Unit-2b (MBM-543)

environmental
scanningand
IndustryAnalysis
The Arctic is undergoing an extraordinary transformationa transformation
that will have global impact not only on wildlife, but upon many countries
and a number of industries. Some of the most significant environmental changes
are retreating sea ice, melting glaciers, thawing permafrost, increasing coastal
erosion, and shifting vegetation zones. The average temperature of the Arctic has risen
at twice the rate of the rest of the planet. According to Impacts of a Warming Arctic: Arctic
Climate Impact Assessment, a 2004 report by the eight-nation Arctic Council, the melting of the
areas highly reflective snow and sea ice is uncovering darker land and ocean surfaces, further in-
creasing the absorption of the suns heat. Reductions in Arctic sea ice will drastically shrink marine
habitats for polar bears, ice seals, and some seabirds. The warming of the tundra will likely boost
greenhouse gases by releasing long-stored quantities of methane and carbon dioxide.
In addition to containing a large percentage of the worlds water as ice, the Arctic is a large
storehouse of natural resources. Given that the Arctic Ocean could be ice-free in the summer by
2040, countries bordering the Arctic are already positioning themselves for exploitation of these
resources. Lawson Brigham, Alaska Office Director of the U.S. Arctic Research Commission and
a former chief of strategic planning for the U.S. Coast Guard, examined how regional warming
will affect transportation systems, resource development, indigenous Arctic peoples, regional
environmental degradation and protection schemes, and overall geopolitical issues. From this,
he proposes four possible scenarios for the Arctic in 2040:
1. Globalized frontier: In this scenario, the Arctic by 2040 has become an integral component
of the global economic system, but is itself a semi-lawless frontier with participants jockey-
ing for control. The summer sea ice has completely disappeared for a two-week period, al-
lowing greater marine access and commercial shipping throughout the area. The famous
Northwest Passage dreamed by 16th century navigators is now a reality. Rising prices for
oil, natural gas, nickel, copper, zinc, and freshwater in conjunction with an easily accessible
and less-harsh climate have made Arctic natural resource exploitation economically viable.
Even though overfishing has reduced fish stocks, Arctic tourism is flourishing. By now, well-
worn oil and gas pipelines in western Siberia and Alaska are experiencing recurring serious
LearningObjectives
After reading this chapter, you should be able to:
{
Recognize aspects of an organizations

environment that can influence its long-
term decisions
Identify the aspects of an organizations
environment that are most strategically
important
Conduct an industry analysis to
understand the competitive forces that
influence the intensity of rivalry within an
industry
Understand how industry maturity affects
industry competitive forces
{
Categorize international industries based

on their pressures for coordination and
local responsiveness
Construct strategic group maps to assess the
competitive positions of firms in an industry
Identify key success factors and develop an
industry matrix
Use publicly available information to
conduct competitive intelligence
Know how to develop an industry scenario
Be able to construct an EFAS table that
summarizes external environmental factors
{
{
{
{
{
{
{
{
Environmental
Scanning:
Gathering
Information
Strategy
Formulation:
Developing
Long-range Plans
Strategy
Implementation:
Putting Strategy
into Action
Evaluation
and Control:
Monitoring
Performance
External:
Opportunities
and Threats
Mission
Reason for
existence
Objectives
What
results to
accomplish
by when
Natural
Environment:
Resources and
climate
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Societal
Environment:
General forces
Programs
Activities
needed to
accomplish
a plan
Task
Environment:
Industry analysis
Budgets
Cost of the
programs
Procedures
Sequence
of steps
needed to
do the job
Internal:
Strengths and
Weaknesses
Performance
Actual results
Structure:
Chain of command
Culture:
Beliefs, expectations,
values
Resources:
Assets, skills,
competencies,
knowledge
Feedback/Learning: Make corrections as needed
95
96
PART 2
ScanningtheEnvironment
spills. By 2020, Canada, Denmark (Greenland), Norway, Russia, and the United States
had asserted their sovereignty over sea bed resources beyond 200 nautical milesleav-
ing only two small regions in the central Arctic Ocean under international jurisdiction.
Environmental concerns that once fostered polar cooperation have been replaced by
economic and political interests. The protection, development, and governance of the
Svalbard Islands became a problem when Russia refused to recognize Norways 200-
nautical mile exclusive economic zone around the islands. Issues regarding freedom of
navigation and commercial access rights are highly contentious. The eight permanent
members of the Arctic Council have increasingly excluded outside participation in the
Councils deliberations.
2. Adaptive frontier: In this scenario, the Arctic in 2040 is being drawn much more slowly
into the global economy. The area is viewed as an international resource. Competition
among the Arctic countries for control of the regions resources never grew beyond a
low level and the region is the scene of international cooperation among many inter-
national stakeholders. The indigenous peoples throughout the area have organized
and now have significant influence over decisions relating to regional environmental
protection and economic development. The exploitation of Arctic oil and gas is re-
stricted to the few key areas that are most cost-competitive. Air and water transporta-
tion systems flourish throughout the area. Commercially viable fishing has continued,
thanks to stringent harvesting quotas and other bilateral agreements. The Arctic Coun-
cil is a proactive forum resolving several disputes and engaging the indigenous peoples
in all deliberations. Nevertheless, the impact of global warming on the Arctic is wide-
spread and serious. Contingency planning for manmade and natural emergencies is ad-
vanced and well coordinated. Sustainable development is widely supported by most
stakeholders. The Arctic region has become a model for habitat protection. Arctic na-
tional parks have expanded modestly and adapted to deal with increased tourism.
3. Fortress frontier: In this scenario, widespread resource exploitation and increased in-
ternational tension exist throughout the Arctic. The region is viewed by much of the
global community as a storehouse of natural resources that is being jealously guarded
by a handful of wealthy circumpolar nations. Although the Arctic is part of the global
economic system, any linkage is controlled by the most powerful Arctic countries for
their own benefit. By 2040, the Arctic is undergoing extreme environmental stress, as
global warming continues unabated. Many indigenous peoples have been displaced
from their traditional homelands due to extreme environmental events. Illegal immi-
gration becomes an issue in many subarctic regions. Although air and marine trans-
portation routes are open, foreign access has been periodically suspended for
political or security reasons. Russia and Canada, in particular, continue to tightly con-
trol marine access through the Northern Sea Route and Northwest Passage. Fishing
rights have been suspended to all but the Arctic countries. Oil and gas exploration
and production has intensified throughout the Arctic. The Svalbard Islands, claimed
CHAPTER 4
EnvironmentalScanningandIndustryAnalysis
97
by Norway, have been a source of potential conflict over access to living and nonliv-
ing resources. Norway, Russia, and the United States have increased military forces in
the region. Rather than dealing with sustainable development, the Arctic Council fo-
cuses on economic and security concerns, such as illegal immigrants and controlling
the flow of exports from the Arctic consortium. Early in the 21st century, the five
countries bordering the Arctic declared their sovereignty over resources beyond
200 nautical miles to the edge of the continental shelf extensions. By 2030, the Arctic
Council unilaterally took jurisdiction over the two small regions that remained within
international jurisdiction. Arctic tourism thrives, since many other traditional destina-
tions are experiencing turmoil and a shortage of necessities.
4. Equitable frontier: In this scenario, the Arctic is integrated with the global economic
system by 2040, but international concern for sustainable development has slowed the
regions economic development. Mutual respect and cooperation among the circum-
polar nations allows for the development of a respected Arctic governance system.
Even though the world is working hard to reduce greenhouse gas emissions, the Arc-
tic continues to warm. Transport user fees and other eco-taxes are used to support en-
dangered wildlife and impacted indigenous communities. The growth of the Northern
Sea Route and Northwest Passage has enabled significant efficiencies in commercial
shipping. Canada and Russia have maintained stringent marine regulations that em-
phasize environmental protection. Despite differences over freedom of navigation,
the United States, Canada, and Russia have negotiated an agreement that allows a
seamless voyage around Alaska and through the routes under a uniform set of opera-
tional procedures. The Arctic Council has created regional disaster teams to respond to
maritime and other emergencies. Boundary disputes have been resolved and fishing
rights have been allocated to various nations. The University of the Arctic has brought
quality online education to easy reach of all northern citizens. The Arctic Council has
brokered an agreement to allow 30,000 environmental refugees to settle in subarctic
territories. Oil exploration and production in the Arctic has slowed considerably. Arc-
tic tourism continues its steady growth, prompting national and regional parliaments
to establish additional wilderness lands funded by tourist fees. There is low military
presence in the region, thanks to the diplomatic efforts of the Arctic Council.
The Arctic is a complex, but relatively small region. These four scenarios suggest how
climate change combined with a growing need for natural resources might impact this re-
gion and the world.1
{
{
Which of the four preceding scenarios is most likely?
Which industries are likely to be affected (either positively or negatively) by the
warming of the Arctic?
{
If in an affected industry, how could a business corporation prepare for each of these
scenarios?
98
PART 2
A changing environment can help as well as hurt a company. Many pioneering com-
panies have gone out of business because of their failure to adapt to environmental
change or, even worse, because of their failure to create change. For example, Baldwin
Locomotive, the major manufacturer of steam locomotives, was very slow in making the
switch to diesel locomotives. General Electric and General Motors soon dominated the
diesel locomotive business and Baldwin went out of business. The dominant manufactur-
ers of vacuum tubes failed to make the change to transistors and consequently lost this
market. Eastman Kodak, the pioneer and market leader of chemical-based film photogra-
phy, continues to struggle with its transition to the newer digital technology. Failure to
adapt is, however, only one side of the coin. The aforementioned Arctic warming exam-
ple shows how a changing environment can create new opportunities at the same time it
destroys old ones. The lesson is simple: To be successful over time, an organization needs
to be in tune with its external environment. There must be a strategic fit between what
the environment wants and what the corporation has to offer, as well as between what
the corporation needs and what the environment can provide.
Current predictions are that the environment for all organizations will become even
more uncertain with every passing year. What is environmental uncertainty? It is the
degree of complexity plus the degree of change that exists in an organizations external
environment. As more and more markets become global, the number of factors a company
must consider in any decision becomes huge and much more complex. With new technolo-
gies being discovered every year, markets change and products must change with them.
On the one hand, environmental uncertainty is a threat to strategic managers be-
cause it hampers their ability to develop long-range plans and to make strategic decisions
to keep the corporation in equilibrium with its external environment. On the other hand,
environmental uncertainty is an opportunity because it creates a new playing field in
which creativity and innovation can play a major part in strategic decisions.
4.1
EnvironmentalScanning
Beforeanorganizationcanbeginstrategyformulation,itmustscantheexternalenvironmentto
identifypossibleopportunitiesandthreatsanditsinternalenvironmentforstrengthsandweak
nesses.Environmentalscanningisthemonitoring,evaluation,anddisseminationofinformation
fromtheexternalandinternalenvironmentstokeypeoplewithinthecorporation.Acorporation
usesthistooltoavoidstrategicsurpriseandtoensureitslongtermhealth.Researchhasfounda
positiverelationshipbetweenenvironmentalscanningandprofits. 2Approximately70%ofexec
utivesaroundtheworldstatethatglobalsocial,environmental,andbusinesstrendsareincreas
inglyimportanttocorporatestrategy,accordingtoa2008surveybyMcKinsey&Company. 3
IDENTIFYING EXTERNAL ENVIRONMENTAL VARIABLES
Inundertakingenvironmentalscanning,strategicmanagersmustfirstbeawareofthemany
variableswithinacorporationsnatural,societal,andtaskenvironments(seeFigure13).The
CHAPTER 4
99
naturalenvironmentincludesphysicalresources,wildlife,andclimatethatareaninherent
partofexistenceonEarth.Thesefactorsformanecologicalsystemofinterrelatedlife.The
societalenvironmentismankindssocialsystemthatincludesgeneralforcesthatdonotdi
rectlytouchontheshortrunactivitiesoftheorganizationthatcan,andoftendo,influenceits
longrundecisions.Thesefactorsaffectmultipleindustriesandareasfollows:
{
{
{
Economicforcesthatregulatetheexchangeofmaterials,money,energy,andinformation.
Technologicalforcesthatgenerateproblemsolvinginventions.
Politicallegalforcesthatallocatepowerandprovideconstrainingandprotectinglaws
andregulations.
Socioculturalforcesthatregulatethevalues,mores,andcustomsofsociety.
{
Thetaskenvironmentincludesthoseelementsorgroupsthatdirectlyaffectacorporationand,
inturn,areaffectedbyit.Thesearegovernments,localcommunities,suppliers,competitors,
customers,creditors,employees/laborunions,specialinterestgroups,andtradeassociations.
Acorporationstaskenvironmentistypicallytheindustrywithinwhichthefirmoperates.
Industryanalysis(popularizedbyMichaelPorter)referstoanindepthexaminationofkey
factorswithinacorporationstaskenvironment.Thenatural,societal,andtaskenvironments
mustbemonitoredtodetectthestrategicfactorsthatarelikelyinthefuturetohaveastrong
impactoncorporatesuccessorfailure.Changesinthenaturalenvironmentusuallyaffecta
businesscorporationfirstthroughitsimpactonthesocietalenvironmentintermsofresource
availabilityandcostsandthenuponthetaskenvironmentintermsofthegrowthordeclineof
particularindustries.
ScanningtheNaturalEnvironment
Thenaturalenvironmentincludesphysicalresources,wildlife,andclimatethatareanin
herentpartofexistenceonEarth.Untilthe20thcentury,thenaturalenvironmentwasgen
erallyperceivedbybusinesspeopletobeagivensomethingtoexploit,notconserve.It
wasviewedasafreeresource,somethingtobetakenorfoughtover,likearableland,dia
mondmines,deepwaterharbors,orfreshwater.Oncetheywerecontrolledbyapersonor
entity,theseresourceswereconsideredassetsandthusvaluedaspartofthegeneraleco
nomicsystemaresourcetobebought,sold,orsometimesshared.Sideeffects,suchas
pollution,wereconsideredtobeexternalities,costsnotincludedinabusinessfirmsac
countingsystem,butfeltbyothers.Eventuallytheseexternalitieswereidentifiedbygov
ernments,whichpassedregulationstoforcebusinesscorporationstodealwiththeside
effectsoftheiractivities.
Theconceptofsustainabilityarguesthatafirmsabilitytocontinuouslyrenewitselffor
longtermsuccessandsurvivalisdependentnotonlyuponthegreatereconomicandsocialsys
temofwhichitisapart,butalsouponthenaturalecosysteminwhichthefirmisembedded. 4
Abusinesscorporationmustthusscanthenaturalenvironmentforfactorsthatmightpreviously
havebeentakenforgranted,suchastheavailabilityoffreshwaterandcleanair.Globalwarm
ingmeansthataspectsofthenaturalenvironment,suchassealevel,weather,andclimate,are
becomingincreasinglyuncertainanddifficulttopredict.Managementmustthereforescannot
onlythenaturalenvironmentforpossiblestrategicfactors,butalsoincludeinitsstrategic
decisionmakingprocessestheimpactofitsactivitiesuponthenaturalenvironment.Inaworld
concernedwithglobalwarming,acompanyshouldmeasureandreduceitscarbonfootprint
theamountofgreenhousegasesitisemittingintotheair.Researchrevealsthatscanningthe
marketforenvironmentalissuesispositivelyrelatedtofirmperformancebecauseithelpsman
agementidentifyopportunitiestofulfillfuturemarketdemandbaseduponenvironmentally
friendlyproductsorprocesses.5SeetheEnvironmentalSustainabilityIssuefeaturetolearn
howindividualscanalsomeasureandshrinktheirpersonalcarbonfootprints.
100
PART 2
ENVIRONMENTAL
sustainabilityissue
mated 18% of global carbon emissions, eating a ham-
burger results in carbon emissions by the consumer. Some-
thing as small as an iPod adds to a persons carbon
footprint due not only to the energy used to produce and
transport the product, but also to the energy used to
charge it over its lifetimeapproximately 68 pounds of
CO2. Both the Nature Conservancy and the U.S. Environ-
mental Protection Agency provide ways to measure an in-
dividual carbon footprint. The EPA even offers a carbon
calculator on its Web site, epa.gov.
Carbonrally offers concrete ways to start cutting carbon
emissions. One 2008 contest challenged people to avoid
bottled soda, tea, and sports drinks for a month for an av-
erage individual savings of 25.7 pounds of CO2.
Other challenges were using a clothesline to dry one
laundry load a week, unplugging computers every night
for one month, and using a personal cup for coffee instead
of using a disposable cup. By the end of 2008, nearly 15,000
individuals had completed a challenge, effectively reducing
over 1,622.57 tons of CO2.
Given that global carbon dioxide emissions total more
than 28 billion tons annually, one persons reductions can
seem very small. Why bother? Carbonrally might respond
that the best way to change the world is one person at a
time.
MEASURING AND SHRINKING
YOUR PERSONAL CARBON FOOTPRINT
As people become more
green, that is more con-
scious of environmental sus-
tainability, they wonder what they
can do as individuals to reduce the emission of green-
house gases. This is an important issue given that a typical
American produces more than 20 tons of carbon dioxide
annuallya very large carbon footprint. Even a homeless
American has a carbon footprint of 8.5 tons, more than
twice the global average! The first problem for concerned
individuals is finding a way to measure the size of their
own carbon footprint. The second problem is developing
feasible programs to reduce that footprint in some mean-
ingful way.
The Web site carbonrally.com solves these problems by
presenting competitive environmental challenges and
keeping score by translating green actions into pounds of
carbon dioxide averted. For instance, cutting the time of a
daily shower by two minutes for a month reduces CO 2
emissions by 15.3 pounds. According to Kelsey Schroeder,
who has logged savings of more than 1,000 pounds of
emissions, This has been a great motivational technique.
We just want to keep going and see if we can do better.
How does Carbonrally calculate someones carbon shoe
size? Since everything a person does that is powered by
fossil fuels has a carbon dioxide cost, many activities have
the potential of being counted. Commuting in a gasoline
powered car has obvious carbon costs, but so does eating
a hamburger. Since livestock are responsible for an esti-
SOURCES: B. Walsh and T. Sharples, Sizing Up Carbon Footprints,
Time (May 26, 2008), pp. 5355 and www.carbonrally.com.
ScanningtheSocietalEnvironment:STEEPAnalysis
Thenumberofpossiblestrategicfactorsinthesocietalenvironmentisveryhigh.Thenumber
becomesenormouswhenwerealizethat,generallyspeaking,eachcountryintheworldcanbe
representedbyitsownuniquesetofsocietalforcessomeofwhichareverysimilartothose
ofneighboringcountriesandsomeofwhichareverydifferent.
Forexample,eventhoughKoreaandChinashareAsiasPacificRimareawithThai
land,Taiwan,andHongKong(sharingmanysimilarculturalvalues),theyhaveverydiffer
entviewsabouttheroleofbusinessinsociety.ItisgenerallybelievedinKoreaandChina
(andtoalesserextentinJapan)thattheroleofbusinessisprimarilytocontributetona
tionaldevelopment;howeverinHongKong,Taiwan,andThailand(andtoalesserextent
inthePhilippines,Indonesia,Singapore,andMalaysia),theroleofbusinessisprimarilyto
makeprofitsfortheshareholders.6Suchdifferencesmaytranslateintodifferenttraderegu
lationsandvaryingdifficultyintherepatriationofprofits(thetransferofprofitsfromafor
eignsubsidiarytoacorporationsheadquarters)fromonegroupofPacificRimcountriesto
another.
CHAPTER 4
101
STEEPAnalysis:MonitoringTrendsintheSocietalandNaturalEnvironments.As
showninTable41,largecorporationscategorizethesocietalenvironmentinanyone
geographicregionintofourareasandfocustheirscanningineachareaontrendsthathave
corporatewiderelevance.Byincludingtrendsfromthenaturalenvironment,thisscanningcan
becalledSTEEPAnalysis,thescanningofSociocultural,Technological,Economic,
Ecological,andPoliticallegalenvironmentalforces.7(ItmayalsobecalledPESTELAnalysis
forPolitical,Economic,Sociocultural,Technological,Ecological,andLegalforces.)
Obviously,trendsinanyoneareamaybeveryimportanttofirmsinoneindustrybutoflesser
importancetofirmsinotherindustries.
Trendsintheeconomicpartofthesocietalenvironmentcanhaveanobviousimpacton
businessactivity.Forexample,anincreaseininterestratesmeansfewersalesofmajorhome
appliances.Why?Arisinginterestratetendstobereflectedinhighermortgagerates.Because
highermortgageratesincreasethecostofbuyingahouse,thedemandfornewandusedhouses
tendstofall.Becausemostmajorhomeappliancesaresoldwhenpeoplechangehouses,are
ductioninhousesalessoontranslatesintoadeclineinsalesofrefrigerators,stoves,anddish
washersandreducedprofitsforeveryoneintheapplianceindustry.Changesinthepriceofoil
haveasimilarimpactuponmultipleindustries,frompackagingandautomobilestohospital
ityandshipping.
