on surviving and, if they can, growing. They typically don't have additional staff to do research, or information systems to provide them with performance data when they need it, and are so pressed for time by the exigencies of day-today demands they don't often �ind time for strategic planning. Many small-business owners don't know how to do strategic planning and often cannot afford a consultant to help them. Finally, they may not need to do strategic planning. They may be pursuing the same strategy they had when the company was founded, spending all their resources, time, and energy in making it work, getting established, and surviving amid the competition. If the strategy is not working, the company will go under, usually by the owner declaring personal bankruptcy. It often has neither the know-how nor the resources to adopt a new strategy even if it knew what that might be.

Small businesses in the $1–10 million range also face the same challenges to do strategic planning but are probably organized better, have systems in place, and more experienced managers in leadership positions to help the owner. But they are still strapped for time and resources and may see no need to change the strategy if they are still growing. If the strategy faltered, the owner would seek either to be acquired or to declare bankruptcy. However, if performance had dropped far enough (or debt risen high

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Small businesses that grow to a certain size begin doing strategic planning.

Comstock/Stockbyte/Thinkstockenough) to adversely affect the price the company could get for selling it, then it might seek consulting assistance to explore other alternatives, like targeting a completely different market and restructuring its debt and cutting costs.

Larger small businesses, with revenues over $10 million, are often more sophisticated and �inancially more able to do strategic planning. However, in many cases, it is more likely than not for the owner to dictate what the company should do strategically and get the other functional vice presidents to go along. Doing really participative, research-based strategic planning with a group of top executives and operational managers is still rare with companies of this size. They have grown successfully without doing it and, subconsciously, often feel they can continue in the same vein.

The Association for Strategic Planning (ASP), a nonpro�it professional society whose mission is to help people and organizations to succeed through improved strategic thinking, planning, and action (Association for Strategic Planning, n.d.) has, since its inception, tried to appeal to small businesses. To date, however, small business owners and managers account for only about 1.5% of its current membership. The inference is that despite ASP's efforts and word-of-mouth advertising, small businesses don't have time to even learn more about strategic planning.

Strategic Management for Small Businesses

Some small businesses that reach a certain size do begin doing strategic planning, if only because they are not sure what the best course of action is in the foreseeable future. Perhaps also a recent executive hire with strategic-planning experience persuaded the owner/CEO that the bene�its of doing it would outweigh the costs. Either way, there are obstacles that need to be overcome.

First, assuming that the company's new executive could organize and facilitate a strategicplanning process, it would have to be explained and justi�ied to the other key managers in the company. There would need to be training: What is it? Why do it? How will things change? There would need to be preparation; speci�ic people would be asked to compile more information on external changes and educate the group. Then the group might spend a weekend offsite for an open discussion about feasible options the company could consider and, under the circumstances, which one might be best. If an option other than the one the company was pursuing were chosen, then the discussion should tackle how it was going to implement it and how it might be funded.

Even doing bare-bones strategic planning is not easy, especially for managers that are not used to the process in which decisions are made based on their input. But the predominant bene�it for doing strategic management is a greater level of con�idence that the company is pursuing the right strategy to be able to compete more effectively and achieve its vision and objectives. Without going through strategic planning, the company wouldn't have paused to re�lect on what it was doing and whether there was anything else it could be doing that would bene�it it more. Other bene�its, particularly for smaller businesses doing

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strategic planning for the �irst time, are updating everyone's mental models to re�lect a common reality and realizing that change is inevitable—the best kind being that which you initiate, not that to which you have to react.

Discussion Questions

1. Startups and small businesses often don't do strategic planning, or they have an aversion toward it; yet, changes keep happening all around them all the time. How are they able to grow and survive without doing strategic planning?

2. What arguments would you use to persuade the owner/president of a small business that strategic planning would bene�it his or her company, even if only one person participated?

3. Do venture capitalists and angel investors need to have a strategic-planning background in order to judge whether a business plan is real enough and has a good chance of succeeding? Discuss.

