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Strategy Formulation: Functional Strategy and Strategic Choice

Chapter 8

Learning Objectives

Identify a variety of functional strategies that can be used to achieve organizational goals and objectives

Understand what activities and functions are appropriate to outsource in order to gain or strengthen competitive advantage

Recognize strategies to avoid and understand why they are dangerous

Construct corporate scenarios to evaluate strategic options

Develop policies to implement corporate, business and functional strategies

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After reading this chapter, you should be able to:

Identify a variety of functional strategies that can be used to achieve organizational goals and objectives

Understand what activities and functions are appropriate to outsource in order to gain or strengthen competitive advantage

Recognize strategies to avoid and understand why they are dangerous

Construct corporate scenarios to evaluate strategic options

Develop policies to implement corporate, business and functional strategies

Functional Strategy

Functional strategy

the approach a functional area takes to achieve corporate and business unit objectives and strategies by maximizing resource productivity

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Functional strategy is the approach a functional area takes to achieve corporate and business unit objectives and strategies by maximizing resource productivity.

Marketing Strategy

Marketing strategy

deals with pricing, selling and distributing a product

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Marketing strategy deals with pricing, selling and distributing a product

Marketing Strategy

Market development strategy

a company or business unit can (1) capture a larger share of an existing market for current products through market saturation and market penetration or (2) develop new uses and/or markets for current products.

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Using a market development strategy, a company or business unit can (1) capture a larger share of an existing market for current products through market saturation and market penetration or (2) develop new uses and/or markets for current products.

Marketing Strategy

Product development strategy

a company or unit can (1) develop new products for existing markets or (2) develop new products for new markets.

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Using the product development strategy, a company or unit can (1) develop new products for existing markets or (2) develop new products for new markets.

Marketing Strategy

Brand extension

using a successful brand name to market other products

Push strategy

trade promotions to gain or hold shelf space in retail outlets

Pull strategy

advertising to “pull” products through the distribution channels

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Using a successful brand name to market other products is called brand extension, and it is a good way to appeal to a company’s current customers.

Many large food and consumer products companies in the United States and Canada follow a push strategy by spending a large amount of money on trade promotion in order to gain or hold shelf space in retail outlets. The Kellogg Company decided a few years ago to change its emphasis from a push to a pull strategy,

in which advertising “pulls” the products through the distribution channels.

Marketing Strategy

Skim pricing

offers the opportunity to “skim the cream” from the top of the demand curve with a high price while the product is novel and competitors are few

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When pricing a new product, a company or business unit can follow one of two strategies. For new-product pioneers, skim pricing offers the opportunity to “skim the cream” from the top of the demand curve with a high price while the product is novel and competitors are few.

Marketing Strategy

Penetration pricing

attempts to hasten market development and offers the pioneer the opportunity to use the experience curve to gain market share with low price and then dominate the industry

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Penetration pricing, in contrast, attempts to hasten market development and offers the pioneer the opportunity to use the experience curve to gain market share with a low price and then dominate the industry.

Financial Strategy

examines the financial implications of corporate- and business-level strategic options and identifies the best financial course of action

The management of dividends and stock price is an important part of a corporation’s financial strategy.

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Financial strategy examines the financial implications of corporate- and business-level strategic options and identifies the best financial course of action.

The management of dividends and stock price is an important part of a corporation’s financial strategy.

Financial Strategy

Leveraged buyout

company is acquired in a transaction financed largely by debt usually obtained from a third party

Reverse stock split

investor’s shares are split in half for the same total amount of money

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In a leveraged buyout, a company is acquired in a transaction financed largely by debt, usually obtained from a third party, such as an insurance company or an investment banker. A number of firms have been supporting the price of their stock by using reverse stock splits. Contrasted with a typical forward 2-for-1 stock split in which an investor receives an additional share for every share owned (with each share being worth only half as much), in a reverse 1-for-2 stock split, an investor’s shares are split in half for the same total amount of money (with each share now being worth twice as much).

Research and Development Strategy

deals with product and process innovation and improvement

also deals with the appropriate mix of different types of R&D and question of how new technology should be accessed

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R&D strategy deals with product and process innovation and improvement. It also deals with the appropriate mix of different types of R&D (basic, product or process) and with the question of how new technology should be accessed—through internal development, external acquisition or strategic alliances.

Research and Development Strategy

Technological leader

pioneering an innovation

Technological follower

imitating the products of competitors

Open innovation

firm uses alliances and connections with corporate, government, academic labs and consumers to develop new products and processes

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One of the R&D choices is to be either a technological leader, pioneering an innovation, or a technological follower, imitating the products of competitors.

A newer approach to R&D is open innovation, in which a firm uses alliances and connections with corporate, government, academic labs and consumers to develop new products and processes.