TherapideconomicdevelopmentofBrazil,Russia,India,andChina(oftencalledthe
BRICcountries)ishavingamajorimpactontherestoftheworld.By2007,Chinahadbecome
theworldssecondlargesteconomyaccordingtotheWorldBank.WithIndiagraduatingmore
Englishspeakingscientists,engineers,andtechniciansthanallothernationscombined,ithas
becometheprimarylocationfortheoutsourcingofservices,computersoftware,andtelecom
munications.8EasternEuropehasbecomeamajormanufacturingsuppliertotheEuropean
Unioncountries.AccordingtotheInternationalMonetaryFund,emergingmarketsmakeup
lessthanonethirdoftotalworldgrossdomesticproduct(GDP),butaccountformorethan
halfofGDPgrowth.9
TABLE 41
Economic
GDPtrends
Interestrates
Moneysupply
Inflationrates
Some Important Variables in the Societal Environment
Technological
Totalgovernmentspending
forR&D
Totalindustryspending
forR&D
Focusoftechnologicalefforts
Patentprotection
Newproducts
Newdevelopmentsin
technologytransferfromlab
tomarketplace
Productivityimprovements
throughautomation
Internetavailability
Telecommunication
infrastructure
Computerhackingactivity
PoliticalLegal
Antitrustregulations
Environmentalprotection
laws
Globalwarminglegislation
Immigrationlaws
Taxlaws
Specialincentives
Foreigntraderegulations
Attitudestowardforeign
companies
Lawsonhiringand
promotion
Stabilityofgovernment
Outsourcingregulation
Foreignsweatshops
Sociocultural
Lifestylechanges
Careerexpectations
Consumeractivism
Rateoffamilyformation
Growthrateofpopulation
Agedistribution
ofpopulation
Regionalshifts
inpopulation
Lifeexpectancies
Birthrates
Pensionplans
Healthcare
Levelofeducation
Livingwage
Unionization
Unemploymentlevels
Wage/pricecontrols
Devaluation/revaluation
Energyalternatives
Energyavailability
andcost
Disposableand
discretionaryincome
Currencymarkets
Globalfinancialsystem
102
PART 2
Changesinthetechnologicalpartofthesocietalenvironmentcanalsohaveagreatimpact
onmultipleindustries.Improvementsincomputermicroprocessorshavenotonlyledtothe
widespreaduseofpersonalcomputersbutalsotobetterautomobileengineperformanceinterms
ofpowerandfueleconomythroughtheuseofmicroprocessorstomonitorfuelinjection.Digi
taltechnologyallowsmoviesandmusictobeavailableinstantlyovertheInternetorthroughca
bleservice,butitalsomeansfallingfortunesforvideorentalshopssuchastheMovieGallery
andCDstoressuchasTowerRecords.Advancesinnanotechnologyareenablingcompaniesto
manufactureextremelysmalldevicesthatareveryenergyefficient.Developingbiotechnology,
includinggenemanipulationtechniques,isalreadyprovidingnewapproachestodealingwith
diseaseandagriculture.ResearchersatGeorgeWashingtonUniversityhaveidentifiedanumber
oftechnologicalbreakthroughsthatarealreadyhavingasignificantimpactonmanyindustries:
{
Portableinformationdevicesandelectronicnetworking:Combiningthecomputing
powerofthepersonalcomputer,thenetworkingoftheInternet,theimagesofthetelevi
sion,andtheconvenienceofthetelephone,theseapplianceswillsoonbeusedbyamajor
ityofthepopulationofindustrializednationstomakephonecalls,sendemail,and
transmitdocumentsandotherdata.Evennow,homes,autos,andofficesarebeingcon
nected(viawiresandwirelessly)intointelligentnetworksthatinteractwithoneanother.
Thistrendisbeingsupportedbythedevelopmentofcloudcomputing,inwhichaperson
cantapintocomputingpowerelsewherethroughaWebconnection. 10Thetraditionalstand
alonedesktopcomputermaysoonjointhemanualtypewriterasahistoricalcuriosity.
Alternativeenergysources:Theuseofwind,geothermal,hydroelectric,solar,biomass,
andotheralternativeenergysourcesshouldincreaseconsiderably.Overthepasttwo
decades,thecostofmanufacturingandinstallingaphotovoltaicsolarpowersystemhas
decreasedby20%witheverydoublingofinstalledcapacity.Thecostofgeneratingelec
tricityfromconventionalsources,incontrast,hasbeenrisingalongwiththepriceofpe
troleumandnaturalgas.11
Precisionfarming:Thecomputerizedmanagementofcropstosuitvariationsinland
characteristicswillmakefarmingmoreefficientandsustainable.Farmequipmentdealers
suchasCaseandJohnDeereaddthisequipmenttotractorsforanadditional$6,000orso.
Itenablesfarmerstoreducecosts,increaseyields,anddecreaseenvironmentalimpact.
Theoldsystemofsmall,lowtechfarmingisbecominglessviableaslargecorporate
farmsincreasecropyieldsonlimitedfarmlandforagrowingpopulation.
Virtualpersonalassistants:Verysmartcomputerprogramsthatmonitoremail,faxes,
andphonecallswillbeabletotakeoverroutinetasks,suchaswritingaletter,retrieving
afile,makingaphonecall,orscreeningrequests.Actinglikeasecretary,apersonsvir
tualassistantcouldsubstituteforapersonatmeetingsorindealingwithroutineactions.
Geneticallyalteredorganisms:Aconvergenceofbiotechnologyandagricultureiscre
atinganewfieldoflifesciences.Plantseedscanbegeneticallymodifiedtoproducemore
neededvitaminsortobelessattractivetopestsandmoreabletosurvive.Animals(includ
ingpeople)couldbesimilarlymodifiedfordesirablecharacteristicsandtoeliminatege
neticdisabilitiesanddiseases.
Smart,mobilerobots:Robotdevelopmenthasbeenlimitedbyalackofsensorydevices
andsophisticatedartificialintelligencesystems.Improvementsintheseareasmeanthat
robotswillbecreatedtoperformmoresophisticatedfactorywork,runerrands,dohouse
holdchores,andassistthedisabled.12
{
{
{
{
{
Trendsinthepoliticallegalpartofthesocietalenvironmenthaveasignificantimpactnotonly
onthelevelofcompetitionwithinanindustrybutalsoonwhichstrategiesmightbesuccessful. 13
Forexample,periodsofstrictenforcementofU.S.antitrustlawsdirectlyaffectcorporategrowth
CHAPTER 4
103
strategy.Aslargecompaniesfinditmoredifficulttoacquireanotherfirminthesameorarelated
industry,theyaretypicallydriventodiversifyintounrelatedindustries. 14Highlevelsoftaxation
andconstraininglaborlawsinWesternEuropeancountriesstimulatecompaniestoaltertheir
competitivestrategiesorfindbetterlocationselsewhere.ItisbecauseGermanyhassomeofthe
highestlaborandtaxcostsinEuropethatGermancompanieshavebeenforcedtocompeteatthe
topendofthemarketwithhighqualityproductsorelsemovetheirmanufacturingtolowercost
countries.15Governmentbureaucracycancreatemultipleregulationsandmakeitalmostimpos
sibleforabusinessfirmtooperateprofitablyinsomecountries.Forexample,thenumberofdays
neededtoobtainthegovernmentapprovalsnecessarytostartanewbusinessvaryfromonlyone
dayinSingaporeto14inMexico,59inSaudiArabia,87inIndonesia,to481intheCongo. 16
The$66trillionglobaleconomyoperatesthroughasetofrulesestablishedbytheWorld
TradeOrganization(WTO).Composedof153membernationsand30observernations,the
WTOisaforumforgovernmentstonegotiatetradeagreementsandsettletradedisputes.Orig
inallyfoundedin1947astheGeneralAgreementonTariffsandTrade(GATT),theWTOwas
createdin1995toextendthegroundrulesforinternationalcommerce.Thesystemspurpose
istoencouragefreetradeamongnationswiththeleastundesirablesideeffects.Amongitsprin
ciplesistradewithoutdiscrimination.Thisisexemplifiedbyitsmostfavorednationclause,
whichstatesthatacountrycannotgrantatradingpartnerlowercustomsdutieswithoutgrant
ingthemtoallotherWTOmembernations.Anotherprincipleisthatofloweringtradebarri
ersgraduallythoughnegotiation.Itimplementsthisprinciplethroughaseriesofroundsof
tradenegotiations.Asaresultofthesenegotiations,industrialcountriestariffratesonindus
trialgoodshadfallensteadilytolessthan4%bythemid1990s.TheWTOiscurrentlynego
tiatingitsninthroundofnegotiations,calledtheDohaRound.TheWTOisalsoinfavoroffair
competition,predictabilityofmembermarkets,andtheencouragementofeconomicdevelop
mentandreform.Asaresultofmanynegotiations,developednationshavestartedtoallow
dutyfreeandquotafreeimportsfromalmostallproductsfromtheleastdevelopedcountries. 17
Demographictrendsarepartofthesocioculturalaspectofthesocietalenvironment.Even
thoughtheworldspopulationisgrowingfrom3.71billionpeoplein1970to6.82billionin
2010to8.72billionby2040,notallregionswillgrowequally.Mostofthegrowthwillbein
thedevelopingnations.Thepopulationofthedevelopednationswillfallfrom14%oftheto
talworldpopulationin2000toonly10%in2050.18Around75%oftheworldwillliveinacity
by2050comparedtolittlemorethanhalfin2008.19Developingnationswillcontinuetohave
moreyoungthanoldpeople,butitwillbethereverseintheindustrializednations.Forexam
ple,thedemographicbulgeintheU.S.populationcausedbythebabyboominthe1950scon
tinuestoaffectmarketdemandinmanyindustries.Thisgroupof77millionpeoplenowintheir
50sand60sisthelargestagegroupinalldevelopedcountries,especiallyinEurope.(See
Table42.)AlthoughthemedianageintheUnitedStateswillrisefrom35in2000to40by
2050,itwillincreasefrom40to47duringthesametimeperiodinGermany,anditwillin
creaseupto50inItalyassoonas2025.20By2050,oneinthreeItalianswillbeover65,nearly
TABLE 42
Current U.S.
Generations
Generation
WWII/SilentGeneration
BabyBoomers
GenerationX
GenerationY
Born
19321945
19461964
19651977
19781994
Age in 2005
6073
4159
2840
1127
Number
32million
77million
45million
70million
SOURCE:DevelopedfromdatalistedinD.Parkinson,VoicesofExperience:MatureWorkersintheFutureWork
force(NewYork:TheConferenceBoard,2002),p.19.
104
PART 2
doublethenumberin2005.21Withitslowbirthrate,Japanspopulationisexpectedtofallfrom
127.6millionin2004toaround100millionby2050.22Chinasstringentbirthcontrolpolicy
iscausingtheratioofworkerstoretireestofallfrom20to1duringtheearly1980sto2.5to
oneby2020.23Companieswithaneyeonthefuturecanfindmanyopportunitiestoofferprod
uctsandservicestothegrowingnumberofwoofies(welloffoldfolksdefinedaspeople
over50withmoneytospend).24Thesepeopleareverylikelytopurchaserecreationalvehicles
(RVs),takeoceancruises,andenjoyleisuresports,suchasboating,fishing,andbowling,in
additiontoneedingfinancialservicesandhealthcare.Anticipatingtheneedsofseniorsforpre
scriptiondrugsisonereasontheWalgreenCompanyhasbeenopeninganewcornerpharmacy
every19hours!25
Toattractoldercustomers,retailerswillneedtoplaceseatsintheirlargerstoressoaging
shopperscanrest.Washroomsneedtobemoreaccessible.Signsneedtobelarger.Restaurants
needtoraisetheleveloflightingsopeoplecanreadtheirmenus.Homeappliancesneedsim
plerandlargercontrols.Automobilesneedlargerdooropeningsandmorecomfortableseats.
ZimmerHoldings,aninnovativemanufacturerofartificialjoints,islookingforwardtoitsmar
ketgrowingrapidlyoverthenext20years.AccordingtoJ.RaymondElliot,chairandCEOof
Zimmer,Itssimplemath.Ourbestyearsarestillinfrontofus.26
EightcurrentsocioculturaltrendsaretransformingNorthAmericaandtherestoftheworld:
1.Increasingenvironmentalawareness:Recyclingandconservationarebecomingmore
thanslogans.BuschGardens,forexample,haseliminatedtheuseofdisposablestyrofoam
traysinfavorofwashingandreusingplastictrays.
2.Growinghealthconsciousness:Concernsaboutpersonalhealthfuelthetrendtoward
physicalfitnessandhealthierliving.Asaresult,salesgrowthisslowingatfastfood
burgersandfriesretailerssuchasMcDonalds.Changingpublictastesawayfrom
sugarladenprocessedfoodsforcedInterstateBakeries,themakerofTwinkiesandWon
derBread,todeclarebankruptcyin2004.In2008,theFrenchgovernmentwasconsider
ingincreasingsalestaxesonextrafatty,salty,orsugaryproducts. 27TheEuropeanUnion
forbadetheimportationofgeneticallyalteredgrain(Frankenfood)becauseofpossible
sideeffects.ThespreadofAIDStomorethan40millionpeopleworldwideaddsevenfur
therimpetustothehealthmovement.
3.Expandingseniorsmarket:Astheirnumbersincrease,peopleoverage55willbecome
anevenmoreimportantmarket.Alreadysomecompaniesaresegmentingtheseniorpop
ulationintoYoungMatures,OlderMatures,andtheElderlyeachhavingadifferentset
ofattitudesandinterests.Bothmaturesegments,forexample,aregoodmarketsforthe
healthcareandtourismindustries;whereas,theelderlyarethekeymarketforlongterm
carefacilities.Thedesireforcompanionshipbypeoplewhosechildrenaregrowniscaus
ingthepetcareindustrytogrow4.5%annuallyintheUnitedStates.In2007,forexam
ple,71.1millionhouseholdsintheU.S.spent$41billionontheirpetsmorethanthe
grossdomesticproductofallbut16countriesintheworld.28
4.ImpactofGenerationYBoomlet:Bornbetween1978and1994tothebabyboomand
Xgenerations,thiscohortisalmostaslargeasthebabyboomgeneration.In1957,thepeak
yearofthepostwarboom,4.3millionbabieswereborn.In1990,therewere4.2million
birthsinGenerationYspeakyear.By2000,theywereovercrowdingelementaryandhigh
schoolsandenteringcollegeinnumbersnotseensincethebabyboomers.Nowinitsteens
and20s,thiscohortisexpectedtohaveastrongimpactonfutureproductsandservices.
5.Decliningmassmarket:Nichemarketsaredefiningthemarketersenvironment.People
wantproductsandservicesthatareadaptedmoretotheirpersonalneeds.Forexample,
EsteLaudersAllSkinandMaybellinesShadesofYoulinesofcosmeticproducts
arespecificallymadeforAfricanAmericanwomen.Masscustomizationthemaking
CHAPTER 4
105
andmarketingofproductstailoredtoapersonsrequirements(Dellforexample,and
Gatewaycomputers)isreplacingthemassproductionandmarketingofthesameprod
uctinsomemarkets.Only10%ofthe6,200magazinessoldintheUnitedStatesin2004
wereaimedatthemassmarket,downfrom30%inthe1970s.29
6.Changingpaceandlocationoflife:Instantcommunicationviaemail,cellphones,and
overnightmailenhancesefficiency,butitalsoputsmorepressureonpeople.Mergingthe
personalcomputerwiththecommunicationandentertainmentindustriesthroughtele
phonelines,satellitedishes,andcabletelevisionincreasesconsumerschoicesandallows
workerstoleaveovercrowdedurbanareasforsmalltownsandtelecommuteviapersonal
computersandmodems.
7.Changinghouseholdcomposition:Singlepersonhouseholds,especiallythoseofsingle
womenwithchildren,couldsoonbecomethemostcommonhouseholdtypeintheUnited
States.Marriedcouplehouseholdsslippedfromnearly80%inthe1950sto50.7%ofall
householdsin2002.30By2007,forthefirsttimeinU.S.history,morethanhalfofwomen
weresingle.31ThirtyeightpercentofU.S.childrenarecurrentlybeingbornoutofwed
lock.32AtypicalfamilyhouseholdisnolongerthesameasitwasonceportrayedinThe
BradyBunchinthe1970sorTheCosbyShowinthe1980s.
8.Increasingdiversityofworkforceandmarkets:Betweennowand2050,minorities
willaccountfornearly90%ofpopulationgrowthintheUnitedStates.Overtime,group
percentagesofthetotalUnitedStatespopulationareexpectedtochangeasfollows:Non
HispanicWhitesfrom90%in1950to74%in1995to53%by2050;Hispanic
Whitesfrom9%in1995to22%in2050;Blacksfrom13%in1995to15%in2050;
Asiansfrom4%in1995to9%in2050;AmericanIndians1%,withslightincrease. 33
Heavyimmigrationfromthedevelopingtothedevelopednationsisincreasingthe
numberofminoritiesinalldevelopedcountriesandforcinganacceptanceofthevalueof
diversityinraces,religions,andlifestyle.Forexample,24%oftheSwisspopulationwas
bornelsewhere.34Traditionalminoritygroupsareincreasingtheirnumbersinthework
forceandarebeingidentifiedasdesirabletargetmarkets.Forexample,Sears,Roebuck
transformed97ofitsstoresinOctober2004intomulticulturalstorescontainingfash
ionsforHispanic,AfricanAmerican,andAsianshoppers. 35
InternationalSocietalConsiderations.Eachcountryorgroupofcountriesinwhicha
companyoperatespresentsauniquesocietalenvironmentwithadifferentsetofeconomic,
technological,politicallegal,andsocioculturalvariablesforthecompanytoface.
Internationalsocietalenvironmentsvarysowidelythatacorporationsinternalenvironment
andstrategicmanagementprocessmustbeveryflexible.CulturaltrendsinGermany,for
example,haveresultedintheinclusionofworkerrepresentativesincorporatestrategic
planning.BecauseIslamiclaw(sharia)forbidsinterest(riba),loansofcapitalinIslamic
countriesmustbearrangedonthebasisofprofitsharinginsteadofinterestrates. 36
Differencesinsocietalenvironmentsstronglyaffectthewaysinwhichamultinational
corporation(MNC),acompanywithsignificantassetsandactivitiesinmultiplecountries,
conductsitsmarketing,financial,manufacturing,andotherfunctionalactivities.Forexample,
Europeslowerlaborproductivity,duetoashorterworkweekandrestrictionsontheabilityto
layoffunproductiveworkers,forcesEuropeanbasedMNCstoexpandoperationsincountries
wherelaborischeaperandproductivityishigher.37Movingmanufacturingtoalowercostlo
cation,suchasChina,wasasuccessfulstrategyduringthe1990s,butacountryslaborcostsrise
asitdevelopseconomically.Forexample,ChinarequiredallfirmsinJanuary2008toconsult
employeesonmaterialworkrelatedissues,enablingthecountrytoachieveitsstatedobjective
ofhavingtradeunionsinallofChinasnonstateownedenterprises.BySeptember2008,the
AllChinaFederationofTradeUnionshadsignedwith80%ofthelargestforeigncompanies. 38
106
PART 2
Toaccountforthemanydifferencesamongsocietalenvironmentsfromonecountrytoan
other,considerTable43.Itincludesalistofeconomic,technological,politicallegal,andso
cioculturalvariablesforanyparticularcountryorregion.Forexample,animportanteconomic
variableforanyfirminvestinginaforeigncountryiscurrencyconvertibility.Withoutconvert
ibility,acompanyoperatinginRussiacannotconvertitsprofitsfromrublestodollarsoreuros.
Intermsofsocioculturalvariables,manyAsiancultures(especiallyChina)arelessconcerned
withthevaluesofhumanrightsthanareEuropeanandNorthAmericancultures.SomeAsians
actuallycontendthatU.S.companiesaretryingtoimposeWesternhumanrightsrequirements
ontheminanattempttomakeAsianproductslesscompetitivebyraisingtheircosts. 39
Beforeplanningitsstrategyforaparticularinternationallocation,acompanymustscan
theparticularcountryenvironment(s)inquestionforopportunitiesandthreats,anditmust
comparethosewithitsownorganizationalstrengthsandweaknesses.Focusingonlyonthede
velopednationsmaycauseacorporationtomissimportantmarketopportunitiesinthedevel
opingnationsoftheworld.Althoughthosenationsmaynothavedevelopedtothepointthat
theyhavesignificantdemandforabroadspectrumofproducts,theymayverylikelybeonthe
thresholdofrapidgrowthinthedemandforspecificproductslikecellphones.Thiswouldbe
theidealtimeforacompanytoenterthismarketbeforecompetitionisestablished.Thekey
istobeabletoidentifythetriggerpointwhendemandforaparticularproductorserviceis
readytoboom.SeetheGlobalIssueboxedhighlightforanindepthexplanationofatech
niquetoidentifytheoptimumtimetoenteraparticularmarketinadevelopingnation.
CreatingaScanningSystem.Howcananyonemonitorandkeeptrackofallthetrendsand
factorsintheworldwidesocietalenvironment?WiththeexistenceoftheInternet,itisnow
possibletoscantheentireworld.Nevertheless,thevastamountofrawdatamakesscanning
TABLE 43
Economic
Some Important Variables in International Societal Environments
Technological
Regulationsontechnology
transfer
Energyavailability/cost
Naturalresourceavailability
Transportationnetwork
Skilllevelofworkforce
Patenttrademarkprotection
Internetavailability
Telecommunication
infrastructure
Computerhackingtechnology
Newenergysources
PoliticalLegal
Formofgovernment
Politicalideology
Taxlaws
Stabilityofgovernment
Governmentattitudetoward
foreigncompanies
Regulationsonforeign
ownershipofassets
Strengthofoppositiongroups
Traderegulations
Protectionistsentiment
Foreignpolicies
Terroristactivity
Legalsystem
Globalwarminglaws
Immigrationlaws
Sociocultural
Customs,norms,values
Language
Demographics
Lifeexpectancies
Socialinstitutions
Statussymbols
Lifestyle
Religiousbeliefs
Attitudestoward
foreigners
Literacylevel
Humanrights
Environmentalism
Sweatshops
Pensionplans
Healthcare
Slavery
Economicdevelopment
Percapitaincome
Climate
GDPtrends
Monetaryandfiscal
policies
Unemploymentlevels
Currencyconvertibility
Wagelevels
Natureofcompetition
Membershipinregional
economicassociations,
e.g.,EU,NAFTA,
ASEAN
MembershipinWorld
TradeOrganization
(WTO)
Outsourcingcapability
Globalfinancialsystem
CHAPTER 4
107
GLOBAL
issue
IDENTIFYING POTENTIAL MARKETS IN DEVELOPING NATIONS
were purchased in Mexico last year, using the PPP model
would effectively increase the Mexican GDP by $5 million
to $10 million. Using PPP, China becomes the worlds
second-largest economy after the United States, fol-
lowed by Japan, India, and Germany.
A trigger point identifies when demand for a particular
product is about to rapidly increase in a country. Identify-
ing a trigger point can be a very useful technique for de-
termining when to enter a new market in a developing
nation. Trigger points vary for different products. For exam-
ple, an apparent trigger point for long-distance telephone
services is at $7,500 in GDP per capitaa point when de-
mand for telecommunications services increases rapidly.
