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UNIT 1 CONCEPT OF STRATEGY

Objectives
After reading this unit, you shoulcfbe able to:
define strategy and understand its meaning;
understand the essence of strategy;
distinguish between strategy, policy, tactics, programmes, procedures and rules;
understand strategic decisions and its difference with operational decisions;
understand different levels of strategy; and
know the importance of strategy.

Structure
1.1

l ntroduction

1.2

Meaning of Strategy

1.3

Nature of Strategy

1.4

Essence of Strategy

1.5

Strategy vls Policies and Tactics

1.6

Strategy vls Programmes, Procedure and Rules

1.7

Levels of Strategy

1 .8

1m portance of Strategy

1.9

Summary

1.10 Key Words

1.1 1 Self Assessment Questions


1.12 References and Further Readings

INTRODUCTION

The top management of an organizatio~iis concerned with selection of a course of


action from among different alternatives to meet the organizational objectives. The
process by which objectives are formulated and achieved is known as strategic
management and strategy acts as the means to achieve the objective. Strategy is tlie
grand design or an overall 'plan' which an organization chooses in order to move or
react towards tlie set objectives by using its resources. Strategies most often devote a
general programme of action and an implied deployment of emphasis and resources to
attain cornprehensive objectives. An organization is considered efficient and
operationally effective if it is characterized by coordination betweerf objectives and
strategies. There has to be integratioli of the parts into a complete structure. Strategy
helps the organization to meet its uncertain situations with due diligence. Without a
strategy, the organization is like a ship witl~outa rudder. It is like a tramp, which has
no particular destination to go to. Without an appropriate strategy effectively
implemented, the future is always dark and hence, more are the chances of business
failure.

Introduction to Strategic
Management

1.2

MEANING'W STRATEGY

Thc \cord 'stl-atcg\' has entered in the field ofmanagement from tlie military services
where it reli.r\ r o apply the forces against an enemy to win a war. Originally, tlie word
strateg) has been derived from Greek 'strategos' whicli means generalship. The word
was used for tlie first time in aroulid 400 BC. The word strategy means the art of tlie
general to fight in war.

The dictionary meaning of strategy is, "the art of so moving or disposing the
instrument of warfare as to impose upon enemy, tlie place time and conditions for
fighting by one self."
In management, the concept of strategy is taken in more broader terms. According to
Glueck, "Strategy is the unified, comprehensive and integrated plan that relates
the strategic advantage of the firm to the challenges of the environment and is
designed to ensure that basic objectives of the enterprise are achieved through
proper implementation process."
Tliis definition of strategy lays stress on the following:
b)

Unified co~npreliensiveand integrated plan.


Strategic advantage related to challenges of environment.

c)

Proper implementation ensuring achievement of basic objectives.

a)

Another definition of strategy is given below which also relates strategy to its
environment. " Strategy is organization's patteni of response to its enviro~ilnentover a
period of time to achieve its goals and mission."

Tliis definition lays stress on the following:


a)

It isorganizatio~i'spattern of response to its environment.

b)

The objective is to achieve its goals and mission.

However, various experts do not agree about the precise scope of strategy. Lack of
consensus has lead to two broad categories of definitions: strategy as action inclusive
of objective setting and strategy as action exclusive of objective setting.
Strategy as Action, Inclusive o f Objective Setting

In 1960s, Chandler made an attempt to define strategy as "the determination of basic


long term goals and objective of an enterprise and the adoption of tlie courses of
action and the allocation of resources necessary for carrying out these goals."
This definition provides for three types of actions involved in strategy:
i)

Deterlnination of long term goals and objectives.

ii) Adoption of courses of action.


iii) Allocation of resources.
Strategy as Action Exclusive of Objective Setting
This is another view in which strategy has been defined. It states that strategy is a way
in which the firm, reacting to its environment, deploys its principal resources and
marshalls its efforts in pursuit of its purpose. Michael Porter has defined strategy as
"Creation of a unique and valued position involving a different set of activities.
The company that is strategically positioned performs different activities from
rivals or performs similar activities in different ways."

.
7

Tlie people wlio believe this version oftlie definition call strategy a unified,
co~iipreliensiveand integrated plan relating to tlie strategic advantages of the firm to
tlie challenges of the environment.
After considering both tlie views, strategy can simply be put as management's plan for
achieving its ob-jectives.It basically includes determination and evaluatio~iof
alternative paths to an already established missio~ior objective and eventually, clioice
of best alternative to be adopted.

1.3

NATURE OF STRATEGY

Based on tlie above definitions, we can understand the nature of strategy. A few
aspects regarding nature of strategy are as follows:
Strategy is a ma-jorcourse of action tlirough which an organization relates itself
to its environment particularly the external factors to facilitate all actions
involved in meeting the ob-jectivesoftlie organization.
Strategy is the blend of i~iter~ial
and external factors. To meet the opportunities
and threats provided by the external factors, internal factors are matched witli
Strategy is the co~iibinationof actions aimed to meet a particular condition, to
solve certain problems or to achieve a desirable end. The actions are different for
different situations.
Due to its dependence on environmental variables, strategy may involve a
corltradictory action. An organization may take co~itradictoryactions either
simultaneously or with a gap oftime. For example, a fir111is engaged in closing
down of some of its business and at the same time expanding some.
Strategy is firti~reoriented. Strategic actions are required for new situations
which have not arisen before in the past.
Strategy requires some systems and norms for its efficient adoption in any
organization.
Strategy provides overall framework for guiding enterprise thinking and action.
Tlie purpose of strategy is to determine and communicate a picture of enterprise
through a system of ~iiajorobjectives and policies. Strategy is concerned witli a unified
direction and efficient allocation of an organization's resources. A well made strategy
guides managerial action and thought. It provides an integrated approach fortlie
organization a~:d aids in meetirig the challenges posed by enviro~i~nent.

iI

1.4

ESSENCE OF STRATEGY

Strategy, according to a survey co~iductedin 1974, includes tlie deter~nination and


evaluation of alternative paths to an already establislied mission or objective and
eventually, choice oftlie alternative to be adopted. Strategy is characterized by four
important aspects.

I
I

I
,

Longterm objectives
Co~npetitiveAdvantage
Vector

Concept of Strategy

Introduction to Strategic
Management

Long Term Objectives


Strategy is formulated keeping in mind the long term objectives oftlie organization. It
is so because it emphasizes on long term growth and development. Strategy is future
oriented and therefore concerned with the objectives which have a long term
perspective.

The objectives give directions for implementing a strategy.

:I

Competitive Advantage
Whenever strategy is formulated, managers have to keep in mind tlie co~npetitorsof
the organization. Tlie environment has to be conti~iuouslymonitored for forming a
strategy. Strategy has to be made in a sense that the firm may have competitive
advantage. It makes tlie organization competent e~ioughto meet the external threats
and profit from tlie environmental ~pportut~ir
ir. The changes that take place over a
h3ve made
.r.r, r f strategy Inore beneficial.
period oftime in the environ~ne~it
While making plans, competitors may be igilored LA,
in making strategy, competitors
are given due importance.

t h a b

Vector
Strategy involves adoption of the course of action and allocation of resource for
meeting tlie long term objectives. From among tlie various courses of action
available, the, managers have to choose tlie one which utilizes the resources oftlie
organization in the best possible manner and helps in tlie ac1iievement oftlie
organizational objectives. A series of decisions are taken and they are in tlie
same direction.
Strategy provides direction to tlie whole organization. When the objective has bee11
set, they bring about clarity to tlie whole organization. They provide clear direction to
persons in the organization who are responsible for implementing the various courses
of action. Most people perform better ifthey know clearly what they are expected to
do and where tlie organization is going.

Synergy
Once we take a series of decisions to acco~nplislitlie objectives in the same direction,
there will be synergy. Strategies boost the prospects by providing synergy.
Let us now take an example to illustrate the essence of strategy in a firm dealing with
chemicals. Tlie scope of the firm relating tlie product is basic chemicals and
pharmaceuticals. The objectives of tlie firm can be:

Return on Investment: Threshold 20%, goal 35%.


Sales growth rate: Threshold lo%, goal 15%.
The strategy which comprises of the competitiveadvantage, growth vector
and synergy can be:

Competitive advantage: Patent protection and well developed R & D


division.
Growth vector: Product development and concentric diversification.
Synergy: Use of the firm's research capabilities and production technology.
In this manner each firm can individually have its own strategy.

Activity 1
1.

Ask tlie managers of three organizations about their perception regarding concept
of strategy.

..........................................................................................................................
2.

Explain tlie term vector. How is it important in decision making?

3.

Discuss the nature of strategy.

1.5

STRATEGY VIS POLICIES AND TACTICS

In this section, the concept of strategy is compared with concept.of policies and
tactics.

Strategy v/s Policies


Strategy has often been used as a synonym of policy. However, both are different and
shoi~ldnot be used interchangeably.

Policy is the guideline for decisions and actions on the part of subordinates. It is a
general statement of understanding made for acliieve~nentof objectives. Policies are
statements or a co:nmonly accepted i~nderstandingof decision making. They are
thought oriented. Power is delegated to tlie subordinates for implementation of
policies. I n general terms, policy is concerned with course of action chosen for the
fulfillment oftlie set objectives. It is an overall guide that governs and controls
managerial actions. Policies may be general or specific, organizational or functional,
written or implied. They should be clear and consistent. Policies have to be integrated
so that strategy is implemented successfully and effectively. For example, when the
performance oftwo employees is similar, the promotion policy may require the
promotion oftlie senior employee and hence lie would be eligible for promotion.

Strategies on the other hand are concerned with the direction in wliicli Iii~manand
physical resources are deployed and applied in order to maximize the chances of
achieving organizational objectives in the face of environmental variable. Strategies
are specific actiol~ssuggested to achieve the objectives. Strategies are action oriented
and everyone in the organization are empowered to implement them. Strategy cannot
be delegated downward because it may require last minute decisions.
Strategies and polices both are the nieans towards the end. 111otlier words, both are
directed towards meeting organizational objectives. Strategy is a rule for makillg
decision while policy is contingen~clecision.

Concept of Strategy

Introduction to Strategic
Management

Strategy v/s Tactics


Strategies are on one end ofthe organizational decisions spectriun while tactics lie on
tlie other end.
Carl Von Clausewitz, a Prussian army general and military scientist defines military
strategy as making use of battles in the furtherance of tlie war and tlie tactics as "the
use of arined forces in battle". A few points of distinction between the two are as
follows:
i)

Strategy determines tlie major plalis to be undertaken while tactics is the means
by which previously determined plans are executed.

ii)

Tlie basic goal of strategy according to military science is to break tlie will of the
army, deprive the eneiny of the means to fight, occupy his territory, destroy or
obtain control of his resources or make him surrender. The goal of tactics is to
achieve success in a given action and this forms one part of a group of related
military action.

iii) Tactics decisions can be delegated to all the levels of an organization while
strategic decisions cannot be delegated too low in the organization. The authority
is not delegated below the levels than those which possess the perspective
required for taking decisions effectively.
iv) Strategy is formulated in both a continuous as well as irregular manner. The
decisions are taken on the basis of opportunities, new ideas etc. Tactics is
A fixed time table may
determined on a periodic basis by various organizatio~~s.
be made for following tactics.
v)

Strategy has a long term perspective and occasionally it may have a short term
duration. Thus, the time horizon in terms of strategy is flexible but in case of
tactics, it is short run and definite.

vi) The decisions taken as part of strategy for~nulationand imple~nentationhave a


high element of uncertainty and are taken under the conditions of partial
ignorance. In contrast tactical decisions are more certain as they work upon the
framework set by the strategy. So the evaluation of strategy is difficult than the
evaluation of tactics.
vii) Since an attempt is made in strategy to relate the organization with its
environment, the requirement of information is more than that required in
tactics. Tactics use information available internally in an organization.
viii) The formulation of strategy is affected considerably by the personal values of the
person involved in the process but the same is not tlie case in tactics
implementation.

ix) Strategies are the most important factor oforgaliization because they decide the
future course of action for organization as a whole. On the other hand tactics are
of less importance because they are concerned with specific part of the
organization.

Activity 2
1

List the policies of any organization and also state the strategies it undertook.

2.

,Distinguish between strategy and tactics.

..........................................................................................................................

3. Distinguish between strategy and policy.

1.6

STRATEGY V/S PROGRAMMES,


PROCEDURE AND RULES

In this section, the relationship of strategy is explained with programmes, procedure


and rules.

Programmes
A prograninie is a single use comprehensive plan laying down the principle steps for
acco~nplisl~ing
a specific objective and sets an approximate time limit for each stage.
It is basically concerned witli providing answers to questions like: By whom will
the actions be taken up? When will the actions be taken? Where will the actions be
taken'? Program~nesare guided by organization's objectives and strategies and cover
Inany of the other types of plans. Therefore, they provide a step by step approach to
guide the action necessary to meet the objectives as set in the strategy. Programmes
provide the sequence of activities in a proper order which are designed to
imple~nentpolices. Progra~nmesare the instruments for coordination as they
require system, thinking and action. They also involve integrated and coordinated
planning efforts.

Procedure
terms, a procedure can be defined as " A series of functions or steps
performed to accomplish a specific task or undertaking." Strategies, programmes,
policies, budgets etc. need to be supplemented with detailed specifications i.e. how
they are to operate or would operate. A procedure is a precise means of making a step
by step guide to action that operates within a policy framework. Most companies have
I ike selection, promotion, transfer etc. They are essential for
hundreds of procedt~~.es
smooth opernt ll>n of the business activities. For example, procedure may include
calling tentle~s for purchasing materials, keeping them in stock roo111 and issuing them
against requisition slips. Procedures are concerned witli com~nunicatio~i
oftasks to be
perfor~ncd,organization interfaces and the responsibilities ofthe individuals involved.
The) describe the customary method for handling a future activity. It gives sequence
of actions directed at a single goal (usually short term) that is repeatedly pursued, i.e.
adopting budget, making procedures or granting sick leave to an employee against
medical certificate etc. Procedures are more rigid and allow no freedom as against
I11 general

Concept of Strategy

Introduction to Strategic
Management

Rules
A rule is principle to which an action or a procedure conforms or is intended to
conform. It is a standard or a norm to be followed in the conduct of a business in a
particular situation. It is more rigid and demands a specific action with respect to
particular situation. It does not mention any kind oftime estimate or sequence as in
the case of procedures. It is much more specific than a policy. It allows no liberty or
leniency and does not tolerate much deviati In. Rules have to be strictly followed and
lion compliance may entail penalty or punishment. For example, "NO Smoking" is a
rule wliicli has to be adhered to, by all tlie levels of management.

1.7

LEVELS OF STRATEGY

It is believed that strategic decision making is the responsibility oftop management.


However, it is considered useful to distinguish between the levels of operation ofthe
strategy. Strategy operates at different levels vis-a-vis:
Corporate Level
Business Level
Functional Level
There are basically two categories of companies- one, which have different businesses
organized as different directions or product groups known as profit centres or strategic
business units (SBUs) and other, wliicli consists of co~npanieswliicli are single
product companies. The example of first category can be that of Reliance Industries
Limited which is a highly integrated company producing textiles, yarn, and avariety
of petro chemical products and the example of the second category could be Asliok
Leyland Limited wliicli is engaged in the manufacturing and selling of heavy
commercial vehicles. The SBU concept was introduced by General Electric Company
(GEC) of USA to liialiage product business. The fundamental concept in the SBU is
tlie identification of dicrete independent product/ market segments served by the
organization. Because ofthe different environments served by each product, a SBU is
created for each independent product/ segment. Eacli and every SBU is different from
another SBU due to the distinct business areas (DBAs) it is serving. Eacli SBU has a
clearly defined productlmarket segment and strategy. It develops its strategy
according to its own capabilities and needs with overall organizations
capabilities and needs. Eacli SBU allocates resources according to its individual
requirements for the achievement of organizational objectives. As against the multi
product organizations, the single prodi~ctorganizations have single Strategic
Business Unit. In these organizations, corporate level strategy serves tlie whole
business. The strategy is implanted at tlie next lower level by functional strategies. I11
multiple product company, a strategy is formulated for each SBU (known as business
level strategy) and such strategies lie between corporate and functional level
The three levels are explained as follows:

Carporate Level Strategy


At the corporate level, strategies are formulated according to organization wise
polices. Tliese are value oriented, conceptual and less concrete than decisions at tlie
other two levels. Tliese are cliaracterized by greater risk, cost and profit potential as
and
well as flexibility. Mostly, corporate level strategies are futuristic, i~i~iovative
pervasive in nature. They occupy the highest level of strategic decision making and
cover tlie actions dealing with the objectives ofthe organization. Such decisions are

made by top management of the firm. The example of such strategies include
acquisition decisions, diversification, structural redesigning etc. The board of
Directors and the Chief Executive Officer are the primary groups involved in this level
of strategy making. In s~nalland family owned businesses, the entrepreneur is both the
general manager and chief strategic manager.

Business Levelstrategy
The strategies formulated by each SBU to make best use of its resources given the
environment it faces, come under the ganiut of business level strategies. At such a
level, strategy is a comprehensive plan providing objectives for SBUs, allocation of
resources among functional areas and coordination between them for achievement of
corporate level objectives. These strategies operate within the overall organizational
strategies i.e. within the broad constraints and polices and long term objectives set by
the corporate strategy. The SBU managers are involved in this level of strategy. The
strategies are related with a unit within the organization. The SBU operates within the
defined scope of operations by the corporate level strategy and is limited by the
assignment of resources by the corporate level. However, corporate strategy is not the
sum total of business strategies of the organization. Business strategy relates with the
"how" and the corporate strategy relates with the "whaf"' Business strategy defines
the choice of product or service and market of individual business within the firm. The
corporate strategy has impact on business strategy.

Functional Level Strategy


This strategy relates to a single functional operation and the activities involved
therein. This level is at the operating end ofthe organization. The decisions at this
level within the organization are described as tactical. The strategies are concerned
with how different functions of the enterprise like marketing, finance, manufacturing
etc. contribute to the strategy of other levels. Functional strategy deals with a
relatively restricted plan providing objectives for specific function, allocation of
resources among different operations within the functional area and coordination
between them for achievement of SBU and corporate level objectives.
Sometimes a fourth level of strategy also exists. This level is known as the operating
level. It comes below the functional level strategy and involves actions relating to
various sub functions of the major function. For example, the functional level strategy
of marketing function is divided into operating levels such as marketing research, sales
promotion etc.
Three levels of strategies have different characteristics as shown in the following
table.
Table 1.1: Strategic Decisions at Different Levels
Dimensions

Impact
Risk Involved
Profit Potential
Time Horizon
Flexibility
Adaptability

Corporate

Levels
Business

Functionnl

Significant
High
High
Long
High
Insignificant

Major
Medium
Medium
Medium
Medium
Medium

Insignificant
Low
Low
Low
Low
Significant

Concept of Strategy

Introduction to Strategic
Management

1.8

IMPORTANCE OF STRATEGY

With the increase in the pressure ofexternal threats, companies have to make clear
strategies and implement them effectively so as to survive. There have been companies
like Martin Burn, Jessops etc. that have completely become extinct and some
companies which were not existing before they became the market leaders like
Reliance, Infosys, Technologies etc. The basic factor responsible for differentiation
has not been governmental policies, infrastructure or labour relations but the type of
strategic thinking that different companies have shown in conducting the business.
Strategy provides various benefits to its users:
Strategy helps an organization to take decisions on long range forecasts.
It allows the firm to deal with a new trend and meet competition in an effective
manner.
With the help of strategy, the management becomes flexible to meet unanticipated
changes.
Efficient strategy formation and implementation result into financial benefits to
the organization in the form of increased profits.
4

Strategy provides focus in terms of organizational objectives and thus provides


clarity of direction for achieving the objectives.
Organizational effectiveness is ensured with effective implementation ofthe
strategy.
Strategy contributes towards organizational effectiveness by providing
satisfaction to the personnel.
It gets managers into the habit of thinking and thus makes them, proactive and
more conscious of their environment.
It provides motivation to employees as it paves the way for them to shape their
work in the context of shared corporate goals and ultimately they work for the
achievement of these goals.
Strategy formulation & implementation gives an opportunity to the management
to involve different levels of management in the process.
It improves corporate communication, coordination and allocation of resources.
With all the benefits listed above, it is quite clear that strategy forms an integral part
of an organization and is the means to achieve the end in an efficient and effective
manner.
Activity 3
1)

Distinguish corporate level strategy with business level strategy.

..........................................................................................................................
2)

State three benefits of strategy.

SUMMARY

1.9

In this unit we introduced tlie concept of strategy. Strategy is the conscious and
rational management
exercise which involves defining and achieving an organization's
objectives and implanting its mission. Strategy is a inajor course of action, a blend of
internal & external factors and is particular to a specific situation. It is dependent on
environmental variables and is futuristic i11 nature. Strategy has been misused with
terms like policy, tactics, programmes and procedures and rules. It is differentiated
with all these concepts. Strategy is operational at three levels - Corporate level,
Business level and Functional level. There may be a fourth level known as the
Operations level as well. Strategies are lifeblood of business activities.

1.10

KEY WORDS

Policy

Procedures

Programmes :

Rules

Strategy

Tactics

1.1 1
1)

2)
3)
4)
5)
6)
7)

Guideline for decisions and actions on the part of subordinates and


is a general statement of understanding made for the achievement
of objectives.
A series of functions or steps performed to accomplish a specific
task or undertaking.
A single use co~nprehensiveplan laying down the principle steps
for accomplishing a specific objective and sets an approximate
time limit for each stage.
A principle to which an action or a procedure conforms or is
intended to conform.
A unified, comprehensive and integrated plan that relates the
strategic advantage of the firm to the challenges of the
environment.
It is the ineans by which previously determined plans are executed.

SELF ASSESSMENT QUESTIONS

Wliat do you mean by strategy? Explain the nature of strategy.


"Strategy is synonymous with policies". Comment on the statement.
Differentiate between strategy and programmes, procedures and rules.
What are the various levels at which a strategy may exist?
Wliat is tlie importancebf strategy? Illustrate your answer with examples.
List tlie important characteristics of strategy.
Distinguish between business level and functional strategies.

1.12

REFERENCES AND FURTHER READINGS

Gliosh, P.K., I.C. Dhingra, N. Rajan Nair and K.P. Mani. (1997). "Advanced
Munagentent Accounting Strategic Management ", Sultan Chand & Sons, New Delhi.
Kaz~iii, Azliar. (2002). "Business Policy and Strategic Managenzent ",Tata McGraw
Hill Publishing Co, Ltd., New Delhi.
Mamoria, C.B., Mamoria, Satish and Rao, P. Subba. (2001). "Business Planning
u ~ tPolicy
l
",Himalaya Publishi~igHouse, Mumbai.
Prasad, L.M. (2002). "Business Policy: Strategic Management ",Sultan Chand &
Sons, New Delhi.
Slirivastava, R.M. (1999) "Management Policy and Strategic Management:
concept,^, SkiUs and Practices, Himalaya Publication House, Mumbai.

Concept of Strategy

understand the process of strategy;


identify various steps of strategy formulation;
understand the role played by different participants in the process; and
know the sequence of activities involved i n the process.

Structure
2.1

Introduction

2.2

Process of Strategy

2.3

Strategic Intent

2.4

Environmental and Organizational Analysis

2.5

Identification of Strategic Alternatives

2.6

Choice of Strategy

2.7

Implementation of Strategy

2.8

Evaluatioll and Control

2.9

Summary

2.10

Key Words

2.1 1

Self Assessment Questions

2.12

References and Further Readings

2.1

INTRODUCTION

There are two dimensions of every action - substantive and procedural. The former
involves determination of what to do and the latter is concerned with determination of
how to do. Both of these dimensions are interdependent and taken together help in
achieving the objectives for which the action is contemplated. In the context ofan
organization engaged in strategy formulation and implementation, the substantive
dimension deals with the determination of strategy or set of strategies and procedural
dimension deals with putting a strategy into operation. Besides these, it has to be
decided that who will do what in completing the action. The logic of a process is that
its particular elements are undertaken in a sequence over a period. The strategy
process involved in strategy includes a number of elements. The process can be
defined as a set of management decisions and actions which determines the
loi~grun direction and performance of the organization. It is a dynamic and
continuous process. However, there are two problems in identifying and sequencing
the elements:
i)

There is no unanimity among various authors about the elements and their
interaction.

ii)

After the elements have been identified, their sequential arrangement is another
problem.

UNIT 3 STRATEGIC FRAMEWORK

Strategic Framework

Objectives
After studying this unit, you should be able to:
l

understand the meaning of intent and vision;

understand the issues related to core values and core purpose;

know the concept of mission and its characteristics;

appreciate the process of formulating mission statements;

discuss the characteristics, need and issues with respect to objectives; and

distinguish the concepts of vision and mission, objectives and goals, intent and
vision etc.

Structure
3.1

Introduction

3.2

Strategic Intent

3.3

Vision

3.4

Core Values and Core Purpose

3.5

Mission

3.6

Business Definition

3.7

Objectives and Goals

3.8

Summary

3.9

Key Words

3.10 Self Assessment Questions


3.11 References and Further Readings

3.1

INTRODUCTION

Strategies are involved in the formulation, implementation and evaluation of process.


The hierarchy of strategic intent lays the foundation for strategic management process.
The process of establishing the hierarchy of strategic intent is very complex. In this
hierarchy, the vision, mission, business definition and objectives are established.
Formulation of strategies is possible only when strategic intent is clearly set up. This
step is mostly philosophical in nature. It will have long term impact on the
organization.

3.2

STRATEGIC INTENT

The foundation for the strategic management is laid by the hierarchy of strategic
intent. The concept of strategic intent makes clear WHAT AN ORGANISATION
STANDS FOR, Harvard Business Review, 1989 described the concept in its infancy.
Hamed and Prahalad coined the term strategic intent. A few aspects about strategic
intent are as follows:
l

It is an obession with an organization.

This obession may even be out of proportion to their resources and capabilities.

31

Introduction to Strategic
Management

It envisions a derived leadership position and establishes the criterion, the


organization will use to chart its progress.

It involves the following:


l
l
l
l

Creating and Communicating a vision


Designing a mission statement
Defining the business
Setting objectives

Vision serves the purpose of stating what an organization wishes to achieve in the
long run.
Mission relates an organization to society.
Business explains the business of an organization in terms of customer needs,
customer groups and alternative technologies.
Objectives state what is to be achieved in a given time period.
l

The strategic intent concept also encompasses an active management process that
includes focussing the organizations attention on the essence of winning.

The concept of stretch and leverage is relevant in this context.

Stretch is a misfit between resources and aspirations.


Leverage concentrates, accumulates, conserves and recovers resources so that a
meagre resource base can be stretched. Leverage reduces the stretch and focusses
mainly on efficient utilization of resources.
l

l
l

3.3

The strategic fit matches organizational resources and environment. This


positions the firm by assessing organizational capabilities and environmental
opportunities.
Under fit, the strategic intent would seem to be more realistic.
It is hierarchy of intentions ranging from a board vision through mission and
purpose down to specific objectives.

VISION

It is at the top in the hierarchy of strategic intent. It is what the firm would ultimately
like to become. A few definitions are as follows:
Kotter description of something (an organization, corporate culture, a business, a
technology, an activity) in the future. The definition itself is comprehensive and states
clearly the futuristic position.
Miller and Dess defined vision as the category of intentions that are broad, all
inclusive and forward thinking
The definition lays stress on the following:
l
broad and all inclusive intentions;
l
vision is forward thinking process.

32

A few important aspects regarding vision are as follows:


l
It is more of a dream than articulated idea.
l
It is an aspiration of organization. Organization has to strive and exert to
achieve it.
l
It is powerful motivator to action.
l
Vision articulates the position of an organization which it may attain in distant
future.

Envisioning

Strategic Framework

This is the process of creating vision. It is a difficult and complex task. A well
conceived vision must have:
l

Core Ideology

Envisioned Future

Core Ideology will remain unchanged. It has the enduring character. It consists of
core values and core purpose. Core values are essential tenets of an organization. Core
purpose is related to the reasoning of the existence of an organization.
Envisioned Future will basically deal with following:
l

The long term objectives of the organization.

Clear description of articulated future.

Advantages of having a Vision


A few benefits accruing to an organization having a vision are as follows:
l

They foster experimentation.

Vision promotes long term thinking.

Visions foster risk taking.

They can be used for the benefit of people.

They make organizations competitive, original and unique.

Good vision represent integrity.

They are inspiring and motivating to people working in an organization.

Appendix 1 gives an example of vision and mission of Reliance Technology Centre so


as to develop an understanding of the concept of vision in the corporate world.
Activity 1
1.

What is envisioning?
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

2.

What is strategic intent? Discuss the concept giving an example from the
corporate world.
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

3.

Explain the concept of leverage stretch and fit.


..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
33

Introduction to Strategic
Management

3.4

CORE VALUES AND CORE PURPOSE

Initial reference of these two terms were given in section 3.3. These concepts are very
important in the process of envisioning. Collins and Porras have developed this
concept for better philosophical perspective. As has already been discussed, a well
conceived vision consists of core ideology and envisioned future. Core ideology rests
on core values and core purpose.
Core Values are the essential and enduring tenets of an organization. They may
be beliefs of top management regarding employees welfare, costumers interest and
shareholders wealth. The beliefs may have economic orientation or social orientation.
Evidences clearly indicate that the core values of Tatas are different from core values
of Birlas or Reliance. The entire organization structure revolves around the
philosophy coming out of core values.
Core Purpose is the reason for existence of the organization. Its reasoning needs to be spelt.
A few characteristics of core purpose are as follows:
i)

It is the overall reason for the existence of organization.

ii)

It is why of an organization.

iii) This mainly addresses to the issue which organization desires to achieve
internally.
iv) It is the broad philosophical long term rationale.
v)

It is the linkage of organization with its own people.

Activity 2
1.

What is core purpose? How is it different from core value?


..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

2.

Give examples of two companies with respect to core purpose and core values.
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

3.5

MISSION

The mission statements stage the role that organization plays in society. It is one of the
popular philosophical issue which is being looked into business managers since last
two decades.

Definition
A few definitions of mission are as follows:
Hynger and Wheelen purpose or reason for the organizations existence.

34

David F. Harvey states A mission provides the basis of awareness of a sense of


purpose, the competitive environment, degree to which the firms mission fits its
capabilities and the opportunities which the government offers.

Thompson states mission as the essential purpose of the organization, concerning


particularly why it is in existence, the nature of the business it is in, and the customers
it seeks to serve and satisfy.

Strategic Framework

The above definition reveals the following:


i)

It is the essential purpose of organization.

ii)

It answers why the organization is in existence.

iii) It is the basis of awareness of a sense of purpose.


iv) It fits its capabilities and the opportunities which government offers.
Nature
A few points regarding nature of mission statement are as follows:
l

It gives social reasoning. It specifies the role which the organization plays in
society. It is the basic reason for existence.

It is philosophical and visionary and relates to top management values. It has


long term perspective.

It legitimises societal existence.

It has stylistic objectives. It reflects corporate philosophy, identity, character and


image of organization.

Characteristics
In order to be effective, a mission statement should posses the following characteristics.
i)

A mission statement should be realistic and achievable. Impossible statements


do not motivate people. Aims should be developed in such a way so that may
become feasible.

ii)

It should neither be too broad nor be too narrow. If it is broad, it will become
meaningless. A narrower mission statement restricts the activities of
organization. The mission statement should be precise.

iii) A mission statement should not be ambiguous. It must be clear for action.
Highly philosophical statements do not give clarity.
iv) A mission statement should be distinct. If it is not distinct, it will not have any
impact. Copied mission statements do not create any impression.
v)

It should have societal linkage. Linking the organization to society will build
long term perspective in a better way.

vi) It should not be static. To cope up with ever changing environment, dynamic
aspects be looked into.
vii) It should be motivating for members of the organization and of society. The
employees of the organization may enthuse themselves with mission statement.
viii) The mission statement should indicate the process of accomplishing objectives.
The clues to achieve the mission will be guiding force.

Examples of Mission Statement


A few examples of mission statement (academically not accepted) are as follows:
l

India Today The complete new magazine.

Bajaj Auto, Value for Money for Years.

HCL, To be a world class Competitor.

HMT, Timekeepers of the Nation.

35

Introduction to Strategic
Management

Some experts argue that these are the publicity slogans. They are not mission
statements. A few other examples are as follows:
Ranbaxy Industries To become a research based international Pharmaceuticals
Company.
Eicher Consultancy To make India an economic power in the lifetime, about 10 to 15
years, of its founding senior managers.

Formulation of Mission Statements


The mission statements are formulated from the following sources:
i)

National Priorities projected in plan documents and industrial policy statements.

ii)

Corporate philosophy as developed over the years.

iii) Major strategists have vision to develop mission statements.


iv) The services of consultants may be hired.

Mission vs Purpose
The term purpose was used by some strategists. At some places, it was used as
synonymous to mission. A few major points of distinction are as follows:
i)

Mission is the societal reasoning while the purpose is the overall reason.

ii)

Mission is external reasoning and relates to external environment. Purpose is


internal reasoning and relates to internal environment.

iii) Mission is for outsiders while purpose is for its own employees.
Activity 3
1.

Distinguish between Mission and Purpose.


..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

2.

Explain the essentials of Mission statement.


..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

3.

Formulate Mission statements of any two organizations of your choice.


..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

36

3.6

BUSINESS DEFINITION

Strategic Framework

It explains the business of an organization in terms of customer needs, customer


groups and alternative technologies.
Oerik Abell suggests defining business along the three dimension of customer
groups. Customer functions and alternative technologies. They are developed as
follows:
i)

Customer groups are created according to the identity of the customers.

ii)

Customer functions are based on provision of goods/services to customers.

iii) Alternative Technologies describe the manner in which a particular function can
be performed for a customer.
For a watch making business, these dimensions may be outlined as follows:
l

Customer groups are individual customers, commercial organizations, sports


organizations, educational institutions etc.

Customer functions are record time, finding time, alarm service etc. It may be a
gift item also.

Alternative technologies are manual, mechanical and automatic.

A clear business definition is helpful in identifying several strategic choices.


The choices regarding various customer groups, various customer functions and
alternative technologies give the strategists various strategic alternatives. The
diversification, mergers and turnaround depend upon the business definition.
Customer oriented approach of business makes the organization competitive.
On the same lines, product/ service concept could also give strategic alternatives
from a different angle. Business can be defined at the corporate or SBU levels.
At the corporate level, it will concern itself with the wider meaning of customer
groups, customer functions and alternative technologies. If strategic alternatives are
linked through a business definition, it results in considerable amount of synergic
advantage.

3.7

OBJECTIVES AND GOALS

Objectives refer to the ultimate end results which are to be accomplished by the
overall plan over a specified period of time. The vision, mission and business
definition determine the business philosophy to be adopted in the long run. The goals
and objectives are set to achieve them.

Meaning
l

Objectives are openended attributes denoting a future state or out come and are
stated in general terms.

When the objectives are stated in specific terms, they become goals to be
attained.

In strategic management, sometimes, a different viewpoint is taken.

Goals denote a broad category of financial and non-financial issues that a firm
sets for itself.

Objectives are the ends that state specifically how the goals shall be achieved.

It is to be noted that objectives are the manifestation of goals whether


specifically stated or not.
37

Introduction to Strategic
Management

Difference between objectives and goals


The points of difference between the two are as follows:
l

The goals are broad while objectives are specific.

The goals are set for a relatively longer period of time.

Goals are more influenced by external environment.

Goals are not quantified while objectives are quantified.

Broadly, it is more convenient to use one term rather than both. The difference
between the two is simply a matter of degree and it may vary widely.

Need for Establishing Objectives


The following points specifically emphasize the need for establishing objectives:
l

Objectives provide yardstick to measure performance of a department or SBU


or organization.

Objectives serve as a motivating force. All people work to achieve the


objectives.

Objectives help the organization to pursue its vision and mission. Long term
perspective is translated in short-term goals.

Objectives define the relationship of organization with internal and external


environment.

Objectives provide a basis for decision-making. All decisions taken at all levels
of management are oriented towards accomplishment of objectives.

What Objectives should be set?


According to Peter Druker, objectives should be set in the area of market standing,
innovation productivity, physical and financial resources, profitability, manager
performance and development, worker performance and attitude and public
responsibility. Researchers have identified the following areas for setting objectives:
Profit Objective: It is the most important objective for any business enterprise. In
order to earn a profit, an enterprise has to set multiple objectives in key result areas
such as market share, new product development, quality of service etc. Ackoff calls
them performance objectives.
Marketing Objective may be expressed as: to increase market share to 20 percent
within five years or to increase total sales by 10 percent annually. They are related
to a functional area.
Productivity Objective may be expressed in terms of ratio of input to output. This
objective may also be stated in terms of cost per unit of production.
Product Objective may be expressed in terms of product development, product
diversification, branding etc.
Social Objective may be described in terms of social orientation. It may be tree
plantation or provision of drinking water or development of parks or setting up of
community centers.
Financial Objective relates to cash flow, debt equity ratio, working capital, new
issues, stock exchange operations, collection periods, debt instruments etc. For
example a company may state to decrease the collection period to 30 days by the end
of this year.
38

Human resource Objective may be described in terms of absenteeism, turnover,


number of grievances, strikes and lockouts etc. An example may be to reduce
absenteeism to less then 10 percent by the end of six months.

Strategic Framework

Characteristics of Objectives
The following are the characteristics of corporate objectives:
i)

They form a hierarchy. It begins with broad statement of vision and mission and
ends with key specific goals. These objectives are made achievable at the lower
level.

ii)

It is impossible to identify even one major objective that could cover all
possible relationships and needs. Organizational problems and relationship
cover a multiplicity of variables and cannot be integrated into one objectives.
They may be economic objectives, social objectives, political objectives etc.
Hence, multiplicity of objectives forces the strategists to balance those
diverse interests.

iii) A specific time horizon must be laid for effective objectives. This timeframe
helps the strategists to fix targets.
iv) Objectives must be within reach and is also challenging for the employees.
If objectives set are beyond the reach of managers, they will adopt a
defeatist attitude. Attainable objectives act as a motivator in the
organization.
v)

Objectives should be understandable. Clarity and simple language should be the


hallmarks. Vague and ambiguous objectives may lead to wrong course of action.

vi) Objectives must be concrete. For that they need to be quantified.


Measurable objectives help the strategists to monitor the performance in a
better way.
vii) There are many constrants internal as well as external which have to be
considered in objective setting. As different objectives compete for scarce
resources, objectives should be set within constraints.

Process of Setting Objectives


Glueck identifies four factors that should be considered for objective setting. These
factors are: the forces in the environment, realities of an enterprises resources and
internal power relations, the value system of top executives and awareness by the
management of the past objectives. They are briefly narrated below:
i)

Environmental forces, both internal and external, may influence the interests of
various stake holders. Further, these forces are dynamic by nature. Hence
objective setting must consider their influence on its process.

ii)

As objectives should be realistic, the efforts be made to set the objectives in such
a way so that objectives may become attainable. For that, existing resources of
enterprise and internal power structure be examined carefully.

iii) The values of the top management influence the choice of objectives. A
philanthropic attitude may lead to setting of socially oriented objectives while
economic orientation of top management may force them to go for profitability
objective.
iv) Past is important for strategic reasons. Organizations cannot deviate much from
the past. Unnecessary deviations will bring problems relating to resistance to
change. Management must understand the past so that it may integrate its
objectives in an effective way.
39

Introduction to Strategic
Management

Activity 4
1.

For a company of your choice, apply the concept of business definition.


..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

2.

Select any organization of your choice. You formulate vision, business


definition, mission, objectives, core purpose and core values.
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

3.8

SUMMARY

Strategic intent refers to the purpose for which the organization strives for. It is the
philosophical framework of strategic management process. The hierarchy of strategic
intent covers the vision and mission, business definition and the goals and objectives.
Stretch is misfit between resources and aspirations. Leverage stretches the meagre
resource base to meet the aspirations. The fit positions the firm by matching its
organizational resources to its environment. Vision constitutes future aspirations. This
articulates the position that a firm would like to attain in the distant future.
Mission is the social reasoning of organization. It has external orientation. It
legitimizes social existence.
Business definition explains the business of an organization in terms of customer
needs, customer groups and alternative technologies goal denote a broad category of
issues which a firm sets for itself. Objectives are the ends that state specifically how
the goals shall be achieved. Overall this unit tries to give a view of strategic intent as a
whole.

3.9

40

KEY WORDS

Business Definition

: It explains the business of an organization in terms of


customer needs, customer groups and alternative
technologies.

Core Purpose

: It is the reason for organizations existence.

Core Values

: It is the essential and enduring character of organization.

Goals

: A broad category of financial and non financial issues that


a firm sets for itself.

Mission

: It is the social reasoning of organization. It links


organization to society.

Objectives

: What is to be achieved in a given time period. They are the


manifestation of goals.

Strategic Intent

: It makes clear what an organization stands for.

Vision

: What an organization wishes to achieve in the long run.

3.10

SELF ASSESSMENT QUESTIONS

1)

What is strategic intent? Discuss the concept of leverage, stretch and fit with
respect to business organization.

2)

What is mission? How is it different from purpose? Discuss the essentials of a


mission statement.

3)

Stage five mission statements of big companies in India and review them
critically.

4)

Explain the three dimensions of a business definition. Illustrate.

5)

What are objectives? How are they set? State the characteristics of objectives.

6)

How will you set objectives for a large organization? Assume imaginary details.

7)

Explain the following:

8)

a)

Core Value

b)

Core Purpose

c)

Leverage

Strategic Framework

Visit two companies of your choice and collect the details regarding hierarchy of
strategic intent.

3.11

REFERENCES AND FURTHER READINGS

Drucker, P.F. (1974). Management Task Responsibilities and Practices, Harper &
Row, New York.
Ghosh, P.K. (1996). Business Policy Strategic planning and Management, Sultan
Chand & Sons, New Delhi.
Glueck, W.F. and Iavch L.R. (1984). Business Ploicy and Strategic Management
Mc graw Hill, New York.
Kazmi, Azhar (2002). Business Policy and Strategic Management, Tata Mcgraw
Hill Publishing Co, Ltd., New Delhi.
Miller A. and Den G. G. (1996). Strategic Management Mcgraw hill, New York.
Prasad, L.M. (2002). Business Policy: Strategic Management, Sultan Chand &
Sons, New Delhi.
Shrivastava, R.M. (1995). Corporate Strategic Management, Pragati Prakashan,
Meerut.
Tompson, J.L. (1997). Strategic Management: Awareness and Change,
International Thompson Business Press, London.

41

Introduction to Strategic
Management

Appendix 1
RELIANCE TECHNOLOGY CENTRE
Reliance Industries Limited is the largest private sector in India and is the
second largest manufacturer of polyster in the world. Reliance Technology
Centre was set up in 1997 and presently is engaged in manufacturing PET
homo and co-polymer fibres. The following is the vision and mission of the
company.
VISION
l

To establish a centre of excellence for research and development in PET homo


and copolymer fibres and resins through disciplined, motivated and time bound
execution of projects;

To create an environment conducive to intellectual growth, efficient flow of


information and accountability in order to achieve a productive and sustained
phase of research activities;

To closely interact with the business group companies and technical for short,
medium and long-term quality and process issues;

To thrive to become a catalyst to the growth of companys polyster business;

To leverage synergy between Reliances PET, polymers and fibre intermediate


business;

To create, maintain and pursue strategic research alliance for top end research
activities.

MISSION
To achieve Global leadership in polymers, fibres and resin businesses.
Source: www.ril.com

42

Introduction to Strategic
Management

UNIT 2 PROCESS OF STRATEGY


Objectives
After reading this unit, you should be able to:

understand the process of strategy;

identify various steps of strategy formulation;

understand the role played by different participants in the process; and

know the sequence of activities involved in the process.

Structure
2.1

Introduction

2.2

Process of Strategy

2.3

Strategic Intent

2.4

Environmental and Organizational Analysis

2.5

Identification of Strategic Alternatives

2.6

Choice of Strategy

2.7

Implementation of Strategy

2.8

Evaluation and Control

2.9

Summary

2.10

Key Words

2.11

Self Assessment Questions

2.12

References and Further Readings

2.1

INTRODUCTION

There are two dimensions of every action substantive and procedural. The former
involves determination of what to do and the latter is concerned with determination of
how to do. Both of these dimensions are interdependent and taken together help in
achieving the objectives for which the action is contemplated. In the context of an
organization engaged in strategy formulation and implementation, the substantive
dimension deals with the determination of strategy or set of strategies and procedural
dimension deals with putting a strategy into operation. Besides these, it has to be
decided that who will do what in completing the action. The logic of a process is that
its particular elements are undertaken in a sequence over a period. The strategy
process involved in strategy includes a number of elements. The process can be
defined as a set of management decisions and actions which determines the
long run direction and performance of the organization. It is a dynamic and
continuous process. However, there are two problems in identifying and sequencing
the elements:

16

i)

There is no unanimity among various authors about the elements and their
interaction.

ii)

After the elements have been identified, their sequential arrangement is another
problem.

Both these problems highlight the complexity of strategic process. The process
includes definition of organizational vision, mission and objectives, environmental
analysis, identification and evaluation of strategic alternatives, making a choice,
implementing it and evaluating and controlling the strategy.

2.2

Process of Strategy

PROCESS OF STRATEGY

The process of strategy is cyclical in nature. The elements within it interact among
themselves. Figures 2.1 and 2.2 present the process for single SBU firm and multiple
SBU firm respectively. The process has to be adjusted for multiple SBU firms because
there it is conducted at corporate level as well as SBU levels as these firms insert SBU
strategy between corporate strategy and functional strategy. Initially, the process of
strategy was discussed in terms of four phases which are:
l

Identification phase

Development phase

Implementation phase

Monitoring phase

The process of strategy does not have the same steps as stated by different authors.
According to C.K. Prahalad, the process comprises of five steps. They are:
l

Strategic Intent

Environmental Analysis

Evaluation of strategic alternatives and choice

Strategy Implementation

Strategy Evaluation and Control

For our understanding, the process has been divided into the following steps:
l

Strategic Intent

Environmental and Organizational Analysis

Identification of Strategic Alternatives

Choice of Strategy

Implementation of Strategy

Evaluation and Control

2.3

STRATEGIC INTENT

Setting of organizational vision, mission and objectives is the starting point of strategy
formulation. The organizations strive for achieving the end results which are vision,
mission, purpose, objective, goals, targets etc. The hierarchy of strategic
intent lays the foundation for the strategic management of any organization. The
strategic intent makes clear what an organization stands for. It is reflected through
vision, mission, business definition and objectives. Vision serves the purpose of stating
what an organization wishes to achieve in long run. The process of assigning a part of
a mission to a particular department and then further sub dividing the assignment
among sections and individuals creates a hierarchy of objectives. The objectives of the
sub unit contribute to the objectives of the larger unit of which it is a part. From
strategy formulation point of view, an organization must define why it exists, how
it justifies that existence, and when it justifies the reasons for that existence. The
answers to these questions lies in the organizations mission, business definition,
objectives and goals. These terms become the base for strategic decisions and actions.

17

Introduction to Strategic
Management

Defining Vision, Mission and


Business

Environmental Analysis

Organizational Analysis

Setting Objectives and Goals

s s

Reset if
required

Identifying Alternative
Strategies

Reformulate
if required

Choice of Strategy

Reimplement
if required

Implementation of
Strategy

Strategy Evaluation
and Control

s
s
s

18

Feedback

Figure 2.1: Strategic Process in a Single SBU Firm

Process of Strategy
s

SBU Objectives
s

Setting
Organizational
Loing-term
Objectives

Deifining Vision,
Mission and Business

Environmental
Analysis for Present
and Potential SBU

Environmental
Analysis for
SBU

Organizational and
SBU Analysis

Analysis of SBU

s
s

Strategic Alternatives

Strategic
Alternatives
s
s

Choice of Strategy

Choice of Strategy

Implementation
Strategy

s
s

Implementation
Strategy

s
s
s

Feedback

Evaluation of
SBU Results

Evaluation of
Organisation and
SBU Results

Feedback

Figure 2.2: Strategic Management Processing in a Multiple SBU Firm

19

Introduction to Strategic
Management

Mission
The vision of an organization is the expectation of the owner of the organization and
putting this vision into action is mission. Often these terms are used interchangeably,
but both are different. The dictionary meaning of mission is that, mission relates to
that aspect for which an individual has been or seems to have been sent into the
world. Mission is relatively less abstract, subjective, qualitative, philosophical and
non-imaginative. Mission has a societal orientation and is a statement which reveals
what an organization intends to do for a society. It is a public statement which gives
direction for different activities which organizations have to carry on. It motivates
employees to work in the interest of the organization.

Business Definition
The answer to the question that how does an organization justify its existence is
defining business of the organization. A business definition is the clear cut statement
of the business or a set of businesses, the organization engages or wishes to pursue in
the future. It also defines the scope of the organization. An organization can face its
competitors not by doing what they do but by doing it differently. Business can be
defined along three dimensions viz a viz product, customer and technology. In
whatever dimensions, it is defined, it must reflect two features:
l

focus

differentiation

Focus of business is defined in terms of the kind of functions the business performs
rather than the broad spectrum of industry in which the organization operates. A sharp
focus on business definition provides direction to a company to take suitable actions
including positioning of the companys business.
The next feature involved in business definition is differentiation i.e. how an
organization differentiates itself from others so that the business concentrates on
achieving superior performance in the market. Differentiation can be on several bases
like quality, price, delivery, service or any other factor which the concerned market
segment values. For example, an organization can charge comparatively lower price
as compared to its competitors in the same product quality segment, then price is not
the differentiating factor. As against this, if the organization is charging a much lower
price in the same product group excluding quality, price becomes a differentiating
factor. For example, in synthetic detergent market, HLL and Nirma provide for such a
differentiation. We will discuss this aspect in detail in Block 3.

Objectives and Goals


Once the organizations mission has been determined, its objective, desired future
positions that it wishes to reach, should be identified. Organizational objectives are
defined as ends which the organization seeks to achieve by its existence and operation.
Objectives represent desired results which the organization wishes to attain. They
indicate the specific sphere of aims, activities and accomplishments. An organization
can have objectives in terms of profitability and productivity. Objectives provide a
direction to the organization and all the divisions work towards the attainment of the
set objectives. Objectives and goals are the terms which are used interchangeably.
It is necessary for the organization to assess the process identifying the objectives of
each functional area. After accomplishment of these objectives, the overall objectives
of the organization are achieved. Organizations mission becomes the cornerstone for
strategy. Objectives are other factors which determine the strategy. By choosing its
objectives, an organization commits itself for these.
20

Activity 1
1.

Process of Strategy

Explain strategic process in a single business firm.


..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

2.

Distinguish between mission, objectives, and goals. Give some real world
examples.
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

3.

Explain hierarchy of strategic intent and its importance.


..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

2.4 ENVIRONMENTAL AND ORGANIZATIONAL


ANALYSIS
Every organization operates within an environment. This environment may be internal
or external. For conducting an environmental analysis, the strategic intent has to be
very clear. This clarity in definition of mission and objectives helps in the detailed
analysis of the environment. Environmental analysis, also known as environmental
scanning or appraisal, is the process through which an organization monitors and
comprehends various environmental factors and determines the opportunities and
threats that are provided by these factors. There are two aspects involved in
environmental analysis:
l

Monitoring the environment i.e. environmental search and

Identifying opportunities and threats based on environmental monitoring i.e.


environmental diagnosis.

Environmental analysis is an exercise in which total view of environment is taken. The


environment is divided into different components to find out their nature, function and
relationship for searching opportunities and threats and determining where they come
from, ultimately the analysis of these components is aggregated to have a total view of
the environment. Some elements indicate opportunities while others may indicate
threats.
A large part of the process of environmental analysis seeks to explore the unknown
terrain, the dimensions of future. The analysis emphasizes on what could happen and
not necessarily what will happen. The factors which comprise firms environment are
of two types:
l

factors which influence environment directly including suppliers, customers and


competitors, and

factors which influence the firm indirectly including social, technological,


political, legal, economic factors etc.
21

Introduction to Strategic
Management

The environmental analysis plays a very important role in the process of strategy
formulation. The environment has to be analysed to determine what factors in the
environment present opportunities for greater accomplishment of organizational
objectives and what factors present threats. Environmental analysis provides time to
anticipate the opportunities and plan to meet the challenges. It also warns the
organization about the threats. The analysis provides for elimination of alternatives
which are inconsistent with the organizations objectives. Due to the element of
uncertainty, environmental analysis provides for certain anticipated changes in the
organizations network. The organization equips itself to meet the unanticipated
changes and face the ever increasing competition.
For doing the environmental analysis, there can be the strategic advantage profile
which provides for analysis of internal environment, and the organization capability
profile as well. For analyzing the external environment, environmental threat and
opportunity profile could be adopted. An organization has to continuously grow in
term of its core business and develop core competencies.
Through organizational analysis, the organization has to understand its strengths and
weaknesses. It has to identify the strengths and emphasize on them. At the same time,
it has to identify its weaknesses and unprove them or try to eliminate them.
Organizational threats and opportunities, strengths and weaknesses help in identifying
the relevant environmental factors for detailed analysis.
Therefore, after developing the strategic intent, environmental analysis becomes the
next important step in the process of strategy formation. The environmental analysis is
covered in detail in unit 4 of block 2.

2.5

IDENTIFICATION OF STRATEGIC ALTERNATIVES

After environmental analysis, the next step is to identify the various strategic
alternatives. After the identification of strategic alternatives they have to be evaluated
to match them with the environmental analysis. According to Glueck & Jauch,
strategic alternatives revolve around the question whether to continue or change the
business, the enterprise is currently improving the efficiency or effectiveness with
which the firm achieves its corporate objectives in its chosen business sector the
process may result into large number of alternatives through which an organization
relates itself to the environment. All alternatives cannot be chosen even if all of these
provide the same results. Obviously, managers evaluate them and limit themselves.
According to Glueck, there are basically four grand strategic alternatives:
l

Stability

Expansion

Retrenchment

Combination

These are together known as stability strategies/ basic strategies.


Stability: In this, the company does not go beyond what it is doing now. The company
serves with same product, in same market and with the existing technology. This is
possible when environment is relatively stable. Modernization, improved customer
service and special facility may be adopted in stability.
Expansion: This is adopted when environment demands increase in pace of activity.
Company broadens its customer groups, customer functions and the technology. These
may be broadened either singly or jointly. This kind of a strategy has a substantial
impact on internal functioning of the organization.
22

Retrenchment: If the organization is going for this strategy, then it has to reduce its
scope in terms of customer group, customer function or alternative technology. It
involves partial or total withdrawal from three things. For example L & T getting out
of the cement business. The objective varies from company to company.

Process of Strategy

Combination: When all the three strategies are taken together, this is known as
combination strategy. This kind of strategy is possible for organizations with large
number of portfolios.
Apart from these four grand strategies, different strategies which are used commonly
are as follows:
Modernization: In this , technology is used as the strategic tool to increase production
and productivity or reduce cost. Through modernization, the company aims to gain
competitive and strategic strength.
Integration: The company starts producing new products and services of its own
either creating facility or killing others. Integration can either be forward or
background in terms of vertical integration. In forward integration it gains ownership
over distribution or retailers, thus moving towards customers while in backward
integration the company seeks ownership over firms suppliers thus moving towards
raw materials. When the organization gains ownership over competitors, it is engaged
in horizontal integration.
Diversification: Diversification involves change in business definition either in terms
of customer functions, customer groups or alternative technology. It is done to
minimize the risk by spreading over several businesses, to capitalize organization
strength and minimize weaknesses, to minimize threats, to avoid current instability in
profit & sales and to facilitate higher utilization of resources. Diversification can be
either related or unrelated, horizontal or vertical, active or passive, internal or
external. It is of the following types:
l

Concentric diversification

Conglomerate diversification

Horizontal diversification

Joint Ventures: In joint ventures, two or more companies form a temporary


partnership ( consortium). Companies opt for joint venture for synergistic advantages
to share risk, to diversify and expand, to bring distinctive competences, to manage
political and cultural difficulty, to take technological advantage and to explore
unexplored market.
Strategic Alliance: When two or more companies unite to pursue a set agreed upon
goals but remain independent it is known as strategic alliance. The firms share the
benefits of the alliance and control the performance of assigned tasks. The pooling of
resources, investment and risks occur for mutual gain.
Mergers: It is an external approach to expansion involving two or more than two
organizations. Companies go for merger to become larger, to gain competitive
advantage, to overcome weaknesses and sometimes to get tax benefits. Merger takes
place with mutual consent and common goals.
Acquisition: For the organization which acquires another, it is acquisition and for
organization which is acquired, it is merger.
Takeovers: In takeovers, there is a strong motive to acquire others for quick growth
and diversification.
Divestment: In divestment, the company which is divesting has no ownership and
control in that business and is engaged in complete selling of a unit. It is referred to
the disposing off a part of the business.

23

Introduction to Strategic
Management

Turnaround Strategy: When the company is sick and continuously making losses, it
goes for turnaround strategy. It is the efforts in reversing a negative trend and it is the
efforts to keep an organization alive.
All these alternatives are available to an organization and according to its objectives,
it can decide on the one which is most suitable. We will study all these strategies in
detail in block 4.
Activity 2
1.

What is strategic advantage profile?


..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

2.

Select any two strategic alternatives and cite company examples of each.
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

2.6

CHOICE OF STRATEGY

The next logical step after evaluation of strategic alternatives is choice of the most
suitable alternative. For a business group, it may be possible to choose all strategic
alternatives but for a single company it is quite difficult. The strategic alternatives has
to be matched with the problem. While making a choice, two types of factors have to
be considered:
l

Objective factors

Subjective factors

Objective factors are the ones which can be quantified while subjective factors are the
ones which cannot be quantified and are based on experience and opinion of people.
Strategic choice is like a decision making process. There are three objective ways to
make a choice:
l

Corporate Portfolio Analysis

Competitor Analysis

Industry Analysis

Corporate Portfolio Analysis


When the company is in more than one business, it can select more than one strategic
alternative depending upon demand of the situation prevailing in the different
portfolios. It is necessary to analyze the position of different business of the business
house which is done by corporate portfolio analysis. This analysis can be done by
using any of the seven technologies given below:

24

Experience curve

PLC concept

BCG Matrix

GE nine cell Matrix

Space Diagram

Hofers product market evaluation matrix

Directional Policy Matrix

Process of Strategy

In the experience curve technique, the experience of the strategist enables him to
decide which businesses to enter or quit.
Depending upon the stage of the product life cycle of the business, one can make a
strategic choice for different portfolio.
Boston consultancy developed a matrix called BCG Matrix which is helpful to make
strategic choice. In this, the products are positioned based on various external and
internal factors to know the continuity, growth and discontinuing product. The factors
given are specific in nature and attempt has been made to quantify them.
The GE Nine Cell Matrix is a matrix in which nine positions are defined in terms of
business strength factors and industry attractiveness factors. The business strength
factors include market share, profit margin, ability to compete, market knowledge,
competitive position, technology, and management caliber and the industry
attractiveness factor include market size, growth rate, profit, competition, economics
of scales, technology and other environmental factors. Nine cells are divided into three
zones and depicted by different colours i.e. green, yellow and red. Each zone of matrix
presents a specific type of strategy or set of strategies.
The strategic position and action evaluation (SPACE) is an extension of two
dimensional portfolio analysis which helps an organization to hammer out an
appropriate strategic posture. It involves consideration of dimensions like
organizations competitive advantage, organizations financial strength, environmental
stability etc. Various SPACE factors are measured in terms of degrees, often
quantified from 0 to 5 with 0 indicating most unfavourable and 5 indicating most
favourable. On basis of four dimensions, organization can choose its strategy.
Hofer and Schendel suggested the product market evaluation matrix. They
constructed a 15 cell matrix taking competitive position and stages of product / market
evolution dimensions.
The directional policy matrix was developed by shell chemicals, U.K. It used two
dimensions business sector prospects and companys competitive capabilities to
choose strategies. Each dimension is further divided into unattractive, average and
attractive (for business sector prospects) and weak, average and strong (for
companys competitive capabilities. Each quadrant shows a different strategy which
the organization may adopt.

Competitor Analysis
In this analysis, we try to assess what the competitor has and what he does not have.
We explore everything with respect to the competitor. In competitor analysis, focus is
on external environment as one of the components of external environment is the
competitor. The difference between SWOT analysis and competitor analysis is that in
competitor analysis we are concerned with only one component of the environment i.e.
competitor while in SWOT analysis we take about all the factors of the environment.

Industry Analysis
In industry analysis, all the competitors belonging to the particular industry with
which the organization is associated are looked at. All the members of the industry are
considered as a whole. In competitive analysis, only the major competitors are
assessed while in industry analysis all the competitors belonging to the industry are
looked at.

