Key Terms of Strategic Management / Key Terms in Strategic Management



Creating Competitive Advantages 

There  are  two  perspectives  of  leadership:  
the romantic  view  of  leadership,  and  the  external view  of  leadership.  The  implicit  assumption  of the  romantic  view  of  leadership  is  that  the leader  is  the  key to  the  (lack  of)  organizational success.  In  the  external  view  of  leadership, focus  is  on  external  factors  that  influence  the success  of  an  organization.  Neither  of  these perspectives is entirely correct, but both have to be acknowledged in strategic management. 

Strategic management consists of the actions, decisions,  and  analyses  (these  processes  are highly interdependent and often don’t occur in a sequential fashion) a firm undertakes in order to achieve a sustainable  competitive advantage

Sustainable  competitive  advantage  is  possible only  by  performing  different  activities  from rivals or performing similar activities in different ways.  Performing  similar  activities  better  than rivals  is  called  operational  effectiveness

Furthermore,  strategic  management  has  four main attributes: 
•  It  is  conducted  at  overall,  firm-level organizational goals and objectives; 
•  It  includes  multiple  stakeholders  in the making of decisions; 
•  It requires managers to have both short-term and long-term perspectives; 
•  It involves the recognition of trade-offs between effectiveness and efficiency

Some  authors  have  developed  the  concept  of ambidexterity. Ambidexterity encompasses  the manager’s  challenge  to  both  align  resources  to take  advantage  of  existing  product  markets (which is referred to as exploitation) as well as actively  explore  a  new  opportunity  (which  is referred to as exploration).                                    

Organizational  decisions  that  are  determined only  by  analysis  constitute  the  intended strategy  of  a  firm. The final realized  strategy of  an  organization  is  strategy  in  which organizational decisions are both determined by analysis,  unforeseen  environmental  develop-ments,  unanticipated  resource  constraints, and/or changes in managerial preferences. 

As mentioned earlier, the three core processes of strategic  management  are  analyses,  decisions, and  actions.  Strategy  analysis  consists  of  the work  that  needs  to  be  done  in  order  to effectively formulate (decide on) and implement strategies  (actions).  Strategy  formulation  is developed  at  different  levels:  business-level strategy  (how  to  compete  in  a  given  business) and  corporate-level  strategy  (what  business  to compete in, and how to achieve synergy). Lastly, strategy  implementation  involves  ensuring proper  strategic  controls  and  organizational designs. 

The  overall  purpose  of  a  corporation  is  to maximize  the  long-term  return  to  the  owners (shareholders).  Corporate  governance  is  the relationship  among  various  participants  in determining  the  direction  and  performance  of corporations.  The  primary  participants  in corporate  governance  are  the  shareholders,  the management, and the board of directors.

There  are two  opposing  ways of  looking at  the role  of  stakeholder  management.  In  the  zero-sum  perspective,  stakeholders  compete  for  the resources  of  the  organization:  the  gain  of  one stakeholder is the loss of other stakeholders. The stakeholder  symbiosis  perspective  recognizes that stakeholders are dependent upon each other for their success and well-being.  

Social  responsibility  is  the  expectation  that businesses or individuals will try to improve the overall  welfare  of  society.  Many  companies  are now  measuring  what  has  been  called  a  triple bottom line, which involves assessing financial, social, and environmental performance.                        
Stakeholders  are  organizations,  groups,  and individuals  who  have  a  stake  in  the  success  of  an organization, including owners, employees, etc. 

Effectiveness means tailoring actions to the needs of an organization.  

Efficiency  refers  to  performing  actions  at  a  low cost relative to a benchmark.

As  mentioned  earlier,  organizations  must  strive toward  common  goals  and  objectives.  Firms express  priorities  best  through  stated  goals  and objectives that form a hierarchy of goals, which include  the  organization’s  vision,  mission,  and strategic  objectives.  At  the  top,  we  find  those organizational goals that are less specific yet able to evoke powerful and compelling mental images (a  vision),  and  at  the  bottom  we  find  the organizational  goals  that  are  more  specific  and measurable (the mission statement and  strategic objectives)

A  company’s  mission  statement  is  a  set  of organizational  goals  that  include  both  the purpose  of  the  organization,  its  scope  of operations,  and  the  basis  of  its  competitive advantage. 

Finally, strategic objectives are a set of  organizational  goals  that  are  used  to operationalize the mission statement and that are specific and cover a well-defined time frame. For strategic objectives to be meaningful, they must be  measurable,  specific,  appropriate,  realistic, and timely.