Once national wealth surpasses $15,000 per capita, de-
mand increases at a much slower rate with further in-
creases in wealth. The trigger point for life insurance is
around $8,000 in GDP per capita. At this point, the de-
mand for life insurance increases between 200% and
300% above those countries with GDP per capita below
the trigger point.
SOURCE: D. Fraser and M. Raynor, The Power of Parity, Forecast
(May/June, 1996), pp. 812; A Survey of the World Economy:
The Dragon and the Eagle, Special Insert, Economist (October 2,
2004), p. 8; The Big Mac Index: Food for Thought, Economist
(May 29, 2004), pp. 7172.
Research by the Deloitte &
Touche Consulting Group
reveals that the demand for a
specific product increases ex-
ponentially at certain points in a
countrys development. Identifying this
trigger point of demand is thus critical to entering emerg-
ing markets at the best time. A trigger point is the time
when enough people have enough money to buy what a
company has to sell but before competition is established.
This can be determined by using the concept of purchasing
power parity (PPP), which measures the cost in dollars of
the U.S.produced equivalent volume of goods that an
economy produces.
PPP offers an estimate of the material wealth a nation
can purchase, rather than the financial wealth it creates as
typically measured by Gross Domestic Product (GDP). As a
result, restating a nations GDP in PPP terms reveals much
greater spending power than market exchange rates
would suggest. For example, a shoe shine costing $5 to
$10 in New York City can be purchased for 50 in Mexico
City. Consequently the people of Mexico City can enjoy the
same standard of living (with respect to shoe shines) as
people in New York City with only 5% to 10% of the
money. Correcting for PPP restates all Mexican shoe shines
at their U.S. purchase value of $5. If one million shoe shines
forinformationsimilartodrinkingfromafirehose.Itisadauntingtaskforevenalarge
corporationwithmanyresources.Todealwiththisproblem,in2002IBMcreatedatoolcalled
WebFountaintohelpthecompanyanalyzethevastamountsofenvironmentaldataavailable
ontheInternet.WebFountainisanadvancedinformationdiscoverysystemdesignedtohelp
extracttrends,detectpatterns,andfindrelationshipswithinvastamountsofrawdata.For
example,IBMsoughttolearnwhethertherewasatrendtowardmorepositivediscussions
aboutebusiness.Withinaweek,thecompanyhaddatathatexpertswithinthecompanyused
toreplacetheirhuncheswithvalidconclusions.ThecompanyusesWebFountainto:
{
{
{
{
{
Locatenegativepublicityorinvestordiscontent
Trackgeneraltrends
Learncompetitiveinformation
Identifyemergingcompetitivethreats
Unravelconsumerattitudes40
ScanningtheTaskEnvironment
AsshowninFigure41,acorporationsscanningoftheenvironmentincludesanalysesofall
therelevantelementsinthetaskenvironment.Theseanalysestaketheformofindividualre
portswrittenbyvariouspeopleindifferentpartsofthefirm.AtProcter&Gamble(P&G),for
108
PART 2
FIGURE 41
Scanning External
Environment
AnalysisofSocietalEnvironment
Economic, Sociocultural, Technological, PoliticalLegal Factors
Market
Analysis
Community
Analysis
Competitor
Analysis
Supplier
Analysis
Selectionof
StrategicFactors
Opportunities
Threats
Interest Group
Analysis
Government
Analysis
example,peoplefromeachofthebrandmanagementteamsworkwithkeypeoplefromthe
salesandmarketresearchdepartmentstoresearchandwriteacompetitiveactivityreport
eachquarteroneachoftheproductcategoriesinwhichP&Gcompetes.Peopleinpurchasing
alsowritesimilarreportsconcerningnewdevelopmentsintheindustriesthatsupplyP&G.
Theseandotherreportsarethensummarizedandtransmittedupthecorporatehierarchyfor
topmanagementtouseinstrategicdecisionmaking.Ifanewdevelopmentisreportedregard
ingaparticularproductcategory,topmanagementmaythensendmemosaskingpeople
throughouttheorganizationtowatchforandreportondevelopmentsinrelatedproductareas.
Themanyreportsresultingfromthesescanningefforts,whenboileddowntotheiressentials,
actasadetailedlistofexternalstrategicfactors.
IDENTIFYING EXTERNAL STRATEGIC FACTORS
Theoriginofcompetitiveadvantageliesintheabilitytoidentifyandrespondtoenvironmen
talchangewellinadvanceofcompetition.41Althoughthisseemsobvious,whyaresomecom
paniesbetterabletoadaptthanothers?Onereasonisbecauseofdifferencesintheabilityof
managerstorecognizeandunderstandexternalstrategicissuesandfactors.Forexample,ina
globalsurveyconductedbytheFuldGiladHerringAcademyofCompetitiveIntelligence,
twothirdsof140corporatestrategistsadmittedthattheirfirmshadbeensurprisedbyasmany
asthreehighimpacteventsinthepastfiveyears.Moreover,asrecentlyas2003,97%stated
thattheircompanieshadnoearlywarningsysteminplace. 42
Nofirmcansuccessfullymonitorallexternalfactors.Choicesmustbemaderegarding
whichfactorsareimportantandwhicharenot.Eventhoughmanagersagreethatstrategicim
portancedetermineswhatvariablesareconsistentlytracked,theysometimesmissorchoose
toignorecrucialnewdevelopments.43Personalvaluesandfunctionalexperiencesofacorpo
rationsmanagersaswellasthesuccessofcurrentstrategiesarelikelytobiasboththeirper
ceptionofwhatisimportanttomonitorintheexternalenvironmentandtheirinterpretations
ofwhattheyperceive.44
Thiswillingnesstorejectunfamiliaraswellasnegativeinformationiscalledstrategicmy
opia.45Ifafirmneedstochangeitsstrategy,itmightnotbegatheringtheappropriateexternal
CHAPTER 4
FIGURE 42
109
ProbableImpactonCorporation
High
Medium
Low
Issues Priority
Matrix
High
High
Priority
High
Priority
Medium
Priority
ProbabilityofOccurrence
Medium
High
Priority
Medium
Priority
Low
Priority
Medium
Priority
Low
Priority
Low
Priority
SOURCE:ReprintedfromLongRangePlanning,Vol.17,No.3,1984,Campbell,ForesightActivitiesintheU.S.A.:
TimeforaReAssessment?p.46.Copyright1984withpermissionfromElsevier.
informationtochangestrategiessuccessfully.Forexample,whenDanielHessebecameCEO
ofSprintNextelinDecember2007,heassumedthatimprovingcustomerservicewouldbeone
ofhisbiggestchallenges.HequicklydiscoveredthatnoneofthecurrentSprintNextelexecu
tiveswereeventhinkingaboutthetopic.WewerenttalkingaboutthecustomerwhenIfirst
joined,saidHesse.NowthisistheNo.1priorityofthecompany. 46
Onewaytoidentifyandanalyzedevelopmentsintheexternalenvironmentistousethe
issuesprioritymatrix(seeFigure42)asfollows:
1.Identifyanumberoflikelytrendsemerginginthenatural,societal,andtaskenviron
ments.Thesearestrategicenvironmentalissuesthoseimportanttrendsthat,iftheyoccur,
determinewhattheindustryortheworldwilllooklikeinthenearfuture.
2.Assesstheprobabilityofthesetrendsactuallyoccurring,fromlowtomediumtohigh.
3.Attempttoascertainthelikelyimpact(fromlowtohigh)ofeachofthesetrendsonthe
corporationbeingexamined.
Acorporationsexternalstrategicfactorsarethekeyenvironmentaltrendsthatarejudgedto
havebothamediumtohighprobabilityofoccurrenceandamediumtohighprobabilityofim
pactonthecorporation.Theissuesprioritymatrixcanthenbeusedtohelpmanagersdecide
whichenvironmentaltrendsshouldbemerelyscanned(lowpriority)andwhichshouldbe
monitoredasstrategicfactors(highpriority).Thoseenvironmentaltrendsjudgedtobeacor
porationsstrategicfactorsarethencategorizedasopportunitiesandthreatsandareincluded
instrategyformulation.
4.2
IndustryAnalysis:AnalyzingtheTaskEnvironment
Anindustryisagroupoffirmsthatproducesasimilarproductorservice,suchassoftdrinks
orfinancialservices.Anexaminationoftheimportantstakeholdergroups,suchassuppliers
andcustomers,inaparticularcorporationstaskenvironmentisapartofindustryanalysis.
Low
110
PART 2
PORTERS APPROACH TO INDUSTRY ANALYSIS
MichaelPorter,anauthorityoncompetitivestrategy,contendsthatacorporationismostcon
cernedwiththeintensityofcompetitionwithinitsindustry.Thelevelofthisintensityisdeter
minedbybasiccompetitiveforces,asdepictedinFigure43.Thecollectivestrengthofthese
forces,hecontends,determinestheultimateprofitpotentialintheindustry,whereprofitpo
tentialismeasuredintermsoflongrunreturnoninvestedcapital. 47Incarefullyscanningits
industry,acorporationmustassesstheimportancetoitssuccessofeachofsixforces:threat
ofnewentrants,rivalryamongexistingfirms,threatofsubstituteproductsorservices,bar
gainingpowerofbuyers,bargainingpowerofsuppliers,andrelativepowerofotherstakehold
ers.48Thestrongereachoftheseforces,themorelimitedcompaniesareintheirabilitytoraise
pricesandearngreaterprofits.AlthoughPortermentionsonlyfiveforces,asixthother
stakeholdersisaddedheretoreflectthepowerthatgovernments,localcommunities,and
othergroupsfromthetaskenvironmentwieldoverindustryactivities.
UsingthemodelinFigure43,ahighforcecanberegardedasathreatbecauseitislikely
toreduceprofits.Alowforce,incontrast,canbeviewedasanopportunitybecauseitmayal
lowthecompanytoearngreaterprofits.Intheshortrun,theseforcesactasconstraintsona
companysactivities.Inthelongrun,however,itmaybepossibleforacompany,throughits
choiceofstrategy,tochangethestrengthofoneormoreoftheforcestothecompanysadvan
tage.Forexample,DellsearlyuseoftheInternettomarketitscomputerswasaneffectiveway
tonegatethebargainingpowerofdistributorsinthePCindustry.
Astrategistcananalyzeanyindustrybyratingeachcompetitiveforceashigh,medium,
orlowinstrength.Forexample,theglobalathleticshoeindustrycouldberatedasfollows:
FIGURE 43
Forces Driving
Industry
Competition
Potential
Entrants
Relative
Power
of Unions,
Governments,
Special
Interest
Groups, etc.
Threat
of New
Entrants
Other
Stakeholders
Industry
Competitors
Bargaining
Power
of Buyers
Buyers
Suppliers
Bargaining
Power
of Suppliers
Rivalry Among
Existing Firms
Threat of
Substitute
Products
or Services
Substitutes
SOURCE:ReprintedwiththepermissionofTheFreePress,ADivisionofSimon&Schuster,fromCOMPETITIVE
ADVANTAGE:TechniquesforAnalyzingIndustriesandCompetitorsbyMichaelE.Porter.Copyright1980,1988
byTheFreePress.Allrightsreserved.
CHAPTER 4
111
rivalryishigh(Nike,Reebok,NewBalance,Converse,andAdidasarestrongcompetitors
worldwide),threatofpotentialentrantsislow(theindustryhasreachedmaturity/salesgrowth
ratehasslowed),threatofsubstitutesislow(othershoesdontprovidesupportforsportsac
tivities),bargainingpowerofsuppliersismediumbutrising(suppliersinAsiancountriesare
increasinginsizeandability),bargainingpowerofbuyersismediumbutincreasing(prices
arefallingasthelowpricedshoemarkethasgrowntobehalfoftheU.S.brandedathleticshoe
market),andthreatofotherstakeholdersismediumtohigh(governmentregulationsandhu
manrightsconcernsaregrowing).Basedoncurrenttrendsineachofthesecompetitiveforces,
theindustryslevelofcompetitiveintensitywillcontinuetobehighmeaningthatsalesin
creasesandprofitmarginsshouldcontinuetobemodestfortheindustryasawhole. 49
ThreatofNewEntrants
Newentrantstoanindustrytypicallybringtoitnewcapacity,adesiretogainmarketshare,
andsubstantialresources.Theyare,therefore,threatstoanestablishedcorporation.Thethreat
ofentrydependsonthepresenceofentrybarriersandthereactionthatcanbeexpectedfrom
existingcompetitors.Anentrybarrierisanobstructionthatmakesitdifficultforacompany
toenteranindustry.Forexample,nonewdomesticautomobilecompanieshavebeensuccess
fullyestablishedintheUnitedStatessincethe1930sbecauseofthehighcapitalrequirements
tobuildproductionfacilitiesandtodevelopadealerdistributionnetwork.Someofthepossi
blebarrierstoentryare:
{
Economiesofscale:Scaleeconomiesintheproductionandsaleofmicroprocessors,for
example,gaveIntelasignificantcostadvantageoveranynewrival.
Productdifferentiation:CorporationssuchasProcter&GambleandGeneralMills,
whichmanufactureproductssuchasTideandCheerios,createhighentrybarriersthrough
theirhighlevelsofadvertisingandpromotion.
Capitalrequirements:Theneedtoinvesthugefinancialresourcesinmanufacturingfa
cilitiesinordertoproducelargecommercialairplanescreatesasignificantbarriertoen
trytoanycompetitorforBoeingandAirbus.
Switchingcosts:OnceasoftwareprogramsuchasExcelorWordbecomesestablishedin
anoffice,officemanagersareveryreluctanttoswitchtoanewprogrambecauseofthe
hightrainingcosts.
Accesstodistributionchannels:Smallentrepreneursoftenhavedifficultyobtainingsu
permarketshelfspacefortheirgoodsbecauselargeretailerschargeforspaceontheir
shelvesandgiveprioritytotheestablishedfirmswhocanpayfortheadvertisingneeded
togeneratehighcustomerdemand.
Costdisadvantagesindependentofsize:Onceanewproductearnssufficientmarket
sharetobeacceptedasthestandardforthattypeofproduct,themakerhasakeyad
vantage.Microsoftsdevelopmentofthefirstwidelyadoptedoperatingsystem(MS
DOS)fortheIBMtypepersonalcomputergaveitasignificantcompetitiveadvantage
overpotentialcompetitors.ItsintroductionofWindowshelpedtocementthatadvan
tagesothattheMicrosoftoperatingsystemisnowonmorethan90%ofpersonalcom
putersworldwide.
Governmentpolicy:Governmentscanlimitentryintoanindustrythroughlicensingre
quirementsbyrestrictingaccesstorawmaterials,suchasoildrillingsitesinprotectedareas.
{
{
{
{
{
{
RivalryamongExistingFirms
Inmostindustries,corporationsaremutuallydependent.Acompetitivemovebyonefirmcan
beexpectedtohaveanoticeableeffectonitscompetitorsandthusmaycauseretaliation.For
112
PART 2
example,theentrybymailordercompaniessuchasDellandGatewayintoaPCindustryprevi
ouslydominatedbyIBM,Apple,andCompaqincreasedthelevelofcompetitiveactivitytosuch
anextentthatanypricereductionornewproductintroductionwasquicklyfollowedbysimilar
movesfromotherPCmakers.ThesameistrueofpricesintheUnitedStatesairlineindustry.Ac
cordingtoPorter,intenserivalryisrelatedtothepresenceofseveralfactors,including:
{
Numberofcompetitors:Whencompetitorsarefewandroughlyequalinsize,suchasin
theautoandmajorhomeapplianceindustries,theywatcheachothercarefullytomake
surethattheymatchanymovebyanotherfirmwithanequalcountermove.
Rateofindustrygrowth:Anyslowinginpassengertraffictendstosetoffpricewarsin
theairlineindustrybecausetheonlypathtogrowthistotakesalesawayfromacompetitor.
Productorservicecharacteristics:Aproductcanbeveryunique,withmanyqualities
differentiatingitfromothersofitskindoritmaybeacommodity,aproductwhosechar
acteristicsarethesame,regardlessofwhosellsit.Forexample,mostpeoplechooseagas
stationbasedonlocationandpricingbecausetheyviewgasolineasacommodity.
Amountoffixedcosts:Becauseairlinesmustflytheirplanesonaschedule,regardless
ofthenumberofpayingpassengersforanyoneflight,theyoffercheapstandbyfares
wheneveraplanehasemptyseats.
Capacity:Iftheonlywayamanufacturercanincreasecapacityisinalargeincrementby
buildinganewplant(asinthepaperindustry),itwillrunthatnewplantatfullcapacity
tokeepitsunitcostsaslowaspossiblethusproducingsomuchthatthesellingprice
fallsthroughouttheindustry.
Heightofexitbarriers:Exitbarrierskeepacompanyfromleavinganindustry.Thebrew
ingindustry,forexample,hasalowpercentageofcompaniesthatvoluntarilyleavethein
dustrybecausebreweriesarespecializedassetswithfewusesexceptformakingbeer.
Diversityofrivals:Rivalsthathaveverydifferentideasofhowtocompetearelikely
tocrosspathsoftenandunknowinglychallengeeachothersposition.Thishappensof
tenintheretailclothingindustrywhenanumberofretailersopenoutletsinthesame
locationthustakingsalesawayfromeachother.Thisisalsolikelytohappeninsome
countriesorregionswhenmultinationalcorporationscompeteinanincreasinglyglobal
economy.
{
{
{
{
{
{
ThreatofSubstituteProductsorServices
Asubstituteproductisaproductthatappearstobedifferentbutcansatisfythesameneedas
anotherproduct.Forexample,emailisasubstituteforthefax,Nutrasweetisasubstitutefor
sugar,theInternetisasubstituteforvideostores,andbottledwaterisasubstituteforacola.
AccordingtoPorter,Substituteslimitthepotentialreturnsofanindustrybyplacingaceiling
onthepricesfirmsintheindustrycanprofitablycharge. 50Totheextentthatswitchingcosts
arelow,substitutesmayhaveastrongeffectonanindustry.Teacanbeconsideredasubstitute
forcoffee.Ifthepriceofcoffeegoesuphighenough,coffeedrinkerswillslowlybeginswitch
ingtotea.Thepriceofteathusputsapriceceilingonthepriceofcoffee.Sometimesadiffi
culttask,theidentificationofpossiblesubstituteproductsorservicesmeanssearchingfor
productsorservicesthatcanperformthesamefunction,eventhoughtheyhaveadifferentap
pearanceandmaynotappeartobeeasilysubstitutable.
BargainingPowerofBuyers
Buyersaffectanindustrythroughtheirabilitytoforcedownprices,bargainforhigherquality
ormoreservices,andplaycompetitorsagainsteachother.Abuyeroragroupofbuyersispow
erfulifsomeofthefollowingfactorsholdtrue:
CHAPTER 4
{
113
Abuyerpurchasesalargeproportionofthesellersproductorservice(forexample,oil
filterspurchasedbyamajorautomaker).
Abuyerhasthepotentialtointegratebackwardbyproducingtheproductitself(forexam
ple,anewspaperchaincouldmakeitsownpaper).
Alternativesuppliersareplentifulbecausetheproductisstandardorundifferentiated(for
example,motoristscanchooseamongmanygasstations).
Changingsupplierscostsverylittle(forexample,officesuppliesareeasytofind).
Thepurchasedproductrepresentsahighpercentageofabuyerscosts,thusprovidingan
incentivetoshoparoundforalowerprice(forexample,gasolinepurchasedforresaleby
conveniencestoresmakesuphalftheirtotalcosts).
Abuyerearnslowprofitsandisthusverysensitivetocostsandservicedifferences(for
example,grocerystoreshaveverysmallmargins).
Thepurchasedproductisunimportanttothefinalqualityorpriceofabuyersproductsor
servicesandthuscanbeeasilysubstitutedwithoutaffectingthefinalproductadversely
(forexample,electricwireboughtforuseinlamps).
{
{
{
{
{
{
BargainingPowerofSuppliers
Supplierscanaffectanindustrythroughtheirabilitytoraisepricesorreducethequalityofpur
chasedgoodsandservices.Asupplierorsuppliergroupispowerfulifsomeofthefollowing
factorsapply:
{
Thesupplierindustryisdominatedbyafewcompanies,butitsellstomany(forexample,
thepetroleumindustry).
Itsproductorserviceisuniqueand/orithasbuiltupswitchingcosts(forexample,word
processingsoftware).
Substitutesarenotreadilyavailable(forexample,electricity).
Suppliersareabletointegrateforwardandcompetedirectlywiththeirpresentcustomers
(forexample,amicroprocessorproducersuchasIntelcanmakePCs).
Apurchasingindustrybuysonlyasmallportionofthesuppliergroupsgoodsandser
vicesandisthusunimportanttothesupplier(forexample,salesoflawnmowertiresare
lessimportanttothetireindustrythanaresalesofautotires).
{
{
{
{
RelativePowerofOtherStakeholders
AsixthforceshouldbeaddedtoPorterslisttoincludeavarietyofstakeholdergroupsfrom
thetaskenvironment.Someofthesegroupsaregovernments(ifnotexplicitlyincludedelse
where),localcommunities,creditors(ifnotincludedwithsuppliers),tradeassociations,
specialinterestgroups,unions(ifnotincludedwithsuppliers),shareholders,andcomplemen
tors.AccordingtoAndyGrove,ChairmanandpastCEOofIntel,acomplementorisacom
pany(e.g.,Microsoft)oranindustrywhoseproductworkswellwithafirms(e.g.,Intels)
productandwithoutwhichtheproductwouldlosemuchofitsvalue. 51Anexampleofcom
plementaryindustriesisthetireandautomobileindustries.Keyinternationalstakeholderswho
determinemanyoftheinternationaltraderegulationsandstandardsaretheWorldTradeOr
ganization,theEuropeanUnion,NAFTA,ASEAN,andMercosur.