4. The success rate of venture-capital investments is only 20%. Do you believe the reason for this is unforeseen circumstances, a poor assessment of the entrepreneur, or a lack of experience (and strategic-planning knowledge) on the part of the venture capitalist? Explain your choice.

5. An entrepreneur has written a detailed business plan, probably with the help of a consultant. What advice would you give to prepare him or her for a meeting with investors that have read the business plan? How can the entrepreneur make the best impression?

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Nonpro�it organizations rely on funding from philanthropists, foundations, corporations, and individual charitable donations to raise funds.

Associated Press/Chuck Burton

11.5 Nonpro�it Organizations

MBA programs, in general, don't have speci�ic courses on managing nonpro�it or not-for-pro�it organizations. Many feel this is a huge omission. Nonpro�its or 501(c) tax-exempt organizations in the United States in 2009 numbered over 1.5 million, accounted for 9% of all wages and salaries paid in the United States, and comprised 5.4% of GDP (Urban Institute, n.d.a).

Nonpro�its include arts organizations, some institutions of higher education, some hospitals, human- services organizations, religious organizations, foundations, museums, social-welfare, labor unions, neighborhood organizations, business leagues, and social and recreational clubs, among many other categories (Urban Institute, n.d.b). Only those organizations knowledgeable about strategic management manage strategically, and then with variable success. Numerous consulting �irms specialize in strategic planning and organizational development for nonpro�it organizations. For example, Raybin Associates specializes in fundraising, strategic planning, and management development for arts-related organizations and has completed projects for the New York Public Library, the Historic House Trust, and the Virginia Museum of Fine Arts (Raybin.com., n.d.).

How Nonpro�its Differ from For-Pro�it Corporations

The key difference between nonpro�it organizations and for-pro�it organizations is that their primary goal is not �inancial in nature, and this applies even to foundations, which must manage huge endowments. Yet all of them need money to exist and operate, and they must be managed. Being registered as a nonpro�it means that the organization is a legal entity, giving its members and of�icers the bene�it of limited liability. Counterintuitively, so long as the organization does not bene�it a single person and is organized for a nonpro�it purpose, it can make a pro�it on which it is not taxed if it has also met the IRS test for tax-exempt status. It has to meet both state and federal requirements to operate as a tax-exempt

organization (Allen, 2006).

Another difference is that the source of funding comes from a third party and not directly from those that bene�it from the service—that is, a customer. Nonpro�its must rely on reports of past progress and accomplishments and proposals for more funding. The feedback from "customers" that for-pro�its rely on to dictate what products to produce is missing for nonpro�its. If the customer is whoever is supplying money to the entity, is the foundation, philanthropist, or corporate donor "the customer"? Clearly not.

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A �inal difference is that in the absence of �inancial objectives, most nonpro�its are cause-driven and serve an important social purpose. This makes it hard to determine how well a nonpro�it is doing. Instead of measuring the economic value created, which is relatively easy for a forpro�it corporation, measuring the social value created is far more dif�icult. For example, the mission of Habitat for Humanity is not building houses ef�iciently (on which measure it would score low since building takes place only on weekends when volunteers are available) but it is rather, to build houses for people who could not afford it, to add to the social capital generated when individuals contribute to their community and to the welfare of others (Magretta, 2002).

Unique Challenges for Nonpro�its

Nonpro�its rely on funding—whether from foundations, philanthropists, alumni, or charitable donations —from sources and people that believe in the cause or social purpose to which the nonpro�it is committed. So fundraising is a constant challenge for nonpro�its, and administrative costs for doing so (for example, widely distributing mailers to targeted prospective donors as well as paying for such lists) are appreciable and unending.

