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KDI SCHOOL WORKING PAPER SERIES

Growth Strategy: A Conceptual Framework


Seung-Joo Lee

May 2004 Working Paper 04-10

This paper can be downloaded without charge at: KDI School of Public Policy and Management Working Paper Series Index: http://library.kdischool.ac.kr/publication/paper.asp The Social Science Network Electronic Paper Collection: http://ssrn.com/abstract= 556921

Growth Strategy: A Conceptual Framework

Seung-Joo Lee KDI School of Public Policy and Management, Korea sjlee@kdischool.ac.kr

Abstract: Growth Strategy is one of the top CEO agenda in most corporations today. The main objective of this paper is to review the existing literature on growth and provide a conceptual framework for managers to think systematically about growth strategy. The framework consists of seven key questions that could be used as a diagnostic tool to focus attention and stimulate strategic thinking. Each question has been elaborated further with specific examples of successful growth companies. JEL classification: M00, M10 Key words: growth strategy, strategy formulation, strategic thinking

I. Introduction

Growth is a hot topic today and one of the top CEO agenda in most corporations worldwide. Profitable growth is considered to be a key driver of shareholder value, organizational vitality and competitive sustainability. Corporate growth is also important for the national economy as it is a key determinant of job creation and the general prosperity of a nation. Sustained profitable growth, however, is difficult to achieve. The harsh reality is that only 10 percent of companies with above-average growth will sustain it for more than ten years(Baghai, 1999). Another study by Bain&Company(Zook, 2004) found that 75 percent of growth initiatives fail or do not meet shareholders expectations. In todays mature, low-growth economic environment, the odds against winning the growth game are considerable. The main objective of this paper is to provide a conceptual framework for managers to think systematically about growth strategy. Previous literature on growth does not sufficiently address some of the key issues senior executives should consider when developing a growth strategy. The framework consists of seven fundamental questions that could be used as a diagnostic tool or checklist to stimulate strategic thinking and focus analyses. The key questions and frameworks were derived from a thorough review of the existing literature on strategy and the authors personal experience advising corporations on their growth strategies. The paper will first review the existing literature on growth and will be followed by a description of the conceptual framework based on the seven fundamental questions.

II. Literature Review on Growth Strategy


There is a vast literature on growth written by management scholars and consultants. Among them, the following are particularly noteworthy in terms of intellectual contribution and practical insights.

Edith Penroses(1959) book, The Theory of the Growth of the Firm, is considered by many scholars in the strategy field to be the seminal work for describing the processes through which firms grow. Penroses major ideas can be summarized as follows: 1) Firms can be conceptualized as bundles of resources within administrative coordination. The heterogeneity of services from resources gives each firm its unique character. 2) Firms always have excess resources due to resource indivisibilities and new knowledge creation. Since excess resources can provide services at zero marginal cost, they motivate entrepreneurs to apply them to new activities, engendering growth and diversification. 3) The external environment is an image in the mind of the entrepreneur. Firms activities are governed by their productive opportunity. i.e. all the productive possibilities that the entrepreneur can see and take advantage of. 4) There are limits to the growth of the firm, but not to its size. Firm-specific management resources are the most important and may control the amount of new managerial resources that can be absorbed, and thus limit the rate of growth of firms. Penroses work has had a significant influence on the strategy field and provided the intellectual foundations for the development of the resource-based theory of the firm.

Resource-based theory emphasizes the critical importance of firm-specific resources and capabilities for sustainable competitive advantage and growth. This perspective complements the traditional emphasis of strategy on industry structure and strategic positioning as the determinants of competitive advantage. The resource-based view assumes that resources are heterogeneously distributed across firms and that resource differences persist over time(Wernefelt, 1984; Mahoney

and Pandian, 1992; Amit and Schoemaker, 1993). Firm performance is a function of how well managers build their organizations around resources that are valuable, rare, inimitable, and lack substitutes(Barney, 1991;Peteraf, 1993;Connor and Prahalad, 1996). Isolating mechanisms or barriers to imitation explain the generation of rents and provide the rationale for intra-industry differences in performance. Scholars have extended resource-based view to dynamic markets by emphasizing the dynamic capabilities by which managers integrate, build, and reconfigure internal and external competencies to address rapidly changing environments (Teece, Pisano and Shuen, 1997). From a dynamic perspective, innovation, especially in terms of new resource combinations can substantially contribute to sustainable superior returns. Hamel and Prahalads article on The Core Competence of the Corporation(1990) and their best-selling book, Competing for the Future(1994), were instrumental in popularizing the notion of core competence and helping executives think in terms of resources and capabilities in developing growth strategies for the future.