Theimportanceofthesestakeholdersvariesbyindustry.Forexample,environmental
groupsinMaine,Michigan,Oregon,andIowasuccessfullyfoughttopassbillsoutlawingdis
posablebottlesandcans,andthusdepositsformostdrinkcontainersarenowrequired.This
effectivelyraisedcostsacrosstheboard,withthemostimpactonthemarginalproducerswho
114
PART 2
couldnotinternallyabsorballthesecosts.Thetraditionallystrongpowerofnationalunionsin
theUnitedStatesautoandrailroadindustrieshaseffectivelyraisedcoststhroughoutthesein
dustriesbutisoflittleimportanceincomputersoftware.
INDUSTRY EVOLUTION
Overtime,mostindustriesevolvethroughaseriesofstagesfromgrowththroughmaturityto
eventualdecline.Thestrengthofeachofthesixforcesmentionedearliervariesaccordingto
thestageofindustryevolution.Theindustrylifecycleisusefulforexplainingandpredicting
trendsamongthesixforcesthatdriveindustrycompetition.Forexample,whenanindustryis
new,peopleoftenbuytheproduct,regardlessofprice,becauseitfulfillsauniqueneed.This
usuallyoccursinafragmentedindustrywherenofirmhaslargemarketshare,andeach
firmservesonlyasmallpieceofthetotalmarketincompetitionwithothers(forexample,
cleaningservices).52Asnewcompetitorsentertheindustry,pricesdropasaresultofcompeti
tion.Companiesusetheexperiencecurve(discussedinChapter5)andeconomiesofscaleto
reducecostsfasterthanthecompetition.Companiesintegratetoreducecostsevenfurtherby
acquiringtheirsuppliersanddistributors.Competitorstrytodifferentiatetheirproductsfrom
oneanothersinordertoavoidthefiercepricecompetitioncommontoamaturingindustry.
Bythetimeanindustryentersmaturity,productstendtobecomemorelikecommodities.
Thisisnowaconsolidatedindustrydominatedbyafewlargefirms,eachofwhichstrug
glestodifferentiateitsproductsfromthoseofthecompetition.Asbuyersbecomemoreso
phisticatedovertime,purchasingdecisionsarebasedonbetterinformation.Pricebecomesa
dominantconcern,givenaminimumlevelofqualityandfeatures,andprofitmarginsdecline.
Theautomobile,petroleum,andmajorhomeapplianceindustriesareexamplesofmature,con
solidatedindustrieseachcontrolledbyafewlargecompetitors.InthecaseoftheUnitedStates
majorhomeapplianceindustry,theindustrychangedfrombeingafragmentedindustry(pure
competition)composedofhundredsofappliancemanufacturersintheindustrysearlyyears
toaconsolidatedindustry(matureoligopoly)composedofthreecompaniescontrollingover
90%ofUnitedStatesappliancesales.AsimilarconsolidationisoccurringnowinEuropean
majorhomeappliances.
Asanindustrymovesthroughmaturitytowardpossibledecline,itsproductsgrowthrate
ofsalesslowsandmayevenbegintodecrease.Totheextentthatexitbarriersarelow,firms
beginconvertingtheirfacilitiestoalternateusesorsellthemtootherfirms.Theindustrytends
toconsolidatearoundfewerbutlargercompetitors.Thetobaccoindustryisanexampleofan
industrycurrentlyindecline.
CATEGORIZING INTERNATIONAL INDUSTRIES
AccordingtoPorter,worldindustriesvaryonacontinuumfrommultidomestictoglobal(see
Figure44).53Multidomesticindustriesarespecifictoeachcountryorgroupofcountries.
Thistypeofinternationalindustryisacollectionofessentiallydomesticindustries,suchas
FIGURE 44
Continuum
of International
Industries
Multidomestic
Industry in which companies tailor
their products to the specific needs
of consumers in a particular country.
Retailing
Insurance
Banking
Global
Industry in which companies manufacture
and sell the same products, with only minor
adjustments made for individual countries
around the world.
Automobiles
Tires
Television sets
CHAPTER 4
115
retailingandinsurance.Theactivitiesinasubsidiaryofamultinationalcorporation(MNC)
inthistypeofindustryareessentiallyindependentoftheactivitiesoftheMNCssubsidiaries
inothercountries.Withineachcountry,ithasamanufacturingfacilitytoproducegoodsfor
salewithinthatcountry.TheMNCisthusabletotailoritsproductsorservicestothevery
specificneedsofconsumersinaparticularcountryorgroupofcountrieshavingsimilarsoci
etalenvironments.
Globalindustries,incontrast,operateworldwide,withMNCsmakingonlysmalladjust
mentsforcountryspecificcircumstances.InaglobalindustryanMNCsactivitiesinone
countryaresignificantlyaffectedbyitsactivitiesinothercountries.MNCsinglobalindustries
produceproductsorservicesinvariouslocationsthroughouttheworldandsellthem,making
onlyminoradjustmentsforspecificcountryrequirements.Examplesofglobalindustriesare
commercialaircraft,televisionsets,semiconductors,copiers,automobiles,watches,andtires.
Thelargestindustrialcorporationsintheworldintermsofsalesrevenueare,forthemostpart,
MNCsoperatinginglobalindustries.
Thefactorsthattendtodeterminewhetheranindustrywillbeprimarilymultidomesticor
primarilyglobalare:
1.PressureforcoordinationwithintheMNCsoperatinginthatindustry
2.Pressureforlocalresponsivenessonthepartofindividualcountrymarkets
Totheextentthatthepressureforcoordinationisstrongandthepressureforlocalresponsive
nessisweakforMNCswithinaparticularindustry,thatindustrywilltendtobecomeglobal.In
contrast,whenthepressureforlocalresponsivenessisstrongandthepressureforcoordination
isweakformultinationalcorporationsinanindustry,thatindustrywilltendtobemultidomes
tic.Betweenthesetwoextremeslieanumberofindustrieswithvaryingcharacteristicsofboth
multidomesticandglobalindustries.Theseareregionalindustries,inwhichMNCsprimarily
coordinatetheiractivitieswithinregions,suchastheAmericasorAsia. 54Themajorhomeap
plianceindustryisacurrentexampleofaregionalindustrybecomingaglobalindustry.Japa
neseappliancemakers,forexample,aremajorcompetitorsinAsia,butonlyminorplayersin
EuropeorAmerica.Thedynamictensionbetweenthepressureforcoordinationandthepres
sureforlocalresponsivenessiscontainedinthephrase,Thinkgloballybutactlocally.
INTERNATIONAL RISK ASSESSMENT
Somefirmsdevelopelaborateinformationnetworksandcomputerizedsystemstoevaluate
andrankinvestmentrisks.Smallcompaniesmayhireoutsideconsultants,suchasBostons
ArthurD.LittleInc.,toprovidepoliticalriskassessments.Amongthemanysystemsthatex
isttoassesspoliticalandeconomicrisksaretheBusinessEnvironmentRiskIndex,theEcon
omistIntelligenceUnit,andFrostandSullivansWorldPoliticalRiskForecasts.The
EconomistIntelligenceUnit,forexample,providesaconstantflowofanalysisandforecasts
onmorethan200countriesandeightkeyindustries.Regardlessofthesourceofdata,afirm
mustdevelopitsownmethodofassessingrisk.Itmustdecideonitsmostimportantriskfac
torsandthenassignweightstoeach.
STRATEGIC GROUPS
Astrategicgroupisasetofbusinessunitsorfirmsthatpursuesimilarstrategieswithsimi
larresources.55Categorizingfirmsinanyoneindustryintoasetofstrategicgroupsisvery
usefulasawayofbetterunderstandingthecompetitiveenvironment. 56Researchshowsthat
somestrategicgroupsinthesameindustryaremoreprofitablethanothers. 57Becauseacorpo
rationsstructureandculturetendtoreflectthekindsofstrategiesitfollows,companiesor
116
PART 2
businessunitsbelongingtoaparticularstrategicgroupwithinthesameindustrytendtobe
strongrivalsandtendtobemoresimilartoeachotherthantocompetitorsinotherstrategic
groupswithinthesameindustry.58
Forexample,althoughMcDonaldsandOliveGardenareapartofthesameindustry,the
restaurantindustry,theyhavedifferentmissions,objectives,andstrategies,andthustheybe
longtodifferentstrategicgroups.Theygenerallyhaveverylittleincommonandpaylittleat
tentiontoeachotherwhenplanningcompetitiveactions.BurgerKingandHardees,however,
haveagreatdealincommonwithMcDonaldsintermsoftheirsimilarstrategyofproducing
ahighvolumeoflowpricedmealstargetedforsaletotheaveragefamily.Consequently,they
arestrongrivalsandareorganizedtooperatesimilarly.
Strategicgroupsinaparticularindustrycanbemappedbyplottingthemarketpositions
ofindustrycompetitorsonatwodimensionalgraph,usingtwostrategicvariablesasthever
ticalandhorizontalaxes(SeeFigure45):
1.Selecttwobroadcharacteristics,suchaspriceandmenu,thatdifferentiatethecompanies
inanindustryfromoneanother.
2.Plotthefirms,usingthesetwocharacteristicsasthedimensions.
3.Drawacirclearoundthosecompaniesthatareclosesttooneanotherasonestrategic
group,varyingthesizeofthecircleinproportiontothegroupsshareoftotalindustry
sales.(Youcouldalsonameeachstrategicgroupintherestaurantindustrywithaniden
tifyingtitle,suchasquickfastfoodorbuffetstyleservice.)
FIGURE 45
High
RedLobster
OliveGarden
ChiChis
Mapping Strategic
Groups in the
U.S. Restaurant
Chain Industry
Perkins
InternationalHouse
ofPancakes
Ponderosa
Bonanza
Price
Shoneys
Dennys
CountryKitchen
KFC
PizzaHut
LongJohnSilvers
Arbys
Dominos
Hardees
BurgerKing
Low
Limited Menu
Wendys
DairyQueen
TacoBell
McDonalds
Full Menu
ProductLineBreadth
CHAPTER 4
117
Otherdimensions,suchasquality,service,location,ordegreeofverticalintegration,
couldalsobeusedinadditionalgraphsoftherestaurantindustrytogainabetterunderstand
ingofhowthevariousfirmsintheindustrycompete.Keepinmind,however,thatthetwodi
mensionsshouldnotbehighlycorrelated;otherwise,thecirclesonthemapwillsimplylie
alongthediagonal,providingverylittlenewinformationotherthantheobvious.
STRATEGIC TYPES
Inanalyzingthelevelofcompetitiveintensitywithinaparticularindustryorstrategicgroup,
itisusefultocharacterizethevariouscompetitorsforpredictivepurposes.Astrategictypeis
acategoryoffirmsbasedonacommonstrategicorientationandacombinationofstructure,
culture,andprocessesconsistentwiththatstrategy.AccordingtoMilesandSnow,competing
firmswithinasingleindustrycanbecategorizedintooneoffourbasictypesonthebasisof
theirgeneralstrategicorientation.59Thisdistinctionhelpsexplainwhycompaniesfacingsim
ilarsituationsbehavedifferentlyandwhytheycontinuetodosooverlongperiodsoftime. 60
Thesegeneraltypeshavethefollowingcharacteristics:
{
{
{
{
Defendersarecompanieswithalimitedproductlinethatfocusonimprovingtheeffi
ciencyoftheirexistingoperations.Thiscostorientationmakesthemunlikelytoinno
vateinnewareas.Withitsemphasisonefficiency,LincolnElectricisanexampleofa
defender.
Prospectorsarecompanieswithfairlybroadproductlinesthatfocusonproductinnova
tionandmarketopportunities.Thissalesorientationmakesthemsomewhatinefficient.
Theytendtoemphasizecreativityoverefficiency.Rubbermaidsemphasisonnewprod
uctdevelopmentmakesitanexampleofaprospector.
Analyzersarecorporationsthatoperateinatleasttwodifferentproductmarketareas,
onestableandonevariable.Inthestableareas,efficiencyisemphasized.Inthevariable
areas,innovationisemphasized.Multidivisionalfirms,suchasIBMandProcter&
Gamble,whichoperateinmultipleindustries,tendtobeanalyzers.
Reactorsarecorporationsthatlackaconsistentstrategystructureculturerelationship.
Their(oftenineffective)responsestoenvironmentalpressurestendtobepiecemealstrate
gicchanges.MostmajorU.S.airlineshaverecentlytendedtobereactorsgiventheway
theyhavebeenforcedtorespondtonewentrantssuchasSouthwestandJetBlue.
Dividingthecompetitionintothesefourcategoriesenablesthestrategicmanagernotonlyto
monitortheeffectivenessofcertainstrategicorientations,butalsotodevelopscenariosoffu
tureindustrydevelopments(discussedlaterinthischapter).
HYPERCOMPETITION
Mostindustriestodayarefacinganeverincreasinglevelofenvironmentaluncertainty.They
arebecomingmorecomplexandmoredynamic.Industriesthatusedtobemultidomesticare
becomingglobal.Newflexible,aggressive,innovativecompetitorsaremovingintoestab
lishedmarketstorapidlyerodetheadvantagesoflargepreviouslydominantfirms.Distribu
tionchannelsvaryfromcountrytocountryandarebeingaltereddailythroughtheuseof
sophisticatedinformationsystems.Closerrelationshipswithsuppliersarebeingforgedtore
ducecosts,increasequality,andgainaccesstonewtechnology.Companieslearntoquickly
imitatethesuccessfulstrategiesofmarketleaders,anditbecomeshardertosustainanycom
petitiveadvantageforverylong.Consequently,thelevelofcompetitiveintensityisincreasing
inmostindustries.
118
PART 2
RichardDAvenicontendsthatasthistypeofenvironmentalturbulencereachesmorein
dustries,competitionbecomeshypercompetition.AccordingtoDAveni:
Inhypercompetitionthefrequency,boldness,andaggressivenessofdynamicmovementbythe
playersacceleratestocreateaconditionofconstantdisequilibriumandchange.Marketstabil
ityisthreatenedbyshortproductlifecycles,shortproductdesigncycles,newtechnologies,fre
quententrybyunexpectedoutsiders,repositioningbyincumbents,andtacticalredefinitionsof
marketboundariesasdiverseindustriesmerge.Inotherwords,environmentsescalatetoward
higherandhigherlevelsofuncertainty,dynamism,heterogeneityoftheplayersandhostility. 61
Inhypercompetitiveindustriessuchascomputers,competitiveadvantagecomesfromanup
todateknowledgeofenvironmentaltrendsandcompetitiveactivitycoupledwithawilling
nesstoriskacurrentadvantageforapossiblenewadvantage.Companiesmustbewillingto
cannibalizetheirownproducts(thatis,replacepopularproductsbeforecompetitorsdoso)inor
dertosustaintheircompetitiveadvantage.SeeStrategyHighlight4.1tolearnhowMicrosoftis
operatinginthehypercompetitiveindustryofcomputersoftware.(Hypercompetitionisdis
cussedinmoredetailinChapter6.)
USING KEY SUCCESS FACTORS TO CREATE AN INDUSTRY MATRIX
Withinanyindustrythereareusuallycertainvariableskeysuccessfactorsthatacom
panysmanagementmustunderstandinordertobesuccessful.Keysuccessfactorsarevari
ablesthatcansignificantlyaffecttheoverallcompetitivepositionsofcompanieswithinany
particularindustry.Theytypicallyvaryfromindustrytoindustryandarecrucialtodetermin
ingacompanysabilitytosucceedwithinthatindustry.Theyareusuallydeterminedbythe
STRATEGY
highlight4.1
MICROSOFT IN A HYPERCOMPETITIVE INDUSTRY
from current products. Microsoft was one of the first com-
panies to disprove this argument against cannibalization.
Bill Gates, Microsofts co-founder, chair, and CEO, real-
ized that if his company didnt replace its own DOS prod-
uct line with a better product, someone else would (such
as Linux or IBMs OS/2 Warp). He knew that success in the
software industry depends not so much on company size
as on moving aggressively to the next competitive advan-
tage before a competitor does. This is a hypercompetitive
market, explained Gates. Scale is not all positive in this
business. Cleverness is the position in this business. By
2008, Microsoft still controlled over 90% of operating sys-
tems software and had achieved a dominant position in
applications software as well.
Microsoft is a hypercompet-
itive firm operating in a hy-
percompetitive industry. It has
used its dominance in operating
systems (DOS and Windows) to
move into a very strong position in appli-
cation programs such as word processing and spread-
sheets (Word and Excel). Even though Microsoft held 90%
of the market for personal computer operating systems in
1992, it still invested millions in developing the next gen-
erationWindows 95 and Windows NT. These were soon
followed by Windows Me, XP, and Vista. Instead of trying
to protect its advantage in the profitable DOS operating
system, Microsoft actively sought to replace DOS with var-
ious versions of Windows. Before hypercompetition, most
experts argued against cannibalization of a companys own
product line because it destroys a very profitable product
instead of harvesting it like a cash cow. According to this
line of thought, a company would be better off defending
its older products. New products would be introduced only
if it could be proven that they would not take sales away
SOURCE: Richard A. DAveni, Hypercompetition: Managing the
Dynamics of Strategic Maneuvering. Copyright 1994 by
Richard A. DAveni. All rights reserved.
CHAPTER 4
119
TABLE 44
Industry Matrix
Weight
1
2
Company A
Rating
3
Company A
Weighted Score
4
Company B
Rating
5
Company B
Weighted Score
6
Key Success Factors
Total
1.00
SOURCE:T.L.WheelenandJ.D.Hunger,IndustryMatrix.Copyright1997,2001,and2005byWheelen&HungerAssociates.Reprinted
withpermission.
economicandtechnologicalcharacteristicsoftheindustryandbythecompetitiveweaponson
whichthefirmsintheindustryhavebuilttheirstrategies. 62Forexample,inthemajorhome
applianceindustry,afirmmustachievelowcosts,typicallybybuildinglargemanufacturing
facilitiesdedicatedtomakingmultipleversionsofonetypeofappliance,suchaswashingma
chines.Because60%ofmajorhomeappliancesintheUnitedStatesaresoldthroughpower
retailerssuchasSearsandBestBuy,afirmmusthaveastrongpresenceinthemassmerchan
diserdistributionchannel.Itmustofferafulllineofappliancesandprovideajustintimede
liverysystemtokeepstoreinventoryandorderingcoststoaminimum.Becausetheconsumer
expectsreliabilityanddurabilityinanappliance,afirmmusthaveexcellentprocessR&D.
Anyappliancemanufacturerthatisunabletodealsuccessfullywiththesekeysuccessfactors
willnotsurvivelongintheU.S.market.
Anindustrymatrixsummarizesthekeysuccessfactorswithinaparticularindustry.As
showninTable44,thematrixgivesaweightforeachfactorbasedonhowimportantthatfac
torisforsuccesswithintheindustry.Thematrixalsospecifieshowwellvariouscompetitors
intheindustryarerespondingtoeachfactor.Togenerateanindustrymatrixusingtwoindus
trycompetitors(calledAandB),completethefollowingstepsfortheindustrybeinganalyzed:
1.InColumn1(KeySuccessFactors),listthe8to10factorsthatappeartodeterminesuc
cessintheindustry.
2.InColumn2(Weight),assignaweighttoeachfactor,from1.0(MostImportant)to0.0(Not
Important)basedonthatfactorsprobableimpactontheoverallindustryscurrentandfu
turesuccess.(Allweightsmustsumto1.0regardlessofthenumberofstrategicfactors.)
3.InColumn3(CompanyARating),examineaparticularcompanywithintheindustryfor
example,CompanyA.Assignaratingtoeachfactorfrom5(Outstanding)to1(Poor)based
onCompanyAscurrentresponsetothatparticularfactor.Eachratingisajudgmentregard
inghowwellthatcompanyisspecificallydealingwitheachkeysuccessfactor.
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
Outstanding
AboveAverage
Average
BelowAverage
Poor
4.InColumn4(CompanyAWeightedScore),multiplytheweightinColumn2foreach
factorbyitsratinginColumn3toobtainthatfactorsweightedscoreforCompanyA.
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PART 2
5.InColumn5(CompanyBRating),examineasecondcompanywithintheindustryin
thiscase,CompanyB.Assignaratingtoeachkeysuccessfactorfrom5.0(Outstanding)
to1.0(Poor),basedonCompanyBscurrentresponsetoeachparticularfactor.
6.InColumn6(CompanyBWeightedScore),multiplytheweightinColumn2for
eachfactortimesitsratinginColumn5toobtainthatfactorsweightedscorefor
CompanyB.
7.Finally,addtheweightedscoresforallthefactorsinColumns4and6todeterminethe
totalweightedscoresforcompaniesAandB.Thetotalweightedscoreindicateshow
welleachcompanyisrespondingtocurrentandexpectedkeysuccessfactorsinthe
industrysenvironment.Checktoensurethatthetotalweightedscoretrulyreflectsthe
companyscurrentperformanceintermsofprofitabilityandmarketshare.(Anaverage
companyshouldhaveatotalweightedscoreof3.)
Theindustrymatrixcanbeexpandedtoincludeallthemajorcompetitorswithinanindustry
throughtheadditionoftwoadditionalcolumnsforeachadditionalcompetitor.
4.3
CompetitiveIntelligence
Muchexternalenvironmentalscanningisdoneonaninformalandindividualbasis.Informa
tionisobtainedfromavarietyofsourcessuppliers,customers,industrypublications,em
ployees,industryexperts,industryconferences,andtheInternet. 63Forexample,scientistsand
engineersworkinginafirmsR&Dlabcanlearnaboutnewproductsandcompetitorsideas
atprofessionalmeetings;someonefromthepurchasingdepartment,speakingwithsupplier
representativespersonnel,mayalsouncovervaluablebitsofinformationaboutacompetitor.
Astudyofproductinnovationfoundthat77%ofallproductinnovationsinscientificinstru
mentsand67%insemiconductorsandprintedcircuitboardswereinitiatedbythecustomerin
theformofinquiriesandcomplaints.64Intheseindustries,thesalesforceandservicedepart
mentsmustbeespeciallyvigilant.