Again counterintuitively, just because they are nonpro�its doesn't mean they don't compete. They compete for funding, for good people, and for clients. A museum or opera company, for example, competes with all other forms of entertainment and leisure activities for patrons. The Chronicle of Philanthropy maintains a list called the "Philanthropy 400" of the nonpro�its that annually raise the highest amount of funds. The 400 institutions in the survey in 2009 raised $68.6-billion, though the drop they suffered in contributions that year (11% over the previous year) was nearly four times as great as the next biggest annual decrease: 2.8% in 2001, when charities also labored to raise funds from donors affected by the recession (Barton & Hall, 2010). There are many examples of nonpro�its competing. Kaiser Permanente, the largest nonpro�it HMO (health maintenance organization) in the United States, competes with for-pro�its for subscribers. David Lawrence, then chairman and CEO, wondered, "Was it possible to compete in the marketplace and, at the same time, remain true to our social mission?" (Magretta, 2002, p. 90). The Metropolitan Museum of Art competes with other museums, art institutions, and private collections worldwide when bidding for art works to add to their collections.

Another major challenge is recruiting people to work in the nonpro�it who share the values and social purpose of the organization. Sometimes people happily �ind the organization and apply to work there. But that alone is insuf�icient; they must also have the requisite skills and management experience of the position to be �illed. It is tempting to �ill a position with someone that has the skills and experience but not the values and mission of the enterprise.

Another challenge is deciding on what objectives to achieve. A nonpro�it that is committed to reducing the teenage crime rate in a community through conducting classes for high-school students shouldn't be measuring the number of classes taught and the attendance at each class, but rather the extent to which the teen-crime rate in the area discussed, declines. How might the Red Cross, to use a complex, global nonpro�it, measure how effectively it is achieving its mission? Should foundations focus on the number of

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grants they've awarded or on the outcomes those grants were designed to produce? Parents and taxpayers alike (not to mention the school principals involved) would like public education to do a better job of educating students—but what exactly is meant by "better education" or "an effective teacher" or "student learning"? Translating the nonpro�it's mission into measurable performance outcomes is not easy, and without such measures no one in the organization or that depends on it will know what is expected of them. What gets measured gets managed, in any kind of organization, and that means measuring results, not activity (Magretta, 2002).

Yet another challenge is competing for clients, just like for-pro�its. Museums, to be viable, must still advertise to get people to come to see their exhibits. Similarly, symphony orchestras, opera companies, and theater-production companies get people to come to their performances.

A �inal challenge for some but not all nonpro�its is maintaining their status as nonpro�its. Things change over time, and some nonpro�its start pro�it-making businesses (like cafeterias, websites) and must declare pro�its from such operations as income. If those initiatives grow, the relative amount of pro�it and the divergence from the stated mission could cause a problem in maintaining the nonpro�it's tax-exempt status.

Case Study Measuring Effectiveness in Ashoka

Ashoka is a multinational nonpro�it organization dedicated to �inding and supporting true social entrepreneurs. It considers social entrepreneurs as drivers of innovative solutions and extraordinary outcomes that improve the lives of millions of people. By �inding and supporting them, Ashoka leverages its in�luence for bene�iting society. Since it began, it has supported more than 1,800 social entrepreneurs, called Ashoka Fellows ("Fellows"), in more than 60 countries around the world. The enterprises they indirectly sponsor range from agriculture to public health.

Ashoka is interested not only in the immediate success of its Fellows, but also in the enduring value that they have years after their funding has �inished. Here's how it measures this value.

Each year, Ashoka conducts a Measuring Effectiveness study focusing on the Fellows selected in the past 5–10 years. The study includes a survey sent to all Fellows elected in a given year, as well as a series of in-person interviews with a cross-section of survey respondents. The survey features the following indicators of success and social impact:

1. Original vision: Is the Fellow still working toward his or her original vision? (Five years later, 94% of Fellows say they are.)

2. Independent replication: Are others mimicking the programs started by the Fellows? (Five years later, 93% of Fellows say yes.)

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3. Policy in�luence: Have the Fellows' programs in�luenced public policy? (Five years later, 56% respond af�irmatively.)