Operations Strategy

determines how and where a product or service is to be manufactured, the level of vertical integration in the production process, the deployment of physical resources and relationships with suppliers

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Operations strategy determines how and where a product or service is to be manufactured, the level of vertical integration in the production process, the deployment of physical resources and relationships with suppliers.

Purchasing Strategy

deals with obtaining raw materials, parts and supplies needed to perform the operations function

multiple, sole and parallel sourcing

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Purchasing strategy deals with obtaining the raw materials, parts and supplies needed to perform the operations function. The basic purchasing choices are multiple, sole and parallel sourcing.

Purchasing Strategy

Multiple sourcing

the purchasing company orders a particular part from several vendors

Sole sourcing

relies on only one supplier for a particular part

Parallel sourcing

two suppliers are the sole suppliers of two different parts, but they are also backup suppliers for each other’s parts

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Under multiple sourcing, the purchasing company orders a particular part from several vendors. Sole sourcing relies on only one supplier for a particular part

In parallel sourcing, two suppliers are the sole suppliers of two different parts, but they are also backup suppliers for each other’s parts.

Logistics Strategy

deals with the flow of products into and out of the manufacturing process

Trends include:

Centralization

Outsourcing

Internet

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Logistics strategy deals with the flow of products into and out of the manufacturing process. Three trends related to this strategy are evident: centralization, outsourcing, and the use of the Internet.

HRM Strategy

HRM strategy

addresses the issue of whether a company or business unit should hire a large number of low-skilled employees who receive low pay, perform repetitive jobs and will most likely quit after a short time (the fast-food restaurant strategy) or hire skilled employees who receive relatively high pay and are cross-trained to participate in self-managing work teams

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HRM strategy, among other things, addresses the issue of whether a company or business unit should hire a large number of low-skilled employees who receive low pay, perform repetitive jobs and will most likely quit after a short time (the fast-food restaurant strategy) or hire skilled employees who receive relatively high pay and are cross-trained to participate in self-managing work teams.

Information Technology

Follow-the-sun management

project team members living in one country can pass their work to team members in another country in which the work day is just beginning.

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Multinational corporations are finding that having a sophisticated intranet allows employees to practice follow-the-sun management, in which project team members living in one country can pass their work to team members in another country in which the work day is just beginning.

The Sourcing Decision: Location of Functions

Outsourcing

purchasing from someone else a product or service that had been previously provided internally

the reverse of vertical integration

Offshoring

the outsourcing of an activity or a function to a wholly owned company or an independent provider in another country.

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Outsourcing is purchasing from someone else a product or service that had been previously provided internally. Thus, it is the reverse of vertical integration.

Offshoring is the outsourcing of an activity or a function to a wholly owned company or an independent provider in another country.

Disadvantages of Outsourcing

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Some disadvantages of outsourcing are:

Customer complaints

Locked in to long-term contracts

Lack of ability to learn new skills and develop new core competencies

Lack of cost savings

Poor product quality

Customer complaints

Locked in to long-term contracts

Lack of ability to learn new skills and develop new core competencies

Lack of cost savings

Poor product quality

Errors in Outsourcing to Avoid

Outsourcing the wrong activities

Selecting the wrong vendor

Writing a poor contracts

Overlooking personnel issues

Lack of control

Overlooking hidden costs

Lack of an exit strategy

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A study of 91 outsourcing efforts conducted by European and North American firms found seven major errors that should be avoided:

Outsourcing the wrong activities

Selecting the wrong vendor

Writing a poor contracts

Overlooking personnel issues

Lack of control

Overlooking hidden costs

Lack of an exit strategy

Proposed Outsourcing Matrix

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Figure 8-1

An outsourcing decision depends on the fraction of total value added that the activity under consideration represents and on the amount of potential competitive advantage in that activity for the company or business unit. See the outsourcing matrix in Figure 8–1.

Strategies to Avoid

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Several strategies that could be considered corporate, business or functional are very dangerous. Managers who have made poor analyses or lack creativity may be trapped into considering some of the following strategies to avoid:

Follow the leader

Hit another home run

Arms race

Do everything

Losing hand

Follow the leader

Hit another home run

Arms race

Do everything

Losing hand

Strategic Choice: Selecting the Best Strategy

Corporate scenarios

pro forma (estimated future) balance sheets and income statements that forecast the effect each alternative strategy and its various programs will likely have on division and corporate return on investment

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Corporate scenarios are pro forma (estimated future) balance sheets and income statements that forecast the effect each alternative strategy and its various programs will likely have on division and corporate return on investment.

Corporate Scenario Steps

Use industry scenarios to develop assumptions about the task environment

Develop common-size financial statements for prior years

Construct detailed pro forma financial statements for each strategic alternative

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To construct a corporate scenario, follow these steps:

Use industry scenarios to develop assumptions about the task environment

Develop common-size financial statements for prior years

Construct detailed pro forma financial statements for each strategic alternative

Scenario Box for Use in Generating Financial Pro Forma Statements

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Develop common-size financial statements (as discussed in Chapter 12) for the company’s or business unit’s previous years to serve as the basis for the trend analysis projections of pro forma financial statements. Use the Scenario Box form shown in Table 8–1.