Analyzing the External Environment of the Firm

Environmental scanning  involves surveillance of  a  firm’s  external  environment  to  predict environmental  changes  and  detect  changes  that are  already  under  way.  Environmental monitoring  tracks  the  evolution  of  trends, sequences  of  events,  or  streams  of  activities. Finally,  competitive  intelligence  aids  firms  in defining  and  understanding  their  industry  and identifying rivals’ strengths and weaknesses.

These  three  processes  are  the  fundamental  of environmental forecasting, which refers to the development  of  plausible  projections  about  the direction, scope, and intensity of environmental change. A danger of forecasting is that managers can  underestimate  or  overestimate  uncertainty, which  results  in  decisions  that  neither  take advantage  of  opportunities  nor  defend  against threats. A more in-depth approach to forecasting is  scenario  analysis,  which  involves  experts’ detailed  assessments  of  societal  trends, economics,  politics,  technology,  or  other dimensions of the external environment.

A  basic  technique  for  analyzing  firm  and industry  conditions  is  SWOT  analysis.  SWOT stands for Strengths, Weaknesses, Opportunities, and Threats.  The  strengths  and  weaknesses  portion refers to internal conditions of the firm; threats and  opportunities  are  environmental  conditions external  to  the  firm.  The  basic  idea  of  SWOT analysis is that a firm’s strategy must: 
•  Build on its strengths; 
•  Try to remedy or avoid the weaknesses; 
•  Take advantage of the opportunities; 
•  Protect the firm from the threats.

The  SWOT  approach  is  very  popular  for  a number  of  reasons.  It  forces  managers  to simultaneously  consider  internal  and  external factors; it encourages firms to be proactive, not reactive;  finally,  its  conceptual  simplicity  is achieved without sacrificing analytical rigor.

The  general  environment  consists  of  factors external  to  an  industry,  and  usually  beyond  a firm’s  control  that  affect  a  firm’s  strategy.  The general  environment  is  divided  into  six segments. These are demographic, sociocultural, political/legal,  technological,  economical,  and global. Key trends and events are listed below.

The  demographic  segment  includes  elements such as the aging population, rising or declining affluence,  changes  in  ethnic  composition, geographic  distribution  of  the  population,  and disparities in income level. 

The  sociocultural  segment  includes  a  higher percentage  of  women  in  the  workforce,  dual-income  families,  increases  in  the  number  of temporary  workers,  greater  concern  for  healthy diets and  physical fitness, greater interest in  the environment, and postponement of having kids. 

Important areas of the political/legal segment include  tort  reform,  the  1990  Americans  with Disabilities  Act  (ADA),  banks  being  allowed  to offer brokerage services, deregulation of utilities and  other  industries,  and  increases  in  the federally mandated minimum wage.

Examples  of  trends  and  developments  in  the technological  segment  genetic  engineering, Internet technology, computer-aided design and computer-aided  manufacturing  (CAD/CAM), research in artificial and exotic materials, and, on the downside, pollution and global warming. 

The  economic  segment  impacts  all  industries. Key  economic  indicators  include  interest  rates, unemployment rates, the Consumer Price Index (CPI),  the  gross  domestic  product  (GDP),  and net disposable income.

Firms increasingly operate abroad. Key elements of  the  global  segment  include  currency exchange  rates,  increasing  global  trade,  the economic emergence of China, trade agreements amongst  national  blocs  (NAFTA,  EU)  and  the General Agreement on Tariffs and Trade. 

In  addition  to  the  general  environment, managers  must  consider  the  competitive environment.  This  environment  consists  of many  factors  that  pertain  to  an  industry  and affect  a  firm’s  strategies.  One  of  the  most commonly  used  analytical  tools  for  examining the  competitive  environment  is  Michael  E. Porter’s  Five-Forces  Model,  which  the environment in terms of five basic forces:

1.  The threat of new entrants; 
2.  The bargaining power of suppliers; 
3.  The bargaining power of buyers; 
4.  The threat of substitutes; 
5.  The intensity of competitive rivalry.

The  threat  of  new  entrants  refers  to  the possibility that the profits of established firms in the industry may be eroded by new competitors. There are six major sources of entry barriers: 
(a) economies  of  scale;  
(b)  product  differentiation; 
(c)  capital  requirements;  
(d)  switching  costs;  
(e) access  to  distribution  channels;  and  
(f)  cost disadvantages  independent  of  scale.  
If  few  of these barriers are present, the threat of new entry is high, and vice versa,  

The  bargaining  power  of  suppliers  can  drive down industry profitability. Suppliers’ bargaining power will be high in the following instances: 
(a) the  supplier  group  is  dominated  by  only  a  few companies  and  is  more  concentrated  than  the industry it sells to; 
(b) the supplier group is not obliged to contend  with substitute products for sale  to  the  industry;  (c)  the  industry  is  not  an important  customer  of  the  supplier  group;  
(d) the  supplier’s  product  is  an  important  input  to the  buyer’s  business;  
(e)  the  supplier  group’s products  are  differentiated  or  it  has  built  up switching  costs  for  the  buyer;  and  
(f)  the supplier group poses a credible threat of forward integration.