ArecentsurveyofglobalexecutivesbyMcKinsey&Companyfoundthatthesinglefac
torcontributingmosttotheincreasingcompetitiveintensityintheirindustrieswastheim
provedcapabilitiesofcompetitors.65Yet,withoutcompetitiveintelligence,companiesrunthe
riskofflyingblindinthemarketplace.Ina2008surveyofglobalexecutives,themajorityre
vealedthattheircompaniestypicallylearnedaboutacompetitorspricechangeorsignificant
innovationtoolatetorespondbeforeitwasintroducedintothemarket. 66Accordingtowork
byRyall,firmscanhavecompetitiveadvantagessimplybecausetheirrivalshaveerroneous
beliefsaboutthem.67Thisiswhycompetitiveintelligencehasbecomeanimportantpartofen
vironmentalscanninginmostcompanies.
Competitiveintelligenceisaformalprogramofgatheringinformationonacompanys
competitors.Oftencalledbusinessintelligence,itisoneofthefastestgrowingfieldswithin
strategicmanagement.Researchindicatesthatthereisastrongassociationbetweencorporate
performanceandcompetitiveintelligenceactivities.68Accordingtoasurveyofcompetitivein
telligenceprofessionals,theprimaryreasonsforpracticingcompetitiveintelligenceareto
buildindustryawareness(90.6%),supportthestrategicplanningprocess(79.2%),develop
newproducts(73.6%),andcreatenewmarketingstrategiesandtactics. 69Asearlyasthe1990s,
78%oflargeU.S.corporationsconductedcompetitiveintelligenceactivities. 70Inaboutathird
ofthefirms,thecompetitive/businessintelligencefunctionishousedinitsownunit,withthe
remainderbeinghousedwithinmarketing,strategicplanning,informationservices,business
development(merger&acquisitions),productdevelopment,orotherunits. 71Accordingtoa
CHAPTER 4
121
2007surveyof141largeAmericancorporations,spendingoncompetitiveintelligenceactiv
itieswasrisingfrom$1billionin2007to$10billionby2012. 72AtGeneralMills,forexam
ple,allemployeeshavebeentrainedtorecognizeandtapsourcesofcompetitiveinformation.
Janitorsnolongersimplyplaceorderswithsuppliersofcleaningmaterials;theyalsoaskabout
relevantpracticesatcompetingfirms!
SOURCES OF COMPETITIVE INTELLIGENCE
Mostcorporationsuseoutsideorganizationstoprovidethemwithenvironmentaldata.Firms
suchasA.C.NielsenCo.providesubscriberswithbimonthlydataonbrandshare,retailprices,
percentagesofstoresstockinganitem,andpercentagesofstockoutstores.Strategistscanuse
thisdatatospotregionalandnationaltrendsaswellastoassessmarketshare.Informationon
marketconditions,governmentregulations,industrycompetitors,andnewproductscanbe
boughtfrominformationbrokerssuchasMarketResearch.com(Findex),LexisNexis(com
panyandcountryanalyses),andFinsburyDataServices.Companyandindustryprofilesare
generallyavailablefromtheHooversWebsite,atwww.hoovers.com.Manybusinesscorpo
rationshaveestablishedtheirowninhouselibrariesandcomputerizedinformationsystemsto
dealwiththegrowingmassofavailableinformation.
TheInternethaschangedthewaystrategistsengageinenvironmentalscanning.Itprovides
thequickestmeanstoobtaindataonalmostanysubject.AlthoughthescopeandqualityofIn
ternetinformationisincreasinggeometrically,itisalsolitteredwithnoise,misinformation,
andutternonsense.Forexample,anumberofcorporateWebsitesaresendingunwantedguests
tospeciallyconstructedbogusWebsites.73Unlikethelibrary,theInternetlacksthetightbibli
ographiccontrolstandardsthatexistintheprintworld.ThereisnoISBNorDeweyDecimal
Systemtoidentify,search,andretrieveadocument.ManyWebdocumentslackthenameofthe
authorandthedateofpublication.AWebpageprovidingusefulinformationmaybeaccessible
ontheWebonedayandgonethenext.Unhappyexemployees,faroutenvironmentalists,and
prankpronehackerscreateblogWebsitestoattackanddiscreditanotherwisereputablecor
poration.RumorswithnobasisinfactarespreadviachatroomsandpersonalWebsites.This
createsaseriousproblemforresearchers.Howcanoneevaluatetheinformationfoundonthe
Internet?Forawaytoevaluateintelligenceinformation,seeStrategyHighlight4.2.
Somecompanieschoosetouseindustrialespionageorotherintelligencegatheringtech
niquestogettheirinformationstraightfromtheircompetitors.Accordingtoasurveybythe
AmericanSocietyforIndustrialSecurity,PricewaterhouseCoopers,andtheUnitedStates
ChamberofCommerce,Fortune1000companieslostanestimated$59billioninoneyear
aloneduetothetheftoftradesecrets.74Byusingcurrentorformercompetitorsemployeesand
privatecontractors,somefirmsattempttostealtradesecrets,technology,businessplans,and
pricingstrategies.Forexample,AvonProductshiredprivateinvestigatorstoretrievefroma
publicdumpsterdocuments(someofthemshredded)thatMaryKayCorporationhadthrown
away.OracleCorporationalsohireddetectivestoobtainthetrashofathinktankthathadde
fendedthepricingpracticesofitsrivalMicrosoft.Studiesrevealthat32%ofthetrashtypi
callyfoundnexttocopymachinescontainsconfidentialcompanydata,inadditiontopersonal
data(29%)andgossip(39%).75EvenP&G,whichdefendsitselflikeafortressfrominforma
tionleaks,isvulnerable.Acompetitorwasabletolearnthepreciselaunchdateofaconcen
tratedlaundrydetergentinEuropewhenoneofitspeoplevisitedthefactorywheremachinery
wasbeingmade.Simplyaskingafewquestionsaboutwhatacertainmachinedid,whomit
wasfor,andwhenitwouldbedeliveredwasallthatwasnecessary.
SomeofthefirmsprovidinginvestigatoryservicesareKrollInc.with4,000employees
in25countries,Fairfax,SecurityOutsourcingSolutions,TridentGroup,andDiligenceInc. 76
Trident,forexample,specializesinhelpingAmericancompaniesentertheRussianmarketand
122
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STRATEGY
highlight4.2
EVALUATING COMPETITIVE INTELLIGENCE
found through library research in sources such as Moodys
Industrials, Standard & Poors, or Value Line can generally
be evaluated as having a reliability of A. The correctness of
the data can still range anywhere from 1 to 5, but in most
instances is likely to be either 1 or 2, but probably no worse
than 3 or 4. Web sites are quite different.
Web sites, such as those sponsored by the U.S. Securi-
ties and Exchange Commission (www.sec.gov), the Econo-
mist (www.economist.com), or Hoovers Online (www
.hoovers.com) are extremely reliable. Company-sponsored
Web sites are generally reliable, but are not the place to go
for trade secrets, strategic plans, or proprietary informa-
tion. For one thing, many firms think of their Web sites pri-
marily in terms of marketing and provide little data aside
from product descriptions and distributors. Other compa-
nies provide their latest financial statements and links to
other useful Web sites. Nevertheless, some companies in
very competitive industries may install software on their
Web site to ascertain a visitors web address. Visitors from
a competitors domain name are thus screened before they
are allowed to access certain Web sites. They may not be
allowed beyond the product information page or they may
be sent to a bogus Web site containing misinformation.
Cisco Systems, for example, uses its Web site to send visi-
tors from other high-tech firms to a special Web page ask-
ing if they would like to apply for a job at Cisco!
A basic rule in intelligence
gathering is that before a
piece of information can be
used in any report or briefing, it
must first be evaluated in two
ways. First, the source of the information
should be judged in terms of its truthfulness and reliability.
How trustworthy is the source? How well can a researcher
rely upon it for truthful and correct information? One ap-
proach is to rank the reliability of the source on a scale from
A (extremely reliable), B (reliable), C (unknown reliability),
D (probably unreliable), to E (very questionable reliability).
The reliability of a source can be judged on the basis of the
authors credentials, the organization sponsoring the infor-
mation, and past performance, among other factors.
Second, the information or data should be judged in terms
of its likelihood of being correct. The correctness of the
data may be ranked on a scale from 1 (correct), 2 (proba-
bly correct), 3 (unknown), 4 (doubtful), to 5 (extremely
doubtful). The correctness of a piece of data or information
can be judged on the basis of its agreement with other bits
of separately-obtained information or with a general trend
supported by previous data. For every piece of information
found on the Internet, for example, list not only the URL of
the Web page, but also the evaluation of the information
from A1 (good stuff) to E5 (bad doodoo). Information
isaU.S.basedcorporateintelligencefirmfoundedandmanagedbyformerveteransofRus
sianintelligenceservices,liketheKGB.77
Tocombattheincreasingtheftofcompanysecrets,theUnitedStatesgovernmentpassed
theEconomicEspionageActin1996.Thelawmakesitillegal(withfinesupto$5millionand
10yearsinjail)tostealanymaterialthatabusinesshastakenreasonableeffortstokeepse
cretandthatderivesitsvaluefromnotbeingknown.78TheSocietyofCompetitiveIntelligence
Professionals(www.scip.org)urgesstrategiststostaywithinthelawandtoactethicallywhen
searchingforinformation.Thesocietystatesthatillegalactivitiesarefoolishbecausethevast
majorityofworthwhilecompetitiveintelligenceisavailablepubliclyviaannualreports,Web
sites,andlibraries.Unfortunately,anumberoffirmshirekites,consultantswithquestion
ablereputations,whodowhatisnecessarytogetinformationwhentheselectedmethodsdo
notmeetSPICethicalstandardsorareillegal.Thisallowsthecompanythatinitiatedtheac
tiontodenythatitdidanythingwrong.79
MONITORING COMPETITORS FOR STRATEGIC PLANNING
Theprimaryactivityofacompetitiveintelligenceunitistomonitorcompetitorsorganiza
tionsthatoffersame,similar,orsubstitutableproductsorservicesinthebusinessareainwhich
aparticularcompanyoperates.Tounderstandacompetitor,itisimportanttoanswerthefol
lowing10questions:
CHAPTER 4
123
1.Whydoyourcompetitorsexist?Dotheyexisttomakeprofitsorjusttosupportanotherunit?
2.Wheredotheyaddcustomervaluehigherquality,lowerprice,excellentcreditterms,or
betterservice?
3.Whichofyourcustomersarethecompetitorsmostinterestedin?Aretheycherrypicking
yourbestcustomers,pickingtheonesyoudontwant,orgoingafterallofthem?
4.Whatistheircostbaseandliquidity?Howmuchcashdotheyhave?Howdotheygettheir
supplies?
5.Aretheylessexposedwiththeirsuppliersthanyourfirm?Aretheirsuppliersbetter
thanyours?
6.Whatdotheyintendtodointhefuture?Dotheyhaveastrategicplantotargetyourmar
ketsegments?Howcommittedaretheytogrowth?Arethereanysuccessionissues?
7.Howwilltheiractivityaffectyourstrategies?Shouldyouadjustyourplansandoperations?
8.Howmuchbetterthanyourcompetitordoyouneedtobeinordertowincustomers?Do
eitherofyouhaveacompetitiveadvantageinthemarketplace?
9.Willnewcompetitorsornewwaysofdoingthingsappearoverthenextfewyears?Who
isapotentialnewentrant?
10.Ifyouwereacustomer,wouldyouchooseyourproductoverthoseofferedbyyourcom
petitors?Whatirritatesyourcurrentcustomers?Whatcompetitorssolvetheseparticular
customercomplaints?80
Toanswertheseandotherquestions,competitiveintelligenceprofessionalsutilizeanumberof
analyticaltechniques.InadditiontothepreviouslydiscussedSWOTanalysis,MichaelPorters
industryforcesanalysis,andstrategicgroupanalysis,someofthesetechniquesarePortersfour
cornerexercise,TreacyandWiersemasvaluedisciplines,Giladsblindspotanalysis,andwar
gaming.81SeeAppendix4.Aformoreinformationaboutthesecompetitiveanalysistechniques.
Doneright,competitiveintelligenceisakeyinputtostrategicplanning.AvnetInc.,one
oftheworldslargestdistributorsofelectroniccomponents,usescompetitiveintelligencein
itsgrowthbyacquisitionstrategy.AccordingtoJohnHovis,Avnetsseniorvicepresidentof
corporateplanningandinvestorrelations:
Ourcompetitiveintelligenceteamhasasignificantresponsibilityintrackingallofthevaried
competitors,notjustourdirectcompetitors,butalltheperipheralcompetitorsthathaveapo
tentialtoimpactourabilitytocreatevalue....Oneofthethingsweareaboutisfindingnew
acquisitioncandidates,andourcompetitiveintelligenceunitisverymuchinvolvedwithourac
quisitionteam,inhelpingtoprofilepotentialacquisitioncandidates. 82
4.4
Forecasting
Environmentalscanningprovidesreasonablyharddataonthepresentsituationandcurrent
trends,butintuitionandluckareneededtoaccuratelypredictwhetherthesetrendswillcon
tinue.Theresultingforecastsare,however,usuallybasedonasetofassumptionsthatmayor
maynotbevalid.
DANGER OF ASSUMPTIONS
Faultyunderlyingassumptionsarethemostfrequentcauseofforecastingerrors.Neverthe
less,manymanagerswhoformulateandimplementstrategicplansrarelyconsiderthattheir
successisbasedonaseriesofbasicassumptions.Manystrategicplansaresimplybasedon
124
PART 2
projectionsofthecurrentsituation.Forexample,fewpeoplein2007expectedthepriceofoil
(light,sweetcrude,alsocalledWestTexasintermediate)toriseabove$80perbarrelandwere
extremelysurprisedtoseethepriceapproach$150byJuly2008,especiallysincetheprice
hadbeenaround$20perbarrelin2002.U.S.autocompanies,inparticular,hadcontinuedto
designandmanufacturelargecars,pickuptrucks,andSUVsundertheassumptionofgaso
linebeingavailableforaround$2.00agallon.Marketdemandforthesetypesofcarscol
lapsedwhenthepriceofgasolinepassed$3.00toreach$4.00agalloninJuly2008.In
anotherexample,manybanksmadeanumberofquestionablemortgagesbasedontheas
sumptionthathousingpriceswouldcontinuetoriseastheyhadinthepast.Whenhousing
pricesfellin2007,thesesubprimemortgageswerealmostworthlesscausinganumber
ofbankstoselloutorfailin2008.Assumptionslikethesecanbedangeroustoyourhealth!
USEFUL FORECASTING TECHNIQUES
Varioustechniquesareusedtoforecastfuturesituations.Theydonottellthefuture;theymerely
statewhatcanbe,notwhatwillbe.Assuch,theycanbeusedtoformasetofreasonableassump
tionsaboutthefuture.Eachtechniquehasitsproponentsanditscritics.Astudyofnearly500of
theworldslargestcorporationsrevealedtrendextrapolationtobethemostwidelypracticed
formofforecastingover70%usethistechniqueeitheroccasionallyorfrequently. 83Simply
stated,extrapolationistheextensionofpresenttrendsintothefuture.Itrestsontheassumption
thattheworldisreasonablyconsistentandchangesslowlyintheshortrun.Timeseriesmeth
odsareapproachesofthistype;theyattempttocarryaseriesofhistoricaleventsforwardinto
thefuture.Thebasicproblemwithextrapolationisthatahistoricaltrendisbasedonaseriesof
patternsorrelationshipsamongsomanydifferentvariablesthatachangeinanyonecandrasti
callyalterthefuturedirectionofthetrend.Asaruleofthumb,thefurtherbackintothepastyou
canfindrelevantdatasupportingthetrend,themoreconfidenceyoucanhaveintheprediction.
Brainstorming,expertopinion,andstatisticalmodelingarealsoverypopularforecasting
techniques.Brainstormingisanonquantitativeapproachthatrequiressimplythepresenceof
peoplewithsomeknowledgeofthesituationtobepredicted.Thebasicgroundruleistopro
poseideaswithoutfirstmentallyscreeningthem.Nocriticismisallowed.Wildideasareen
couraged.Ideasshouldbuildonpreviousideasuntilaconsensusisreached. 84Thisisagood
techniquetousewithoperatingmanagerswhohavemorefaithingutfeelthaninmorequan
titativenumbercrunchingtechniques.Expertopinionisanonquantitativetechniqueinwhich
expertsinaparticularareaattempttoforecastlikelydevelopments.Thistypeofforecastis
basedontheabilityofaknowledgeableperson(s)toconstructprobablefuturedevelopments
basedontheinteractionofkeyvariables.Oneapplication,developedbytheRANDCorpora
tion,istheDelphitechnique,inwhichseparatedexpertsindependentlyassessthelikelihoods
ofspecifiedevents.Theseassessmentsarecombinedandsentbacktoeachexpertforfine
tuninguntilagreementisreached.Theseassessmentsaremostusefuliftheyareshapedinto
severalpossiblescenariosthatallowdecisionmakerstomorefullyunderstandtheirimplica
tion.85Statisticalmodelingisaquantitativetechniquethatattemptstodiscovercausalorat
leastexplanatoryfactorsthatlinktwoormoretimeseriestogether.Examplesofstatistical
modelingareregressionanalysisandothereconometricmethods.Althoughveryusefulinthe
graspingofhistorictrends,statisticalmodeling,suchastrendextrapolation,isbasedonhis
toricaldata.Asthepatternsofrelationshipschange,theaccuracyoftheforecastdeteriorates.
PredictionmarketsisarecentforecastingtechniqueenabledbyeasyaccesstotheInter
net.AsemphasizedbyJamesSurowieckiinTheWisdomofCrowds,theconclusionsoflarge
groupscanoftenbebetterthanthoseofexpertsbecausesuchgroupscanaggregatealarge
amountofdispersedwisdom.86Predictionmarketsaresmallscaleelectronicmarkets,fre
quentlyopentoanyemployee,thattiepayoffstomeasurablefutureevents,suchassalesdata
CHAPTER 4
125
foracomputerworkstation,thenumberofbugsinanapplication,oraproductusagepatterns.
Thesemarketsyieldpricesonpredictioncontractspricesthatcanbeinterpretedasmarket
aggregatedforecasts.87CompaniesincludingMicrosoft,Google,andEliLillyhaveaskedtheir
employeestoparticipateinpredictionmarketsbybettingonwhetherproductswillsell,when
newofficeswillopen,andwhetherprofitswillbehighinthenextquarter.Earlypredictions
havebeenexceedinglyaccurate.88Intrade.comoffersafreeWebsiteinwhichpeoplecanbuy
orsellvariouspredictionsinamannersimilartobuyingorsellingcommonstock.OnMay26,
2008,forexample,Intrade.comlistedthebuyingpricefordemocraticpresidentialcandidate
BarackObamaas$91.50comparedto$8.00forHillaryClinton,and$37.70forJohnMcCain.
Thusfar,predictionmarketshavenotbeendocumentedforlongtermforecasting,soitsvalue
instrategicplanninghasnotyetbeenestablished.Otherforecastingtechniques,suchascross
impactanalysis(CIA)andtrendimpactanalysis(TIA),havenotestablishedthemselvessuc
cessfullyasregularlyemployedtools.89
Scenariowritingisthemostwidelyusedforecastingtechniqueaftertrendextrapolation.
OriginatedbyRoyalDutchShell,scenariosarefocuseddescriptionsofdifferentlikelyfutures
presentedinanarrativefashion.Ascenariothusmaybemerelyawrittendescriptionofsome
futurestate,intermsofkeyvariablesandissues,oritmaybegeneratedincombinationwith
otherforecastingtechniques.Oftencalledscenarioplanning,thistechniquehasbeensuccess
fullyusedby3M,LeviStrauss,GeneralElectric,UnitedDistillers,Electrolux,BritishAir
ways,andPacificGasandElectricity,amongothers.90AccordingtoMikeEskew,Chairman
andCEOofUnitedParcelService,UPSusesscenariowritingtoenvisionwhatitscustomers
mightneedfivetotenyearsinthefuture.91ThefourArcticscenariosthatbeganthischapter
areanexampleofscenariowritingthatshouldbeaninputtoatransportationcompanysstrate
gicplanning.
Anindustryscenarioisaforecasteddescriptionofaparticularindustryslikelyfuture.
Suchascenarioisdevelopedbyanalyzingtheprobableimpactoffuturesocietalforcesonkey
groupsinaparticularindustry.Theprocessmayoperateasfollows:92
1.Examinepossibleshiftsinthenaturalenvironmentandinsocietalvariablesglobally.
2.Identifyuncertaintiesineachofthesixforcesofthetaskenvironment(thatis,potential
entrants,competitors,likelysubstitutes,buyers,suppliers,andotherkeystakeholders).
3.Makearangeofplausibleassumptionsaboutfuturetrends.
4.Combineassumptionsaboutindividualtrendsintointernallyconsistentscenarios.
5.Analyzetheindustrysituationthatwouldprevailundereachscenario.
6.Determinethesourcesofcompetitiveadvantageundereachscenario.
7.Predictcompetitorsbehaviorundereachscenario.
8.Selectthescenariosthatareeithermostlikelytooccurormostlikelytohaveastrongimpact
onthefutureofthecompany.Usethesescenariosasassumptionsinstrategyformulation.
4.5
TheStrategicAudit:
AChecklistforEnvironmentalScanning
Onewayofscanningtheenvironmenttoidentifyopportunitiesandthreatsisbyusingthe
StrategicAuditfoundinAppendix1.AattheendofChapter1.Theauditprovidesacheck
listofquestionsbyareaofconcern.Forexample,PartIIIoftheauditexaminesthenatural,
societal,andtaskenvironments.Itlooksatthesocietalenvironmentintermsofeconomic,
technological,politicallegal,andsocioculturalforces.Italsoconsidersthetaskenvironment
126
PART 2
(industry)intermsofthreatofnewentrants,bargainingpowerofbuyersandsuppliers,threat
ofsubstituteproducts,rivalryamongexistingfirms,andtherelativepowerofotherstake
holders.