Despite the contribution of the resource-based view on deepening our understanding of firm capabilities, competitive advantage and growth, it has a number of limitations. For example, some of the key concepts, such as resources, capabilities, core competence and strategic assets have not been agreed upon by scholars and the mechanisms by which resources and capabilities actually contribute to competitive advantage remain vague and ambiguous. It has also been criticized for lack of sufficient empirical grounding regarding cause-and-effect relationship among variables. According to a McKinsey article(Coyne, 1997), Core competence is clearly an important concept. But for most, it is like a mirage: Something that from a distance appears to offer hope in a hostile environment, but that turns to sand when approached.

In order to help executives with practical advice on growth strategies, McKinsey & Co. conducted a major research project which was published in the book, The Alchemy of Growth(1999). Based on detailed case studies of 40 successful growth companies and practical insights from client engagement works, the book provides a variety of useful frameworks such as the following: 1) The three horizons concept emphasizes the need for active management of three distinct stages in a pipeline of continuous business creation so that leaders attention to managing their core business is balanced with efforts to develop new businesses. If

continual growth is the goal, the pace of replenishment must be faster than the pace of decline. Building and managing a continuous pipeline of business creation is the central challenge of sustained growth. 2) The seven degrees of freedom provides a systematic approach for identifying growth opportunities in existing and new customers, new products and services, new delivery approaches, new geographies, new industry structure, and new competitive arenas. By systematically addressing each degree of freedom in turn, managers can learn to think more broadly about growth opportunities in their business. 3) The staircases to growth approach suggests that successful growers take a series of measured steps, not big bold steps to achieve their aspirations. Each step takes them a little closer to their ultimate goal, making money in its own right, and adds capabilities that prepare them for further opportunities.

Bain & Companys research on growth, published in the book, Profit from the Core(2001), suggests that successful growth starts with a clear definition of a companys core business. Many business fail to deliver value to customers and shareholders because they wander too far from their core business. A core business involves one or more of the following: 1) Your most potentially profitable franchise customers 2) Your most differentiated and strategic capabilities 3) Your most critical product offerings 4) Your most important channels 5) Any other critical strategic assets, such as key patents and brands In a more recent study published in the book, Beyond the Core(2004), Bain consultants suggest that successful growers expand their strong, core business in predictable, repeatable ways into related markets where they can excel. Such companies develop and rigorously apply a strict repeatability formula to those adjacency moves. This formula enables them to change just one variable at a time to reduce risks and execute moves faster.

Slywotzky and Wise of Mercer Management Consulting, in their book, How to Grow When Markets Dont(2003) focus on two key concepts- demand innovation and hidden assets- as the key drivers of growth. Demand innovation is about creating new growth by offering customers economic benefits beyond the functionality of their traditional products. Demand innovation focuses on using ones product position as a starting point from which to do new things for customers that solve their biggest problems and improve their overall performance. Opportunities could take the form of follow-on services, such as installation, maintenance, financing, training, outsourced operation or anything that can help customers improve their cost structure, reduce waste, complexity, risks etc. Translating those opportunities into profits require hidden assets, those intangible capabilities and advantages such as customer relationships, strategic real estates, networks and information that companies have built in the normal course of doing business. Hidden assets, once created, can be extended or reused at little or no cost, and can help create powerful competitive barriers as they are difficult and expensive to replicate.