Like that of suppliers, the bargaining power of customers  can  also  drive  down  the  profits  of firms  in an  industry, especially if  a  buyer group satisfies  the  following  conditions:  
(a)  it  is concentrated or purchases large volumes relative to seller sales; 
(b) the products it purchases from the industry are standard or undifferentiated; 
(c) it  faces  few  switching  costs;  
(d)  it  earns  low profits; 
(e) it poses a credible threat of backward integration;  and  
(f)  the  industry’s  product  is unimportant  to  the  quality  of  its  products  or services. 

All  firms  in  an  industry  compete  with  other industries  producing  substitute  products  and services.  The  threat  of  substitutes  limits  the potential  returns  of  an  industry  by  placing  a ceiling  on  the prices  those  firms  in  an  industry can  profitably  charge.  The  more  attractive  the price/performance  ratio  of  substitute  products, the tighter the lid on an industry’s profitability is. 

The  final  element  of  the  Five-Forces  Model  is the  intensity  of  competitive  rivalry.  Intense rivalry is the result of several interacting factors, including:  
(a)  numerous  or  equally  balanced competitors;  
(b)  slow  industry  growth;  
(c)  high fixed or storage costs; 
(d) lack of differentiation or  switching  costs;  
(e)  capacity  augmented  in large increments; and 
(f) high exit barriers.

There are, however, caveats to industry analysis. First,  managers  should  not  always  avoid  low-profit  industries,  as  these  can  still  yield  high returns  for  some  players  who  pursue  sound strategies.  Second,  Porter’s  five-force  analysis implicitly assumes a zero-sum game, determining how  a  firm  can  enhance  its  position  relative  to the  forces.  But  this  approach  can  overlook  the many  potential  benefits  of  developing  win-win relationships  with  buyers  and  suppliers.  Third, the  five-force  model  has  been  criticized  for being essentially a static analysis: external forces and firms’ strategies are continually changing the structure of all industries.

In an industry analysis, two assumptions cannot be assailed: (1) no two firms are totally different, and  (2)  no  two  firms  are  exactly  the  same. Clusters of firms that share similar strategies are known  as  strategic  groups.  The  value  of strategic  grouping  is  fourfold.  First,  it  helps  a firm to identify barriers to mobility that protect a group  from  attacks  by  other  groups;  second,  it helps  a  firm  identify  groups  whose  competitive position  may  be  marginal  or  tenuous;  third,  it helps  chart  the  future  directions  of  firms’ strategies;  and  fourth,  it  is  helpful  in  thinking through the  implications  of each industry trend for the strategic group as a whole.

Assessing the Internal Environment of the Firm 

Value-chain analysis  sees the  organization as  a sequential  process  of  value-creating  activities. Activities  can  be  classified  in  two  categories: primary activities and support activities. Primary activities  are  sequential  activities  of  the  value chain  that  refer  to  the  physical  creation  of  the product  or  service.  There  are  five  primary activities, explained below: 

Inbound Logistics: location of distribution facilities to  minimize  shipping  times,  excellent  material and inventory control systems, systems to reduce time  to  send  “returns”  to  suppliers,  warehouse layout  and  designs  to  increase  efficiency  of operations for incoming materials. 

Operations: efficient plant operations to minimize costs,  appropriate  level  of  automation  in manufacturing,  quality  production  control systems  to  reduce  costs  and  enhance  quality, efficient plant layout and workflow design. 

Outbound Logistics: effective shipping processes to provide  quick  delivery  and  minimize  damages, efficient  finished  goods  warehousing  processes, shipping of goods in large lot sizes to minimize transportation  costs,  quality  material  handling equipment to increase order picking. 

Marketing  and  Sales:  highly  motivated  and competent sales force, innovative approaches to promotion  and  advertising,  selection  of  most appropriate  distribution  channels,  proper identification  of  customer  segments  and  needs, effective pricing strategies. 

Service:  effective  use  of  procedures  to  solicit customer  feedback  and  to  act  on  information, quick  response  to  customer  needs  and emergencies, ability to furnish replacement parts as  required,  effective  management  of  parts  and equipment  inventory,  quality  of  service personnel  and  ongoing  training,  appropriate warranty and guarantee policies. 