25

Introduction to Strategic
Management

The strategic choice is a decision making process which looks into the following steps:
l

Focussing on strategic alternatives

Evaluating strategic alternatives

Considering decision factors objective factors and subjective factors.

Finally, making the strategic choice.

2.7

IMPLEMENTATION OF STRATEGY

After the evaluation of the alternatives, the choice of strategy is made. This choice
now needs to be implemented i.e. strategy is now put into action. This step of strategy
process is the implementation step. This includes the activation of the strategic
alternatives chosen. Strategy making and strategy implementation are two different
things. Strategy making requires person with vision while strategy implementation
requires a person with administrative ability. If the strategy made is not implemented
properly then the objectives would be lost. Strategy implementation is as good as
starting a new business. The stage requires looking at the problems and eliminating
them. In strategy implementation, one has to pass through different steps:
l

Project Implementation

Procedural Implementation

Resource Allocation

Structural Implementation

Functional Implementation

Behavioural Implementation

Project implementation is a comprehensive plan of action from acquiring land to the


installation of machinery within a time frame.
Procedural implementation takes place by following the Law of the Land i.e. the
rules and regulation in terms of wastage cost, utility etc. It involves completing all
those procedural formalities that have been prescribed by the governments both
central and state. A procedure is a series of related tasks that make up the
chronological sequence and the established way of performing the work to be
accomplished. Procedural implementation involves different steps. These steps vary
from industry to industry. Also these may change as per the changes in the government
policies. The major procedural requirements are:
l
l
l
l
l
l

Licensing Requirements
FEMA Requirements
Foreign Collaboration Procedure
Capital Issue Requirements
Import and Export requirements
Incentives and benefits

After procedural implementation thire comes resource allocation. The organization


has to allocate resource both inside the company and outside the company. It has to
make decisions regarding short term and long term allocation. The problems
associated with resource allocation is the problem involved in the process. The
problems emerge because:
l
l

26

Resources are limited.


There are competing organizational units with each trying to have the major
portion.
Organizations past commitment.

The structural implementation of strategy involves designing of the organization


structure and interlinking various units and sub units of the organization. It involves
issues like
l

How the work of the organization will be divided?

How will the work be assigned among various positions, groups, department,
divisions, etc.?

The coordination among these for achivement of organizational objectives.

Process of Strategy

There are basically two aspects:


l

Differentiation and

Integration

Differentiation refers to, the differences in cognitive and emotional orientations


among managers in different functional departments.
Integration refers to, the quality of the state of collaboration that are required to
achieve unity of efforts in the organization.
The organization has to emphasize on both aspects and therefore, it must design
organization structure and provide systems for integration and coordination among
organizations parts and members.
Functional implementation deals with the development of policies and plans in
different areas of functions which an organization undertakes. The major functions of
the organization include:
l

Production

Marketing

Finance

Personnel

Each and every function makes its own policies and plans in tune with the whole
organizations strategy and then implements to fulfill the objectives. For example, the
production function may involve decisions relating to size and location of plants,
technology to be used, cost factor, production capacity, quality of the product,
research and development etc. Similarly marketing function may include the decisions
relating to type of products, price of products, product distribution and product
promotion.
The financial function deals with decisions like sources of funds, usage of funds and
management of earnings. Likewise, the major consideration in personnel policies
include recruitment of right personnel, development of personnel, motivation system,
retaining personnel, personnel mobility, industrial relations etc.
Behavioural implementation deals with those aspects of strategy implementation that
have impact on behaviour of people in the organizations. Since human resources form
an integral part of the organization, their activities and behaviour need to be directed
in a certain way. Any departure may lead to the failure of strategy. The five issues in
this context relevant to strategy implementation are:
l

Leadership

Organization Culture

Values and Ethics

Corporate Governance, and

Organizational Politics
27

Introduction to Strategic
Management

2.8

EVALUATION AND CONTROL

This is the last step of the strategy making process. This is an ongoing process and
evaluation and control have to be done for future course of action as well. To get
successful results and to achieve organizational objectives, there has to be continuous
monitoring of the implementation of strategy. The evaluation and control of strategy
may result in various actions that the organization may have to take for successful
well being, such actions may involve any kind of corrective measures concerned with
any of the steps involved in the whole process be it choice for setting mission or
objectives. The process of strategy formulation is considered as a dynamic process
wherein corrective actions are taken and change is brought in any of the factors
affecting strategy.
Evaluation of strategy is done by the top managers to determine whether their strategic
choice is implemented in a manner that it is meeting the organizations objectives.
Evaluation emphasizes measurement of results of a strategic action. On the other
hand, control emphasizes on taking necessary action in the light of gap that exists
between intended results and actual results in the strategic action.
When evaluation and control is carried out efficiently, it contributes in three basic
areas:
l

Measurement of organizational process,

Feedback for future actions, and

Linking performance and rewards.

The board of directors, the chief executive and other managers all play a very
important role in strategy evaluation and control. Control can be of three types:
l

Control of inputs that are required in an action, known as feed forward control.

Control at different stages of action process, known as concurrent control.

Past action control based on feedback from completed action known as feedback
control.

Control is exercised by mangers in the form of four steps:


l

Setting performance standards

Measuring actual performance

Analyzing variance

Taking corrective actions

After evaluation and control, the strategy process continues in an efficient manner.
The effectiveness could be assessed only when the strategy helps in the fulfillment of
organizational objectives.

2.9

28

SUMMARY

A good strategy is one which helps in the accomplishment of the organization s


objectives. The first step, therefore, is the development of strategic intent i.e. the
setting of organizational mission and objectives. After this, the organization has to
assess its environment external to it and which affects its strategy. It has to assess the
opportunities and threats in the environment. Alongwith the environmental analysis,
the organization has to go for an organizational analysis as well, through which it
assesses its own strengths and weakness and then incorporates them in the strategy
being formulated. It becomes necessary for the organization to identify the various
strategic alternatives and choose from them the one which is most compatible with the

organizational objectives. The strategic choice has to be implemented in a manner that


the organizations culture and structure support the implementation. After
implementing the strategy, strategic evaluation and control is carried out so that the
firm is successful in meeting its objectives.

2.10

Process of Strategy

KEY WORDS

Acquisition

: For the organization which acquires another it is


acquisition and for organization which is acquired, it is
merger.

Diversification

: is a growth strategy which involves adding of new


products or services to existing ones.

Diversification

: Diversification involves change in business definition


either in terms of customer functions, customer groups or
alternative technology.

Divestment

: In divestment, the company which is divesting has no


ownership and control in that business and is engaged in
complete selling of a unit. It is referred to the disposing off
a part of the business.

Expansion

: Strategy in which company broadens its customer groups,


customer function and the technology.

Mergers

: It is an external approach to expansion involving two or


more than two organizations.

Retrenchment

: Strategy in which organization has to reduce its scope in


terms of customer group, customer functions or alternative
technology.

Stability

: Strategy in which the company serves the same product in


same market and with existing technology.

Structure

: is the configuration of resources used by management to


coordinate the activities of the organization so that the
objectives can be achieved.

Takeovers

: In takeovers, there is strong motive to acquire others for


quick growth and diversification.

Turnaround Strategy : When the company is sick and continuously making losses,
it goes for turnaround strategy. It is the efforts in reversing
a negative trend and it is the efforts to keep an organization
alive.

2.11 SELF ASSESSMENT QUESTIONS


1.

Describe the process of strategy formulation.

2.

What are the various strategic alternatives? Give example of each.

2.12 REFERENCES AND FURTHER READINGS


Drucker, P.F. (1974). Management Task Responsibilities and Practices, Harper &
Row, New York.
Ghosh, P.K. (1996). Business Policy Strategic planning and Management, Sultan
Chand & Sons, New Delhi.

29

Introduction to Strategic
Management

Ghosh, P.K., I.C. Dhingra, N. Rajan Nair and K.P. Mani (1997). Advanced
Management Accounting Strategic Management, Sultan Chand & Sons, New Delhi.
Glueck, W.F. and Iavch, L.R. (1984). Business Ploicy and Strategic Management
Mc graw Hill, New York.
Kazmi, Azhar. (2002). Business Policy and Strategic Management, Tata Mcgraw
Hill Publishing Co, Ltd., New Delhi.
Mamoria, C.B., Mamoria Satish and Rao, P. Subba. (2001). Business Planning and
Plicy, Himalaya Publishing House, Mumbai.
Miller, A. and Den, G.G. (1996). Strategic Management Mcgraw hill, New York.
Prasad, L.M. (2002). Business Policy: Strategic Management, Sultan Chand &
Sons, New Delhi.
Shrivastava, R.M. (1995). Corporate Strategic Management, Pragati Prakashan,
Meerut.
Shrivastava, R.M. (1999). Management Policy and Strategic Management:
Concepts, Skills and Practices, Himalaya Publication House, Mumbai.
Thompson, J.L. (1997). Strategic Management: Awareness and Change,
International Thompson Business Press, London.

30

UNIT 4 ENVIRONMENTAL ANALYSIS


Objectives
After reading tliis unit, you sliould be able to understand:
0
tlie importance of enviro~imental(external) analysis;
tlie relevant broad dimensions i n a general environment;
0
0

e
0

tlie relationsliip between the general environment and strategy;


tlie PESTEL framework for analysis and the i~nplicatio~is
of its factors;
McKinsey's 7 s framework and its role in analysis;
the structural drivers of change; and
the differential impact of enviro~inientalinfluences.

Structure
4.1

Introduction

4.2

of External Environment
Broad Di~ne~isions

4.3
4.4
4.5
4.6
4.7

PESTEL Framework
McKinsey's 7 s Framework
General Environment and OrganizationsStrategy
Environmental Scanning
Summary

4.8 Keywords
4.9 Self Assessnient Questions
4.10 References and Further Readings

4.1

INTRODUCTION

Strategic analysis is basically concerned with tlie structuring of tlie relationsliip


between a busitiess and its environme~~t.
The environment in wliicli business operates
has a greater influence on their successes or failures. There is a strong linkage
between tlie changing environment, tlie strategic response of tlle business to such
changes and the performance. It is therefore important to understand the forces of
external environment tlie way tliey influence tliis linkage. Tlie external erivironment
which is dynamic ahd cliangi~igholds both opporturiities and tlireats for tlie
organisations. The organisations while attempting at strategic realignments, try to
capture these opporti~riitiesand avoid tlie emerging tlireats. At tlie same time the
changes,in the environment affect tlie attractiveness or risk levels of various
investments of the organizations or the investors.

4.2 BROAD DIMENSIONS OF EXTERNAL ENVIRONMENT


The macroenvironment in which all organizations operate broadly consist of tlie
econo~nicenvironment, tlie political and legal environment, the socio cultural aspects
and the environment related issues like pollution, sustainabilityetc. Tlie teclinological
temper and its progress has been the key driver behind the major changes witnessed it1
the external environment making it increasingly complex.

Strntcgic Analysis

These factors often overlap and the developments in one area ]nay influence
developrnents in other. For example, the opening up of economy integrated the lnarkets
globally and increased the colnpetition between private and public fir~iis.This forced
tlie Indian government to revisit its econo~nicpolicies. Uiider its new liberalization
policy and economic reforms of 1991, regulations like MRTP, wliich restricted the size
oftlie business and therefore inhibited their efficiency and colnpetitive levels, were
removed with a positive impact on the indigenous industries. However, the delay in
addressing to the policies like Indian co~~ipa~lies
act or Exim policies, organisations
both from doinestic and abroad still tind the Indian business environment not so
cond~~cive
for business. The current political developments are sure,to have mo1;e
uncertainties in the minds of business people regarding the future policy direction in
certain sectors. Tlie social considerations in tlie context of a developilig country like
India also plays a critical role in deciding the broad dynamics oftlie business
e~lvironment.The clash of ideologies between preserving tlie Indian ethos and culture
and giving a freedoill of choice to people often create problems and confusion for
business.

4.3

PESTEL FRAMEWORK

Caref~~l
analysis of tlie above factors will help in identifying major trends for different
industries. Exhibit-] sllows the PESTEL fra~neworlcwhicli is most popularly used for
SLICII analysis.
The external forces can be classified into six broad categories: Political, Economic,
Social, Tecl~nological,Environmental and Legal Forces. Changes in these exter~~al
forces affect the changes in consumer demand for both industrial and cousumer
products and services. These external forces affect the types of products produced, the
nature of positioiiing them and market segmentation strategies, tlie
types of services offered, and choice ofbusiness. Therefore, it becomes
impostant for the organizations to identify and evalilate external opporti~nitiesa d
threats so as to develop a clear mission, designing strategies to achieve long-term
objectives and develop policies to acliieve shol-t-termgoals. Here, we will discuss all
the six forces individually and then try to come to tlie conclusion regarding
environmental analysis.
Few indicative points are listed to guide you to find the key forces at work in
the general environn~ent.While tlze fra111ewo1.kmay be used to understand tlie
nlost impol-tant factors at the present time, it should be primarily used to
look into the fi1tul.e impact wl~ichmay be different from their present or
past impact.
Exhibit 1

The PESTEL Framework- Macro-environmental i~ifluences.The framework


priinarily involves the following two areas:
1 . Tlze environmental factors affecting the organization;

2. The i~nportantfactors relevant in the present context and i n the years to come.

( Political
I.
2.
3.
4.
5.

Government stability
Political values and beliefs shaping policies
Regulations towards trade and global business
Taxation policies
Priorities i l l social sector

Economic Factors
1. GNP trends

2.
3.
4.
5.
6.
7.
8.

Interest rates/savings rate


Money supply
Inflation rate
Une~i~ployment
Disposable i~icoliie
Business cycles
Trade deficit/surplus

Socio-cultnral Factors
1. Population demograpliics
e
ethnic composition
e
aging of population
regional cliariges in population growth and decline
e

2.
3.
4.
5.
6.
7.

Social mobility
Lifestyle changes
Attitudes to work aiid leisure
Education - spread or erosion of educational stalidards
I-lealth and fitness awareness
Multiple income families

Technological

I.
2.
3.
4.
5.
6.
7.
8.

Bioteclinology
Process innovation
Digital revolution
Government spendilig 011 research
Govelnniellt and industry foc~lson techllological effort
New discoveries/development
Speed of teclil~ologytransfer
Rates of obsolesce~ice

Legal
1. Moliopolies legislatioii/Aiititr~lst
regulation

2. Employment law
3. I-lealth aiid safety
4. Product safety
-

Political: Politics lias a serious impact on the ecolio~nicenvil.onrnentof a country.


Political ideology and political stability or illstability strotigly iiiflueilce the pace and
direction oftlie economic growth. Also it co~itribuiesto tlie econo~nicenviroiilnent
wliicli is conducive for some busiliesses to grow or relnaitis illdifferent for some
busillesses and at ti~liesis a hurdle. Subsequent to general elections of 2004 in the
country, there has been a change in the governmeut at tlie ceiitre. A new coalitioli
United Progressive Allialice (UPA) led by tlle Congress party and supported by Left is
ruling at tlie ceiitre and the implications on business can be seen through few of tlie
policy statements aniiouliced by tlie gover~iment.Eve11though the broad policy
direction is in line with tlie policy of an open econolny alld private sector initiative, the

Environmentrl Analysis

Strntegic Analysis

Coinmon Minimum Programme has identified few priority areas which is going to
have an impact different tlian before. Particularly when there are certain ideologies
which view differently the issues like FDI and privatization, the future ofdifferent
sectors like insurance and banking, aviation and telecommunication have become
uncertain.
Looking back into tlie history dueto certain ideological beliefs prevalent in some
section of politics, foreign companies like Coca Colaand IBM had to move out of
India in the late 70s. Entry barriers, protectionist policies, high tariffs, nationalist
pursuits all worked towards a closed economy which continued till tlie time
liberlization policies were introduced in 1991. This situation had a cumulative effect
on making the economy weak and the busi~iesseswere hardly competitive as compared
to tlie international standards. However in subsequent years, tlie political colisensus
developed on issues such as labour reforms, power sector reforms, importailce of
infrastructure sector is doing a lot good for business. Nevertheless, the deteriorating
standards in politics, i~lcreasiilgcorruption and the criminal nexus are creating hurdles
for business in certain areas.

1
t

Activity 1
Identify few key active political forces. Discuss how they are sliapi~lgthe overall
environme~~t
in the country.

...................................................................................................................................
Economic: Exhibit 2 gives you a view of broad inbicators which give the economic
picture of the general eiivironment and these should be carefully Iooked into while
doing the environmental analysis.

Exhibit 2
Common Economic Indicators
A. National Income
GNP

Personal disposable Income


Personal consumption
C. Savings

Personal savings
Corporate savings
Balance of Payments
E. Industry

Industry Investment
FDI flows
Services
Infrastructure
G. Capital Market

Equity market
Bond market

B. Policy Initiatives

Monetary policy
Fiscal policy
Labour and employment policy
D. Foreign Sector

Exchange rates
Exports/Imports
F. Sectoral Growth

Agriculture
Industry

H. Prices, Wages, Productivity


Inflation
Labour productivity

Economic factors throw light on the nature and direction of the economy in which a
firm operates. The firms must focus on economic trends in segments that affect their
industry. For example the present trend of low interest rates on personal savings may
compel individuals to niove towards equity and bond markets leading to n boom in the
capital market activity and the mutual fund industry. Consumption patterns are
usually governed by the relative affluence of market segments and firms must
understand them through tlie level of disposable income and tlie tendency of people to
spend. Interest rates, inflation rates, unemployment rates and trends in tlie gross
national product, government policies and sectoral growth rates are other economic
influences it must consider.
The services sector's contribution to national income is increasing year after year and
tlie family incolnes are rising faster than individual incomes, job oppo~-tunitiesare
more diverse and therefore tl~esespeak for different types of opportunities and
challenges wliicli are emerging before the business. Witli tlie opening up of the
economy, trends in global market needs a careful look.
Tlie above needs to be analyzed and incorporated in your inferences for tlie general
environment and its otlier forces and how all these together may influence business.
Activity 2
Suppose tlie foreign exchange reserves in the country gets depleted by half oftlie
present level because of few developments in the outside world. Discuss tlie
environniental effects it may lead to.

Social

Demograpltic Factors: Demograpliic cliaracteristics such as population, age


distribution, literacy levels, inter-state migration, rural-urban mobility, incolne
distribution etc. are tlie key indicators for ~~nderstanding
tlie demographic impact on
environment. The shifts in age distribution caused by i~iiprovedbirth control methods
liave created opportunities for youtli centric products ranging from clotlies to
entertainment to media. Tlie growing number of senior citizens and their 1 iveliliood
needs have been highlighted and the government is being forced to pay niore attention
in the form of social security benefits etc.
Considering Literacy and the composition of literates in tlie country creates
opportunities for particular type of industries and type of jobs. For example on one
hand, tlie preseiice of a large number of Englisli speaking engineers encouraged many
software giants to set up shops in India and on tlie other, tlie availability of cheap
labour, India beco~iiesa destination for labour intensive pro-jects.Moreover, large
labour mobility across different occupatio~isand regions, in recent times, has cut
down wage differentials greatly and this lias an impact for business which needs to be
understood.
CulturnlFactors: Social attitudes, values, customs, beliefs, rituals and practices also
influence business practices in a major way. Festivals in India offer great business
opportunity for certain industries like clotlies and garments, jewellery, gift items,
sweetmeats and many others, the list could be endless.
Social values and beliefs are important as they affect our buying beliaviour. For
example, Mc Doiialds does not serve tlie beef burgers in India because Indians do not

Strategic Analysis

have cow meat since the animal is co~lsideredholy and sacred. A related exalnple of
Walt Disney also brings out clearly, the impact different cultures may bring to
business. Walt Disney whicli has been so suffcessful in US ~narlcetcould not be so
in European countries because of the difference in the way in
similarly s~~ccessfi~l
which people entertain themselves there. Walt Disney had to customize its offerings in
order lo be successfi~lin these markets. TIle spread of consumerism, the rise of the
tniddle class with liigii disposable income, the flashy lifestyles of people wo~~king
in
software, telecom, media and multinational co~ilpaniesseem to have cl~angedthe
socio-cultural scenario and this needs to be uilderstood deeply.
,

Values in society also determines the work culture, approacl~towards stakeholders and
the various responsibilites the organization thinks of owing to its stockholders and the
society.
Activity 3

There has been a thrust on women literacy. Discuss the influences you see in the social
environment and their impact on business.

Technology: Technological factors represent major opportunities and threats which


must be taken illto accou~ltwhile formulating strategies. Techtlological brealdhrougl~s
can dramaticall y influence the organisat ion's products, services markets, suppliers,
distributors, competitorss, customers, ~nanufacturi~lg
processes, marketing practices
and con~petitiveposition. Technological advancements can ope11 up new marlcets,
change the relative position of a11 industry and render existing products and services
obsolete. Technological changes can reduce or elimiate cost barriers between
businesses, create shorter production runs, create shortages in technical skills and
result in changing valuesand expectations of customers and employees.
The impact of information tecl~tlology(IT) which co~nbinesfruits of both
teleco~n~nunications
and co~nputershas been revolutionary in every field. Not only has
it opened up new vistas of business but also has changed the way the businesses are
done. 1T has specificaIIybrought i n another di~nension'Speed' which orga~lizations
recognize as theadditional source of competitive advantage beyond low cost and
differentiation. Matlufacturers, bankers and retailers have used IT to carry out their
traditional tasks at lower costs and deliver higher value added products and sel-vices.
Activity 4

Enulnerate few of the technological advances in the field of agriculture and discuss its
role in tapping better opportunities in the overseas market.

Environment: Environment conservation and protection is an issue, which


has gained pro111inence because of deteriorating environ~nentalbalance which is
threatening the sustainability of life and nature. Largely, business is also held
responsible for such situations as emissions from industries poluting the air,
I S unfit for
excessive chemical affluents drained out in water making it ~ O ~ S O D O Land
use, usage of bio non-degradable resources affecting the bio-chain adversely and
exposure of employees to hazardous radiations bring their life in danger. All these
have been tal<envery seriously by different stakeholders in the society including the
government and legislations and movements are creating pressure for an
environment friendly business. These have far reacl~ingi~nplicationsfor business
ranging from the kind of business, the product being manufactured, I~owit is
~nan~~facturecl
and how friendly it is for mankind a ~ nature.
~ d Big companies like Coca
Cola ancl Pepsi have also come under the purview ofthe society regarding the
environmental hazards. Ifthe chal.ges on them of using chemicals beyond accepted
soft d r i ~ ~are
k s confirmed, they will have a black spot on their
levels for man~~facturing
names and business. So, it is important for the organisations to take care of the
environment as we1 1.
Activity 5
List out five major industries which in your view, pose danger to environ~nental
conditions. Mentioning your reasons suggest how these industries may correct the
situation.

Legal: Licensing policies, quota restrictions, import duties, Forex regulations,


restrictions on FDI flows, controls on distribution and pricing of commodities
together made business difficult during license per~nitraj before the liberalizatio~l
policy of I 99 1. However, with economic reforms things I~avechanged and legal
formalities have eased. Nevertheless with globalization, the rules of competition, trade
mark rights and patents, WTO rules and ililpl ications, price controls and product
quality laws and a number of other legal issues in individual csuntries have become
important and therefore they need to be included while understanding the general
environment.
Activity G
Discuss the legislation 011 patents in I~ldiaandconunent on its impact on the
business.

Environmental Annlysis

Strntegic Analysis

4.4

MCKINSEU'S 7s FRAMEWORK

Let us now use blank grid for PESTEL analysis to understand the role of McKinsey7s
7 s framework.
Exhibit 3

BLANK GRID FOR PESTEL ANALYSIS


Political
'

Economic

Social

Environmental

Techno!ogical

Local
National
Global

The sta~~ting
point would be to brainstorm an appropriate PESTEL checklist, using the
boxes in Exhibit 3. The PESTEL checklist can be used to analyze which factors in the
e~lvironmentare helpful to the unit, and which inay impede progress ofthe unit in ,
acllieving its aims. There is of course a danger, common to all checklists, that once an
entry has been made under each of the headings it is deemed complete, regardless of
whether or not the list reflects the conlplexity of the reality. Another comtnon error in
the i~nplelnentationis that 'boxes' are co~npletedwithout reference to the aims of the
organisation. This can lead to considerable expenditure oftime and energy for little
benefit.
Let us now discuss ill brief Mckinsey's 7 s framework. According to Waterman et al.,
organizational clla~lgeis not only a matter of structure, althougll strucutre is a
significant variable in the management of change. When we talkof an effective
organizational change, we can see that it is a complex relationship between strategy,
structure, systems, staff, style, shared values, skills and superordinate goals. This
relationsl~ipis represented ill a pictorial manner
in Figure 4.1.

(7
Structure

Figure 4.1: The Mckinsey 7-S Framework


12

Source:Thomas J. Peters and Roberts H. Waterman, Jr., In Search of Excellence: Lessons


from Americal's Best Run Companies (p. 10)

EnvirunmentaI An~lySis

Tlle framework suggests that there is a lnultiplicity of factors that influence an


orga~lisatioll'sability to change and its proper mode of change. Because of the
interconnectedness of the variables, it would be difficult to make significant progress
in one area without making progress in the others as well. There is no starting point or
implied hierarchy in tlle shape of the diagram, and it is not obvious whicl~ofthe seven
factors would be the driving force in changing a particular organisation at a ce~tain
point in time. Tlle critical variables would be different across organisations and in the
same organisatioll at different points of time.
In this context there may be a role for using 'McKinsey's 7 s Framework' llelping a
clnit, structure the analysis. Let us first discuss the concept of McKinsey's 7 s
framework in brief:
Superordinate Goals: are the fundamental ideas around which a business is built;
Structure: Salient features of tlie unit's organisational chart (e.g. degree of hierarcl~y,
presence of internal market, extent of centralization/decentralization)and
interconnections wit11i11the ofice;
Systems: procedures and routine processes, including how i~lforlnationlnoves around
tlie unit;
Staff: Personnel categories within the unit and the use to which staff are put, sltiII
base, etc.;

Style: Characterization of how key lnaliagers behave in order to achieve the unit's
goals;
Shared Values Strategy: The significant meanings or guiding concepts that the unit
imbues on its members;
Skills: Distinctive capabilities of key personnel and the unit as a whole.
Tile 7 s nlodel can be used in two ways:

Considering the links between each ofthe Ss one can identify strengths and
weakliesses of an organization. No S is strengtli or a weakness in its ow11 riglit; it
is o111yits degree of support, or otherwise, for the other Ss whicl~is relevant. Any
Ss that harlnonises with all the other Ss can be thought of as strengths and
weaknesses.

The model liigliliglits how a change made in any one of the Ss will have an
impact on all the others. Thus if a planned change is to be effective, then cllanges
in one S must be accompanied by complementary changes in the others.

4.5

GENERAL ENVIRONMENT AND


ORGANIZATIONS' STRATEGY

As a next important step the manager needs to analyze the kind of impact the change
may bring in their own indi~stryas the impacts are never same for all industries. For
example, the emerging younger demographic profile of India will have very different
consequences for businesses say in health care or entertainment. While the former will
face an adverse effect, the latter will have a positive effect and this needs to be
analyzed and integrated into strategic decision making. In response to these
assessments of differential impacts, managers will be able to take advantages of the
opportunitiesor guard themselves of the threats. Exhibit 4 shows in how different
ways various industries get affected by the different environmental trends.
Responding to these variocls impacts with new strategic initiatives the managers must
take notice oftlle fact that ifthe changes are significant, it may have tlie potential of
changing the competitive rules of the game in the industry. For example, in India the

Strategic Analysis

competitive rules of the game for sectors like telecoin, banking and insurance etc, in
the post liberalization period changed specially in last two years. With the easing of
FDI and particiption of major global players, norms have changed drainatically which
is reflected in the strategies of most of tlie firms in the sector. These changes can be
seen in the area oftechnology and pricing, intensity of advertisii~gand promotions,
their business alliances and iletwork in the country.
Managers need to be cautioils of tlie fact that there may be developments, wllich are
not so easy to be predicted and therefol-eneed fi~rtherattention so that they can be
incorporated in their strategy. In the global context, the managers must see the kind of
impact any single change will have in different markets. It is quite possible that they
are very different both in degree and their nature.

Exhibit 4
Environmental
Trends

Potentially positive
effects

Probably neutral
effects

Probably negative
effects

1.

Aging population

meclical services

minerals

colleges atid schools

2.

Multiple income
families

fast food

machine tools

grocer's supplies

3.

Deregulation

shippilig

4.

Increased
envisonmental
lelgislation

waste management

5.

Growing global

telecolntnut~ication
competition
small scale~handicrafts

financial sector

softwarc

leather

mining

Structural Drivers to Change


The PESTEL analysis gives a number of factors and their likely infliiences. However
it is iinportant to identify the specific factors wl~ichinay influence an industry and
force them towards competitive adjustments. These factors are ter~nedas stluctural
drivers of change which have the likely effect on the structure of an industry or on the
competitive e~~vironinent.
As a first step based on PESTEL analysis, the key driving forces need to be identified
and then impact ofthe combined effect ofthese forces sllould also be made. Increasing
globalization of the industry and the E enabled era could be such driving forces
capable of affecting the structure of an industry or its enviro~lment.

4.6

ENVIRONMENTAL SCANNING

The factors or the forces u~lderstoodunder PESTEL framework put together, present
ahiglily co~nplexand uncertain environme~~t
whicll are difficult to predict or foresee.
From a long tern1 view of strategy I~owever,reaching somewhat closer to such forces
are important in uilderstanding the key factors influencing the success of such
strategies.
E~~vironinental
scanning is one ofthe few ways to detect filture driving forces early
and this involves studyiilg and iilterpreting the developments of social, political,
economic, ecological and technical events that could become driving forces. It
attempts to figure out few radical happendings or path breaking develop~nelltswhich
may be catchiilg on and see their possible i~nplicatioils5 to 20 years into the future.
The purpose of the environmental scanning is to raise the consciousness of managers
about potential developments that could have an impact on industry conditions and
bring in new threats or opportunities.

Environmental scanning is normally accolnplislied by systematically monitoring and


studying currellt events, constructing scenarios and employing the Delphi method (a
technique for finding consensus among a group of k~iowledgeableexperts).
Co~istr~cti~ig
scenarios involves a detailed plausible view of liow the business
environment of an organization might develop ill the future based on the groupings of
lcey environmental influences and drivers of change about which there is high level of
uncertainty. For exa~iiplein industries like energy, transportation, defence equipment
etc. there is a need for views of the business e~ivironmentof Inore than 10- 15 years
and factors lilte raw materials, substitutes, consumption patterns, geo politics etc.
would be of crucial importance. Foreseeing precisely for such a longer duration may
be vely difficult but drawing up possible fiitures [nay be possible. It is not unnatural
to believe that several scenarios could unfold ovel-ti~neand these need to be
ilnderstood.

Environnientnl Analysis

Scenario Planning technique is briefly discussed in Unit 5 i~llderthe colnpetitive


environmelit.

4.7

SUMMARY

Understanding ofthe general environ~nentin which an organization operates is tlie


forelnost pre-requisite towards strategy formulatioii. The six broad dinlensions which
the PESTEL fralneworlt provides oftlie environment-political, economic, sociocultural, leclinological, environmental and legal are capaable of giving a
comprehensive overview of liow tl~i~igs
may be il~ifoldi~ip.
The objective of the
aiialysis out orthis framework llowever should not only restrict to the present and past
but the real focus should be on projectiiig the trends into filti~rein order to get tlie real
feel oftlie ellvironnient then. Tliis shall enable the finii to proactively strategize for
future considering the general environment, it is going to face and tlie issues which
will be of importance.

4.8

KEY WORDS

PESTEL Framework: Tliis framework categorizes environuiiental influelices into Six


maill types - political, etco~iomic,social, technological, environmental and legal.
Shared Values: The significant meanings or guiding concepts that tlie illlit inbues on
itsmembers.
Structural Drivers of Change: factors which have the likely effect on the structure of
an industry or on the competitive environment.
Environmental Scanning: One of tlie few ways to detect fiiture driving forces.

4.9

SELF ASSESSMENT QUESTIONS

1)

Briefly sulnrnarize what you iuiderstand by the general environment and its
i~nporta~lce
for business.

2)

Explain what is external analysis and how is it connected to strategy


formulation?

3)

Briefly explaiu the PESTEL framework.

4)
5)

Discuss tlie role of McKiiisey 7s inodel in analyzing external environment.


Iildelltify an industry of your choice and do a PESTEL analysis. Draw lip few
inference points.
15

4.10

REFERENCES AND FURTHER READINGS

Johnson, Gerrry & Scholes, Kevan. (2004). Exploring Corporate Strategy. Sixth
edition, Prentice-Hall oflndia, New Delhi.
Thoiiipso~i,A. Arthur, Jr. and Strickland, A.J. 111. (2003). Strategic Management,
Concepts ai~clCases,Thirteenth edition. Tata McGraw Hill Publislling, New Delhi.
Miller, Alex. Strategic Managenzent, Third edition. Irwin McGraw Hi 11.
Peters, Thomas J. and Robert, H. Water~nan,Jr. (I 982). In Search of Excellence:
Lessonsfionz Anlerica 's Best-Run Conipanies,New York: Harper and Row.
David, R. Fred. ( I 997). Concepts of Strategic Managenzent. Prentice Hall
I~iten~atioiial
Inc.

UNIT 5 COMPETITIVE FORCES


Objectives
After reading this unit you should be able to understand the:
@
competitive environment;
@
conipetitiveforces of the competitive environment;
0
Porter's five forces framework to analyze competitive environment;
0

process for analyzing the external environment; and


concepts of strategic groups and scenario planning.

Structure
5.1

Introduction

5.2

CompetitiveEnvironment

5.3

Porter's Five Forces Framework

5.4

Process for Analyzing External Environment

5.5

Sce~~ario
Plalining

5.6

Summary

5.7

Key Words

5.8

Self Assessment Questions

5.9

References and Furtller Readings


Appendix

5.1

INTRODUCTION

In unit 4, we discussed the first level of the external analysis i.e. understanding of the
macro environment, which have an influence on the success or failure of an
organisation's strategies. However, it is the immediate competitive e~ivironmentwhich
also influences an organisation and therefore has to be understood alongside the
general environment. The impact of the changes of the macro environment is felt on
the organisation and its strategies through their influences on the competitive forces of
the competitive environment. Hencean indepth understanding ofthe industryis
competitive character is the next important step for an orga~zizationas part of its
external analysis.

5.2 COMPETITIVE ENVIRONMENT


The competitive environment refers to the situation which Organisation's face within
its specific area of operation, and this can be understood at an industry level or with
respect to smaller groups called Strategic groups (Refer appendix). Generally
understood, an industry in the economy is recognized as agroup of firms producing
the same principal product or more broadly the group of firms producing products
that are close substitutes for each other and in a given industry different organisations
have different intermediate basis of understanding its relative position with respect to
other organisatians in the industry.

UNIT 7 COST

Cost

Objectives
The objectives of this unit are to acquaint you with:
l

cost levels of Indian industry;

concept of experience curve; and

concept of cost leadership.

Structure
7.1

Introduction

7.2

Cost Levels in India

7.3

Causes and Effects of High Costs in India

7.4

Changing Role of Cost in Different Market Conditions

7.5

The Experience Curve

7.6

Causes of Experience Curve Effect

7.7

Additional Considerations for Using Experience Curve Effect

7.8

Experience Curve and Competitive Strategy

7.9

Experience Curve and its Applicability

7.10

Limitations of Experience Curve

7.11

Role of Cost in Business Growth

7.12

Cost Leadership

7.13

Summary

7.14

Key Words

7.15

Self-Assessment Questions

7.16

References and Further Readings

7.1

INTRODUCTION

Cost analysis occupies an important place in business strategy. In order to gain and
sustain competitive advantage, a firm should not only monitor its cost performance
but also should endeavour to control it. Several strategic decisions like fixation of
competitive prices, provision of after-sale services, quality of the products etc. depend
upon relative cost level of the business firm. This unit highlights the elements and role
of cost in overall business strategy. The unit begins by acquainting you first with the
cost levels for some industries in India. The role of cost in different market conditions
is also examined. The unit also discusses experience curve to explain the cost concept.
Michael Porter in his book Competitive Advantage suggested three generic
competitive strategies aiming to develop a dependable position in the long-run and
out-perform the competitors. These three strategies are: Cost Leadership;
Differentiation; and Focus.
All the three strategies can either be used individually or in combination to each other.
In this unit we would restrict ourselves to cost leadership and discuss different aspects
of cost to define cost leadership as a strategy.

Business Level Strategy

7.2

COST LEVELS IN INDIA

It is widely accepted by the industrialists as well as the planners that Indian economy
and industry are becoming increasingly high cost-oriented. This narrowed down our
domestic market particularly for consumer durables and also impeded Indian products
from competing in the international markets in the 80s but in the post-liberalization
era, the scene changed. With multinationals coming to the country, the demand for
Indian goods reduced. To understand this observation, let us consider some specific
examples of different industrial sectors in India.

Textile Industry
Clothing is one of the three basic human needs alongwith food and shelter. Further,
India was once known all over the world for its fine clothes made from silk and cotton,
and was a major supplier of textiles to the rest of the world. But today our own people
cant afford to have cloth at reasonable prices because of our high cost of production.

Tyre and Tube Industry


Road transportation represents an important component in the life-line of economic
activity of any country, and tyres and tubes form a significant input of the operating
costs in this section. A comparison between the costs for the raw materials which go
into the production of tyres and tubes. Again we see that these inputs cost the Indian
tyre and tube manufacturers much more, and in turn this is reflected in the tyres and
tubes as paid by the prices of transporters. The cost is then passed on to the industrial
customers using the services of the transporters. Thus, there is a cascading effect
whereby costs get accumulated over different stages and the final consumers have to
bear the cumulative costs.
Of course, as regards tyre industry, it is often observed that the leading tyre
manufacturers have operated like a cartel in supplying and pricing their products. To
make up for shortages and to provide price competition the Government allowed
substantial imports of tyres recently.

Aluminium Industry
In aluminium industry also, considered today the parameter for determining the
industrial development of a nation, the Indian costs are much higher than the
international prices. This is despite the fact that India has an advantage in this sector
because of the natural resources. But, even without the excise duty and taxes, the
prices of aluminium in India are higher than in U.K. (indicating international levels).

Activity 1
Arrange a meeting with the Cost Accountant of the organization in which you are
working and try to ascertain the cost level (average cost per unit) of the major product
(or service) of your organization for the latest completed year. Is it different from the
cost level in previous years? Account for the reasons.
...........................................................................................................................................................................................
...........................................................................................................................................................................................
...........................................................................................................................................................................................
...........................................................................................................................................................................................
...........................................................................................................................................................................................
6

...........................................................................................................................................................................................

7.3

CAUSES AND EFFECTS OF HIGH COSTS IN INDIA

Cost

The cost differences mentioned above for some sectors of the Indian industry are
illustrative of a somewhat general situation prevailing in India. A large number of
factors go into the high costs of Indian products, such as the growing excise, customs
and sales tax levels etc. But a significant component of these high costs may be due to
uneconomic production levels, use of obsolete technology, high fixed or variable costs,
high break-even points or excessive dependence on imports of semi-finished goods,
etc.
It is pertinent for us to consider the effects of such high costs in India. As the
component of government imposed levels in the prices increase, the rising prices cause
a shrinkage in consumption and demand. For instance, in terms of 1970-71 prices, the
average household expenditure on essential consumer goods like sugar, clothing and
footwear etc. has actually declined from Rs. 2,802 in 1977-78 to Rs. 2,778. Similarly,
for the industrial goods, the household expenditure correspondingly declined from
Rs. 1,106 to Rs. 1,092. A recent manifestation of such high cost of production and the
corresponding shrinkage in demand created havoc in the Light Commercial Vehicle
(LCV) industry where there was an added burden of high exchange rate between Yen
and Rupee on the imported components from Japan. The present situation has changed
with companies trying to develop products indigenously in an effort to reduce costs.

7.4

CHANGING ROLE OF COST IN DIFFERENT


MARKET CONDITIONS

Cost is an important aspect of running any business opertion. It is a major level for
running the business activities, and has its influence on the progress of an
organization. Acceleration, stagnation or deceleration in progress are affected by it.

Cost in Sellers Market


While the markets are operating as sellers markets, the cost may not be considered so
critical in determining the profits of a running organization. Under sellers market
conditions, price is fixed on cost plus basis. So whatever is the internal cost, the
desired profit margin is added to it by the business firm, and the price is derived
accordingly.
Thus, Price of a Product = Internal Cost + Desired Profit Margin.
Here, the price of the product is the derived variable, and the cost is an independent
variable. The customer in the market is forced to pay the price so derived by the
sellers. If the cost moves up, due to certain unavoidable factors like scarcity of raw
material, labour problems or additional taxation, the manufacturer/seller merely takes
the boosted cost figures, adds his/her desirable profit margin and sells the goods at the
enhanced price. In the sellers market conditions (say due to shortage in emergency
conditions or man-made), the customer has no choice but to buy goods at the new
prices. Under these conditions, the seller is not much worried about the costs or their
upward movements, as he can pass on these additional burdens to the customers.

Cost in Buyers Markets


On the other hand, as the number of suppliers grow due to conspicuous profits in
sellers markets, the competition from the internal (or external) sources may increase.
A surplus supply of goods in the market may be created, if the demand does not move
at the corresponding rate. In such conditions the buyers get a choice to pick and
choose from. The markets are thus governed by the buyers and the way their

Business Level Strategy

preferences change. Under these competitive conditions, the manufacturer or supplier


is no more free to choose whatever price s/he wishes. The equilibrium equation
changes to:
Profit Margin = Permissible Price Internal Cost
Or
Tolerable Cost = Permissible Price Acceptable Profit
Under the new conditions, the price of a product is decided outside the organization in
the market place and, not according to the wishes of the maufacturer or supplier.
The price becomes an independent variable decided by the competition in the market
place. Each competitor, in general, may choose a different level of acceptable profit
for himself or fix the price matching with the market requirements. As the competitors
become more and more active there will be a downward push on these permissible
profits, unless the firm activates itself for effective cost reduction. Thus, unlike in the
sellers market conditions, now the cost or profit margin becomes the derived variable.
If the firm cant do much about the cost of manufacture or supply, then the profit
margin also gets fixed by the market forces, and the firm has to decide whether it can
survive at the prescribed level.
The other alternative for the organization is to fix a minimum acceptable profit (or
contribution), and then determine its tolerable level of cost. The next step is to do a
careful introspection and see what are the different variables getting into the cost of
goods, and find ways and means to reduce the cost so as to improve its profitability.
One way of doing this is to make use of the Experience Curve, and the other way is to
carefully consider its break-even point and operate well above this level.

7.5

THE EXPERIENCE CURVE

Cost has been correlated with the accumulated experience (of say production) by the
Experience Curve Effect. The underlying principle behind the experience curve is that
as total quantity of production of a standardised item is increased, its unit
manufacturing cost decreases in a systematic manner. The concept of the experience
curve was presented by BCG in 1966 and since then it has been accepted as one of the
important phenomenon.
The experience curve is a rule of thumb. It says costs of value added net of inflation
will characteristically decline 25% to 30% each time the total accumulated experience
has been doubled (Henderson, 1989). This is also known as learning curve. Initially,
this inverse relationship was discovered for the learning costs which are the costs for
direct labour input in the manufacturing cost. Thus, as the production of a particular
item (such as aircraft components) increased, the quantum of time of direct labour
component to make each of these successive items declined. This helped the aircarft
manufacturers to predict the cost of man-hours required to manufacture in future, say
the number of aircraft, and helped them to fix the price accordingly. The Experience
Curve Effect phenomenon, where costs fall with accumulated volume of experience,
was known to industrial managers for many years. It took momentum as a tool in
business strategy after Boston Consulting Group (BCG) provided the concept.
Let us take an illustration to understand this concept. When one starts the production
of a new product (2 units), the unit cost is, say Rs. 100. Then, as the accumulated
production volume reaches 4 units, the unit cost is reduced by say 20%, to Rs. 80.
Furthermore, as the accumulated production reaches 8 units, the cost gets reduced by
another 20%, to only Rs. 64, and so on. This trend has been tabulated in Table 7.1.
8

Cost

Table 7.1: 80% Experience Curve


Accumulated
production
2
4
8
16
32
64
128
256
512
1000

Cost/Unit
(Rs.)
100 x .80 =
80 x .80 =
64 x .80 =
51 x .80 =
41 x .80 =
33 x .80 =
26 x .80 =
21 x .80 =
17 x .80 =
........
........

100
80
64
51
41
33
26
21
17
13

The data of this table when plotted on a plain graph, it gives an 80% Experience
Curve, as shown in Figure 7.1. The Experience Curve has a hyperbolic shape.

Accumulated Experience N
Figure 7.1: Experience Curve

As we have seen in the illustration, the experience curve is a cost relationship but
looking at the practical situation, the prices may not go hand in hand with costs in the
long run. In every nation, there are certain cases where the prices of a particular
commodity or service remain unchanged in terms of their respective currency while
the costs decrease. But this case, then is followed by prices falling faster than the
costs. This then results in a shift in the market share and leadership of an enterprise.
Japan is one country where this unstable pattern rarely occurs.
In the experience curve one thing is to be noted that each element of cost in an endproduct experience curve goes down its own independent cost curve and each such

Business Level Strategy

element has its own starting point (Henderson, 1989). Therefore, the slope of each
element may be different and each cost element may share experience with other end
products. Looking at this explanation, it can be said that an experience curve is an
approximation of a trendline.

7.6

CAUSES OF EXPERIENCE CURVE EFFECT

In order to fully utilise the experience curve effect, it is important to fully grasp what
causes this effect. With increase in accumulated production of a standardised product,
the experience curve effect of systematic reduction in cost is caused due to
management synergy, as follows:

Improved Productivity of Labour


As the accumulated production of standardised product increases, the labour force
acquires the skills to do their task more efficiently. This may be in the form of
memorising the steps involved, or developing reflex actions for doing the needed
operations. However, as the experience accumulates, not only the direct labour, but
also the supervisory staff as well as managers must successively streamline the needed
operation to improve the efficiency.
It is important to note that to consolidate the above gains for a sustained improvement,
adequate training facilities have to be provided to the new entrants.

Increased Specialisation
Increased volume of standardised production may also merit specialisation of
individual or a group of skills among different employees.
Thus as the production volume increases, individual components may also become
viable to be produced in different profit centres. Alternatively, suitable vendors for
ancillaries may be developed to shift the overheads and other non-productive expenses
away from the organisation. For example, a large vehicle plant can procure engines,
transmission train, drive, wheel, gear boxes etc. from outside, and do their assembly
only within their plants.

Innovation in Production Methods


With accumulated experience and higher specialisation, the concerned workers are
likely to come across innovative ways of improving the production processes.
For instance, Japanese engineering workers evolve unique jigs and fixtures which
facilitate their working and smooth flow of operations. However, fixed investments in
such jigs and fixtures are viable only at high volumes of production, and they cant be
utilised at low production volumes. On enlarged volumes, the unit fixed cost per item
reduces substantially, and benefits far exceed the cost.

Value Engineering and Fine Tuning


As the experience with the production as well as usage of a product accumulates,
newer ideas based on value engineering may be adopted to cut down the unnecessary
material consumption and other under-utilised inputs.

10

For instance, for conduction of electricity, copper wires are often the preferred choice.
However, by now it has been also scientifically demonstrated that in copper
conductors, the current flows only on the surface of the conductors. Thus, to save cost
without compromising performance, the lead conductors coated on the surface by
copper have been successfully substituted with substantial economies in initial costs
and replacement costs. But such coating operations would necessarily require high
volume of production.

Cost

Balancing Production Line


Sometimes, by mere addition of balancing equipments, substantial increases in
capacities can be increased without incurring the proportionate new investments.
Thus, all these factors have an accumulated integrated influence of reducing the cost
with accumulated experience, and the manager must facilitate and promote these
factors to get the desired reduction in cost.
In the absence of the above, cost economies would not come about.

Methods and System Rationalisation


The standardisation in production, marketing and administrative procedures results in
efficiencies over time. Also, more up-to-date technology with better economies of scale
can be inducted as the volume increases.

7.7

ADDITIONAL CONSIDERATIONS FOR USING


EXPERIENCE CURVE EFFECT

The experience curve, in general, is simple approximation of extremely complex realtime interaction of a variety of associated parameters. Therefore, while utilising the
experience curve effect for actual day-to-day decision-making, extreme care is
necessary to get reliable results.

Distinguish Experience from Time


Many a time, there is a tendency to substitute passage of time for the experience, and
to expect fall in costs related to time, say on an annual basis. For example, a
machinery manufacturer makes 1,000 units per year, and the production increases
10% per annum. Now let us also suppose that the production of machine follows the
80% experience curve. Then, the production and the experience or cumulative
production would vary as shown in Table 7.2.
Table 7.2: Production and Experience with Time
Year

Annual Production

1st
2nd
3rd
4th
5th
6th
7th
8th
9th
10th

1000
1100
1210
1331
1464
1610
1771
1948
2143
2357

Experience (cumulative)
1000
2100
3310
4641
6105
7715
9486
11434
13577
15934

Thus, it takes 10 years to achieve four doublings of the experience, and the annual
production level has reached nearly two and a half times mark. The unit cost at the
end of this period, should be about 41% of the initial cost. Due to the Experience
Effect, it reduces to 80% in 2nd years, 64% in the middle of 4th year and 51% in the
early part of the 7th year and so on.

What is a Unit Experience?


Another important consideration is to carefully define the basic unit of experience.
This is particularly so in the recent years when the market segmentation is proceeding
at a fast rate. (Thus, one has to make sure that apples are not being compared with
potatoes.)

11

Business Level Strategy

For example, should a vehicle manufacturer consider that all vehiclestrucks, light
commercial (LCV) and passenger carsfollow a common experience curve effect, or
should these be considered separately on their respective individual experience curves?
To focus attention on the segmental specialisation, may be one should take the
individual truck or LCV or the passenger car as the unit of analysis rather than
collectively as vehicles.

How to Consider Influence of Time?


As the experience curve effect is to consider cost effects for production of a
standarised product, it is important to consider the likely effects of varying short-term
fluctuations and inflation. The experience curve effect is a long-run trend, and it will
not be able to account for year-to-year variations in costs due to manufacturing
bottlenecks, industrial relations problems or other supply-demand mismatches.
Similarly, the cost data for experience curve, must be in terms of real money or net
of inflation.
The managers planning to use the experience curve effect for building the cost related
strategies must keep these additional considerations in mind to derive the desired
benefits with accumulated experience. A unit experience must be clearly defined for
the concerned business. The experience should be distinguished from certain timerelated changes. Further, concerned cost figures must be net of inflation.

7.8

EXPERIENCE CURVE AND COMPETITIVE


STRATEGY

The experience curve relationship provides a good framework for managerial


considerations for predicting industrial scenario with respect to future costs, profit
margins and corresponding cash flows for the managers own as well as his/her
competitors operations. Here the only underlying assumption is that the costs and
therefore the prices will follow the experience curve effect, which can also be verified
and correlated with the trend of the past few years.
For example, the market price of a product P at present is Rs. 100, and it is being
manufactured by three companies in the industry, X Co., Y Co., and Z Co., which
compete with each other by direct selling. Their annual sales and market shares are
shown below:
Sales Volume
Market Share

10,000
57%

X Co.
5,000
29%

Y Co.
2,500
14%

Z Co.
17,500
100%

Total

Let us assume that the slope of the Experience Curve = 80% and the annual growth
rate in demand = 20%.
Now, the corporate manager in X Co. also knows his/her cost as Rs. 80.
On the basis of such information s/he has to determine the costs of making these
products in Y Co. and Z Co. To do so, s/he knows that his market share is twice that
of Y Co., so the cost of Y Co. on the 80% experience curve would be 80 x (100/80) =
Rs. 100. Similarly, the cost of Z Co., with half the market share of Y Co., would be
100 x (100/80) = Rs. 125. Thus, the costs and the profit margin, at a common price
would look like:
Cost/unit
Profit/Loss
12

X Co.
80
20

Y Co.
100
0

Z Co.
125
(25)

In other words, the manager in X Co. can determine that while they are selling the
product at 20% profit margin, their competitors have little chance of breaking even.
Armed with this information s/he can then develop suitable competititve strategies.
These strategies may be:
a)

Selling product at most competitive price;

b)

Maximising profits by selling at the highest price the market can afford;

c)

Selling at a higher price initially but crashing the prices later to keep the
competition out.

Cost

These major strategy options are graphically presented in Figure 7.2.

Figure 7.2: Major Strategy Options


13

Business Level Strategy

7.9

EXPERIENCE CURVE EFFECT AND ITS


APPLICABILITY

The experience curve effect has been demonstrated very well in some segments of the
electronics industry where, as the volumes grew, a real decline in cost as well as prices
has been observed.
One consequence of this effect has been that in the early stages of the market war in
the personal computer business, the manufacturers with high volumes became more
aggressive and led the markets with lower costs and prices, whereas the manufacturers
with smaller production volumes had uncompetititvely higher costs and prices. The
latter could not survive in the competitive market arena.
The experience curve effect has some clear implications for maufacturing strategy, so
that only a few large plants with standardised products would be able to supply the
global market. Further, their marketing efforts should be fully coordinated with their
manufacturing plans. On the other hand, with competition, the marketing department
is forced to reduce the prices, and the maufacturing department should be ready to
supply the higher volume. This demands careful and close linkage with the purchasing
department and relationship with vendors for prompt sub-contracting. Further, while
prices are lowered the products should not get associated with inferior quality. The
quality levels must be carefully guarded. This is how the Japanese have managed to
conquer the world markets for their cars, electronic appliances and other sectors. It
may however be observed that the relationship implied in the simplistic model of
experience curve cannot be applied universally.
To begin with, experience curve effect is applicable only if the demand is sufficiently
elastic so that by lowering the prices, it is possible to generate the needed higher
demand. Thus larger volumes of goods will be produced and correspondingly the costs
will be lowered. The overall contribution and profitability levels are maintained or
improved further. Under such a setting, a market leader can push the volumes to such
an extreme that he/she markets the products at such low prices that it would become
impossible for any new competitor to enter the market and gain volume high enough
for him/her to operate viably.
Looked at it from another perspective, in a dynamic competitive market the laggards
among the lot, complacent about their comfortable position, will become successively
less competitive and more uneconomic and will eventually be driven out. On the other
hand, the experience curve effect cannot be utilised if the demand is inelastic so that
by lowering the prices, additional demand volumes cannot be generated. As such the
costs will not come down but will stay at higher levels. Under such circumstances, the
contributions and profit margins will shrink. The company can stay and survive in the
market only with low margins. A similar situation will exist when the comeptition is so
severe that it is difficult to increase market volumes dramatically, or increase output
significantly to gain major reductions in cost.
Thus, the experience curve effect can damage the company if it is not cautious and
careful in its aggressive activities for increasing production of standardised product.
And this situation of crisis may arise if the demand falls suddenly in the market. With
this the company is forced to reduce its volume of production, and correspondingly its
costs will rise. Under such a scenario, if the company is forced to increase its prices,
then the demand may fall further. Thus, a recessionary trend may set in.

7.10
14

LIMITATIONS OF EXPERIENCE CURVE

The experience curve, a simple conceptual model, has its own difficulties in
application, though it might look otherwise. To understand this let us take an example.

While compiling costs, the managers may come to know that the costs of the products
manufactured in their plants are not being separately accounted for, and are instead
being lumped together department-wise, or division-wise. Over the experience scale
also, the systematic cost data may not be available, but may instead be accounted
batch-wise or lot-wise. Sometimes, the accounting practices may be changed over the
years or the cost allocations may be modified.

Cost

For determining the data regarding competitors, the problems are further compounded.
Generally, in highly competitive markets, installed production capacities are not
disclosed by the manufacturers openly. Besides, each competitor has a different
starting point, so the respective cost data may have to be adjusted accordingly. The
cost differences between different manufacturers are of critical importance for
developing an effective strategic plan, but these are very difficult to obtain in reality.
In terms of the experience curve effect a late entrant, in order to survive in the
competitive world, firms must necessarily operate at lower initial cost than the
competitors who entered earlier. To be profitable, the late entrants have to learn about
the business and develop technological advantage regarding their equipment etc. over
their predecessors. They may also acquire the experience of others by offering higher
incentives to the experienced employees, thus snatching them from the earlier entrants.
A manager must utilise the experience curve effect most effectively, keeping in mind
the inherent limitations of the phenomenon as well as the organization under
consideration.
The experience curve cannot be termed as a strategy or even a base for formulating a
strategy instead it is a way to understand how the costs in the competitive market
may shift. By now we all very well know that strategy is developed based on
competitive differences and we also know that no two competitors can have the same
way of living. If they do have the same way, then it is not for a longer period of time
because having exactly the same ways cannot have competition. This shows that a
successful competitor only dominates his/her own segment and this is an observable
fact. Similarly, is the fact that experience curve is observable. Thus, it is very clear the
main aim of the strategy is to differentiate the segments competitively so as to increase
both absolute amount and its value in the marketplace.

7.11

ROLE OF COST IN BUSINESS GROWTH

You have noted that costs play an important role in the survival and growth of a
business firm. For survival, a business firm must make some profit so that it can
sustain its operations on a long-term basis and fulfill its other obligations.
Before a business startes operating, it has to incur certain initial costs for acquiring
assets, such as land, building, plant and equipment. These assets have to be installed
and commissioned. Then the raw materials are paid for and fed into the machines so
that the finished goods can be produced. These are then sold in the market to generate
revenue. A part of this revenue is used for repaying instalments towards loans and
other borrowings. The shareholders also expect certain returns in the form of
dividends on the equity held by them.
Hopefully, after meeting such expenses, the firm is left with some revenue to buy the
raw materials and other needed utilities so that it can run the next operating cycle of
the business process. The survival and growth of the business firm, to a large extent,
depends on what the firm pays for its fixed costs and what contribution it generates
after meeting all the expenses.
Apportioning of the fixed costs incurred by the firm in starting a business depends on
the volume of its operations. A lower volume of products puts a heavy burden on each
unit produced. A larger volume of operations reduces the cost per unit. The total

15

Business Level Strategy

variable cost, which varies with the volume produced, may also reduce, as a
consequence of the Experience Curve Effect.

Relative Cost Advantage and Competitive Strategy


Bhattacharyya and Venkataraman have commented on successes of Modis in Tyre
industry, Nirma in detergent industry and Hero in cycles, based mostly on relative cost
advantages. Modis initially entered only into the largest product segment, i.e. truck
tyres and aimed at dominant market share. Their latest technology helped them. They
initially priced their products lower than industry leaders, and offered good value for
money to truck operators. Subsequently they matched the market leaders price and
displaced by capturing higher market share
Nirma has used relative cost advantages in three areas: production, distribution and
promotion. By adopting semi-manual production process and concentrating in the
North and West Zone urban markets, and by cost effective distributor incentive
schemes and spots on Vividh Bharti (initially), Nirma kept their costs low in three
areas and offered a highly price competitive product.
Hero cycles by dropping the irrelevant product attributes and by sub-contracting the
production of parts to small units, it achieved cost advantages which helped the
company in processing their products very competitively.

Activity 2
Think of more such success stories and comment on their competitive stratgegy.
...........................................................................................................................................................................................
...........................................................................................................................................................................................
...........................................................................................................................................................................................
...........................................................................................................................................................................................

7.12

COST LEADERSHIP

The firms operating in this highly competitive environment are always on the move to
become successful. To strive in this competitive environment the firms should have an
edge over the competitors. To develop competitive advantage, the firms should
produce good quality products at minimum costs etc. This means that the firms should
provide high quality at low cost so that the customer gets the best value for the
product he/she is buying. Therefore, it becomes necessary for the firms to have a
strategic edge towards its competitors. One such competitive strategy is overall cost
leadership, which aims at producing and delivering the product or service at a low
cost relative to its competitors at the same time maintaing the quality. According to
Porter, following are the prerequisites of cost leadership (Cherunilam, 2004):
1)
2)
3)
4)
5)

16

Aggressive construction of efficient scale facilities;


Vigorous pursuit of cost reduction from experience;
Tight cost and overhead control;
Avoidance of marginal customer accounts;
Cost minimization.

According to Porter cost leadership is perhaps the clearest of the three generic or
business level strategies (Bolten & McManus, 1999). To sustain the cost leadership
throughout, the firm must be clear about its accomplishment through different
elements of the value chain. Figure 7.3 shows a matrix of the three generic competitive
strategies and their interrelationship given by Porter.

COMPETITIVE ADVANTAGE
Lower cost

Broad Target

Cost

Differentiation

1) Cost Leadership

2) Differentiation

3A) Cost Focus

3B) Focused
Differentiation

COMPETITIVE
SCOPE

Narrow Target

Figure 7.3: Three Generic Competitive Strategies


Source: Adapted from Porter, E. Michael (1985). Competitive Advantage Creating and
Sustaining Superior Performance.