Christensen and Raynor, in their book, The Innovators Solution(2003) suggest that companies have two basic options when they seek to build new growth business. They can purse a sustaining innovation strategy, in which they bring better products to existing customers in existing markets. Or they can pursue a disruptive innovation strategy that either create a new market by targeting non-consumers or offer a good enough product to overserved customers at a lower price. Sustaining innovations are the lifeblood of established firms. They improve the performance of established products and services along the dimensions that mainstream customers in major markets historically have valued, but they dont tend to create new growth platforms. Disruptive innovations, on the other hand, establish an entirely new performance trajectory. After taking root in a simple, undemanding application, disruptive innovations continuously get better until they change the game and naturally lead entrenched incumbents to retreat from or ignore potential attackers. Taking advantage of this sort of asymmetries of motivation allows entering firms to capture disruptive growth from the incumbents.

III. Conceptual Framework Seven Key Questions for Growth

The existing literature on growth, even though very insightful in its own way, does not fully address some of the key issues senior executives should consider in developing a robust growth strategy. In formulating strategy, asking the right questions and thinking through the issues in a creative way may be more important than finding the solution(Ohmae, 1982; Markides, 2000). For example, Markides(2000) suggests that strategy is all about finding answers to three interrelated questions: 1) Who will be my targeted customers? 2) What products and services should I be offering? 3) How should I offer these products and services to my targeted customers in an efficient and innovative way? Building upon Markides questions and extending it further, I developed a conceptual framework(see Table 1) consisting of seven fundamental questions that can be used as a diagnostic checklist in developing a companys growth strategy. Each question will be elaborated further with specific case examples.

Table 1

Conceptual Framework: Seven Key Questions for Growth

Key Questions

Key Considerations

1. Where to Compete?

Establishing strategic focus in terms of - Business domain - Geographic markets Choice of target customers - Market segmentation - Key decision-makers - Product/service offering - Value proposition to customers - Business system & value chain design - Core competence & competitive advantage - Resource allocation & development - Partnership/alliance design - Choice of partner - Timing and speed of strategic moves - Scenario-based contingency planning - Uncertainty & risk management

2. Who to Target as Customers?

3. What to Offer?

4. How to Compete?

5. With Whom to Partner?

6. When to Compete? 7. What If?

1. Where to Compete?
The first question- where to compete- is about establishing strategic focus in terms of business domain and geographic markets. Firms cannot compete in every conceivable businesses and markets given limited resources and competitive threats from more focused competitors. Thus, firms have to make explicit trade-off as to which businesses and geographic markets they will concentrate their resources and where they will not compete. Making such trade-off explicit is not always easy, but the pay-off can be significant in terms of achieving strategic focus and clarity. The three-circle concept as used by Jack Welch at GE can be a powerful tool for establishing strategic focus in a highly diversified corporation. The three circles divided GE businesses into one of three categories: core manufacturing, high technology, and services. Each business within the circle would have to achieve No.1 or No. 2 in terms of global market share. Any businesses outside the circles would be subject to fix, sell, or close. Theses businesses were the marginal performers, or were in low-growth markets, or just had a poor strategic fit with GEs major businesses. Although very broad, the three circles concept helped GE streamline its business portfolio and achieve strategic focus in the allocation of its scare resources. Between 1981 and 1990, GE sold or divested more than 200 businesses, which freed up over $ 11 billion of capital. In the same time frame, the company made over 370 acquisitions, investing more than $21 billion in new acquisitions to strengthen its core businesses (Bartlett and Wozny, 1999) A clear strategic intent as used by Nokia can help focus resources and management attention toward a unified goal. When Jorma Ollila became CEO of Nokia in 1992, he explicitly defined Nokias strategic intent into four words focused, global, telecomoriented, and value-added- which summarized his vision of what Nokia ought to become by 2000. For the next five years, these provided the basis for deciding which businesses Nokia ought to keep and grow and which it should divest. As a result, Nokia disposed of non-core businesses such as power, tires, cables and television and refocused on just two businesses: telecommunications and mobile phones. To kickstart growth, it launched its first GSM mobile phone and pushed a worldwide drive for geographic expansion. Today, Nokia is the world leader in mobile phones and wireless communications equipment and a pioneer of wireless applications and multimedia products.