4. Leadership building: Have Fellows developed into leaders in their �ields? (Five years later, 54% of Fellows have.)

5. Leverage: How did Ashoka support help Fellows to succeed? This measure looks at how the stipend, collaboration, communications assistance, and other dimensions of Ashoka support, helped the Fellows.

Ashoka's approach is far ahead of the �ield simply because it desires to measure its long-term social impacts.

Source: Ashoka, measuring effectiveness: A six-year summary of methodology and �indings. Arlington, VA: Ashoka, 2006; and www.ashoka.org, as cited in Arthur C. Brooks, Social entrepreneurship: A modern approach to social value creation. Upper Saddle River, NJ: Pearson Prentice-Hall.

Strategic Management for Nonpro�its

Just as for-pro�its need to know what not to do as well as what to do, so also do nonpro�its; it is a hallmark of strategy. Small nonpro�its have clear missions and an unequivocal direction. However, some larger ones are faced with choices that might alter their mission (or not if they ignore the choices), and so should engage in strategic thinking and strategic planning. For example, Habitat for Humanity, discussed earlier, builds homes in stable communities that allow local merchants, volunteers, and the future homeowner to contribute to each other's welfare in a true grassroots endeavor. Should it extend its efforts to urban homelessness or disaster relief? Does that �it its business model, social mission and what makes it unique (Magretta, 2002)?

In today's rapidly changing environment of scarce resources, nonpro�its need to behave as tough competitors and thus constantly be aware of how their environment is changing and what it takes to stay on course. The need to manage strategically is more acute than ever.

And when a nonpro�it is changing course and has to revise its mission, it doesn't need to get permission from its sponsors for making such strategic decisions, but it does need to be clear on its new mission and why it was changed. And it needs to make sure that its stakeholders or members also share that revised mission.

Discussion Questions

1. Think of 2–3 nonpro�its to which you contribute or would like to contribute (i.e., with whose cause or social purpose you identify). It is one thing to know how the nonpro�it is spending the money it receives from people like you, but do you know how well it is achieving its mission? If you don't, why is that?

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2. Many benefactors feel good when they give donations (both cash and in-kind) to a charity, and not just because they get a tax deduction for doing so. But they don't read the letter and pamphlet showing what they have accomplished and what there is still to accomplish that many charities send only to donors. Is there a solution to this problem? Is it a problem?

3. Many famous private universities have huge endowments and are actually very well off. Give one or more good reasons why they should retain their tax exempt status.

4. Following (3), why should alumni get a tax deduction for giving to an alma mater that is, actually, very well off �inancially?

5. Many social-welfare nonpro�its, like hospitals, care for the indigent; hospices, etc. rely on donations from the general public as well as benefactors. Why doesn't the government support them? (The government does provide support in many areas like health for seniors (Medicare), education, the arts, and cancer research, to name a few.)

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Summary

This chapter focused on the dif�iculties and added complexity of strategic management in complex organizations. Multibusiness organizations simply have more than one strategic business unit (SBU) to run, and choose carefully who will head up each one. When the number of SBUs owned reaches the high double-digits, the company has to manage a portfolio of companies and make sure each one is performing to the best of its ability and that its strategy makes sense. In such organizations, management must rely more on �inancial results to assess the SBU. If its current portfolio is not achieving �inancial objectives set for the corporation as a whole, it has the ability to sell off those that are underperforming and acquire more highly performing companies. Diversi�ied corporations have, by de�inition, subsidiaries or divisions that are in different industries or in very different segments of the same industry, unlike multibusiness corporations, which could have companies in the same industry. Both have to manage portfolios of companies.

When companies expand into the international arena, they do so either because their home market has matured or because they see real opportunities in foreign markets. The key international- expansion strategies are exporting (no presence in the host country is required), market expansion (requires sales of�ices in the host country), manufacturing in the host country (if tariffs or transportation costs get too high), forming strategic alliances (principally with distributors and because alliances are expected in order to enter some countries like Japan), forming joint ventures and acquiring a company in the host country (usually but not exclusively in the same industry). Companies who develop a core competence in a particular strategy will fare very well.