Next  to  primary  activities,  there  are  support activities,  i.e.  activities  of  the  value  chain  that either  add  value  by  themselves  or  add  value through  important  relationships  with  primary and  other  support  activities.  There  are  four support activities, listed and explained below:

General Administration: effective planning systems to  attain  overall  goals  and  objectives,  ability  of top  management  to  anticipate  and  act  on  key environmental  trends  and  events,  ability  to obtain  low-cost  funds  for  capital  expenditures and working capital, excellent relationships with diverse stakeholder groups, ability to coordinate and integrate activities across the “value system”, high visibility to  inculcate organizational culture and  values,  effective  IT  to  integrate  value-creating activities. 

Human  Resource  Management:  effective  recruiting and development and retention mechanisms for employees,  quality  relations  with  trade  unions, quality  work  environment  to  maximize  overall employee  performance  and  minimize  absentee-ism, reward and incentive programs to motivate. 

Technology  Development:  effective  R&D  activities for  process  and  product  initiatives,  positive collaborative  relationships  between  R&D  and other  departments,  state-of-the-art  facilities  and equipment,  culture  that  enhances  creativity  and innovation, excellent qualifications of personnel.

Procurement:  procurement  of  raw  material  inputs to  optimize  quality  and  speed  and  to  minimize the associated costs, development of  “win-win” relationships with suppliers, effective procedures to  purchase  advertising  and  media  services, analysis  and  selection  of  alternate  sources  of inputs to minimize dependence on one supplier, ability to make proper lease-vs.-buy decisions.

Managers  should  not  ignore  the  importance  of relationships among value-chain activities. There are  two  levels:  (1)  interrelationships  between activities  within  the  firm,  and  (2)  relationships among activities within  the firm and  with other organizations  that  are  part  of  the  firm’s expanded value chain, e.g. buyers and suppliers.

The  resource-based  view  of  the  firm  is  the perspective  that  firms’  competitive  advantages are  due  to  their  endowment  of  strategic resources  that  are  valuable,  rare,  costly  to imitate, and costly to substitute. It combines two perspectives:  (1)  the  internal  analysis  of phenomena  within  a  company,  and  (2)  an external  analysis  of  the  industry  and  its competitive environment. A firm possesses three key types of resources, explained below.

Tangible  resources  are  organizational  assets that  are  relatively  easy  to  identify,  including financial resources, physical assets, organizational  resources,  and  technological  resources. Intangible  resources  are  organizational  assets that are difficult to identify and account for and are  typically  embedded  in  unique  routines  and practices, including human resources, reputation resources,  and  innovation  resources.  Organizational capabilities are the competencies and skills  that  a  firm  employs  to  transform  inputs into outputs.

For  a  resource  to  provide  a  firm  with  the potential for a sustainable competitive advantage it  must  have  four  attributes. It  must  be  valuable (neutralize threats and exploit opportunities), rare (not  many  firms  possess),  difficult  to  imitate (physically  unique,  path  dependency,  causal ambiguity,  social  complexity),  and  difficult  to substitute  (no  equivalent  strategic  resources  or capabilities). Only  if  a resource satisfies all  four of  these  conditions,  it  creates  sustainable competitive advantages. If a resource is valuable and  rare,  it  creates  a  temporary  competitive advantage;  if  it  is  only  valuable,  it  creates competitive  parity.  If  it  satisfies  none  of  the conditions, there is a competitive disadvantage.

The resource-based view, however, is not suited for  addressing  how  a  firm’s  profits  will  be distributed to a firm’s management and workers. There  are  four  factors  that  help  explain  the extent to which employees and managers will be able to obtain a proportionally high level of the profits that they generate: 
•  Employee bargaining power;
•  Employee replacement cost; 
•  Employee exit cost; 
•  Manager bargaining power. 

Two approaches can be used when evaluating a firm’s  performance.  The  first  is  financial  ratio analysis,  which,  generally  speaking,  identifies how  a  firm  performs  according  to  its  balance sheet,  income  statement,  and  market  valuation. The  starting  point  in  analyzing  the  financial position of a firm is to compute and analyze five different types of financial ratios: •  Short-term solvency or liquidity; 
•  Long-term solvency measures; 
•  Asset management (turnover); 
•  Market value; 
•  Profitability. 

A  meaningful  ratio  analysis  should  not  only calculate  and  interpret  financial  ratios,  but  also how they change over time and are interrelated.

Path  dependency  means  a  resource  is  developed and/or  accumulated  through  a  unique  series  of events.

Causal  ambiguity  means  a  resource  is  costly  to imitate because a competitor  cannot  determine  what it is and/or how it can be recreated.

