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Strategic Management for Organizations

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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).

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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.

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 difPicult 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

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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. 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

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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 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

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

Chris Clinton/Digital Vision/Thinkstock

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 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

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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

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

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

How does strategic planning differ from strategic management?3. 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 Pirm'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

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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.

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

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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 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

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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

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.

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

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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

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?

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?

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

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.

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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 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

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Free trade agreements resulted in a transformation of the Mexican textile industry. When cotton imports Plooded the market, many textile plants like Negociación Fabril de la Aurora were forced to close their doors.

Associated Press/Eduardo Verdugo

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, 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

Can a company today survive in its domestic market by remaining entirely domestic?1.

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How would you rank order the threats it faces from nondomestic companies? 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?

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?

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 conPlicts 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

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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, 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

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

What things can or do you buy now that did not exist _ive years ago? Three years ago?

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)?

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

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.

Daniel Haller/iStockphoto/ThinkStock

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

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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 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.

ProPit

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 proPit 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 proPit 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

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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

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 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,

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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

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?

What measures might you look at personally to assess how happy you are?2. 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?

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?

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

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?

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

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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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Innovation strategy is a product- development strategy that requires research and development to focus on introducing technologically advanced processes or products.

JupiterImages/Creatas/Thinkstock

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-diversiPication 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

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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

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

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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.

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

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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 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

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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 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

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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

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.

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).

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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.

DiversiPication

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

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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

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.

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?

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?

In 1984, General Motors (GM) and Toyota created and operated a joint venture (JV)4.

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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 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? 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?

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

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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 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

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?

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

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

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might encounter as they transition from making operational decisions to making strategic ones. 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?

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 NetPlix. 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

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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 speciPic customers.

McDonalds: Decentralization of Business Model

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 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

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McDonalds: Decentralization of Business Model From Title: The Execution Plan

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.

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

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?

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.

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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 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

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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 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

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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

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

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?

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?

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

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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 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).

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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.

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–diversiPication 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

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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.

diversiPication 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.

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

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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").

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

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price it likes, since customers cannot get the product from anyone else.

net proPit 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 proPit 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 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

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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.

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

moodboard/SuperStock

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.

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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. 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 inPluence rather than authority to get people to do what they want them to do.

George Doyle/Stockbyte/Thinkstock

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

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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

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,

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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.

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

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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 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

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

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

Are most CEOs and presidents today "strategic" leaders? Why or why not?3. Why do organizations _ind it dif_icult to develop a good vision statement?4. 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.

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?

If a company has a good vision statement, why is a mission statement necessary?7. 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

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Transform Transact

Empower Control

Encourage diversity Enforce uniformity

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

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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-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.

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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.

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

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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?

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.

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.

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).

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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

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?

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

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.).

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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 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).

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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

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

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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.

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

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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%.

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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 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

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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.

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

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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

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

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

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?

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

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?

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

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:

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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.

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

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

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)?

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?

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

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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,

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When a company "goes public," it means that the general public can purchase, sell, and trade shares on several stock exchanges, like the New York Stock Exchange and NASDAQ.

Scott Barrow, Inc./SuperStock thorough, and accurate information can people undertake wise investment decisions (U.S. Securities and Exchange Commission).

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.

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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, 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 BenePits 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

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

Kablonk/SuperStock

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 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.

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Discussion Questions

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

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?

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?

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 ofPicers, 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.

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Figure 2.1: Functional organization design

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

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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.

Associated Press/Mark Lennihan

Monica, California, that undertakes research and policy projects for all 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

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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 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

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.

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?

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,

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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

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. 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

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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 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

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?

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?

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?

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

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,

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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).

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

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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?

Discussion Questions

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

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)?

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?

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, GlobalCrossing, HMOs

Frozen Gridlock, denial, authoritarian,unresponsive to change Telecoms, airlines, Kmart, cable companies, steel industry

Chaotic Fragmented, unfocused, no mission AOL, advertising, softwareindustry

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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

Political Balkanized, retaliatory Universities, large partnerships,law _irms

Bureaucratic Procedural, rigid, regimented,authoritarian, demands conformity Utilities, government agencies, insurance companies, banks

Service Customer focus, quality, authoritativefocus, 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

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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 Culture Change at the PaciPica 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%)

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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 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

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?

Can an organization with a bureaucratic culture ever change? Why or why not?2. Some companies replace their CEO as a way of changing their culture quickly. Is this a3.

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good idea? Why or why not? 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?

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,

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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.

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).

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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 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

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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.

Discussion Questions

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.

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?

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

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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.

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

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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. 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

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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 ofPicers 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.

Compensation and BenePits 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.

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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).

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.

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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 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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