The low-cost leadership strategy at times enables the firm to defend itself against each
of five competitive forces. If we see the concept of cost-leadership in the Indian
context, we find that it had worked wonders with industries like Reliance, Ranbaxy,
Arvind Mills etc.
A cost leader, however, cannot ignore the bases of differentiation (Porter, 1985).

Activity 3
Scan the business dailies or any of the business magazines available and prepare a
case study of any of the business organization, which has become successful in the
recent past by adopting cost leadership strategy.
...........................................................................................................................................................................................
...........................................................................................................................................................................................
...........................................................................................................................................................................................
...........................................................................................................................................................................................
Though, low cost can be one of the most important competitive advantages enjoyed by
firms all over the globe but it does have its drawbacks. Some of the drawbacks can be
listed as follows:
l
l
l

l
l

initiation by the competitive firms;


threat of competitive firms from other countries;
firm losing cost leadership due to fast technological changes, which require high
capital investment;
threat by competitors to capture still lower cost segments;
competition based on other than cost.

Looking at these drawbacks, one can say that cost leadership strategy has to be
adopted keeping in mind, the risks involved and develop an overall effective coststrategy.
17

Business Level Strategy

7.13

SUMMARY

The cost levels in Indian industry in general are high and this is having an adverse
effect on the demand of the products, both in the domestic and the international
markets. To illustrate this point, we cited the examples of cost levels in textiles, tyres
and tubes, aluminium industry. A number of factors such as high government levies
(excise, custom, and sales tax), uneconomic production levels and high manufacturing
costs are reesponsible for this.
What would be the role of cost depends upon the nature of the market, i.e., whether it
is buyers market or sellers market. While cost is of critical importance to a producer
operating in a buyers market, it is relatively of little significance where s/he is
operating in a sellers market. The reason being that in the latter case s/he can pass on
increase in cost to the buyers. As such s/he has no motivation to control or cut down
costs.
The Experience Curve, developed by the Boston Consulting Group, is a method of
understanding the behaviour of costs which is based on accumulated experience of the
past. As the quantity of production of standardised product increases, the cost per unit
goes on declining in a systematic manner. This is known as the Experience Curve
Effect. Since experience curve effect is basically a trend effect, as much historical data
as is possible should be collected before one sets it to analysis in order to improve its
reliability. A number of factors have a bearing on the experience curve. The
experience curve effect should be developed in real money terms, that is, after
removing the effect of inflation. Further, joint costs should be carefully allocated to
different products. Where there is a common cost experience, the costs may be
grouped together.
This unit also discusses the concept of low cost competitive strategy known as cost
leadership and how it helps the firms to defend themselves against the five competitive
forces. Overall the unit deals with cost and its use as a strategy.

7.14

KEY WORDS

Experience Curve: Method of understanding the behaviour of costs which is based


on accumulated experience of the past.
Competitive Strategy: is business level strategy to succeed in the chosen business.
Cost-leadership: is a low-cost competitive strategy.

7.15

18

SELF-ASSESSMENT QUESTIONS

1)

It is often stated that Indian economy is high-cost economy. Do you agree with
the statement? Support your answer with some facts and figures.

2)

What are the causes of high cost levels of Indian products and what are their
consequences?

3)

Examine the role of cost in: (i) sellers market, and (ii) buyers market.

4)

What are the relative merits and demerits of volume strategy of Exerience Curve
vis-a-vis segmented market niche based strategy?

5)

Consider the factors due to which the auto manufacturing in India, particularly
LCV segment, did not expand as anticipated earlier.

6)

Enumerate and discuss the products which have followed the Experience Curve
Effects, and ones which will not.

7)

Discuss the concept of cost leadership in the present context.

7.16

REFERENCES AND FURTHER READINGS

Cost

Boston Consulting Group. (1972). Perspectives on Experience, BCG Inc.: Boston.


Henderson, Bruce D. (1979). Henderson on Corporate Strategy. Abt Books:
Cambridge.
Bhattacharyya S.K. and N. Venkataraman (1983). Managing Business Enterprises
Strategies, Structures and Systems, Vikas Publishing: New Delhi.
Henderson, Bruce D. (1989). The logic of Business Strategy. Ballinger Publishing
Company: Cambridge.
Cherunilam, Francis. (2004). Business Policy and Strategic ManagementText and
Cases. Himalaya Publishing House.
Bolten, Neil & McManus, John. (1999). Competitive Strategies for Service
Organisations. Macmillan Press Ltd.
Rao, Subba P. (2004). Business Policy and Strategic Management. Himalaya
Publishing House.
Porter, E. Michael. (1985). Competitive Advantage Creating and Sustaining
Superior Performance. Free Press: London.

19

Business Level Strategy

UNIT 8 DIFFERENTIATION AND FOCUS


Objectives
After going through this unit, you should be able to:
l

understand the concept of differentiation;

distinguish between tangible and intangible differentiation;

explain the advantages and disadvantages of differentiation;

understand the concept of focus; and

acquaint yourself with variants of focus.

Structure
8.1

Introduction

8.2

Concept of Differentiation

8.3

Types of Differentiation

8.4

Sources of Differentiation

8.5

Cost of Differentiation

8.6

Advantages and Disadvantages of Differentiation

8.7

Focus: A Concept

8.8

Summary

8.9

Key Words

8.10

Self-Assessment Questions

8.11

References and Further Readings

8.1

INTRODUCTION

Strategy and competitive advantage exist to defend against competitive forces and
securing the consumers. Competition in modern times have become a part and parcel
of any activity. It has become the deciding factor of regarding the success and failure
of any business organization. With competition, the performance of any firms
activities be it creativity, innovation, R & D, organization culture, etc. can be
determined. Taking this into view the competitive strategy has been developed.
Basically it aims at establishing a profitable and sustainable position against the
forces that determine industry competition (Porter, 1985). Strategy and competitive
advantage go hand in hand, hence competitive strategy is formulated. Porter has
defined business level strategy as competitive strategy and classified it into three basic
strategies, vis-a-vis overall cost leadership, differentiation and focus. We have already
discussed the concept of cost and cost leadership in unit 7. In this unit, we will discuss
differentiation and focus.

20

Cost leadership stresses on producing quality products at low cost for the consumers
who are price sensitive. Differentiation is a strategy, which is directed at producing
goods and services considered unique in its industry and directed at consumers who
are relatively price-insensitive. Focus strategy concentrates on producing products and
services that fulfill the needs of small groups of consumers (David, 1997) and is based
on segmentation. To gain competitive advantage, it is essential for the firms to transfer
skills and expertise among autonomous business units effectively. The competitive

advantages in cost leadership differentiation and focus can be achieved depending on


factors like; type of industry, size of firm, and nature of competition.

Differentiation and Focus

Differentiation strategy is more of a positioning strategy whereby the firm tries to be


unique in its industry by positioning itself along certain dimensions. The degree of
differentiation varies with different strategies.
Differentiation is industry-wide whereas focus strategy is based on a segment or group
of segments in the industry. There are two variants of focus strategy, which are cost
focus and differentiation focus. This unit discusses all these aspects.

8.2

CONCEPT OF DIFFERENTIATION

Every individual customer is unique in itself so is his/her preferences regarding tastes,


preferences, attitudes, etc. These needs of the customers are fulfilled by the firms by
producing differentiated products. In our day-to-day life we see many such examples
of differentiated products. Most of the fast moving consumer goods like; biscuits,
soaps, toothpastes, oils, etc. come under the category of differentiated products. To
satisfy the diverse needs of the customers, it becomes essential for the firms to adopt a
differentiation strategy. To make this strategy successful, it is necessary for the firms
to do extensive research to study the different needs of the customers. A firm is able to
differentiate from its competitors if it is able to position itself uniquely at something
that is valuable to buyers. Differentiation can lead to Differential advantage in which
the firm gets the premium in the market, which is more than the cost of providing
differentiation. The extent to which the differentiation occurs depends on the overall
strategy of the firm. Previously differentiation was viewed narrowly by the firms, but
in the present scenario it has become one of the essential components of the firms
strategy. Reliance Infocomm, offers varied products like; different facilities to its
customers in the CDMA telephones. This is differentiation.
When we talk of differentiation, it can be said that virtually any product can be
differentiated (Sadler, 2004). The greatest potential of differentiation lies in products,
which are of complex nature but do not have to adhere to strict regulatory standards,
but the success of a differentiation strategy depends on the firms commitment towards
customers and the understanding of customer needs as differentiation is all about
perceiving on the part of the customer of something unique. Differentiation can be said
to have more competititve advantage than the cost advantage as it is quite difficult to
imitate the differentiated products. Even if the initiation is done in terms of concept,
then also a particular product remains unique regarding its value, style, packaging,
etc. Therefore, when we talk about differentiation, it is important to understand the
demand of the customers and fulfilling this demand keeping in mind the differentiation
advantage. In this case, one thing the firms should concentrate on its creativity and
innovativeness than on market research. We have discussed about the concept of
differentiation as a whole but we need to know the why aspect of differentiation, i.e.,
why do the firms need differentiation?

Need
There are a number of reasons depending on the nature of firm to adopt a
differentiation strategy. It is not necessary that the firm should and must go for
differentiation strategy if it does not require one. The requirement is need based and
depends on the firms position in the market. There are a number of factors which
result in differentiation. Some of them are as follows:
l
l
l
l

to compete against the rivals;


to create entry barriers for newcomers by building a unique product;
to reduce the threats arising from the substitutes;
to develop a differentiation advantage.

21

Business Level Strategy

Looking at these reasons, one can say that differentiation indeed helps the firms to get
a competitive advantage over its rival firms.

Activity 1
Give the examples of any three major firms, which have achieved differentiation
advantage by adopting differentiation strategy. Do name the differentiated products
they are offering.
1) .........................................................................................................................
.........................................................................................................................
.........................................................................................................................
2)

.........................................................................................................................
.........................................................................................................................
.........................................................................................................................

3)

.........................................................................................................................
.........................................................................................................................
.........................................................................................................................

8.3

TYPES OF DIFFERENTIATION

Differentiation can be classified into two basic types vis a vis.


l

Tangible differentiation

Intangible differentiation

As the name suggests, tangible means, something which is real and can be seen,
touched, etc. whereas intangible means, something which is abstract in nature and
cannot be touched, it can just be felt. We have already discussed the tangible aspect.
Infact most of the time while discussing differentiation, we actually discuss the
tangible differentiation. Table 8.1 shows some of the opportunities available for
creating uniqueness within the firm. These opportunities in one way or the other
measure the performance of the firm, but when these opportunities are related to the
customers psychology, the intangible aspect to differentiation comes into the picture.
Table 8.1: Opportunity for Creating Uniqueness within the Firm
Activity

Differentiation opportunity

Purchasing
Design

Quality of components and material acquired


Aesthetic appeal
Robustness of performance
Ease of maintenance
Minimization of defects
Speed in fulfilling customer orders
Reliability in meeting promised delivery items
Improved training and motivation increases customer
service capability
Permits responsiveness to the needs of specific
customers
Improves stability of the firm
Building of product and company reputation through
advertising
Providing pre-sales information to customers

Manufacturing
Delivery
Human Resource Management
Technology Management
Financial Management
Marketing
22

Customer Service

Source: Adapted from Sadler, Philip (2004). Strategic Management.

Projecting an image about a particular product is one form of intangible


differentiation. This can be done with the help of packaging, style, etc. This shows
that tangible as well as intangible go hand in hand and either of them cannot exist
independently. Exhibit 1 shows some tangible and intangible components, which result
in differentiation of a particular product.

Differentiation and Focus

Exhibit 1: Tangible and Intangible Components of Differentiation


Tangible

Intangible

Design
Packaging
Style
Quality

Image
Brand
Company reputation
Customer preferences

Composition

Intangible differentiation is more effective in those cases where the customer has once
experienced the product, for example, chocolates. Every brand has a unique taste,
different packaging style, etc. This is the case where quality can be judged only after
using the product once but in case where the quality cannot be judged by experience,
e.g., medical services, the intangible differentiation is not that effective. In short, it can
be said that intangible differentiation is accompanied by tangible differentiation.

8.4

SOURCES OF DIFFERENTIATION

Its not only the low price at which different products are offered, which creates
differentiation, instead the firm can differentiate from its competitors by providing
something unique, which is valuable to the customers of that product. Differentiation
occurs from the specific activities a firm performs and how they affect the buyer.
Value Chain: It shows that differentiation occurs out of the firms value chain (Porter,
1985). The value activity determines the uniqueness of the product. The value chain
consists of a set of value activities resulting in the production of a specified product.
The value activities for each differentiated product differs depending on the nature of
the product. The steps of value activity range from procurement of raw material to the
sale of product. Each differentiated product has its own value activities. To
understand this concept, let us take an illustration.

Illustration
Cadbury, a well-known company of dairy products, manufactures different
brands of chocolates, i.e., it has a set of differentiated products regarding
chocolates. In India, it offers brands like; Dairy Milk, Five Star, Perk, etc.
Each product is manufactured through a different set of activities as the taste
of each is different.
If we compare the products at the global level, then also they are differentiated. For
example, dairy milk in India is eggless whereas in other parts of the globe, it has egg
as one of its ingredient. This shows that the product can be differentiated keeping in
mind a set of value activities comprising of both tangible and intangible components
of differentiation. These activities include all kinds of activities like; marketing
activities, financial activities, HR activities, production activities. If these activities
are performed properly, then only a differentiated product can satisfy the customers
and get premium over the cost of the product.
23

Business Level Strategy

Activity 2
Think of some examples of differentiated products/services of two firms having
different set of products and list them.
1)

.........................................................................................................................
.........................................................................................................................
.........................................................................................................................

2)

.........................................................................................................................
.........................................................................................................................
.........................................................................................................................

There can be more differentiating factors. Some of them are as follows: (Porter, 1985)
l

ability to serve customers needs anywhere;

simplified maintenance for the customers;

single point at which the buyer can purchase;

superior compatibility among products.

One thing is important here that these factors require consistency and proper
coordination to achieve them.

Uniqueness
There are a number of factors, which determine the uniqueness of a firm in a value
activity. Apart from cost factor, there are many more factors, which are responsible
for differentiated products. The following are the factors or drives (according to
Porter):
l

Policy Choice

Links

Timing

Location

Inter-relationships

Learning

Integration

Scale

Institutional factors

Policy Choice: Every firm decides its own policies regarding the activities to be
performed and the activities to be ignored. The policy choices are basically related to
the type of services to be provided to the customers, the credit policy, to what extent a
particular activity (like; advertising spend) be adopted, the content of activity, skill
and experience required by the exployees, etc.
Links: The uniqueness of a product depends to a large extent on the links within the
value chain with suppliers and distribution channel, the firm deals with. If the firm has
a good link with suppliers and has a sound distribution channel, then it becomes easy
for the firm to produce and supply the products to the end-users.
Timing: The firms can achieve uniqueness by encashing the opportunities at the right
time. If the timing is perfect then a successful differentiation strategy can be adopted.
24

Location: This is one of the important factors for the firms to have uniqueness. For
example, a bank may have its branch which is accessible to the customers, then the
bank will gain an edge towards other banks.

Differentiation and Focus

Interrelationships: A better service can be offered to the customers by sharing certain


activities, e.g., sales force with the firms sister concerns.
Learning: To perform better and better, continuous improvement is necessary and this
comes through continuous learning.
Integration: The firm can be termed as unique, if its level of integration is high. The
integration level means the coordination level of value activities.
Scale: Larger the scale, more will be the uniqueness. If small volumes of products are
produced, then the uniqueness of the product will be lost over a longer period of time.
A very good example can be home-delivery services. The type of scale leading to
differentiation varies depending on the individual firms activities.
Institutional factors: This factor sometimes play a role in making a firm unique, like
relationship of management with employees.
Looking at these factors one can say that differentiation is governed by value activities
in a value chain and these activities in turn are governed by certain driving factors,
which makes the firm unique.

8.5

COST OF DIFFERENTIATION

Differentiation is normally costly. The differentiation adds costs as it involves added


features to cater to the needs of the customers. Usually the cost is incurred in the
following cases:
l

Increased expenditure on training;

Increased advertising spend to promote the product;

Cost of hiring highly skilled salesforce;

Use of more expensive material to improve the quality of the product, etc.

There can be many more cost drivers depending on the nature of the firms activity. It
is not necessary that differentiation is always costly. Some differentiation are surely
costly but if the value activities are coordinated properly, the cost can be minimized.
The cost of maximizing profits by minimizing costs can surely be achieved. It is
believed that differentiation in having more product features can be more costly than
having different but more desired features. Similarly, for bigger products,
differentiation is likely to be less costly than for the small products like soaps. The
cost of differentiation more or less depends on the cost drivers. The cost drivers
determine the uniqueness of the differentiation activity for a particular firm. The
different forms of differentiation have different effect of cost drivers. But the crux of
the whole concept is that the cost be minimized to achieve an appropriate
differentiation strategy, which gives a premium price for the product. Though it is
very difficult to develop a trade-off between differentiation and cost efficiency but not
impossible. This practice is very popular in case of automobile industry where
different firms have many variants but the difference is basically related to the
features of the product.
With the world becoming smaller due to high technological innovations, differentiation
strategies adopted by many firms is accompanied by computer aided work culture.
Though application of modern technology increases the cost but on the other hand, the
labour cost is reduced to a large extent and technical efficiency achieved is very high.
The economies of scale can be exploited to a large extent with the help of a trade-off
between cost and differentiation.

25

Business Level Strategy

8.6

ADVANTAGES AND DISADVANTAGES OF


DIFFERENTIATION

Everything is accompanied by advantages and disadvantages and so is differentiation.


Let us first discuss the advantages of differentiation followed by disadvantages.

Advantages
l

Premium price for the firm;

Increase in number of units sold;

Increase in brand loyalty by the customers;

Sustaining competitive advantage.

Premium price for the firm: When the firm is able to exploit all sources of
differentiation that are less costly or are not costly, then the firm can differentiate from
its rival firms. There can be many examples like changing the mix of product features
than adding more features, which are less costly but differentiate the product giving a
competitive advantage, i.e., the price premium to the firm.
Increase in number of units sold: If the product is unique then the demand for it
increases, henceforth increasing the number of units sold. A very good example is of
Maggie noodles, which has competition from big companies like Top Ramen,
but is still considered to be different from its rivals. Here, the number of
customers are won by smart differentiating strategy, thereby increasing the
number of units sold.
Increase in brand loyalty by the customers: A well-positioned and differentiated
product gains the brand loyalty of the customers. For example, Nescafe. It has
developed a brand loyalty amongst coffee lovers. First, it came in powdered form,
but it differentiated itself by coming in granular form, maintaining the quality.
Once experienced, the brand loyalty or customer loyalty for a particular brand is
developed.
Sustaining competitive advantage: Last, but not the least, this is the crux of the
differentiation. This can be achieved by optimizing cost and increasing profits. It is
more often known as low-cost differentiation strategy. It is the combination of all three
advantages discussed above.
Looking at these advantages, one can say that encashing the buyer/customer value is
the must. The firms must concentrate on those activities which affect the customer
value than the ones which do not.

Disadvantages
It is not necessry that everytime the firm goes for differentiation strategy, it is
successful. At times there are disadvantages associated with it. Some of the most
common disadvantages are:

26

Uniqueness of the product not valued by buyers;

Excess amount of differentiation;

Loss due to differentiation.

Uniqueness of the product not valued by buyers: There are a number of cases
where the differentiated product has not gained importance by the customers, hence
failed to position itself in the market. Uniqueness necessarily does not lead to
differentiation. More important is the perception of buyers regarding a particular
product.

Excess amount of differentiation: Too much of anything is bad. Same is the case
with differentiation. If the firm is unable to understand the customer needs and
preferences but goes on differentiating the product, then the firm loses its market
value. Unnecessary differentiation results in failure.

Differentiation and Focus

Loss due to differentiation: In certain cases the firm while differentiating does not
realize the importance of coordinated activities in the value chain, which results in
high costs. Considering the fact that differentiation always leads to profitability is
absolute nonsense. This results in loss to the firms.
The disadvantages associated with differentiation should be looked upon with utmost
care by the firms going in for differentiation.

8.7

FOCUS: A CONCEPT

The third business level strategy is focus. Focus is different from other business
strategies as it is segment based and has narrow competitive scope. This strategy
involves the selection of a market segment, or group of segments, in the industry and
meeting the needs of that preferred segment (or niche) better than the other market
competitors (Bolter & Mcmanus, 1999). This is also known as a niche strategy. In
focus strategy, the competitive advantage can be achieved by optimizing strategy for
the target segments.
Focus strategy has two variants. They are:
l

Cost Focus; and

Differentiation Focus

Cost focus is where a firm seeks a cost advantage in the target segment; and
Differentiation focus where a firm seeks differentiation in the target segment
(Cherumilan, 2004). We shall discuss these variants later.
When we talk about focus strategy as a niche strategy, it means that a market niche is
chosen where customers have distinct preferences or requirements. According to
Thompson and Strickland the term niche is defined as geographic uniqueness, by
specialised requirements in using the product or by special product attributes that
appeal only to niche members (Rao, 2004).
The success of the focus strategy depends on the difference of the target segment from
other segments. To explain this concept, let us take example of soft drink market.
Coca Cola and Pepsi are the major players in the Indian market and are rivals but
each has developed a competitive advantage by serving different segments offering
flavoured drinks as well. Coca Cola has different brands like; Thums Up, Limca and
Pepsi has brands like Lehar Pepsi and Sprite catering different market segments. The
focuser can also have an above average level of performance by having an appropriate
cost-focus and differentiation focus strategies.
Focus strategy can be effective in certain situations only. According to Rao (2004),
following can be the situations where a focus strategy is efficient:
l
l
l
l
l
l
l

Market segment large enough to be profitable;


Market segment has good growth potential;
Market segment is not significant to the success of major competitors;
Focuser has efficient resources;
focuser is able to defend against challenges;
High costs are difficult to the competitors to meet the specialised needs of the niche;
Focuser is able to choose from different segments.

There can be more situations depending on the need of the focuser.

27

Business Level Strategy

Focus/niche strategy has certain advantages as well as disadvantages or risks


associated with it.

Advantages
Focus strategy, if implemented properly, has following advantages:
l

Focuser can defend against Porters competitive forces;

Focuser can reduce competition from new firms by creating a niche of its own;

Threat from producers producing substitute products is reduced;

The bargaining power of the powerful customers is reduced;

Focus strategy, if combined with low-cost and differentiation strategy, would


increase market share and profitability.

Risks
The risks associated with focus strategy can be:
l
Market segment may not be large enough to generate profits;
l
Segments need may become less distinct from the main market;
l
Competition may take over the target-segment.
We can very well say that the main objective of the focus/niche strategy is to perform
a better job of serving buyers in the target market niche than rivals.

Activity 3
List one example each of automobile sector, technology sector, and airlines where the
companies of respective sectors have adopted focus strategy.
1)

Automobile
...........................................................................................................................................................................

2)

Technology
..........................................................................................................................................................................

3)

Airlines
...............................................................................................................................................................................

Let us now discuss the two variants of focus.

Cost Focus
This is basically a niche-low cost strategy whereby a cost advantage is achieved in
focusers target segment. According to Porter, cost focus exploits differences in cost
behaviour in some segments. In this the focuser concentrates on a narrow buyer
segment and out-competes rivals on the basis of lower cost (www.csuchio.edu).

Differentiation Focus
In this, the firm offers niche buyers something different from rivals. Here, the firm
seeks differentiation in its target segment. Differentiation focus exploits the special
needs of buyers in specified segments. A very good example of differentiation focus is
the newly launched MayBach luxury car. This car is targetted to a certain segment
where the customers can afford to pay a sum as large as Rs. 6 crore. This is just one
example, there can be many more examples where the cost of the product may not be
so high.
After understanding all these business/generic strategies, we can say that if all the
three are combined and the cost is optimized, then the market share and profitability
can be increased. Figure 8.1 explains this concept.
28

PROFITABILITY

A
Focus low-cost/
Differentiation

B
Low-cost/Differentiation
Multiple strategies

Differentiation and Focus

Focus
Low-cost
Low-cost
Differentiation

Focus
Differentiation

MARKET SHARE
Figure 8.1
Source: Adapted from Rao, P. Subba (2004). Business Policy and Strategic Management.

Focus strategy can be a tool to help the management team define and rebuild their
business strategy, in turn helping them gain an edge over their competitors.

8.8

SUMMARY

The three business/generic strategies, viz. an overall cost leadership, differentiation


and focus, play an important role in the success of a business. All the three strategies
can be used individually or in combination to create a sustainable competitive
advantage. Porter has specifically suggested that these strategies can be used to defend
against the competitive forces.
In unit 7, the concept of cost was discussed. In this unit, the effort has been made to
develop an understanding of differentiation and focus and how the two can be brought
into practice. In differentiation, the firm tries to be unique in the industry whereas in
focus, the firm tries to concentrate on a specific segment or a niche market. Overall,
the unit tries to develop a practical approach towards understanding the business
strategies.

8.9

KEY WORDS

Competitive advantage: It is about how a firm puts the business strategies into
practice.
Differentiation: A strategy where a firm seeks to be unique in its industry along some
dimensions that are widely valued by buyers.
Focus: A strategy which involves the selection of a market segment, or group of
segments, in the industry and meeting the needs of that preferred segment (or niche)
better than the other rivals.

8.10

SELF-ASSESSMENT QUESTIONS

1)

Explain the concept of differentiation strategy. Illustrate your answer with


suitable examples.

2)

Suppose you are the business strategist of your company, which is into
manufacturing FMCGs. What would be your differentiation strategy looking at
the present trends? Discuss.

3)

Is focus strategy relevant in the present context? Discuss.

29

Business Level Strategy

8.11

REFERENCES AND FURTHER READINGS

Kourdi, Jeremy. (2004). Business Strategy: A Guide to Effective Decision-making.


The Economist Newspaper Ltd.
Sadler, Philip. (2004). Strategic Management. Kogan Page India Pvt. Ltd.
Bolten, Neil and McManus, John. (1999). Competitive Strategies for Service
Organisations. MacMillan Press Ltd.
Cherunilane, Francis. (2004). Business Policy and Strategic Management. Himalaya
Publishing House.
Rao, P. Subba. (2004). Business Policy and Strategic Management. Himalaya
Publishing House.
David, R. Fred. (1997). Concepts of Strategic Management. Prentice Hall
International Inc.
Porter, E. Michael. (1985). Competitive Advantage Creating and Sustaining
Superior Performance. The Free Press.
www.csuchio.edu

30

Corporate Level
Strategy

UNIT 12 TURNAROUND
Objectives
The objectives of this unit are to:
l

introduce you to the concept of retrenchment strategy;

explain the need for retrenchment strategy;

understand the concept of turnaround strategy; and

discuss other variants of retrenchment strategy.

Structure
12.1

Introduction

12.2

Retrenchment Strategies

12.3

Turnaround Strategy

12.4

Survival Strategy

12.5

Liquidation Strategy

12.6

Summary

12.7

Key Words

12.8

Self-Assessment Questions

12.9

References and Further Readings

12.1

INTRODUCTION

Many organizations decline due to falling sales, declining profits and more
importantly declining demand. Demand in an industry declines for a variety of
reasons (Harrigan & Porter, 1983). New substitutes emerge (computers with word
processing capabilities replacing manual electronic typewriters) often with higher
quality and lower cost (PVC pipes for GI pipes, Ball pens for fountain pens) or buyers
shrink or simply disappear (jute industries). Changing customer needs, lifestyles and
tastes also lead to declining demand (vanaspati oil, cigarettes, agarbattis, etc.). Also
cost of inputs may increase and reduce demand for products (Petrol cars). In such
situations, top managers must find a strategy that will stop the organizations decline
and put it back on a successful path.
Organizational decay is a slow, long-term deterioration of the firms operations caused
by its inability to change and adapt to its external environment. It is a function of
environmental adversity (external opportunities and threats) and internal adversity
(organizational negative aspects). HMT Watches Division, a market leader in
mechanical watches, is a case of an organization, which could not adapt itself to the
rapid technological changes. The company was not quick enough to latch on the
growing digital watches market and its premier position in the process. Another
example of this decay is evident in the period before LTV, a US Steel producer,
declared bankruptcy. LTVs financial difficulties included reduced steel orders as a
result of an increase in the level of steel imports (to 20% per year), a decrease in
domestic automobile sales (LTVs sales of the flat rolled steel products to GM
Corporation represented approximately 14% of its 1986 sales), and high price
competition from national and local producers, especially in the bar steel products.
68

Also, profit had deteriorated as a result of the high costs of raw materials and the low
productivity of labor. These conditions reduced the availability of trade credit and
long-term financing.

Turnaround

Environmental adversity may be viewed as an overall measure of the firms difficulty


in coping with the environment. The higher the level of adversity encountered by the
organization, the more difficult it is to achieve its goals. This results in organizational
decay (decline). Low adversity produces more appropriate adjustments and motivates
the firm to pursue a defensible niche. Severe adversity generally produces mixed
results ranging from adaptation to complete misalignment with the business
environment. Many firms faced with severe adversity make short term or stop gap
arrangements at the expense of the long-term arrangements, which only exacerbate the
already worsening situation. Proactive organizations, which exercise strategic options,
before reaching a very high level of adversity, can significantly reduce threats from the
environment.

Activity 1
Identify a company either in public or private sector, which in recent times has closed
down. State the reasons (external and internal) that have lead to its decline.
....................................................................................................................................
....................................................................................................................................
....................................................................................................................................
....................................................................................................................................
....................................................................................................................................
....................................................................................................................................
Impact of Decline/decay on the organizations:
Companies on the decline or facing bankruptcy may experience several negative
effects discussed below.

Psychological and Behavioural Reactions to Decline


When employees and management recognize the onset of organizational decay and
scarce resources, they experience low morale (because few needs are met) and may
withdraw their confidence in or blame top management. Other negative responses to
decay include: a) conservatism, rejection of new alternatives, and risk aversion;
b) competition and infighting for acquiring scarce resources; and c) employee turnover
(the most competent leaders tend to leave first, causing leadership anaemia).

The Stigma of Closing the Company


Retrenchment and more so liquidating a firm is a discrediting label that causes key
constituents (buyers and suppliers) to react negatively toward the firm, including:
a) severing business ties if possible; b) reducing the quality of engagements (e.g. bad
supplies); c) bargaining for more favorable terms than in earlier relationships; and
d) assaulting the credibility of the company and its leaders.
These significant and potentially devastating negative reactions continue through the
retrenchment and restructuring process. Stigma often creates negative perceptions and
potentially spoils the image, self-esteem, and reputation of the organization and its
management leading to a) organizational death; b) damaged managerial careers; and
c) an accelerated chance of managerial succession.
69

Corporate Level
Strategy

Factors Contributing to Rapid Decline or Decay


Organizational Slack
Slack is uncommitted or committed (but under utilized) resources that are at the
disposal of the organization. The existence of uncommitted slack (especially in the
form of cash and liquid assets) is considered a necessary strategic factor for the
survival of the declining organization because during decline, there are not enough
sales to generate sufficient cash. On the other hand, slack may be a handicap during
growth period and it may represent a high opportunity cost causing a drag on
performance. While organizations in decline require high discretion and flexibility in
using slack, in more stable or growing markets, high levels of slack (especially in the
form of cash) may reduce performance. Hence, critical to the choice and the timing of
retrenchment strategies and the likelihood of survival, is the amount of slack within
the organization. Unfortunately this situation does not exist in many organizations
facing decline or decay. In particular, while exercising retrenchment strategy as a
strategic option, the existence of critical slack, will give the organization more
flexibility in dealing with internal and external adversity.
Leadership
The lack of effective leadership has been identified as one of the most significant
causes of business failure. Leadership vacuum may exist due to managerial
incompetence or managerial succession. As mentioned earlier, this problem is more
acute in declining organizations since qualified managers seek alternate employment
before they become associated with any potential stigma. A critical success factor for
companies facing high adversity and unpredictability created by competition is the
existence of leaders who can create an agenda for change and build an effective
implementation environment. The leaders should also be able to alter the
organizational philosophy, defining success as lower growth and smaller size and
persuade the various constituencies to support the retrenchment choice.
It may be a good idea to recruit influential leaders prior to implementing a
retrenchment strategy because in the retrenchment process and more specifically in
turnaround process, powerful leaders with an access to elite groups and other
networks can; a) provide more flexibility with creditors, stockholders, and the
government, b) influence creditors to support the managements right to continue in
control, and c) provide additional capital more easily and on better terms. Highly
educated, well connected, competent, and trustworthy leaders have better chances of
successful reorganization.
Managerial Control
In successful organizations, managerial depth provides better coordination and
control. However, organizations in decline often choose to cut back their managerial
staff especially at the middle levels of management. Creditors may also force cutbacks
in staff or reduction in management compensation. Excess reduction in managerial
depth may eliminate critical functions and decrease chances of survival. Organizations
may have the option, however, to replace personnel involved with coordination and
control functions by applying appropriate information technology. In order to cope
with high complexity in the external and internal environment, firms may find it useful
to increase their usage of information and communication technology.

70

An organization can stop its decay and increase its survival by adopting an
appropriate retrenchment strategy at the appropriate time. The following propositions
provide guidelines for the timing of retrenchment strategies. The choice of a specific
strategy is a function of the level of environmental adversity and the level of
organizational slack.

Condition of Moderate Adversity

Turnaround

Firms with low slack should consider an early retrenchment strategy when faced with
moderate adversity because alternatives are limited. In the context of strategic
planning, retrenchment may include the shrink selectively strategy: discharging some
debts while restructuring others, reducing stigma, and shifting the organizational
philosophy to define success as accepting lower growth and size. It is important to
trigger the actions and implement a retrenchment strategy while talented top
management is still in the organization and still feels positive (moderate adversity)
about their business and its future.
When slack is moderate, the organization should focus on profitable or promising
businesses in which it has distinctive skills and experience. This strategy variant may
take the shape of a combination of an extracting cash strategy and a shrink
selectively strategy. Firms with high slack can withstand moderate levels of
adversity. High slack enables the organization to maintain its strategic direction
through the use of uncommitted or under utilized (committed) assets.

Condition of High/Severe Adversity


Small firms are more likely to stop operations apparently due to lack of slack
resources, thus increasing the probability for failure. Large firms have greater
physical and financial capacities to hold excess resources and are expected to have
more slack than small firms. Therefore, small firms or firms with low levels of slack,
faced with high/severe adversity, may select to sell off assets outside of its strategic
focus (i.e. SSS) or to accept a leverage buyout (divest). When high slack exists,
augmenting the organizations leadership and managerial resources would be
beneficial. The coordination and control provided by managerial depth could take the
form of a computer based reporting and budgeting system linked with the strategic
planning system.

12.2

RETRENCHMENT STRATEGIES

Retrenchment is a short-run renewal strategy designed to overcome organizational


weaknesses that are contributing to deteriorating performance. It is meant to replenish
and revitalize the organizational resources and capabilities so that the organization can
regain its competitiveness. Retrenchment may be thought as a minor surgery to correct
a problem. Managers often try a minimal treatment firstcost cutting or a small
layoffhoping that nothing more painful will be needed to turn the firm around.
When performance measures reveal a more serious situation, more drastic action must
be taken to restore performance.
Retrenchment strategies call for two primary actions: cost cutting and restructuring.
One or both of these tools will be employed more extensively in turnaround situations,
because the problems are deeper there than in retrenchment situations. A cost cutting
program should be preceded by careful thought and analysis. Rarely is it wise to use a
simplistic across-the-board cost cutting program. Some departments or projects
may need additional funding, while others need modest cuts, and still others need
drastic cuts or need to be eliminated altogether. If cost cutting is a part of the strategy
implementation, then the plan of implementation should clearly specify how it will be
applied across the organization and why is it being proposed.
Retrenchment strategy alternatives include shrinking selectively, extracting cash for
investment in other businesses, and divestment. While these strategies result in
generating cash, they differ in terms of their intentions. Divestment of the whole
business is an end game strategy and it may be done via selling or liquidation of

71

Corporate Level
Strategy

business. Under the strategy of extraction of cash for investment in other business,
cash is generated from the troubled business mainly via budget and cost
contraction. In both strategies, the intention of management is to quit the
troubled business.
In the shrinking selectively strategy (SSS), cash is generated via downsizing
(contraction of size or divesting some operations. The strategy of shrinking selectively
involves retrieving the value of investments in some parts of the market while
reinvesting in others because in some niches demand will continue to be grow while
in others the demand shrivels. The objective is to capture the desirable niches. A firm,
which chooses the shrink selectively strategy, should have some internal competitive
advantages, which it hopes to preserve. Thus, it may prefer to retain some part of its
former businesses by shrinking rather than divesting, because of the possible
advantages it had built up through the years.
Shrinking selectively as a repositioning strategy (i.e., matching market niche with
distinctive competence) often results in renewed strength. For example, the TATA
group continued concentrating on its various business including steel, automobile
manufacturing, etc while selling Tomco, which did not share a synergistic
relationship with its current portfolio of businesses. Similarly, the LTV steel
companys decision (after filing in 1986) to concentrate on flat rolled steel products,
while divesting other steel operations, reflects the intent to maintain a leadership
position in production of high-quality, value-added steel for critical engineering
application.
In essence, restructuring involves an organization refocusing on its primary business.
During the 1970s, many firms diversified into businesses they knew little about.
Management teams thought this conglomerate diversification would spread their
firms risks. If the fortunes of one business declined, the others in its business
portfolio would protect earnings. Quite often, companies struggled to compete well in
the business lines they knew little about. Many of the mergers of the 1980s occurred
because these firms restructured their businesses by trying to sell off these businesses
and refocus their efforts in their original lines.
Variants of Retrenchment Strategy:
The three major variants of retrenchment strategy are turnaround strategy, survival
strategy and liquidation strategy. These are discussed in the following sections.

12.3

72

TURNAROUND STRATEGY

A turnaround situation exists when a firm encounters multiple years of declining


financial performance subsequent to a period of prosperity (Bibeault, 1982; Hambrick
& Schecter, 1983; Schendel et al., 1976; Zammuto & Cameron, 1985). Turnaround
situations are caused by combinations of external and internal factors (Finkin, 1985;
Heany, 1985; Schendel et al., 1976) and may be the result of years of gradual
slowdown or months of precipitous financial decline. The strategic causes of
performance downturns include increased competition, raw material shortages, and
decreased profit margins, while operating problems include strikes and labour
problems, excess plant capacity and depressed price levels. The immediacy of the
resulting threat to company survival posed by the turnaround situation is known as
situation severity (Altman, 1983; Bibeault, 1982; Hofer, 1980). Low levels of severity
are indicated by declines in sales or income margins, while extremely high severity
would be signaled by imminent bankruptcy. The recognition of a relationship between
cause and response is imperative for a turnaround process and hence, the importance
of properly assessing the cause of the turnaround situation so that it could be the focus
of the recovery response is very important.

The Turnaround Process

Turnaround

The Turnaround Process begins with a depiction of external and internal factors as
causes of a firms performance downturn. If these factors continue to detrimentally
impact the firm, its financial health is threatened. Unchecked financial decline places
the firm in a turnaround situation. A turnaround situation represents absolute and
relative-to-industry declining performance of a sufficient magnitude to warrant
explicit turnaround actions. A turnaround is typically accomplished through a two
stage process. The initial stage is focused on the primary objectives of survival and
achievement of a positive cash flow. The means to achieve this objective involves an
emergency plan to halt the firms financial haemorrhage and a stabilization plan to
streamline and improve core operations. In other words, it involves the classic
retrenchment activities: liquidation, divestment, product elimination, and down sizing
the workforce. Retrenchement strategies are also characterized by the revenuegenerating, product/market refocusing or cost cutting and asset reduction activities.
While cost cutting, asset reduction and product/market refocusing are easy to
visualize, the idea of revenue-generating is best captured by a strategy that is
characterized by increased capacity utilization, and increased employee productivity.
Retrenchment is an integral component of turnaround strategy. The critical role of
retrenchment in providing a stable base from which to launch a recovery phase of the
turnaround process is well established.. Many firms that have achieved a reversal of
financial or competitive decline inevitably refer to the presence of retrenchment as a
precursor or prelude to the implementation of a successful recovery strategy (Bibeault,
1982; Finkin, 1985; Goodman, 1982; Hall, 1980). The question remains, however, as
to why retrenchment is so frequently an appropriate first step in an overall turnaround
process. One possible explanation is that economic decline diminishes the firms
resource slack. Cost retrenchment helps to preserve the residual resources. Resource
flexibility provides additional slack and is achieved through asset redeployment
Resource flexibility must be substituted for slack that has been largely depleted, or
when the heightened requirements of strategic redirection place additional demands on
the firm for resources. These heightened requirements stem from concurrent demands
on the firm to overcome the destructive momentum of the established strategy and to
cover the high startup costs of implementing the new strategic initiatives.
Consequently, retrenchment may be necessary to stabilize the situation by securing or
providing slack regardless of the subsequent recovery strategy that is chosen.
The second phase involves a return-to-growth or recovery stage (Bibeault, 1982;
Goodman, 1982) and the turnaround process shifts away from retrenchment and
move towards growth and development and growth in market share. The means
employed for achieving these objectives are acquisitions, new products, new markets,
and increased market penetration. The importance of the second stage in the
turnaround situation is underscored by the fact that primary causes of the turnaround
situation have been associated with this phase of the turnaround process- the recovery
response (Hofer, 1980; Schendel et al., 1976). For firms that declined primarily as a
result of external problems, turnaround has most often been achieved through
strategies based on an revenue driven reconfiguration of business assets. For firms
that declined primarily as a result of internal problems, turnaround has been most
frequently achieved through recovery responses that were heavily weighted toward
efficiency maintenance strategies. Recovery is said to have been achieved when
economic measures indicate that the firm has regained its pre-downturn levels of
performance.
Between these two stages, a clear strategy is needed for a firm. As the financial
decline stops, the firm must decide whether it will pursue recovery in its retrenchmentreduced form through a scaled-back version of its preexisting strategy, or whether it
will shift to a return-to-growth stage. It is at this point that the ultimate direction of

73

Corporate Level
Strategy

the turnaround strategy becomes clear. Essentially, the firm must choose either to
continue to pursue retrenchment as its dominant strategy or to couple the retrenchment
stage with a new recovery strategy that emphasizes growth. The degree and duration
of the retrenchment phase should be based on the firms financial health.

Turnaround Situations: Severity and Speed of Strategic Response


The nature, extent and speed of the appropriate strategic response depends primarily
on two dimensions of the turnaround situation: severity and causality. Severity of the
turnaround situation is a measure of the firms financial health; it gauges the
magnitude of the threat to company survival. Since the immediate concern to the firm
is the extent to which the decline is a threat to its short-term survival, severity is the
governing factor in estimating the speed with which the retrenchment response will be
formulated and activated. Of course, performance that declines relative to that of
competitors, but not absolutely, may necessitate almost no retrenchment. Rather, a
reconsideration of strategy with a probable reconfiguration of assets would usually be
deemed appropriate.
When severity is low, a firm has some financial cushion. Stability may be achieved
through cost retrenchment alone. When the turnaround situation severity is high, a
firm must immediately stabilize the decline or bankruptcy is imminent. Cost
reductions must be supplemented with more drastic asset reduction measures.
Assets targeted for divestiture are those determined to be underproductive.
In contrast, more productive resources are protected from cuts or reconfigured as
critical elements of the future core business plan of the company, i.e., the intended
recovery response.
In addition, Robbins and Pearce found that the severity of the turnaround situation
was the best indicator of the type and extent of retrenchment that was needed,
although an immediate cost cutting response to financial decline (absolute and relative
to the industry) was consistently found to be of value. The researchers also presented
a model of turnaround based on evidence that business firm turnaround
characteristically involved a multi-stage process in which retrenchment could serve as
either a grand or operating strategy. Hofer (1980) conceptualized a link between
severity of the downturn and the degree of cost and asset reductions that a firm should
include in its recovery response. He referred to cost and asset reduction activities as
operating turnaround strategies. Operating strategies designed for cost reduction were
recommended for firms in less severe turnaround situations. Drastic cost reductions
coupled with asset reductions were recommended for firms in more severe turnaround
situations i.e., more severe problems require more drastic solutions. Usually, asset
reduction is more drastic than cost reduction.
As the importance of external environmental factors assume importance relative to the
internal factors, effective and innovative activities are more appropriate in the
recovery phase of the turnaround process. If the reverse is true, efficiency maintenance
activities are more appropriate. In either case, the recovery phase of the turnaround
process is likely to be more successful in accomplishing turnaround when it is
preceded by proactively structured retrenchment which results in the achievement of
near-term financial stabilization. Innovative turnaround strategies involve doing things
differently whereas efficiency turnaround strategies entail doing the same things on a
smaller or more efficient scale. Revenue generating through product reintroduction,
increased advertising and selling efforts, and lower prices represent modifications in
existing strategy and can, therefore, be classified as innovative turnaround strategiesIn
other words, innovative turnaround strategies involve product or market based
activities while efficiency strategies focus on the production and management systems
within the firm.
74

ONeill (1986) investigated the relationship of contextual factors to the effectiveness


of four primary turnaround strategies: management (new head executive, new
definition of business, new top management team, morale building among
employees), cutback (cost cutting, financial and expense controls, replacing losing
subsidiaries), growth (new product promotion methods, entering new product areas,
acquisitions, add markets), and restructuring (change in organizational structure,
new manufacturing methods). His model predicted a negative relationship between
growth strategies and turnaround success where there were strong competitive
pressures. Where firms were in weak market positions, success was found for
cutback and restructuring strategies. For firms competing in mature or declining
industries, efficiency or operating recovery strategies offer the best prospects for
successful turnaround. Retrenchment (cost cutting and asset reducing) are
sufficient under certain circumstances to reestablish the long term viability
of the firm. (Refer to case study-1 in Appendix-4).

Turnaround

Activity 2
Scan business dailies in the last few months or browse the Internet for companies that
implemented turnaround strategy successfully. Discuss the important issues involved
in these cases.
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12.4

SURVIVAL STRATEGY

When the company is on the verge of extinction, it can follow several routes for
renewing the fortunes of the company.These are discussed in the following sections.

Divestment
An organization divests when it sells a business unit to another firm that will continue
to operate it. Threatened with bankruptcy between 1979 and 1982, Chrysler sold its
U.S. Army tank division to General Dynamics, its AirTemp air conditioning unit to
Fedders, and its European distribution units to Peugeot/Citroen. The purpose was to
focus only on the U.S. auto market- its main market. In our country, the TATA group
has, in some form or the other, been realigning its portfolio since the early 1990s. But
in the past few years it had done this in a more structured manner. The divestment of
Tomco and Tata Steels cement plant was a conscious decision. It was Tata Steels
decision to concentrate on steel and get out of the cement business. As for Tomco, the
company had reached a point where it required immediate attention, not only in
financial terms but in terms of management as well. The group felt that it did not have
the requisite managerial skills in the specific area where Tomco operated and hence
decided to hive it off.

Spin-Off
In a spin-off, a firm sets up a business unit as a separate business through a
distribution of stock or a cash deal. This is one way to allow a new management team
to try to do better with a business unit that is a poor or mediocre performer.
75

Corporate Level
Strategy

For instance, Indian Rayon and Industries Ltd (IRIL), an Aditya Birla group
enterprise, has decided to spin-off its insulators business under Jaya Shree Insulator
Division, in favour of a new company - Vikram Insulators Private Ltd (VIPL). The
net assets of Rs 92.98 crore of the insulators division were transferred in favour of
VIPL and a 50:50 joint venture with the Japanese insulators giant - NGK Insulators
Ltd - was forged. The joint venture with NGK Insulators Ltd was proposed in order to
upgrade the quality of the existing insulators and to develop new and more technically
advanced insulators.
In consideration of transfer of the insulators business, VIPL would allot to
IRIL 1.25 crore equity shares of Rs 10 each at par and debentures of (rupee
equivalent) $ 25 million. On completion of the demerger, NGK would subscribe to
1.25 crore equity shares of Rs 10 each of VIPL for cash at a premium. This would
result in equal shareholding for both IRIL and NGK and equal board
representation in VIPL.
With increased and complex demands of the power transmission system, the quality
and technical requirements of insulators have become more stringent and rigid. The
existing manufacturers of insulators in the country, including IRIL, did not have the
technical capability of manufacturing insulators of such high quality and specification
and hence the need for this new arrangement.

Restructuring the Business Operations


The company tries to survive by restructuring its management team, financial
reengineering or overall business reengineering. Business reengineering involves
throwing aside all old business processes and starting from scratch to design more
efficient processes. This may cut costs and assist a turnaround situation. This is much
easier to visualize in a manufacturing process, where each step of assembly is
examined for improvement or elimination. It would be foolish to find more efficient
ways to perform processes that should be abandoned and hence, reengineering is
strongly suggested in such cases.
Downsizing is a euphemism for a layoff. As the case of Kirloskar Pneumatic
Company suggests, it is a good way to cut costs quickly. But unless downsizing is tied
to a rational strategy, problems can crop up. Cutting staff without changing the
amount and type of work done simply means that the remaining employees must do
more work. This will result in cost reduction, but product quality and customer
service may suffer. On the other hand, if the firm does not down size, its performance
deteriorates. Hence any downsizing plan recommended should fit logically with the
strategy proposed. (Refer to case study-2 in Appendix-4).

Activity 3
Aditya Birla group withdrew from certain sectors as part of strategic restructuring of
the group. Identify these businesses and state the reasons for the group for exiting
these businesses.
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76

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12.5

LIQUIDATION STRATEGY

Turnaround

Liquidation is the final resort for a declining company. This is the ultimate stage in the
process of renewing company. Sometimes a business unit or a whole company
becomes so weak that the owners cannot find an interested buyer. A simple shutdown
will prevent owners from throwing good money after bad once it is clear that there is
no future for the business. In such a situation, liquidation is the best option. A case in
point is the liquidation of loss-making Bharat Starch, a B M Thapar group company,
following the sale of its starch and citric acid divisions to English India Clays and Bilt
Chemicals, respectively. This was done as a part of financial restructuring to relieve
the company of its outstanding liabilities. As part of the deal, the two buyers would
actually take over the liabilities of Bharat Starch thereby reducing a major part of the
debt burden of the company. The Thapar family is the largest shareholder in the
company with a 45 per cent stake, followed by UK-based Tate & Lyle, which has a 40
per cent stake. The rest is divided between financial institutions and the public. For
Bilt Chemicals, the takeover of the citric acid plant in Gujarat was a perfect fit since
the company was planning to go in for expansions in the segment.
Bankruptcy is a last resort when the business fails financially. The court will liquidate
its assets. The proceeds will be used to pay off the firms outstanding debts. Some
companies file for bankruptcy instead of liquidating. Under this option, the firm
reorganizes its operations while being protected from its creditors. If the firm can
emerge from bankruptcy, it pays off its creditors as best as it can.

12.6

SUMMARY

Many organizations decline due to falling sales, declining profits and more
importantly declining demand. In such situations, top managers must find a strategy
that will stop the organizations decline and put it back on a successful path.
Retrenchment strategies normally followed by companies during their decline stage.
Retrenchment is a short-run renewal strategy designed to overcome organizational
weaknesses that are contributing to deteriorating performance. It is meant to replenish
and revitalize the organizational resources and capabilities so that the organization can
regain its competitiveness.
Retrenchment strategies call for two primary actions: cost cutting and restructuring.
Retrenchment strategy alternatives include shrinking selectively, extracting cash for
investment in other businesses, and divestment. The three major variants of
retrenchment strategy are turnaround strategy, survival strategy and liquidation
strategy. A turnaround situation represents absolute and relative-to-industry declining
performance of a sufficient magnitude to warrant explicit turnaround actions. A
turnaround is typically accomplished through a two stage process. The initial stage is
focused on the primary objectives of survival and achievement of a positive cash flow
and the second phase involves a return-to-growth or recovery stage where the
turnaround process shifts away from retrenchment and moves toward growth and
development and growth in market share.
When the company is on the verge of extinction, it can follow several routes for
renewing the fortunes of the company and survive. An organization divests when it
sells a business unit to another firm that will continue to operate it. This is called a
divestment strategy. Spin-off is another version of survival strategy. In a spin-off, a
firm sets up a business unit as a separate business through a distribution of stock or a
cash deal. This is one way to allow a new management team to try to do better with a
business unit that is a poor or mediocre performer. Sometimes a company tries to
survive by restructuring its management team, financial reengineering or overall
77

Corporate Level
Strategy

business reengineering and downsizing its operations. Liquidation is the final resort
for a declining company. This is the ultimate stage in the process of renewing a
company. Sometimes a business unit or the whole company becomes so weak that the
owners cannot find an interested buyer. A simple shutdown will prevent owners from
throwing good money after bad once it is clear that there is no future for the business.
In such a situation, liquidation is the best option.

12.7

KEY WORDS

Bankruptcy: When a business fails financially the court will liquidate its assets and
the proceeds will be used to pay off the firms outstanding debts.
Divestment: An organization divests when it sells a business unit to another firm that
will continue to operate it.
Liquidation: It is the final resort for a declining company. This is the ultimate stage in
the process of renewing company.
Organizational Decay: It is a slow, long-term deterioration of the firms operations
caused by the inability to change and adapt to its external environment.
Organizational Slack: Slack is uncommitted or committed (but under utilized)
resources that are at the disposal of the organization.
Turnaround Strategy: It is a strategy adopted by firms to arrest the decline and
revive their growth.

12.8

SELF ASSESSMENT QUESTIONS

1)

What are the conditions under which firms adopt retrenchment strategies? Briefly
describe the variants of these strategies.

2)

What is a turnaround strategy? Describe the different steps involved in


turnaround process.

3)

When should a company adopt survival strategies? What are the various
approaches to survival strategy?

4)

What is divestment strategy and how does it differ from liquidation strategy?

12.9

REFERENCES AND FURTHER READINGS

Altman, E.I. (1983). Corporate financial distress: A complete guide to predicting,


avoiding, & dealing with bankruptcy. New York: Wiley-Interscience.
Bibeault, D. G. (1982). Corporate turnaround: How managers turn losers into
winners. New York: McGraw-Hill.
Finkin, E. F. (1985). Company turnaround. The Journal of Business Strategy, 5(4):
14-24.
Goodman, S. J. (1982). How to manage a turnaround. New York: Free Press.
Hall, W. K. (1980). Survival strategies in a hostile environment. Harvard Business
Review, (September-October): 75-85.
Hambrick, D. C. & Schecter, S. M. (1983). Turnaround strategies for mature
industrial-product business units. Academy of Management Journal, 231-248.
Harrigan, K. & Porter, M. (1983). End-game strategies for declining industries.
Harvard Business Review, 61(4): 111-120.
78

Heany, D. F. (1985). Businesses in profit trouble. The Journal of Business Strategy,


5(4): 4-12.

Hofer, C. W. (1980). Turnaround strategies. Journal of Business Strategy, 1(1): 19-31.

Turnaround

ONeill, H. M. (1986). Turnaround and recovery: What strategy do you need? Long
Range Planning, 19(1): 80-88.
Robbins, D. K. & Pearce, J. A., II. (1992). Turnaround: Recovery and retrenchment.
Strategic Management Journal, 13(4): 287-309.
Schendel, D. E., Patton, G. R., & Riggs, J. (1976). Corporate turnaround strategies.
Journal of General Management, (Spring): 3-11.
Zammuto, R. F. & Cameron, K. S. (1985). Environmental decline and organizational
response. Pp. 223-262 in B. Staw & L. L. Cummings (Eds.), Research in
organizational behavior, Vol. 7. Greenwich, CT: JAI.

79

Corporate Level
Strategy

Appendix-4
Case Study-1
Kirloskar Pneumatic Company Limited-Turnaround Success
Kirloskar Pneumatic Company Limited (KPC) was set up in 1958. It started
operations with the manufacture of air compressors and pneumatic tools in
collaboration with Broom and Wade Ltd., U.K. and then diversified into Airconditioning, Refrigeration and Transmission. Currently its activities are grouped into
four major divisions: Air-Compressor, Air-conditioning and Refrigeration, Hydraulic
Power Transmission and Process gas.
During the recession in the late 1990s, the sales bottomed out and the management
realized that the business could not grow any more. This triggered a period of
introspection and the company started looking inwards. Every time any business hits
the bottom, there are two perspectives external and internal. Since the management
had little control over external factors, it focused on managing the internal working of
the company. Fortunately, even on the external front, the company had a chance to
buy out one of their major competitors K G Khosla. The move started in 1994 when
KG Khosla Company became sick and the ICICI requested the Kirloskars to manage
this business. Subsequently both the companies, KPC & KG Khosla, were merged in
the year 2000.
The first thing KPC management team did was to understand the business of KG
Khosla - their product lines, style of business, etc. Then it started leveraging the
synergies between the two companies. Since the sales of the KPC were already
bottoming out and the Khosla product line with its manufacturing facilities was added
to its plant in Pune, the company was left with no other option except to cut costs
across the board. By the end of 2000, the management of KPC had through an
understanding with the staff at Faridabad plant of KG Khosla reduced the employee
strength considerably. The VRS at Faridabad was introduced with a total
understanding with the parting staff. KPC then shifted 90 people from Pune to
Faridabad for about three months during which time the company saw to it that the
production continued at Faridabad with these workers. After this activity at
Faridabad, the company also restructured its Pune plant by reducing the strength by
650 people. The final strength of employees at both the plants after this whole
downsizing exercise finally stood at 800.
The company then turned its attention on restructuring its debt to bring the interest
costs down. The third element of improvement was adding new product lines to its
existing range while concentrating on improving the efficiency of its existing products.
As a result, KPC turned around after successful implementation of all these wellplanned initiatives during the period 1999 2002.

Case Study-2
Gillette India-Restructuring for Growth

80

Gillette India has achieved its growth target in the most profitable manner through
strategic restructuring and functional excellence. The strategic restructuring focused
on its business portfolio to identify the businesses it would like to continue and the
ones it wishes to exit. Consequent to strategic restructuring, Gillette exited the Geep
Battery business and the Braun business. Likewise, it discontinued all the nonprofitable and non-strategic business lines in its existing portfolio. The company also
developed strategic governing statements for each of the business, which made each
business extremely focused. Advertising spend was focused on the right strategic

product. Advertising or sales promotion, which gave short-term benefits, was


discontinued. The company also focused on improving short-term gross profit margins
of its core businesses. Comprehensive profit improvement plans were put in place
through promotions, SKU rationalizations, cost reduction and improved asset
management. Functional excellence initiatives ensured that each and every process
within the organization is benchmarked against peer group companies and process
improved through a well-defined action plan.

Turnaround

Post Restructuring Scenario


After the divestiture of Geep battery business, grooming business (blades and razors)
has emerged as the single largest business accounting for 70% of turnover. Focus
has been on the premium double edge, which was declining earlier, but with focused
support and advertising this product made a strong rebound. Mach III the flagship
brand of the company continues to perform extremely well with its niche premium
positioning. Overall, the blades and razors business has registered a 22% growth. In
addition, a new product called Vector Plus has been introduced in India. The product,
which is an outcome of three years of development at its Boston Research and
Development Facility, is based on the Indian consumer habits.
In personal care business, the main focus was on the tube shaped gel and the Gillette
Series products in aerosol, gel, foam, after-shave and splash. This segment has
registered a growth of 400%. Activities aimed at preventing the growth gray market
have also aided growth in this segment. The oral care strategy for India has been
revised to target the mass segment. Two products have been launched - Oral-B Classic
and Oral-B Plus, both positioned in the popular price segment. This business has
grown by 34% during 1999.
The alkaline battery segment (Duracell), accounts for a small part of turnover, but
company enjoys a very high market share in the category. The strategy here would be
wait and watch till the alkaline category starts growing. This business has grown at
about 11% year on year.

Financial Results
All these restructuring initiatives resulted in:
l

The company reporting the highest ever profit of Rs.170 million by Gillette in
India. Net profit during the nine month ended September 2003 stood at Rs.437
million

Operating margins jumped from a low 10% in second quarter of 2002 to 26% in
second quarter of 2003. Besides the divestment of the low margin battery
business, the strengthening of the Indian rupee also aided profitability, as 40% of
Gillette products sold in Indian market are imported products.

Core grooming business registered a healthy topline growth of 11% and gross
margins also improved.

Inventory came down by 14% and receivables have also been bought down.

Ad-spend in first nine months of the year of 2003 was Rs.211 million (7.7% of
net sales). The company planned to increase ad-spend in the fourth quarter of
2003 and 2004. Surplus cash freed through sale of assets and working capital
improvement was proposed to be reinvested in brand building.

81

UNIT 11

STRATEGIC ALLIANCES

Strategic Alliances

Objectives
After reading this unit, you should be able to:
l

understand the concept of strategic alliances;

acquaint yourself with the worldwide trends in this area;

explain the factors responsible for the rise of strategic alliances;

develop an awareness of costs and benefits of alliance arrangements;

explain the process of planning successful alliances; and

discuss the issue of corporate responsibility of the alliance partners.