4.6
SynthesisofExternalFactorsEFAS
Afterstrategicmanagershavescannedthesocietalandtaskenvironmentsandidentifieda
numberoflikelyexternalfactorsfortheirparticularcorporation,theymaywanttorefinetheir
analysisofthesefactorsbyusingaformsuchasthatgiveninTable45.UsinganEFAS(Ex
ternalFactorsAnalysisSummary)Tableisonewaytoorganizetheexternalfactorsintothe
generallyacceptedcategoriesofopportunitiesandthreatsaswellastoanalyzehowwellapar
ticularcompanysmanagement(rating)isrespondingtothesespecificfactorsinlightofthe
perceivedimportance(weight)ofthesefactorstothecompany.TogenerateanEFASTablefor
thecompanybeinganalyzed,completethefollowingsteps:
1.InColumn1(ExternalFactors),listtheeighttotenmostimportantopportunitiesand
threatsfacingthecompany.
TABLE 45
External Factors
External Factor Analysis Summary (EFAS Table): Maytag as Example
Weight
1
2
Rating
3
Weighted
Score
4
Comments
5
Opportunities
EconomicintegrationofEuropeanCommunity
{ Demographicsfavorqualityappliances
{ EconomicdevelopmentofAsia
{ OpeningofEasternEurope
{ TrendtoSuperStores
Threats
{
{
{
{
{
{
.20
.10
.05
.05
.10
.10
.10
.15
.05
.10
1.00
4.1
5.0
1.0
2.0
1.8
4.3
4.0
3.0
1.2
1.6
.82
.50
.05
.10
.18
.43
.40
.45
.06
.16
3.15
AcquisitionofHoover
Maytagquality
LowMaytagpresence
Willtaketime
Maytagweakinthischannel
Wellpositioned
Wellpositioned
Hooverweakglobally
Questionable
OnlyAsianpresencein
Australia
Increasinggovernmentregulations
StrongU.S.competition
WhirlpoolandElectroluxstrongglobally
Newproductadvances
Japaneseappliancecompanies
TotalScores
NOTES:
1.Listopportunitiesandthreats(810)inColumn1.
2.Weighteachfactorfrom1.0(MostImportant)to0.0(NotImportant)inColumn2basedonthatfactorsprobableimpactonthecom
panysstrategicposition.Thetotalweightsmustsumto1.00.
3.Rateeachfactorfrom5.0(Outstanding)to1.0(Poor)inColumn3basedonthecompanysresponsetothatfactor.
4.MultiplyeachfactorsweighttimesitsratingtoobtaineachfactorsweightedscoreinColumn4.
5.UseColumn5(comments)forrationaleusedforeachfactor.
6.AddtheindividualweightedscorestoobtainthetotalweightedscoreforthecompanyinColumn4.Thistellshowwellthecompanyis
respondingtothefactorsinitsexternalenvironment.
SOURCE:T.L.Wheelen,J.D.Hunger,ExternalFactorsAnalysisSummary(EFAS).Copyright1987,1988,1989,1990,and2005by
T.LWheelen.Copyright1991,2003,and2005byWheelen&HungerAssociates.Reprintedbypermission.
CHAPTER 4
127
2.InColumn2(Weight),assignaweighttoeachfactorfrom1.0(MostImportant)to0.0(Not
Important)basedonthatfactorsprobableimpactonaparticularcompanyscurrentstrate
gicposition.Thehighertheweight,themoreimportantisthisfactortothecurrentandfu
turesuccessofthecompany.(Allweightsmustsumto1.0regardlessofthenumberof
factors.)
3.InColumn3(Rating),assignaratingtoeachfactorfrom5.0(Outstanding)to1.0(Poor)
basedonthatparticularcompanysspecificresponsetothatparticularfactor.Eachrating
isajudgmentregardinghowwellthecompanyiscurrentlydealingwitheachspecificex
ternalfactor.
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
1.0
Outstanding
AboveAverage
Average
BelowAverage
Poor
4.InColumn4(WeightedScore),multiplytheweightinColumn2foreachfactortimes
itsratinginColumn3toobtainthatfactorsweightedscore.
5.InColumn5(Comments),notewhyaparticularfactorwasselectedandhowitsweight
andratingwereestimated.
6.Finally,addtheweightedscoresforalltheexternalfactorsinColumn4todeterminethe
totalweightedscoreforthatparticularcompany.Thetotalweightedscoreindicateshow
wellaparticularcompanyisrespondingtocurrentandexpectedfactorsinitsexternalen
vironment.Thescorecanbeusedtocomparethatfirmtootherfirmsintheindustry.
Checktoensurethatthetotalweightedscoretrulyreflectsthecompanyscurrentperfor
manceintermsofprofitabilityandmarketshare.Thetotalweightedscoreforanaverage
firminanindustryisalways3.0.
Asanexampleofthisprocedure,Table45includesanumberofexternalfactorsforMaytag
Corporationwithcorrespondingweights,ratings,andweightedscoresprovided.Thistableis
appropriatefor1995,longbeforeMaytagwasacquiredbyWhirlpool.NotethatMaytags
totalweightwas3.15,meaningthatthecorporationwasslightlyaboveaverageinthemajor
homeapplianceindustryatthattime.
EndofChapterSUMMARY
WayneGretzkywasoneofthemostfamouspeopleevertoplayprofessionalicehockey.He
wasntveryfast.Hisshotwasfairlyweak.Hewasusuallylastinhisteaminstrengthtraining.
Hetendedtooperateinthebackofhisopponentsgoal,anticipatingwherehisteammembers
wouldbelongbeforetheygotthereandfedthempassessounsuspectedthathewouldoften
surprisehisownteammembers.InaninterviewwithTimemagazine,Gretzkystatedthatthe
keytowinningisskatingnottowherethepuckisbuttowhereitisgoingtobe.Peopletalk
aboutskating,puckhandlingandshooting,butthewholesportisanglesandcaroms,forget
tingthestraightdirectionthepuckisgoing,calculatingwhereitwillbediverted,factoringin
alltheinterruptions,explainedGretzky.93
Environmentalscanninginvolvesmonitoring,collecting,andevaluatinginformationin
ordertounderstandthecurrenttrendsinthenatural,societal,andtaskenvironments.The
128
PART 2
informationisthenusedtoforecastwhetherthesetrendswillcontinueorwhetherotherswill
taketheirplace.Howwilldevelopmentsinthenaturalenvironmentaffecttheworld?What
kindofdevelopmentscanweexpectinthesocietalenvironmenttoaffectourindustry?What
willanindustrylooklikein10to20years?Whowillbethekeycompetitors?Whoislikely
tofallbythewayside?Weusethisinformationtomakecertainassumptionsaboutthefuture
assumptionsthatarethenusedinstrategicplanning.Inmanyways,successinthebusiness
worldislikeicehockey:Thekeytowinningisnottoassumethatyourindustrywillcontinue
asitisnowbuttoassumethattheindustrywillchangeandtomakesurethatyourcompany
willbeinpositiontotakeadvantageofthosechanges.
ECO-BITS
TheInternationalPanelonClimateChangereportsthat
carbondioxideemissionsarerisingfasterthanits
worstcasescenarioandthatwithoutnewgovernment
actiongreenhousegaseswillrise25%to90%over
2000levelsby2030.
ChinasurpassedtheUnitedStatesincarbonemissions
in2006byproducing6.6billiontonsofcarbondioxide,
24%oftheworldsannualproductionofCO2.
Thetotalnumberofpeopleaffectedbynaturaldisasters
hastripledoverthepastdecadetotwobillionpeople.
By2025,1.8billionpeoplecouldbelivinginwater
scarceareaswiththelikelyresultbeingmassmigra
tionsoutoftheseareas.94
DISCUSSION QUESTIONS
1.Discusshowadevelopmentinacorporationsnaturaland
societalenvironmentscanaffectthecorporationthrough
itstaskenvironment.
2.AccordingtoPorter,whatdeterminesthelevelofcom
petitiveintensityinanindustry?
3.AccordingtoPortersdiscussionofindustryanalysis,is
PepsiColaasubstituteforCocaCola?
4.Howcanadecisionmakeridentifystrategicfactorsina
corporationsexternalinternationalenvironment?
5.Compareandcontrasttrendextrapolationwiththewrit
ingofscenariosasforecastingtechniques.
STRATEGIC PRACTICE EXERCISE
Howfarshouldpeopleinabusinessfirmgoingatheringcom
petitiveintelligence?Wheredoyoudrawtheline?
Evaluateeachofthefollowingapproachesthataperson
couldusetogatherinformationaboutcompetitors.Foreach
approach,markyourfeelingaboutitsappropriateness:
1(DEFINITELYNOTAPPROPRIATE),2(PROBABLYNOTAPPROPRIATE),
3(UNDECIDED),4(PROBABLYAPPROPRIATE),OR5(DEFINITELYAPPROPRIATE).
Thebusinessfirmshouldtrytogetusefulinformationabout
competitorsby:
_____Carefullystudyingtradejournals
_____Wiretappingthetelephonesofcompetitors
_____Posingasapotentialcustomertocompetitors
_____Gettingloyalcustomerstoputoutaphonyrequest
forproposalsolicitingcompetitorsbids
_____Buyingcompetitorsproductsandtakingthemapart
_____Hiringmanagementconsultantswhohaveworkedfor
competitors
_____Rewardingcompetitorsemployeesforusefultips
_____Questioningcompetitorscustomersand/orsuppliers
_____Buyingandanalyzingcompetitorsgarbage
_____Advertisingandinterviewingfornonexistentjobs
CHAPTER 4
_____Takingpublictoursofcompetitorsfacilities
_____Releasingfalseinformationaboutthecompanyin
ordertoconfusecompetitors
_____Questioningcompetitorstechnicalpeopleattrade
showsandconferences
_____Hiringkeypeopleawayfromcompetitors
SOURCE:DevelopedfromW.A.Jones,Jr.,andN.B.Bryan,Jr.,
BusinessEthicsandBusinessIntelligence:AnEmpiricalStudyof
InformationGatheringAlternatives,InternationalJournalofMan
agement(June1995),pp.204208.Foractualexamplesofsomeof
theseactivities,seeJ.Kerstetter,P.Burrows,J.Greene,G.Smith,
andM.Conlin,TheDarkSideoftheValley,BusinessWeek
(July17,2000),pp.4243.
129
_____Analyzingcompetitorslaborunioncontracts
_____Havingemployeesdatepersonswhoworkfor
competitors
_____Studyingaerialphotographsofcompetitorsfacilities
Aftermarkingeachoftheprecedingapproaches,compare
yourresponsestothoseofotherpeopleinyourclass.Foreach
approach,thepeoplemarking4or5shouldsaywhythey
thoughtthisparticularactwouldbeappropriate.Thosewho
marked1or2shouldthenstatewhytheythoughtthisact
wouldbeinappropriate.
GototheWebsiteoftheSocietyforCompetitive
IntelligenceProfessionals(www.scip.org).WhatdoesSCIP
sayabouttheseapproaches?
KEY TERMS
competitiveintelligence(p.120)
competitors(p.122)
complementor(p.113)
consolidatedindustry(p.114)
EFASTable(p.126)
entrybarrier(p.111)
environmentalscanning(p.98)
environmentaluncertainty(p.98)
exitbarrier(p.112)
fragmentedindustry(p.114)
globalindustry(p.115)
hypercompetition(p.118)
industry(p.109)
industryanalysis(p.99)
industrymatrix(p.119)
industryscenario(p.125)
issuesprioritymatrix(p.109)
keysuccessfactor(p.118)
multidomesticindustry(p.114)
multinationalcorporation(MNC)
(p.105)
naturalenvironment(p.99)
newentrant(p.111)
regionalindustries(p.115)
societalenvironment(p.99)
STEEPanalysis(p.101)
strategicgroup(p.115)
strategictype(p.117)
substituteproduct(p.112)
taskenvironment(p.99)
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APPENDIX
4.A
Competitive
AnalysisTechniques
AnalyticaltechniquescommonlyusedincompetitiveintelligenceareSWOTanalysis,Portersindustry
forces,ratioanalysis,andstrategicgroupanalysis(alsocalledcompetitiveclusteranalysis).Inaddition
tothesearePortersfourcornerexercise,TreacyandWiersemasvaluedisciplines,andGiladsblind
spotanalysis.Thesecanbeusedinawargamesimulationinwhichpeopleroleplaydifferentcompetitors
andtheirpossiblefuturestrategies.
Portersfourcornerexerciseinvolvesanalyzingaspecificcompetitorsfuturegoals,assumptions,
currentstrategies,andcapabilitiesinordertocompileacompetitorsresponseprofile.SeeFigure46.
Havingknowledgeofacompetitorsgoalsallowspredictionsabouthowlikelythecompetitoristochange
strategyandrespondtochangingconditions.Identifyingacompetitorsassumptionsaboutitselfandthe
industrycanrevealblindspotsabouthowmanagementperceivesitsenvironment.Consideringacom
petitorscurrentstrategyandhowlongithasbeeninplacemayindicatewhetherthecompanyislikelyto
continueinitscurrentdirection.Ifastrategyisnotstatedexplicitly,oneshouldconsideritsactionsand
policiesinordertonoteitsimplicitstrategy.Thelaststepistoobjectivelyevaluateacompetitorscapa
bilitiesintermsofstrengthsandweaknesses.Thecompetitorsgoals,assumptions,andcurrentstrategy
influencethelikelihood,timing,nature,andintensityofacompetitorsreactions.Itsstrengthsandweak
nessesdetermineitsabilitytoinitiateorreacttostrategicmovesandtodealwithenvironmentalchanges. 95
TreacyandWiersemasvaluedisciplinesinvolvestheevaluationofacompetitorintermsofthreedi
mensions:productleadership,operationalexcellence,andcustomerintimacy.(SeeFigure47.)Afteran
alyzing80marketleadingcompanies,TreacyandWiersemanotedthateachofthesefirmsdevelopeda
compellingandunmatchedvaluepropositionononedimensionbutwasabletomaintainacceptablestan
dardsontheothertwodimensions.Operationallyexcellentcompaniesdeliveracombinationofquality,
price,andeaseofpurchasethatnoothercanmatchintheirmarket.AnexampleisDellComputer,amas
terofoperationalexcellence.Aproductleaderconsistentlystrivestoprovideitsmarketwithleadingedge
productsornewapplicationsofexistingproductsorservices.Johnson&Johnsonisanexampleofaprod
uctleaderthatfindsnewideas,developsthemquickly,andthenlooksforwaystoimprovethem.Acom
panythatdeliversvaluethroughcustomerintimacybondswithitscustomersanddevelopshighcustomer
loyalty.IBMisanexampleofacompanythatpursuesexcellenceincustomerintimacy.IBMscurrent
strategyistoprovideatotalinformationtechnologyservicetoitscustomerssothatcustomerscantotally
relyonIBMtotakecareofanyInformationTechnology(IT)problems. 96AccordingtoWayne
Rosenkrans,pastpresidentofSCIP,itispossibletomarkaspotoneachofthethreevaluedimensions
showninFigure47foreachcompetitorbeinganalyzed.Thenonecandrawlinesconnectingeachofthe
marks,resultinginatrianglethatrevealsthatcompetitorsoverallvalueproposition. 97
Giladsblindspotanalysisisbasedonthepremisethattheassumptionsheldbydecisionmakersre
gardingtheirowncompanyandtheirindustrymayactasperceptualbiasesorblindspots.Asaresult,
(1)thefirmmaynotbeawareofstrategicallyimportantdevelopments,(2)thefirmmayinaccuratelyper
ceivestrategicallyimportantdevelopments,or(3)evenifthefirmisawareofimportantdevelopments,
itmaylearntooslowlytoallowforatimelyresponse.Itisimportanttogathersufficientinformation
aboutacompetitoranditsexecutivestobeabletolisttopmanagementsassumptionsaboutbuyerspref
erences,thenatureofthesupplychain,theindustryskeysuccessfactors,barrierstoentry,andthethreat
appealofsubstitutestocustomers.Oneshouldanalyzetheindustryobjectivelywithoutregardtothese
assumptions.Anygapbetweenanobjectiveindustryanalysisandacompetitorstopmanagementas
sumptionsisapotentialblindspot.Oneshouldincludetheseblindspotswhenconsideringhowthiscom
petitormightrespondtoenvironmentalchange. 98
133
134
PART 2
FIGURE 46
Four-Corner
Exercise: Porters
Components
of Competitor
Analysis
WhatDrives
theCompetitor
WhattheCompetitor
IsDoingandCanDo
FUTUREGOALS
CURRENTSTRATEGY
At all levels of management
and in multiple dimensions
How the business is
currently competing
COMPETITORSRESPONSEPROFILE
Is the competitor satisfied with current position?
What likely moves or strategy shifts will the competitor make?
Where is the competitor vulnerable?
What will provoke the greatest and most effective retaliation by the competitor?
ASSUMPTIONS
Held about itself
and the industry
CAPABILITIES
Both strengths
and weaknesses
SOURCE:ReprintedwiththepermissionofTheFreePress,ADivisionofSimon&Schuster,fromCOMPETITIVE
ADVANTAGE:TechniquesforAnalyzingIndustriesandCompetitorsbyMichaelE.Porter.Copyright1980,1998
byTheFreePress.Allrightsreserved.
RosenkranssuggeststhatananalystshouldfirstusePortersindustryforcestechniquetodevelopthe
fourcorneranalysis.Thentheanalystshouldusethefourcorneranalysistogenerateastrategicgroup
(cluster)analysis.Finally,theanalystshouldincludethethreevaluedimensionstodevelopablindspot
analysis.
Thesetechniquescanbeusedtoconductawargamesimulatingthevariouscompetitorsinthein
dustry.Gatherpeoplefromvariousfunctionalareasinyourowncorporationandputthemintoteams
identifiedasindustrycompetitors.Eachcompanyteamshouldperformacompleteanalysisofthecom
petitoritisroleplaying.Eachcompanyteamfirstcreatesstartingstrategiesforitscompanyandpresents
ittotheentiregroup.Eachcompanyteamthencreatescounterstrategiesandpresentsthemtotheentire
group.Afterallthepresentationsarecomplete,thefullgroupcreatesnewstrategicconsiderationstobe
includedasitemstomonitorinfutureenvironmentalscanning. 99Someofthecompaniesthathaveused
wargamingsuccessfullyareKimberlyClark,BaxterHealthcare,LockheedMartin,HewlettPackard,
andDowCorning.Ifacorporationdoesnothavetheexpertiseneededtorunawargame,itcanutilize
managementconsultants,likeKappaWest,whoprepareandfacilitateacompletewargamesimulation.
Somecompetitiveintelligenceanalyststakethewargameapproachonestepfurtherbycreating
aninventedcompanythatcouldappearinthefuturebutdoesnotexisttoday.Ateambrainstormswhat
typeofstrategytheinventedcompetitormightemploy.Thestrategyisoftenbasedonanewbreak
throughproductthatisradicallydifferentfromcurrentofferings.Itsgoals,strategies,andcompetitive
CHAPTER 4
FIGURE 47
135
Value
Discipline Triad
Best product
ProductLeadership
Product
differentiation
Operational
Competence
Customer
Responsive
OperationalExcellence
Best total cost
CustomerIntimacy
Best total solution
SOURCE:FromDISCIPLINEOFMARKETLEADERSbyMichaelTreacy.Copyright1997MichaelTreacy.
ReprintedbypermissionofPerseusBooksGroup.
postureshouldbedifferentfromanycurrentlybeingusedintheindustry.AccordingtoLiamFahey,an
authorityoncompetitiveintelligence,theinventedcompetitorisprovingtobeaspurtoboldandin
novativethinking.100Wargamesareespeciallyusefulwhen(externally)themarketisshifting,com
petitiverulesarechanging,newcompetitorsareenteringtheindustry,asignificantcompetitoris
changingitsstrategy,afirmscompetitivepositionisweakening,theuncontrollablesaregetting
stronger,and/orwhen(internally)thecompanyisflyingblind,itscurrentstrategyisstaleorconfused,
managersareoverconfidentorarrogant,and/orthefirmsuffersfromasilomentality. 101
7
strategyformulation:
corporateStrategy
What is the best way for a company to grow if its primary business is ma-
turing? A study of 1,850 companies by Zook and Allen revealed two conclusions:
First, the most sustained profitable growth occurs when a corporation pushes out
of the boundary around its core business into adjacent businesses. Second, corpo-
rations that consistently outgrow their rivals do so by developing a formula for ex-
panding those boundaries in a predicable, repeatable manner.1
Nike is a classic example of this process. Despite its success in athletic shoes, no one expected
Nike to be successful when it diversified in 1995 from shoes into golf apparel, balls, and equip-
ment. Only a few years later, it was acknowledged to be a major player in the new business. Ac-
cording to researchers Zook and Allen, the key to Nikes success was a formula for growth that
the company had applied and adapted successfully in a series of entries into sports markets,
from jogging to volleyball to tennis to basketball to soccer and, most recently, to golf. First, Nike
established a leading position in athletic shoes in the target market, in this case, golf shoes. Sec-
ond, Nike launched a clothing line endorsed by the sports top athletesin this case, Tiger
Woods. Third, the company formed new distribution channels and contracts with key suppliers
in the new business. Nikes reputation as a strong marketer of new products gave it credibility.
Fourth, the company introduced higher-margin equipment into the new market. In the case of
golf clubs, it started with irons and then moved to drivers. Once it had captured a significant
share in the U.S. market, Nikes next step was global distribution.
Zook and Allen propose that this formula was the reason Nike moved past Reebok in the
sporting goods industry. In 1987, Nikes operating profits were only $164 million compared to
Reeboks much larger $309 million. Fifteen years later, Nikes operating profits had grown to
$1.1 billion while Reeboks had declined to $247 million.2 Reebok was subsequently acquired by
Adidas in 2005 while Nike went on to generate operating profits of $2.4 billion in 2008.