2. Who to Target as Customers


Once a company has defined its business domain and geographic scope, it should focus its attention on defining its target customers. The choice of target customers is a strategic decision, since companies cannot sell to everyone. Identifying and selecting target customers requires a good segmentation of the market. The key is to find an attractive segment which is profitable and growing and which allows the company to maximize the impact of its unique capabilities relative to those of its competitors(Markides, 2000). Dell, the worlds leading PC maker, segments the PC market into nine segments. For Dell, the primary differentiation is between a relationship and a transaction customer. Relationship customers are primarily interested in an ongoing relationship and depends on product testing and price/performance information in shaping their purchase decisions. By contrast, transaction customers are consumers or small business that tend to make one purchase at a time and generally do not require a designated sales representatives assigned to them. Dells knowledge of the different needs of customers by segment allowed Dell to penetrate different market segments efficiently by providing each segment with appropriate levels of sales support and services. For example, the largest relationship accounts had significant on-site assigned sales staff and received Premier Pages that allowed corporate purchasing agents to monitor sales, place orders, monitor delivery, spending etc. By contrast the consumer business was serviced solely by telephone and Internet, whereby a pre-programmed configurator guided purchases, provided order status updates, and pricing information. One common pitfalls in customer selection is to focus too much on short-term product line or transaction profitability. For example, GM in the 1980s, de-emphasized the small car segment based on financial analyses that showed that small cars were relatively unprofitable compared to large vehicles. This led to Japanese and European automakers to dominate the lower-priced, small car segment which initially served as a platform for acquiring young first-time buyers. When theses same customers began to purchase larger cars as they evolved through the customer life cycle, they continued to buy Japanese cars. As a result, GM inadvertently created a generation of young American consumers who grew up buying Japanese and European cars (Blattberg, Getz

and Thomas, 2001)

3. What to Offer?
The question of what to offer is about choosing the right product/service offering and, from the customers point of view, the right value proposition to its customers. A value proposition is a clear statement of product/service benefits that can be provided to a set of target customers. Developing a winning value proposition is at the core of strategy formulation and requires the following: 1) Target customers clearly identified 2) Benefits and price explicitly stated 3) Viable in light of competitors value proposition 4) Achievable with current resources and capabilities Southwest Airlines, the only airline that hasnt lost money in the past 25 years, has a clear value proposition to its customers. Its strategic principle is to meet customers short-haul travel needs at fares competitive with the cost of automobile travel (Gadiesh and Gilbert, 2001). In order to meet this goal, the company emphasized three key factors: speed, frequent point-to-point departures and friendly service (Kim and Mauborgne, 2002). By avoiding the hub-and-spoke system, the company is able to avoid the systemwide delays often associated with connecting flights through hub airports, which results in shorter turnaround times and higher equipment utilization. To simplify its operations, Southwest does not make extra investments in meals, lounges, and seating choices. But Southwest is not just a low-fare, low-cost carrier. It also emphasizes friendly customer service through its unique corporate culture. As a result, the airline has the best record in the industry in terms of on-time performance, fewest lost bags, and fewest number of customer complaints (OReilly and Pfeffer, 2000). Starbucks, which played a major role in creating the U.S. specialty coffee market, has a unique value proposition that goes beyond products and services. Starbucks executives believe that what the company actually provides is a consistent, satisfying coffee experience that combined premium coffee beverages such as caffe latte, cappuccino, espresso macchiato with outstanding customer service and an inviting, sociable atmosphere that put people at ease and comfort. This experience included not only what

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the coffee customers drank, the interactions they had with store employees, and the visual environment they confronted; it also encompassed the coffee aromas in the air, background music, and overall ambiance of company stores (Koehn,2001)