Structure
11.1

Introduction

11.2

Strategic Alliance Trends

11.3

Factors Promoting the Rise of Strategic Alliances

11.4

Types of Strategic Alliances

11.5

Benefits of Strategic Alliances

11.6

Costs and Risks of Strategic Alliances

11.7

Factors Contributing to Successful Alliances

11.8

Planning for a Successful Alliance

11.9

Corporate Social Responsibility

11.10 Summary
11.11 Key Words
11.12 Self Assessment Questions
11.13 References and Further Readings

11.1

INTRODUCTION

Gallo, the worlds largest producer of wine, does not grow a single grape and likewise,
Nike, the worlds largest producer of athletic foot-wear, does not manufacture a single
shoe, Boeing, the giant aircraft manufacturer, makes little more than cockpits and
wing bits (Quinn, 1995). How is this possible? These companies, like many other
companies these days, have entered into strategic alliances with their suppliers to do
much of their actual production and manufacturing for them.
From software to steel, aerospace to apparel, the pace of strategic alliances worldwide
is accelerating. Strategic alliances, broadly defined as arrangements in which two
organizations conjoin to pursue common interests, are a rapidly growing phenomenon
in the contemporary business environment. Alliances represent strategic responses to
the powerful forces of deregulation, globalization, technological change, and time-tomarket concerns. These forces have made the business environment vastly more
competitive, complex, and uncertain than ever before. Companies are turning to
strategic alliances in order to manage their uncertainty and risk and specifically to
access a wide range of competencies, technologies, and markets.

45

Corporate Level
Strategy

A strategic alliance is an agreement between firms to do business together in ways that


go beyond normal company-to-company dealings, but fall short of a merger or a full
partnership (Wheelen and Hungar, 2000). Strategic alliances can be as simple as two
companies sharing their technological and/or marketing resources. In contrast, they
can be highly complex, involving several companies, located in different countries.
These firms may in turn be linked with other organizations in separate alliances. The
result is a maze of intertwined companies, which may be competing with each other in
several product areas while collaborating in some. These alliances also range from
informal handshake agreements to formal agreements with lengthy contracts in
which the parties may also exchange equity, or contribute capital to form a joint
venture corporation. Much of the discussion in the literature on strategic alliances
revolves around alliances between two companies, but there is an increasing trend
towards multi-company alliances. For instance, a six-company strategic alliance was
formed between Apple, Sony, Motorola, Philips, AT&T and Matsushita to form
General Magic Corporation to develop Telescript communications software.
In essence, strategic alliance, a form of corporate partnering, is the joining of two or
more companies to exchange resources, share risks, or divide rewards from a joint
enterprise. It can take any number of forms such as: a strong relationship with a major
customer, a partnership with a source of distribution, a relationship with a supplier of
innovation or product, or an alliance in pursuit of a common goal. Sometimes partners
form a new jointly owned company. In other instances a firm purchases equity in
another. Most often the relationship is defined by a contract. Many features of
strategic alliances are very similar to other forms of partnering. The differences relate
to the greater difficulty of achieving a good partnering relationship or developing the
strategic nature of an alliance. They are harder to do because of the need to match the
expectations of different cultures and business practices.

11.2

STRATEGIC ALLIANCE TRENDS

Strategic alliances are becoming more and more prominent in the global economy.
According to Peter F. Drucker, the management guru, the greatest change in corporate
culture, and the way business is being conducted, is the accelerating growth of
relationships based not on ownership, but on partnership (Drucker, 1996). He also
observed that there is not just a surge in alliances but a worldwide restructuring of
companies in the shape of alliances and partnerships. His views are endorsed by the
fact that even a cursory search for strategic alliances in business dailies produces
numerous press releases about companies forming alliances. According to a recent
survey by the global consulting major, Booz, Allen and Hamilton, strategic alliances
are spreading in every industry and are becoming an essential driver of superior
growth. The number of alliances in the world is surging for instance, more than
20,000 new alliances were formed in the U.S. between 1987 and 1992, compared with
5100 between 1980 and 1987 and 750 during the 1970s. The firm also predicts that
within the next five years, the value of alliances is projected to range between $30
trillion to $50 trillion. The survey also reveals that more than 20% of the revenue
generated from the top 2,000 U.S. and European companies now comes from
alliances, with more predicted in the near future. These same companies also earned
higher return on investment (ROl) and return on equity (ROE) on their alliances than
from their core businesses. The report also concludes that leading edge alliance
companies are creating a string of interconnected relationships, which allows them to
overpower the competition (www.boozeallen.com).

46

Generally two or more companies collaborate to create a new product or a service in a


strategic alliance. Ideally this new product or service will bring a unique value
proposition to the market as agreed by the collaborating parties. The potential of

strategic alliances strategy is enormous and if implemented correctly can dramatically


improve an organizations operations and competitiveness (Brucellaria, 1997).
According to a survey conducted by Coopers & Lybrand, 54 percent of firms that
formed alliances did so for joint marketing and promotional purposes (Coopers and
Lybrand, 1997). Companies are also forming alliances to obtain technology, to gain
access to specific markets, to reduce financial risk, to reduce political risk and to
achieve or ensure competitive advantage (Wheelen and Hungar, 2000). However,
while many organizations often rush to jump on the bandwagon of strategic alliances,
few succeed (Soursac, 1996). The failure rate of strategic alliances strategy is
projected to be as high as 70 percent (Kalmbach and Roussel, 1999), and hence, an
appreciation of the factors that contribute to strategic alliance success and failure is
critically important.

Strategic Alliances

The rest of the unit explores why and how companies are forming strategic alliances,
examine risks and problems associated with entering and maintaining successful
strategic alliance and identify factors that may impact the success of strategic
alliances in an increasingly competitive marketplace. Important implications for the
successful introduction and implementation of strategic alliances are also discussed.

11.3

FACTORS PROMOTING THE RISE OF


STRATEGIC ALLIANCES

Since the 1980s, strategic alliances have been very popular. Alliances can be a
powerful tool, particularly in todays world, due to the need to build differential
capabilities in more areas than a company has resources or time to develop. The
legendary Jack Welch, who headed GE in the past, echoing this sentiment once said,
If you think you can go it alone in todays global economy, you are highly mistaken.
It is becoming more difficult for organizations to remain self-sufficient in an
international business environment that demands both focus and flexibility. As
companies are increasingly feeling the effects of global competition, they are trying to
achieve a sustainable competitive advantage through strategic alliances.
Competitive boundaries are blurring as advances in communication and the trend
toward global markets link formerly disparate products, markets, and geographical
regions. Competition is no longer confined to a single nations borders -making all
firms vulnerable to threats posed by cooperative strategies. Both, rapid technological
shifts and the need for rapid product innovation, are putting pressure on management
to act faster and smarter with fewer resources. Effectively identifying, protecting, and
enhancing ones core capabilities is the key challenge of our time. In this environment,
successful companies need to select, build, and deploy the critical capabilities that can
come from strategic alliances, which will enable them to gain competitive advantage,
enhance customer value, and drive their markets.
The alliance approach better matches and responds to the uncertainties and
complexities of todays globalized business environment. These partnerships allow
access to skills and resources of other parties in order to strengthen the organizations
competitive strategies. Alliance partnerships are initiated as effective strategies to
overcome the skill and resource gaps encountered in gaining access to global markets.
Establishing strategic alliance relationships provides access to new markets,
accelerates the pace of entry, encourages the sharing of research and development,
manufacturing, and/or marketing costs, broadening the product line/filling product;
and learning new skills. Dowling et al, suggest the partners pool, exchange, or
integrate specified business resources for mutual gain. Yet, the partners remain
separate businesses. In todays fast changing business landscape, strategic alliances
enable business to gain competitive advantage through access to a partners resources,
47

Corporate Level
Strategy

including markets, technologies, capital and people. Teaming up with others adds
complementary resources and capabilities, enabling participants to grow and expand
more quickly and efficiently. Especially fast-growing companies rely heavily on
alliances to extend their technical and operational resources. In the process, they save
time and boost productivity by not having to develop their own, from scratch. They
are thus freed to concentrate on innovation and their core business.
Many fast-growth technology companies use strategic alliances to benefit from moreestablished channels of distribution, marketing, or brand reputation of bigger, betterknown players. However, more-traditional businesses tend to enter alliances for
reasons such as geographic expansion, cost reduction, manufacturing, and other
supply chain synergies. As global markets open up and competition grows, midsize
companies need to be increasingly creative about how and with whom they align
themselves to go to the market. All these factors have hastened and highlighted the
need for strategic alliances.
To summarize, few companies have everything they need to succeed in a competitive
market place alone. No matter what they need, there is someone who has it. They can,
therefore, either buy what they need or partner with others. Partnering is frequently
quicker and less costly. While avoiding difficult and time-consuming internal changes,
partnering allows a company to:
l

Rapidly move to decisively seize opportunities before they disappear.

Respond more quickly to change with greater flexibility.

Increase your market share.

Gain access to a new market or beat others to that market.

Quickly shore up internal weaknesses.

Gain a new skill or area of competence.

Succeed although the company lacks key resources.

11.4

TYPES OF STRATEGIC ALLIANCES

Firms can enter into a number of different types of strategic alliances. These could
include comparatively simple, more distant arrangements in which firms work with
one another on a short-term or a contractually defined basis where the two parties
effectively do not combine their managers, value chains, core technologies, or other
skill sets. Examples of such simpler alliance vehicles include licensing, crossmarketing deals, limited forms of outsourcing, and loosely configured customersupply arrangements. On the other hand, companies may seek to partner more closely
in their cooperative ventures, combining managers, technologies, products, processes,
and other value-adding assets in varying ways to bring the companies more closely
together. Examples of alliance modes in this league include technology development
pacts, coproduction arrangements, and formal joint ventures in which the partners
contribute a defined amount of capital to form a third party entity. Finally, in even
more complex strategic alliance arrangements, partners can take significant equitystake holdings in one another, thus approximating many organizational and strategic
characteristics of an outright merger or acquisition.
In a study by Coopers and Lybrand (1997), they identified the following types of
alliances, and found their clients were engaged in them as follows:

48

joint marketing/promotion, 54 per cent;

joint selling or distribution, 42 per cent;

production, 26 per cent;

design collaboration, 23 per cent;

technology licensing, 22 per cent;

research and development contracts, 19 per cent;

other outsourcing purposes, 19 per cent.

Strategic Alliances

Technology Associates and Alliances, a strategic alliance consulting company, lists the
following types of alliances:
Marketing and sales alliances:
l

joint marketing agreements;

value added resellers.

Product and manufacturing alliances:


l

procurement-supplier alliances;

joint manufacturing.

Technology and know-how alliances:


l

technology development;

university/industry joint research.

Technology Associates and Alliances, suggests that alliances can be hybrids between
these different types. For example, an R&D alliance may be a cross between a product
and manufacturing alliance and a technology and know-how alliance, and a
collaborative marketing agreement is a cross between a marketing and sales alliance
and a product and manufacturing alliance. The important thing to remember is that
there are various types of alliances, and they may range from simple licensing
arrangement, ad hoc alliance, joint operations, joint venture, consortia, distribution,
and value-chain partnership alliances to more complex hybrid alliances.
The simplest form of strategic alliance is a contractual arrangement. Contractualbased strategic alliances generally are short-term arrangements that are appropriate
when a formal management structure is not required. While the specific provisions of
the contract will depend upon the business arrangement, the contract should address:
(i) the duties and responsibilities of each party; (ii) confidentiality and noncompetition; (iii) payment terms; (iv) scientific or technical milestones; (v) ownership
of intellectual property; (vi) remedies for breach; and (vii) termination. Examples of
contractual strategic alliances are license agreements, marketing, promotion, and
distribution agreements, development agreements, and service agreements.
The most complex form of strategic alliance is a joint venture. A joint venture
involves creating a separate legal entity (generally a corporation, limited liability
company, or partnership) through which the business of the alliance is conducted.
A joint venture may be appropriate if: (i) the parties intend a long-term alliance;
(ii) the alliance will require a significant commitment of resources by each party;
(iii) the alliance will require significant interaction between the parties; (iv) the
alliance will require a separate management structure; or (v) if the business of the
alliance may be subject to unique regulatory issues. In addition, a joint venture will be
appropriate if the parties expect that the alliance ultimately may be able to function as
a separate business that could be sold or taken public.
Historically, information technology and life sciences companies have sought minority
equity investments from strategic commercial partners. This form of strategic alliance
has gained increased popularity in the current economic climate. In many cases, the
equity investment will also be accompanied by a contractual arrangement between the
parties such as a license agreement or a distribution agreement. From the companys
perspective, an equity investment from a strategic commercial partner may be

49

Corporate Level
Strategy

structured on more favorable terms than those obtained from venture capitalists, and it
may increase the companys valuation and enhance the companys ability to secure
future rounds of funding. Venture capitalists and underwriters generally view these
types of strategic alliances as validating an early stage companys technology and
business model. In some cases, they have even become a condition to an underwriter
taking a life science company public. The strategic commercial partner may desire this
form of alliance to gain a competitive advantage through access to new technologies
and to share in the upside of the other partys business through equity ownership.
The following section will focus on three broad types of strategic alliances: licensing
arrangements, joint ventures, and cross-holding arrangements that include equity
stakes and consortia among firms. Each broad type of strategic alliance is
implemented differently and imposes its own set of managerial skills, constraints, and
coordination requirements needed to build competitive advantage.

Licensing Arrangements
In most manufacturing industries, licensing represents a sale of technology or product
based knowledge in exchange for market entry. In service-based firms, licensing is the
right to enter a market in exchange for a fee or royalty. Licensing arrangements have
become more pronounced across both categories. In many ways they represent the
least sophisticated and simplest form of strategic alliance. Licensing arrangements are
simple alliances because they allow the participants greater access to either a
technology or market in exchange for royalties or future technology sharing than
either partner could do on its own. Within the pharmaceutical industry, for example,
many of the technology sharing arrangements that allow a licensee to produce and sell
products developed by the licensor. The relationship between the companies does not
go beyond this level. Unlike joint ventures or more complex cross-holding/equity stake
consortia, licensing arrangements provide no joint equity ownership in a new entity.
Companies enter into licensing agreements for several reasons. The primary reasons
are (1) a need for help in commercializing a new technology, and (2) global expansion
of a brand franchise or marketing image.
Nicholas Piramal India Ltd (NPIL), for instance, has recently entered into a 5-year inlicensing agreement with Genzyme Corp, USA, for synvisc viscose supplementation in
the Indian market. Synvisc, which is used for the treatment of osteoarthritis of the
knee, has sales of $250 million in international market. It expects the market size in
India to be about Rs.200 Million. Johnson & Johnson, is expanding involvement in
and commitment to biotechnology through new partnerships, licensing agreements,
equity investments and acquisitions. Through its excellence centres such as Centocor
and Ortho Biotech, and its global research, development and marketing operations to
form an integrated enterprise that is well positioned to deliver biotechnologys
extraordinary promise to patients and physicians around the world.

Joint Ventures
Joint ventures are more complex and formal than licensing arrangements. Unlike
licensing, joint ventures involve partners creation of a third entity representing the
interests and capital of the two partners. Both partners contribute capital, distinctive
skills, managers, reporting systems, and technologies to the venture in certain
proportions. Joint ventures often entail complex coordination between partners in
carrying out value chain activities. Firms enter into joint ventures for four reasons:
(1) seeking vertical integration, (2) needing to learn a partners skills, (3) upgrading
and improving skills, and (4) shaping future industry evolution.

50

Vertical integration is a critical reason why many firms enter joint ventures. Vertical
integration is designed to help firms enlarge the scope of their operations within a

single industry. Yet, for many firms, expanding their set of activities within the value
chain can be an expensive and time-consuming proposition. Joint ventures can help
firms achieve the benefits of vertical integration without saddling them with higher
fixed costs. This benefit is especially appealing when the core technology used in the
industry is changing quickly. Joint ventures can also help firms retain some degree of
control over crucial supplies at a time when investment funds are scarce and cannot be
allocated to backward integration or when the company has difficulty in accessing the
raw material. By partnering with the suppliers to form a strategic alliance the firm can
increase the stability of its supplies. The organizations forming the alliance will have a
common goal and be better integrated. This will ensure that they all have a shared
interest in making certain that the alliance is successful, including ensuring the
supplies of materials, information, advice or any other necessary input to the alliance
is met in a timely, efficient and consistent manner. A case in point is the Jindal
Stainless Steel Ltd (JSSL), which plans to source raw materials from abroad. The
company is planning strategic alliances with companies in South Africa, South East
Asia and Europe for long- term supplies of ferro chrome, chrome ore and nickel. The
whole objective of the alliance is to ensure that supplies are managed efficiently with
resultant improvements in profitability. A strategic alliance can also rationalize supply
chains. By selecting integrated suppliers, the number of links in a supply chain can be
significantly reduced.

Strategic Alliances

Joint ventures are quite common in India. In the highly capital-intensive industries
such as automobiles, chemicals, pharmaceuticals and petroleum industries, joint
ventures are becoming more widespread as firms seek to overcome the high fixed costs
required for managing ever more scale-intensive production processes. In all these
industries, production is highly committed in nature, which means that it is difficult
for firms on their own to build sufficient scale and profitability in products that often
face highly volatile pricing and deep cyclical downturns when markets collapse.
For instance, Telco (now rechristened as Tata Motors) is the leader in the commercial
vehicle segment with a 54% market share in Light Commercial Vehicle (LCV) and
63% market share in Medium & Heavy Commercial Vehicle (M&HCV) (2003
figures). It garnered a market share of 21% in the utility vehicle (UV) segment and a
9% market share in the passenger car industry in a short span of three years. The
company is open to alliances, but is not willing to enter into any alliance without a
strong underlying reason. The view of the top management is that a strategic alliance
should bring complementary strengths together. Around 85% of the Indian market
consists of small cars and this trend is expected to continue for the next 10-15 years.
Tata Indica, which is one of the best and technologically contemporary value
propositions available, caters to this segment. Hence the company is primarily
interested in an alliance with a global major who can offer a better proposition in the
small car market than the Indica and who already has a presence in India. Second, the
company is looking for a strategic alliance to enhance their product portfolio in the
more premium or niche segments and to open the overseas markets for them.
Firms often enter into joint ventures to learn another firms distinctive skills or
capabilities. In many high-technology industries, many years of development are
required before a company possesses the proprietary technologies and specialized
processes needed to compete effectively on its own. These skills may already be
available in a potential partner. A joint venture can help firms learn these new skills
without retracing the steps of innovation at great cost. For example, Voltas plans on
leveraging its technology-sharing alliances with overseas collaborators, and in seeking
fresh ones, for serving the domestic market. In the Air Conditioning and Refrigeration
business, Voltas a new generation of clientele, such as multiplexes, shopping malls,
entertainment centres, and establishments in the private telecom industry and
hospitality. More than mere cooling, these clients seek solutions encompassing

51

Corporate Level
Strategy

controlled environments, with clean and pure air, and energy-efficient systems. The
company is well placed to deliver these solutions by leveraging the competencies of its
range of partners for example, the success of the Vertis brand of room and split air
conditioners is yet another example of the success of alliances. The Vertis brand
features advanced technology from Fedders International Inc. USA, one of the worlds
largest manufacturers of air conditioners, with whom the company has a
manufacturing-only joint venture. This alliance has resulted in a brand, which has
moved from fifth place to second place in the Indian market in the space of two years.
Joint ventures are instrumental in helping firms with similar skills improve and build
upon each others distinctive competences. Even though some of these joint ventures
are likely to involve rivals competing within the same industry, companies may still
benefit from close cooperation in developing an underlying cutting-edge technology
that could transform the industry. In anticipation of WTO, MNCs are strengthening
their ranks in India (either setting up new 100% subsidiaries or marketing tie-ups with
major domestic players. Large local players are consolidating through brand
acquisitions, co-marketing/ contract manufacturing tie-ups with MNCs etc) and to
counter this threat, Cadilla Healthcare Limited (CHL), for instance, has formed joint
ventures in some of the high growth areas with CHL bringing to table its strength in
manufacturing and marketing and JV partners bringing in the technology. Firms can
cooperate in a joint venture to develop and commercialize new technologies that may
significantly influence an industrys future direction. The need to maintain industry
dynamism and momentum in research is a motivating force that drives drug
companies to engage in joint ventures, even when they compete in existing product
lines.

Cross-Holdings, Equity Stakes, and Consortia


The third category of strategic alliance includes some of the more complex forms of
alliance arrangements. These alliances bring together companies more closely than
licensing and joint venture mechanism. Broadly amalgamated together as consortia,
these alliances represent highly complex and intricate linkages among groups of
companies. The term consortia is used to focus on two types of complex alliance
evolution: (1) multipartner alliances designed to share an underlying technology and
(2) formal groups of companies that own large equity stakes in one another. In either
case, consortia represent the most sophisticated form of strategic alliance and involve
complex coordination mechanisms that often go beyond the boundaries of individual
firms (Refer to case study in Appendix-3).
Activity 1
Scan the various business dailies and magazines and identify the various types of
alliances Indian companies have adopted in the recent past. Also list out the various
reasons, which the companies have stated for forming these alliances.What benefits do
these companies expect from these partnership arrangements.
................................................................................................................................................................
................................................................................................................................................................
................................................................................................................................................................
................................................................................................................................................................

11.5
52

BENEFITS OF STRATEGIC ALLIANCES

In the new economy, strategic alliances enable business to gain competitive advantage
through access to a partners resources, including markets, technologies, capital and

people. Teaming up with others adds complementary resources and capabilities,


enabling participants to grow and expand more quickly and efficiently. Strategic
alliances also benefit companies by reducing manufacturing costs, and developing and
diffusing new technologies rapidly. Alliances are also used to accelerate product
introduction and overcome legal and trade barriers expeditiously. In this era of rapid
tecnological changes and global markets forming alliances is often the fastest, most
effective method of achieving growth objectives. However, companies must ensure
that the objectives of the alliance are compatible and in tune with their existing
businesses so their expertise is transferable to the alliance.

Strategic Alliances

Many fast-growth technology companies use strategic alliances to benefit from moreestablished channels of distribution, marketing, or brand reputation of bigger, betterknown players. However, more-traditional businesses tend to enter alliances for
reasons such as geographic expansion, cost reduction, manufacturing, and other
supply-chain synergies. As global market opens up and competition grows, midsize
companies need to be increasingly creative about how and with whom they align
themselves to go to the market.
Firms often enter into alliances based on opportunity rather than linkage with their
overall goals. This risk is greatest when a company has a surplus of cash. In recent
years, Mercedes-Benz and Toyota Motor Corporation have been investing surplus
funds into seemingly unrelated businesses, with Benz already facing difficulties as a
result.Especially fast-growing companies rely heavily on alliances to extend their
technical and operational resources. In the process, they save time and boost
productivity by not having to develop their own, from scratch. They are thus freed to
concentrate on innovation and their core business.

Entering New Markets


The Coopers & Lybrand study rates growth strategies and entering new markets
among the top reasons for forming strategic alliances (Coopers and Lybrand, 1997).
As Ohmae (1992) points out, (companies) simply do not have the time to establish
new markets one-by one. In todays fast-paced world economy, this is increasingly
true. Therefore, forming an alliance with an existing company already in that
marketplace is a very appealing alternative. Partnering with an international company
can make the expansion into unfamiliar territory a lot easier and less stressful for a
company. According to the Coopers & Lybrand (1997) study, 50 percent of firms
involved in alliances market their goods and services internationally versus 30 percent
of nonallied participants. For instance, Tata Motors has short listed Brilliance
Automotive Holdings of China to set up a joint venture for producing cars. Tata
Motors, which recently acquired the commercial truck facility of Daewoo Motors in
South Korea for Rs.465 crore, is also reported to be scouting for another joint venture
in Northern China in order to have a full-fledged presence in China.
Often a company that has a successful product or service has a desire to introduce it
into a new market. Yet perhaps the company recognizes that it lacks the necessary
marketing expertise because it does not fully understand customer needs, does not
know how to promote the product or service effectively, or does not understand or
have access to the proper distribution channels. Rather than painstakingly trying to
develop this expertise internally, the company may identify another organization that
possesses those desired marketing skills. Then, by capitalizing on the product
development skills of one company and the marketing skills of the other, the resulting
alliance can serve the market quickly and effectively. Alliances may be particularly
helpful when entering a foreign market for the first time because of the extensive
cultural differences that may abound. They may also be effective domestically when
entering regional or ethnic markets. Asian Paints, the largest paint-maker in India,
acquired a strategic stake in Singapore-based Berger International in 2002. Asian

53

Corporate Level
Strategy

Paints now appears to be trying to gain control over the Berger brand in some key
regional markets like Pakistan. Berger International, which is now a subsidiary of
Asian Paints, has entered into a strategic alliance with Karachi-based Berger Paints
Pakistan, which is owned by the Mahmood family. Berger International will provide
technical consultancy and strategic advice to Berger Pakistan, which is the secondlargest paints company in Pakistan. Berger Pakistan will also have the right to import
products from Asian Paints.

Reducing Manufacturing Costs


Strategic alliances may allow companies to pool capital or existing facilities to gain
economies of scale or increase the use of facilities, thereby reducing manufacturing
costs. In the increasingly competitive European automobile market, when the Japanese
are seeking to gain market share as they did in the U.S. during the 1980s, many
European companies have formed joint ventures to reduce manufacturing costs. Ford
and Volkswagan are jointly planning to make four-wheel-drive vehicles in Portugal,
and Nissan and Ford intent to build a plant in Spain to produce vans. These
companies will benefit from cost sharing and will reduce expenses by building and
operating facilties in relatively low-cost countries, at least by West European
standards. Companies may also reduce costs throug strategic alliances with suppliers
or customer reaching agreements to supply products or services for longer periods and
working together, meet customers needs, each partner may apply its expertise, and
benefits may be shared in the form of lower costs or new products.

Developing and Diffusing Technology


Alliances may also be used to build jointly on the technical expertise of two or more
companies in developing products technologically beyond the capability of the
companies acting independently. Not all companies can provide the technology that
they need to effectively compete in their markets on their own. Therefore, they are
teaming up with other companies who do have the resources to provide the technology
or who can pool their resources so that together they can provide the needed
technology. Both sides receive benefit from the partnership. Technology transfer
is not only viewed as being significant to the success of a strategic alliance,
according to Hsieh (1997): host countries now demand more in the way of
technology transfer. As evidence of this growing trend, Hsieh cites China as
a prime example.
For example, Tata Consultancy Services (TCS) and ANSYS Inc, a global innovator
of simulation software and product development technology, have entered into an
alliance that will help their clients accelerate product development dramatically and
simultaneously enhance the quality and reliability of their designs through integrated
digital prototyping. The industries that will benefit include automotive, power, heavy
machinery, consumer products and electronics. Customers will derive increased
productivity in the design and production processes by 70-90 percent. By pooling
resources to develop software products built upon the expertise of each company,
TCS and ANSYS Inc intend to create a new market and reap the associated benefits.

Reduce Financial Risk and Share Costs of Research and Development

54

Some companies may find that the financial risk that is involved in pursuing a new
product or production method is too great for a single company to undertake. In such
cases, two or more companies come together and agree to spread the risk among all of
them. One example of this is found in strategic alliance between the Rs.235-crore
Elder Pharma, which has 25 international partners for strategic alliances, has entered
into a tie-up with Reliance Life Sciences. The company is focusing on dermatology

and the tie-up with Reliance is to obtain aloe vera extracts for cosmetics. Elder has
launched a dedicated skincare division with products under El-Dermis brand and plans
to launch a number of over the counter products in the skincare segment.

Strategic Alliances

Achieve or Ensure Competitive Advantage


Alliances are particularly alluring to small businesses because they provide the tools
businesses need to be competitive. For many small companies the only way they can
stay competitive and even survive in todays technologically advanced, ever-changing
business world is to form an alliance with another company. Small companies can
realize the mutual benefits they can derive from strategic alliances in areas such as
marketing, distribution, production, research and development, and outsourcing.
By forming alliances with other companies, small businesses are able to
accomplish bigger projects more quickly and profitably, than if they tried to do it on
their own. According to Booz, Allen and Hamilton the world has entered a new
age - an age of collaboration - and that only through allying can companies obtain the
capabilities and resources necessary to win in the changing global marketplace.
Self-reliance is an option few companies will be able to afford (Booz, Allen and
Hamilton, 1997).

11.6

COSTS AND RISKS OF STRATEGIC ALLIANCES

Any firm opting for strategic alliance incurs certain costs as well as gains benefits,
compared to a firm that goes on its own. Strategic alliances have their risks,
particularly if the parties are not financial equals. These risks include the loss of
operational control and confidentiality of proprietary information and technology.
Some alliances can involve a clash of corporate cultures or the perceived diminution
of independence. In addition, the parties may deprive themselves of future business
opportunities with competitors of their strategic partner.
The parties must carefully consider a number of factors in the decision of whether to
enter into a strategic alliance, and how best to govern the relationship once the alliance
is formed. In addition to the parties business objectives, the parties should consider a
variety of accounting, tax, antitrust and intellectual property issues when structuring a
strategic alliance. A properly structured strategic alliance can bring many new
opportunities and enhance the parties growth potential. In addition, it can provide an
alternative source of capital during difficult economic times. The various costs/risks
of entering into alliances include:

Cultural and Language Barriers


Cultural clash is probably one of the biggest problems that corporations in alliances
face today. These cultural problems consist of language, egos, chauvinism, and
different attitudes to business can all make the going rough. The first thing that can
cause problems is the language barrier that they might face. It is important for the
companies that are working together to be able to communicate and understand each
other well or they are doomed before they even start. The importance of
communication becomes even more paramount when operating across the participants
to a strategic alliance. Language barriers at times can be a source for delays and
frustrations. However, English is becoming a common international language.
Communication problems may also arise because job definitions are much more
specific in Western companies than in Asian companies.
Cultural differences often create problems in making strategic alliances work especially between Asian and Western companies. For example, Japanese companies
put employee interests ahead of the shareholders interests. Western companies, on the

55

Corporate Level
Strategy

other hand, are managed to benefit their shareholders. Such a difference can cause
serious conflict over investment and dividend policies. The decision process in Asian
companies often takes longer as compared to those in their Western counterparts.
Patience rather than pushing for a decision becomes a helpful strategy. Not only do the
cultural differences exist among international firms seeking alliances, but also
corporate cultures may be different among firms from the same country. In the final
analysis, flexibility and management learning are the greatest tools in overcoming this barrier.

Lack of Trust
Risk sharing is the primary bonding tool in a partnership. A sense of commitment
must be generated throughout the partnership. In many alliance cases one company
will point the failure finger at the partnering company. Shifting the blame does not
solve the problem, but increases the tension between the partnering companies and
often leads to alliance ruin Building trust is the most important and yet most difficult
aspect of a successful alliance. Only people can trust each other, not the company.
Therefore, alliances need to be formed to enhance trust between individuals. The
companies must form the three forms of trust, which include responsibility, equality,
and reliability. Many alliances have failed due to the lack of trust causing unsolved
problems, lack of understanding, and despondent relationships.

Loss of Autonomy
The firm gets committed not only to a goal of its own but that of its alliance partner.
This involves cost in terms of goal displacement. The firm also loses the autonomy
and hence its ability to unilaterally control the outcomes. All the partners in an
alliance have control over the performance of the assigned tasks. No partner, hence,
can unilaterally control the outcome of an alliance activity. Similarly, all the partners
in an alliance have to depend on each other. As against these, the firm benefits in
terms of gain of influence over domain and improvement in competitive positioning.
This is because the firms strengths are supplemented by the strengths of its alliance
partner as well as by the synergy additionally created. This improves the value chain
of the firm. The firm may also use its improved competitive position to penetrate new
markets in the same country. The increase in capacities may also support the firms
presence in new markets. The firm may also gain access to the foreign markets by
choosing an alliance partner based in or having operations in such countries.
The firm may not be able to use its own time-tested technology, if the alliance partner
does not subscribe to it. It may have to use the dominant partners technology, which
could be different, or the combination of its own technology and its partners. This is
likely to have its impact on the stability of the firm as it gets exposed to the
uncertainty of using unfamiliar technology. On the other hand, the firm develops its
ability to manage uncertainty under real or perceived protective support of its
experienced alliance partner. This helps the firm solve invisible and complex problems
with the help of increased confidence and or support from the alliance partner. The
firm may be able to specialize in its field if its alliance partner contributes to fill the
missing gaps in the value chain of the firm. The firm may also diversify into other
unrelated fields with the support of its alliance partner. Thus, the firm will be in a
better position to ward off its competitors, who are likely to get immobilized at least
for the time being as they would have to revise their strategies keeping in view the
changed competitive positioning of the firm. This situation could be used by the firm
to push its advantage further.

Lack of Clear Goals and Objectives


56

Many strategic alliances are formed for the wrong reasons. This will surely lead to
disaster in the future. Many companies enter into alliances to combat industry

competitors. Corporate management feels this type of action will deter competitors
from focusing on their company. On the contrary, this action will raise flags that
problems exist within the joining companies. The alliance may put the companies in
the spotlight causing more competition. Alliances are also formed to correct internal
company problems. Once again, management feels that an increase in numbers
signifies a quick fix. In this case, the company is probably already doomed and is just
taking another along for the ride. Many strategic alliances, although entered into for
all the right reasons, do not work. Dissimilar objectives, inability to share risks, and
lack of trust lead to an early alliance demise. Cooperation on all issues is the key to a
successful alliance. Many managers enter into an alliance without properly
researching the steps necessary to ensure the basic principles of cooperation.

Strategic Alliances

Lack of Coordination between Management Teams


Action taken by subordinates that are not congruent with top-level management can
prove particularly disruptive, especially in instances where companies remain
competitors in spite of their strategic alliance. If it were to happen that one company
would go off on its own and do its own marketing and sell its own product while in
alliance with another company it would for sure be grounds for the two to break up,
and they would most likely end up in a legal battle which could take years to solve if it
were settled at all.

Differences in Management Styles


Failure to understand and adapt to new style of management is a barrier to success
in an alliance. Changes are required in management style to run successful alliances.
The adaptation of a new style of management requires a change in corporate culture,
which must be initiated and nurtured from the top. Companies need to devote more
resources to understanding the alliance management process, from contract
negotiations to establishing effective communications. They need to develop managers
with a new set of competences, including foreign languages, and other communicating
and team-building skills. Other problems that can occur between companies in trade
alliances are different attitudes among the companies; one company may deliver its
good or service behind schedule, or do a bad job producing their goods or service,
which may lead to distrust between the two companies. This could upset the partner
and may sometimes lead to a takeover.

Lack of Commitment
The possibility that partner firms lack ironclad commitment to the alliance could
undermine the prospects of an alliance. Partner firms tend to be interested more in
pursuing their self-interest than the common interest of the alliance. Such
opportunistic behavior include shirking, appropriating the partners resources,
distorting information, harboring hidden agendas, and delivering unsatisfactory
products and services. Because these activities seriously jeopardize the viability of an
alliance, lack of commitment to the alliance is an important component of the overall
risk in strategic alliances. Commitment also gets diluted because the individuals who
negotiated or implemented the initial alliance agreement may have changed due to
promotions, transfers, retirement, or terminations. Continuity of total commitment for
the alliance is needed at all levels in the organization without which the alliance will
fail to reach its full potential.
There is a probability that an alliance may fail even when partner firms commit
themselves fully to the alliance. The sources of such a risk includes environmental
factors, such as government policy changes, war, and economic recession; market
factors, such as fierce competition and demand fluctuations; and internal factors, such
as a lack of competence in critical areas, or sheer bad luck.

57

Corporate Level
Strategy

Creating a Potential Competitor


One partner, for example, might be using the alliance to test a market and prepare the
launch of a wholly owned subsidiary. By declining to cooperate with others in the area
of its core competency, a company can reduce the likelihood of creating a competitor
that would threaten its main area of business; likewise, a company can insist on
contractual clauses that constrain partners from competing against it in certain
products or geographic regions.

Problems of Coordination and Loss of Agility


Alliance firms, however, are likely to suffer from delays in solutions due to problems
of coordination and an alert competitor may exploit this weakness in-built in any
alliance to its great advantage. The competitor could use a combination of strategies
which exploit the weakness of all the alliance partners timing it in such a way that the
weakness of one alliance partner is exploited quickly before another alliance partner
comes to its rescue to defend the alliance. This is how a competitor may induce the
synergy to work in reverse in such strategic alliances. This would improve the
competitors competitive position manifold. On the other hand, the firm under
strategic alliance may benefit from the rapidity of the response to the changing market
demands when its new alliance partner readily supplies technologies. The delay in the
use of new technology is reduced which benefits the firm in creating a competitive
edge over its competitors.

Potential for Conflicts


The understanding reached among the alliance partners is crystallized into an
agreement of alliance. However, no agreement can capture all the details of an
understanding. The complexity increases when a situation arises which is unforeseen
or not provided for in the agreement. These may create conflict over goals, domain,
and methods to be followed in the alliance activity among the alliance partners and
might result in setbacks to the alliance. On the other hand, the group synergy may be
beneficial to the alliance partners in such a way that they support each other mutually
and amicably resolve whatever differences may arise. This leads to a harmonious
working relationship intra and inter alliance firms, which in turn further increases the
synergic benefits and the cycle goes on. The competitor, deprived of the benefits of
group synergy, would lose his competitiveness and, in turn, cohesiveness and harmony
and the cycle goes on.

Difficulty in Managing Alliances


Strategic alliance is a relatively new concept in management. It is also more difficult
to manage, and hence may lead to failure of strategic alliances formed even by
excellent firms. A failure would mean loss of time, money, material, information,
reputation, status, technological superiority, competitive position, and financial
position. The benefits of success are in terms of gain of resources like time, money,
information, and raw material. The firm also gains legitimacy and status and benefits
through utilization of unused plant capacity. Above all, the firm has opportunities to
learn, to adapt, develop competencies, or jointly develop new products as well as
share the cost of product development and associated risks.

Other Issues

58

Experience is the best teacher in alliances but it comes at a very heavy cost. This
blunts the inquisitiveness of any firm to learn through the failure of an experiment.
Strategic alliance provides some security to an inexperienced firm that even if the
experiment goes haywire it can look forward to rescue by .the other experienced
alliance partner. When the assigned tasks are to be carried out by the firms partner in

alliance, the firm still benefits by the firm being a witness to the process of
implementation of such tasks. Perhaps, the most important benefit strategic alliance
offers to a firm is the opportunities to learn.

Strategic Alliances

Often, a firm aiming to expand its operations abroad benefits by going in for an
alliance as it helps gain acceptance from the government of the foreign country. This
is so because the government of the foreign country may desire involvement and
development of the local firms. On the other hand, the firm may suffer restrictions
from governmental regulations if the government feels that such strategic alliances
would be detrimental to furtherance of the public interest. However, it would still be
desirable to have strategic alliance with a foreign firm because it would be
knowledgeable about the complexity of the local conditions as well as be more
sensitive to the changing environmental conditions and so it may raise timely alarm for
the firm to respond appropriately.
Other reasons for under performance and failure of strategic alliances include a
breakdown in trust, a change in strategy, the champions moved on, the value did not
materialize, the cultures did not mesh, and the systems were not integrated. Another
main reason strategic alliances fail to meet expectations is the failure to grasp and
articulate their strategic intent, which includes the failure to investigate alternatives to
an alliance. Lack of recognition of the close interplay between the overall strategy of
the company and the role of an alliance in that strategy can also lead to failure of
alliance.
Activity 2
A large number of strategic alliances have failed in India. Identify five such cases
from various sources and identify the reasons for their failure.
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11.7

FACTORS CONTRIBUTING TO SUCCESSFUL


STRATEGIC ALLIANCES

Senior Management Commitment


The commitment of the senior management of all companies involved in a strategic
alliance is a key factor in the alliances ultimate success. For alliances to be truly
strategic they must have a significant impact on the companies overall strategic
plans; and must therefore be formulated, implemented, managed, and monitored with
the full commitment of senior management. Without senior managements
commitment, alliances will not receive the resources they need. If senior management
is not committed to alliances, adequate managerial resources, in addition to capital,
production, marketing and labor resources, may not be assigned in order for alliances
to accomplish their objectives. Senior managements commitment to alliances is
important not only to ensure the alliances receive the necessary resources, but also to
convince others throughout the organization of the importance of the alliance. By
demonstrating a commitment to alliance and a strong leadership role, management can
minimize this viewpoint. The biggest hurdle senior management has to overcome in
committing itself to strategic alliances is managements own fear of a loss of control.
But good partnerships, like good marriages are not built on the basis of ownership or
control. It takes effort and commitment and enthusiasm from both sides if either is to
realize the benefits.

59

Corporate Level
Strategy

Similarity of Management Philosophies


Successful partnerships are forged between those companies whose management
philosophies, strategies and ideas are most similar to their own. Indeed, differences in
corporate partners personalities can often lead to tragic results. The philosophical
differences of unsuccessful alliances are, in part due to cultural differences, so there is
significant potential for cross-border alliances to include such widespread differences
in managerial philosophies as well. Therefore, in order to ensure the best chance of
success, companies should either seek partners who do have similar management
philosophies, or draft an alliance agreement that adequately addresses the differences,
and provides for their resolution.
The best strategy to grow via alliances may be to move slowly, and start with simple
alliances and the move towards more complex ones as alliance experience and talent is
acquired. Managers of strategic alliances must create and maintain an environment of
trust. This is perhaps easier said than done. It requires the surrender of at least some
managerial control, and it also takes time to build a high degree of trust in a business
partnership

Frequent Performance Feedback


In order for strategic alliances to succeed, their performance must be continually
assessed and evaluated against the short and long-term goals and objectives for the
alliance. The results of these reviews must be summarized in briefing reports, which
should be distributed to management and also keyed into a strategic alliance tracking
data base.
In order for the feedback monitoring system to be successful, it is important that the
goals of the alliance be well defined and measurable. In addition, benchmarks for
alliance performance should be set to assist management in evaluating alliance results.
In general, an alliance is successful if both partners achieve their objectives. Strategic
alliances are very tough to measure and evaluate, but can be done with the help of
understanding the form used and understanding the goals of the companies involved.

Clearly Defined, Shared Goals and Objectives


Some alliances are highly integrated with one or more of the parent organizations and
share such resources as manufacturing facilities, management staff, and support
functions like payroll, purchasing, and research and development while, others may be
autonomous and independent from their parent organizations. Whatever the
relationship between the partners, it is extremely important that alliances are aligned
with the company strategy. Top management must articulate a clear link between
where it expects the industrys future profit pools will be, how to capture a larger
share of those, and where, if at all, alliances fit in that plan.

Thorough Planning

60

Planning, commitment, and agreement are essential to the success of any relationship.
The overall strategy for the alliance must be mutually developed. Key managing
individuals and areas of focus for the alliance must be identified. The first step is to
gain a clear understanding of the vision and values of each company. The next step is
to gain agreement on the market conditions in the region of the world that the joint
venture will be operating in. The next step is to clearly state the issues, strengths,
and concerns of each organization. These steps allow the participants to bridge
preliminary gaps of understanding at the onset of the process. During this initial
fact finding meetings the partners can learn a great deal about their
potential partner.

The next step is to identify areas of common ground. Here, the commonality in the
strategic direction among the partners can be identified. Next the partners need to
define the internal and external value of the alliance. They will also need to agree on
the strategic opportunities to mutually pursue. The final step in this planning process
is to create a tactical plan to address the strategic targets. Thorough planning is one of
the key ingredients to the successful formation of strategic alliances.

Strategic Alliances

Clearly Understood Roles


In forming strategic alliances the partners must have clearly understood roles. It is
crucial that the question of control is resolved before the alliance is formed. A
strategic alliance by definition falls short of a merger or a full partnership. For this
reason, control is not dependent on majority ownership. The degree to which each
partner is in control of operations and can offer influential input for decision making
must be determined before the alliance is formed. Some firms view strategic alliances
as a second-best option that they would prefer to do without. This attitude towards an
alliance is problematic at best. Because of uncertainty and discomfort, the feeling is
that these alliances must be closely managed and controlled so as not to get out of
hand. This is a counterproductive attitude that often leads to an unsatisfactory
outcome for at least one partner. If the partners in an alliance decide upfront exactly
what each partners role is in the newly formed business, then there is no
misunderstanding or uncertainty as to how decisions will be made.

Global Vision
In order to succeed in an international strategic alliance, managers of firms must
incorporate a global strategic vision into their enterprise. the most effective alliances
are not forged simply as a means to complete one deal. Smart companies spin a web
of relationships that open a series of potential projects, add value to them, and
improve risk management. In order to compete in the growing international market, it
will be increasingly necessary for firms to cooperate on a global level and continually
build international relationships, which will facilitate the process of global
competition.

Partner Selection
Partnership selection is perhaps the most important step in creating a successful
alliance. A successful alliance requires the joining of two competent firms, seeking a
similar goal and both intent on its success. A strategic alliance must be structured so
that it is the intent of both parties that it will actually succeed - through the need for
speed, adaptation, and facilitated evolution. The foundation of a successful strategic
alliance is laid during the formation process. This process includes partner selection
and the initial agreement between parties. Selecting an appropriate partner and
deciding the agenda of the alliance are the most difficult process in the formation of an
alliance. Yet done correctly, they help ensure a higher quality, longer lasting
relationship. Having selected a partner, the alliance should be structured so that the
firms risks of giving too much away to the partner are reduced to an acceptable level.
The safeguards are blocking off critical technology, establishing contractual
safeguards, agreeing to swap valuable skills and technologies, and seeking credible
commitments.

Communication between Partners: Maintaining Relationships


Communication is an essential attribute for the alliance to be successful. Without
effective communication between partners, the alliance will inevitably dissolve as a
result of doubt and mistrust. Ohmae best sums up the necessity for good

61

Corporate Level
Strategy

communications in building and maintaining a strong strategic alliance relationship.


An alliance is a lot like a marriage. There may be no formal contract. There is no
buying and selling of equity. There are few, if any, rigidly binding provisions. It is a
loose evolving kind of relationship. Sure, there are guidelines and expectations, but no
one expects a precise, measured return on the initial commitment. Both partners bring
to an alliance a faith that they will be stronger together than they would be separately.
Both believe that each has unique skills and functional abilities the other likes. And
both have to work diligently over time to make the union successful.
Activity 3
Hero Cycles of India and Honda Motor Company of Japan have successfully operated
their Joint Venture and so did Wipro and GE. List out the reasons for their success.
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11.8

PLANNING FOR A SUCCESSFUL ALLIANCE

Alliance building is now fundamental to the way large companies conduct business
from technology and product development to manufacturing and marketing. The world
has never been as interdependent as it is now, and all trends point to cooperation as a
fundamental growing force in business. Businesses are moving from the classic
closed system which depends on its internal capabilities and resources to an open
system in which reliance on external capabilities and the development of complex
relationships with external entities are becoming commonplace (Steele, 1989).

Strategic Alliance Model


The essence of a strategic alliance is the quest for mutual benefit - the belief that by
working together to address a market need the combined offering will be more potent /
valuable / successful than the contributors could deliver by themselves or through a
lesser partnering relationship. It is commonplace for the boundaries between the
operations of strategic alliance partners to become blurred as activities are integrated
into a focused delivery capability. All effective partnering relationships have a heavy
reliance on trust for a strategic alliance to succeed this trust is absolutely
fundamental.

62

It is important to identify the steps and variables involved in the workings of a typical
strategic alliance. Barriers to the success of the alliance should also be identified.
Scanning the environment for opportunities is the first step in developing strategic
alliances. It includes the firms analysis of its own strengths, weaknesses,
opportunities and threats (SWOT). Clear understanding of strengths and
opportunities allows the firm to set the short-term and long-term goals and objectives,
while the analysis of weaknesses and threats provides direction to look for alliances.
These may include competitors, suppliers, or other firms, which could provide the
needed strengths. These firms constitute the group with alliance potential. The firm
should perform similar analyses (SWOT) for the potential alliance partner. This not
only complements the investigation as to the compatibility of the organization; but,
more importantly, enables a firm to assess the capacity, both financial and physical,
to form an integral and harmonious member of the alliance. The following
checklist identifies the key issues to consider when contemplating entering into a
strategic alliance:

1)

Choosing the partner carefully As ever vital to any partnering relationship


absolutely critical if two companies decide to go deeper into a Strategic Alliance
and integrate each others business process. Synergy among partners is the major
reason for and the advantage of the alliance. The partnership is efficient,
effective and, as a result, much more competitive compared to each alliance
partner performing the similar tasks individually.

2)

Clarity of purpose Both parties need to understand what they are expecting to
get out of the relationship, how they will measure and recognize success which
may not be conventional profit and revenue measures. Goal compatibility is
essential among alliance partners. If they are striving for the same ends then they
are more likely to achieve their objectives. Without such compatibility, the
alliance partners may pull in different directions. All relationships require
sharing. The foundation of strategic alliance is sharing benefits according to the
agreed expectations, which may differ. A key component of each alliance that
needs to be agreed up front is the expectations of all the partners in the alliance.
They need to be identified and agreed so that any gaps do not become blockers to
progress in the future. By forming a strategic alliance a firm seeks to change the
nature and the scope of what it does. By upsizing it may to be entering a more
intensive and competitive market where the competition will be more intense.
The firm needs to be aware of this likely situation and plan accordingly.
This will influence its choice of partnering organization. In addition, if the
partnering organizations share common attitudes then this is an additional
factor likely to lead to successful partnering. If the alliance partners think in a
similar way then they are more likely to agree on how to proceed and disputes
are less likely.

3)

Select a project product or market area that could benefit from the increased
strength and flexibility provided by Strategic Alliances. This should normally
relate to an existing operation although it could be a means of breaking new
ground. Select suitable partnering organizations as set out in detail in this guide.
Partnering arrangements frequently focus on innovative approaches to products
and process reflecting the strategic nature of the relationship as the parties strives
to ensure that they are able to fully meet the objectives of the partnering
agreement. They can then overcome any potential sources of difficulty in meeting
those objectives.

4)

Understand each others business processes and realizing the full benefits from
a strategic alliance normally require the integration of business processes in
order to optimize the operations and eliminate duplication another area for
some tough decisions. Clear understanding of what value each partner will bring
to the alliance is the foundation on which trust and relationships are built for
future success.

5)

An alliance plan needs to be formulated, such that it becomes a living document.


It needs to embody both the revenue and the non-revenue (e.g. market activities,
relationship building and levels of satisfaction) aspects of the alliance, with a set
of supporting actions identified against members of all the partners involved. The
arrangements can often be less formal than in a more normal contractual
situation. This is deliberate, so that the partnering organizations can have
complete flexibility and to avoid the situations of confrontation and claims
arising. Flexibility in establishing and operating any partnering arrangement is of
paramount importance. Again a spirit of mutual understanding and co-operation
that allows for the accommodation of variations in the operation of the agreement
will enhance the benefits derived and the whole outcome of the partnering
arrangement.

Strategic Alliances

63

Corporate Level
Strategy

6)

Balancing contributions of partners in the areas of product development,


manufacturing, and marketing are necessary so that no one partner dominates the
alliance. Absence of such a balance may result in the takeover of the weaker
partner by the dominant firm or a short-term relationship, usually resulting in
breaking the alliance without achieving its full potential. A strategic alliance
requires an equal standing in the relationship between the respective partners
even though the strategic alliance partners may be of different sizes. This is not a
buyer-seller relationship. Understand each others strengths combining each
others strengths and building on these is a key aspect of gaining the maximum
benefit from a strategic alliance. This often requires tough decisions to be made
regarding roles and responsibilities. Careful consideration must also be given to
the most appropriate formal structure for the strategic alliance to flourish.

7)

Complete trust between the partnering organizations is an essential ingredient.


This enables the resolution of confrontations and disputes, which can arise. The
partnering organizations need to be able to rely implicitly on each other to act in
full accord with the aims and objectives of the partnering arrangement. They
need to act in a manner that will support the totality of the agreement, not their
individual interests at the expense of the overall project. Above all they need to
be able to discuss issues as they arise in an open and positive way to prevent
minor differences becoming major crises. The risks and rewards of a partnering
arrangement should be shared and allocated in the most appropriate way, in
accordance with the key business drivers of each particular instance.

8)

Participation at the top All partnering relationships require the commitment


from the top to be successful. An essential ingredient is the commitment and
support of senior management of all the alliance partners. Without that
commitment alliances can get into difficulty or fail. High-level support is needed
at the outset to ensure that potential problems that can arise can be adequately
dealt with. The commitments needed to make the alliance successful needs to
permeate throughout the participating companies for it to succeed. Before a firm
hopes to operate the alliance successfully it needs to gain full support from
within its own organization at every level. In other words, the management must
sell the idea internally. This is especially the case when contemplating a strategic
alliance where the effects on the existing business will be more marked and
unpredictable. This is going to be more important and challenging if it is the first
time the firm has ever undertaken a partnering arrangement. The management
must be prepared to seek external as well as internal support and guidance to
build up the case for approval. This must include an assessment of which
markets and products will be suitable for such a new venture and why the firm
has selected a particular partner or partners.

9)

Freedom to innovate Often the motivation to establish a strategic alliance is to


stimulate innovative thinking in the joint activity. Getting the correct balance
between necessary regulation and control and creative freedom is a key
consideration.

10) Have an exit strategy Given that a strategic alliance is a very deep
relationship, then exit is likely to be a complex and potentially costly affair.
Nevertheless it needs considering at the time of entry.

64

Recognizing these issues, taking expert advice where appropriate, and encouraging the
chosen strategic alliance partner to do likewise ought to help secure a firm foundation
on which to build the strategic alliance. A key feature of all successful partnering
arrangements is the ability to refine and develop the processes involved continually so
that they can be improved, enhanced and applied in new or enlarged situations. They
are essential so that progress can be monitored, difficulties addressed and the
partnering arrangement is made to work. Again the more usual requirements of

national partnering apply. Examples of this are agreeing the style of the
relationship, tangible objectives and continuous improvement as well as an exit
strategy. Also important are such features as agreed key measures, regular joint
review and audit, extension of the programme and developing new partners for
the future.

11.9

Strategic Alliances

CORPORATE SOCIAL RESPONSIBILITY

This is an area of increasing importance in every market and supply chain. Factors
addressed here include cultural differences, differences in perceptions and beliefs and
the effect of a fragile ecology. In a domestic strategic alliance, as opposed to an
international situation, it is expected that there would be a shared culture; where such
issues as say child labor are probably not an issue at all, because they do not arise.
However, there could be just as fundamental differences between organizations on
what at first might not seem such important issues. Different organizations have
different attitudes and criteria that they apply to such issues as waste disposal. One
may have a very strict and environmentally friendly approach to the disposal of waste
products, especially hazardous ones; while the alliance partner may not. In such a
case, in an alliance, one could become tarnished by the alliance partners lesser
concern with such issues. Such differences need to be ascertained, their treatment
explored and a common agreed policy developed. This is a matter that needs to be
addressed at the outset and embodied in any alliance plan. There will be other issues
such as differences in the way human resources are treated, which will similarly need
addressing. They will be more or less important as circumstances and attitudes dictate.
Even more sensitive can be the effects of large-scale operations, particularly mineral
extraction or even more the oil industry on not only fragile or vulnerable ecologies but
also local populations or economies.
Corporate social responsibility can extend to activities not necessarily seen as being
mainstream or core to your business. This could extend to supporting programmes
that, while they may not directly or immediately affect a companys current business,
could raise its profile in an area that could be of future benefit or even bring goodwill
for future projects.

11.10

SUMMARY

From software to steel, aerospace to apparel, the pace of strategic alliances worldwide
is accelerating. A strategic alliance is an agreement between firms to do business
together in ways that go beyond normal company-to-company dealings, but fall short
of a merger or a full partnership. Strategic alliances can be as simple as two
companies sharing their technological and/or marketing resources. In contrast, they
can be highly complex, involving several companies, located in different countries.
Strategic alliances are becoming more and more prominent in the global economy.
Strategic alliances enable business to gain competitive advantage through access to a
partners resources, including markets, technologies, capital and people. Teaming up
with others adds complementary resources and capabilities, enabling participants to
grow and expand more quickly and efficiently. Strategic alliances also benefit
companies by reducing manufacturing costs, and developing and diffusing new
technologies rapidly. Any firm opting for strategic alliance incurs certain costs and
risks compared to a firm going alone. These risks include the loss of operational
control and confidentiality of proprietary information and technology. In addition, the
parties may deprive themselves of future business opportunities with competitors of
their strategic partner. Alliances also raise the specter of potential conflicts, loss of
autonomy, difficulties in coordination and management, mismatch of cultures, etc.

65

Corporate Level
Strategy

11.11

KEY WORDS

Cross-Holdings, Equity Stakes, and Consortia: These alliances bring together


companies more closely than licensing and joint venture mechanism. Broadly
amalgamated together as consortia, these alliances represent highly complex and
intricate linkages among groups of companies.
Joint Ventures: This arrangement involves partners creation of a third entity
representing the interests and capital of the two partners. Both partners contribute
capital, distinctive skills, managers, reporting systems, and technologies to the venture
in certain proportions.
Licensing Arrangements: Licensing represents a sale of technology or product based
knowledge in exchange for market entry in a manufacturing industry. In service-based
firms, licensing is the right to enter a market in exchange for a fee or royalty.
Strategic Alliance: A strategic alliance is an agreement between firms to do business
together in ways that go beyond normal company-to-company dealings, but fall short
of a merger or a full partnership.

11.12

SELF-ASSESSMENT QUESTIONS

1)

What do you understand from the term strategic alliances? Explain the different
types of strategic alliances that companies follow? Give examples of Indian
companies for each type of strategic alliance.

2)

Why do companies form strategic alliances?

3)

What are the risks and costs associated with strategic alliances?

4)

What are the features of a successful alliance? What are the barriers to a
successful alliance?

11.13

REFERENCES AND FURTHER READINGS

Booz, Allen and Hamilton (1997). Cross-border alliances in the age of


collaboration, Viewpoint.
Brucellaria, M. (1997). Strategic Alliances Spell Success, Management Accounting,
77,7, 18.
Coopers and Lybrand (1997). Strategic alliances, Coopers and Lybrand Barometer.
Dowling, P., Schuler, R., Welch, D. International Dimensions of Human Resource
Management, Wadsworth Publishing Company.
Hamel, G, Doz, Y, Prahalad, C., Collaborate with your Competitors and Win,
Harvard Business Review, 67, 1, 1989, 133-9.
Kalmbach, C., Roussel, R. (1999). Dispelling Myths about alliances, www.2c.com
Ohmae, K. The mind of the strategist, Art of Japanese Business, McGraw-Hill,
New York, NY, 1987.
Quinn, J.B. (1995). On the edge of outing, The Alliance Analyst,
www.alliance.analyst.com.
Soursac, T. (1996). When the Hub Spoke, The Alliance Analyst,
www.alliance.analyst.com.
66

Wheelen, T.L, Hunger, D.J. (2000). Strategic Management and Business Policy, 7th
ed, Addison Wesley Publishing Company, New York, NY, 125-134, 314.

Appendix-3

Strategic Alliances

Case Study
Ambalal Sarabhai Enterprises Ltd-Profiting through Strategic Alliances
The US$300 billion global pharmaceutical industry is research driven. New drug
R&D cost being prohibitive, it is limited to pharmaceutical MNCs in developed
nations where product patents are enforced. High prices of under-patent drugs are
causing a shift to generics, especially in USA and European markets. So, to spread
their R&D costs over a larger base, pharma MNCs are consolidating through mergers/
alliances. Historically, India has recognized only process patents. Under WTO, as per
TRIPs agreement India too has to enforce product patents latest by year 2005 AD.
In the Rs130 billion Indian pharma sector, prices of over 60% of the drugs/
formulations are Government controlled (through DPCO). In the domestic bulk drugs
market, low entry barriers have resulted in overcapacity and price wars. So, major
players are focusing on formulations, where brand image and distribution network act
as entry barriers. Most players are increasing their overseas marketing/-manufacturing
network in order to enhance exports (under patent drugs to third world countries and
generics to developed nations). In anticipation of WTO, MNCs are strengthening their
ranks in India - either setting up new 100% subsidiaries or marketing tie-ups with
major domestic players. Large local players are consolidating through brand
acquisitions, co-marketing/ contract manufacturing tie-ups with MNCs etc.
In this scenario, Ambalal Sarabhai Enterprises Ltd (ASMA) has aggressively formed
alliances in the last couple of years to leverage upon the technical expertise and strong
brands. ASMA has major presence in anti-infectives, anti-epileptic and NSAIDs. The
company is the largest manufacturer of Vitamin C in India. ASMA is the market
leader in Veterinary healthcare sector. On domestic front the company has formed
50:50 JV to market the brands. The company has tied up with BV Chiron,
Netherlands for marketing anti-cancer products in India, Grunenthal of Germany to
manufacture and market Tramadol (an analgesic), with Biobrass of Brazil for the
marketing of procine and insulin and with Abic of Israel for the marketing of poultry
vaccines in India.
ASMA is pursuing major restructuring program and to further strategic alliances and
collaborations.. With commitment of the management to turnaround the company
through alliances, restructuring of operations and cutting down the high cost debt,
ASMA is expected to improve profitability in the next two years.