LearningObjectives
{
{
{
Understand the three aspects of corporate

strategy
Apply the directional strategies of growth,
stability, and retrenchment
Understand the differences between
vertical and horizontal growth as well as
concentric and conglomerate
diversification
{
{
{
Identify strategic options to enter a

foreign country
Apply portfolio analysis to guide decisions
in companies with multiple products and
businesses
Develop a parenting strategy for a
multiple-business corporation
Environmental
Scanning:
Gathering
Information
Strategy
Formulation:
Developing
Long-range Plans
Strategy
Implementation:
Putting Strategy
into Action
Evaluation
and Control:
Monitoring
Performance
External:
Opportunities
and Threats
Mission
Reason for
existence
Objectives
What
results to
accomplish
by when
Natural
Environment:
Resources and
climate
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Societal
Environment:
General forces
Programs
Activities
needed to
accomplish
a plan
Task
Environment:
Industry analysis
Budgets
Cost of the
programs
Procedures
Sequence
of steps
needed to
do the job
Internal:
Strengths and
Weaknesses
Performance
Actual results
Structure:
Chain of command
Culture:
values
Resources:
Assets, skills,
competencies,
knowledge
205
206
PART 3
StrategyFormulation
7.1
CorporateStrategy
ThevignetteaboutNikeillustratestheimportanceofcorporatestrategytoafirmssurvival
andsuccess.Corporatestrategydealswiththreekeyissuesfacingthecorporationasawhole:
1.Thefirmsoverallorientationtowardgrowth,stability,orretrenchment(directionalstrategy)
2.Theindustriesormarketsinwhichthefirmcompetesthroughitsproductsandbusiness
units(portfolioanalysis)
3.Themannerinwhichmanagementcoordinatesactivitiesandtransfersresourcesandcul
tivatescapabilitiesamongproductlinesandbusinessunits(parentingstrategy)
Corporatestrategyisprimarilyaboutthechoiceofdirectionforafirmasawholeandtheman
agementofitsbusinessorproductportfolio.3Thisistruewhetherthefirmisasmallcompany
oralargemultinationalcorporation(MNC).Inalargemultiplebusinesscompany,inparticu
lar,corporatestrategyisconcernedwithmanagingvariousproductlinesandbusinessunitsfor
maximumvalue.Inthisinstance,corporateheadquartersmustplaytheroleoftheorganizational
parent,inthatitmustdealwithvariousproductandbusinessunitchildren.Eventhough
eachproductlineorbusinessunithasitsowncompetitiveorcooperativestrategythatitusesto
obtainitsowncompetitiveadvantageinthemarketplace,thecorporationmustcoordinatethese
differentbusinessstrategiessothatthecorporationasawholesucceedsasafamily. 4
Corporatestrategy,therefore,includesdecisionsregardingtheflowoffinancialandother
resourcestoandfromacompanysproductlinesandbusinessunits.Throughaseriesofcoor
dinatingdevices,acompanytransfersskillsandcapabilitiesdevelopedinoneunittoother
unitsthatneedsuchresources.Inthisway,itattemptstoobtainsynergyamongnumerous
productlinesandbusinessunitssothatthecorporatewholeisgreaterthanthesumofitsindi
vidualbusinessunitparts.5Allcorporations,fromthesmallestcompanyofferingoneproduct
inonlyoneindustrytothelargestconglomerateoperatinginmanyindustrieswithmanyprod
ucts,mustatonetimeoranotherconsideroneormoreoftheseissues.
Todealwitheachofthekeyissues,thischapterisorganizedintothreepartsthatexamine
corporatestrategyintermsofdirectionalstrategy(orientationtowardgrowth),portfolio
analysis(coordinationofcashflowamongunits),andcorporateparenting(thebuildingof
corporatesynergiesthroughresourcesharinganddevelopment). 6
7.2
DirectionalStrategy
Justaseveryproductorbusinessunitmustfollowabusinessstrategytoimproveitscompet
itiveposition,everycorporationmustdecideitsorientationtowardgrowthbyaskingthefol
lowingthreequestions:
1.Shouldweexpand,cutback,orcontinueouroperationsunchanged?
2.Shouldweconcentrateouractivitieswithinourcurrentindustry,orshouldwediversify
intootherindustries?
3.Ifwewanttogrowandexpandnationallyand/orglobally,shouldwedosothroughinter
naldevelopmentorthroughexternalacquisitions,mergers,orstrategicalliances?
CHAPTER 7
FIGURE 71
StrategyFormulation:CorporateStrategy
207
Corporate
Directional
Strategies
GROWTH
Concentration
Vertical Growth
Horizontal Growth
Diversification
Concentric
Conglomerate
STABILITY
Pause/Proceed with Caution
No Change
Profit
RETRENCHMENT
Turnaround
Captive Company
Sell-Out/Divestment
Bankruptcy/Liquidation
Acorporationsdirectionalstrategyiscomposedofthreegeneralorientations(some
timescalledgrandstrategies):
{
{
{
Growthstrategiesexpandthecompanysactivities.
Stabilitystrategiesmakenochangetothecompanyscurrentactivities.
Retrenchmentstrategiesreducethecompanyslevelofactivities.
Havingchosenthegeneralorientation(suchasgrowth),acompanysmanagerscanselect
fromseveralmorespecificcorporatestrategiessuchasconcentrationwithinoneproduct
line/industryordiversificationintootherproducts/industries.(SeeFigure71.)Thesestrate
giesareusefulbothtocorporationsoperatinginonlyoneindustrywithoneproductlineand
tothoseoperatinginmanyindustrieswithmanyproductlines.
GROWTH STRATEGIES
Byfarthemostwidelypursuedcorporatedirectionalstrategiesarethosedesignedtoachieve
growthinsales,assets,profits,orsomecombination.Companiesthatdobusinessinexpand
ingindustriesmustgrowtosurvive.Continuinggrowthmeansincreasingsalesandachance
totakeadvantageoftheexperiencecurvetoreducetheperunitcostofproductssold,thereby
increasingprofits.Thiscostreductionbecomesextremelyimportantifacorporationsindus
tryisgrowingquicklyorconsolidatingandifcompetitorsareengaginginpricewarsinat
temptstoincreasetheirsharesofthemarket.Firmsthathavenotreachedcriticalmass(that
is,gainedthenecessaryeconomyoflargescaleproduction)facelargelossesunlesstheycan
findandfillasmall,butprofitable,nichewherehigherpricescanbeoffsetbyspecialproduct
orservicefeatures.ThatiswhyOracleacquiredPeopleSoft,arivalsoftwarefirm,in2005.Al
thoughstillgrowing,thesoftwareindustrywasmaturingaroundahandfuloflargefirms.Ac
cordingtoCEOLarryEllison,Oracleneededtodoubleoreventripleinsizebybuyingsmaller
andweakerrivalsifitwastocompetewithSAPandMicrosoft. 7Growthisapopularstrategy
becauselargerbusinessestendtosurvivelongerthansmallercompaniesduetothegreater
availabilityoffinancialresources,organizationalroutines,andexternalties. 8
Acorporationcangrowinternallybyexpandingitsoperationsbothgloballyanddomes
tically,oritcangrowexternallythroughmergers,acquisitions,andstrategicalliances.A
mergerisatransactioninvolvingtwoormorecorporationsinwhichstockisexchangedbut
inwhichonlyonecorporationsurvives.Mergersusuallyoccurbetweenfirmsofsomewhat
similarsizeandareusuallyfriendly.Theresultingfirmislikelytohaveanamederivedfrom
itscompositefirms.OneexampleisthemergingofAlliedCorporationandSignalCompanies
208
PART 3
StrategyFormulation
toformAlliedSignal.Anacquisitionisthepurchaseofacompanythatiscompletelyabsorbed
asanoperatingsubsidiaryordivisionoftheacquiringcorporation.Procter&Gambles
(P&Gs)purchaseofGilletteisanexampleofarecentacquisition.Acquisitionsusuallyoccur
betweenfirmsofdifferentsizesandcanbeeitherfriendlyorhostile.Hostileacquisitionsare
oftencalledtakeovers.
Growthisaveryattractivestrategyfortwokeyreasons:
{
{
Growthbasedonincreasingmarketdemandmaymaskflawsinacompanyflawsthat
wouldbeimmediatelyevidentinastableordecliningmarket.Agrowingflowofrevenue
intoahighlyleveragedcorporationcancreatealargeamountoforganizationslack(un
usedresources)thatcanbeusedtoquicklyresolveproblemsandconflictsbetweende
partmentsanddivisions.Growthalsoprovidesabigcushionforturnaroundincasea
strategicerrorismade.Largerfirmsalsohavemorebargainingpowerthandosmallfirms
andaremorelikelytoobtainsupportfromkeystakeholdersincaseofdifficulty.
Agrowingfirmoffersmoreopportunitiesforadvancement,promotion,andinteresting
jobs.GrowthitselfisexcitingandegoenhancingforCEOs.Themarketplaceandpoten
tialinvestorstendtoviewagrowingcorporationasawinneroronthemove.Exec
utivecompensationtendstogetbiggerasanorganizationincreasesinsize.Largefirms
arealsomoredifficulttoacquirethanaresmallerones;thusanexecutivesjobinalarge
firmismoresecure.
Thetwobasicgrowthstrategiesareconcentrationonthecurrentproductline(s)inone
industryanddiversificationintootherproductlinesinotherindustries.
Concentration
Ifacompanyscurrentproductlineshaverealgrowthpotential,concentrationofresourceson
thoseproductlinesmakessenseasastrategyforgrowth.Thetwobasicconcentrationstrate
giesareverticalgrowthandhorizontalgrowth.Growingfirmsinagrowingindustrytendto
choosethesestrategiesbeforetheytrydiversification.
VerticalGrowth.Verticalgrowthcanbeachievedbytakingoverafunctionpreviously
providedbyasupplierorbyadistributor.Thecompany,ineffect,growsbymakingitsown
suppliesand/orbydistributingitsownproducts.Thismaybedoneinordertoreducecosts,
gaincontroloverascarceresource,guaranteequalityofakeyinput,orobtainaccessto
potentialcustomers.Thisgrowthcanbeachievedeitherinternallybyexpandingcurrent
operationsorexternallythroughacquisitions.HenryFord,forexample,usedinternalcompany
resourcestobuildhisRiverRougeplantoutsideDetroit.Themanufacturingprocesswas
integratedtothepointthatironoreenteredoneendofthelongplant,andfinishedautomobiles
rolledouttheotherend,intoahugeparkinglot.Incontrast,CiscoSystems,amakerofInternet
hardware,chosetheexternalroutetoverticalgrowthbypurchasingScientificAtlantaInc.,a
makerofsettopboxesfortelevisionprogramsandmoviesondemand.Thisacquisitiongave
CiscoaccesstotechnologyfordistributingtelevisiontolivingroomsthroughtheInternet. 9
Verticalgrowthresultsinverticalintegrationthedegreetowhichafirmoperatesver
ticallyinmultiplelocationsonanindustrysvaluechainfromextractingrawmaterialstoman
ufacturingtoretailing.Morespecifically,assumingafunctionpreviouslyprovidedbya
supplieriscalledbackwardintegration(goingbackwardonanindustrysvaluechain).The
purchaseofCarrollsFoodsforitshoggrowingfacilitiesbySmithfieldFoods,theworlds
largestporkprocessor,isanexampleofbackwardintegration. 10Assumingafunctionprevi
ouslyprovidedbyadistributorislabeledforwardintegration(goingforwardonanindustrys
valuechain).FedEx,forexample,usedforwardintegrationwhenitpurchasedKinkosinorder
toprovidestorefrontpackagedropoffanddeliveryservicesforthesmallbusinessmarket. 11
CHAPTER 7
209
Verticalgrowthisalogicalstrategyforacorporationorbusinessunitwithastrongcom
petitivepositioninahighlyattractiveindustryespeciallywhentechnologyispredictableand
marketsaregrowing.12Tokeepandevenimproveitscompetitiveposition,acompanymayuse
backwardintegrationtominimizeresourceacquisitioncostsandinefficientoperationsaswell
asforwardintegrationtogainmorecontroloverproductdistribution.Thefirm,ineffect,builds
onitsdistinctivecompetencebyexpandingalongtheindustrysvaluechaintogaingreater
competitiveadvantage.
Althoughbackwardintegrationisoftenmoreprofitablethanforwardintegration(because
oftypicallowmarginsinretailing),itcanreduceacorporationsstrategicflexibility.There
sultingencumbranceofexpensiveassetsthatmightbehardtosellcouldcreateanexitbarrier,
preventingthecorporationfromleavingthatparticularindustry.Examplesofsingleuseassets
areblastfurnacesandbreweries.Whendemanddropsineitheroftheseindustries(steelor
beer),theseassetshavenoalternativeuse,butcontinuetocostmoneyintermsofdebtpay
ments,propertytaxes,andsecurityexpenses.
Transactioncosteconomicsproposesthatverticalintegrationismoreefficientthancon
tractingforgoodsandservicesinthemarketplacewhenthetransactioncostsofbuyinggoods
ontheopenmarketbecometoogreat.Whenhighlyverticallyintegratedfirmsbecomeexces
sivelylargeandbureaucratic,however,thecostsofmanagingtheinternaltransactionsmaybe
comegreaterthansimplypurchasingtheneededgoodsexternallythusjustifying
outsourcingoververticalintegration.Thisiswhyverticalintegrationandoutsourcingaresit
uationspecific.Neitherapproachisbestforallcompaniesinallsituations. 13SeetheStrategy
Highlight7.1featureonhowtransactioncosteconomicshelpsexplainwhyfirmsvertically
integrateoroutsourceimportantactivities.Researchthusfarprovidesmixedsupportforthe
predictionsoftransactioncosteconomics.14
Harriganproposesthatacompanysdegreeofverticalintegrationcanrangefromtotal
ownershipofthevaluechainneededtomakeandsellaproducttonoownershipatall. 15(See
Figure72.)Underfullintegration,afirminternallymakes100%ofitskeysuppliesandcom
pletelycontrolsitsdistributors.Largeoilcompanies,suchasBritishPetroleumandRoyalDutch
Shell,arefullyintegrated.Theyowntheoilrigsthatpumptheoiloutoftheground,theships
andpipelinesthattransporttheoil,therefineriesthatconverttheoiltogasoline,andthetrucks
thatdeliverthegasolinetocompanyownedandfranchisedgasstations.SherwinWilliams
Company,whichnotonlymanufacturerspaint,butalsosellsitinitsownchainof3,000retail
stores,isanotherexampleofafullyintegratedfirm.16Ifacorporationdoesnotwantthedisad
vantagesoffullverticalintegration,itmaychooseeithertaperorquasiintegrationstrategies.
Withtaperintegration(alsocalledconcurrentsourcing),afirminternallyproducesless
thanhalfofitsownrequirementsandbuystherestfromoutsidesuppliers(backwardtaperin
tegration).17InthecaseofSmithfieldFoods,itspurchaseofCarrollsallowedittoproduce27%
ofthehogsitneededtoprocessintopork.Intermsofforwardtaperintegration,afirmsellspart
ofitsgoodsthroughcompanyownedstoresandtherestthroughgeneralwholesalers.Although
Applehad216ofitsownretainstoresin2008,muchofthecompanyssalescontinuedtobe
throughnationalchainssuchasBestBuyandthroughindependentlocalandregionaldealers.
Withquasiintegration,acompanydoesnotmakeanyofitskeysuppliesbutpurchases
mostofitsrequirementsfromoutsidesuppliersthatareunderitspartialcontrol(backward
FIGURE 72
Vertical
Integration
Continuum
Full
Integration
Taper
Integration
Quasi
Integration
LongTerm
Contract
SOURCE:SuggestedbyK.R.Harrigan,StrategiesforVerticalIntegration(Lexington,Mass.:LexingtonBooks,D.C.
Health,1983),pp.1621.
210
PART 3
StrategyFormulation
STRATEGYhighlight7.1
TRANSACTION COST ECONOMICS
ANALYZES VERTICAL GROWTH STRATEGY
Why do corporations use ver-
tical growth to permanently
own suppliers or distributors
when they could simply purchase in-
dividual items when needed on the open market? Transac-
tion cost economics is a branch of institutional economics
that attempts to answer this question. Transaction cost eco-
nomics proposes that owning resources through vertical
growth is more efficient than contracting for goods and
services in the marketplace when the transaction costs of
buying goods on the open market become too great. Trans-
action costs include the basic costs of drafting, negotiating,
and safeguarding a market agreement (a contract) as well
as the later managerial costs when the agreement is creat-
ing problems (goods arent being delivered on time or qual-
ity is lower than needed), renegotiation costs (e.g., costs of
meetings and phone calls), and the costs of settling dis-
putes (e.g., lawyers fees and court costs).
According to Williamson, three conditions must be met
before a corporation will prefer internalizing a vertical
transaction through ownership over contracting for the
transaction in the marketplace: (1) a high level of uncer-
tainty must surround the transaction, (2) assets involved in
the transaction must be highly specialized to the transac-
tion, and (3) the transaction must occur frequently. If there
is a high level of uncertainty, it will be impossible to write
a contract covering all contingencies, and it is likely that
the contractor will act opportunistically to exploit any gaps
in the written agreementthus creating problems and in-
creasing costs. If the assets being contracted for are highly
specialized (e.g., goods or services with few alternate
uses), there are likely to be few alternative suppliersthus
allowing the contractor to take advantage of the situation
and increase costs. The more frequent the transactions, the
more opportunity for the contractor to demand special
treatment and thus increase costs further.
Vertical integration is not always more efficient than the
marketplace, however. When highly vertically integrated
firms become excessively large and bureaucratic, the costs
of managing the internal transactions may become greater
than simply purchasing the needed goods externallythus
justifying outsourcing over ownership. The usually hidden
management costs (e.g., excessive layers of management,
endless committee meetings needed for interdepartmental
coordination, and delayed decision making due to exces-
sively detailed rules and policies) add to the internal trans-
action coststhus reducing the effectiveness and
efficiency of vertical integration. The decision to own or to
outsource is, therefore, based on the particular situation
surrounding the transaction and the ability of the corpora-
tion to manage the transaction internally both effectively
and efficiently.
SOURCES: O. E. Williamson and S. G. Winter, eds., The Nature of
the Firm: Origins, Evolution, and Development (New York: Oxford
University Press, 1991); E. Mosakowski, Organizational Bound-
aries and Economic Performance: An Empirical Study of Entrepre-
neurial Computer Firms, Strategic Management Journal
(February 1991), pp. 115133; P. S. Ring and A. H. Van de Ven,
Structuring Cooperative Relationships Between Organizations,
Strategic Management Journal (October 1992), pp. 483498.
quasiintegration).Acompanymaynotwanttopurchaseoutrightasupplierordistributor,but
itstillmaywanttoguaranteeaccesstoneededsupplies,newproducts,technologies,ordistri
butionchannels.Forexample,thepharmaceuticalcompanyBristolMyersSquibbpurchased
17%ofthecommonstockofImCloneinordertogainaccesstonewdrugproductsbeingde
velopedthroughbiotechnology.Anexampleofforwardquasiintegrationwouldbeapaper
companyacquiringpartinterestinanofficeproductschaininordertoguaranteethatitsprod
uctshadaccesstothedistributionchannel.Purchasingpartinterestinanothercompanyusu
allyprovidesacompanywithaseatontheotherfirmsboardofdirectors,thusguaranteeing
theacquiringfirmbothinformationandcontrol.AsinthecaseofBristolMyersSquibband
ImClone,aquasiintegratedfirmmaylaterdecidetobuytherestofakeysupplierthatitdid
notalreadyown.18
Longtermcontractsareagreementsbetweentwofirmstoprovideagreedupongoods
andservicestoeachotherforaspecifiedperiodoftime.Thiscannotreallybeconsideredto
beverticalintegrationunlessitisanexclusivecontractthatspecifiesthatthesupplierordis
tributorcannothaveasimilarrelationshipwithacompetitivefirm.Inthatcase,thesupplier
CHAPTER 7
211
ordistributorisreallyacaptivecompanythat,althoughofficiallyindependent,doesmostof
itsbusinesswiththecontractedfirmandisformallytiedtotheothercompanythroughalong
termcontract.
Recentlytherehasbeenamovementawayfromverticalgrowthstrategies(andthusver
ticalintegration)towardcooperativecontractualrelationshipswithsuppliersandevenwith
competitors.19Theserelationshipsrangefromoutsourcing,inwhichresourcesarepurchased
fromoutsidersthroughlongtermcontractsinsteadofbeingmadeinhouse(forexample,
HewlettPackardboughtitslaserenginesfromCanonforHPslaserjetprinters),tostrategic
alliances,inwhichpartnerships,technologylicensingagreements,andjointventuressupple
mentafirmscapabilities(forexample,ToshibahasusedstrategicallianceswithGE,Siemens,
Motorola,andEricssontobecomeoneoftheworldsleadingelectroniccompanies). 20
HorizontalGrowth.Afirmcanachievehorizontalgrowthbyexpandingitsoperationsinto
othergeographiclocationsand/orbyincreasingtherangeofproductsandservicesofferedto
currentmarkets.Researchindicatesthatfirmsthatgrowhorizontallybybroadeningtheir
productlineshavehighsurvivalrates.21Horizontalgrowthresultsinhorizontal
integrationthedegreetowhichafirmoperatesinmultiplegeographiclocationsatthesame
pointonanindustrysvaluechain.Forexample,Procter&Gamble(P&G)continuallyadds
additionalsizesandmultiplevariationstoitsexistingproductlinestoreducepossibleniches
competitorsmayenter.Inaddition,itintroducessuccessfulproductsfromonepartoftheworld
tootherregions.P&GhasbeenintroducingintoChinaasteadystreamofpopularAmerican
brands,suchasHead&Shoulders,Crest,Olay,Tide,Pampers,andWhisper.By2007,ithad
6,300employeesinChinaandtheextensivedistributionnetworkitneededtoprosperinthe
worldsfastestgrowingmarket.22
Horizontalgrowthcanbeachievedthroughinternaldevelopmentorexternallythrough
acquisitionsandstrategicallianceswithotherfirmsinthesameindustry.Forexample,Delta
AirlinesacquiredNorthwestAirlinesin2008toobtainaccesstoNorthwestsAsianmarkets
andthoseAmericanmarketsthatDeltawasnotthenserving.Incontrast,manysmallcom
muterairlinesengageinlongtermcontractswithmajorairlinesinordertoofferacomplete
arrangementfortravelers.Forexample,theregionalcarrierMesaAirlinesarrangedcontrac
tualagreementswithUnitedAirlines,U.S.Airways,andAmericaWesttobelistedontheir
computerreservations,respectively,asUnitedExpress,U.S.AirwaysExpress,andAmerica
WestExpress.