4. How to Compete
The question of how to compete involve making choices on a number of issues such as how to design the business system or value chain, how to leverage and develop core competence, how to allocate resources across activities and and so on. A business system or value chain is the set of linked activities a company does to create and deliver value to customers. A company can change the rules of the game by reconstructing and redesigning the value chain to deliver superior value. The key to such strategic innovation is to identify a firms distinctive competence and devise a breakthrough strategy that leverages these to the maximum. Nike built its large and successful business on a business system that involved a total reconfiguration of the activities of the traditional shoe manufacturing firm(Grant, 1998). Instead of manufacturing shoes in-house, its primary activity is product design and marketing(primarily in the U.S.) and the coordination of supplier network including the production under contract of components(primarily in Korea and Taiwan), and the labor-intensive, mass assembly of shoes(in China, the Philippine, India, Thailand, and several other low-wage countries). In penetrating new markets, Nike uses a consistent formula that has been successfully applied and adapted in a series of entries into sports markets. First, Nike begins by establishing a leading position in athletic shoes in the target market. Next, it launches a clothing line endorsed by the sports top athletes. Then it starts to feed higher-margin equipment into the markets, and in the final step, moves beyond the U.S. market to global distribution. This formula for growth has been used again and again in different sports categories, and enabled Nike to win over Reebok as leader in the sporting goods industry(Zook 2004). In the PC industry, Dell achieved leadership through its innovative direct sales model. By selling direct to the end customers, Dell eliminated the middleman and took customized orders over the phone or internet. The company outsourced all components and designed an integrated supply chain linking its suppliers very closely to its

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assembly factories and the order-taking system. Dells customer intimacy through its direct dealing with end-users gave the company superior ability to forecast market demand. This allowed Dell to pursue just-in-time manufacturing with very low levels of finished goods and components inventory, with little risk of stock-outs. Radical reductions in inventory not only lowered costs but also enabled Dell to be first to market with the latest products, solidifying its leadership position(Govindarajan and Gupta, 2001).

5. With Whom to Partner


With whom to partner is the question about forging partnerships and alliances. In todays interdependent world, no company is an island. Every company has to think in terms of working with others, even with competitors. A partnership may provide any one of the missing pieces, for example, market access, product line, technology, brand name, capital, or operating scale. To fill in theses pieces, partnerships may range from simple operating and distribution agreements, to formal joint ventures. Historically, about 40-60 percent of cross-border alliances do not succeed(Ernst, 2003). Of those that succeed, one partner usually buys out the other. Companies should have a clear vision of the end game. Are they looking to eventually buy or be bought? The choice of partner of critical. Companies need to carefully choose their partners based on strategic compatibility, resource complementarity, cultural fit, and mutual commitment and trust. The Nissan-Renault alliance is a case example of how two companies, deeply rooted in their own culture and identity, have been able to cooperate successfully, without losing their uniqueness. The partnership began in 1999, when Renault invested $5.4 billion in Nissan for 36.8% of the company. Nissan, at that time, was strapped for cash, which prevented it from making badly needed investments in its aging product line. The alliance created the worlds fourth largest automobile group with strong complementarities in products(platform and components), geographic markets, and capabilities. Under the leadership of Carlos Ghosn, Nissan achieved a dramatic corporate turnaround and rapidly reemerged as a major player in the global auto industry. Three years after the initial agreement, Nissan and Renault solidified its partnership by executing a cross-shareholding agreement wherein Renault raised its stake in Nissan to

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44.4%, and Nissan acquired a 15% stake in Renault(Yoshino and Fagan, 2003). Partnerships and alliances may be based on loosely coupled market-based incentives as evidenced in Li & Fungs process network. Li & Fung acts as an orchestrator of a process network connecting and coordinating many different links in the global supply chain of fast-moving apparel and consumer goods. Li & Fung owns none of the facilities involved in the production of apparel, but it maintains priviledged access to some 7,500 supply and manufacturing companies around the world that possess specialized production and distribution capabilities. Through its experience with the thousand of suppliers in its network, Li & Fung maintains a detailed, up-to-date view of supplier performance. This deep knowledge of supplier capabilities enables the company to quickly tailor the supply chain to meet each customers particular needs. By leveraging other companies assets, Li & Fung has been able to achieve impressive growth in the slow-growing apparel industry(Hagel, 2002).