67

UNIT 10 GROWTH STRATEGIES-II

Growth Strategies-II

Objectives
The Objectives of this unit are to:
l

acquaint you with the various diversification strategies;

explain the reasons for pursuing diversification strategies;

explain the various routes to diversification;

make clear the mechanics of M&A and the basic steps involved in M&A;

explain the rationale behind M&A;

identify the attributes of successful and effective acquisitions; and

provide you with a brief overview of the M&A scenario in India.

Structure
10.1

Diversification

10.2

Related Diversification (Concentric Diversification)

10.3

Unrelated Diversification (Conglomerate Diversification)

10.4

Rationale for Diversification

10.5

Alternative Routes to Diversification

10.6

Mergers and Acquisitions (M&A)

10.7

Merger and Acquisition Strategy

10.8

Reasons for Failure of Merger and Acquisition

10.9

Steps in Merger and Acquisition Deals

10.10

Mergers and Acquisitions: The Indian Scenario

10.11

Summary

10.12

Key Words

10.13

Self-Assessment Questions

10.14

References and Further Readings

10.1

DIVERSIFICATION

Diversification involves moving into new lines of business. When an industry


consolidates and becomes mature, most of the firms in that industry would have
reached the limits of growth using vertical and horizontal growth strategies. If they
want to continue growing any further the only option available to them is
diversification by expanding their operations into a different industry. Diversification
strategies also apply to the more general case of spreading market risks: adding
products to the existing lines of business can be viewed as analogous to an investor
who invests in multiple stocks to spread the risks. Diversification into other lines of
business can especially make sense when the firm faces uncertain conditions in its core
product-market domain.

27

Corporate Level
Strategy

While intensification limits the growth of the firm to the existing businesses of the
firm, diversification takes it beyond the confines of the current product-market domain
to uncharted and unfamiliar products- market territory. In other words, this strategy
steers the organization away from both its present products and its present market
simultaneously. Of the various routes to expansion, diversification is definitely the
most complex and risky route. Diversification approach to expansion is complex since
it seeks to enter new product lines, processes, services or markets which involve
different skills, processes and knowledge from those required for the current
bussiness. It is risky since it involves deviating from familiar territory: familiar
products and familiar markets.
Diversification of a firm can take the form of concentric and conglomerate
diversification. Concentric (Related) diversification is appropriate when a
firm has a strong competitive position but industry attractiveness is low.
Conglomerate (unrelated) diversification is an appropriate strategy when current
industry is unattractive and that the firm lacks exceptional and outstanding
capabilities or skills in related products or services. Generally, related diversification
strategies have been demonstrated to achieve higher value creation (profitability and
stock value) than unrelated diversification strategies (conglomerates).
The interpretation of this finding is that there must be some advantage achieved
through shared resources, experience, competencies, technologies, or other
value-creating factors. This is the so called synergy effect of diversification i.e.,
the whole is greater than the sum of its parts. While it is difficult to predict
what is a synergistic match of a business to an existing corporate portfolio, the test
must be that the business creates new value when it is added to a corporations line of
existing businesses.

10.2

RELATED DIVERSIFICATION (CONCENTRIC


DIVERSIFICATION)

In this alternative, a company expands into a related industry, one having synergy with
the companys existing lines of business, creating a situation in which the existing and
new lines of business share and gain special advantages from commonalities such as
technology, customers, distribution, location, product or manufacturing similarities,
and government access. In essence, in concentric diversification, the new industry is
related in some way to the current one. This is often an appropriate corporate strategy
when a company has a strong competitive position and distinctive competencies, but
its existing industry is not very attractive. Thus, a firm is said to have pursued
concentric diversification strategy when it enters into new product or service area
belonging to different industry category but the new product or service is similar to the
existing one with respect to technology or production or marketing channels or
customers. Such diversification may be possible in two ways: internal development
through product and market expansion utilizing the existing resources and
capabilities or through external acquisitions operating in the same market space.
Addition of lease financing activity in India is a case of market-related concentric
diversification. Another type of concentric diversification is technology related in
which the firm employs similar technology to manufacture new products.
Addition of tomato ketchup and sauce to the existing Maggi brand processed items
of Food Specialities Ltd. is an instance of technological-related concentric
diversification.

28

10.3

UNRELATED DIVERSIFICATION
(CONGLOMERATE DIVERSIFICATION)

Growth Strategies-II

Conglomerate diversification is a growth strategy in which a company seeks to grow


by adding entirely unrelated products and markets to its existing business. A company
that consists of a grouping of businesses from unrelated streams is called a
conglomerate. In conglomerate diversification, a firm generally introduces new
products using different technologies in new markets. A conglomerate consists of a
number of product divisions, which sell different products, principally to their own
markets rather than to each other. Conglomerates diversify their business risk through
profit gained from profit centers in various lines of business. However, some may
become so diversified and complicated that they are too difficult to manage efficiently.
However, since their huge popularity in the 1960s to 80s, many conglomerates have
reduced their business lines by restricting to a choice few. The reasons for considering
this alternative are primarily to seek more attractive opportunities for growth, spread
the risk across different industries, and/or to exit an existing line of business. Further,
this may be an appropriate strategy when, not only the present industry is unattractive,
but the company also lacks outstanding competencies that it could transfer to related
products or industries. However, since it is difficult to manage and excel in unrelated
business units, it is often difficult to realize the expected and anticipated results.
In India, a large number of companies diversified their operations following economic
liberalization. Gujarat Narmada Valley Fertilizers Ltd. has diversified from fertilizers
to personal transport, chemicals and electronic industries, while Arvind group,
hitherto confined to textiles, diversified into unrelated activities such as manufacturing
of agro- products, floriculture and export of fresh fruits. Likewise, BPL has decided
to venture into sectors like power generators, cement, steel and agricultural inputs in a
big way. Wipro is another company with wide ranging business interests
encompassing vegetable oils, computer hardware, and software, medical equipment,
hydraulic systems, consumer products, lighting, export of leather shoe nippers and has
recently entered into financial services (Refer to case study 1 in appendix-2).

10. 4

RATIONALE FOR DIVERSIFICATION

Under strict assumptions of an efficient market theory, there is no convincing rationale


for one company to acquire another, especially less efficient or unrelated businesses.
Since the markets are imperfect and do not follow the norms of efficient market
theory, companies do diversify for several reasons given below:
Economies of Scale and Scope (Synergy): The merger of two companies producing
similar products should allow the combined firms to pool resources and attain lower
operating costs. By making optimal use of existing marketing, investment, operating
and managerial facilities of the two combining firms and eliminating redundant and
overlapping activities, the combined entity can lower the operating costs and increase
operational efficiency. The saving may come from reduced overheads or the ability to
spread a larger amount of production over lower (consolidated) fixed costs. There may
also be differential management capabilities: an efficiently managed firm may acquire
a less efficient firm with the intent of bringing better management to the business.
Efficiencies can also be gained through pooled financial resources or simply through
pooled risk.
Widen Market Base and Enhance Market Power: Large number of collaborations
and acquisitions are aimed at expanding the market for the firms products. For
instance, HCL and Hewlett Packard Ltd., Tata-IBM, Ranbaxy Laboratories and Eli
Lilly Company, Hindustan Motors and General Motors and Tata Tea and Tetley of

29

Corporate Level
Strategy

USA, entered into tie-up arrangements mainly to exploit the market opportunities.
Mergers and acquisitions can increase a firms market share when both firms are in
the same business. But, market share does not necessarily translate to higher profits or
greater value for owners unless the merger substantially reduces the inter-firm rivalry
in the industry.
Profit Stability: Acquisition of new business can reduce variations in corporate
profits by expanding the companys lines of business. This typically occurs when the
core business depends on sales that are seasonal or cyclical. A large number of
organizations pursue diversification strategy just to avoid instability in sales and
profits which can result from events such as cyclical and seasonal shifts in demand,
changes in the life cycles and other destabilizing forces in the micro, meso and macro
environment.
Improve Financial Performance: Large firms generate cash that can be invested in
other ventures. The firm acts as a banker of an internal capital market. The core
business sustains itself on its moneymaking ventures, and uses this cash flow to create
new ventures that generate additional profits. A firm may also be tempted to exploit
diversification opportunities because it has liquid resources far in excess of the total
expansion needs. Sometimes a company may seek a merger with another organization
with the intention of tiding over its financial problems.
Growth: Diversification is basically a way to grow. Indeed, managers often cite
growth as the principle reason for diversification. The most important factor that
motivates management to diversify is to achieve higher growth rate than which is
possible with intensification strategy. If the management feels that the existing
products and markets do not have the potential to deliver expected growth, the only
alternative they have is to diversify into new territories. Unlike organic growth, which
is slow, an acquisition or merger (inorganic) can deliver the results rather quickly
since resources, skills, other factors essential for faster growth are immediately
available.
Counter Competitive Threats: Organizations are driven at times towards external
diversification through merger by competitive pressures. Such a strategic move is
expected to counter the competitive threats by reducing the intensity of competition.
Access to Latest Technology: Many Indian firms enter into strategic alliances with
foreign firms to gain access to the latest technologies without spending huge amount
of money on R&D. For instance, Johnson and Nicholson India Ltd., a leading
domestic paint manufacturer, has strengthened its position in the Indian market and
also diversified into industrial electronics along with its German partner, Carl Schevek
AG of Germany.
Regulatory Factors: A large number of organizations have diversified their
operations geographically to exploit opportunities in different regions and countries
and also to take advantage of the incentives being offered by the various governments
to attract investment. Many companies enter other countries to avoid restrictions
placed by the regulators in their host country.
Activity 1
Compare and contrast the strategies of Bajaj group and TVS group. Are they
following concentric or conglomerate diversification?
..........................................................................................................................................
..........................................................................................................................................
..........................................................................................................................................

30

..........................................................................................................................................

10.5

ALTERNATIVE ROUTES TO DIVERSIFICATION

Growth Strategies-II

Once a firm opts for diversification, it must select one of the options discussed below.
There are three broad ways to implement diversification strategies:

Mergers and Acquisitions


A merger is a legal transaction in which two or more organizations combine
operations through an exchange of stock. In a merger only one organization
entity will eventually remain. An acquisition is a purchase of one organization by
another. In recent years, there were quite a few acquisitions in which the target firms
resisted the take-over bids. These acquisitions are referred to as hostile takeovers. It
is natural for the target organizations management to try to defend against the
takeover. Although they are used synonymously, there is a slight distinction between
the terms merger and acquisition. This will be discussed more in detail in the
later sections.

Strategic Partnering
Strategic partnering occurs when two or more organizations establish a relationship
that combines their resources, capabilities, and core competencies to achieve some
business objective. The three major types of strategic partnerships: joint ventures,
long-term partnerships, and strategic alliances are discussed below:
Joint Ventures: In a joint venture, two or more organizations form a separate,
independent organization for strategic purposes. Such partnerships are usually focused
on accomplishing a specific market objective. They may last from a few months to a
few years and often involve a cross-border relationship. One firm may purchase a
percentage of the stock in the other partner, but not a controlling share. The joint
ventures between various Indian and foreign companies such Hindustan Motors and
General Motors, Hero Cycles with Honda Motor Company, Wipro and General
Electric, etc are examples of such strategic partnering.
Long-Term Contracts: In this arrangement, two or more organizations enter a legal
contract for a specific business purpose. Long-term contracts are common between a
buyer and a supplier. Many strategists consider them more flexible and less inhibiting
than vertical integration. It is usually easier to end an unsatisfactory long-term
contract than to end a joint venture. A good example is the change in supplier
relationships that Chryslers management undertook after 1989, when it launched the
LH project to create a new generation of cars. Supplier relationships are critical at
Chrysler since outsourced components constitute about 70 percent of Chryslers cars,
compared to about 50 percent for GM and Ford. Japanese automakers also enter into
such arrangements with their vendors frequently.
Strategic Alliances: In a strategic alliance, two or more organizations share
resources, capabilities, or distinctive competencies to pursue some business purpose.
Strategic alliances often transcend the narrower focus and shorter duration of joint
ventures. These alliances may be aimed at world market dominance within a product
category. While the partners cooperate within the boundaries of the alliance
relationship, they often compete fiercely in other parts of their businesses.

10.6 MERGERS AND ACQUISITIONS (M&A)


Mergers and acquisitions and corporate restructuringor M&A for shortare a big
part of the corporate finance. One plus one makes three: this equation is the special
alchemy of a merger or acquisition. The key principle behind buying a company is to

31

Corporate Level
Strategy

create shareholder value over and above that of the sum of the two companies. Two
companies together are more valuable than two separate companiesat least, thats
the reasoning behind M&A. This idea is particularly attractive to companies when
times are tough. Strong companies will act to buy other companies to create a more
competitive, cost-efficient company. The companies will come together hoping to gain
a greater market share or achieve greater efficiency. Because of these potential
benefits, target companies will often agree to be purchased when they know they
cannot survive alone.
A corporate merger is essentially a combination of the assets and liabilities of two
firms to form a single business entity. Although they are used synonymously, there is a
slight distinction between the terms merger and acquisition. Strictly speaking, only
a corporate combination in which one of the companies survives as a legal entity is
called a merger. In a merger of firms that are approximate equals, there is often an
exchange of stock in which one firm issues new shares to the shareholders of the other
firm at a certain ratio. In other words, a merger happens when two firms, often about
the same size, agree to unite as a new single company rather than remain as separate
units. This kind of action is more precisely referred to as a merger of equals. Both
companies stocks are surrendered, and new company stock is issued in its place.
When a company takes over another to become the new owner of the target company,
the purchase is called an acquisition. From the legal angle, the target company
ceases to exist and the buyer gulps down the business and stock of the buyer
continues to be traded.
In summary, acquisition is generally used when a larger firm absorbs a smaller firm
and merger is used when the combination is portrayed to be between equals. For
the sake of discussion, the firm whose shares continue to exist (possibly under a
different company name) will be referred to as the acquiring firm and the firms whose
shares are being replaced by the acquiring firm will be referred to as the target firm.
However, a merger of equals doesnt happen very often in practice. Frequently, a
company buying another allows the acquired firm to proclaim that it is a merger of
equals, even though it is technically an acquisition. This is done to overcome some
legal restrictions on acquisitions.
Synergy is the main reason cited for many M&As. Synergy takes the form of
revenue enhancement and cost savings. By merging, the companies hope to
benefit through staff reductions, economies of scale, acquisition of technology,
improved market reach and industry visibility. Having said that, achieving synergy is
easier said than done-synergy is not routinely realized once two companies merge.
Obviously, when two businesses are combined, it should results in improved
economies of scale, but sometimes it works in reverse. In many cases, one and one add
up to less than two.
Excluding any synergies resulting from the merger, the total post-merger value of the
two firms is equal to the pre-merger value, if the synergistic values of the merger
activity are not measured. However, the post-merger value of each individual firm is
likely to be different from the pre-merger value because the exchange ration of the
shares will not exactly reflect the firms values compared to each other. The exchange
ration is distorted because the target firms shareholders are paid a premium for their
shares. Synergy takes the form of revenue enhancement and cost savings. When two
companies in the same industry merge, the revenue will decline to the extent that the
businesses overlap. Hence, for the merger to make sense for the acquiring firms
shareholders, the synergies resulting from the merger must be more than the value lost
initially.

32

Different forms of Mergers

Growth Strategies-II

There are a whole host of different mergers depending on the relationship between the
two companies that are merging. These are:
l

Horizontal Merger: Merger of two companies that are in direct competition in


the same product categories and markets.

Vertical Merger: Merger of two companies which are in different stages of the
supply chain. This is also referred to as vertical integration. A company taking
over its suppliers firm or a company taking control of its distribution by
acquiring the business of its distributors or channel partners are examples of this
type of merger.

Market-extension Merger: Merger of two companies that sell the same


products in different markets.

Product-extension Merger: Merger of two companies selling different but


related products in the same market.

Conglomeration: Merger of two companies that have no common business


areas.

Activity 2
Scan The Economic Times, Business Line, Business Standard or any other business
daily for news on mergers. Classify the mergers you have come across during your
search into various types discussed.
..........................................................................................................................................
..........................................................................................................................................
..........................................................................................................................................
..........................................................................................................................................
From the finance standpoint, there are three types of mergers: pooling of interests,
purchase mergers and consolidation mergers. Each has certain implications for the
companies and investors involved:
Pooling of Interests: A pooling of interests is generally accomplished by a common
stock swap at a specified ratio. This is sometimes called a tax-free merger. Such
mergers are only allowed if they meet certain legal requirements. A pooling of
interests is generally accomplished by a common stock swap at a specified ratio.
Pooling of interests is less common than purchase acquisitions.
Purchase Mergers: As the name suggests, this kind of merger occurs when one
company purchases another one. The purchase is made by cash or through the issue of
some kind of debt investment, and the sale is taxable. Acquiring companies often
prefer this type of merger because it can provide them with a tax benefit. Acquired
assets can be written up to the actual purchase price, and the difference between
book value and purchase price of the assets can depreciate annually, reducing taxes
payable by the acquiring company. Purchase acquisitions involve one company
purchasing the common stock or assets of another company. In a purchase
acquisition, one company decides to acquire another, and offers to purchase the
acquisition targets stock at a given price in cash, securities or both. This offer is
called a tender offer because the acquiring company offers to pay a certain price if the
targets shareholders will surrender or tender their shares of stock. Typically, this
tender offer is higher than the stocks current price to encourage the shareholders to
tender the stock. The difference between the share price and the tender price is called
the acquisition premium. These premiums can sometimes be quite high.
33

Corporate Level
Strategy

Consolidation Mergers: In a consolidation, the existing companies are dissolved, a


new company is formed to combine the assets of the combining companies and the
stock of the consolidated company is issued to the shareholders of both companies.
The tax terms are the same as those of a purchase merger. The Exxon merger with
Mobil Oil Company is technically a consolidation.

Acquisitions
As stated earlier, an acquisition is only slightly different from a merger. Like mergers,
acquisitions are actions through which companies seek economies of scale,
efficiencies, and enhanced market visibility. Unlike all mergers, all acquisitions
involve one firm purchasing anotherthere is no exchanging of stock or consolidating
as a new company. In an acquisition, a company can buy another company with cash,
stock, or a combination of the two. In smaller deals, it is common for one company to
acquire all the assets of another company. Another type of acquisition is a reverse
merger, a deal that enables a private company to get publicly listed in a relatively
short time period. A reverse merger occurs when a private company that has strong
prospects and is eager to raise finance buys a publicly listed shell company, usually
one with no business and limited assets. The private company reverse merges into the
public company and together they become an entirely new public corporation with
tradable shares. Regardless of the type of combination, all mergers and acquisitions
have one thing in common: they are all meant to create synergy and the success of a
merger or acquisition hinges on how well this synergy is achieved. (Refer to case
study-2 in Appendix-2).

10.7

MERGER AND ACQUISITION STRATEGY

There are a number of reasons that mergers and acquisitions take place. These issues
generally relate to business concerns such as competition, efficiency, marketing,
product, resource and tax issues. They can also occur because of some very personal
reasons such as retirement and family concerns. Some people are of the opinion that
mergers and acquisitions also occur because of corporate greed to acquire everything.
Various reasons for M&A include:
Reduce Competition: One major reason for companies to combine is to eliminate
competition. Acquiring a competitor is an excellent way to improve a firms position
in the marketplace. It reduces competition and allows the acquiring firm to use the
target firms resources and expertise. However, combining for this purpose is as such
not legal and under the Antitrust Acts it is considered a predatory practice. Therefore,
whenever a merger is proposed, firms make an effort to explain that the merger is not
anti-competitive and is being done solely to better serve the consumer. Even if the
merger is not for the stated purpose of eliminating competition, regulatory agencies
may conclude that a merger is anti-competitive. However, there are a number of
acceptable reasons for combining firms.
Cost Efficiency: Due to technology and market conditions, firms may benefit from
economies of scale. The general assumption is that larger firms are more costeffective than are smaller firms. It is, however, not always cost effective to grow.
Inspite of the stated reason that merging will improve cost efficiency, larger companies
are not necessarily more efficient than smaller companies. Further, some large firms
exhibit diseconomies of scale, which means that the average cost per unit increases, as
total assets grow too large. Some industry analysts even suggest that the top
management go in for mergers to increase its own prestige. Certainly, managing a big
company is more prestigious than managing a small company.
34

Avoid Being a Takeover Target: This is another reason that companies merge. If a
firm has a large quantity of liquid assets, it becomes an attractive takeover target

because the acquiring firm can use the liquid assets to expand the business, pay off
shareholders, etc. If the targeted firm invests existing funds in a takeover, it has the
effect of discouraging other firms from targeting it because it is now larger in size, and
will, therefore, require a larger tender offer. Thus, the company has found a use for
its excess liquid assets, and made itself more difficult to acquire. Often firms will
state that acquiring a company is the best investment the company can find for its
excess cash. This is the reason given for many conglomerate mergers.

Growth Strategies-II

Improve Earnings and Reduce Sales Variability: Improving earnings and sales
stability can reduce corporate risk. If a firm has earnings or sales instability, merging
with another company may reduce or eliminate this provided the latter company is
more stable. If companies are approximately the same size and have approximately
the same revenues, then by merging, they can eliminate the seasonal instability. This
is, however, not a very inefficient way of eliminating instability in strict economic
terms.
Market and Product Line Issues: Often mergers occur simply because one firm is in
a market that the other company wants to enter. All of the target firms experience
and resources are readily available of immediate use. This is a very common reason
for acquisitions. Whatever may be the explanation offered for acquisition, the
dominant reason for a merger is always quick market entry or expansion . Product line
issues also exert powerful influence in merger decisions. A firm may wish to expand,
balance, fill out or diversify its product lines. For example, acquisition of Modern
Foods by Hindustan Lever Limited is primarily related product line.
Acquire Resources: Firms wish to purchase the resources of other firms or to
combine the resources of the two firms. These may be tangible resources such as
plant and equipment, or they may be intangible resources such as trade secrets,
patents, copyrights, leases, management and technical skills of target companys
employees, etc. This only proves that the reasons for mergers and acquisitions are
quite similar to the reasons for buying any asset: to purchase an asset for its utility.
Synergy: Synergy popularly stated, as two plus two equals five, is similar to the
concept of economies of scope. Economies of scope would occur if two companies
combine and the combined company was more cost efficient at both activities because
each requires the same resources and competencies. Although synergy is often cited
as the reason for conglomerate mergers, cost efficiencies due to synergy are difficult to
document.
Tax Savings: Although tax savings is not a primary motive for a combination, it can
certainly sweeten the deal. When a purchase of either the assets or common stock
of a company takes place, the tender offer less the stocks purchase price represents a
gain to the target companys shareholders. Consequently, the target firms
shareholders will usually gain tax benefits. However, the acquiring company may
reap tax savings depending on the market value of the target companys assets when
compared to the purchase price. Also, depending on the method of corporate
combination, further tax savings may accrue to the owners of the target company.
Cashing Out: For a family-owned business, when the owners wish to retire, or
otherwise leave the business and the next generation is uninterested in the business, the
owners may decide to sell to another firm. For purposes of retirement or cashing out,
if the deal is structured correctly, there can be significant tax savings.
To summarize, firms take the M&A route to seize the opportunities for growth,
accelerate the growth of the firm, access capital and brands, gain complementary
strengths, acquire new customers, expand into new product- market domains, widen
their portfolios and become a one-stop-shop or end-to end solution provider of
products and services.
35

Corporate Level
Strategy

10.8

REASONS FOR FAILURE OF MERGER AND


ACQUISITION

The record of M&As world over has not been impressive. Advocates of M&As argue
that they boost revenues to justify the price premium. The notion of synergy, 1+1 =
3, sounds great, but the assumptions behind this notion are too simplistic. In real life
things are not that simple and rosy. Past trends show that roughly two thirds of all big
mergers have not produced the desired results. Rationale behind mergers can be
flawed and efficiencies from economies of scale may prove elusive. Moreover, the
problems associated with trying to make merged entities work cannot be overcome
easily. Reasons supporting the use of diversification have been explained in the
previous section. The potential pitfalls of this strategy are explained in this section.
The conclusion that one may draw from this discussion will be that successful
diversification would involve a well thought strategy in selecting a target, avoiding
over-paying, creating value in the integration process.
The potential pitfalls that a firm is likely to encounter during diversification include:
Integration Difficulties: Integrating two companies following mergers and acquisition
can be quite difficult. Issues such as melding two disparate corporate cultures, linking
different financial and control systems, building effective financial and control
systems, building effective working relationships, etc., will come to the fore and they
have to be contend with.
Faulty Assumptions: A booming stock market encourages mergers, which can spell
danger. Deals done with highly rated stock as currency appear easy and cheap, but
underlying assumptions behind such deals is seriously flawed. Many top managers try
to imitate others in attempting mergers, which can be disastrous for the company.
Mergers are quite often more to do with personal glory than business growth. The
executive ego plays a major in M&A decisions, which is fuelled further by bankers,
lawyers and other advisers who stand to gain from the fat fees they collect from their
clients engaged in mergers. Most CEOs and top executives also get a big bonus for
merger deals, no matter what happens to the share price later.
Mergers are also driven by fear psychosis: fear of globalization, rapid technological
developments, or a quickly changing economic scenario that increases uncertainty can
all create a strong stimulus for defensive mergers. Sometimes the management feels
that they have no choice but to acquire a raider before being acquired. The idea is that
only big players will survive in a competitive world.
Failure to carry out effective due-diligence: The failure to complete due-diligence
often results in the acquiring firm paying excessive premiums. Due diligence involves
a thorough review by the acquirer of a target companys internal books and
operations. Transactions are often made contingent upon the resolution of the due
diligence process. An effective due-diligence process examines a large number of
items in areas as diverse as those of financing the intended transaction, differences in
cultures between the two firms, tax concessions of the transaction, etc.
Inordinate increase in debt: To finance acquisitions, some companies significantly
raise their levels of debt. This is likely to increase the likelihood of bankruptcy leading
to downgrading of firms credit rating. Debt also precludes investment in areas that
contribute to a firms success such as R&D, human resources development and
marketing.

36

Too much diversification: The merger route can lead to strategic competitiveness and
above-average returns. On the flip-side, firms may lose their competitive edge due to
over diversification. The threshold level at which this happens varies across
companies, the reason being that different companies have different capabilities and

resources that are required to make the mergers work. Crossing these threshold limits
can result in overstretching these capabilities and resources leading to deteriorating
performance. Evidence also suggests that a large size creates efficiencies in various
organizational functions when the firm is not too large. In other words, at some level
the costs required to manage the larger firm exceed the benefits of efficiency created
by economies of scale.

Growth Strategies-II

Problems in making M&A work: Mergers can distract them from their core
business, spelling doom for the company. The chances for success are further
hampered if the corporate cultures of the companies are very different. When a
company is acquired, the decision is typically based on product or market synergies,
but cultural differences are often ignored. Its a mistake to assume that these issues are
easily overcome. A McKinsey study on mergers concludes that companies often focus
too narrowly on cutting costs following mergers, without paying attention to revenues
and profits. The exclusive cost-cutting focus can divert attention from the day-to-day
business and poor customer service. This is the main reason for the failure of mergers
to create value for shareholders.
However, not all mergers fail. Size and global reach can be advantageous and tough
managers can often squeeze greater efficiency out of poorly run acquired companies.
The success of mergers, however, depends on how realistic the managers are and how
well they can integrate the two companies without losing sight of their existing
businesses. Though the acquisition strategies do not consistently produce the desired
results, some studies suggest certain decisions and actions that firms may follow
which can increase the probability of success. The attributes leading to successful
acquisition suggested by various studies are that the:
l

Acquired firm has assets or resources that are complimentary to the acquiring
firms core business.

Acquisition is friendly.

Acquiring firm selects target firms and conducts negotiation carefully and
methodically.

Acquiring firm has adequate cash and fovourable debt position.

Merged firms maintains low to moderate debt position.

Acquiring firm has experience with change and is flexible and adaptable.

Acquiring firm maintains sustained and consistent emphasis on R&D and


innovation

10. 9

STEPS IN MERGER AND ACQUISITION DEALS

A firm that intends to take over another one must determine whether the purchase will
be beneficial to the firm. To do so, it must evaluate the real worth of being acquired.
Logically speaking, both sides of an M&A deal will have different ideas about the
worth of a target company: the seller will tend to value the company as high as
possible, while the buyer will try to get the lowest price possible. There are, however,
many ways to assess the value of companies. The most common method is to look at
comparable companies in an industry, but a variety of other methods and tools are
used to value a target company. A few of them are listed below.
1) Comparative Ratios
The following are two examples of the many comparative measures on which
acquirers may base their offers:
37

Corporate Level
Strategy

P/E (price-to-earnings) Ratio: With the use of this ratio, an acquirer makes an offer
as a multiple of the earnings the target company is producing. Looking at the P/E for
all the stocks within the same industry group will give the acquirer good guidance for
what the targets P/E multiple should be.
EV/Sales (price-to-sales) Ratio: With this ratio, the acquiring company makes an
offer as a multiple of the revenues, again, while being aware of the P/S ratio of other
companies in the industry.
2) Replacement Cost
In a few cases, acquisitions are based on the cost of replacing the target company. The
value of a company is simply assessed based on the sum of all its equipment and
staffing costs without considering the intangible aspects such as goodwill,
management skills, etc. The acquiring company can literally order the target to sell at
that price, or it will create a competitor for the same cost. This method of establishing
a price certainly wouldnt make much sense in a service industry where the key
assetspeople and ideasare hard to value and develop.
3) Discounted Cash Flow
An important valuation tool in M&A, the discounted cash flow analysis, determines a
companys current value according to its estimated future cash flows. Future cash
flows are discounted to a present value using the companys weighted average cost of
capital. Though this method is a little difficult to use, very few tools can rival this
valuation method.
4) Synergy
Quite often, acquiring companies pay a substantial premium on the stock value of the
companies they acquire. The justification for this is the synergy factor: a merger
benefits shareholders when a companys post-merger share price increases by the
value of potential synergy. For buyers, the premium represents part of the post-merger
synergy they expect can be achieved. The following equation solves for the minimum
required synergy and offers a good way to think about synergy and how to determine
if a deal makes sense. In other words, the success of a merger is measured by whether
the value of the buyer is enhanced by the action. The equation:
(Pre-merger value of both firms + synergies)
= Pre-merger stock price
Post-merger number of shares
Here the pre-merger stock price refers to the price of the acquiring firm. Increase in
the value of the acquiring firm is a test of success of the merger. However, the
practical aspects of mergers often prevent the anticipated benefits from being fully
realized and the expected synergy quite often falls short of expectations.
Some more criteria to consider for valuation include:

38

A reasonable purchase price - A small premium of, say, 10% above the market
price is reasonable.

Cash transactions- Companies that pay in cash tend to be more careful when
calculating bids, and valuations come closer to target. When stock is used for
acquisition, discipline can be a casualty.

Sensible appetite An acquirer should target a company that is smaller and in a


business that the acquirer knows intimately. Synergy is hard to create from
disparate and unrelated businesses. And, sadly, companies have a bad habit of
biting off more than they can chew in mergers.

The Basics Steps in Mergers and Acquisitions

Growth Strategies-II

1) Initial Offer by the Intending Buyer


When a company decides to go for a merger or an acquisition, it starts with a tender
offer. Working with financial advisors and investment bankers, the acquiring company
will arrive at an overall price that its willing to pay for its target in cash, shares, or
both. The tender offer is then frequently advertised in the business press, stating the
offer price and the deadline by which the shareholders in the target company must
accept (or reject) it.
2) Response from Target Company
Once the tender offer has been made, the target company can do one of the several
things listed below:
Accept the Terms of the Offer: If the target firms management and shareholders are
happy with the terms of the transaction, they can go ahead with the deal.
Attempt to Negotiate: The tender offer price may not be high enough for the target
companys shareholders to accept, or the specific terms of the deal may not be
attractive. If target firm is not satisfied with the terms laid out in the tender offer, the
targets management may try to work out more agreeable terms. Naturally, highly
sought-after target companies that are the object of several bidders will have greater
latitude for negotiation. Therefore, managers have more negotiating power if they can
show that they are crucial to the mergers future success.
Execute a Poison pill or some other Hostile Takeover Defense: A target company
can trigger a poison pill scheme when a hostile suitor acquires a predetermined
percentage of company stock. To execute its defense, the target company grants all
shareholdersexcept the acquireroptions to buy additional stock at a hefty
discount. This dilutes the acquirers share and stops its control of the company. It can
also call in government regulators to initiate an antitrust suit.
Find a White Knight: As an alternative, the target companys management may seek
out a friendly potential acquirer, or white knight. If a white knight is found, it will
offer an equal or higher price for the shares than the hostile bidder.
3) Closing the Deal
Finally, once the target company agrees to the tender offer and regulatory
requirements are met, the merger deal will be executed by means of some transaction.
In a merger in which one company buys another, the acquirer will pay for the target
companys shares with cash, stock, or both. A cash-for-stock transaction is fairly
straightforward: target-company shareholders receive a cash payment for each share
purchased. This transaction is treated as a taxable sale of the shares of the target
company. If the transaction is made with stock instead of cash, then its not taxable.
There is simply an exchange of share certificates. The desire to steer clear of the
taxman explains why so many M&A deals are carried out as cash-for-stock
transactions.
When a company is purchased with stock, new shares from the acquirers stock are
issued directly to the target companys shareholders, or the new shares are sent to a
broker who manages them for target-company shareholders. Only when the
shareholders of the target company sell their new shares are they taxed. When the deal
is closed, investors usually receive a new stock in their portfoliothe acquiring
companys expanded stock. Sometimes investors will get new stock identifying a new
corporate entity that is created by the M&A deal.
39

Corporate Level
Strategy

10.10

MERGERS AND ACQUISITIONS: THE INDIAN


SCENARIO

M&A activity had a slow take-off in India. Traditionally, Indian promoters have been
very reluctant to sell out their businesses since it was synonymous with failure and
was never viewed as a sensible move. This scenario changed dramatically in the 90s
with the Tatas selling TOMCO and Lakme. Suddenly selling out had become a
sensible option. The second major reason for the slow take-off of M&A activity was
due to the fact that even while the companies continued to decline, the banks and
financial institutions, normally the biggest stakeholders in most Indian companies
were reluctant to change the managements. Fortunately this situation has changed for
the better. Worried about the spectre burgeoning NPAs, these institutions are now
willing to force the promoters to sell out. The FIs and banks are flushed with funds
and they are willing to assist big companies in acquiring new companies.
Indian cement industry was trendsetter in M&A in India. The cement industry was
ripe for consolidation in many ways. The industry comprised of four or five dominant
players in addition to a number of small players having economically viable
capacities, but with very small market shares. Rapid expansion by the bigger players
in a capital-intensive industry meant that these small players would naturally be
marginalized. Moreover, the excess capacity due to rapid expansion of big players
meant that the smaller players would lose money. This situation naturally spurred the
merger activity in the cement industry.
The past few years have been record years for M&A globally with mega deals
dwarfing the previous records. M&A has also become a buzzword among Indian
companies as well. HDFC-Times Bank, Gujarat Ambuja-DLF and ICICI BankCenturion Bank mergers have all been in the news recently for this reason. The merger
wave in the country was catalyzed by economic liberalization in 1991. M&A activity
is on the rise and the Indian industry has witnessed a spate of mergers and acquisitions
in the past few years. Mergers and acquisitions are here to stay and more are expected
to follow in the near future.
Mergers and acquisitions in India, just as in other parts of the world, are primarily
aimed at expanding a companys business and profits. Acquisitions bring in more
customers and business, which in turn brings in more money for the companies thus
helping in its overall expansion and growth. More and more companies are, therefore,
moving towards acquisitions for a fast-paced growth. Consolidation has become a
compelling necessity to counter the effects of increasing globalization of businesses,
declining tariff barriers, price decontrols and to please the ever demanding and
discerning customers. And these pressures are expected to intensify and relentlessly
batter every business in the future. The M&A activity is helping the companies
restructure, gain market share or access to markets, rationalize costs and acquire
brands to counter these threats. The shareholders of many companies are also
supporting these moves and sharp increase in share prices is an indication of this
support.

40

Since size and focus are factors that matter for surviving the onslaught of
competition, mergers and acquisitions have emerged as key growth drivers of Indian
business. Tax benefits were the sole reason to justify mergers in the past but for many
Indian promoters, that is no longer an incentive. Indian companies have taken to
M&A many reasons. Experts feel that Indian companies look at M&As due to the size
factor, the niche factor or for expanding their market reach. They are also of the
opinion that acquisitions help in the inorganic (and quicker) growth of the business of
a company. Besides these factors, the pricing pressures and consolidation of
global companies by building offshore capabilities have made M&A relevant for
Indian enterprises.

Many Indian companies have also followed the M&A route to grow in size by adding
manpower and to facilitate overall expansion by moving into new market space.
Another reason behind M&A has been to gain new customers. For instance, vMoksha,
an IT firm, saw a rise in the number of its customers due to acquisitions as it
expanded considerably in the US market and leveraged on the existing customer base.
Similarly, Mphasis added new customers in the Japanese and Chinese markets after
the acquisition of Navion. The need for skill enhancement seems to be another major
reason for companies to merge and make new acquisitions. The Polaris-OrbiTech
merger helped in combining skill sets of both companies, which consequently led to
growth and expansion of the merged entity. Likewise, Wipro acquired GE Medical
Systems Information Techno-logy (India) to leverage its expertise in the health science
domain. (Refer to case study-3 in Appendix-2).

10.11

Growth Strategies-II

SUMMARY

Diversification involves moving into new lines of business. Of the various routes to
expansion, diversification is definitely the most complex and risky route.
Diversification of a firm can take the form of concentric and conglomerate
diversification. A firm is said to pursue concentric diversification strategy when it
enters into new product or service areas belonging to different industry category but
the new product or service is similar to the existing one in many respects.
The two major routes to diversification are mergers and acquisitions and strategic
partnering. One plus one makes three: this equation is the special alchemy of a merger
or acquisition. Although they are used synonymously, there is a slight distinction
between the terms merger and acquisition. The term acquisition is generally used
when a larger firm absorbs a smaller firm and merger is used when the combination is
portrayed to be between equals.
Firms take the M&A route mainly to seize the opportunities for growth, accelerate the
growth of the firm, access capital and brands, gain complementary strengths, acquire
new customers, expand into new product-market domains, wident their portfolios and
become a one-stop-shop or end-to-end solution provider of products and services. The
three basic steps in the merger process areoffer by the acquiring firm, response by
the target firm and closing the deal.
M and A activity had a slow take-off in India. However, M&A has become a
buzzword among Indian companies after the economic liberalization in 1991. M&A
activity is on the rise and the Indian industry has witnessed a spate of mergers and
acquisitions in the past few years.

10.12

KEY WORDS

Acquisitions: A company taking over controlling interest in another company.


Concentric Diversification: A firm is said to have pursued concentric diversification
strategy when it enters into new product or service area belonging to different industry
but the new product or service is similar to the existing one with respect to technology
or production or marketing channels or customers.
Conglomerate Diversification: Conglomerate diversification is a growth strategy in
which a company seeks to grow by adding entirely unrelated products and markets to
its existing business.
Diversification: Diversification involves moving into new lines of business.
Joint Ventures: Two or more organizations form a separate, independent organization
for strategic purposes.

41

Corporate Level
Strategy

Mergers: The conpination of two or more companies.


Strategic Alliances: Two or more organizations share resources, capabilities, or
distinctive competencies to pursue some business purpose.
Strategic Partnering: Two or more organizations establish a relationship that
combines their resources, capabilities, and core competencies to achieve some
business objective.

10.13

SELF-ASSESSMENT QUESTIONS

1)

What is meant by diversification? What are the pros and cons of a diversification
strategy?

2)

Explain the mechanics of mergers and acquisitions. What motivates the top
management to go in for M&A?

3)

What are the pitfalls that a management should take into consideration while
going for M&A?

4)

Explain the basic steps involved in the M&A process.

5)

Scan the business newspapers in the past few months and explain the M&A
trends in Indian business scenario and list out the various reasons why Indian
companies plan to follow M&A strategy.

10.14

REFERENCES AND FURTHER READINGS

Hitt, Michael A. Ireland, Duane R. and Hoskisson, Robert E. (2001). Strategic


management: competitiveness and globalization, 4th ed., Thomson Learning.
Srivastava, R.M. (1999). Management Policy and Strategic management (concepts,
skills and practice), 1st ed., Himalaya Publishing House.
Ramaswamy, V.S. and Namakumari, S. (1999). Strategic Planning: Formulation of
corporate strategy (Texts and Cases)-The Indian context, 1st ed., Macmillan India
Limited.

42

Appendix-2

Growth Strategies-II

Case Study-1
Aditya V Birla Group: A Case of a Highly Diversified Group
The Aditya V Birla group is one of the fastest growing industrial houses in the
country. Grasim, a group company, was incorporated as Gwalior Rayon Silk
Manufacturing (Weaving) Co Ltd in 1947. It started as a textile manufacturing mill
and integrated backward in 1954, to produce VSF (Viscose Staple Fiber) used in
textiles. It expanded its capacity further through backward integration into
manufacture of rayon grade wood pulp, caustic soda and manufacturing equipment to
become a low cost producer. Grasim diversified into cement when industry was
decontrolled. It also diversified into production of sponge iron in 1993. Grasim has
presence in exports and computer software as well. It holds significant equity in
several other Birla group companies.
The manufacturing facilities of Grasim are spread all across the country. Grasims
sponge iron plant is located at Raigarh near Mumbai, while its cement plants are
located at Jawad, Shambhupura in Rajasthan and Raipur in MP. The VSF plants are
located at Mavoor and Harihar in Karnataka and Nagda in MP and it has recently set
up a new VSF plant at Surat, Gujarat. It has pulping facilities at Nagda, Harihar and
Mavoor. Grasims textile mills are located at Gwalior and Bhiwani near Delhi.
The Aditya Birla Groups strategy has been to diversify into capital-intensive
businesses and become a cost-leader by leveraging on its various strengths. Apart
from Grasim, major companies in the group include Hindalco Industries Ltd
(aluminium), Indian Rayon (Cement, VFY, carbon black, insulators etc), Indo-Gulf
Fertilizer (Fertilizer - Urea), Tanfac Industries (Chemicals for aluminum), Bihar
Caustic & Chemicals Ltd (Caustic Soda/ chlorine), Hindustan Gas Industries (gas
producer), Birla Growth Fund (financial services), Mangalore Refinery (oil refinery).
Grasim holds a 58.6% stake in Kerala Spinners Ltd, which manufactures synthetic/
blended yarn. Grasims fully owned subsidiaries, Sun God Trading and Investments
Ltd and Samruddhi Swastik Trading and Investments Ltd, are into asset based
financing. The group also owns several companies in Thailand, Indonesia and
Malaysia manufacturing textiles, synthetic/ acrylic yarn, rayon, carbon black and
other chemicals.

Case Study-2
Ispat International: Building a Muscle of Steel
Steel magnate Lakhmi N. Mittals Ispat International announced the acquisition of
LNM Holdings and a merger with the US based International Steel Group Inc (ISG)
in a deal worth $ 17.8 billion to form the worlds largest steel firm, Mittal Steel Co.
Mittal Steel, with operations in 14 countries in Europe, Africa, Asia and the United
States and 165,000 employees will have pro forma revenues of $30 billion in 2004
and an annual production capacity of 70 million tones, according to a statement from
Ispat International. The Netherlands-based Ispat International, 77-percent owned by
Mr.Mittal, will issue 525 million new shares, valued at $ 13.3 billion to the
shareholder of LNM Holdings. The Mittal Steel Co. will then pay $42 a share in cash
and stock-or about $4.5 billion- depending on Mr.Mittals share price, to the ISG
shareholders.
These transactions dramatically change the landscape of the global steel industry.
The coming together of Ispat International, LNM Holdings and ISG, one of the largest
steel producers in America, will create global powerhouse. This combination also

43

Corporate Level
Strategy

provides Mittal Steel with a more significant presence in important industrialized


economies such as those in North America and Europe and in economies that are
expected to experience above average in steel consumption, including Asia and Africa.
According to Mr.Aditya Mittal, President and CEO of the new combined entity, Mittal
Steel will be a leader not only in terms of its global reach and operational excellence
but also among the most profitable steel producers in the world. LNM Holdings
earned $ 9.9 billion revenue and had an operating income of $3.2 billion in the first
nine months of 2004, and was also one of the largest steel companies. (Source: The
Hindu, October 26, 2004)

Case Study-3
Nicholas Piramal India Ltd: Profiting from M and A
Nicholas Piramal India Ltd (NPIL), best known for its growth by mergers and
acquisitions, is among the top ten companies in the domestic formulations market with
a major presence in anti-bacterial, CNS & CVS-Diabetic. NPIL has expanded
aggressively after the Nicholas group took over Nicholas Laboratories in 1986. The
turnover and net profit have grown at a healthy compounded annual growth (CAGR)
of 33% and 45% respectively in the past decade. With more than a dozen joint
ventures with pharmaceutical companies in different healthcare segments, NPIL has
mastered the art of forging JVs and running them successfully.
Prices of over 60% of the drugs and formulations are controlled by the government
through DPCO in the Rs130 billion Indian pharmaceutical market. In the domestic
bulk drugs market, low entry barriers have resulted in overcapacity and price wars.
Major domestic players are, therefore, focusing on formulations, where brand image
and distribution network act as entry barriers. They are increasing their overseas
marketing and manufacturing network to enhance their exports (under patent drugs to
third world countries and generics to developed nations). In anticipation of WTO
regime, multinational corporations are strengthening their operations in India by
setting up 100% subsidiaries or through marketing tie-ups with major domestic
players. The big local players are also strengthening their operations through brand
acquisitions, co-marketing and contract manufacturing tie-ups with MNCs.
Following this trend, NPIL is focusing on strengthening its R&D to gear up for the
patents regime. The companys R&D facility with more than 100 scientists (acquired
from Hoechst Marion in 1999, renamed as Quest science Institute) is one of the best
R&D centers in India. NPIL has hived off its Falconnage (glass) and bulk drug
division into separate entities to improve efficiencies. It is working on seven new
chemical entities (NCE). The first one, an anti-malarial drug, is already
commercialized. NPIL has set a growth target of more than 30% through aggressive
product launches as well as mergers and acquisitions of brands and companies in the
therapeutic segment of anti-bacterial, CVS-diabetes, Nutrition and GI tract and
Central Nervous System (CNS).

44

UNIT 9

GROWTH STRATEGIES-I

Growth Strategies-I

Objectives
The objectives of this unit are to:
l

acquaint you with the concept of corporate strategy;

familiarize you with the various generic corporate strategies;

explain the nature, scope and approaches to implementation of stability and


growth strategies; and

finally discuss the rationale for adopting these strategies.

Structure
9.1

Introduction

9.2

Nature and Scope of Corporate Strategies

9.3

Nature of Stability Strategy

9.4

Expansion Strategies

9.5

Expansion through Intensification

9.6

Expansion through Integration

9.7

International Expansion

9.8

Summary

9.9

Key Words

9.10

Self-Assessment Questions

9.11

References and Further Readings

9.1

INTRODUCTION

Strategic management deals with the issues, concepts, theories approaches and action
choices related to an organizations interaction with the external environment.
Strategy, in general, refers to how a given objective will be achieved. Strategy,
therefore, is mainly concerned with the relationships between ends and means, that is,
between the results we seek and the resources at our disposal. For the most part,
strategy is concerned with deploying the resources at your disposal whereas tactics is
concerned with employing them. Together, strategy and tactics bridge the gap
between ends and means.
Some organizations are groups of different business and functional units, each of them
must be having its own set of goals, which may not necessarily be same as the goals
of the corporate headquarters looking after the interests of the entire organization.
Since the goals are different and the means to achieve them are different, strategies are
likely to be different. This understanding has led to the hierarchical division of
strategy at two levels: a business-level (competitive) strategy and a company-wide
strategy (corporate strategy) (Porter, 1987). In addition to these strategies, many
authors also mention functional strategies, practiced by the functional units of a
business unit, as another level of strategy.
Corporate Strategies: These are concerned with the broad, long-term questions of
what businesses are we in, and what do we want to do with these businesses? The
corporate strategy sets the overall direction the organization will follow. It matters

Corporate Level
Strategy

whether a firm is engaged in one or several businesses. This will influence the overall
strategic direction, what corporate strategy is followed, and how that strategy is
implemented and managed. Corporate strategies vary from drastic retrenchment
through aggressive growth. Top management need to carefully assess the environment
before choosing the fundamental strategies the organization will use to achieve the
corporate objectives.
Competitive Strategies: Those decisions that determine how the firm will compete in
a specific business or industry. This involves deciding how the company will compete
within each line of business or strategic business unit (SBU). Competitive strategies
include being a low-cost leader, differentiator, or focuser. Formulating a specific
competitive strategy requires understanding the competitive forces that determine how
intense the competitive forces are and how best to compete.
Functional Strategies: Also called operational strategies, are the short-term (less than
one year), goal-directed decisions and actions of the organizations various functional
departments. These are more localized and shorter-horizon strategies and deal with
how each functional area and unit will carry out its functional activities to be effective
and maximize resource productivity. Functional strategies identify the basic courses of
action that each functional department in a strategic business unit will pursue to
contribute to the attainment of its goals.
In a nutshell, corporate-level strategy identifies the portfolio of businesses that in total
will comprise the corporation and the ways in which these businesses will relate. The
competitive strategy identifies how to build and strengthen the businesss long-term
competitive position in the marketplace while the functional strategies identify the
basic courses of action that each department will pursue to contribute to the
attainment of its goals.
Activity 1
Explain the various corporate, competitive and functional strategies followed by a
firm of your choice. What is the impact of these strategies on the firms performance?
............................................................................................................................................................
............................................................................................................................................................
............................................................................................................................................................
............................................................................................................................................................

Corporate Strategy
Corporate strategy is essentially a blueprint for the growth of the firm. The corporate
strategy sets the overall direction for the organization to follow. It also spells out the
extent, pace and timing of the firms growth. Corporate strategy is mainly concerned
with the choice of businesses, products and markets. The competitive and functional
strategies of the firm are formulated to synchronize with the corporate strategy to
enable it to reach its desired objectives. Defined formally, a corporate-level strategy is
an action taken to gain a competitive advantage through the selection and management
of a mix of businesses competing in several industries or product markets. Corporate
strategies are normally expected to help the firm earn above-average returns and
create value for the shareholders (Markides, 1997). Corporate strategy addresses the
issues of a multi-business enterprise as a whole. Corporate strategy addresses issues
relating to the intent, scope and nature of the enterprise and in particular has to
provide answers to the following questions:
l

What should be the nature and values of the enterprise in the broadest sense?
What are the aims in terms of creating value for stakeholders?

What kind of businesses should we be in? What should be the scope of activity in
the future so what should we divest and what should we seek to add?

What structure, systems and processes will be necessary to link the various
businesses to each other and to the corporate centre?

How can the corporate centre add value to make the whole worth more than the
sum of the parts?

Growth Strategies-I

A primary approach to corporate level strategy is diversification, which requires the


top-level executives to craft a multibusiness strategy. In fact, one reason for the use of
a diversification strategy is that managers of diversified firms possess unique
management skills that can be used to develop multibusiness strategies and enhance a
firms competitiveness (Collins and Montgomery, 1998). Most corporate level
strategies have three major components:
a)

Growth or directional strategy, outlines the growth objectives ranging from


drastic retrenchment through stability to varying degrees of growth and methods
and approaches to accomplish these objectives.

b)

Corporations are responsible for creating value through their businesses. They do
so by using a portfolio strategy to manage their portfolio of businesses, ensure
that the businesses are successful over the long-term, develop business units, and
ensure that each business is compatible with others in the portfolio. Portfolio
strategy plans the necessary moves to establish positions in different businesses
and achieve an appropriate amount and kind of diversification. Portfolio strategy
is an important component of corporate strategy in a multibusiness corporation.
The top management views its product lines and business unit as a portfolio of
investments from which it expects a profitable return. A key part of corporate
strategy is making decisions on how many, what types, and which specific lines
of business the company should be in. This may involve decisions to increase or
decrease the breadth of diversification by closing out some lines of business,
adding others, and changing emphasis among the portfolio of businesses. A
portfolio strategy is concerned not only about choice of business portfolio, but
also about portfolio of geographical markets for acquisition of inputs, locating
various value chain activities and selling of outputs. In short, a portfolio strategy
facilitates efficient allocation of corporate resources, links the businesses and
geographically dispersed activities and builds synergy leading to corporate or
parenting advantage.

c)

Corporate parenting strategy, which tries to capture valuable cross-business


strategic fits in a portfolio of business and turn them into competitive
advantages, especially transferring and sharing related technology, procurement
leverage, operating facilities, distribution channels, and/or customers. In other
words, it decides how we allocate resources and manage capabilities and
activities across the portfolio where do we put special emphasis, and how
much do we integrate our various lines of business. Corporate parenting views
the corporation in terms of resources and capabilities that can be used to build
business units value as well as generate synergies across business units.
Corporate parenting generates corporate strategy by focusing on the core
competencies of the parent corporation and on the value create from the
relationship between the parent and its businesses. To achieve corporate
parenting advantage a corporation needs to do at least the following.
l
l
l
l

Better choice of business to compete.


Superior acquisition and development of corporate resources.
Effective deployment, monitoring and controlling of corporate resources.
Sharing and transferring of resources from one business to other leading to
synergy.

Corporate Level
Strategy

9.2

NATURE AND SCOPE OF CORPORATE


STRATEGIES

Growth is essential for an organization. Organizations go through an inevitable


progression from growth through maturity, revival, and eventually decline. The broad
corporate strategy alternatives, sometimes referred to as grand strategies, are:
stability/consolidation, expansion/growth, divestment/retrenchment and combination
strategies. During the organizational life cycle, managements choose between growth,
stability, or retrenchment strategies to overcome deteriorating trends in performance.
Just as every product or business unit must follow a business strategy to improve its
competitive position, every corporation must decide its orientation towards growth by
asking the following three questions:
l

Should we expand, cut back, or continue our operations unchanged?

Should we concentrate our activities within our current industry or should we


diversify into other industries?

If we want to grow and expand nationally and/or globally, should we do so


through internal development or through external acquisitions, mergers, or
strategic alliances?

At the core of corporate strategy must be a clear logic of how the corporate objectives,
will be achieved. Most of the strategic choices of successful corporations have a
central economic logic that serves as the fulcrum for profit creation. Some of the
major economic reasons for choosing a particular type corporate strategy are:
a)

Exploiting operational economies and financial economies of scope.

b)

Uncertainty avoidance and efficiency.

c)

Possession of management skills that help create corporate advantage.

d)

Overcoming the inefficiency in factor markets and

e)

Long term profit potential of a business.

The non-economic reasons for the choice of corporate strategy elements include
a) dominant view of the top management, b) employee incentives to diversify
(maximizing management compensation), c) desire for more power and management
control, d) ethical considerations and e) corporate social responsibility.
There are four types of generic corporate strategies. They are:
l

Stability strategies: make no change to the companys current activities

Growth strategies: expand the companys activities

Retrenchment strategies: reduce the companys level of activities

Combination strategies: a combination of above strategies

Each one of the above strategies has a specific objective. For instance, a concentration
strategy seeks to increase the growth of a single product line while a diversification
strategy seeks to alter a firms strategic track by adding new product lines.
A stability strategy is utilized by a firm to achieve steady, but slow improvements in
growth while a retrenchment strategy (which includes harvesting, turnaround,
divestiture, or liquidation strategies) is used to reverse poor-organizational
performance. Once a strategic direction has been identified, it then becomes necessary
for management to examine business and functional level strategies of the firm to
make sure that all units are moving towards the achievement of the company-wide
corporate strategy.
8

Stability Strategy

Growth Strategies-I

Stability strategy is a strategy in which the organization retains its present strategy at
the corporate level and continues focusing on its present products and markets. The
firm stays with its current business and product markets; maintains the existing level
of effort; and is satisfied with incremental growth. It does not seek to invest in new
factories and capital assets, gain market share, or invade new geographical
territories. Organizations choose this strategy when the industry in which it operates
or the state of the economy is in turmoil or when the industry faces slow or no growth
prospects. They also choose this strategy when they go through a period of rapid
expansion and need to consolidate their operations before going for another bout of
expansion.

Growth Strategy
Firms choose expansion strategy when their perceptions of resource availability and
past financial performance are both high. The most common growth strategies are
diversification at the corporate level and concentration at the business level. Reliance
Industry, a vertically integrated company covering the complete textile value chain has
been repositioning itself to be a diversified conglomerate by entering into a range of
business such as power generation and distribution, insurance, telecommunication,
and information and communication technology services. Diversification is defined
as the entry of a firm into new lines of activity, through internal or external modes.
The primary reason a firm pursues increased diversification are value creation through
economies of scale and scope, or market dominance. In some cases firms choose
diversification because of government policy, performance problems and uncertainty
about future cash flow. In one sense, diversification is a risk management tool, in that
its successful use reduces a firms vulnerability to the consequences of competing in a
single market or industry. Risk plays a very vital role in selecting a strategy and
hence, continuous evaluation of risk is linked with a firms ability to achieve strategic
advantage (Simons, 1999). Internal development can take the form of investments in
new products, services, customer segments, or geographic markets including
international expansion. Diversification is accomplished through external modes
through acquisitions and joint ventures. Concentration can be achieved through
vertical or horizontal growth. Vertical growth occurs when a firm takes over a
function previously provided by a supplier or a distributor. Horizontal growth occurs
when the firm expands products into new geographic areas or increases the range of
products and services in current markets.

Retrenchment Strategy
Many firms experience deteriorating financial performance resulting from market
erosion and wrong decisions by management. Managers respond by selecting
corporate strategies that redirect their attempt to turnaround the company by
improving their firms competitive position or divest or wind up the business if a
turnaround is not possible. Turnaround strategy is a form of retrenchment strategy,
which focuses on operational improvement when the state of decline is not severe.
Other possible corporate level strategic responses to decline include growth and
stability.

Combination Strategy
The three generic strategies can be used in combination; they can be sequenced, for
instance growth followed by stability, or pursued simultaneously in different parts of
the business unit. Combination Strategy is designed to mix growth, retrenchment, and
stability strategies and apply them across a corporations business units. A firm

Corporate Level
Strategy

adopting the combination strategy may apply the combination either simultaneously
(across the different businesses) or sequentially. For instance, Tata Iron & Steel
Company (TISCO) had first consolidated its position in the core steel business, then
divested some of its non-core businesses. Reliance Industries, while consolidating its
position in the existing businesses such as textile and petrochemicals, aggressively
entered new areas such as Information Technology.
Activity 2
Search the website for information on Reliance Group, Tata group and Aditya Birla
group of companies. Compare the business models and briefly explain the type of
corporate strategies that these corporates are following.
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9.3

NATURE OF STABILITY STRATEGY

A firm following stability strategy maintains its current business and product
portfolios; maintains the existing level of effort; and is satisfied with incremental
growth. It focuses on fine-tuning its business operations and improving functional
efficiencies through better deployment of resources. In other words, a firm is said to
follow stability/ consolidation strategy if:
l

It decides to serve the same markets with the same products;

It continues to pursue the same objectives with a strategic thrust on incremental


improvement of functional performances; and

It concentrates its resources in a narrow product-market sphere for developing a


meaningful competitive advantage.

Adopting a stability strategy does not mean that a firm lacks concern for business
growth. It only means that their growth targets are modest and that they wish to
maintain a status quo. Since products, markets and functions remain unchanged,
stability strategy is basically a defensive strategy. A stability strategy is ideal in stable
business environments where an organization can devote its efforts to improving its
efficiency while not being threatened with external change. In some cases,
organizations are constrained by regulations or the expectations of key stakeholders
and hence they have no option except to follow stability strategy.
Generally large firms with a sizeable portfolio of businesses do not usually depend on
the stability strategy as a main route, though they may use it under certain special
circumstances. They normally use it in combination with the other generic strategies,
adopting stability for some businesses while pursuing expansion for the others.
However, small firms find this a very useful approach since they can reduce their risk
and defend their positions by adopting this strategy. Niche players also prefer this
strategy for the same reasons.

Conditions Favouring Stability Strategy

10

Stability strategy does entail changing the way the business is run, however, the range
of products offered and the markets served remain unchanged or narrowly focused.
Hence, the stability strategy is perceived as a non-growth strategy. As a matter of fact,
stability strategy does provide room for growth, though to a limited extent, in the
existing product-market area to achieve current business objectives. Implementing

stability strategy does not imply stagnation since the basic thrust is on maintaining the
current level of performance with incremental growth in ensuing periods. An
organizations strategists might choose stability when:
l

The industry or the economy is in turmoil or the environment is volatile.


