Strategic Commitments

Two armies wish to occupy an island located between their countries and connected by a bridge to both (see figure below). Each army prefers letting its opponent have the island to fighting. If you were the general of one of the armies, explain what your best strategy would be?

The Resource-Based View of the Firm

Resource Endowments

Activities

A Dynamic View of the Firm

Resource Endowments

Resource Commitments

Activities

Impact of Strategic Commitments

Irreversibility, not the amount of money involved, is the correct measure of whether a particular decision is commitment-intensive or not.

There are three economic indicators of such irreversibility

significant sunk costs

opportunity costs

time lags

Impact of Strategic Commitments

Sunk costs create irreversibility through lock-in. When a company sinks a lot of money into resources specialized to a particular course of action that cannot easily be sold off, there is a presumption in favor of continuing to use them. Otherwise, they would be valueless.

Impact of Strategic Commitments

Boeing's decision to develop the wide-bodied airframe for the 747.
At some point, the company's net investment in the project > its net worth. As a result, it was sunk unless it could make the plane fly. That meant Boeing was committed to the 747 once it was well into its development, even though it may not have even started had it known of the hurdles that lay ahead, such as the increases in take-off weight that would be demanded by its launch customer.

Impact of Strategic Commitments

Opportunity costs create irreversibility through lock-out, the mirror image of lock-in. Lock-out effects persist because of the difficulty of

reactivating dormant resources

reacquiring discarded resources

recreating lapsed opportunities to deploy particular resources in particular ways

Impact of Strategic Commitments

Pepsi-Cola lagged CocaCola in expanding internationally.

As a result, Pepsi earns one-tenth as much from its nonU.S. soft drinks operations as Coke

Impact of Strategic Commitments

When Coors began to take its beer national, everyone knew that the switch from a regional to a national position would require 10 years.

The third economic indicator of irreversibility is the time lag in altering a firm's endowment of resources.

Impact of Strategic Commitments

Among other things, Coors would have to modify its traditional preoccupation with production, develop additional marketing know-how, build a national clientele by spending more per barrel on advertising than its entrenched competitors, establish relationships with distributors in new states, and open its first new manufacturing facility.

Impact of Strategic Commitments

A national rollout of this sort could work only if Coors stuck with it long enough to test the key advantage for a national position, economies of national scale in advertising. So when Coors rolled out, it committed itself to acting in a particular way for a substantial period of time.

Impact of Strategic Commitments

Commitments can blunt the threat of imitation

Du Pont's preemption of capacity expansion opportunities in the U.S. titanium dioxide industry in the 1970s. Thanks to a production process based on low-cost feedstock, Du Pont enjoyed a 20% cost advantage over competitors' processes. Mastering the cheaper feedstock technology could be accomplished only by investing $100 million and several years of testing time in an efficiently scaled plant.

Impact of Strategic Commitments

Despite these costs and risks, imitation of Du Pont's superior technology might have been attempted if Du Pont hadn't also built a large new plant that effectively crowded out large-scale expansions by competitors over this period.

Du Pont is still the sole operator of the low-cost production process in the world as a result of its aggressive capacity commitments.

Using Strategic Commitments

First, the multiplicity of possible outcomes must be recognized if uncertainty is to be addressed effectively:

This requires the construction of multiple scenarios rather than the shoehorning of all risk into a discount rate.

Second, while uncertainty can sometimes increase the attractiveness of alternatives to making commitments such as hedging one's bets or delaying action, it rarely pays to try to stay totally flexible:

That would lead to lock-out risks, reduce a company's ability to influence the resolution of uncertainty and result in mediocre performance.

Using Strategic Commitments

Third, the problem of commitment under conditions of uncertainty is lessened by the fact that many commitmentintensive choices afford high learn-to-burn ratios
the rate at which information is received about whether a commitment is turning out to be a plum or a lemon divided by the rate at which sunk or opportunity costs are incurred in pursuing it.

High learn-to-burn ratios provide timely feedback in a way that permits revisions of commitments in response to bad news

Using Strategic Commitments

Fourth, realization of the potential for high learn-to-burn ratios requires careful management and can be enhanced in a variety of ways
by experimenting, engaging in pilot programs, appropriately staging or sequencing commitments, setting milestones and triggers for terminating commitment to a losing course of action, ensuring that appropriate incentives are in place.

Using Strategic Commitments

increase the odds of success and let the firm "fall forward" rather than Finally, a powerful backward in response approach for dealing with the uncertainty is to unanticipated to develop superior challenges.
capabilities that

Nucor
USXs precommitments
strategy site geometry target capacity HRM capacity customer base

Philips CD Decision
Baseline: no competition
Delay IFF p(success)<=38%

Competition with information symmetry

Delay IFF p(success)<=0.06% Whats the diff? Competition forecloses options, thus commitment

Competition with information asymmetry in Philips favor

Delay IFF p(success)<=13% Whats the diff? Better quality of information about the market, thus more choice, flexibility

Using Strategic Commitments

The power of signaling- visibility can deter competition and entry- Airbus More irreversible, less likely imitation- Airline industry Visibility v. provocation Analyze rivals previous commitments to decide whether they may imitate - Nucor Analyze your informational advantage, competitive intensity, and other relevant variables to decide between commitment and flexibility - Philips

Common Forms of Strategy Under Uncertainty

Commitment A big bet Often intended to shape the future Experimentation A series of small bets Exploits the correlation structure of the underlying uncertainty (e.g., through hedges) Attractive when landscape is unknown but knowable Flexibility Investment in the ability to change Relies upon organizational flexibility and adaptiveness Attractive when landscape changes continually

Attractive when you have a better grasp of future than others Examples: Du Pont, Nucor, Republic

Source: Jan W. Rivkin

Aligning Elements of Strategy

Summary of Type A strategy developed for current efficiency and regularity Summary of Type B strategy developed for innovation and flexibility

Resources
Human Financial Technological Emphasis on qualities of compliance and commitment Growth financed largely from ongoing business Emphasis on incremental product and process improvements Emphasis on qualities of originality and commitment Significant development investment requiring financial capacity Emphasis on the development of entirely new products and basic new technologies

Organization
Structure Centralized/functional orientation Clear vertical chain of authority for decisions/communication Sales and/or operations the dominant functions Decentralized/product orientation Network of influence and communication Utilize projects and task forces Marketing and/or R&D the dominant functions Loose planning around objectives (management by objectives)

Controls

Tight, detailed plans and budgets Reviews at short intervals Specific individual or group targets Compete with internal comparisons Stretch goals defined in terms of sales or production levels Tie rewards to individual or group performance Promote for making plans

Standards

General targets Compete with external comparisons Stretch goals defined in terms of project deliver dates Tie rewards to total business performance Promote for innovative results Reward risk-takers with soft landing for failure Bottom-up and top-down decision processes Use a clear maze Pride in being first with bright ideas Emphasis on creative teamwork Working hours and dress to meet individual preferences

Rewards

Policies/ processes Working environment

Top-down decision process Establish clear career tracks Pride in marine-like precision Emphasis on making your numbers in terms of costs, delivery, and quality Regular working hours and dress

Source: Excerpted from Heskett (198