6. When to Compete
The question of when to compete is about deciding on the right timing of strategic moves and the speed and pace of implementation. A company that postpones a commitment may learn more about the feasibility of an option, but postponement may also increase the risk that a more aggressive competitor will preempt a companys proposed strategy. Optimal timing of entry into an emerging market is a complex issue and depends on the characteristics of the technology, the presence of technical standards, the importance of complementary resources, as well as the capabilities and goals of the individual firm. As a major driving force of the semiconductor industry, Intels strategy is to continually introduce higher performing microprocessors through technology leadership. The company used overlapping development teams for subsequent generation microprocessors and invested heavily in design automation tools to speed up the development process. To implement its microprocessor strategy, Intel continued to invest aggressively in manufacturing capacity for its high-performance chips. Production investment decisions were usually made long before demand for these chips could be ascertained, which set it apart from its competitors. Intels time-paced strategy enabled the company to dictate the pace of strategic change that other players--

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customers, competitors, suppliers, and complementors---must adhere to(Burgelman, 2002). Research by Tellis and Golder(2002), however, suggests that market pioneers rarely endure as leaders. On average, pioneers have only a 16 percent share of the market and the failure rate is quite high(56 percent). The real causes of enduring market leadership, according to the authors, are vision and will. Enduring market leaders such as Microsoft, P&G, Gillette, and Eastman Kodak have a revolutionary and inspiring vision of the mass market, and they exhibit an indomitable will to realize that vision. They persist under adversity, innovate relentlessly, commit financial resources, and leverage assets to realize their vision. Eastman Kodak, for example, was neither a pioneer nor a dominant player in dryplate photography, but the company developed a very simple camera targeted for the mass market. The camera was an immediate success, and sales exploded. With this simple, relatively inexpensive gadget, Eastman Kodak unlocked the mass market for photography. It was not superior in quality to existing technology, but it was far simpler and cheaper, and of sufficient quality to appeal strongly to amateurs. Over a few decades of continuous innovation, the company was able to make obsolete the older, dominant technology primarily used by professionals (Tellis and Golder, 2002).

7. What If
The question What If is used to anticipate possible changes in the environment and prepare the organization for future uncertainties. Change and uncertainty are the facts of business life. A good strategy, however well-crafted, has to be constantly adapted and revised in response to the changing environment. Even well-run companies like Cisco and Corning failed to anticipate the precipitous fall in demand in the telecom sector and, as a result, their revenues and share prices fell over 70 percent---a serious price to pay for not having a plan B. In todays turbulent business environment, companies need to build strategic contingency planning into their culture and craft strategies to address their worst-case scenarios. For example, companies need to ask the following questions and prepare contingency plans to address those issues.

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1) What if demand suddenly falls off? 2) What if price drops precipitously? 3) What if global events disrupt your supply chain? 4) What if new competitors enter the market and cut the price? 5) What if labor strike shuts down the factory operation? Scenario planning is a critical step toward a comprehensive contingency strategy. Its main characteristics is the sketching out of not just one predicted future but a range of plausible developments that could significantly influence the organization. The purpose of developing scenarios is not to pinpoint the future, but rather to gain experience in a simulated future, so that you develop a set of instincts that allow you to respond quickly and effectively to new challenges as they unfold (Schoenmaker, 2002). Scenarios attempt to capture the richness and range of possibilities and can be used to challenge the prevailing mind-set, stimulating decision-makers to consider changes they would otherwise ignore. When faced with high uncertainty, a focused strategy might enable a company to reap the highest returns in some scenarios, but it may also expose it to large downside losses in other scenarios. If a company want to ensure against such downside losses, it should build a portfolio of initiatives and manage the risks inherent in individual initiatives. An analogy may be the use of convoys in moving supplies and ships across the Pacific Ocean during World War II. Convoys, with a mix of aircraft carriers, battleships, destroyers, escort ships, and supply ships, improved the ability of each ship to cross the ocean and ensure, through portfolio effects, that sufficient supplies make it across the ocean even when some ships didnt (Bryan, 2002). Likewise, a CEO can think about growth strategy as a portfolio of initiatives aimed at achieving favorable outcomes for the entire enterprise.

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IV. Conclusion
The main objective of this paper has been to provide a conceptual framework for managers to think systematically about growth strategy. Even though growth is a hot topic today, the existing literature does not sufficiently address some of the key issues senior executives should consider when developing a growth strategy. The framework consists of the following seven fundamental questions that could be used as a diagnostic checklist to stimulate strategic thinking: 1) Where to compete? 2) Who to target as customers? 3) What to offer? 4) How to compete? 5) With whom to partner? 6) When to compete? 7) What if? It is hoped that the framework will add value and help managers gain insights in formulating a successful and robust growth strategy for the future.

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