Uncertain conditions might convince strategists to be conservative until they
became more certain.

Environmental turbulence is minimal and the firm does not foresee any major
threat to itself and the industry concerned as a whole.

The organization just finished a period of rapid growth and needs to consolidate
its gains before pursuing more growth.

The firms growth ambitions are very modest and it is content with incremental growth

The industry is in a mature stage with few or no growth prospects and the firm is
currently in a comfortable position in the industry

Growth Strategies-I

Rationale for Using Stability Strategy


There are a number of circumstances in which the most appropriate growth stance for
a company is stability rather than growth. Stability strategy is normally followed for
a brief period to consolidate the gains of its expansion and needs a breathing spell
before embarking on the next round of expansion. Organizations need to cool off for
a while after an aggressive phase of expansion and must stabilize for a while or they
will become inefficient and unmanageable. India Cements went through a rapid
expansion by acquiring other cement companies before stabilizing and consolidating
its operations. Videocon and BPL had first diversified into new businesses and then
started consolidating once faced with stiff competition.
Managers pursue stability strategy when they feel that the enterprise has been
performing well and wish to maintain the same trend in subsequent years. They would
prefer to adopt the existing product-market posture and avoid departing from it.
Sometimes, the management is content with the status quo because the company
enjoys a distinct competitive advantage and hence does not perceive an immediate
threat.
Stability strategy is also adopted in a number of organizations because the
management is not interested in taking risks by venturing into unknown terrain. In fact
they do not consider any other option as long as the pursuit of existing business
activity produces the desired results. Conservative managers believe product
development, market development or new ways of doing business entail great risk and
therefore, avoid taking decisions, which can endanger the company. A number of
managers also pursue consolidation strategy involuntarily. In fact, they do not react to
environmental changes and avoid drastic changes in the current strategy unless
warranted by extraordinary circumstances.
Sometimes environmental forces compel an organization to follow the strategy of
status quo. This is particularly true for bigger organizations, which have acquired
dominant market share. Such organizations are usually not permitted by the
government to expand because it may lead to monopolistic and restrictive trade
practices detrimental to public interest.

Approaches to Stability Strategy


There are various approaches to developing stability/consolidation strategy. The
Management has to select the one that best suits the corporate objective. Some of
these approaches are discussed below. In all these approaches, the fundamental course
of action remains the same, but the circumstances in which the firms choose various
options differ.

11

Corporate Level
Strategy

Holding Strategy: This alternative may be appropriate in two situations: (a) the need
for an opportunity to rest, digest, and consolidate after growth or some turbulent
events - before continuing a growth strategy, or (b) an uncertain or hostile
environment in which it is prudent to stay in a holding pattern until there is change
in or more clarity about the future in the environment. With a holding strategy the
company continues at its present rate of development. The aim is to retain current
market share. Although growth is not pursued as such, this will occur if the size of
the market grows. The current level of resource input and managerial effort will not
be increased, which means that the functional strategies will continue at previous
levels. This approach suits a firm, which does not have requisite resources to pursue
increased growth for a longer period of time. At times, environmental changes
prohibit a continuation in growth.
Stable Growth: This alternative essentially involves avoiding change, representing
indecision or timidity in making a choice for change. Alternatively, it may be a
comfortable, even long-term strategy in a mature, rather stable environment, e.g., a
small business in a small town with few competitors. It simply means that the firms
strategy does not include any bold initiatives. It will just seek to do what it already
does, but a little better. In this approach, the firm concentrates on one product or
service line. It grows slowly but surely, increasingly its market penetration by steadily
adding new products or services and carefully expanding its market.
Harvesting Strategy: Where a firm has the dominant market share, it may seek to
take advantage of this position and generate cash for future business expansion.
This is termed has harvesting strategy and is usually associated, with cost cutting and
price increases to generate extra profits. This approach is most suitable to a firm
whose main objective is to generate cash. Even market share may be sacrificed to
earn profits and generate funds. A number of ways can be used to accomplish the
objective of making profits and generating funds. Some of these are selective
price increases and reducing costs without reducing price. In this approach,
selected products are milked rather than nourished and defended. Hindustan
Levers Lifebuoy soap is an example in point. It yielded large profits under careful
management
Profit or Endgame Strategy: A profit strategy is one that capitalizes on a situation in
which old and obsolete product or technology is being replaced by a new one. This
type of strategy does not require new investment, so it is not a growth strategy. Firms
adopting this strategy decide to follow the same technology, at least partially, while
transiting into new technological domains. Strategists in these firms reason that the
huge number of product based on older technologies on the market would create an
aftermarket for spare parts that would last for years. Sylvania, RCA, and GE are
among the firms that followed this strategy. They decided to stay in the vacuum tube
market until the end of the game. As with most business decisions, timing is critical.
All competitors eventually must shelve the old assets at some point of time and move
to the new product or technology. The critical question is, Can we make more money
by using these assets or by selling them? The answer to that question changes as time
passes.
Activity 3
Identify Indian companies following stability strategy. Also identify the type of
stability strategy followed by these firms.
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12

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9.4

EXPANSION STRATEGIES

Growth Strategies-I

Every enterprise seeks growth as its long-term goal to avoid annihilation in a


relentless and ruthless competitive environment. Growth offers ample opportunities to
everyone in the organization and is crucial for the survival of the enterprise. However,
this is possible only when fundamental conditions of expansion have been met.
Expansion strategies are designed to allow enterprises to maintain their competitive
position in rapidly growing national and international markets. Hence to successfully
compete, survive and flourish, an enterprise has to pursue an expansion strategy.
Expansion strategy is an important strategic option, which enterprises follow to fulfill
their long-term growth objectives. They pursue it to gain significant growth as
opposed to incremental growth envisaged in stability strategy. Expansion strategy is
adopted to accelerate the rate of growth of sales, profits and market share faster by
entering new markets, acquiring new resources, developing new technologies and
creating new managerial capabilities.
Expansion strategy provides a blueprint for business enterprises to achieve their longterm growth objectives. It allows them to maintain their competitive advantage even
in the advanced stages of product and market evolution. Growth offers economies of
scale and scope to an organization, which reduce operating costs and improve
earnings. Apart from these advantages the organization gains a greater control over
the immediate environment because of its size. This influence is crucial for survival in
mature markets where competitors aggressively defend their market shares.

Conditions for Opting for Expansion Strategy


Firms opt for expansion strategy under the following circumstances:
l

When the firm has lofty growth objectives and desires fast and continuous
growth in assets, income and profits. Expansion through diversification would be
especially useful to firms that are eager to achieve large and rapid growth since it
involves exploiting new opportunities outside the domain of current operations.

When enormous new opportunities are emerging in the environment and the firm
is ready and willing to expand its business scope

Firms find expansion irresistible since sheer size translates into superior clout.

When a firm is a leader in its industry and wants to protect its dominant position.

Expansion strategy is opted in volatile situations. Substantive growth would act


as a cushion in such conditions.

When the firm has surplus resources, it may find it sensible to grow by levering
on its strengths and resources.

When the environment, especially the regulatory scenario, blocks the growth of
the firm in its existing businesses, it may resort to diversification to meets its
growth objectives.

When the firm enjoys synergy that ensues by tapping certain opportunities in the
environment, it opts for expansion strategies. Economies of scale and scope and
competitive advantage may accrue through such synergistic operations. Over the
last decade, in response to economic liberalisation, some companies in India
expanded the scale of existing businesses as well as diversified into many new
businesses.

Growth of a business enterprise entails realignment of its strategies in product


market environment. This is achieved through the basic growth approaches of
intensive expansion, integration (horizontal and vertical integration), diversification
and international operations. Firms following intensification strategy concentrate on

13

Corporate Level
Strategy

their primary line of business and look for ways to meet their growth objectives by
increasing their size of operations in this primary business. A company may expand
externally by integrating with other companies. An organization expands its
operations by moving into a different industry by pursuing diversification strategies.
An organization can grow by going international, i.e., by crossing domestic borders
by employing any of the expansion strategies discussed so far.

9.5

EXPANSION THROUGH INTENSIFICATION

Intensification involves expansion within the existing line of business. Intensive


expansion strategy involves safeguarding the present position and expanding in the
current product-market space to achieve growth targets. Such an approach is very
useful for enterprises that have not fully exploited the opportunities existing in their
current products-market domain. A firm selecting an intensification strategy,
concentrates on its primary line of business and looks for ways to meet its growth
objectives by increasing its size of operations in its primary business. Intensive
expansion of a firm can be accomplished in three ways, namely, market penetration,
market development and product development first suggested in Ansoffs model.
Intensification strategy is followed when adequate growth opportunities exist in the
firms current products-market space. However, while going in for internal expansion,
the management should consider the following factors.
l

While there are a number of expansion options, the one with the highest net
present value should be the first choice.

Competitive behaviour should be predicted in order to determine how and when


the competitors would respond to the firms actions. The firm must also assess
its strengths and weaknesses against its competitors to ascertain its competitive
advantages.

The conditions prevailing in the environment should be carefully examined to


determine the demand for the product and the price customers are willing to pay.

The firm must have adequate financial, technological and managerial capabilities
to expand the way it chooses.

Technological, social and demographic trends should be carefully monitored


before implementing product or market development strategies. This is very
crucial, especially, in a volatile business environment.

Ansoffs Product-Market Expansion Grid


The product/market grid first presented by Igor Ansoff (1968), shown in exhibit 1, has
proven to be very useful in discovering growth opportunities. This grid best illustrates
the various intensification options available to a firm. The product/market grid has
two dimensions, namely, products and markets. Combinations of these two dimensions
result in four growth strategies. According to Ansoffs Grid, three distinct strategies
are possible for achieving growth through the intensification route. These are:

14

Market Penetration: The firm seeks to achieve growth with existing products in
their current market segments, aiming to increase its markets share.

Market Development: The firm seeks growth by targeting its existing products
to new market segments.

Product Development: The firm develops new products targeted to its existing
market segments.

Diversification: The firm grows by diversifying into new businesses by


developing new products for new markets.

Growth Strategies-I

Exhibit 1: Ansoffs Grid


Markets/Products

Current Markets

New Markets

Current Products

Market Penetration

Market Development

New Products

Product Development

Diversification

Market Penetration
When a firm believes that there exist ample opportunities by aggressively exploiting
its current products and current markets, it pursues market penetration approach.
Market penetration involves achieving growth through existing products in existing
markets and a firm can achieve this by:
l

Motivating the existing customers to buy its product more frequently and in
larger quantities. Market penetration strategy generally focuses on changing the
infrequent users of the firms products or services to frequent users and frequent
users to heavy users. Typical schemes used for this purpose are volume
discounts, bonus cards, price promotion, heavy advertising, regular publicity,
wider distribution and obviously through retention of customers by means of an
effective customer relationship management.

Increasing its efforts to attract its competitors customers. For this purpose, the
firm must develop significant competitive advantages. Attractive product design,
high product quality, attractive prices, stronger advertising, and wider
distribution can assist an enterprise in gaining lead over its competitors. All
these require heavy investment, which only firms with substantial resources, can
afford. Firms less endowed may search for niche segments. Many small
manufacturers, for instance, survive by seeking out and cultivating profitable
niches in the market. They may also grow by developing highly specialized and
unique skills to cater to a small segment of exclusive customers with special
requirements.

Targeting new customers in its current markets. Price concessions, better


customer service, increasing publicity and other techniques can be useful in this
effort.

In a growing market, simply maintaining market share will result in growth, and there
may exist opportunities to increase market share if competitors reach capacity limits.
While following market penetration strategy, the firm continues to operate in the same
markets offering the same products. Growth is achieved by increasing its market
share with existing products. However, market penetration has limits, and once the
market approaches saturation another strategy must be pursued if the firm is to
continue to grow. Unless there is an intrinsic growth in its current market, this
strategy necessarily entails snatching business away from competitors. The market
penetration strategy is the least risky since it leverages many of the firms existing
resources and capabilities. Another advantage of this strategy is that it does not
require additional investment for developing new products.

Market Development Strategy


Market Development strategy tries to achieve growth by introducing existing products
in new markets. Market development options include the pursuit of additional market
segments or geographical regions. The development of new markets for the product
may be a good strategy if the firms core competencies are related more to the specific
product than to its experience with a specific market segment or when new markets
offer better growth prospects compared to the existing ones. Because the firm is
expanding into a new market, a market development strategy typically has more risk
than a market penetration strategy. This is because managers do not normally possess

15

Corporate Level
Strategy

sound knowledge of new markets, which may result in inaccurate market assessment
and wrong marketing decisions.
In market development approach, a firm seeks to increase its sales by taking its
product into new markets. The two possible methods of implementing market
development strategy are, (a) the firm can move its present product into new
geographical areas. This is done by increasing its sales force, appointing new channel
partners, sales agents or manufacturing representatives and by franchising its
operation; or (b) the firm can expand sales by attracting new market segments.
Making minor modifications in the existing products that appeal to new
segments can do the trick.

Product Development Strategy


Expansion through product development involves development of new or
improved products for its current markets. The firm remains in its present
markets but develops new products for these markets. Growth will accrue if the new
products yield additional sales and market share. This strategy is likely to
succeed for products that have low brand loyalty and/or short product life cycles.
A Product development strategy may also be appropriate if the firms strengths are
related to its specific customers rather than to the specific product itself. In this
situation, it can leverage its strengths by developing a new product targeted to its
existing customers. Although the firm operates in familiar markets, product
development strategy carries more risk than simply attempting to increase
market share since there are inherent risks normally associated with new
product development.
The three possible ways of implementing the product development strategy are:
l

The company can expand sales through developing new products.

The company can create different or improved versions of the current products.

The company can make necessary changes in its existing products to suit the
different likes and dislikes of the customers.

Combination Strategy
Combination strategy combines the intensification strategy variants i.e., market
penetration, market development and product development to grow. In the market
development and market penetration strategy, the firm continues with its current
product portfolio, while the product development strategy involves developing new or
improved products, which will satisfy the current markets.
Activity 4
Search for information about Hindustan Lever Limited and explain which of the above
intensification strategies is it currently following. Why is the company following these
strategies? Discuss.
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16

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9.6

EXPANSION THROUGH INTEGRATION

Growth Strategies-I

In contrast to the intensive growth, integration strategy involves expanding externally


by combining with other firms. Combination involves association and integration
among different firms and is essentially driven by need for survival and also for
growth by building synergies. Combination of firms may take the merger or
consolidation route. Merger implies a combination of two or more concerns into one
final entity. The merged concerns go out of existence and their assets and liabilities are
taken over by the acquiring company. A consolidation is a combination of two or
more business units to form an entirely new company. All the original business
entities cease to exist after the combination. Since mergers and consolidations
involve the combination of two or more companies into a single company, the term
merger is commonly used to refer to both forms of external growth. As is the case in
all the strategies, acquisition is a choice a firm has made regarding how it intends to
compete (Markides, 1999). Firms use integration to (1) increase market share,
(2) avoid the costs of developing new products internally and bringing them to the
market, (4) reduce the risk of entering new business, (5) speed up the process of
entering the market, (6) become more diversified and (7) quite possibly to reduce the
intensity of competition by taking over the competitors business. The costs of
integration include reduced flexibility as the organization is locked into specific
products and technology, financial costs of acquiring another company and difficulties
in integrating various operations. There are many forms of integration, but the two
major ones are vertical and horizontal integration.
i) Vertical Integration: Vertical integration refers to the integration of firms
involved in different stages of the supply chain. Thus, a vertically integrated firm has
units operating in different stages of supply chain starting from raw material to
delivery of final product to the end customer. An organization tries to gain control of
its inputs (called backwards integration) or its outputs (called forward integration) or
both. Vertical integration may take the form of backward or forward integration or
both. The concept of vertical integration can be visualized using the value chain.
Consider a firm whose products are made via an assembly process. Such a firm may
consider backward integrating into intermediate manufacturing or forward integrating
into distribution. Backward integration sometimes is referred to as upstream
integration and forward integration as downstream integration. For instance, Nirma
undertook backward integration by setting up plant to manufacture soda ash and
linear alkyl benzene, both important inputs for detergents and washing soaps, to
strengthen its hold in the lower-end detergents market. Forward integration refers to
moving closer to the ultimate customer by increasing control over distribution
activities. For example, a personal computer assembler could own a chain of retail
stores from which it sells its machines (forward integration). Many firms in India such
as DCM, Mafatlal and National Textile Corporation have set up their own retail
distribution systems to have better control over their distribution activities.
Some companies expand vertically backwards and forward. Reliance
Petrochemicals grew by leveraging backward and forward integration: it
began with manufacturing of textiles and fibres, moved to polymers and other
intermediates then went into the manufacture of fibres, then to petrochemicals and oil
refining. In power, Reliance Energy wants to do the same thing and the catchphrase
that for this vertical integration is from well-head to wall-socket. Reliance
Energys strategy is to straddle the entire value chain in the power business.
It plans to generate power by using the groups production of gas, transmit and
distribute it to the domestic and industrial consumers, reaping the returns of not just
generating power using its own gas but selling what it generates not as a bulk
supplier but to the end user.
17

Corporate Level
Strategy

In essence, a firm seeks to grow through vertical integration by taking control of the
business operations at various stages of the supply chain to gain advantage over its
rivals. The record of vertical integration is mixed and hence, decisions should be taken
after a comprehensive and careful consideration of all aspects of this form of
integration. In most cases the initial investments may be very high and exiting an
arrangement that does not prove beneficial may be hard. Vertical integration also
requires an organization to develop additional product market and technology
capabilities, which it may not currently possess.
Factors conducive for vertical integration include (1) taxes and regulations on market
transactions, (2) obstacles to the formulation and monitoring of contracts,
(3) similarity between the vertically-related activities, (4) sufficient large production
quantities so that the firm can benefit from economies of scale and (5) reluctance of
other firms to make investments specific to the transaction. Vertical integration may
not yield the desired benefit if, (1) the quantity required from a supplier is much less
than the minimum efficient scale for producing the product. (2) the product is widely
available commodity and its production cost decreases significantly as cumulative
quantity increases, (3) the core competencies between the activities are very different,
(4) the vertically adjacent activities are in very different types of industries (For
example, manufacturing is very different from retailing.) and (5) the addition of the
new activity places the firm in competition with another player with which it needs to
cooperate. The firm then may be viewed as a competitor rather than a partner.
Firms integrate vertically to (1) reduce transportation costs if common ownership
results in closer geographic proximity, (2) improve supply chain coordination,
(3) capture upstream or downstream profit margins, (4) increase entry barriers to
potential competitors, for example, if the firm can gain sole access to scarce resource,
(5) gain access to downstream distribution channels that otherwise would be
inaccessible, (6) facilitate investment in highly specialized assets in which upstream or
downstream players may be reluctant to invest and (7) facilitate investment in highly
specialized assets in which upstream or downstream players may be reluctant to
invest.
The downside risks of an integration strategy to a company include (1) difficulty of
effectively integrating the firms involved, (2) incorrect evaluation of target firms
value, (3) overestimating the potential for synergy between the companies involved,
(4) creating a combination too large to control, (5) the huge financial burden that
acquisition entails, (6) capacity balancing issues. (For instance, the firm may need to
build excess upstream capacity to ensure that its downstream operations have
sufficient supply under all demand conditions), (7) potentially higher costs due to low
efficiencies resulting from lack of supplier competition, (8) decreased flexibility due to
previous upstream or downstream investments, (however, that flexibility to coordinate
vertically related activities may increase.), (9) decreased ability of increase product
variety if significant in-house development is required, and (10) developing new core
competencies may compromise existing competencies.
There are alternatives to vertical integration that may provide some of the same
benefits with fewer drawbacks. The following are a few of these alternatives for
relationships between vertically related organizations.

18

Long-term explicit contracts

Franchise agreements

Joint ventures

Co-location of facilities

Implicit contracts (relying on firms reputation)

Figure 9.1 shows the backward and forward integration followed by an illustration:
No Integration

Backward Integration

Forward Integration

Raw Materials

Raw Materials

Raw Materials

Intermediate
Manufacturing

Assembly

Assembly

Intermediate
Manufacturing

Intermediate
Manufacturing

Growth Strategies-I

Assembly

Distribution

Distribution
s

Distribution

End Customer

End Customer

End Customer

Figure 9.1: Backward and Forward Integration


Illustration: Digital Giants to Accelerate Vertical Integration
Samsung Electronics and LG Electronics plan to streamline production lines in
cooperation with their affiliates to reduce factors of uncertainty in the procurement
of components. The two South Korean giants seek to manufacture top-of-the-line
products like cell phones and digital TVs in a self-sufficient fashion. LG Group will
invest 30 trillion won by 2010 to develop certain electronic components that include
system integrated chips, plasma displays and camera modules. Samsung Electronics
already retains a strong portfolio, comprising Samsung Corning (display-specific
glass), Samsung SDI (displays) and Samsung Electro-Mechanics (camera
modules), and aims to further hone its push for vertical integration.
So-called vertical integration refers to the degree to which a company owns or
controls its upstream suppliers, subcontractors or affiliates and its downstream
buyers. The advantage of the strategy is the expansion of core competencies by
reducing risks in the supply of components as well as the slashing of transportation
costs. Some experts have said vertical integration is vital to the improvement of
these two giant digital firms competitiveness despite criticism that such expansion
would increase the entry barriers for industry newcomers.
Source: Korean Times
ii) Horizontal Combination / Integration: The acquisition of additional business in
the same line of business or at the same level of the value chain (combining with
competitors) is referred to as horizontal integration. Horizontal growth can be
achieved by internal expansion or by external expansion through mergers and
acquisitions of firms offering similar products and services. A firm may diversify by
growing horizontally into unrelated business. Integration of oil companies, Exxon and
Mobil, is an example of horizontal integration. Aditya Birla Groups acquisition of
L&T Cements from Reliance to increase its market dominance is an example of

19

Corporate Level
Strategy

horizontal integration. This sort of integration is sought to reduce intensity of


competition and also to build synergies.

Benefits of Horizontal Integration


The following are some benefits of horizontal integration:
l

Economies of scale-achieved by selling more of the same product, for example,


by geographic expansion.

Economies of scope achieved by sharing resources common to different


products. Commonly referred to as synergies.

Increased bargaining power over suppliers and downstream channel members.

Reduction in the cost of global operations made possible by operating plants in


foreign markets.

Synergy achieved by using the same brand name to promote multiple products.

Hazards of Horizontal Integration


Horizontal integration by acquisition of a competitor will increase a firms market
share. However, if the industry concentration increases significantly then anti-trust
issues may arise. Aside from legal issues, another concern is whether the anticipated
economic gains will materialize. Before expanding the scope of the firm through
horizontal integration, management should be sure that the imagined benefits are real.
Many blunders have been made by firms that broadened their horizontal scope to
achieve synergies that did not exist, for example, computer hardware manufacturers
who entered the software business on the premise that there were synergies between
hardware and software. However, a connection between two products does not
necessarily imply realizable economies of scope. Finally, even when the potential
benefits of horizontal integration exist, they do not materialize spontaneously. There
must be an explicit horizontal strategy in place. Such strategies generally do not arise
from the bottom up, but rather, must be formulated by corporate management.

9.7

INTERNATIONAL EXPANSION

An organization can go international by crossing domestic borders as it employs


any of the strategies discussed above. International expansion involves establishing
significant market interests and operations outside a companys home country.
Foreign markets provide additional sales opportunities for a firm that may be
constrained by the relatively small size of its domestic market and also reduces the
firms dependence on a single national market. Firms expand globally to seek
opportunity to earn a return on large investments such as plant and capital equipment
or research and development, or enhance market share and achieve scale economies,
and also to enjoy advantages of locations. Other motives for international expansion
include extending the product life cycle, securing key resources and using low-cost
labour. However, to mold their firms into truly global companies, managers must
develop global mind-sets. Traditional means of operating with little cultural
diversity and without global competition are no longer effective firms
(Kedia and Mukherji, 1999).
International expansion is fraught with various risks such as, political risks (e.g.
instability of host nations) and economic risks (e.g. fluctuations in the value of the
countrys currency). International expansions increases coordination and distribution
costs, and managing a global enterprise entails problems of overcoming trade barriers,
logistics costs, cultural diversity, etc.
20

There are several methods for going international. Each method of entering an
overseas market has its own advantages and disadvantages that must be carefully
assessed. Different international entry modes involve a tradeoff between level of risk
and the amount of foreign control the organizations managers are willing to allow. It
is common for a firm to begin with exporting, progress to licensing, then to
franchising finally leading to direct investment. As the firm achieves success at each
stage, it moves to the next. If it experiences problems at any of these stages, it may not
progress further. If adverse conditions prevail or if operations do not yield the desired
returns in a reasonable time period, the firm may withdraw from the foreign market.
The decision to enter a foreign market can have a significant impact on a firm.
Expansion into foreign markets can be achieved through:
l
l
l
l

Growth Strategies-I

Exporting
Licensing
Joint Venture
Direct Investment

Exporting: Exporting is marketing of domestically produced goods in a foreign


country and is a traditional and well-established method of entering foreign markets.
It does not entail new investment since exporting does not require separate production
facilities in the target country. Most of the costs incurred for exporting products are
marketing expenses.
Licensing: Licensing permits a company in the target country to use the property of
the licensor. Such property usually is intangible, such as trademarks, patents, and
production techniques. The licensee pays a fee in exchange for the rights to use the
intangible property and possible for technical assistance. Licensing has the potential
to provide a very large ROI since this mode of foreign entry also does require
additional investments. However, since the licensee produces and markets the product,
potential returns from manufacturing and marketing activities may be lost.
Joint Venture: There are five common objectives in a joint venture: market entry,
risk/reward sharing, technology sharing and joint product development, and
conforming to government regulations. Other benefits include political connections
and distribution channel access that may depend on relationships.
Joint ventures are favoured when:
l
l

The partners strategic goals converge while their competitive goals diverge;
The partners size, market power, and resources are small compared to the
industry leaders; and
Partners are able to learn from one another while limiting access to their own
proprietary skills.

The critical issues to consider in a joint venture are ownership, control, length of
agreement, pricing, technology transfer, local firm capabilities and resources, and
government intentions. Potential problems include, conflict over asymmetric
investments, mistrust over proprietary knowledge, performance ambiguity how to
share the profits and losses, lack of parent firm support, cultural conflicts, and finally,
when and how when to terminate the relationship.
Joint ventures have conflicting pressures to cooperate and compete:
l

Strategic imperative; the partners want to maximize the advantage gained for the
joint venture, but they also want to maximize their own competitive position.
The joint venture attempts to develop shared resources, but each firm wants to
develop and protect its own proprietary resources.
The joint venture is controlled through negotiations and coordination processes,
while each firm would like to have hierarchical control.

21

Corporate Level
Strategy

Direct Investment: Direct investment is the ownership of facilities in the


target country. It involves the transfer of resources including capital, technology, and personnel. Direct investment may be made through the acquisition of
an existing entity or the establishment of a new enterprise. Direct ownership
provides a high degree of control in the operations and the ability to better
know the consumers and competitive environment. However, it requires a
high degree of commitment and substantial resources. Exhibit 2 compares
different International Market Entry Modes.
Exhibit 2: Comparison of International Market Entry Modes
Mode

Conditions Favoring this Mode


l

Exporting
l

l
l

Licensing
l

l
l

Joint
Ventures

l
l
l
l
l

Limited sales potential in


target country; little product
adaptation required
High target country;
production costs
Liberal import policies
High political risk
Import and investment
barriers
Legal protection possible in
target environment
Low sales potential in target
country
Large cultural distance
Licensee lacks ability to
become a competitor

Import barriers
Large cultural distance
Assets cannot be fairly priced
High sales potential
Some political risk
Government restrictions on
foreign ownership
Local company can provide
skills, resources, distribution
network, brand name etc.

Advantages
l

l
l

Direct
Investment

l
l
l

Import barriers
Small cultural distance
Assets cannot be fairly priced
High sales potential
Low political risk

l
l

l
l

Minimizes risk
and investment
Speed of entry
Able to
circumvent trade
barriers
High ROI

22

Minimizes risk
and investment
Speed of entry
Maximizes scale;
uses existing
facilities

Disadvantages

Overcomes
ownership
restrictions and
cultural distance
Combines
resources of 2
companies
Potential for
learning
Viewed as insider
Less investment
required
Greater
knowledge of
local market
Can better apply
specialised skills
Minimise
knowledge
spillover
Can be viewed
as an insider

Trade barriers &


tariffs add to costs
Transport costs
Limits access to
local market
information
Company viewed
as an outsider
Lack of control
over use of
assets
Licensee may
become
competitor
Knowledge
leakages
License period
is limited
Difficult to
manage
Dilution of
control
Greater risk
than exporting
& licensing
Knowledge
spillovers
Partner may
become a
competitor
Higher risk
than other
modes
Requires more
resources and
commitment
May be difficult
to manage the
local resources.

There are three major strategy options for going international:

Growth Strategies-I

Multidomestic: The organization decentralizes operational decisions and activities to


each country in which it is operating and customizes its products and services to each
market. For years, U.S. auto manufacturers maintained decentralized overseas units
that produced cars adapted to different countries and regions. General Motors
produced Opel in Germany and Vauxhall in Great Britain while Chrysler produced the
Simca in France and Ford offered a Canadian Ford.
Global: The organization offers standardized products and uses integrated operations.
Example: Ford is treating its Contour as a car for all world marketsone that can be
produced and sold in any industrialized nation.
Transnational: The organization seeks the best of both the multidomestic and global
strategies by globally integrating operations while tailoring products and services to
the local market. In other words a company thinks globally but acts locally. Many
authors refer to this concept as Glocalization. Global electronic communications and
connectivity can help integrate operations while flexible manufacturing enables firms
to produce multiple versions of products from the same assembly line, tailoring them
to different markets. This gives more choice in locating facilities to take advantage of
cheaper labor or to get the best of other factors of production

Managing Global Supply Chains to Enhance Competitiveness


Logistics capabilities (the movement of supplies and goods) make or mar global
operations. Global operations involve highly coordinated international flow of goods,
information, cash, and work processes. Setting up a global supply chain to support
producing and selling products in many countries at the right cost and service levels is
a very difficult task. However the benefits of managing this difficult task has many
benefits, which include rationalization of global operations by setting up right number
of factories and distribution centers and integration of far-flung operations under a
unified command to better manage inventory and order filling activities. Optimizing
global supply chain operations can cut the delivery times and costs drastically and
improve global competitiveness. Smart supply chain planning may result in locating
facilities where they make the most logistical sense, while saving on taxes. This is
better than simply locating where labor is cheapest, but where taxes and other cost
may not be most favourable (Refer case study in Appendix 1).

9.8

SUMMARY

Strategy refers to how a given objective will be achieved. Therefore, strategy is


concerned with the relationships between ends and means, that is, between the results
we seek and the resources at our disposal. There are three levels of strategy, namely,
corporate strategies, competitive strategies and functional strategies. Corporate
strategies are concerned with the broad, long-term questions of what businesses are
we in, and what do we want to do with these businesses? It sets the overall direction
the organization will follow. On the other hand, competitive strategies determine how
the firm will compete in a specific business or industry. This involves deciding how
the company will compete within each line of business. Functional strategies, also
referred to as operational strategies, are the short-term (less than one year), goaldirected decisions and actions of the organizations various functional departments.
There are various approaches to developing stability strategy. They are holding
strategy, stable growth, harvesting strategy, profit or endgame strategy. Growth of
business enterprises implies realignment of its business operations to different product
market environments. This is achieved through the basic growth approaches of
intensive expansion, integration (horizontal and vertical integration), diversification
and international operations. All these aspects have been covered in this unit.

23

Corporate Level
Strategy

9.9

KEY WORDS

Corporate Strategies: Corporate strategy is essentially a blueprint for the growth of


the firm.
Competitive Strategies: Strategies that determine how the firm will compete in a
specific business or industry.
Combination Strategy: Combination strategy may include combination of two
alternatives i.e., market penetration and market development or combination of all the
three alternatives.
Diversification: the firm grows by diversifying into new businesses by developing
new products for new markets.
Expansion Strategies: Growth or expansion strategy is the most important strategic
option, which firms pursue to gain significant growth as opposed to incremental
growth envisaged in stable strategy.
Functional Strategies: Also called operational strategies, these are the short-term,
goal-directed decisions and actions of the organizations various functional
departments.
Generic Corporate Strategies: The four variants of corporate strategy, namely,
stability strategy, growth/expansion strategy, retrenchment/divestment strategy and
combination strategy are called generic corporate strategies or grand strategies.
Harvesting Strategy: The firm has a dominant market share, which it wants to
leverage to generate cash for future business expansion.
Integration Strategy: The combination or association with other companies to
expand externally is termed as integration strategy.
Intensification Strategy: Intensive expansion strategy involves safeguarding its
present position and expanding in the firms current product-market space to achieve
growth targets.
International Expansion: Global expansion involves establishing significant market
interests and operations outside a companys home country.
Product Development: The firm develops new products targeted to its existing
market segments.
Stability Strategy: Strategy, which aims to retain present strategy of the firm at the
corporate level by focusing on its present products and markets.
Strategy: Strategy refers to how a firm plans to achieve a given objective.

9.10

24

SELF-ASSESSMENT QUESTIONS

1)

What is corporate level strategy? Why is it important for a diversified firm?

2)

What are the various reasons that firms choose to move from either a single- or a
dominant-business position to a more diversified position?

3)

What do you mean by stability strategy? Does this strategy mean that a firm
stands still? Explain.

4)

Under what circumstances do firms pursue stability strategy? What are the
different approaches to stability strategy?

5)

What resources and incentives encourage a firm to pursue expansion strategies?


What are the main problems that affect a firms efforts to use an expansion
strategy?

6)

Given the advantages of international expansion, why do some firms choose not
to expand internationally?

7)

What is the example of a political risk in expanding operations into Africa or


Middle East?

9.11

Growth Strategies-I

REFERENCES AND FURTHER READINGS

Collins D.J. & Montgomery, C.A. (1998). Creating Corporate Advantage, Harvard
Business Review, 76(3) 70-83.
Hitt, Michael A., Duane, Ireland R. and Hoskisson, Robert E. (2001) Strategic
Management: Competitiveness and Globalization, 4e, Thomson Learning.
Kedia, B.L. & Mukherji, A. (1999). Global Managers; Developing a Mindset for
Global Competitiveness, Journal of World Business, 34 (3); 230-251.
Markides, C.C. (1999). To Diversify or not Diversify, Harvard Business Review,
75(6); 93-99.
Markides, C.C. (1999). A Dynamic View of Strategy, Sloan Management Review, 40
(3); 55-63.
Porter, M.E. (1987). From Competitive Advantage to Corporate Strategy, Harvard
Business Review, 65 (3); 43-59.
Ramaswamy, V.S. and Namakumari, S. (1999). Strategic Planning: Formulation of
Corporate Strategy (Texts and Cases)-The Indian Context, 1e, Macmillan India
Limited.
Simons R. (1999). How Risky is Your Company? Harvard Business Review; 77 (3);
85-94.
Srivastava, R.M. (1999). Management Policy and Strategic Management (Concepts,
Skills and Practice), 1e, Himalaya Publishing House.

25

Corporate Level
Strategy

Appendix-1
Case Study
Ranbaxy A Company with a Global Vision
The late Dr. Parvinder Singh was one of the first Indian entrepreneurs to develop a
global vision. He expanded Ranbaxys operations to more than 40 countries. The
company is today a net forex earner, with exports to over 40 countries. It has JVs/
subsidiaries in 14 countries, marketing offices in six other countries and a licensing
arrangement in Indonesia.
Ranbaxys exports, mainly antibiotics, have grown at a compounded average growth
rate of around 28 per cent over the last five years. Although the bulk of exports are in
comparatively low-value bulk drugs, the proportion of formulations is expected to rise
significantly in the next few years. Cifran, for instance, has already proved to be a
leading product in China and Russia. Ranbaxy has acquired pharma companies in
New Jersey and Ireland to increase its penetration in the USA and UK markets. Up
until 1990-91 Ranbaxy was not known for its research. During that year the company
made headlines with the success of the complicated synthesis of an antibiotic drug,
Cefaclor. US drug major Eli Lily, impressed by Ranbaxys ability to resynthesise the
molecule, decided to enter into two joint ventures (JVs) with Ranbaxy. These JVs
opened the door for its overseas expansion.
The company classified the global markets into three categories-advanced, emerging,
and developing based on growth prospects for generic drugs. This led to focusing
attention on the emerging markets such as China, Ukraine and CIS with growth rates
much larger than those in advanced and developing markets. Ranbaxys international
operations have helped the company to cut cost of production by half in some of the
key bulk drugs6APA, 7ADCA, fluoroquinolones and cephalexin. Because of
international operations in 40 odd countries, capacities are higher, which reduces unit
cost of production. The lower cost of production also helps domestic operations. With
19 per cent growth in domestic sales in 1997-98, the company has not neglected the
Indian operations. With international operations on the verge of giving decent returns
the company is keen to shore up its market share in the domestic market.
Obviously, shareholders have been handsomely rewarded. The growth rate in the price
of the scrip has been very impressive in the past few years. The company today
enjoys a unique position of having a balanced mix of finance, marketing and R&D
strengths to start earning higher returns on all its assets.

26

Implementation
and Control

UNIT 16 EVALUATION OF STRATEGY


Objectives
After going through this unit, you should be able to:
l

understand the process of evaluation;

discuss the aspects of business portfolio analyses;

understand the importance of qualitative measures used for evaluation;

understand the concept of balanced score card; and

discuss the characteristics of an effective evaluation system.

Structure
16.1

Introduction

16.2

Process of Evaluation

16.3

Business Portfolio Analyses

16.4

Qualitative Factors

16.5

Balanced Score Card (BSC)

16.6

Structure of Evaluation

16.7

Evaluation System in a Multi-business Company

16.8

Characteristics of an Effective Evaluation Strategy

16.9

Summary

16.10

Key Words

16.11

Self-Assessment Questions

16.12

References and Further Readings

16.1

INTRODUCTION

Strategy evaluation is the last stage of the strategic management process and comes
after strategy formulation and implementation as shown below.
s

STRATEGY FORMULATION STRATEGY STRATEGY


IMPLEMENTATION EVALUATION

An organization can have one of the best formulated and implemented strategies but
if the evaluation of these are not done, they become obsolete over a period of time.
Therefore, it becomes important to have an effective evaluation system so as to help
the organization to achieve its objectives.
The evaluation process involves the control mechanism, which helps in taking
corrective actions. We have already discussed the control process in unit 15 of the
same block. In this unit, we are going to discuss the qualitative aspects and the
portfolio analysis so as to develop a complete understanding of evaluation and
control.

16.2
54

PROCESS OF EVALUATION

The key to a successful strategy is the effective implementation and evaluation

Evaluation of Strategy

system. Any kind of error in the strategic decisions will harm the organization, which
in the long-run may be highly dangerous. Therefore, it is very necessary for the
management to have a continuous evaluation system based on which the corrective
actions may be taken. Figure 16.1 shows the process of evaluation.
Measure
Self-Performance B
Objectives
Performance
Standards and
A
s
and Monitor the
Environment
Environment
s
Strategy
s

(4)

(2)
s

(3)

(1)
s

Implementation

Analyze the
Reasons for
Performance

Reward or corrective action possibilities

Figure 16.1: Evaluation of Strategy

The first phase of this process consists of selecting the key success factors,
developing measures and setting standards for the same, and collecting information
about actual state (performance on these measures). The second phase consists of
comparison with the standards laid down and initiating action to alter performance,
wherever necessary. The follow up action could relate to people/business or both and
could be tactical or strategic. For instance, if the business has not picked up as
expected, it may be necessary to increase promotional efforts, or revise the product
policy, or as a last resort, the firm may pull out of a particular business.
It is necessary to maintain a distinction between the follow up action towards
business/people and evaluation/control process. If major changes in environment
have taken place and if major assumptions about environment have gone wrong, it
may be improper to give credit or discredit to the people for the deviation in
performance from standard set. At the same time good performance of a strategy may
not be due to good performance of the people as there may be windfall gains due to
changes in the environment not imagined at the time of setting the standards of
performance or targets.
From Figure 16.1 it can be realised that the process of evaluation is quite complex
and there are several pitfalls in proper evaluation and control. The success of an
organization is gauged by its effectiveness and efficiency. Effectiveness is measured
by the degree to which the organization has achieved its objectives while efficiency
refers to the manner of resource utilization for achieving the output. The two can thus
be represented as below:
Output
Output
a) Effectiveness = b) Efficiency =
Objectives
Input
It is easy to evaluate efficiency by comparing output/input of various organizations or
organization units with one another. Inputs, by and large, are always quantifiable. An
organization is more efficient than the other if it uses less resources (inputs) than
another, the same output or if for the same input it gives more output. The latter case
requires output to be measured in quantitative terms and hence is more difficult to
assess.
Measurement of effectiveness has both numerator and denominator which are
comparatively more difficult to quantify. Hence assessment of effectiveness is more

55

Implementation
and Control

difficult than the assessment of efficiency of the organization.


The success of coporate strategy should be evaluated both in terms of efficiency and
effectiveness. It is, however, not common to find an efficient but ineffective
organization or vice versa.
In a profit oriented organization, profit becomes a surrogate measure for both
efficiency as well as effectiveness. Profit is the difference between revenue and
expense, and thus is a measure of efficiency. Being the objective itself, profit also
becomes a measure of effectiveness. In organizations with multiple objectives, the
situation is different if the surrogate measures like profit are not available/not
sufficient for evaluating the strategy. In such cases the major problem in evaluating
the strategy is to develop measures for evaluating the strategy. The problem is solved
by identifying the key variables or key success factors which are measures of
performance of certain key activities of the organization.

Activity 1
Analyse the periodical evaluation reports in your organization. Do they emphasise
effectiveness or efficiency?
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................

16.3

BUSINESS PORTFOLIO ANALYSES

Portfolio analysis is an analysis of the corporation as a portfolio of different business


with the objective of managing it for returns on its resources. The business may be in
the forms of organizational units, such as different subsidiaries or divisions of a
parent company or Strategic Business Units (SBUs).
Thus, portfolio analysis looks at the corporate investments in different products or
industries under the common corporate jurisdiction. The corporate manager analyses
the future implications of their present resource allocations and continuously
evaluates which operations or products to expand or add, and which ones to be
curtailed or disposed off, so that the overall portfolio balance is maintained or
improved. The focus is on the present as well as the future.
The activities of a company and its effectiveness in the market place also depends on
what the other competing companies are doing. Therefore, the protfolio analysis
takes into consideration such aspects as the companys competitive strengths,
resource allocation pattern and the industry characteristics.
Portfolio analysis is primarily concered with the balancing of the companys
investments in different products or industries and is useful for highly diversified
multi-product companies operating in a limited market. The different subsidiaries or
strategic business units have to be balanced with respect to the three basic aspects of
running the business:

56

Net Cash Flow

State of Development

Risk

Portfolio analysis is one of the methods to assist managers in evaluating the strategy.
Let us now discuss different types of Business Portfolio Analyses.

Display Matrices

Evaluation of Strategy

The purpose of analysis is to optimally allocate resources for the best total return,
with focus on the corporate strategies. Many different approaches involving different
display matrices have evolved over the years, with the common objective of
successful diversification. Some of the common display matrices are:
l

BCGs Growth-share Matrix

McKinsey Matrix

Strategic Planning Institutes Matrix

Arthur D. Little Companys Matrix

Hofers Product/Market Evolution Matrix

BCGs Growth-Share Matrix


BCGs Portfolio Analysis is based on the premise that majority of the companies
carry out multiple business activities in a number of different product-market
segments. Together these different businesses form the Business Portfolio which can
be characterised by two parameters:
1)

companys relative market share for the business, representing the firms
competitive positions; and

2)

the overall growth rate of that business.

The BCG model proposes that for each business activity within the corporate
portfolio, a separate strategy must be developed depending on its location in a twoby-two portfolio matrix of high and low segments on each of the above mentioned
axes.
Relative Market Share is stressed on the assumption that the relative competitive
position of the company would determine the rate at which the business generates
cash. An organization with a higher relative share of the market compared to its
competitors will have higher profit margins and therefore higher cash flows.
Relative Market Share is defined as the market share of the relevant business divided
by the market share of its largest competitor. Thus, if Company X has 10 per cent,
Company Y has 20 per cent, and Company Z has 60 per cent share of the market,
then Xs Relative Market Share is 1/6m, Ys Relative Market Share is 1/3, and Zs
Relative Market Share 60/20 = 3. Company Z has Company Y as its leading
competitor, whereas Companies X and Y have Company Z as their lead competitor.
The selection of the Rate of Growth of the associated industry is based on the
understanding that an industrial segment with high growth rate would facilitate
expansion of the operations of the participating company. It will also be relatively
easier for the company to increase its market share, and have profitable investment
opportunities. High growth rate business provides opportunities to plough back
earned cash into the business and further enhance the return on investment. The fast
growing business, however, demands more cash to finance its growth.
If an industrial sector is not growing, it would be more difficult for the participating
company to have profitable investments in that sector. In a slow growth business,
increase in the market share of a company would generally come from corresponding
reduction in the competitors market share.
The BCG matrix classifies the business activities along the vertical axis according to
the Business Growth Rate (meaning growth of the market for the product), and the
Relative Market Share along the horizontal axis. The two axes are divided into
57

Implementation
and Control

Low and High sectors, so that the BCG matrix is divided into four quadrants
(refer to Figure 16.2). Businesses falling into each of these quadrants are classified
with broadly different strategic categories, as explained below:
20
Stars

Question Marks
High

16
14
12
10
8

Cows

Dogs

Low

Business Growth Rate %

18

4
2
0

10x

4x

High

1.5x

1x

0.5x

0.1x

Low

Relative Market Share


20
Question Marks
High

15

10

Cows

Dogs
Low

Business Growth Rate %

Stars

10x

4x

High

1.5x

0.5x

0.1x

Low

Relative Market Share


Figure 16.2: BCG Matrix

Cash Cows
The businesses with low growth rate and high market share are classified in this
quadrant. High market share leads to high generation of cash and profits. The low
rate of growth of the business implies that the cash demand for the business would be
low. Thus, Cash Cows normally generate large cash surpluses. Cows can be milked
for cash to help to provide cash required for running other diverse operations of the
company. Cash Cows provide the financial base for the company. These businesses
have superior market position and invariably low costs. But, in terms of their future
potential, one must keep in mind that these are mature businesses with low growth
rate.

Dogs

58

If the business growth rate is low and the companys relative market share is also
low, the business is classified as DOG. The low market share normally also means
poor profits. As the growth rate is also low, attempts to increase market share would
demand prohibitive investments. Thus, the cash required to maintain a competitive
position often exceeds the cash generated, and there is a net negative cash flow.

Under such circumstances, the strategic solution is to either liquidate, or if possible


harvest or divest the DOG business.

Evaluation of Strategy

Question Marks
Like Dogs, Question Marks are businesses with low market share but the businesses
have a high growth rate. Because of their high growth, the cash requirement is high,
but due to their low market share, the cash generated is also low.
As the business growth rate is high, one strategic option is to invest more to gain
market share, pushing from low share to high. The Question Mark business then
moves to a STAR (discussed later) quadrant, and subsequently has the potential to
become cash low, when the business growth rate reduces to a lower level.
Another strategic option is when the company cannot improve its low competitive
position (represented by low market share). The management may then decide to
divest the Question Mark business.
These businesses are called Question Marks because they raise the question as to
whether more money should be invested in them to improve their relative market
share and profitability, or they should be divested and dropped from the portfolio.

Stars
Businesses which have high growth rate and high market share, are called Stars. Such
businesses generate as well as use large amounts of cash. The Stars generate high
profits and represent the best investment oppotunities for growth.
The best strategy regarding Stars is to make the necessary investments and
consolidate the companys high relative competitive position.

Methodology for Building BCG Matrix


The Boston Consulting Group suggests the following step-by-step procedure to
develop the business portfolio matrix and identify the appropriate strategies for
different businesses.
l

Classify various activities of the company into different business segments or


Strategic Business Units (SBUs).

For each business segment determine the growth rate of the market. This is later
plotted on a linear scale.

Compile the assets employed for each business segment and determine the
relative size of the business within the company.

Estimate the relative market shares for the different business segments. This is
generally plotted on a logarithmic scale.

Plot the position of each business on a matrix of business growth rate and
relative market share.

Strategic Implications
Most companies will have different segments scattered across the four quadrants of
BCG matrix, corresponding to Cash Cow, Dog, Question Mark and Star businesses.
The general strategy of a company with diverse portfolio is to maintain its
competitive position in the Cash Cows, but avoid over-investing. The surplus cash
generated by Cash Cows should be invested first in Star businesses, if they are not
self-sufficient, to maintain their relative competitive position. Any surplus cash left
with the company may be used for selected Question Mark businesses to gain market

59

Implementation
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share for them. Those businesses with low market share, and which cannot
adequately be funded, may be considered for divestment. The Dogs are generally
considered as the weak segments of the company with limited or now new
investments allocated to them.
The BCG Growth-share matrix links the industry growth characteristic with the
companys competitive strength (market share), and develops a visual display of the
companys market involvement, thereby indirectly indicating current resource
deployment. (The sales to asset ratio is generally stable over time across industries).
The underlying logic is that investment is required for growth while maintaining or
building market share. But, while doing so, a strong competitive business in an
industry with low growth rate will provide surplus cash for deployment elsewhere in
the Corporation. Thus, growth uses cash whereas market competitive strength is a
potential source of cash. In terms of BCG classification, the cash position of various
types of businesses can be visualised as in Table 16.1
Table 16.1: Cash Positions of Various Businesses
Business
Type

Cash
Source

Cash
Use

Net Cash Balance

1.

COW

More

Less

Funds available, so milk and deploy

2.

STAR

More

More

Build competitive position and grow

3.

DOG

Less

More

Divest and redeploy proceeds

4.

QUESTION

Less

More

Funds needed to invest selectively to


improve competitive position

Limitations of BCG Matrix


The Growth-share BCG Matrix has certain limitations and weak points which must
be kept in mind while using portfolio analysis for developing strategic alternatives.
These are now briefly discussed.

Predicting Profitability from Growth and Market Share


BCG analysis assumes that profits depend on growth and market share.
The attractiveness of an industry may be different from its simple growth rate,
and the firms competitive position may not be reflected in its market share.
Some other sophisticated approaches have been evolved to overcome
such limitations.
There have been specific research studies which illustrate that the well-managed
Dog businesses can also become good cash generators. These organizations
relying on high-quality goods, with medium pricing and judicious expenditure on R
& D and marketing, can still provide impressive return on investment of above
20 per cent.

Difficulty in Determining Market Share


There is a heavy dependence on the market share of a business as an indicator of its
competitive strength. The calculation of market share is strongly influenced by the
way the business activity and the total market are defined. For instance, the market
for helicopters may encompass all types of helicopters, or only heavy helicopters or
only heavy military helicopters. Furthermore, from geographical point of view the
market may be defined on worldwide, national or an even regional bases. In case of
complex and interdependent industries, it may also be quite difficult to determine the
60

market share based on the sales turnover of the final product only.

Evaluation of Strategy

No Consideration for Experience Curve Synergy


In the BCG approach, businesses in each of the different quadrants are viewed
independently for strategic purposes. Thus, Dogs are to be liquidated or divested.
But, within the framework of the overall corporation, useful experiences and skills
can be acquired by operating low-profit Dog businesses which may help in lowering
the costs of Star or Cash Cow businesses. And this may contribute to higher corporate
profits.

Disregard for Human Aspect


The BCG analysis, while considering different businesses does not take into
consideration the human aspects of running an organization. Cash generated within a
business unit may come to be symbolically associated with the power of the
concerned manager. As such managing a Cash Cow business may be reluctant to part
with the surplus cash generated by his unit. Similarly, the workers of a Dog business
which has been decided to be divested may react strongly against changes in the
ownership. They may deem the divestiture as a threat to their livelihood or security.
Thus, BCG analysis could throw up strategic options which may or may not be easy
to implement.

BCG Modifications
It was in 1981 that the Boston Consulting Group realied the limitations of equating
market share with the competitive strength of the company. They have admitted that
the calculation of market share is strongly influenced by the way business activity
and the total market domain are defined. A broadly defined market will give lower
market share, whereas a narrow market definition will result in higher market share
resulting in the company as the leader. It was, therefore, recommended that products
should be regrouped according to the manufacturing process to highlight the
economies of scale manufacturing, instead of stressing the market leadership.
On the other hand, BCG still maintain that for branded goods it is important to be the
market leader so that the advantages of economies of scale and price leadership can
be fully utilised. But they also concede that such advantages may still be achieved
even if the company is not the largest producer in the industry. Some other verions of
portfolio analysis have however developed much beyond these minor modifications
of BCG analysis.

Activity 2
Consider a company with which you are familiar. Collect information regarding its
various businesses and describe them using the BCG growth-share matrix. First give
the chronology of year-wise business development and then the matrix.
..........................................................................................................................................................................................
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GEs Strategic Business Planning Grid


General Electric (or McKinsey) matrix uses market attractiveness as not merely the
growth rate of sales of the product, but as a compound variable dependent on
different factors influencing the future profitability of the business sector. These

61

Implementation
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different factors are either subjectively judged or objectively computed on the basis
of certain weightages, to arrive at the Industry Attractiveness Index. The Index is thus
based on a thorough environmental assessment influencing the sector profitabilities.
Factors determing Industry Attractiveness:
Typical weightage
1)
2)
3)
4)
5)
6)

Size of market
Rate of growth of sales and cyclic nature of business
Nature of competition including vulnerability to
foreign competition
Susceptibility to technological obsolescence and new products
Entry conditions and social factors
Profitability

10%
15%
15%
10%
10%
40%
100%

Against each of these factors, the concerned business is rated on a scale of 1 to 10,
and then the weighted score is determined from a maximum of 10. This gives the
Industry Attractiveness Index for the business under consideration.
Factors determining Competitive Position of the Company as with Industry
attractiveness, the Competitive Position of the Company is analysed not only in terms
of companys market share, but also in terms of other factors often appearing in the
Strength and Weakness analysis of the company. Thus, product quality, technological
and managerial excellence, industrial relations etc. are also incorporated besides
market share and plant capacity.
A typical scoring of companys Competitive Position would be as illustrated below :
Factor
1)
2)
3)
4)
5)
6)
7)

Market Share and Capacity


Growth Rate
Location and Distribution
Management Skill
Workforce Harmony
Technical Excellence including
Product and Process Engg.
Company Image

weightage

rating
(1 to 10)

score

20%
10%
10%
15%
20%

7
7
5
6
7

1.4
0.7
0.5
0.9
1.4

20%

1.6

5%

0.4

High

Medium
Low

INDUSTRY ATTRACTIVENESS

The Industry Attractiveness Index is then plotted along the vertical axis and divided
into low, medium and high sectors. Correspondingly, the Competitive Position is
plotted along the Horizontal axis divided into Strong, Average and Weak segments.
For each business in the portfolio, a circle denoting the size of the industry is shown
in the 3 x 3 matrix grid while shaded portion corresponds to the companys market
share as shown in Figure 16.3.

Strong
62

Average

Weak

INDUSTRY ATTRACTIVENESS

Evaluation of Strategy
Figure 16.3: GEs Business Planning Matrix

GE rates each of its businesses every year on such a framework. If Industrys


Attractiveness as well as GEs Competitive Position is low, a no-growth red stoplight
strategy is adopted. Thus, GE expects to generate earnings but does not plan for any
additional investments in this business. If for a business the Industry Attractiveness is
medium and GEs Competitive Position is high, a growth green stoplight strategy is
evolved for further investment. But if a business has high Industry Attractiveness
Index and low GEs Competitive Position, this is branded as yellow stoplight
business that may be moved either to growth or no growth category. Such grids are
developed at different managerial levels. The final strategic decisions are made by
GEs Corporate Policy Committee comprising the Chairman, the Vice-Chairman and
Vice-Presidents of Operational areas, including finance.

Shells Directional Policy Matrix

Attractive
Average
Attractive

SECTORAL PROSPECTS

As in the GEs approach, the Business Prospects and Competitive Capabilites are
plotted in Shells Directional Policy Matrix. The three-by-three matrix as shown in
Figure 16.4. identifies different strategies for each grid sector. These are explained in
Table 16.2.
Leader
Try POLICY MATRIX
DIRECTIONAL
Double
Harder
or Quit

Leader
Custodial

Phased
Withdrawal

Phased
Withdrawal

Disinvest

Growth

Cash
Generation

Strong

Average

Weak

UNITS COMPETITIVE POSITION

Figure 16.4: Three-by-three Matrix

Table 16.2: Strategies for different grid sector


Strategy

Business Competitive
Prospects Capability

Recommended Strategies

1.

Leader

High

2.

Try Harder High

Medium

3.

Double or
Quit
Growth

High

Weak

Average

Avg. Strong

High priority with all necessary resources


to hold high market position.
Allocate more resources to move to leader
position.
Pick products likely to be future high flyers
for doubling and abandon others.
May have some strong competition with no
one company as leader. Allocate enough
resources to grow with market.

4.

Strong

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Implementation
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5.

Custodial

Average

6.

Phase
Low
Withdrawal

Average

7.

Cash
Low
Generation

Strong

8.

Disinvest

Weak

Low

Average

May have many competitors, so maximise


cash generation with minimal new
resources.
Slowly withdraw to recover most of
investments.

Spend little cash for further expansion,


and use this as a cash source for faster
growing.
Assets should be liquidated as soon as
possible and invested elsewhere.

While using the above analysis, Shell realised that the various zones were of irregular
shape, sometimes with overlapping boundaries.
PIMS Model
A programme for the Profit Impact of Market Strategy (PIMS) was started at General
Electric, and was later used by the Strategic Planning Institute. The PIMS programme
analyses data provided by member companies to discover general laws which
determine the business strategy in different competitive environments producing
different profit results.
Unlike the earlier approaches using judgement for multidimensional factors, the SPI
uses multidimensional cross-sectional regression studies of the profitability of more
than 2,000 businesses. It then develops an industry characteristic, Business Average
Profitability, and compares it with the performance in the concerned company. This
model uses statistical relationship estimated from past experience in place of the
judgmental weightages assigned for the importance of different factors behind
Industry Attractiveness and Competitive Position in previous approaches.
This scientific objective approach has been criticised that the analysis relationship in
it is based on heterogeneous population, i.e., different types of business, taken at
different time periods.
Profitability is closely linked with market share. A 10 per cent improvement in
profitability is linked with 5 per cent improvement in Return on Investment. This has
since been rationalised by a number of arguments, such as the Experience Curve
Effect which implies reduction in average cost with increase in accumulated
production. The larger company can use better quality management, and thus can
exercise greater market power.

Arthur D. Little Companys Matrix

Weak Tenable Favoured Strong Dominant

BUSINESS STRENGTH

Arthur D. Little Companys matrix links the stages of the product life cycle with the
business strength. On the vertical axis, the businesses are classified with respect to
their business strength: Weak, Tenable, Favourable, Strong, or Dominant. Along the
horizontal axis four stages in the life-cycle, Embryonic, Growth, Mature and Decline
are marked as shown in Figure 16.5.

Embryonic

64

Growth

Mature

Decline

INDUSTRY PRODUCT LIFE CYCLE


Figure 16.5: Arthur D. Little Co.s Matrix

Evaluation of Strategy

In the Embryonic and Growth stages, the businesses are recommended for Build
strategy, except when the Business Strength is weak. For Mature stage businesses
with dominant to favourable strength, HOLD Strategy is recommended. Harvest
strategy is proposed for businesses in Decline stage, with Strong or Dominant
position. For weaker businesse in Mature/Decline stage unacceptable ROI is marked.

Hofers Product/Market Evolution Matrix

STAGES OF MARKET EVOLUTION

Charles Hofer has proposed a three-by-five matrix where businesses are plotted in
terms of their product/market evolution and the comeptitive position. Relative sizes
of industries are shown by circles wherein in the market share of the company is
shaded as shown in Figure 16.6.
Development
Growth

Shake out
Maturity to
Saturations
Decline
Strong

Average

Weak

COMPETIVIVE POSTITION

Figure 16.6: Hofers Market Evolution


l

A business in the Developmet or Growth stage has a potential to be a Star. If the


market share is large in these growth oriented stages, more resources must be
invested to develop competitive position. But if market share is low, a strategy
to improve the same must be developed. If the industry is relatively small and
market share is low despite high growth stage, management must consider
divesting and redeploying resources in other more competitive businesses.

A business in the Shake-out or Maturity stage has a potential to be a Cash Cow.


Investments could be made to maintain high market share.

A business in Decline stage with a low market share would be a Dog business.
Though in the short run it may generate cash, in the long run, however, it should
be considered for divestment or liquidation.