Startups and emerging businesses have no history of performance and begin their existence with a single- minded market-entry strategy. The only questions they must answer are whether there is suf�icient demand for the product, whether they can compete with existing companies, and whether they can be pro�itable. Because strategic planning involves choices—what to do and what not to do—startups and very young businesses need a business plan to guide them (and raise the required startup capital), not strategic planning.

As a small business grows, typically beyond $10 million in annual revenues, its systems and organizational processes become more sophisticated, its managers more experienced, and the need for doing strategic planning more pronounced. However, if such a company has never done strategic planning, it faces the challenges of training its managers to do and believe in strategic planning, and to go through the inevitable change process that ensues. Even �inding the right strategic/change consultant can present a problem.

Nonpro�its are ubiquitous in the United States and cover the gamut of types including arts organizations, universities, hospitals, religious organizations and charities, labor unions, foundations, and neighborhood organizations, to name a few. They differ from for-pro�it companies in that they are �inanced in most cases by a third party (not their customers or banks), are cause-driven, serve a social purpose, and qualify as

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tax-exempt. Counterintuitively, nonpro�its are highly competitive; they compete for funding for good staff and for clients. They would be well advised to adopt the competitive mindset of for-pro�it corporations. Nonpro�its cannot use �inancial measures to denote how well they are doing, but rather have to devise ways to measure the extent to which they are achieving their social purpose, a more dif�icult task and one not done well by many nonpro�its. Translating their mission into objectives that clarify the organization's mission is perhaps their greatest challenge.

To be sure, some aspects of managing these more complex organizations are similar to what has been discussed in the previous nine chapters, but managing these more complex organizations presents more challenges.

Concept Check

Key Terms

angel investor A former entrepreneur that has become wealthy from cashing out prior ventures and wants to help other entrepreneurs in the same �ield.

conglomerate A corporation whose portfolio companies are in unrelated businesses.

cross-distribution alliance An agreement between two companies in different countries to market and distribute each other's products in the other's country.

diversi�ied corporation See conglomerate.

franchising An agreement with an independent company to capitalize, open, and operate identical stores/restaurants for an upfront fee and royalties based on gross sales in exchange for the right to use the brand, exclusivity in a certain market area (or country), access to suppliers, training, advertising, and other assistance.

global corporation One that utilizes a centralized strategy and marketing approach for a product that satis�ies customers in different countries without modi�ication and can purchase, produce, do R&D, and direct operations from anywhere in the world.

international corporation One that manufactures a product in its home country and distributes and sells it in foreign countries. (Outsourcing to foreign manufacturers does not make a corporation

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"international.")

multibusiness corporation One that owns more than one strategic business unit or is in more than one business.

multidomestic strategy Tailoring a product (including modifying its features, packaging, advertising, service-delivery methods, and pricing) to the varying demands and needs of customers in different countries, making centralized control virtually impossible.

nonpro�it organization One that has a mission re�lecting a social purpose; relies on taxdeductible contributions from corporations, foundations, philanthropists, and individuals for its funding; does not measure success in �inancial terms; and quali�ies as a taxexempt organization by state and federal tax authorities.

small businesses Privately owned and operated businesses with relatively few employees and small sales volume.

startup A company, venture, or organization that comes into being the moment money is expended in its behalf (not when revenues are achieved or it is registered).

strategic business unit (SBU) A single-business company that competes in a speci�ic industry with speci�ic competitors and requires unique strategies and �inancial resources to enable it, with someone accountable for what it achieves (typically the CEO).

transnational strategy A global strategy that capitalizes on ef�iciencies and economies of scale while being locally responsive—adapting its product in some way to certain markets.

venture capitalist A person that invests in a startup or expanding business venture with potential to achieve signi�icant returns on invested capital.