Social  complexity  means  a  resource  is  costly  to imitate  because  the  social  engineering  required  is beyond  the  capability  of  competitors,  including interpersonal  relations  among  managers, organizational culture, and reputation with buyers and suppliers.

When  analyzing  firms’  financial  performance, important  reference  points  are  needed.  Issues that  must  be  taken  into  account  to  make financial  analysis  more  meaningful  are:  (a) historical  comparisons;  (b)  comparison  with industry  norms;  and  (c)  comparison  with  key competitors. The  second  approach  takes  a  broader  stake-holder view: firms must satisfy a broad range of stakeholders  to  ensure  long-term  viability.  A method that combines both the second and the first approach is the balanced scorecard, which is  a  method  to  evaluate  a  firm’s  performance using the following four questions: 

•  How  do  customers  see  us?  (i.e.  the customer perspective); 
•  What must we excel at? (i.e. the internal business perspective); 
•  Can we keep improving/creating value? (i.e. the innovation and learning perspective); 
•  How  do  we  look  to  shareholders?  (i.e. the financial perspective).

While  most  agree  that  the  balanced  scorecard concept is an  appropriate and useful tool, there are  design  and  implementation  issues  that  may decrease  its  value,  including:  (a)  lack  of  clear strategy;  (b)  limited  or  ineffective  executive sponsorship; (c) too much emphasis on financial measures rather than nonfinancial measures; (d) poor  data  on  actual  performance;  (e)  in-appropriate  links  of  scorecard  measures  to compensation;  and  (f)  inconsistent  or  inappro-priate terminology.

Recognizing a Firm’s Intellectual Assets  

In the knowledge economy, wealth is created through  the  effective  management  of  workers instead of by the efficient control of physical and financial assets. Many have defined intellectual capital  as  the  difference  between  the  market value and the book value of the firm,  including assets  such  as  reputation,  employee  loyalty  and commitment,  customer  relationships,  company values,  brand  names,  and  the  experience  and skills  of  employees.  Intellectual  capital  can  be divided into four types of knowledge.

Explicit  knowledge  is  knowledge  that  is codified,  documented,  easily  reproduced,  and widely  distributed.  Tacit  knowledge  is knowledge that is in the minds of employees and is based on their experiences and backgrounds. 

Human  capital  is  the  individual  capabilities, skills,  knowledge,  and  experience  of  the  firm’s employees  and  managers.  Human  capital consists  of  three  interdependent  activities:  (1) attracting  human  capital;  (2)  retaining  human capital;  and  (3)  developing  human  capital.  For developing human capital, it is especially impor-tant to: (3.a) encourage widespread development; (3.b) transfer knowledge; (3.c) monitor progress and  track  development;  and  (3.d)  evaluate human  capital.  For  retaining  human  capital, firms need: (2.a) their people to identify with the organization’s  mission  and  values;  (2.b)  create challenging work and a stimulating environment; and  (2.c)  provide  (non-)financial  rewards  and incentives. 

Finally, social capital is the network of relation-ships  that  individuals  have  both  outside  and inside the organization. Developing social capital helps tie knowledge workers to a given firm. The Pied  Piper  Effect  refers  to  groups  of professionals,  not  individuals,  who  en-masse leave  (or  join)  an  organization.  Social  relation-ships thus provide an important mechanism for obtaining  both  resources  and  information from individuals and organizations outside the firm.  

Part of social capital is the social network. Social network  analysis  depicts  the  pattern  of  inter-actions between individuals and aids to diagnose effective  and  ineffective  patterns.  In  a  social relationship,  there  are  closure  (the  degree  to which  members  of  a  social  network  have  ties with other group members) and bridging (stress the  importance  of  ties  connecting  otherwise disconnected  people)  relationships.  Structural holes are social gaps between groups in a social network  where  there  are  few  relationships  that bridge  the  groups.  A  potential  downside  of social  capital  is  called  groupthink,  which  is  a tendency  for  individuals  in  an  organization  not to question shared beliefs.

Nowadays, technology plays an important role in leveraging  knowledge  and  human  capital.  The use of technology has also allowed professionals to work as part of electronic teams to enhance the speed and effectiveness with which products are  developed.  Advantages  of  e-teams  are  that they  not  restricted  by  geographic  constraints, and  they  can  be  very  effective  in  generating social capital. However, challenges include a lack of  what  is  called  “identification  and  combi-nation”. These two  processes are  central  to  the effective functioning of face-to-face groups. 

Intellectual property  rights are  more  difficult to determine  and  protect  than  property  rights  for physical assets. But if intellectual property is not reliably protected by the state, no individuals will have the incentive to develop new products and services. Dynamic capabilities entail the capacity to  build  and  protect  a  competitive  advantage. They are about the ability of an organization to challenge  the  conventional  wisdom  within  its industry and market, learn and innovate, adapt to the changing world, and continuously adopt new ways to serve the evolving needs of the market. 