Management’s Attitude Toward Risk

Risk

composed not only of the probability that the strategy will be effective but also of the amount of assets the corporation must allocate to that strategy and the length of time the assets will be unavailable for other uses

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Risk is composed not only of the probability that the strategy will be effective but also of the amount of assets the corporation must allocate to that strategy and the length of time the assets will be unavailable for other uses.

Management’s Attitude Toward Risk

Real-options approach

when the future is highly uncertain, it pays to have a broad range of options open

Net present value

calculates the value of a project by predicting its payouts, adjusting them for risk and subtracting the amount invested

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A new approach to evaluating alternatives under conditions of high environmental uncertainty is to use the real-options theory. According to the real-options approach, when the future is highly uncertain, it pays to have a broad range of options open. This is in contrast to using net present value (NPV) to calculate the value of a project by predicting its payouts, adjusting them for risk and subtracting the amount invested.

Stakeholder Priority Matrix

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Figure 8-2

Stakeholders can be categorized in terms of their (1) interest in the corporation’s activities and (2) relative power to influence the corporation’s activities. As shown in Figure 8–2, each stakeholder group can be shown graphically based on its level of interest (from low to high) in a corporation’s activities and on its relative power (from low to high) to influence a corporation’s activities.

Questions to Assess Stakeholder Concerns

How will this decision affect each stakeholder?

How much of what stakeholders want are they likely to get under the alternative?

What are the stakeholders likely to do if they don’t get what they want?

What is the probability that they will do it?

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Strategic managers should ask four questions to assess the importance of stakeholder concerns in a particular decision:

How will this decision affect each stakeholder?

How much of what stakeholders want are they likely to get under the alternative?

What are the stakeholders likely to do if they don’t get what they want?

What is the probability that they will do it?

Pressures from Stakeholders

Political strategy

plan to bring stakeholders into agreement with a corporation’s actions

constituency building, political action committee contributions, advocacy advertising, lobbying and coalition building

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A political strategy is a plan to bring stakeholders into agreement with a corporation’s actions. Some of the most commonly used political strategies are constituency building, political action committee contributions, advocacy advertising, lobbying and coalition building.

Pressures from the Corporate Culture

If there is little fit, management must decide if it should:

Take a chance on ignoring the culture.

Manage around the culture and change the implementation plan.

Try to change the culture to fit the strategy.

Change the strategy to fit the culture.

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In evaluating a strategic alternative, strategy makers must consider pressures from the corporate culture and assess a strategy’s compatibility with that culture. If there is little fit, management must decide if it should:

■ Take a chance on ignoring the culture.

■ Manage around the culture and change the implementation plan.

■ Try to change the culture to fit the strategy.

■ Change the strategy to fit the culture.

Process of Strategic Choice

Strategic choice

the evaluation of alternative strategies and selection of the best alternative

Failure almost always stems from the actions of the decision maker, not from bad luck or situational limitations.

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Strategic choice is the evaluation of alternative strategies and selection of the best alternative. Failure almost always stems from the actions of the decision maker, not from bad luck or situational limitations.

Avoiding the Consensus Trap

Devil’s advocate

assigned to identify potential pitfalls and problems with a proposed alternative strategy in a formal presentation

may be an individual or a group

Dialectical inquiry

requires that two proposals using different assumptions be generated for each alternative strategy under consideration

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A devil’s advocate (who may be an individual or a group) is one who is assigned to identify potential pitfalls and problems with a proposed alternative strategy in a formal presentation. When applied to strategic decision making, dialectical inquiry requires that two proposals using different assumptions be generated for each alternative strategy under consideration.

Process of Strategic Choice

Criteria for evaluating alternatives includes:

Mutual exclusivity

Success

Completeness

Internal Consistency

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Regardless of the process used to generate strategic alternatives, each resulting alternative must be rigorously evaluated in terms of its ability to meet four criteria:

1. Mutual exclusivity: Doing any one alternative would preclude doing any other.

2. Success: It must be feasible and have a good probability of success.

3. Completeness: It must take into account all the key strategic issues.

4. Internal consistency: It must make sense on its own as a strategic decision for the entire

firm and not contradict key goals, policies and strategies currently being pursued by the

firm or its units.

Developing Policies

When crafted correctly, an effective policy accomplishes three things:

It forces trade-offs between competing resource demands.

It tests the strategic soundness of a particular action.

It sets clear boundaries within which employees must operate, while granting them the freedom to experiment within those constraints.

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When crafted correctly, an effective policy accomplishes three things:

■ It forces trade-offs between competing resource demands.

■ It tests the strategic soundness of a particular action.

■ It sets clear boundaries within which employees must operate, while granting them the freedom to experiment within those constraints.

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