Activity 3
Meet a local representative of any diversified enterprise (e.g., ITC, Reliance) and
gather information on its portfolio. Give your comments.
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Implementation
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16.4

QUALITATIVE FACTORS

Measuring in organizational performance is one of the important parts of strategy


evaluation process. It consists of the qualitative as well as quantitative aspects. We
have already discussed the quantitative measures in unit 15. Here, we will stress upon
the qualitative factors as a criteria for performance measurement.
Basically the qualitative factors constitute human factors. According to Seymour
Tilles (David, 1997), six qualitative questions are useful in evaluating strategies.
They are :
1)

Is the strategy internally consistent?

2)

Is the strategy consistent with the environment?

3)

Is the strategy appropriate in view of available resources?

4)

Does the strategy involve an acceptable degree of risk?

5)

Does the strategy have an appropriate time framework?

6)

Is the strategy workable?

Some additional factors also have an impact on strategy evaluation. They can be :
1)

How good is the firms balance of investments between high-risk and low-risk
projects?

2)

How good is the firms balance of investments between long-term and shortterm projects?

3)

To what extent are the firms alternative strategies socially responsible? etc.

There can be many more such questions which can have an impact on strategy
evaluation.
After assessing all these questions, the final step is to take corrective actions to
reposition the firm. This is necessary to adapt to the changing conditions and be able
to face the competition.

16.5

BALANCED SCORE CARD (BSC)

Any organization, be it private or public, uses certain parameters as a tool for


performance meaurement. This is important to incorporate suggestions thereby
working on a continuous improvement process, in turn evaluating the strategy so as
to transform it into action. This section gives you an insight into one of the tools, i.e.
Balance Score Card (BSC) to measure the performance of a business thereby
evaluating the strategy. We have already learnt about BSC in block 2, unit 6.
Here, we are going to look into this aspect of performance measurement
in little detail.
Performance measures are said to be the indicators of success and form a major part
of any organization. These indicators should be such that they are understood by all
levels of the organization and help in achieving the specific objectives of the
organization. Each organization has its own set of performance measurement
framework. Let us now discuss the concept of BSC and how it can help an
organization in performing effectively.

History
66

1990s saw the emergence of strategic management as a whole new concept. In the
same time period a very new approach to it was developed by Dr. Robert Kaplan
(Harvard Business School) and David Norton (Balance Score and Collaborative) and
named it as Balanced Scorecard. According to them, it provides a clear prescription
as to what companies should measure in order to balance the financial perspective
(www.hrfolks.com).

Evaluation of Strategy

The BSC is a Management system that enables organizations to clarify their vision
and strategy and translate them into action. It provides a feedback around both the
internal business processes and external outcomes so as to improve the strategic
performance and results continuously.
According to Kaplan & Norton The balanced scorecard retains traditional financial
measures. But financial measures tell the story of past events, an adequate strong for
industrial age companies for which investments in long-term capabilities and
customer relationships were not critical for success. These financial measures are
inadequate, however, for guiding and evaluating the journey that information age
companies must make to create future value through investment in customers,
suppliers, employees, processes, technology, and innovation. It is important
to note that according to BSC we view the organization from four perspectives
and they are:
l
l
l
l

The Learning and Growth perspectives


The Business Process perspective
The Customer perspective
The Financial perspective

The learning and growth perspective includes employee training and corporate
cultural attitudes which are related to both individual and corporate selfimprovement. The business process perspective refers to paternal business processes.
This includes the strategic management process. The customer perspective, as the
name suggests, aims at satisfying the customers needs and wants as the customer
satisfaction is one of the performance indicators for any organization.
The last perspective, i.e., the financial perspective relates to the handling and
Financial Perspective

Strategy
BSC

Customer
Perspective

Business Process
Perspective

Learning & Growth


Perspective
Figure 16.7: Balanced Score Card

processing of financial data. Figure 16.7 can be the diagrammatic representation of


BSC for an organization.

Let us understand this concept with the help of an illustration.


Illustration: The business of enterprise is the production and sale of a
localcommunity newspaper. The main focus is on cost control and reduction, low

67

Implementation
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levels of wastage and high levels of output. Interpersonal relationships are the key to
growing revenue through advertising sales where the client can expect a well-targeted
and relatively low-cost entry into the local marketing channels. The following is the
BSC for X enterprise.
Financial Perspective

Customer Perspective

CSF

Measures

CSF

Measures

Maintain low
Overheads
Shared computer
facilities
Flexible credit
arrangements

Cost Ratios
Asset Ratios
Efficiency Ratios

Positive one-on
one relationships
with core
advertisers

Number of sales
% of available
space sold

Business Process Perspective

Learning and Growth Perspectives

CSF

Measures

CSF

Merasures

Home Based
Operations Rapid
production, e.g.,
Desk Top
Publishing,

Measured in deadlines
met and units produced
- print run

Flot organizational
structure High
capacity utilisation
Efficient and cost
effective
information
systems

# of processing
errors, % of raw
material wastage
Time to response

CSF: Critical Success Factors


Source: Adapted from IGNOU study material for CEMBA/CEMPA

In short we can say that BSC is a strategic performance management system for the
organization. It is not only a measurement tool but is also a communication tool to
make strategy clear to all working in the organization and tries to balance the
financial and non-financial aspects of the organization. There is a commitment to
manage and improve continuously. One of the bestsellers You can win by Shiv
Khera quotes that winners dont do different things, they do things differently.
Therefore, BSC is all about doing right thing at right time, but differently.

16.6

STRUCTURE FOR EVALUATION

For effective implementation of strategy, it is necessary that someone is made


exclusively responsible for carrying out the operations. Responsibility centres,
therefore, may be created for achieving the objective of the organistion following the
selected strategy. The responsibility centres should have full freedom to take
operational decisions relevant to their businesses. To an extent the responsibility
centres will be restricted in taking decisions relating to functional policies as those
decisions will not be within the jurisdiction of them.
Responsibility centres may be of several types. In a profit oriented organization, there
could be profit centre, there could be revenue centres or there could be expense or
cost centres.
Profit centre managers are responsible for profits. They have full freedom to decide
their level of sales, margins and production, what to make and what to buy, etc. At
times, however, they do not have jurisdiction over financial policies (sources of
financing) and basic personnel policies. The revenue centre heads are held
responsible for generating the revenue (within the approved costs) and cost centre
heads are responsible for a certain level of production or activities.
68

In the functional structure the only person who can be held responsible for profits is
the chief executive, since the very next level below (i.e., the functional heads) does

not have operational jurisdiction over issues related to other functional areas (but
which influence profits all the same). Functional structure of the organization can
thus have revenue and expense centres. In divisional structure the divisions will have
most of the key operational decisions under their jurisdiction. Hence they can have
profit centres for the success of strategy. The structure, thus, facilitates keeping of
records for managerial accounting (so crucial for strategic decisions and strategy
evaluation), and taking up/divesting a new product/business. The most appropriate
structure for strategy of growth through diversification or expansion is to create profit
centres in the form of divisional structure. Divisional structure also facilitates
grooming of functional executives as general managers, although it dilutes the
functional specialisation to some extent. The holding company-subsidiary structure
also provides similar advantages from evaluation and control point of view, though it
limits the scope of business portfolio management as different companies may be
catering to different businesses.

Evaluation of Strategy

The product divisional structure does not provide any significant advantage for
growth through expansion in the same business or through (backward/forward)
vertical integration. It is so because little flexibility is available to the divisions
involved in the intermediate stages of production and all of them stand or fall
together with changes in environment. Indeed it may be more appropriate in such
cases to make the marketing divisions as revenue centres and production divisions as
expense centres. The situation may be different if the intermediate product lines too
have a significant market of their own. In such cases, making all such divisions as
profit centres may be advisable.

Activity 4
What kind of responsibility centres exist in your organization? If you were given a
free hand, what responsibility centres you would have created? Why?
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16.7

EVALUATION SYSTEM IN A MULTI-BUSINESS


COMPANY

The identification of key success factors and their exact trend values is a complex
process because of inter-business unit transfers of goods and services. Often these
transfers take place at price levels which might suppress the true profitability of the
supplying division. In suh cases transfer price adjustments are carried out for the
purpose of fair evaluation of each unit.
In a multi-product/multi-business company, having several divisions as profit centres,
there may be several products/components which are manufactured and sold by one
division and at the same time required by others for their product/business. In such
cases a system of transfer pricing needs to be developed for transfer of products/
components from one division to another, otherwise a situation may arise when two
divisions may take decisions which may be against the overall interest of the

69

Implementation
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company. For instance, take two divisions A and B as profit centres. Division A
produces a component which is a monopoly item and can fetch a margin as high as
Rs. 30. The component price is say Rs. 100. Division B needs this component for one
of its products. However, if it gets it at a price of Rs. 100, it cannot earn any profit on
its product. Division A is not prepared to reduce its price to Rs. 85 as it cuts its
margin by Rs. 15 to give 10% return on sales to Division B. Division B is left with
two options to ensure 10% cut off return for its operations, either to drop the product
or invest in facilities. The minimum size of facilities is far in excess of the
requirements of the product in Division B, hence it will have to sell in open market.
The prices in that case are likely to fall to Rs. 75 a piece. Division B may also not
like to divert its energies to sell the component separately. It will, therefore, decide to
drop the product. The actions of Divisions A & B in maintaining profitbility of their
respective divisions thus lead to loss to the company as a whole on the margin that
was available to it on product B, if only Division A had reduced the price a bit.
Similar would be the case if Division A has created capacity to meet the
requirements of Division B. However, at a later stage, a situation of glut appears and
the other suppliers resort to heavy price cutting, and B decides to purchase
from open market at a price which A cannot afford to supply without running into
losses. The situation may be even more damaging to the company, if the price
reduction by the other supplier was to force some of the manufacturers
(like Division A) to close the manufacturing facilities for the component and to rise
prices again after the closures. Not only the company as a whole but even Dvision B
will be a loser.
It would be realised that there are two issues involved in situations of transfer
pricing. Firstly, the sourcing decision, i.e., whether the product is to be bought/sold
by a division internally or externally. In view of profit centres as independent
responsibility centres, normally the divisions should be allowed to decide it
themselves. But a situation may arise when the intervention of top management may
be necessary to give sourcing decisions to ensure that buying/selling by divisions is
in the interest of the company. The second question is what should be the (transfer)
price for the transfer of goods from one division to another.
It should be remembered that the purpose of transfer pricing is not to encourage
inefficient operation by dictating a transfer price that will fetch a profit, but to
ensure a fair price to the concerned divisions in the absence of an open and free
competitive market price. That unifies the interests of the divisions with the
interest of the company. Thus, whenever market place prices are available and
when the divisions can meet all their requirements of buying and selling there may be
no need of intervention. Indeed even when these conditions do not prevail, the level
of inter-division transfer may not be significant or no intervention may be necessary/
advisable.

16.8

CHARACTERISTICS OF AN EFFECTIVE
EVALUATION STRATEGY

There are certain basics which should be followed for making the strategic evaluation
effective. These characteristics are as follows:

70

1)

The activities of evaluation must be economical.

2)

The information should neither be too much nor too little.

3)

The control should neither be too much nor too less. It should be balanced.

4)

The evaluation activities should relate to the firms objectives.

5)

It should be designed in such a manner so that a true picuture is portrayed.

Evaluation of Strategy

There can be many more such requirements. Large organizations require a more
elaborate system than the smaller ones.

Activity 5
Think of more such characteristics of an effective evaluation strategy and list them.
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................

16.9

SUMMARY

This unit discusses the different concepts of strategy evaluation. The effort has been
to make you understand the qualitative issues of evaluation system and the
importance of portfolio analysis in strategy evaluation. Portfolio analysis is an
important task of a corporate strategist. It provides a framework for analysing the
mutual compatibility of diverse operations of an organization. Balanced score card is
one of the methods to measure the performance of the organization. There are many
such methods which help in evaluation system.
The crux of the unit is to understand the concept of strategy evaluation as a whole.

16.10

KEY WORDS

Balanced Score Card: A management system that enables organizations to clarify


their vision and strategy and translate them into action.
Evaluation Process: The control mechanism, which helps in taking corrective
actions.
Portfolio analysis: One of the methods to assist managers in evaluating the strategy.
Qualitative Factors: These are the human factors used for evaluation process.

16.11

SELF-ASSESSMENT QUESTIONS

1)

What is the importance of structure for the evaluation of strategy? What are the
advantages of profit centres?

2)

What is the purpose of transfer pricing? What are the merits and demerits of
transfer pricing?

3)

Discuss the importance of the Balanced Score Card in the present context.

4)

Discuss the application of portfolio analysis.

5)

What basic considerations have to be kept in mind while balancing portfolios?

16.12

REFERENCES AND FURTHER READINGS

Abell, D.F. (July 1978). Strategic Windows, Journal of Marketing, 42(3), pp. 21-26.
Anthony, R.N. et al. (1984). Management Control System. Richard D. Irwin:

71

Implementation
and Control

Homewood.
Byars, Lloyd L. (1987). Harper & Row, Publishers, New York.
David, R. Fred. (1997). Concepts of Strategic Management. Prentice Hall
Incorporation Ltd.
Glueck, W.F. et al. (1984). Business Policy and Strategic Management. McGraw Hill:
New York.
Hedley, Barry. (February, 1977). Strategy and the Business Portfolio. Long Range
Planning, pp. 9-15.
Hofer, Charles W. and Dan Schendel. (1978). Strategy Formulation: Analytical
Concepts. West Publishing Co. : St. Paul.
Hussey, David E. (1979). Introducing Corporate Planning, Pergamon Press : Oxford
(Chapter 8).
IGNOU study material for CEMBA-CEMPA on Strategic Management.
Lorentz, C. (1981). Why Boston Theory is on Trial, Financial Times, 11 November.
Panchal, Dhiren N. (2004). Using the Balanced Business Unit Scorecard to Drive
Business Performance. www.hrfolks.com.
Porter, Michael E. (1980). Competitive Strategy, Free Press: New York (Chapter 7).
Porter, Michael E. (May 1979). The Structure within Industries and Companys
Performance. Review of Economics and Statistics.
Rao, P. Subba. (2004). Business Policy and Strategic Management. Himalaya
Publishing House.
Tilles, Seymour. (July-August, 1963). How to Evaluate Corporate Strategy. Harvard
Business Review.
www.hrfolks.com

72

UNIT 14 BEHAVIOURAL DIMENSIONS

Behavioural Dimensions

Objectives
The objectives of this unit are to:
l

explain the role of leadership in strategic management;

discuss the concept of leadership;

acquaint you with various functions of leaders;

understand different leadership styles; and

understand the importance of ethics and values.

Structure
14.1

Introduction

14.2

Role of Leadership

14.3

Concept of Leadership

14.4

Functions of Leadership

14.5

Leadership Styles

14.6

Corporate Culture

14.7

Ethics and Values

14.8

Functional Strategies

14.9

Summary

14.10

Key Words

14.11

Self-Assessment Questions

14.12

References and Further Readings

14.1

INTRODUCTION

Leadership means to guide or to influence into an action. In todays highly


competitive world, it becomes important for organizations to have a good leader. The
well-known book In Search of Excellence concludes that every company that has
maintained its excellence over the years has done so because it had a leader or two
who gave it its structure. This conclusion has since been reinforced in a recent study
by the Stanford Research Institute. It concluded that 12 per cent of effective
management strategy is knowledge and 88 per cent is dealing appropriately with
people. Indeed, dealing appropriately with people is Leadership.
We know instinctively that in every human activity involving a group of people, there
is a need for the guiding hand of a leader. The head of a family is the most ubiquitous
leader since the dawn of human history. It is well accepted that on the quality and
effectiveness of this leader, be it father or the mother, depends the progress and
fortunes of the family.
In the modern complex society thousands of individuals are appointed or elected to
shoulder roles and responsibilities of leadership in junior, middle and senior levels in
factories and farms, schools and colleges, business and financial institutions,
dispensaries and hospsitals, in civil and military organs of the States scientific and
29

Implementation
and Control

research institutions and so on. On their quality and effectiveness depends the
strength, prosperity and happiness of society. In history an effective leader has always
been a force multiplier.
Here in this unit we present to you a holistic and practical approach to leadership as
the behavioural dimension and how it helps in the successful implementation of the
strategy.
It is important to remember that leadership cannot be taught. However, a man does
have the capability to perform himself/herselfto reprogramme his/her personality.
And, it is here, that the most exciting part of human endeavour lies.

14.2

ROLE OF LEADERSHIP

Some researchers have shown that if the executives have good leadership qualities, the
productivity of the nation can increase to a large extent without additional finance or
new technology. It is important to note that the theoretical approach of leadership
taught in classrooms is less effective than the practical approach.
In the prevailing environment in India, it is often argued, that things can improve only
if the top leadership in the country sets the right example. Alternatively, the
educational system should be reformed so that slowly perhaps in 50 years, things may
improve. Both the views do have some theoretical merit: but do not appear to be
practical.
Consequently the only way is to find a method of improving the leadership potential of
those already shouldering responsibilities and of those who are getting ready to enter
the field of leadership in any walk of life. This is the basic philosophy of the practical
and holistic approach to leadershipit is perfectly possible to improve myself; I
can hope to improve others only by personal example is its message.
Consequently the key to effective Strategic Management is to ensure that leadership
runs like a uniform thread through all functions of management to integrate them into
a culture of excellence. One of the primary needs for effective strategic management is
to understand, in practical terms, the meaning of leadership, its functions; and, finally
to ensure that effective leaders are groomed and developed at every level in an
organization. Only then will strategic managers be able to conceive strategic plans and
translate these plans into reality.

Activity 1
Has there been any change in the top leadership of the organization with which you
are associated? If the answer is affirmative, explain in what ways it has affected the
quality of strategic decisions and overall productivity.
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
.........................................................................................................................................................................................

14.3

30

CONCEPT OF LEADERSHIP

However, when it comes to evolving a definition or a theory of leadership we run into


difficulties. If we know all too much about our leaders, we know far too little about
leadershipis it essentially inspiration? Is the leader a definer of values? Satisfier of

needs? If leaders require followers, who leads whom, from where to where, and why?
How do leaders lead followers without being wholly led by followers? Leadership is
one of the most observed and least understood phenomenon on earth.

Behavioural Dimensions

However, despite Maslows very perceptive diagnosis, almost a quarter of a century


ago, an integrated view on this vital and age-old function in human society has not yet
crystallised. Commenting on group dynamics laboratories Maslow observed:
What I smell here is again some of the democratic dogma and pity in which all
people are equal and in which the conception of a factually strong person or natural
leader or dominant person or superior intellect or superior decisiveness or whatever is
bypassed, because it makes everybody uncomfortable, and because it seems to
contradict the democratic philosophy (of course, it does not really contradict it)
(Maslow, 1965).
Maslow made the above remarks as he was fully aware that there were serious
reservations among intellectuals and scholars to the very concept of leadership. Ever
since French revolution the academic community had assiduously tried to devalue
leadership as it had got associated with aristocracy and feudalism and was thus
regarded to be out of tune with the democratic ethos of equality. Equality of
opportunity, which is the real sense of democract, somehow got extrapolated to
equality of capability. It was overlooked that even two brothers with common heritage
are not equal in their capabilities. Potential for leadership has no relation to parental
stations in society. Many of the outstanding leaders in history had a non-affluent
background.
Ralph Stogdill, Fiedler, Hersey and Blanchard, have made useful contributions to
understand various facets of this complex phenomena. A view that emerged in the late
eighties is relevant to the study: McClelland, Hall, Peters and Waterman, Jaques,
Bennishave been working on their parts of the puzzle. I believe that we are,
however, ready to start assembling the parts (Sashkin, 1989). It is time that we took
a practical and holistic view of this ancient human capability on which depends the
success or failure of strategic plans in any human activity.
The fact that the literature on leadership has more than 350 definitions of the word,
indicates that it is a complex process. However, its essential nature is the ability to get
the best out of people. The definition which has the touch of practical common sense
is the one evolved by a medical doctorLord Moran. He was the medical officer of a
British Infantry Battalion during World War I. For two long years he served the
Battalion in France and saw how young officers inspired their fellow citizens to fight
the Germans with enthusiasm and courage, knowing fully well that many among them
would get killed or maimed. He wondered how one individual could exercise such a
decisive influence over others. It was not just the military law or discipline, because
despite these there were examples of demeaning cowardice and inability to lead. About
two decades later he rose to become the Chairman of the British Medical Council and
later, during World War II, he was the personal physician to Sir Winston Churchill,
the war time Prime Minister of Great Britain. In that unique capacity he had a ringside seat to observe the top leaders of the world in every human activitypolitics,
industry, military, labour and so on. Given below is a definition which is based on
what he evolved:
Leadership is the capacity to frame plans which will succeed and the
faculty to persuade others to carry them out in the face of all difficulties.
(Moran, 1984).
The definition has two parts. The first deals with the capacity to frame plans
(programmes, projects or whatever) that have a high probability of success. This
implies that a plan should reflect a leaders grasp and feel of the quality of his
31

Implementation
and Control

resources and the environments in which the plan has to be implemented. The second
part of the definition deals with the implementation of the plan by persuading others to
do what is really expected of them, despite difficulties, discouragement and obstacles.
Indeed, it is this capacity which, as per the Stanford Research Institute, counts for
88 per cent of strategic management.
In common parlance the above definition can be explained in very simple terms. In
any situation, no matter at what level or how complex it amounts to :
knowing what to do + GETTING THINGS DONE
The difference in the size of letters in the two parts indicates the relative importance of
the two components of the leadership process. The faculty to get a plan implemented
is by far the more important, and indeed the more demanding component. In
management terminology leadership can also be expressed as :
capability + EFFECTIVENESS
The best and most realistic explanation is that management is a tool of leadership. The
national bestseller during 1989-90 in the USA. The 7 Habits of Highly Effective
People which is regarded as the handbook of leadership in the USA, has this to say
about this correlationManagement is a bottom line focus. How can I best
accomplish certain things? Leadership deals with the top line. What things I want to
accomplish? In the words of both Peter Drucker and Warren Dennis Management is
doing things right; leadership is doing the right things. Management is efficiency in
climbing the ladder of success; leadership determines whether the ladder is leaning
against the right wall.
Let us now look at the functions of leadership.

14.4

FUNCTIONS OF LEADERSHIP

In practical terms a leader has to achieve the task (mission, objective or goal). For
doing so, s/he has to build his team as a cohesive group and develop every individual
in the team to give his very best. Consequentely, s/he has to harmonise and integrate
the needs related to the accomplishment of the task with those of the group he leads
and individuals in the group. This is best explained diagrammatically by depicting
these needs in three linked circles, as shown in Figure 14.1.

Task Needs

Group Needs

Individual
Needs

Figure 14.1: Functions of Leadership

Source: Adair, John (1973). Action Centred Leadership.

1)

32

Functions for Task Needs


l

Defining the task

Making the plan

2)

3)

Allocating work and resources

Controlling quality and tempo of work

Checking performance against plan

Behavioural Dimensions

Functions of Group Needs


l

Setting standardsexample

Maintaining discipline

Building team spirit

Encouraging, motivating, giving a sense of purpose

Appointing sub-leaders

Ensuring communication within the group

Training the group

Functions for Individual Needs


l

Attending to personal problems

Praising of individuals

Knowing individuals personally

Recognising and using individual abilities

Training individuals

The functions related to the needs of the three areas have been listed separately for
easy understanding. In actual practice, however, most of these are integrated in the
following steps :
l

Planning to achieve the task by using the available resources and people

Initiating work by allocating tasks and resources

Controlling by monitoring the work; modifying plan

Supporting by encouragement and by motivating and training

Evaluating

Activity 2
What functions you think are the most important for a leader from strategic
management point of view and why?
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................

14.5

LEADERSHIP STYLES

The statement that a good leader varies his/her style between authoritarian to
participative (autocractic to democratic, if you like) depending on the task, the
changing situation s/he encounters and changing group that s/he has to lead sums up
rather briefly, the way an effective leader has to function. However, no effective leader
ever consciously adopts a styleit comes, and indeed it must come, naturally from
within. Style invariably is the reflection of the substance. It is the expression of the
man and the strength and balance of his Universal Inner Structure of Effective
Leaders. Rusi Modi while discussing leadership repeatedly emphasises above all be
yourself.

33

Implementation
and Control

Conceptually the changes in style which spread between the two extremes is well
depicted in the model evolved by R. Tannenbaum and W. Smidt shown in Figure 14.2.
It should be seen only as an illustration depicting the range of options available.
Use of Authority by the Manager
Area of Freedom for Subordinates
1. Manager 2. Manager
makes
sells
decision
decision
and
announces
it

3. Manager
presents
ideas and
invites
questions

4. Manager
presents
tentative
decision
subject
to
change

5. Manager 6.
presents
problem,
gets
suggestions,
make
decision

Manager
defines
limits,
asks
group
to make
decision

7. Manager
presents
subordinate
to function
within
limits
defined
by superior

Figure 14.2 : Leadership Styles

In practical terms any change in style is merely an intuitive variation in the mix of
personal example, persuasion and compulsion.
Personal example is the most potent factor in the technique to inspire people to do
what they are expected to do. If a leader can work 12 to 14 hours a day then the
message gets across. Personal example in punctuality, integrity, honesty, frugality,
courage, persistence, initiative unselfish love of poeple, or whatever is infectious with
the Indian people. They try and live up to the standards of a leader. TO DO yourself
what you expect your people to do is the secret of leading people.
There are people and there are times when persuasion is necessary to motivate people
to do what has to be done. When they understand the circumstances, people do rise to
the occasion and go through the most irksome tasks. The long-term persuasion lies in
the organizational culture (esprit de corps) in which people take pride in doing
anything to uphold the honour and good name of the organization.
Compulsion by the way of punishing the few indolent, lazy or resentful individuals
who do not perform their share of work is also necessary to maintain discipline. Also,
to let people know unambiguously that the leader is fair and just, but not tolerant of
the incompetent, the crooked and mischievous. There is an innate tendency among
Indians to kill or retard an organization with kindness. Inability to take appropriate
action is rationlised by arguments like pressures from the top, fear of litigation, trade
union agitation and so on. To a degree it is also due to a lack of moral courage.

Leadership in Indian Context


More and more organizations in the country are reflecting the diversity of Indian
people. Executives and workers in organizations often hail from different parts of the
country, speak different languages, have different customs and traditions, profess
different religions and have different ethnic origin. For a leader to be able to handle
such groups of people, s/he must be able to rise above his/her own narrow regional,
religious, linguistic and ethnic origin, and project, by convictions and actions, a true
all-India personality to be able to command, respect and loyalty of his team. There are
two essential requirements for succeeding in this goal.
First, a leader should have a good grasp and pride in the long history and cultural
ethos of India. Second, a leader should have rudimentary knowledge of all religions of
India and s/he should genuinely respect all faiths.
34

Attributes of successful leader Table 14.1 shows some attributes of successful


leaders.

Table 14.1: Attributes of Successful Leaders


Ambition
Willingness to work hard
Enterprise
Astuteness
Ability to stick to it
Capacity for lucid writing
Imagination
Ability to spot opportunities
Willingness to work long hours
Curiosity
Understanding of others
Skill with numbers
Capacity for abstract thought

:
:
:
:
:
:
:
:
:
:
:
:
:

Behavioural Dimensions

Ability to administer efficiently


Enthusiasm
Capacity to speak lucidly
Singlemindedness
Willing to take risks
Leadership
Ability to take decisions
Analytical ability
Ability to meet unpleasant
situations
Openmindedness
Ability to adopt quickly to
change

Integrity

Activity 3
Ponder over the leadership style of your immediate supervisor in the organization you
are working and answer the following:
a)

How do you describe his/her leadership style?


..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

b)

Is his/her leadership style consistent (or does it vary frequently)?


..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

Developing appropriate leadership is one of the most important elements in the


implementation of a strategy. This is important because leaders are key organic
elements who help an organization cope with changes. Appropriate leadership is
necessary, though not a sufficient condition, for mobilising people, and for developing
effective structure and systems for the success of strategy. Failure of leadership may
lead to difficulties in achieving goal congruence, communication breakdown,
ambiguity with regard to roles of sub-units, and difficulty in obtaining commitment to
a plan, e.g., staff conflicts and lack of strategic thinking. Leadership is the key factor
for developing and maintaining the right culture and climate.

35

Technocracy

Risk Taking

Flexibility

Team
management,
employee
oriented
posture

Authoritarian
values
coercively
secured
compliance
with ones
wishes

Coercion

Organic,
Flexible,
administrative
relationships
employee
authority
vested with
situational
expertise

Participation

Planning &
Technocracy
dominated
decisions,

Risk
taking

Implementation
and Control

Risk
aversion
conservatism

Seat-of
the-pant
decisions

Mechanistic,
rigid
administrative
relationships,
bureaucratic
values

Individual
decision
making
orientation
aversions to
institutionalised
participative
management
s

External
Market
oriented
Dimensions

Non-coercive
values
and behaviour

Internal
Administration
oriented
Dimensions

Figure 14.3 : Dimensions of Leadership Styles

Source: Khandwalla, N.N. (1977) p. 399.

There are several aspects of leadership styles and skills, some of them are more
appropriate to the context/content of a strategy, while others are desirable attributes in
general for the success of an organization.
Leadership styles are manifested through the orientations, Khandwalla has identified
five orientations (dimensions of style) namely, the risk taking (willingness to make
high risk, high return decisions), optimisation (degree of commitment to the use of
planning, and management science techniques in decision making by technically
qualified people vis-a-vis seat-or-the pant decisions), flexibility (degree of looseness
and flexibility in organization structuring), participation (of those other than the ones
holding key positions) and coercion (use of fear and domination) (see Figure 15.3).
For superior performance on key organization goals he proposes that if
l

36

the orientation of top management is risk taking, then it should be at least


moderately organic and coercive in proportion to internal resistance to change.
the orientation is risk aversive, then it should be moderately mechanistic and
non-coercive.
the orientation is of highly optimisation type, then it should be strongly
participative.
the orientation is highly seat-or-the-pant and non-technocratic, then it should be
at least moderately risk taking and non-participative.

Different leadership styles have good fit with different environments. Since the
strategy determines the product/market scope, and also the environment in which the
organization is going to operate in future, it has a bearing on leadership style.
Khandwalla has further categorised leadership styles into seven types to relate them to
environment, each reflecting different mix of the five orientations, as shown in the
table 14.2.

Behavioural Dimensions

Table 14.2: Seven Styles of Top Management


Leadership
Style

Risk
Taking

Technocracy Flexibility
(Optimisation) Organicity

Participation

Coercion

1. Entrepreneurial

High
Variable

Moderate to
low
High

Variable

2. Neoscientific

Moderate to
low
High

3. Quasi-scientific

Variable

High

4. Muddling through

Moderate
to low
Low

Low

5. Conservative
6. Democratic
7. Middle of the
Road

Moderate
to low
Moderate

Moderate to
low
Moderate to
low
Moderate

Moderate to
high
Moderate to
low
Moderate to
low
Moderate to
high
Moderate to
low
Moderate to
high
Moderate

Moderate to
low
Moderate to
low
Moderate to
low
High
Moderate to
low

Moderate
to low
Moderate
to high
Moderate
to high
Variable
Variable
Moderate
to low

Source: Khandwalla, P.N., Some Top Management Styles : Their Context and Performance,
Organisation and Administrative Sciences. Vol. 7 , No. 4, Winter 1976. p. 27.

Like leadership, there are several dimensions of environment also, namely, the degree
of turbulence/volatality (high degree of changeability/unpredictability), hostility
(hostile environment are highly risky and overwhelming), heterogeneity (diversity of
markets/consumers), restrictiveness (economic, social, legal and political constraints)
and the degree of technological sophistication. The leadership styles which are more
appropriate to different types of environment are shown in Table 14.3.
Table 14.3: Environment-Style Fit
Environment
Turbulence

Hostility

Diversity

Restrictiveness

Technological
Complexity

Styles
High
Medium
Low
High
Medium
Low
High
Medium
Low

Entrepreneurial, neo scientific


Neo scientific, middle of the road
Conservative
Entrepreneurial
Neo scientific
Neo scientific, Conservative
Entrepreneurial, Neo scientific
Muddling through, middle of the road
Neo scientific, conservative,
entrepreneurial, quasi-scientific
Neo scientific, entrepreneurial
Entrepreneurial, conservative

High
Medium
Low
High
Medium

Entrepreneurial, Neo scientific


Quasi-scientific

Low

Democratic

Source: Khandwalla, P.N., Some Top Management Styles : Their Context and Performance,
Organisation and Administrative Sciences. Vol. 7 , No. 4, Winter 1976. p. 27.

It should be noted that while the above discussion gives a good idea of orientations
and the styles of leadership to respond effectively to the environmental demands, it
does not cover the leadership skills required for revitalisation or transformation of

37

Implementation
and Control

the organization. The above discussion gives the attributes of a manager who is a
transactional leader, and not a transformational leader. The task of a
transformation or revitalisation leader is to take the organization to a dominant
position. This involves managing change or transition. It has three distinctive phases.
l
l
l

Recognising the need for revitalisation


Creating a new vision
Institutionlising change.

The leadership task in the first phase requires the ability to sense the need for change
(often there is a low threshold to catch trigger events in the environment). The second
phase requires communication skills to create a vision for future that excites people to
move, and also the interpersonal skills and creativity to mobilise commitment of at
least at critical mass in the organization. To perform the task in the third phase of the
transformation process the leader should have the ability to understand and manage
powerful conflicting forces in people. The negative emotions and threats to power and
authority have to be transformed into positive emotions and reconciliation. New ways
of working, new styles, new culture, and new norms have to be developed. The shock
of change has to be reduced.
The challenges of leadership in implementation are grave as leadership is the most
scarce resource. Organizations cope with it in several ways, by changing the current
leadership and by developing appropriate leadership styles. The change of current
leadership may not be easy to achieve even though it might be inevitable for effecting
transformation in the situation. The existing leadership might have been cast in a
particular mold which may be inappropriate to the demands of the organization. The
casting effect can be overcome if changes are introduced gradually in the leadership
styles and skills, to avoid accumulated lags or mismatches between existing leadership
styles/skills and companys changed requirements. This would require a blueprint to
indicate the kinds of styles and skills, and the number of persons of different styles
and skills required in future, current talent available and a plan of recruitment and
grooming. The task of human resources development is thus very closely related and
determined by strategy of the organization.

Activity 4
Describe basic features of the top management styles in your organization. Compare
them with the styles necessary to match the demands of your organization.
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................

14.6

CORPORATE CULTURE

Each organization has its own way of dealing with corporate problems and do have
their own organizational structure. The culture of the organization very much depends
on the behaviour of the employees. If the employees have a strong commitment
towards their organizations, the organization is said to have a strong culture and vice
38

versa. For example, Infosysone of top companies in the area of IT in Indiacan be


said to have a strong organizational culture. This is reflected in its annual results.
It is not easy to have a strong culture in the organization. Lot of it depends on
how the leaders of the organization handle their employees. Looking at this
discussion, we can infer that corporate culture is the values and beliefs accepted and
practiced by all the employees of the company. To have an appropriate corporate
culture, the strategy of the organization should match with it. In this section we would
stress more on the role of leaders in shaping the culture of the organization and will
discuss the role of leaders in handling the employees.

Behavioural Dimensions

When it comes to handling people, the total personality of a leader comes into play.
Managerial effectiveness is the management terminology for leadership. It is well to
remember that this truth is applicable at all the levels of managementJunior, Middle
and Senior. The Katz Model, shown in Figure 14.4 shows the relevant value of
management skills at various levels. Although there have been some minor changes in
the original design, it clearly shows that Human Relation Skill is consistently the
biggest component at all the levels of management.

Conceptual Skills

Senior Management

Middle Management

Human Relations Skills


Technical
Skills

Junior Management

Figure 14.4: Katz ModelSkills of an Effective Manager

A leader in any organization has to handle people in the following three directions:
a)

The firstis downwardshis/her own team which he has to build as an


effective and cohesive group motivated to achieve the coals of the organization.

b)

The secondis lateral, which involves winning the support and cooperation of
colleagues over whom the leader has no control, but who have an important
functional relationship with the group/organization headed by the leader.

c)

The thirdis a purposeful, constructive and harmonious relation with the higher
authority under whom a leader functionsthe boss.

Human nature: In order to handle people effectively it is useful for a leader to


understand human nature. There are a large number of theories about it. For
developing leadership potential it is useful to focus our attention on two concepts
which have a lasting and practical value for learners.
Once people are convinced that s/he is a person who knows them well and s/he truly
cares about them then they would do anything for the leader. However, it requires a
very major effort to know people and know them better than even their own mothers
effort in terms of time, attention and genuine interest in people.
The difference between indulgence and caring should be clearly understood.
Indulgence means excessive gratificationgiving material thingsmoney,
conveniences and so on. Indulgence, by and large, spoils the recipients. Caring, on the
other hand, is a matter of attitudeit is a quality based on unselfish love.
Consequently, caring is a matter of heart and not related to material resources. A skill

39

Implementation
and Control

that often helps a leader to know and care for his/her people is the skill of
communication.
Communication : To know people: The ability to know people is the starting point to
handle them and communication skill plays an important role in this ability. These
help a leader TO TELL what s/he wants done. However, some essential features of
this skill relevant to knowing and handling people need discussion.
Most of the strained and fractured relations can be traced to the mutual breakdown of
communications between individuals in a family, group, community, countries and
even among the community of nations. One starts seeing only the uglier side of others
and it leads to alienation. The ability to communicate, on the other hand, puts human
relations on an even keel by removing misperceptions and misunderstandings. The
ability has two sides:
l

The skill of expression; and

The skill of listening.

The Skill of Expression


The skill of expression does not merely mean gift of the gab or cleverness with words.
For a leader the skill of expression is a vehicle to generate trust. Verbal expression
counts for only 30 per cent in this skill, the balance 70 per cent is the body
languageexpression in the eyes, conviction in the tone, the sincerity in the posture,
and generally, the vibrations that a person conveys. Body language communicates the
total personality of a leader, and its effectiveness depends, entirely on the strength and
balance of the Universal Inner Structure of Effective Leaders. In genuine expression
there can be no pretension. Spontaneity, straightforwardness and sincerity are far
more effective than sheer command over the language.
The Skill of Listening
The skill of listening means understanding and knowing the other person. It has been
found that this part of communication skill is even more important, but, unfortunately
less prevalent. Listen with ears and observe body language with eyes. Even nature has
a design in the listen talk ratio. It gives two ears to a person, but only one mouth.
Listening has three ingredients. The first, of course, is the physical process of hearing
what the other person is saying; this involves attention. Comprehending what the
person is saying is the second ingredient, and demands undivided attention. Looking
out of the window, or attending to routine papers while listening are signs of
inattentiveness. Remembering what you listen is the third ingredient of this skill and,
naturally, comes about only if a leader hears and comprehends what is said. The
ability to listen attentively and with sympathy in which a leader shows signs of
warmth, makes the other person feel that s/he is an individual and not merely a
faceless part of the machine. It helps generate trust in the team. Above all, listening to
the body language with eyes gives a leader an opportunity to really know his people
and their characteristics.
Experience shows that effective communication means:
50 per cent listening;
25 per cent speaking;
15 per cent reading;
10 per cent writing.
The operative part of Leadership capability lies in the ability to handle people in a
manner that they give their best for a cause, organization and the task in hand. This
capability depends on the strength and balance of TO BE in a leaderhis/her
40

Universal Inner Structure of Effective Leadership. Reinforcing this structure is within


the reach of anyone who applies himself to this exciting endeavour with SINCERITY
and WILL POWER till transformation takes place. Even while one is making an
effort to improve the source of leadership a few practical hints to handle people will
be of value to anyone who desires to be more effective.

Behavioural Dimensions

Handling people working for a leader


Self-control : No team captain can hope to control and inspire his/her team unless
s/he learns to control and discipline himself. This is a difficult task, but without it
there is little chance for a man to become a successful leader. It requires a certain
amount of philosophical outlook and frugality which is often associated with
aristocrats and saints. Self-control does not only add to the leadership potential, it also
is a source of great happiness.
Success and Failure : It is a basic trait of human nature that an individual ascribes
successes of an organization to the part played by him/her, and blames failures on the
system. On the other hand, a good leader gives credit to his/her men for successes and
takes responsibility for failures. This approach binds men together in a collective
effort to work for the organization.
Setting Targets : It is useful to let individuals themselves set targets for work. In this
event not only are they likely to meet these targets, but even surpass them.
Correcting Mistakes : A leader has often to correct the people who falter, show
traces of weakness or fail. It is better to say This is not what is expected of a person
of your calibre and ability rather than words to the effect what else one could expect
from a clot like you. The first approach enhances a mans self-respect even in failure.
The second approach makes him your enemy.
We and not you : A good leader always projects himself/herself as a part of the team
and invariably talks in terms of We and not You.
Accessibility : It is a leaders responsibility to ensure that s/he is accessible. S/he
should institutionalise the time and place for meeting the members of his team.
Tragedies and illnesses are a frequent occurrence in human life. A good leader makes
it a point to find time for seeing men who are afflicted to who have difficult problems
to tackle. Visiting them, in case they are hospitalised, should also be a matter of
priority time allocation. You win lasting commitment from people thus handled.
Anger : A good leader does not lose his/her temper. However, righteous anger is very
different from uncontrolled rage and should not be suppressed. However, special care
should be taken to uphold the honour and dignity of an individual in the presence of
his colleagues and family members.
Recognition : Good and effective leaders have used the human urge for recognition
with telling effect to foster interpersonal bonds with their people and to motivate them.
They have scruplously used the principle of praise in public and reprimand in
private to create an organizational culture in which people work much beyond call of
duty to maintain excellence in their organization. The real basis of making
individuals feel like heroes is, of course, genuine care and unselfish love by the leader
for his people.
In the ultimate analysis, handling people is a matter of attitude. It is expecting the
utmost from them while caring for them completely. It is possible only if a leader can
create an atmosphere in which there is free communication. Tolerating shirkers and
parasites in the name of being human does a great deal of damage. Fortunately, such
people are few and far between, and must be dealt with strictly.
41

Implementation
and Control

14.7

ETHICS AND VALUES

It is not easy to build a strong coporate culture in any organization. A strong culture is
based on strong ethics and values. This is very important for the success of the
organization in the long-run. It is very easy to adopt short-cut methods to reach the
top but the downfall also comes at the same rate. Ethics and values ensure that the
organization does not adopt short-cut methods to achieve success; insted it stresses on
the concept of sustained success. Every organization has its own code of ethics and
standards in a written form.
The code of ethics normally contain the following points:
l
l
l

Honesty
Fairness in practices of the companyDisclosing the inside information;
Acquiring and using outside informationDisclosure of outside activities by the
employer to the employee;
Using comapny assets; etc.

The value statements normally include


l

Value of customers

Commitment towards the business practices like quality etc.

duty towards shareholders, suppliers etc.

following the environmental protection norms etc.

These were the few areas which were covered. There can be more such points, which
can be discussed under the head value statements and code of ethics. Each
organization has its own set of value statements and code of ethics.

Activity 5
Take the case of the organization of your choice and write the code of ethics and value
statements of that organization.
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
For the strategy to be implemented effectively, it is important to have a set of formal
value statements and code of ethics. These should not be merely in a written form but
must be followed by each employee of the organization so as to create a strong
corporate culture, which in turn would result in the success of the organization.

14.8

42

FUNCTIONAL STRATEGIES

The strategies have to be ultimately translated into business operations. The operating
decisions are taken by middle and junior level managers. Functional policies provide
guidelines to operating managers so that (a) the strategies are implemented,
(b) executive time in decision making if reduced, (c) similar situations are handled
consistently, and (d) coordination across functional units takes place. Once the
strategy of the company is decided, modification in functional policies may become
necessary to meet the demands of new business or new business philosophy,
particularly if a major deviation in product/market scope is contemplated. This

becomes all the more necessary in the Indian context where unrelated diversification is
not uncommon and where large-scale sickness of business exists. Depending upon the
changes in the present business and the method of its management, the magnitude of
modifications may range from a few minor ones to total revamping of functional
policies. For instance, a company might plan an expansion in sales by introducing
instalment schemes. This may need some alteration in the financial policies. On the
other hand, if a company growing only at a 5% rate wants to be the leader in the
industry and has the ambition of appearing on world scene, major changes may be
imperative not only in financial but also in technology production, marketing,
personnel and R & D policies. The functional policies should be comprehensive; they
should not leave so much choice to operating managers that they work suboptimally or
at cross purposes. At the same time, the policies should be flexible enough to leave
room to managers for responding quickly to situations and make exceptions for good
reasons. The firm should have policies in every major aspect of business, at least in
key functional areas.

Behavioural Dimensions

In the financial management area, the major policies relate to the arrangement and
deployment of funds. Major issues involved are the sources from where the funds will
come, from owners (equity) or by borrowing. How much of the borrowing will be
short-term and how much long-term? In terms of usage of funds, the policy decisions
would relate to whether and to what extent funds have to be deployed in long-term
(fixed) and short-term (current) assets. The long-term or capital investment decisions
relate to buying or leasing the fixed assets. A retrenchment strategy or paucity of
funds may compel the organization to lease rather than buy. In case of an organization
where capital investment decisions are decentralised, a hurdle rate may be fixed so
as to avoid investment in weaker projects by one division and non-investment by
another division.
Apart from capital budgeting, another consideration in financial management which
influences other functional areas is the cashflow. A company may frame bonus and
dividend policies based on availability of cash. In case a company proposes expansion
through internally generated funds, it may reduce bonus and dividend. This is
particularly so when it has formulated ambitious growth policies which require huge
cash. Similarly, if the firm has high risk business, it should have a conservative debt/
equity ratio to guard against falling in red due to heavy interest burden.
The funds position and optimisation orientation of top management also determine the
accounts receivable and payable policies. Financial polcies may even determine the
account keeping (e.g. LIFO or FIFO) as these affect the profitability, balance sheet
and hence cashflow through tax, dividend, bonus, etc.
Functional policies in marketing area are required for marketing-mix decisions,
namely, the four Ps (Product design, Product distribution, Pricing and Promotion) of
marketing. In terms of specifics, the product decisions relate to such issues as the
variety of product/service (shape, size, models, etc.), completeness of the line, quality
requirements, introduction/withdrawal of products, nature of customers, etc. Specific
policies are also necessary regarding distribution channels, i.e., through retailers or
direct selling? What will be the spread of distribution network? Whether new dealers
will be established or old ones developed? What will be the terms of contract with
dealers and the nature/extent of after-sale service (wherever necessary)? The
promotion policies will relate to mode of promotion, coverage and nature (corporate/
product or brand promotion). Very clear and specific policies are to be made about
pricing, e.g., full cost or standard cost based pricing. In the case of latter, at what
sales levels? Offensive vs. defensive postures also influence pricing policies.
The functions relating to production will need policies relating to quality assurance,
machine utilisation, location of facilities, balancing the line, scheduling of production,
and materials management. The strategy for entering into export market will dictate a

43

Implementation
and Control

different policy regarding quality of products and maintenance. In case of common


facilities policies of prioritisation will have to be made for scheduling production.
Location of facilities may be determined by closeness to market or input supply
points. Policies must be made to determine whether and how much to make or buy, on
the basis of cost differential, certainty regarding availability, criticality of the item,
ability to follow up procurement action for production, capacity utilisation of the
existing plant and facility and alternative uses of expanded capacity if expansion
becomes necessary. In case of bought out items, policies regarding the number of
suppliers and the criteria for selecting them are necessary.
In the area of research and development, functional policies regarding nature of
research are necessary. In case of expansion through new product development, heavy
emphasis has to be laid on basic and applied research. On the other hand, for
expansion in the same line, research emphasis has to be on product/process
improvement to cut cost and on added value. It may be noted that in case of basic
research the firm should be prepared to commit resources and wait for outcome for
several years. It cannot have basic research unless it is prepared to commit resources
on long-term basis.
Lastly, functional policies will be necessary in the area of personnel management:
what will be the compensation/incentive system to get the best out of the people and to
make them fit for desired positions in the organization? What compensation/incentive
system will be able to attract people of the desired type to join the organization so as
to meet the task requirements demanded by the strategy? What policies will be
necessary for grooming internal people for new positions? The problem becomes acute
in the context of turnaround strategies. On the one hand, the most competent people
leave and the firm finds it difficult to attract suitable replacements. On the other hand,
it faces problem of surplus staff. Retrenchment policies, though painful, are quite
necessary but difficult to develop.
The functional policies have a lot of interlinkages between themselves and, therefore,
cannot be developed independent of each other. Attempts to do so, for whatever
reason, may lead to chaos and serious mismatches, resulting in failure of the strategy.

Activity 5
List the main functional policies in your organization. What mismatch, if any, do you
notice among them?
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................
..........................................................................................................................................................................................

14.9

44

SUMMARY

In this unit we have discussed different aspects of behavioural issues, which are
important for the implementation of a strategy in an organization. In this unit, the
stress is more on the concept of leadership and the role of leaders in handling the
people. The key to effective strategic management lies in ensuring the integration of
the functions of management into a culture of excellence. This in itself is a great
challenge for leadership.

Whether a leader should change his/her style in according with the demands of the
situation is rather controversial. It is considered better for a leader to be himself/
herself . The role of leader is important for maintaining the corporate culture of the
organization. S/he should set examples to guide his employees to follow a path of
sound values and ethical principles so as to build a strong corporate culture.

14.10

Behavioural Dimensions

KEY WORDS

Corporate Culture is the values and beliefs accepted and practiced by all the
employees of a company.
Ethics is the moral philosophy of the organization.
Leadership is the capacity to frame plans which will succeed and the faculty to
persuade others carry them out in the face of all difficulties.
Values are the moral principles of the organization.

14.11

SELF-ASSESSMENT QUESTIONS

1)

12 per cent of effective management strategy is knowledge and 88 per cent is


dealing appropriately with people. Do you agree with the statement? Discuss.

2)

Discuss the role of leadership in


a) Strategic Management
b) Improving Productivity

3)

Discuss the different functions of leadership.

4)

Should a leader change his/her style or continue with his/her style, which is in
consonance with his/her basic personality? Discuss.

5)

What do you understand by corporate culture? Should the organization have a


corporate culture of its own? Discuss.

6)

Briefly explain the importance of values and ethics in an organization.

14.12

REFERENCES AND FURTHER READINGS

John, Adair. (1973). Action Centred Leadership, McGraw Hill, London.


Journal of Management Development 6.4.
Katz, L. Robert. (1955). Skill of an Effective Administrator. Harvard Business
Review, Jan-Feb. pp. 33-42.
Khandwalla, P.N. (1977). Design of Organizations, Harcourt Brace Jovanovich: New
York, p. 482.
Maslow, A.H. (1965). Eupsychian Management. A Journal. Richard D. Irwin, 1965.
Moran, Lord. (1984). Anatomy of Courage, Book World, Dehradun.
Rao, Subba P. (2004). Business Policy and Strategic Management, Himalaya
Publishing House.
Sashkin, Marshall (1989). A New Vision of Leadership, National Institute of
Education, Washington, D.C.

45

UNIT 13

STRUCTURAL DIMENSIONS

Structural Dimensions

Objectives
After going through this unit, you will be able to understand:
l

importance of matching the structure and the needs of strategy;

importance of strategy to the structure of the organization; and

the benefits of strategy and limitations of different structural designs.

Structure
13.1

Introduction

13.2

Strategic Change

13.3

Matching Organization Structure to Strategy

13.4

Determinants of Organization Structure

13.5

Strategy and Structure Proposition

13.6

The Stages Model of Structure

13.7

Forms of Organization : Strategy Related Benefits and Limitations

13.8

Structuring Multinational (Transnational) Organizations

13.9

Structure for Development Programmes

13.10

Perspectives on Strategy and Structure

13.11

Summary

13.12

Key Words

13.13

Self-Assessment Questions

13.14

References and Further Readings

13.1

INTRODUCTION

Among several other things, successful execution/implementation of strategy depends


on the appropriateness of the internal organization which to a large extent is reflected
in the structure. Structure represents the network of relationships within an
organization over a fairly long period of time. The concept of structure is important
because there are alternative forms of structural designs which an organization can
use. A certain organizational form may be more suitable for dealing with certain
situation than others. For instance, a functional centralised form may be more suitable
for a speciality manufacturing firm but unsuitable for a firm operating in a highly
complex environment. Once a structure is established (or gets established), it is not
easy to change it, for, it reflects the philosophy, prejudices and ambitions of
management or owners and changing it may be perceived by them as threatening.

13.2

STRATEGIC CHANGE

It is important for the organizations to find out the extent to which the change can be
implemented. Each organization has an independent working, therefore the strategies
formulated for these organizations are also different. Therefore there can be different
levels of strategic change depending on the nature of strategy. Exhibit 1 shows
different levels of strategic change.

Implementation
and Control

Exhibit 1 : Levels of Strategic Change


Strategic Change
Stable Strategy
Routine Strategy
Limited Strategy
Radical Strategy
Organizational Redirection

Industry

Organization

Same
Same
Same
Same
New

Same
Same
Same
New
New

Products
Same
Same
New
New
New

Market
Appeal
Same
New
New
New
New

Source: Adapted from Rao, Subba P. (2004).

While implementing a strategy, the whole process involves a number of people, tasks,
business units and products to move from a stable strategy to organizational
redirection. This is not an easy job as moving to organizational redirection means that
organization is entering an entirely new industry. This requires lot of efforts and
implementation process is quite complex. Therefore it becomes important for
management to adapt to the changing times and manage the strategic change.

13.3

MATCHING ORGANIZATION STRUCTURE TO


STRATEGY

An important question before the top management in a firm is : how to match the
structure to the needs of the strategy? A company, depending upon its size and
objectives, may be pursuing several strategies simultaneously. There are no hard and
fast rules to determine what kind of structure would be useful for which type of
strategy. Each firm has its own history behind it and its managers have their own
value systems and philosophies. The structure, therefore, is the consequences of these
and several other variables. Moreover, each strategy rests on a set of key success
factors or critical tasks. It is therefore desirable to design the organizational structure
around the key success factors or critical tasks which are implied in the firms
strategy. This requires not only complete clarity on the key success factors (or critical
tasks), but also requires making the units connected with the critical tasks or functions
the main organizational building blocks. Further, the top management has to determine
the degree of authority that has to be delegated to each unit, bearing in mind the
benefits and costs of centralization vs. decentralization. It has to decide how the
coordination among different units of the organization would be brought about. We
shall now discuss these three aspects briefly.
StrategyCritical Activities
From the point of view of strategies, there are some activities which are critical to the
success of those strategies while a large number of activities are of routine nature. The
routine activities may be either maintenance or support type of activities e.g., handling
pay rolls, accounting, complying with regulations, managing cash flows, controlling
inventories and safe keeping of stores, training of manpower, public relations, market
research etc. However, there are some critical tasks and functions which must be done
exceedingly well for the strategy to be successful. For example, tight cost control is
essential for a firm pursuing the strategy of low-cost leadership. This is particularly
true if the margins are low and price cutting is widely used as a competititve weapon.
For a firm which has chalked out differentiation as its strategy, distinctiveness or
sophistication in the design of its products is necessary. This needs emphasis on
quality and excellence in workmanship. Thus, the activities that are critical to the
strategy and competititve requirements may differ from firm to firm. Two alternative
6

questions should help to identify strategycritical activities: (i) what functions have
to be performed exceedingly well for the strategy to succeed? or (ii) what are the areas
where less than satisfactrory performance would seriously endanger the success of
strategy?

Structural Dimensions

After the critical tasks or functions for a particular strategy have been identified, the
next step is to group the various critical activities, along with routine and support
activities associated with the critical activities, into organizational units or blocks.
This would require a close look into the relationships that prevail within the
organization. The flow of material through the production process, types of customers
served, distribution channels used, sequence of operations to be performed, geographic
locations are some of the bases for scrutinising the relationships.

Degree of Authority (or decentralization)


After the grouping of activities has been done and units have been constituted, the next
question to tackle with is the degree of decision-making authority that has to be
delegated in the managers of various units. Where the firm is engaged in several
businesses, two alternative approaches can be followed. One is to centralize the
strategic decision-making authority at the corporate level and delegate only operating
decisions to the unit managers. The other is to substantially decentralize the strategic
decisions to the unit managers, with the corporate staff providing necessary support to
them. The corporate office in the latter case may limit its role to certain kinds of
strategic decisions only. What should be the degree of authority given to the unit
managers or how much autonomy should be given to them is essentially a question of
managerial judgement and would depend upon a number of factors. The merits and
demerits of decentralization in each situation must be properly weighed, after taking
into consideration the principal decision the business unit managers make and how the
corporate management perceives the importance of the various units in the overall
strategy of the organization.
In what way the authority is to be distributed across various units, some general
observations can be made. Firstly, those activities and organizational units which play
a key role in strategy execution should not be made subordinate to routine and nonkey activities. Secondly, revenue or result producing activities should not be made
subordinate to support activities or staff functions. Thirdly, authority for decisionmaking should be delegated to managers who are closest to the scene of action.
Fourthly, the corporate office should hold authority over operating decisions to the
minimum.

Providing for Coordination


Coordination among several units of the organization can be accomplished in several
ways. The principal way is to position the various activities in the verticle hierarchy of
authority. Managers higher up in the hierarchy generally have broader authority over
several organizational units and this enables them to have more clout to coordinate,
integrate or arrange for the coordination of the units under their supervision. So far as
business units are concerned, general managers are the central points in coordination
because of their position of authority over the whole unit. Apart from positioning
organizational units along verticle scale of managerial authority, a general manager
can also achieve coordination of strategic efforts through informal meetings, special
task forces, standing committees, and six monthly or quarterly strategic planning,
budgeting and review meetings. Further, while formulating the strategic plan itself, a
general manager can solicit the cooperation/association of other general managers in
the planning process and this would provide for inbuilt coordinational bridges right
from the very beginning.
7

Implementation
and Control

13.4

DETERMINANTS OF ORGANIZATION STRUCTURE

What determines the organizational structure is a controversial question. Several


hypotheses have been advanced. Some of the well known propositions relate to : size,
technology, environment, and complexity. The research evidence is not conclusive on
any of these propositions or determinants of structure which together constitute what
has come to be known as the imperative school of thought. It was left to John Child
(Organizational Structure, Environment and Performance: The Role of Strategic
Choice, Sociology, 1972: Vol. VI) who provided the missing link between the
contextual factors (viz. size, technology, environment) and the structure. The missing
link was the manager, his values, aspirations and orientations as shown in Figure 13.1.
Contextual Factors

Environment

Management
(the missing link)

>

Technology

>

Size

>

Managerial
strategic thinking,
values, aspirations
and orientations

Organization

Structure

Figure 13.1: Determinants of Organization Structure

13.5

STRATEGY AND STRUCTURE PROPOSITION

Whether strategy precedes structure or structure precedes strategy is again debatable.


There are arguments for and against the two positions. Research findings are
conflicting. As a matter of fact, strategy and structure are mutually interdependent.
In most of the cases it is found that strategy and structure are interactive. Suppose a
company decides to pursue differentiation (based on quality improvement/new
product development) through intensive R &D efforts as its competitive strategy, this
may involve the creation of a new or substantial revamping of existing R & D
department. This would mean enlargement of the present organizational structure. If
the quality control manager is made to report to the production manager, a conflict of
interests may ensue and the thrust of the new strategy may be lost. The quality control
manager may thererfore be made to report to the chief operating manager. This would
also imply change in the organization structure. This was a simple example where
structure follows strategy. However, the opposite is also possible. And this would be
the case when strategy has to take into account the prevailing structure. Let us take
the example of a shoe chain store which believes in aggressive price competition as its
strategy for market penetration. If the company has a centralized organization
structure where the prices are to be determined by corporate headquarters, the
managers of the local chain stores have only to implement the new price list received
from the headquarters (i.e., change the price tags). On the other hand if the structure is
decentralized with authority for fixing or altering price vested in the stores managers,
the strategy for price competition would be quite different.

Strategy however should not become a slave of the structure i.e., it should not be
constrained by the structure. The implementation of a new strategy must envisage the
necessary changes or modifications in the structure or organizational relationships.
Since the landmark research study by Alfred D. Chandler (Strategy and Structure,
MIT Press, Cambridge Mass, 1962) several authors have veered round the view that
organization structure follows the strategy of the enterprise. It has been suggested that
the organization structure should be so designed that it matches to the particular needs
of the strategy. Chandler found that changes in an organizations strategy bring about

new administrative problems which in turn require a new or refashioned structure if


the new strategy is to be successfully implemented. His surveyof seventy large
industrial firms, supported by indepth study of four large corporations (General
Motors, Dupont, Standard Oil, Sears Roebuck) revealed that structure tends to follow
the growth strategy of the firm but often not until inefficiency and internal operating
problems provoke a structural adjustment. According to him the excperience of these
firms followed a consistent sequential pattern: a company adopts a new strategy
new administrative problems arise, profitability and performance decline a shift to
more appropriate organizational structure takes place which leads to improved
strategy execution and more profitable levels. Chandler found this sequence to be oftrepeated as firms grew and modified their corporate strategies.