Business-Level Strategy 

Michael  E.  Porter  described  three  generic strategies that a firm can use to achieve a compe-titive  advantage.  The  first  of  these  strategies  is overall  cost  leadership,  which  is  based  on appeal  to  the  industry-wide  market  using  a competitive  advantage  based  on  low  cost.  To generate above-average performance, a firm that uses this strategy must attain competitive parity on  the  basis  of  differentiation  relative  to  its competitors.  There  are  a  number  of  potential pitfalls that a cost leadership strategy encounters: (a) too much focus on one or a few value-chain activities; (b) all rivals share a common input or raw  material;  (c)  the  strategy  is  imitated  too easily; (d) a lack of parity on differentiation; and (e) erosion of  cost advantages when the pricing information available to customers increases. 

The second generic strategy is a differentiation strategy.  As  the  name  implies,  this  strategy consists  of  creating  differences  in  the  firm’s product  or  service  offering  by  creating  some-thing  that  is  perceived  industry-wide  as  unique and  valued  by  customers.  Firms  create  sustain-able differentiation  advantages and  attain above average performance when their price premiums exceed the extra costs incurred in being unique. Pitfalls of the differentiation strategy include: (a) uniqueness  that  is  not  valuable;  (b)  too  much differentiation; (c) the price premium is too high; (d)  differentiation that is too  easily imitated;  (e) dilution of brand identification through product-line  extensions;  and  (f)  perceptions  of  differen-tiation may vary between buyers and sellers.

The  third  and  final  generic  strategy,  the  focus strategy,  is  based  on  a  narrow  competitive scope within an industry. Essentially this strategy is  about  the  exploitation  of  a  particular  market niche.  Focus  strategy  has  two  variants:  cost focus  (creating  a  cost  advantage  in  the  target segment)  and differentiation focus  (differentiate in  the  target  market).  Potential pitfalls  of  focus strategies  are:  (a)  erosion  of  cost  advantages within the narrow segment; (b) even product and service  offerings  that  are  highly  focused  are subject  to  competition  from  new  entrants  and from imitation; and (c) focusers can become too focused to satisfy buyer needs.

High performers are  firms that attain both cost and  differentiation  advantages.  This  strategy allows  a  firm  to  provide  two  types  of  value  to customers:  differentiated  attributes  and  lower prices. There are three approaches to combining overall  low-cost  and  differentiation:  (1)  auto-mated  and  flexible  manufacturing  systems;  (2) exploiting  the  profit  pool  concept  for  sustain-able competitive advantage; and (3) coordinating the  “extended”  value  chain  by  way  of  infor-mation  technology.  Pitfalls  of  this  integrated approach are: (a) failing to attain both strategies may  result  in  ending  up  with  neither  one  –  i.e. being  stuck  in  the  middle;  (b)  underestimating the  challenges  and  expenses  associated  with coordinating  value-creating  activities  in  the extended  value  chain;  and  (c)  miscalculating sources of revenue and profit pools in the firm’s industry.

The  industry  life  cycle  refers  to  the  stages  of introduction,  growth,  maturity,  and  decline  that occur  over  the  life  of  an  industry.  Below,  each stage of the industry life cycle will be discussed.

The  first  stage  of  the  industry  life  cycle  is  the introduction  stage.  It  is  characterized  by  new products  that  are  not  yet  known  to  customers, poorly  defined  market  segments,  unspecified product features, low sales growth, rapid techno-logical  change, operating  losses,  and  a  need for financial  support.  The  challenge that  firms  face in  the  introduction  stage  becomes  one  of:  (a) developing the product and finding  ways to  get users  to  try  it;  and  (b)  generating  enough exposure so the product emerges as the standard by which all other rivals’ products are evaluated.

The second stage is the growth stage. This stage is  characterized  by  strong  increases  in  sales, growing  competition,  developing  brand  recog-nition, and a need for financing complementary value-chain  activities  such  as  marketing,  sales, customer service, and research and development. The  primary  key  to  success  in  this  stage  is  to build consumer preferences for  specific brands. In this stage, revenues increase at an accelerating pace  because: (a)  new consumers  are  trying the product;  and (b) a  growing proportion  of  satis-fied customers are making repeat purchases.

The third stage, the maturity stage, is character-ized  by  slowing  demand  growth,  saturated markets,  direct  competition,  price  competition, and  strategic  emphasis  on  efficient  operations. By  (re)positioning  their  products  in  unexpected ways, firms can change how customers mentally categorize them. This can be done using one of two strategies: reverse positioning, which strips away product attributes while  adding new ones, resulting  in  a  lower  prices,  and  breakaway positioning, which associates the product with a radically  different  category.  Similar  to  reverse positioning, this strategy permits the product to shift  backward  on  the  life-cycle  curve,  moving from  the  dismal  maturity  phase  to  a  growth opportunity. 

The  final  stage  of  the  industry  life  cycle  is  the decline  stage.  This  stage  is  characterized  by falling sales and profits, increasing price compe-tition,  and  industry  consolidation.  Firms  must face up to the strategic choices of either exiting or  staying  and  attempting  to  consolidate  their position in the industry. Four basic strategies are available  in  the  decline  phase:  (1)  maintaining; (2)  harvesting;  (3)  exiting  the  market;  and  (4) consolidation.

turnaround  strategy  is  a  strategy  that reverses  a  firm’s  decline  in  performance  and returns it to growth and profitability. A need for turnaround  may  occur  in  any  stage  of  the  life cycle, but is  most prevalent in the  maturity and decline  stage.  There  are  three  basic  turnaround strategies: (1) asset and cost surgery; (2) selective product  and  market  pruning;  and  (3)  piecemeal productivity improvements. 

Corporate-Level Strategy 

Firms diversify to achieve synergy. There are two meanings  to  this  term:  related  diversification enables  a  firm  to  benefit  from  horizontal relationships  across  different  businesses  in  the diversified  corporation  by  leveraging  core competencies and  sharing activities. This  allows a firm to benefit from economies of scope, i.e. cost savings that arise because of this leveraging. 

Firms  generate  value  by  leveraging  their  core competencies.  Core  competencies  are  a  firm’s strategic  resources  that  reflect  the  collective learning in the organization. Core competencies must  meet  three  criteria  to  generate  value:  (1) they  must  enhance  competitive  advantage  by creating  superior  customer  value;  (2)  different businesses in the corporation must be similar in at least one important way related to them; and (3) they must be difficult to imitate or substitute.

Organizations  can  also  achieve  synergy  by sharing  activities,  i.e.  having  activities  of  two or more businesses’ value chains done by one of the  businesses.  The  most  common  types  of synergy  that  result  from  sharing  activities  are cost  reductions.  Furthermore,  sharing  activities can also lead to enhanced revenues. 

Firms  can  also  achieve  related  diversification through market power, which entails the firm’s ability to profit through restricting or controlling supply to a market (vertical integration, i.e. an extension of the firm by integrating preceding or successive production processes) or coordinating with other firms to reduce investments (pooled negotiation power). 

Benefits of vertical integration include: (a) a secure source of raw materials or distribution channels; (b) protection of and control over valuable asses; (c) access to new business opportunities; and (d) simplified  procurement  and  administrative procedures.  However,  there  are  also  risks  that need  to  be  considered:  (a)  costs  and  expenses associated  with  increased  overhead  and  capital expenditures; (b) loss of flexibility resulting from large  investments;  (c)  problems  associated  with unbalanced capacities along the value chain; and (d)  additional  administrative  costs  associated with managing a more complex set of activities. 

In  making  vertical  integration  decisions,  the following six issues should be considered: (1) is the  company  satisfied  with  the  quality  of  the value  that  its  present  suppliers  and  distributors are  providing?  (2)  Are  there  activities  in  the industry value  chain presently being  outsourced or performed independently by others that are a viable source of future profits? (3) Is there a high level of stability in the demand for the products of  the  organization?  (4)  How  high  is  the  pro-portion of additional production capacity that is actually absorbed by existing products or by the prospects of new and similar products? (5) Does the company have the required competencies to execute  the  vertical  integration  strategies?  And (6)  will  the  vertical  integration  initiative  have potential  negative  impacts  on  the  firm’s  stake-holders?

Another approach that prove to be very useful in understanding  vertical  integration  is  the transaction  cost  perspective,  which  is  a perspective  that  the  choice  of  a  transaction’s governance structure (such as vertical integration or  market  transaction)  is  influenced  by transaction  costs,  including  search,  negotiation, contracting, monitoring, and enforcement costs, associated with each choice. Vertical integration, however,  gives  rise  to  a  different  set  of  costs referred to as administrative costs. 

Contrary  to  in  related  diversification,  potential benefits  in  unrelated  diversification  can  be gained from vertical relationships, i.e. creation of synergies  from  the  interaction  of  the  corporate office  with  the  individual  business  units.  There are  two  main  sources  of  such  synergies: parenting  and  restructuring,  and  portfolio management. Both perspectives will be discussed in the following paragraphs.