Structural Dimensions

A logical conclusion of Chandlers study is that not all forms of organization structure
are equally supportive of implementing a given strategy. The thesis that structure
follows strategy has a strong appeal. How the work in an organization is structured is
just a means to an end and not an end itself. Structure is a managerial device for
facilitating the implementtion and execution of the organizations strategy and,
ultimately, for achieving the intended performance and results. The structural deisgn
of an organization helps people pull together in their performance of diverse tasks. It
is a means of tying the organizational building blocks together in ways that promote
strategy accomplishment and improved performance. The top management, and for
that purpose also the general managers, have to provide for the necessary linakges
between strategy and structure for improved performance.

Activity 1
Discuss with an experienced and knowledgeable person of your organization regarding
how strategy and structure affect each other.
.............................................................................................................................................................
.............................................................................................................................................................
.............................................................................................................................................................
.............................................................................................................................................................
.............................................................................................................................................................

13.6

THE STAGES MODEL OF STRUCTURE

The experience of many firms indicate that organization structure evolves through
different stages. What structure an enterprise will have would depend upon its growth
stage, apart from size and the key success factors inherent in its business. For
example, the type of organization structure that suits a small speciality steel tubes
manufacturing firm relying upon focus strategy in a regional market may not be
suitable for a large, vertically integrated steel producing firm with businesses in
diverse geographical areas. To extend our example further, the structural form suitable
for a multi-product, multi-technology, multi-business enterprise pursuing unrelated
diversification is likely to be still different. Recognition of this characteristic pattern
has prompted several attempts to formulate a model linking changes in organizational
structure to stages in an organizations strategic development.*

Salter, Malcalm S., Stages of Corporate Development, Journal of Business Policy 1, No. 1, Spring
1970, pp.23-27; Thain, Donald H., Stages of Corporate Development, The Business Quarterly
Winter 1969, pp. 32-45; Scott, Bruce C., The Industrial State: Old Myths and New Realities,
Harvard Business Review, March-April, 1973, pp. 133-148; and Chandler, Alfred D., Strategy and
Structure, MIT Press, Cambridge, Mass. 1962, Chapter 1.

Implementation
and Control

The basic idea behind the stages concept is that enterprises can be arranged along a
continuum running from simple to very complex organizational forms; and that there
is a tendency for an organization to move along this continuum towards more complex
forms as it grows in size, market coverage, product line scope and as the strategic
aspects of its customertechnologybusiness portfolio become more intricate. The
stages model proposes four distinct stages of strategy-related organization structure.
Stage I : Organizations in this stage are essentially small, single business and
managed by one person. The owner entrepreneur has close daily contact with
employees. He personally knows all phases of operations. Most employees report
directly to him and he makes all pertinent strategic and operating decisions. As a
consequence, the organizations strengths, vulnerabilities and resources are closely
linked with the entrepreneurs personality, managerial ability, style and financial
position. In a way, a Stage I enterprise is an extension of the interests, abilities and
limitations of the personality of its owner. The activities of such a business typically
are concentrated in just one line of business.
Stage II : Compared to a Stage I enterprise, a Stage II enterprise has an increased
scale and scope of operations which necessitate management specialization and
transition from individual management to group management. A State II enterprise is
fundamentally a single business enterprise which divides its strategic responsibility
along classical functional lines: personnel, finance, engineering, public relations,
manufacturing, marketing and so on. In an enterprise which is vertically integrated
such as an oil company, the main organizational units are sequentially organised from
one stage to another e.g., exploration, drilling, pipe lines, refining, wholesale
distribution, retail sales, etc.
Stage III : A Stage III enterprise, though in a single field or product line has
operations which extend to several geographic areas. Within a broad policy
framework, these units have considerable flexibility in formulating their own strategic
plans to meet the specific needs of their geographic areas. Based on the principle of
geographic decentralization, each unit, operating as a semi-autonomous entity, is
structured along financial lines. The main difference between a Stage II and a Stage
III enterprise is that while the functional units of a Stage II enterprise stand or fall
together (since they are built around one business at single location), the operating
units of a Stage III enterprise can stand alone in the sense that the operations in
different geographic units are not inextricably linked or dependent upon the units of
other areas. The firms that represent this category may include firms in the cement,
brewery, heavy machinery, fertiliser industries. The chain stores of a footwear
company like Bata may also fall in this category. IFFCO, SAIL, NTC, HMT, are
some examples of Stage III enterprises.
Stage IV : Stage IV represents the ultimate in the evolutionary growth of an
enterprise. The firms in this category are typically large multi-product, multi-unit,
multi-technology enterprises whose units operate on decentralized lines. Enterprises in
this category reach this stage because their corporate managements generally lay
considerable stress on the strategy of diversificationrelated or unrelated. As with the
Stage III firms, the semi-autonomous units of Stage IV firms may have substantial
flexibility in formulating their strategies and policies relating to their own lines of
business. All the units however report to corporate headquarters in accordance with
the performance parameters decided upon. They conform to the broad guidlines laid
down by the corporate office. The general manager of each unit has overall
responsibility for the total business as his authority extends to all the functional areas.
However, some functions and staff services may be centralized at the corporate level.
The prominent example of firms in this category are: ITC, Shaw Wallace, Grasim
Industries, ICI, JK Industries, etc.

10

Comments on the Stages Model : The stages model provides useful insights into why
structural configuration tends to change in accordance with the change in size,
geographic spread, technology and strategies. As firms progress from small,
entrepreneurial enterprises following a basic concentration strategy to more complex
phases of volume expansion, verticle integration, geographic extension and line of
business diversification, their organization structures evolve from unifunctional to
functionally centralized to multi-divisional decentralized organization forms. While at
one end of the spectrum come single line businesses which invariably have centralized
functional structures, at the other end come highly diversified enterprises which again
invariably have decentralised divisional form. In between come firms which have
limited diversification. Such firms may have hybrid structures partaking the
characteristics of functional and product divisional forms.

Structural Dimensions

Some comments of clarificatory nature at this point are in order. It is not necessary
that a firm must begin at Stage I and reach ultimately to Stage IV. Most of the large
enterprises today right away begin with Stage II or even Stage III. A firm in the
evolutionary process may skip one or more of the stages in the journey.
For example, it is not necessary for a firm in Stage II to pass through Stage III to
reach Stage IV. Some firms may exhibit characteristics of two or more stages at the
same time i.e., some operations of these firms may be decentralized geographically
(for example, warehouses or transport facilities of a large steel mill like TISCO or a
company like Coal India Limited) and some other operations (for example
procurement of raw material, plant and machinery, manufacturing facilities)
may be centralized.
No organizational form is perfect. A kind of subtle experimentation always goes on.
Some firms, after a stint with decentralization may revert to centralised form. For
example, the five separate decentralized, fully integrated units of Dupont of USA
Rayon, Acetate, Nylon, Orlon, and Dacronwere consolidated into a Textile Fibre
Unit with a single multifibre field force (earlier each unit had its own sales force
which vied with each other for business from the same set of customers and thus
competing with each other) organized around four market segments namely: menwear,
womenwear, home furnishing, and industrial products. Whenever management
changes its strategy it must review its organization structure. It must answer this
question : is the organizational structure still alright or does it need modification? The
answer to this question could lead the management in recognising whether there is or
not a mismatch between the strategy and the organization structure.

Activity 2
Try to familiarise yourself with the historical growth of your organization. Discuss the
different stages, the organization has passed through and its present status.
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13.7 FORMS OF ORGANIZATION : STRATEGY


RELATED BENEFITS AND LIMITATIONS
There are some well known forms or approaches to organizational structuring:
Functional, Product Divisions, Holding Company, and Matrix. There are also other
variants of these basic forms. Since you must be familiar with these organization
forms i.e., what these organization forms are and what are their main characteristics,
we shall confine our discussion here to strategy related benefits and limitations of
these forms of organization.

Functional Structure
A functional structure tends to be effective in a single business unit where key
activities revolve around well defined skills and areas of specialization. Concentration
on performing functional area tasks increases specialization leading to greater
operating efficiency and development of distinctive skills. The functional
specialization promotes full utilisation of capacity of resources, including technical
skillsmanpower, facilities and equipment. These are strategically important
considerations for single business organizations, dominant product enterprises and
vertically integrated firms.
What form the functional specialization will take varies according to customerproduct-technology considerations. For instance, a hospital is often
compartmentalised according to the needs of its clients, i.e., outdoor and indoor
divisions which are further departmentalised into paediatrics; orthopaedics;
cardiology, ear, nose and throat, etc. A municipality is also departmentlised according
to purposeful functional areas viz., fire, public safety, health services, maintenance of
road, water and sewerage, recreation, education, etc. A technical instrument
manufacturing firm may be organized around research and development,
engineering, production, technical services, quality control, marketing, personnel,
finance and accounting.
The problem with the functional structure is that it may not be easy to keep strategic
coordination across different functional units. The functional specialists tend to have
their own perspectives on how the task can be accomplished and this creates
difficulties in achieving coordination. Because they talk in different languages, they
may not have adequate understanding of and fail to appreciate each others strategic
roles and changes in the circumstances. Besides, the functional specialists often
develop their own mind-sets and are more loyal to their own functional goals rather
than the goals of the organization as a whole. This imposes considerable strain on the
general manager in terms of resolving cross functional differences and clearing the
clogged communication lines and enforcing cooperation. The functional form may
also stand in the way of promoting entrepreneurial creativity, adapting quickly to
major changes in the customers, market and technological scene and in pursuing
opportunities that go beyond the conventional boundaries of the industry.

Product Divisions
For a diversified enterprise producing a variety of products belonging to different
industry groups, using different technologies and with plants at different locations,
functional structure makes the job of the manager incredibly complex. In such an
enterprise the needs of the strategy virtually dictate that different businesses be
organized into different business (or product) divisions which may then be organized
along functional lines.
12

Putting all activities belonging to the same business under one roof facilitates
implementation of strategies. With appropriate authority delegated to the general
managers of the divisions, accountability for results can be stressed in such an
arrangement. Reward system can be geared to motivate managers for improved
performance by providing incentives. If entrepreneurially oriented and experienced
persons are appointed as general managers of divisions, the performance of the entire
organiztion may improve on account of better responsiveness and quick decisionmaking.

Structural Dimensions

However, where activities are not or cannot be properly divisionalised or where


considerable interdependence exists between the components of the organization, as it
may happen in a firm with related diversification, this form may result in the lack of
cooperation among autonomy conscious managers and thus hinder coordination.
Strategic Business Units : Often by introducing one more layer between the chief
executive officer (CEO) and the general managers of divisions, Strategic Business
Units (SBUs) may be created to give separate but related areas within the total
enterprise some cohesive direction. The SBUs are an attempt to rationalise the firms
varied businesses, particularly where the span of management for the chief executive
is too large i.e., general managers of several divisions, say 40-50, report to him. Under
such conditions it is useful to group strategically related businesses (divisions) and
place them under a Vice-President (a new layer created). This may improve strategic
thinking, planning and coordination of diverse business interests. The strategic
relatedness may include a closely related strategic mission, a common need to compete
globally, and common key success factors. The SBU concept is quite popular in the
United States. The General Electric, Union Carbide, General Foods and some well
known examples of the firms which have capitalised on this concept in that country.
However, the location of tasks between SBUs head (i.e., vice president) and general
manager of various units comprising the SBU is a delicate matter which needs careful
balancing between needs of the general managers for necessary latitude and a need of
the heads of the strategic units for strategic coordination.

Holding Company
Holding company is one which has one or more subsidiary companies. According to
Section 4 of the Companies Act, 1956, a company shall be deemed to be a subsidiary
company if the other company is the controlling company i.e., it (i) holds more than
half in nominal values of its equity share capital (or exercises or controls more than
half of its total voting power); or (ii) controls the composition of its Board of
Directors; or if the subsidiary company itself is a holding company of another
subsidiary company, then the latter will also become the subsidiary of the holding
company of which the former is a subsidiary company.
In India, holding company form has been adopted as one of the structural forms for
organising public sector enterprises. The well known examples are: Fertiliser
Corporation of India, State Bank of India, General Insurance Corporation. Some other
public sector enterprises which have subsidiaries are: Steel Authority of India Limited,
Coal India Limited, and National Textile Corporation. The extent of control, or
involvement may vary from very little to quite substantial. Often, however, the holding
company form is adopted because the management of the parent company wants to
give maximum freedom to the managements of the subsidiary companies.
The holding company may have shareholdings in a variety of connected or
unconnected business operations. In such a situation, the holding company is virtually
a conglomerate, and in another sense it may really be an investment company. In
reality, therefore, it operates a portfolio of autonomous business units or investments.
The subsidiary companies have their separate, legal entities and have their own names,

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Implementation
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thus retaining their own identities. The holding company may limit its role to decisions
involving buying and selling of such companies. A simple organization chart of a
holding company is given in Figure 13.2. The business interests of the parent
company may range from 100 per cent (wholly owned subsidiary) to 51 per cent.
The parent-subsidiary relationship may emerge as a result of original planning of the
promotor or it may come about due to subsequent developments e.g., growth of the
enterprise (new activities/business organised as separate legal entities rather than as
organic divisions). This kind of relationship may also emerge on account of
acquisitions or takeovers. While holding companies in the Indian public sector
typically consist of subsidiaries representing various geographic units, the subsidiaries
in the case of holding companies in the private sector typically consist of companies
with diverse interest, such as construction, shipping, hotels, mining and engineering,
etc. ITC is one such example of the holding company in the private sector.
Parent (Holding)
Company
Head (Corporate) office

Corporate
Staff and
Specialists

Company A
(wholly owned)

Company B
(74% owned)

Company C
(51% owned)

Company D
(51% owned)

Company E
(wholly owned)

Figure 13.2: Holding Company : A Simple Organization Chart

If a holding company consists of clusters of subsidiaries, representing diverse


interests, these clusters may be organised into different divisions at the corporate
headquarters. For instance, the various hotels of a company may all be affiliated to the
hotel division at the headquarters. This enables the corporate management to
formulate company wide business strategy, for example, for all the hotels and
coordinate their activities, if necessary. The essential point in a holding company is the
extent of autonomy the various subsidiaries have in relation to strategic decisions and
this may be influenced by whether or not there are divisions in the parent company.
The holding company form offers several advantages. It enables the spread of risk
across many business ventures and facilitates the divestment of individual companies
if circumstances so demand. The subsidiaries can benefit from their belonging to the
membership of the group. The losses of one may be offset against the profits of
another. Protection is thus afforded to loss-making units in bad times. The subsidiaries
can have the benefit of cheaper finance for investment from the parent company for
expansion or technology upgradation. They are not burdened with high central
overheads since the head office usually has a lean staff.
The holding company form may not be without some pitfalls, especially when
subsidiaries are created as a result of takover craze. The empire building may lead to
lack of internal strategic cohesion. Since the aim in the holding company design is to
keep the centre as slim as possible, the necessary skills at the centre to provide help to
subsidiaries may not be available. This form may also lead to some duplication of
efforts in the enterprise if taken as a whole. There may be very little synergy between
different business interests.
14

Matrix Form

Structural Dimensions

The key feature of the matrix form is that product (or business) divisional form is
overlaid on the functional structure to form a matrix or grid, resulting dual authority
for most of the members of the organization. The combining of the two structural
forms usually results in a compromise between the functional specialization and lineof-business specialization. The members in such an organization have to learn to live a
new way of life. They have to adjust to a different kind of organizational climate.
For organizations which work in a dynamic or fast changing environment or where
product life cycle is relatively short or where the organization has to be constantly on
the look out for new products, matrix form is the answer. The business managers and
resource managers in a matrix structure have important strategic responsibilities. The
team approach implicit in a matrix promotes internal checks and balances the differing
viewpoints and perspectives. Several well known companies in the United States, such
as General Electric, Texas Instruments, Boeing, Dow Corning, Citibank use matrix
structures.
Since matrix form is likely to generate some amount of conflict, friction and
misunderstanding, it must be carefully designed. It is a complex structure to manage.
Apart from the expectation that everybody must communicate with every body else in
the grid, decisions may be delayed.

A Brief Discussion on Forms


From the above discussion on various forms it may be observed that there is no such
thing as an ideal organization design. There are no universally applicable rules for
matching strategy and structure. It is quite possible that two firms with similar
strategies may work with two different structures. Of course, a structure that suits one
strategy may be totally unfit for another. Further, a structure which has worked well in
the past may not work well in the future. Changes in customer-product-technology
relationships may make the structure of a firm strategically obsolete. An organization
structure is thus dynamic. Changes are not only inevitable but typical.
Experience shows that pragmatic considerations, such as the constraints imposed by
the personalities involved and the corporate culture influence the design of the
structure. The design of the structure however should begin with a strategy-structure
framework. The latter should get precedence over the organizations internal situation,
including the personalities involved. Once the structure has been built keeping in mind
this framework; it may be modified to adapt it to the peculiar situation of the
organization.
As already stated, there is nothing like the best form in organization design. Each
form that we have discussed in this section has its own strategy related strengths and
weaknesses. The adoption of one form does not preclude the use of one or more of the
other forms. Many organizations are large and diverse enough to accommodate more
than one form for their different lines of activities. The best organizational form is the
one that best fits the overall situation.
Some generalisations may however be made. Firstly, where the firm is engaged in a
single product line or it uses continuous process or assembly type of technology, the
structure tends to be functionally oriented because standards of performance and
tightly sequenced integration are crucial. Secondly, where an organization operates in
a tightly regulated environment (e.g., government agencies), it often has a more rigid,
authoritarian and bureaucratic organization structure because government rules and
regulations have to be observed. Such rules and procedures leave little latitude for
individual discretion. Thirdly, where a firms products are mostly custom made and
there is a wide variety in the day-to-day work routine or where the process of

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Implementation
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production is high technology based, the structure tends to be decentralized and the
organizational members have greater freedom of decision and action. Fourthly, the
greater the diversity within an organizations business, the greater is the likelihood that
the most effective organization form will be decentralized and multi-divisional.
Finally, the more uncertain and diverse the organizations product-market
environment, the more likely it is that the firm will utilise a loose organic design
(e.g., matrix) with considerable managerial latitude given to subordinates. It is not
difficult to understand the logic that lies behind this. The structural flexibility is more
conducive for the organizational units to adapt to their peculiar environments.

Activity 4
What kind of structural form your organization has? Is it suitable keeping in view the
needs of the strategy? Critically evaluate.
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13.8

STRUCTURING MULTINATIONAL
(TRANSNATIONAL) ORGANIZATIONS

It is a common knowledge that companies typically begin their intertnational


operations through exporting. One way to fit the personnel and resources concerned
with exports is to attach the new export unit to one of the existing major parts of the
organization serving domestic markets. In companies organized along functional lines,
exporting activities or international sales are frequently attached to the sales division.
In firms having a divisionalised product structure (i.e., whose major divisions
correspond to different products or product groups), the export department is often
appended to the product division whose export it handles. Thus, one or all of the
major product divisions may have their own export departments. As export activity
expands, company organized in this fashion will think in terms of amalgamating the
various export departments into a single unit serving entire company. Whether the
structure of the company undergoes change or not, a lot would depend whether
exports are handled directly by the producer company or by a trading company as it
happened in the initial stages in Japan. However, if the producer in course of time
finds that a ready market for its products exists abroad, it may accelerate the
attainment of still larger sales. It may therefore decide to do away with the trading
company and handle exports directly. The producer then makes arrangements for
finance, marketing intelligence and distribution. There is a tendency for such
successful exporters to establish their own sales subsidiaries abroad. The Hitachi
company in Japan relied heavily on the trading companies to carry its products abroad
during early stages of its international development. As its volume of business abroad
expanded, it gradually relied less on trading companies and more on its own
management of foreign operations, including joint ventures and wholly owned
subsidiaries.

16

Once a firm has established its own operating units abroad, the original issues change
from those in the exporting stage to the relationship between overall corporate
structure and quasi-independent foreign based subsidiaries which have their own
management and productive resources.

Structural Dimensions

Mother-Daughter Type Structure


The relationship between the corporate office and the subsidiaries may be informal as
it happened in the early stage of development with most of the multi-national
companies of Europe. The chief executive deals with them on individual basis. The
various operating units (subsidiaries) may be staffed largely by relatives of the
founder. Thus the whole company is a family affair. The highly personalised
relationship between the Chief Executive Officer (CEO) of the parent company and
the managing directors of the foreign subsidiaries has come to be known as motherdaughter type of organization. This is shown in Figure 13.3. This type of organization
allows considerable discretion to the chiefs of the national operating units. Control
from the centre is mainly exercised through personal visits by the chief executive
officer to the various units. The focus of control is often on financial performance.

President
Domestic
Operations

Foreign
Operations

Chief
Product
Division
A

R&D

Chief
Foreign
Subsidiary
X

Finance
Chief
Product
Division
B

Personnel

Chief
Domestic
Subsidiary

Engineering

Chief
Product
Subsidiary
Y
Chief
Product
Subsidiary
Y

Figure 13.3: Mother-Daughter Structure

The limits of the mother-daughter structure usually surface when multinational


companies begin to expand geographically. The CEOs personal knowledge of diverse
countries of say Asia, Africa and the Middle-East can only be superficial. This is why,
perhaps European multinationals such as Philips, Ciba Geigy, and Nestle led the move
away from the mother daughter organization towards more global structures.

International Division
Since most of the multinationals in United States were already organized on product
divisional lines, they added an international division to the existing structure when
they were faced with the expansion of operations abroad. The international division
has its own staff and an executive incharge. The various foreign subsidiaries become
its operating units as shown in Figure 13.4. This form of structure provides a central
focus within the firm with the strategy directed at the firms international
opportunities. The international operations have no longer to play a second fiddle to
the domestic operations. Unlike mother-daughter structure, international division lends
itself more readily to the establishment of formal reporting procedures and a less
personal form of control. Grouping together of the firms international operations not

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Implementation
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only gives them more weightage within the organizational hierarchy but it also
facilitates the training and development of a core of international managers. Moreover,
the considerable autonomy that the heads of the various national subsidiaries typically
enjoy within their national spheres clearly fixes responsibility and accountability for
results while leaving them free to respond to local conditions.
President

Marketing

Personnel

Domestic
Division
A

National
Subsidiary
(India)

Finance

Domestic
Division
C

Domestic
Division
B

National
Subsidiary
(Burma)

National
Subsidiary
(Turkey)

National
Subsidiary
(France)

Research and
Development

International
Division

National
Subsidiary
(Nigeria)

Figure 13.4 : International Division

Activity 5
What could be some other advantages and disadvantages of the international division
form of structure? List them below (one advantage and one disadvantage is listed for
you).

Advantages
i)

Flexibility : The structure can be readily supplemented with special project teams
and international committees for a greater degree of international coordination.

ii)

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Disadvantages
i)

Friction : This form gives rise to friction arising from cultural split between
international managers working abroad and domestic managers oriented towards
national context of the firms home country.

ii)

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iii) ..........................................................................................................................

Global Structures
Global structures may be either global product structures or global area structures.
Let us first talk about global product structure.

18

Global Product Structure : Unlike the international division form where the overall
control, coordination and direction is concentrated with one executive and with one
division, global product structures assign primary responsibility to international
product managers with a world-wide mandate for specified product groups as shown
in Figure 13.5.

Structural Dimensions

President
Corporate Staff:
Functional
Specialists
and International
Area Experts

International
Vice-President
Product Group A

International
Vice-President
Product Group B

International
Vice-President
Product Group C
Asia
Africa
Latin
America
Africa
National
Subsidiary 1
National
Subsidiary 2
Etc.

Figure 13.5 : Global Product Structure

Each manager incharge of an international product group is assisted by a staff


equipped to scan the international environment on a global scale. He has both the
necessary information and authority to mobilise firms international resources behind
global strategies.
Compared to the international division, the global product structure shifts some of the
important authority away from managers managing national subsidiaries and places it
in the hands of executives with world-wide product responsibility. The aim is to
achieve better international coordination within specific product groups. A more
global view of competition and the firms strategic opportunities is possible. It
facilitates cross-border coordination of product activities which may include
manufacturing, marketing and technology transfer. Technology transfer is of
particular importance for firms which have sizeable investment in R & D. They must
defuse the new technology globally within a relatively short period. With its emphasis
on cross-border rationalisation of marketing and productive activities the global
product structure has the potential for improving cost efficiency.
While global product structure offers several benefits, certain amount of duplication
of activities may become inevitable. However, the fact that several of the more
experienced MNCs have continued to use the structure indicates that the problems are
few and manageable, especially if a corps of senior managers with international
outlook and experience are developed.
Global Area Structure : Under global area structure, the firms operations are
segmented geographically into several regions of the world. Each region has
responsibility for an area (or region) and has area (or regional) headquarters. Below
the area headquarters, the activities may be organized either on product basis or on
functional basis. The structures will then be known as global area product
structures, global area functional structures, and global area national structures
respectively. An organizational chart of global area national structure is presented in
Figure 13.6.
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Implementation
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President
Corporate Staff:
Functional Specialist
and International
Area Experts

Vice-President
Europe

Vice-President
Latin America

Vice-President
Gulf Countries

Vice-President
Asia

Figure 13.6 : Global Area Structure

Activity 6
In the preceding section we discussed two types of global structures: Product and
Area. List some common features of these structures (one feature is listed for you).
i)

Multiple international headquarters and staff.

ii)

..........................................................................................................................

iii) ..........................................................................................................................
Taken from the viewpoint of highest level of corporate hierarchy, the move towards a
global structure represents a more decentralized approach to international operations,
as compared to either the international division or the mother-daughter organization.
The responsibility for cross-border coordination among multiple international
headquarters is spread under global structures instead of it being concentrated in a
single headquarters exercising control over all international operations.

Matrix Structures
Under matrix structure, authority and responsibility are assigned along at least two
dimensions which, in the international context, are often product and region. As
illustrated in Figure 13.7 the firms various product groups are coordinated globally,
each by its own vice-president. Its operations are also coordinated by area, with
authority for this type of control vested in regional vice-presidents. The aim is to get
best product and area centred coordination. Problems may sometime arise because of

President
Corporate
Staff
Vice-President
Product A

Vice-President
Product A

Vice-President
Asian Region
Chief National
Subsidiary (India)

Manager
Product B

20

Manager
Product A

Figure 13.7 : Matrix Structure

Other
Regions, etc.

dual authority inherent in such structures. As shown in Figure 13.7 the chief of the
national subsidiary is directly responsible to the Vice-President of the Asian region.
The product groups within his/her subsidiary and under his/her direction also report to
their respective product group Vice-President. The national managers of product
groups A and B are responsible to both the President of the national subsidiaries and
the Vice-President of their respective product groups. Despite its some apparent
shortcomings the matrix structure has been adopted by several leading multinationals.
We also come across cases where matrix structure, due to its own inconsistencies, was
abandoned in favour of global product structures.

13.9

Structural Dimensions

STRUCTURE FOR DEVELOPMENT PROGRAMMES

Though governments world-wide are characterised by hierarchical structures which


depend largely on the use of rules and authority, they however do recognise the
importance of creating new organizational structures and reforming the existing ones.
That they are generally slow in adopting change is another thing. The corporate form
of organization for public sector manufacturing or commercial undertakings in India,
for example, reflects the belief that this form of organization is more appropriate than
the departmental form. Commissions and task forces are often set up by governments
to recommend structural reorganization to fit the changed task requirements.
Ministries and departments are regrouped and sometimes some departments are
abolished, especially when a new government takes over. When strategies change,
structures need to be realigned.

Structural Form
Governments usually have functional structures. The tasks or services are broken up
according to the functions. Since development programmes are normally initiated by
Ministries, there is a tendency for the sponsor to prescribe a structural form (often the
functional form) for the programme. However, an across-the-board approach may not
be desirable for programmes of complex nature. The appropriateness of a structure
can be judged only in relation to a programmes strategy and environment. The
designer should start with the tasks and goals identified in the strategy and search for
the best structural form.
When a programme deals with a single service or is relatively small or the technology
it uses is simple, or production processes are standardized and processing of
information is relatively easy, the functional (hierarchical) structure would suffice.
To illustrate, for a dairy development programme where four basic functions can be
identified, providing service to farmers (extension, inputs), milk collection, quality
control and transport, the functional form can be adopted. The integration of these and
some other support or common functions (e.g., milk processing, marketing, finance,
etc.) takes place at the level of the chief executive.
However, when a programme grows larger geographically, or adopts a multiple
service strategy (e.g., an agricultural programme diversified into health and
education), a simple functional structure may no longer work. Many development
programmes, spread over a wide geographical area, require local adaptation of
services. Matrix structures are increasingly used when programmes diversify their
services or expand. In the agricultural programme that we cited earlier, personnel for
health and educational services may be drawn from relevant Ministries of the
Government on the understanding that the technical back up for the services will be
provided by the Agricultural Ministry.
Though, dual authority exists at the middle level in the matrix organization, it merges
into a unified command at the top. In a large and complex development programme,

21

Implementation
and Control

however, joint decisions and resolution of conflict often require the formal cooperation
of several organizations ouside the programme agency. Network structures would be
more appropriate.

Network Structure
Network structure is more appropriate for large and complex programmes as it
facilitates inter-organizational cooperation. Under the network structure a lead agency
creates a network of relevant public and private agencies which have an influence on
the programme. The lead agency coordinates but does not control which is left to the
local or constituting units. The lead agency influences the collaborating agencies by
joint allocation of funds, joint planning of activities, political support and review at
higher levels. Figure 13.8 illustrates the network structure of the Indonesian
population programme. It will be seen that the lead agency was the Population Board
which had strong political support of the countrys President.
National
President
Ministry of
Health

Ministry of
Education

Ministry of
Information

Religious
Groups

Province B
Government

Province A
Government

BOARD

Regional
Offices

Community
Organizations

Foreign
Assistance
Agencies
Field Staff

Figure 13.8 : Network Structure of the Indonesian Population Programme


Legend:

political support
direct control
strong influence

weak influence

Source: Paul, Samuel C, Strategic Management of Development Programmes, International Labour


Office, Geneva, 1983, p. 83.

The problem with network structure is that the lead agency may have little control or
influence over members of the network, except those who belong to its own
organization i.e., its own regional offices and field staff over which it has direct
control.
We have discussed some structural forms in the preceding paras. For other matters
related with the organizational structures for development programmes, the degree of
decentralization and the amount of autonomy that should be given to the heads of the
various programme agencies.
22

Activity 7

Structural Dimensions

What structure would you suggest for a development authority


i)

Which acquires all its single type of inputs (e.g., coffee seeds) from farmers in a
certain region?
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

ii)

Which depends on several agencies, public and private, provincial and local
governments, for its diverse inputs and functions?
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................
..........................................................................................................................

13.10 PERSPECTIVES ON STRATEGY AND STRUCTURE


In this section we will learn some recent or widely acclaimed perspectives on strategy
and structure. Two perspectives are provided here: one by Michael E. Porter
(Competitive Strategy, The Free Press, New York, 1980) and the other by Thomas J.
Peters and Robert H. Waterman Jr. (In Search of Excellence, Warner Books, 1982).
We shall first take up Porters view.

Porters Perspective
Porter has enunciated three generic strategies: Overall Cost Leadership,
Differentiation and Focus. According to him the successful implementation of the
three generic strategies requires not only different resources and skills but also imply
different organizational arrangements, control procedures and inventive systems.
These strategies are discussed in block-4. Let us briefly recapitulate these three
generic strategies.
Overall cost leadership (common in 1970s in the USA) is achieved through a set of
functional policies culminating into what is popularly known as the Experience Curve
Effect. This strategy requies construction of efficient scale facilities, vigorous pursuits
of cost reduction from experience, tight cost and overhead control and cost
minimisation in areas like R&D, sales force, advertising and so on. A great deal of
managerial attention to cost control is necessary to achieve the aims.
The differentiation strategy implies offering a product or service by the firm which is
perceived in the industry as being unique. Differentiation can be approached in many
ways (one or more at the same time); product design features, brand image,
technology, customer services, dealer network and other dimensions.
The focus strategy means concentrating on a particular buyer group, segment of
product lines, or geographic market.
23

Implementation
and Control

As with differentiation, focus may take many forms. Whereas the low cost and
differentiation strategies aim at achieving their objectives industry-wise, the focus
strategy is built around serving a particular target very well. All functional policies
are geared in that direction. This strategy rests on the premise that the firm is able to
serve its narrow strategic target more effectively and efficiently than those competitors
who are engaged in broader activities.
We now turn our attention to the organizational requirements for each strategy.
Some common implications of the generic strategies in terms of skills and
resources and organizational requirements are presented in Table 13.1 which are
self-explanatory.
Table 13.1 : Organizational Requirements for Different Generic Strategies
Generic
Strategy

Commonly Required
Skills and Resources

Common Organizational
Requirements

Overall Cost
Leadership

Sustained capital investment


and access to capital
Process engineering skills
Intense supervision of labour
Products designed for ease in
manufacture
Low-cost distribution system

Tight Cost Control


Frequent, detailed control reports
Structured organization and
responsibilities
Incentives based on meeting strict
quantitative targets

Differentiation

Strong marketing abilities


Product engineering
Creative flair
Strong capability in basic
research
Corporate reputation for quality
or technological leadership
Long tradition in the industry or
unique combination of skills
drawn from other businesses
Strong cooperation from
channels

Strong Coordination among


functions in R & D, product
development, and marketing
Subjective measurement and
incentives instead of
quantitative measures
Amenities to attract highly skilled
labour, scientists, or creative
people

Focus

Combination of the above


policies directed at the
particular strategic target

Combination of the above


policies directed at the
particular strategic target

Source: Porter, Michael E., p. 40-41.

24

Industry Maturity and Organizational Arrangements: According to Porter, not


only different organizational arrangements, leadership and motivation systems are
needed for different generic strategies, different organizational structures and systems
are also needed as the industry transitions to maturity. Some suitable adjustments
must take place in the area of control and motivation system as well. As the industry
matures, more attention to costs, customer service and true marketing (as opposed to
selling) may be required. More attention to refining old products rather than
introducing new ones may be necessary. The less creativity and more attention to
detail and pragmatism is often what is needed in the mature business. These shifts in
competitive focus obviously require changes in the organizational structures and
systems to support them. Systems designed to highlight and control different areas of
business are necessary. The various elements of the structural and system
requirements of mature business are tabulated in Exhibit 2.
In short, it may be stated that there has to be more emphasis on formal arrangement
than on the informal ones as hitherto. The competitive shifts (e.g., aggressive
marketing, price competition) and new organizational requirements may be presented
to by people within the organization who till the other day found pride in pioneering

Exhibit 2 : Organizational System Requirements of Mature Business


l

Tight budget;

Strict control;

Performance based incentive systems;

Control of financial assets such as inventory and accounts receivable;

More coordination across functions and among manufacturing facilities;

Major changes in plant managers job.

Structural Dimensions

high quality products. Sacrificing quality for costs and close monitoring of costs may
be resisted. Furthermore, new reporting requirements, new controls, new
organizational relationships and other changes may sometimes be seen as a loss in
personal autonomy and as a threat. A company thererore must be prepared to reeducate and remotivate personnels at all levels as it enters the maturity stage.

Peters and Watermans Perspective


Large companies tend to be complex. Unfortunately, many of such companies,
according to Peters and Waterman, respond to complexity by designing complex
systems and structures rather than simple ones. A favourite candidate for the wrong
kind of complex response is the matrix organization structure. For a multiproduct,
multi-location and multi-market company, with several functional departments, a four
dimensional matrix may be a normal choice. However, such a matrix is a logical
mess. The matrix is quite confusing: people arent sure to whom they should report
for what. The most critical problem, it seems, is that in the name of balance,
everything is somehow hooked to everything else. The organization gets paralysed
because the structure not only does not make priorities clear, it automatically dilutes
priorities. In fact, it says to people down the line: everything is important; pay equal
attention to everything.
None of the excellently managed companies, according to the authors, had matrix
structures, except for the project management companies like Boeing. Even early
users of the matrix technique such as Boeing and NASA emphasised one key
dimension of the organization structure to which they accorded clear-cut primacy,
and this could be either product, or geography or function. How have the
excellent companies avoided matrix forms? They have done so by sticking to
simple forms. Most of the excellent companies have a fairly stable, unchanging
formperhaps the product divisions that provides the essential touchstone
which everybody understands, and from which the complexities of day-to-day life can
be approached.
Excellent companies are quite flexible in responding to fast changing conditions in the
environment. They make better use of small divisions or other small units. They can
reorganise more flexibly, frequently, and fluidly. And they can make better use of
temporary forms such as task forces and product centres and other ad hoc devices.
Most of the reorganization takes place around the edges. The fundamental form rarely
changes that much.
Product divisions are the building blocks in the structure of the excellent
companies. A characteristic of structures in such companies is the shifting of people
and even products or product lines among divisions on a regular basis and without
acrimony.
The simple form is not limited to companiesspecialized in creating niches for
themselves. Other companies such as HP, Emerson, Digital, Dana and 3M have also
simple structures. Regardless of industry or apparent scale needs, virtually all the
companies pushed authority far down the line and tried to preserve or maximise

25

Implementation
and Control

practical autonomy for a large number of people. Simplicity in basic structural


arrangement actually facilitated organizational flexibility.
Clean staff at the corporate level is a characteristic feature of excellent companies.
And whatever staff these companies have tends to be out in the field solving problems
rather than being stayput in the home office. Some increasing examples are given
below:
l

Emerson Electric has 54,000 employees, with fewer than 100 in the corporate
headquarters.

Dana employs 35,000 employees and has cut its corporate staff from about 500
in 1970 to around 100 by 1982.

Schlimberger, a $ 6 million diversified oil service company, runs its world wide
empire wth a corporate staff of 90.

That less is more also holds true for some of the top performing smaller companies.
ROLM, for instance, manages a $ 200 million business with about 15 people in
corporate headquarters. Virtually every function in the excellent companies is
radically decentralized down to the divisional level at least. Though strategic
planning is regarded as a corporate function, yet, some companies such as 3-M, HP,
J & J have no planners at the corporate level. Fluor runs its $ 6 million operations
with three corporate planners.
In some excellent companies the research staffers come in from line operations and
then go back after sometime. At IBM, management adheres strictly to the rule of
three year staff rotation. Few staff jobs are manned by career staffers. The others are
manned by line officers. If you know you are going to become a user within thirty six
months, you are not likely to invent an overbearing bureaucracy during your brief
sojourn on the other side of the fence.
A structural form for the future should respond to three prime needs or properties: a

Simple, basic underlying


form
Dominating values
(superordinate goals)
Minimizing/simplifying
interfaces

Regular reorganization
Major thrust overlays
Experimental units
Systems focusing on one
dimension
s

Stability

Breaking
old habits
(shifting
atention)

Entrepreneurship

Entrepreneurial, small is
beautiful, units
Cabals, other problem-solving
implementation groups
Measurement systems based
on amount of entrepreneurship, implementation

Figure 13.11: The Three Pillars of the Structure of the Eighties


26

Source: Peters and Waterman, p. 316.

need for efficiency around the basics (stability pillar); need for regular innovation
(entrepreneurial pillar), and a need to avoid calcification by ensuring at least modest
responsiveness to major threates (habit breaking pillar). The structural form should be
based on these three pillars, each one of which responds to one of the three basic
needs. The idea about the structural form for the future is depicted in Figure 13.11.
The authors further say that an effective structure should have loose-tight property
simultaneously. It is in essence the co-existence of firms central direction and
maximum individual autonomy which the author calls having ones cake and
eating it too. Organizations that live by the loose-tight principle do so through
Faith, through value systems. Beleif in customer, belief in granting autonomy,
belief in quality are some of the values which great managers have demonstrated in
their lives.

13.11

Structural Dimensions

SUMMARY

Successful implementation of strategy, among several other factors, depends upon the
appropriateness of the organization structure. The latter must meet the needs of the
strategy. The various forms of organizational structuring may not be equally
supportive of a particular strategy at hand. In designing an appopriate structure,
tasks and functions which are critical to the achievement of strategy must be first
identified. The organization designer should then think of other supporting and
routine activities which are connected with the critical tasks and place all these in one
unit. In this way various building blocks would be formed.
Though strategy and structure are interactive and interrelated, it has been often
observed that structure follows strategy. Since structure is a tool to realise the aims of
strategy, it helps people pull together in the performance of their diverse tasks to
accomplish those aims. The experience of many firms indicates that organization
structure evolves through different stages. The Stages Model provides useful insights
into why structure tends to change in accordance with changes in size, geographic
spread, technologies, and strategies of an enterprise.
Various forms of organization structuring are available: Functional, Product
Divisions, Strategic Busines Units, Holding Comapny, Matrix, etc. Each form has its
benefits and limitations when looked from a particular strategy point of view. There is
nothing like the best or ideal structure. The best organization structure is the one
that best fits the overall situation.

13.12

KEY WORDS

Global Structure: A kind of structure used by multinational companies. Under a


global area structure, the firms operations are segmented geographically into several
regions in the world.
Holding Company: A company which has one or more subsidiary companies.
International Division: A division (in addition to domestic divisions) created by a
multinational company to which all operating units (subsidiaries) in foreign companies
report for performance based on formal procedures. Accountability thus can be fixed
for performance.
Matrix Structures: In the context of multinational organizations, under a matrix
structure authority and responsibility are assigned along at least two dimensions
which are often product and region.

27

Implementation
and Control

Mother-daughter Type Structure: A form of organization used by (European)


multinational companies where relationship between the parent company and the
subsidiaries is informal, personalised and where most of the staff on important
positions is appointed by the parent company.
Network Structure: Under network structure a lead agency creates a network of
relevant public and private agencies which have an influence on a development
programme initiated by the government.
Stages Model of Structure: The proposition that organization structure evolves
through different stages (Stages I to IV).
Strategy related Critical Talks: Tasks which are critical to the success of strategy of
the organization. Such tasks must be performed exceedingly well for the strategy to
succeed.

13.13
1)
2)
3)
4)
5)
7)

SELF-ASSESSMENT QUESTIONS

Why is the question of appropriateness of an organization important for


management?
While distributing authority to various units of the organization, what general
considerations you would bear in mind? Discuss.
In what ways would you provide for coordination for several units of the
organization? Explain.
Explain the Stages Model of structure. Is it necessary for an organization to pass
through all successive stages of growth?
What is a holding company? Discuss the strategy related benefits and limitations
of this form of organization.
Write short notes on the following:
a)
b)
c)

13.14

Global structure
Mother-daughter type structure
Matrix structure

REFERENCES AND FURTHER READINGS

Chandler, Alfred D. (1962). Strategy and Structure, MIT Press, Cambridge, Mass.
Leontiades, James C. (1985). Multinational Corporate Strategy, Lexington Books.
Miles, Raymond E. and Snow, Charles C. (1978). Organization, Strategy, Structure
and Process, McGraw-Hill.
Paul, Samuel (1983). Strategic Management of Development Programmes,
(Management Development Series No. 19), International Labour Office, Genevga.
Peters, Thomas J. and Robert H. Waterman Jr. (1982). In Search of Excellence,
Warner Books (Chapters 11 and 12).
Rao, Subba P. (2004). Business Policy and Strategic Management, Himalaya
Publishing House.
Salter, Malcolm S., Spring (1970). Stages of Corporate Development, Journal of
Business Policy 1, No.1, pp.23-27.

28

UNIT 15 CONTROL
Objectives
After stildyi~lgthis unit, you should be able to understand:
e

tlie strategic control process;

importance of strategic control in evaluation;

different methods used in control process; and

analysis and follow-up action for control.

Structure
5 1

Introduction
~ t r a t e ~ tControl
ic
Process
Methods of Control
Performance Staildards
Analysis and Follow-up Action for Control
Problems of Control Systems
Suintnary
Key Words
Self-Assessment Questio~is
References and Further Readings

15.1

INTRODUCTION

With the co~npletionof the strategy impleme~ltation,the organization looks forward to


acllievi~lgthe desired goals and ob.jectives. It is necessaly, however, to introduce the
process of strategy evaluatio~iand co~ltrolin the early stages of i~nplementation,to see
whether the strategy is successfi~lor not and to carry out mid-course corrections
wherever necessary. There are several reasons why a strategy may not lead to desired
results. The external enviro~imentnlay not actllally follow a trend as was expected at
the time of planlii~lgthe strategy. The i~lterllalchanges within tlie organization such as
the organizational systems consisting of structure, policies and procedures nlay not
reflect harmony with the strategy. Afler a wliile, the top nlarlagelneilt of even middlelevel managers may find it difficult to exercise a substantial degree of control over
operating systems. The unexpected moves of the co~npetitorsmight create major gaps
evaluatioil and
in the strategy. Thus the list of such factors will require a co~~tinuous
co~ltrolof strategy. In this unit we will describe the control process.

15.2

STRATEGIC CONTROL PROCESS

Tlie evaluation of the strategy of an organization can be done qualitatively as well as


quantitatively. Tlie quantitative evaluatio~lis based on data and is possible through
post facto analysis to detect whether the content of strategy is working or has worked.
However, qualitative evaluation call also be done by addressing the question: Will it
work? The qualitative evaluatio~ican thus be done before activating plans of change.

, 8, ,#
'

.! #,

)I,;

1.:'

The qualitative evaluation and control orstrategy is a real time process. The
performance of strategy is monitored and corrective actions are taken. Tlie basic aim
of any organization is to achieve its goals. But to achieve the goals, the organization
To overcolne these hurdles, it is necessary for any organization
faces lots of 11~11-dles.
to have a sound stratetgic control process. The word meaning of 'control' itself
means 'to regulate' or 'to clieck'. This means that the top management needs to keep
check on how well the strategy is being i~nple~ne~ited
to achieve the objectives ofthe
organization. For example, ifthe business is not giving 1.esu1tsas expected, it may be
necessary to increase p~.ornotionalefforts, or revise the product policy, or as a last
resort, the firm may pull out of a particular business.

Control

I,:

I i

(:

,I,#

'1:iI;,

'1.,

The first phase i.e., tlie evaluation criteria consists of selecting ltey success factors,
developing measures and setting standards fo~.thesame and collecting i11fo1-mation
about actual performance. As discussed, the evaluation criteria can be qualitative as
well as quantitative. In this nit, we will focus on the quantitative aspect. The
t
qualitative aspect would be discussecl in ~ m i16.

i',~
1; ;

The strategic control process is closely related to strategic planning process. Figure
1 5.1 represents the relationship between strategic planning and strategic control
process. Tlie process consists oftliree phases, which are as follows: 1 ) Evaluation
criteria; 2) Performance evaluation; and 3) Feedback.

Strategic
Planning

1,

I,.,

!j

I ';

11'

1:;1
,

'3

. .
#.,I ,

Ol?jeclives
4

,I;:'
I ! 1,
1"
, ,

I
I
I
I

1.''
1

!,~:

.;

----------- Performance Evaluation

.I

I'

:I

,'I.!I 1I

L:

Strategic
Control

Co~ltrolMethods and
Systems

I , !

!I,/
I

1
I

,I;!

'

:IIA:!I :

Organizational
Activities

: ' I

1 ;j

ri 3

Figure 16.1 : Relationsl~ipbetween Strategic Planning rnd Strntegic Control Process

;j(:

Source: Aclnptetl l'rom Byars L. Lloyd, Strategic Management, Planning and Implementation Concepts

I! . ;

IjiI

ant1 Cases. 1987.

:I

'!?!,I

:I! 1

Qurintitrrtive criterifria.forevnkintion : This is i~nportantfor measuring the


organizational performance whereby the actual results are compared wit11 tlie expected
results. Usually the organizations use financial ratios as quantitative criteria for
evaluating strategies. These are used due to the followiilg reasons:

I)
2)
3)

.' < ! a ,

g?

..,,.
.I/(,#

3,

To compare the perrormance ofthe orga~lizationover different time periods;


To cotllpare the performance of the organization with its competitors in the
industl-y;
To compare the organizations' performance to industry averages.

Some of tlie major financial ratios which can be used as criteria for evaluation of strategy are:
1)

2)

Return on invest~nent
Return on equity

47

3)
4)
5)
6)
7)
8)

Impletnentsltion
and Contrbl

Profit margin
Market share
Debt to equity
Earnings per share
Sales growth
Asset growth

These ratios are used by different organizations to measurethe perfonnance oftlle


organization. Here, one thing is to be noted that the qualitative criteria are related
more to short-term objectives than tlle long-term ones. This is the reason why
qualitative criteria are very importallt in evaluating strategies. Therefore, to evaluate
strategies certain qualitative questions sl~ouldalso be taken into consideration. These
questions can be:
e
.

ID

Whether the strategy is inter~iallyconsistent or not?


Whether it is appropriate col~sideringthe available resources or not?
How is the firm balancing its investments between high-risk and low-risk
prospects?

This shows that answers to all these qualitative questions is important to evaluate and
control the strategy.

15.3

METHODS OF CONTROL

There are many methods/tecl~niq~~es


used in strategic control systems. Every
organizatioil has its own way of using a particular technique according to the
requirement of the organization. Most ofthe methods related to the strategic
management are regarding the financial coni%olsystems. Figure 16.2 sl~owsone ofthe
effective systems of financial co~ltrol,which is universally accepted and is used by
many organizatio~lsthrougho~~t
the world. This is system of financial control is known
as DuPont 's system of financial control.

Net Profit Margill

Net Income

Return on Total Assets

I
,

Total Asscts Turnover

+,kq

Net Sales +/Non Opcrating

Surplus/Dedcil

Expenses

Cash, Bank,
and Marketable

'Tax

Receivables

Others

Figure 16.2: DuPont Chart


Source: Adapted from Chandra, Prasanna (1 995), Fzlndamentals of Finai7cial Management.

Control

Tlie other methods which are used most frequently are: Budgets, Audits,
time-related control techniques like: PERT and CPM, Management by Objectives
(MBO). We wi I1 discuss these methods in brief to develop an understanding oftlie
Strategic Co~itroIProcess.
Budgets: These are one of the most widely used control methods. Budget preparation
is one ofthem. 111simple terms budget means 'a plali of income and expenditure'.
Budget usl~allydeals with allocation of resources to different orgaliizational units.
Table 15.1 shows an example of a budget report. Budget gives an idea about the
future expenditures and illcome and at this juncture only the a~ialysisoftlie
performance of the company is done and corrective action call be taken up for flaws,
if any. Since budget is actually a forecast, its revision would be required from time to
time depe~idingupon tlie require~nentof the company. It is one of tlie key elements in
implementing the strategy successfully.
Table 15.1: Budget Report
hrne

5 morrtlrs (year-to-date)

'

Actual

Difference

Budget

Actual

Total cost (Rs) 40,000

50,000

10,000

+25

20,00,00

Budgel

Difrere~~ce
20,50,00

5,000 +25

Audits: This is another method of control. As per American Accounting Association


(AAA), auditing is defined as "a systematic process of objectively obtaining aiid
evaJl~atingevidence regarding assertiolis about economic actiolis and events to
ascertain the degree of correspondence between those assertiolls and established
criteria and communicating the results to interested usersY'(Byars,1987).
Audit functions come under tliree basic groups, viz.
Independent auditors
e Government auditors
e Internal auditors
e

Independent auditors are professionals who provide tlieir services to the


organization.
Government auditors: This precludes the agencies who perform government audits
for organizations.
Internal auditors are e~nployeeswithin the organization and perform their f~~nctioti
from witl~i~i.
There is one more group known as Management Audit, which examines and evaluates
the overall performance of a11 organization's management teain. Audit teams assess
the efficiency of various units in the organization and the control system of tlie
organization. The information provided by them becomes crucial for tlie management.
Nowadays most of tlie organization go in for management audits.

Time-related Control Methods


This includes useful graphical and analytical methods aid these methods serve as a
tool in the strategic control process. The most popular methods include Critical Path
Method (CPM) and Progra~nnieEvaluation and Review TecBnique (PERT). Tlzese are
graphical network depicting tlie different segments ofwork that must be completed
within a given span o f t i ~ n to
e cotnplete a project or task. These provide information
for both project planning and coiltrol aiid is helpful for the inanagement in allocati~lg
its limited resources.

Implementation
and Control

Management By Objectives (MBO)

Tliis is one oftlle methods, which is used both in strategic planning and control. In
this the objectives are establislied for the orga~iizationas a wliole for fi~nctionalareas,
departments and finally individuals oftlie organization. 1t has three minimum
reqi~ire~ne~its
which are as follows:
1)

Objectives for individuals.

2)

Individuals are evaluated and receive feed back on their performance.

3) Individuals are evaluated and rewarded on the basis oftheir performance.


This helps in keeping a check on working of employees in tlie orga~iizationand helps
achieve the goals of tlie organization. Apart from these control methods, other
neth hods like: Management Inforniation Systems (MIS) and Decision Support Systems
(DSS) also call be included undertlie co~itrolmethods.

Activity 1
Suppose you are a fi~la~lcial
expert working for a bank. Identify tlie key fina~~cial
ratios important to evaluate tlle strategy of tlie bank.

15.4

PERFORMANCE STANDARDS
-

--

Having identified the measures relevant for asessing the success of the strategy, the
next important issue is to set the standards against which actual perfor~nanceis to be
measured. The standards of perfor~nancecould be any of the following three types.

a) Historical Standards
In this type of standards, co~nparisonof present performance is made with the past
performance. Though simplest, this type does not take into account the clianges in
environmental conditions between tlie two periods. Moreover, the prior-period
performance itself may not have been acceptable. It also could be misleadii~gin the
fonnative years wl~enthe numerator (previous years figures) is small.

b) Industry Standards
In this type of standards, t l ~ coinparison
e
of a firm's performance is made against
silnilar other firms in the industry. Tlle difficulty here is that all the firms may not be
exactly the same for purposes of comparison.

c) Present.Standards
The goalsltargets are decided by the fir~n'smanagement to be achieved in a particular
period. Present standards convey the aspiration levels and take into account
environmental conditions, if properly derived. These are more realistic and also
consider the organizations' capaci& to achieve them. These, however, require
tremendous analysis. Absence of such analysis may lead to shocking results. However,
for a colnpany developing a conscious strategy, present standards provide the best
alternative.

Activity 2

Control

What Itinds of standards are being used in your organization? What, in your view, are
the problems arising out of it?

15.5

ANALYSIS AND FOLLOW-UP ACTION FOR


CONTROL

Once the actual operations start, information about the actual performance has to be
collected periodically and compared with tlie standards set. If the objectives or major
co~npo~ients
of strategy include such factors as market leadership, information about
market share will also have to be collected. Information may also be collected
of tlie other key factors. If the perfor~nariceon key success
regarding performa~~ce
the long-term success of the strategy may be endangered.
factors is ~~nsatisfactory,
This may be despite tlie current success which may be due to favourable current
environ~nent,for exalnple, boom in tlie industry, scarcity etc.
If tlie perfbrmance is unsatisfactory, two courses of action are possible. The
responsibility centre lnanager may be asked to improve perfor~nance,or if it is not
possible, target or standards of performance may be revised.
TIie evaluation and control reports lnay be oftwo types namely; tlie motivational and
the economic reports. The motivational reports relate to the performance ofthe people
in tlie reslzonsibilitycentres. Economic reports are concerned with. the ecolio~nic
performance ofthe respo~~sibility
centres. The basic difference in the two is that while
tlie latter gives actual economic perfor~nancecovering all factors, tlie for~nerreports
tlie performance of a responsibility centre. For instance, while an economic report will
irlclude all costs, tlie motivational report will includeonly those items of cost over
which it has control.
For exa~nple,tlie division may not have any control over purchase price of materials,
but it may have control over material consulnption. Similarly, the responsibility centre
/
has cont~blover market share while it may not have control over industry volume. It is
advisablk to keep the two reports separate. For instance, iftlie economic performance
is going down despite best efforts of the responsibility centre, there may be a need to
make a shift in the strategy. Similarly, strategic performance based 011 economic
reports rnay be satisfactory but still there may be need for modificationof the strategy
favourable developments.
if the good performance is due to ~~liexpected
From the control point of view the reports ~niistbe timely, otherwise corrective action
may not be possible. The frequeilcy of reports is determined by the lead time required
for corrective action and is constrained by the lead time for processing tlie
transactional data and its transmittal to retrieve data in the form of reports. If on tlle
other liancl, tlie evaluatioi~sare made too early kneejerk reactions are likely which may
hurt tlie plan.
A strategy need not be changed or abandoned just because evaluation has revealed the
causes of poor performance over a short period. It should be tested for a sufficiently

51

lrnplementation
and Control

long period oftime because certain assumptions might have gone wrong and there was
no contingency plan to take care of such situations. Ifeven after reasonable period of
time the performance is not coming up to expectations, it lnay be due to serious
deficiencies in the business strategy. However, before changing the strategy, it would
be advisable to check its i~npleinentationon the test of adequacy. It is quite possible
that some of the Ss of the 7-S model may be grossly out of line with the strategy. And,
if corrected, the strategy may still be quite useful. However, there might have been
serious errors in assessing the external and internal environ~nentseven tliough the
evaluatio~lof implementation reveals 110 major mismatches.

iI

Activity 3
How are the targets fixed for various divisions/departments in your organization?
How and why are the targets revised? Give colnlnents on the duration of target fixing
and revising.

15.6

PROBLEMS OF CONTROL SYSTEMS

'There are a large number of problems associated with control systems for strategy
evaluation. An efficient system may collect a lot of irrelevant data whereas a
sophisticated system might ignore crucial information. Some of the typical problelns
encountered in designing and managing control system are:
e

There inay not be a consensus on the criteria for ~neasuringthe effectiveness and
efficiency of the strategy.

The reporting data may be invalid.

The perfornlance norms may be based on outputs 011 which the relevant business
inay not have a control.

Often perfor~nancestandards may be set with inherent co~ltradictions.For


example, an increase in market share inay be expected in conjunction with an
absolute decrease in marketing expenditure.

E~nployeesinay consider the system to be unfair and therefore nlay not accept it.

Overemphasis on measuring short-term performance may make managers forget


aboyt the strategy which inherently has long connotations.

It is very difficult to set "good7', "average" and "poor" levels of performance in


situations where the outputs are not very tangible.

15.7

SUMMARY

An effective system ofevaluatio~land control is important for the success of corporate


strategy. It is also necessary for taking decisions on whether strategy s h o ~ ~be
ld
continued or modified. The success of a strategy should be considered both in terms of
effectiveness and efficiency. While it is easy to measure efficiency, it is relatively more
difficult to measure effectiveness.

I
1

The problem in evaluatio~iand control is that of developing appropriate measures. The


key variables of the organization may guide the duration of measures for evaluation
and control. Structure also plays an i~nportantrole in evaluation and control of
strategy. Defective structures may lead to inadequate evaluation and c011tro1.The
economic perfornia~iceofan organization unit must bedistinguislied from tlie
performance of people ofthe unit fiom the viewpoint offollow-up action. Factors
which are not under tlie control of a respo~isibilitycentre must be excluded from the
reports in eval~iatingthe performance of the responsibility centre people. For
evaluation of s strategy or concrete action, all factors of cost and environment must be
i ~ i c l ~ ~ dOn
e d tlie
. basis of evaluatio~ltlie corrective action may be taken iftlie
performance is not up to the planned levels. If it is found that tlie performance ofthe
responsibility centre is not improving or is ii~ilikelytoimprove, tlie targets lnay be
revised.
If there are successive failures, tlie strategy may have to be abandoned. Before
abandoning tlie strategy, however, an examination should be made as to whether
implementation has been adequate.

15.8

KEY WORDS

Control : To regulate.
Perforniance Stantlards : Standards against which actual performance is to be
measured.
Ratio Analysis : The principal tool of financial statement analysis.

15.9

SELF-ASSESSMENT QUESTIONS

1)

Compare and contrast different types of standards which call be used for co~itrol
of strategy.

2)

Discuss the strategic control process.

3)

Briefly explain sonle areas in which organizations establish quantitative


evaluation criteria.

4)

What can be the characteristics of an effective co~itrolsystem? Discuss.

15.10

REFERENCES AND FURTHER READINGS

Anthony, R.N., et al. (1 984). Management ControlSystem, Rechard D. Irwin :


Homewoocl.
Byars, Lloyd. (1 987). strategic Managenzent : Planning and Inlplenzentation,
Concepts and Cases, Harper & Row, Publishers, New York.
Cliandra, Prasatina. ( 1 995). Fundanzental of Financial Manageaent, Tata McGrawHill Publislii~igCompany Ltd.New Delhi.
David, Fred R. (1997). Concepts ofStrategic Management, Pre~iticHall International
Inc.

G lueck, W .F., et al. (1 9 84). Busine,rs Policy and Strategic Management, McGraw
Hill : New York.
Til les, Seymonr. (1 963). &'Howlo Evaluate Corporate Strategy", Harvard Business
Review, July-August, pp. 111- 121.

Control