The  positive  contributions  of  the  corporate office to a new business as a result of expertise and  support  provided  and  not  as  a  result  of substantial changes in assets, capital structure, or management  is  referred  to  as  the  parenting advantage.  Another  means  by  which  the corporate  office  can  add  substantial  value  to  a business is by restructuring, which is defined as the intervention of the corporate office in a new business  that  substantially  changes  the  assets, capital  structure  (capital  restructuring),  and/or management,  including  selling  off  parts  of  the business (asset restructuring) changing management (management  restructuring),  reducing  payroll  and unnecessary  sources  of  expenses,  changing strategies,  and  infusing  the  new  business  with new technology, processes, and reward systems.  

Portfolio  management  is  a  method  of  (a) assessing the competitive position of a business within  a  corporation,  (b)  suggesting  strategic alternatives for each business, and (c) to identify priorities for the allocation of resources between the  businesses.  The  key  purpose  of  portfolio management  is  to  assist  a  firm  in  achieving  a balanced portfolio of businesses. 

The  Boston  Consultancy  Group  has  identified four types of strategic business units:
•  Stars  are  competing  in  high-growth industries; relatively high market shares; long-term  growth  potential;  should continue to receive substantial funding. 

•  Question marks are competing in high growth  industries; relatively low  market shares; invest resources to enhance their competitive positions; 

•  Cash  cows  have  high  market  shares; low-growth  industry;  limited  long-run potential; present source of current cash flows to support stars/question marks; 

•  Dogs  have  weak  market  share;  low-growth  industries;  limited  potential; recommend divesting. 

In  using  portfolio  management,  a  firm  tries  to create synergies and value in a number of ways. First,  portfolio  analysis  gives  a  snapshot  of  the businesses in a corporation’s portfolio, enabling more  effective  resource  allocation.  Second,  the expertise  and  analytical  resources  in  the corporate office provide guidance in determining what  firms  may  be  (un)attractive  acquisitions. Third,  the  corporate  office  is  able  to  provide financial  resources  to  the  business  units  on favorable  terms  that  reflect  the  corporation’s overall ability to raise funds. 

There  are,  however,  a  number  of  limitations  to portfolio  analysis:  (1)  they  are  overly  simplistic, because they consists only of the dimensions of growth  and  market  share;  (2)  they  view  each business as separate, ignoring potential synergies; (3)  the  process  may  become  overly  mechanical, ignoring judgment and expertise; (4) the reliance on  strict  rules  for  resource  distribution  across strategic  business  units  can  be  detrimental  to  a firm’s  long-term  viability;  and  (5)  the  imagery (cash cows, question marks, stars and dogs) may lead to overly simplistic prescriptions.  The previous part of this chapter has dealt with the  types  of  diversification.  The  remainder will deal with how diversification can be achieved.

There  are  three  basic  means  of  diversification. Through  mergers  (the  combining  of  two  or more  firms  into  one  new  legal  entity)  and acquisitions (the incorporation of one firm into another  through  purchase),  corporations  can directly acquire a firm’s assets and competencies.  

Motives and benefits of mergers and acquisitions include: (a) obtaining valuable resources that can help  an  organization  expand  its  product offerings and services; (b) provide firms with the opportunity to attain the three bases of synergy, i.e.  leveraging  core  competencies,  sharing activities,  and  building  market  power;  (c) consolidation  within  an  industry  and  forcing other players to merge.  

However,  there  are  also  limitations  to  mergers and  acquisitions:  (a)  the  takeover  premium  that is  paid  for  an  acquisition  is  very  high;  (b) competing  firms  can  often  imitate  any advantages realized or copy synergies that result from  the  merger  and/or  acquisition;  (c) managers’  credibility  and  ego  might  get  in  the way  of  sound  business  decisions;  and  (d)  there can be  many  cultural issues that may  doom  the intended benefits from M&A endeavors.  

The  other  side  of  the  “M&A  coin”  are divestments, which entails the exit of a business from  the  firm’s  portfolio.  Divesting  a  business can  accomplish  many  objectives,  including:  (1) enabling managers to focus more directly on the firm’s  core  businesses;  (2)  providing  the  firm with  more  resources  to  spend  on  attractive alternatives; and (3) raising cash to fund existing businesses. 

strategic  alliance  is  a  cooperative  relation-ship between two or more firms. Joint ventures represent  a  special case  of  alliances,  where  two or  more  firms  contribute  equity  to  establish  a new  legal  entity.  Both  play  a  prominent  role  in leading firms’ strategies, because they have many potential  advantages,  including  entering  new markets, reducing manufacturing (or other) costs in the value chain, and developing and diffusing new technologies.

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