Horizontalgrowthisincreasinglybeingachievedintodaysworldthroughinternational
expansion.AmericansWalMart,FrancesCarrefour,andBritainsTescoareexamplesofna
tionalsupermarketdiscountchainsexpandinghorizontallythroughouttheworld.Thistypeof
growthcanbeachievedinternationallythroughmanydifferentstrategies.
InternationalEntryOptionsforHorizontalGrowth
Researchindicatesthatgrowinginternationallyispositivelyassociatedwithfirmprofitability. 23
Acorporationcanselectfromseveralstrategicoptionsthemostappropriatemethodforentering
aforeignmarketorestablishingmanufacturingfacilitiesinanothercountry.Theoptionsvary
fromsimpleexportingtoacquisitionstomanagementcontracts.SeetheGlobalIssuefeatureto
seehowU.S.basedfirmsareusinginternationalentryoptionsinahorizontalgrowthstrategyto
expandthroughouttheworld.
Someofthemostpopularoptionsforinternationalentryareasfollows:
{
Exporting:Agoodwaytominimizeriskandexperimentwithaspecificproductis
exporting,shippinggoodsproducedinthecompanyshomecountrytoothercountriesfor
marketing.Thecompanycouldchoosetohandleallcriticalfunctionsitself,oritcouldcon
tractthesefunctionstoanexportmanagementcompany.Exportingisbecomingincreasingly
212
PART 3
StrategyFormulation
GLOBAL
issue
COMPANIES LOOK TO INTERNATIONAL
MARKETS FOR HORIZONTAL GROWTH
try in only a few years. Soon imitators began opening their
own versions until the U.S. market was completely satu-
rated with coffee shops. Facing slow growth in its domes-
tic market, Starbucks management made the strategic
decision to add fewer U.S. stores and to make international
expansion its top priority.
Until recently, International Paper (IP) was international
in name only. Founded in 1898, the company had once
supplied 60% of the newsprint for American newspapers.
After years of slow growth and weak financial perfor-
mance, IPs management decided to divest unrelated busi-
nesses and to branch out from its North American roots to
developing international markets. Acquisitions in Russia
and green-field development in Brazil now positioned the
company within low-cost, high-growth markets. IPs man-
agement hoped to soon control about half the office pa-
per market in Latin America.
SOURCES: B. Helm and J. McGregor, Howard Schultzs Grande
Challenge, Business Week (January 21, 2008), p. 28; J. Bush,
Now Its Really International Paper, Business Week (December
17, 2007).
What do Wal-Mart, Star-
bucks, and International Pa-
per have in common? For one
thing, they are successful U.S.
companies that grew to the point that
eventually their products saturated the domestic market
resulting in slower growth in domestic sales and profits. For
another, all are companies that have chosen the corporate
growth strategy of concentrating in one industry. A third
thing in common is that all of them are using international
markets as a key growth opportunity.
From its humble beginnings in Bentonville, Arkansas,
Wal-Mart has successfully grown such that its discount
stores can now be found in most every corner of the nation.
Knowing that Wal-Mart had fewer locations left in the
United States on which to build stores, the companys man-
agement knew that the companys domestic growth could
not be sustained past 2007. Consequently, the company be-
gan acquiring retail chains in other countries to eventually
become the largest company in the world in terms of sales.
Growing from its base in Seattle, Washington, Star-
bucks expanded its coffee shops to every city in the coun-
{
{
{
popularforsmallbusinessesbecauseoftheInternet,faxmachines,tollfreenumbers,and
overnightexpressservices,whichreducetheonceformidablecostsofgoinginternational.
Licensing:Underalicensingagreement,thelicensingfirmgrantsrightstoanotherfirm
inthehostcountrytoproduceand/orsellaproduct.Thelicenseepayscompensationto
thelicensingfirminreturnfortechnicalexpertise.Thisisanespeciallyusefulstrategyif
thetrademarkorbrandnameiswellknown,butthecompanydoesnothavesufficient
fundstofinanceitsenteringthecountrydirectly.AnheuserBuschusedthisstrategyto
produceandmarketBudweiserbeerintheUnitedKingdom,Japan,Israel,Australia,
Korea,andthePhilippines.Thisstrategyisalsoimportantifthecountrymakesentry
viainvestmenteitherdifficultorimpossible.
Franchising:Underafranchisingagreement,thefranchisergrantsrightstoanother
companytoopenaretailstoreusingthefranchisersnameandoperatingsystem.Inex
change,thefranchiseepaysthefranchiserapercentageofitssalesasaroyalty.Franchis
ingprovidesanopportunityforafirmtoestablishapresenceincountrieswherethe
populationorpercapitaspendingisnotsufficientforamajorexpansioneffort. 24Fran
chisingaccountsfor40%oftotalU.S.retailsales.ClosetohalfofU.S.franchisers,such
asYum!Brands,franchiseinternationally.25
JointVentures:Formingajointventurebetweenaforeigncorporationandadomestic
companyisthemostpopularstrategyusedtoenteranewcountry. 26Companiesoftenform
jointventurestocombinetheresourcesandexpertiseneededtodevelopnewproductsor
technologies.Ajointventuremaybeanassociationbetweenacompanyandafirminthe
hostcountryoragovernmentagencyinthatcountry.Aquickmethodofobtaininglocal
CHAPTER 7
213
management,italsoreducestherisksofexpropriationandharassmentbyhostcountryof
ficials.Ajointventuremayalsoenableafirmtoenteracountrythatrestrictsforeignown
ership.Thecorporationcanenteranothercountrywithfewerassetsatstakeandthuslower
risk.UnderIndianlaw,forexample,foreignretailersarepermittedtoownnomorethan
51%ofshopssellingsinglebrandproducts,ortoselltoothersonawholesalebasis.These
andotherrestrictionsdeterredsupermarketgiantsTescoandCarrefourfromenteringIn
dia.Asaresult,97%ofIndianretailingiscomposedofsmall,familyrunstores.Eagerto
enterIndia,WalMartsmanagementformedanequalpartnershipjointventurein2007
withBhartiEnterprisestostartwholesaleoperations.UnderthenameBhartiMart,the
newcompanyplannedtoopenadozensmallretailstoresby2015. 27
{
{
{
{
Acquisitions:Arelativelyquickwaytomoveintoaninternationalareaisthroughacquisi
tionspurchasinganothercompanyalreadyoperatinginthatarea.Synergisticbenefitscan
resultifthecompanyacquiresafirmwithstrongcomplementaryproductlinesandagood
distributionnetwork.Forexample,BelgiumsInBevpurchasedAnheuserBuschin2008
for$52billiontoobtainasolidpositionintheprofitableNorthAmericanbeermarket.Be
foretheacquisition,InBevhadonlyasmallpresenceintheU.S.,butastrongoneinEurope
andLatinAmerican,whereAnheuserBuschwasweak.28Researchsuggeststhatwholly
ownedsubsidiariesaremoresuccessfulininternationalundertakingsthanarestrategical
liances,suchasjointventures.29Thisisonereasonwhyfirmsmoreexperiencedininterna
tionalmarketstakeahigherownershippositionwhenmakingaforeigninvestment. 30
Crossborderacquisitionsnowaccountfor19%ofallacquisitionsintheUnitedStatesup
fromonly6%in1985.31Insomecountries,however,acquisitionscanbedifficulttoarrange
becauseofalackofavailableinformationaboutpotentialcandidates.Governmentrestric
tionsonownership,suchastheU.S.requirementthatlimitsforeignownershipofU.S.air
linesto49%ofnonvotingand25%ofvotingstock,canalsodiscourageacquisitions.
GreenFieldDevelopment:Ifacompanydoesntwanttopurchaseanothercompanys
problemsalongwithitsassets,itmaychoosegreenfielddevelopmentandbuilditsown
manufacturingplantanddistributionsystem.Researchindicatesthatfirmspossessing
highlevelsoftechnology,multinationalexperience,anddiverseproductlinesprefer
greenfielddevelopmenttoacquisitions.32Thisisusuallyafarmorecomplicatedandex
pensiveoperationthanacquisition,butitallowsacompanymorefreedomindesigning
theplant,choosingsuppliers,andhiringaworkforce.Forexample,Nissan,Honda,and
ToyotabuiltautofactoriesinruralareasofGreatBritainandthenhiredayoungwork
forcewithnoexperienceintheindustry.BMWdidthesamethingwhenitbuiltitsauto
plantinSpartanburg,SouthCarolina,tomakeitsZ3andZ4sportscars.
ProductionSharing:CoinedbyPeterDrucker,thetermproductionsharingmeansthe
processofcombiningthehigherlaborskillsandtechnologyavailableindevelopedcoun
trieswiththelowercostlaboravailableindevelopingcountries.Oftencalledoutsourcing,
oneexampleisMaytagsmovingsomeofitsrefrigerationproductiontoanewplantin
Reynosa,Mexico,inordertoreducelaborcosts.Manycompanieshavemoveddatapro
cessing,programming,andcustomerserviceactivitiesoffshoretoIreland,India,Barba
dos,Jamaica,thePhilippines,andSingapore,wherewagesarelower,Englishisspoken,
andtelecommunicationsareinplace.Asthenumberoftechnologyservicesemployeesin
Indiagrewtobe15%ofIBMstotaltechservicesemployeesby2007,thecompanyhas
beenabletoeliminate20,000jobsinhighcostlocationsintheU.S.,Europe,andJapan. 33
TurnkeyOperations:Turnkeyoperationsaretypicallycontractsfortheconstructionof
operatingfacilitiesinexchangeforafee.Thefacilitiesaretransferredtothehostcountry
orfirmwhentheyarecomplete.Thecustomerisusuallyagovernmentagencyof,forex
ample,aMiddleEasterncountrythathasdecreedthataparticularproductmustbepro
ducedlocallyandunderitscontrol.Forexample,FiatbuiltanautoplantinTagliatti,
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{
{
Russia,fortheSovietUnioninthelate1960stoproduceanoldermodelofFiatunderthe
brandnameofLada.MNCsthatperformturnkeyoperationsarefrequentlyindustrial
equipmentmanufacturersthatsupplysomeoftheirownequipmentfortheprojectandthat
commonlysellreplacementpartsandmaintenanceservicestothehostcountry.They
therebycreatecustomersaswellasfuturecompetitors.Interestingly,Renaultpurchasedin
2008a25%stakeinthesameTagliattifactorybuiltbyFiattohelptheRussiancarmaker
modernize,usingRenaultslowcostLoganasthebasefortheplantsnewLadamodel. 34
BOTConcept:TheBOT(Build,Operate,Transfer)conceptisavariationofthe
turnkeyoperation.Insteadofturningthefacility(usuallyapowerplantortollroad)over
tothehostcountrywhencompleted,thecompanyoperatesthefacilityforafixedperiod
oftimeduringwhichitearnsbackitsinvestmentplusaprofit.Itthenturnsthefacility
overtothegovernmentatlittleornocosttothehostcountry. 35
ManagementContracts:Alargecorporationoperatingthroughouttheworldislikelyto
havealargeamountofmanagementtalentatitsdisposal.Managementcontractsoffer
ameansthroughwhichacorporationcanusesomeofitspersonneltoassistafirmina
hostcountryforaspecifiedfeeandperiodoftime.Managementcontractsarecommon
whenahostgovernmentexpropriatespartorallofaforeignownedcompanysholdings
initscountry.Thecontractsallowthefirmtocontinuetoearnsomeincomefromitsin
vestmentandkeeptheoperationsgoinguntillocalmanagementistrained. 36
DiversificationStrategies
AccordingtostrategistRichardRumelt,companiesbeginthinkingaboutdiversificationwhen
theirgrowthhasplateauedandopportunitiesforgrowthintheoriginalbusinesshavebeende
pleted.37Thisoftenoccurswhenanindustryconsolidates,becomesmature,andmostofthe
survivingfirmshavereachedthelimitsofgrowthusingverticalandhorizontalgrowthstrate
gies.Unlessthecompetitorsareabletoexpandinternationallyintolessmaturemarkets,they
mayhavenochoicebuttodiversifyintodifferentindustriesiftheywanttocontinuegrowing.
Thetwobasicdiversificationstrategiesareconcentricandconglomerate.
Concentric(Related)Diversification.Growththroughconcentricdiversificationintoa
relatedindustrymaybeaveryappropriatecorporatestrategywhenafirmhasastrong
competitivepositionbutindustryattractivenessislow.
Researchindicatesthattheprobabilityofsucceedingbymovingintoarelatedbusinessisa
functionofacompanyspositioninitscorebusiness.Forcompaniesinleadershippositions,the
chancesforsuccessarenearlythreetimeshigherthanthoseforfollowers. 38Byfocusingonthe
characteristicsthathavegiventhecompanyitsdistinctivecompetence,thecompanyusesthose
verystrengthsasitsmeansofdiversification.Thefirmattemptstosecurestrategicfitinanew
industrywherethefirmsproductknowledge,itsmanufacturingcapabilities,andthemarketing
skillsitusedsoeffectivelyintheoriginalindustrycanbeputtogooduse. 39Thecorporations
productsorprocessesarerelatedinsomeway:theypossesssomecommonthread.
Thesearchisforsynergy,theconceptthattwobusinesseswillgeneratemoreprofitsto
getherthantheycouldseparately.Thepointofcommonalitymaybesimilartechnology,cus
tomerusage,distribution,managerialskills,orproductsimilarity.Thisistherationaletaken
byQuebecbasedBombardier,theworldsthirdlargestaircraftmanufacturer.Inthe1980s,the
companyexpandedbeyondsnowmobilesintomakinglightrailequipment.Definingitselfas
atransportationcompany,itenteredtheaircraftbusinessin1986,withitspurchaseof
Canadair,thenbestknownforitsfirefightingairplanes.ItlaterboughtLearjet,awellknown
makerofbusinessjets.Overa14yearperiod,Bombardierlaunched14newaircraft.InJuly
2008,thecompanyannounceditsCSeriesAircraftProgramtomanufacturea110130seat
greensingleaislefamilyofairplanestodirectlycompetewithAirbusandBoeing. 40
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215
Afirmmaychoosetodiversifyconcentricallythrougheitherinternalorexternalmeans.
Bombardier,forexample,diversifiedexternallythroughacquisitions.Toro,incontrast,grew
internallyinNorthAmericabyusingitscurrentmanufacturingprocessesanddistributorsto
makeandmarketsnowblowersinadditiontolawnmowers.Whenconsideringconcentricdi
versificationalternatives,seethecriteriapresentedinStrategyHighlight7.2.
Conglomerate(Unrelated)Diversification.Whenmanagementrealizesthatthecurrent
industryisunattractiveandthatthefirmlacksoutstandingabilitiesorskillsthatitcouldeasily
transfertorelatedproductsorservicesinotherindustries,themostlikelystrategyis
conglomeratediversificationdiversifyingintoanindustryunrelatedtoitscurrentone.
Ratherthanmaintainingacommonthreadthroughouttheirorganization,strategicmanagers
whoadoptthisstrategyareprimarilyconcernedwithfinancialconsiderationsofcashflowor
riskreduction.Thisisalsoagoodstrategyforafirmthatisabletotransferitsownexcellent
managementsystemintolesswellmanagedacquiredfirms.GeneralElectricandBerkshire
Hathawayareexamplesofcompaniesthathaveusedconglomeratediversificationtogrow
successfully.ManagedbyWarrenBuffet,BerkshireHathawayhasinterestsinfurniture
retailing,razorblades,airlines,paper,broadcasting,softdrinks,andpublishing. 41
Theemphasisinconglomeratediversificationisonsoundinvestmentandvalueoriented
managementratherthanontheproductmarketsynergycommontoconcentricdiversifica
tion.Acashrichcompanywithfewopportunitiesforgrowthinitsindustrymight,forexam
ple,moveintoanotherindustrywhereopportunitiesaregreatbutcashishardtofind.Another
instanceofconglomeratediversificationmightbewhenacompanywithaseasonaland,
STRATEGY
highlight7.2
SCREENING CRITERIA FOR CONCENTRIC DIVERSIFICATION
Market Attractiveness
Market Feasibility
1. Can the company enter the market within a year?
2. Are there any synergies in the geographic region
where the market is located?
3. Can existing capabilities be leveraged for market
entry?
4. Can existing assets be leveraged for market entry?
5. Can existing employees be used to support this
opportunity?
6. Will current and future laws and regulations affect
entry?
7. Is there a need for a strong brand in the new
market?
8. If there is a need for partners, can the company
secure and manage partner relationships?
SOURCE: Summarized from N. J. Kaplan, Surviving and Thriving
When Your Customers Contract, Journal of Business Strategy
(January/February, 2003), p. 20.
1. Is the market large
enough to be attractive?
2. Is the market growing
faster than the economy?
3. Does it offer the potential to increase revenue from
current customers?
4. Does it provide the ability to sell existing services to
new customers?
5. Does it create a recurring revenue stream?
6. Are average earnings in the industry/market higher
than in current businesses?
7. Is the market already taken by strong competitors?
8. Does it strengthen relationships with existing value-
chain players?
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therefore,unevencashflowpurchasesafirminanunrelatedindustrywithcomplementing
seasonalsalesthatwillleveloutthecashflow.CSXmanagementconsideredthepurchaseof
anaturalgastransmissionbusiness(TexasGasResources)byCSXCorporation(arailroad
dominatedtransportationcompany)tobeagoodfitbecausemostofthegastransmissionrev
enuewasrealizedinthewintermonthstheleanperiodintherailroadbusiness.
CONTROVERSIES IN DIRECTIONAL GROWTH STRATEGIES
Isverticalgrowthbetterthanhorizontalgrowth?Isconcentrationbetterthandiversifica
tion?Isconcentricdiversificationbetterthanconglomeratediversification?Researchre
vealsthatcompaniesfollowingarelateddiversificationstrategyappeartobehigher
performersandsurvivelongerthandocompanieswithnarrowerscopefollowingapurecon
centrationstrategy.42Althoughtheresearchisnotincompleteagreement,growthintoareas
relatedtoacompanyscurrentproductlinesisgenerallymoresuccessfulthanisgrowthinto
completelyunrelatedareas.43Forexample,onestudyofvariousgrowthprojectsexamined
howmanywereconsideredsuccessful,thatis,stillinexistenceafter22years.Theresults
wereverticalgrowth,80%;horizontalgrowth,50%;concentricdiversification,35%;and
conglomeratediversification,28%.44Thissupportstheconclusionfromastudyof40suc
cessfulEuropeancompaniesthatcompaniesshouldfirstexploittheirexistingassetsandca
pabilitiesbeforeexploringfornewones,butthattheyshouldalsodiversifytheirportfolio
ofproducts.45
Intermsofdiversificationstrategies,researchsuggeststhattherelationshipbetweenre
latednessandperformanceiscurvilinearintheshapeofaninvertedUshapedcurve.Ifanew
businessisverysimilartothatoftheacquiringfirm,itaddslittlenewtothecorporationand
onlymarginallyimprovesperformance.Ifthenewbusinessiscompletelydifferentfromthe
acquiringcompanysbusinesses,theremaybeverylittlepotentialforanysynergy.If,how
ever,thenewbusinessprovidesnewresourcesandcapabilitiesinadifferent,butsimilar,busi
ness,thelikelihoodofasignificantperformanceimprovementishigh. 46
Isinternalgrowthbetterthanexternalgrowth?Corporationscanfollowthegrowthstrate
giesofeitherconcentrationordiversificationthroughtheinternaldevelopmentofnewproducts
andservices,orthroughexternalacquisitions,mergers,andstrategicalliances.Thevalue
ofglobalacquisitionsandmergershassteadilyincreasedfromlessthan$1trillionin1990to
$3.5trillionin2000.47AccordingtoaMcKinsey&Companysurvey,managersareprimarily
motivatedtopurchaseothercompaniesinordertoaddcapabilities,expandgeographically,and
buygrowth.48Researchgenerallyconcludes,however,thatfirmsgrowingthroughacquisitions
donotperformfinanciallyaswellasfirmsthatgrowthroughinternalmeans. 49Forexample,on
September3,2001,thedaybeforeHPannouncedthatitwaspurchasingCompaq,HPsstock
wassellingat$23.11.Aftertheannouncement,thestockpricefellto$18.87.Threeyearslater,
onSeptember21,2004,thesharessoldat$18.70.50Onereasonforthispoorperformancemay
bethatacquiringfirmstendtospendlessonR&Dthandootherfirms. 51Anotherreasonmay
bethetypicallyhighpriceoftheacquisitionitself.Studiesrevealthatoverhalftotwothirdsof
acquisitionsarefailuresprimarilybecausethepremiumspaidweretoohighforthemtoearn
theircostofcapital.52Anotherreasonforthepoorstockperformanceisthat50%ofthecus
tomersofamergedfirmarelesssatisfiedwiththecombinedcompanysservicetwoyearsaf
terthemerger.53Itislikelythatneitherstrategyisbestbyitselfandthatsomecombinationof
internalandexternalgrowthstrategiesisbetterthanusingoneortheother. 54
Whatcanimproveacquisitionperformance?Foronething,theacquisitionshouldbe
linkedtostrategicobjectivesandsupportcorporatestrategy.Inaddition,acorporationmust
bepreparedtoidentifyroughly100candidatesandconductduediligenceinvestigationon
around40companiesinordertoultimatelypurchase10companies.Thiskindofeffortrequires
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217
thecapacitytosiftthroughmanycandidateswhilesimultaneouslyintegratingpreviousacqui
sitions.55AstudybyBain&Companyofmorethan11,000acquisitionsbycompanies
throughouttheworldconcludedthatsuccessfulacquirersmakesmall,lowriskacquisitions
beforemovingontolargerones.56Previousexperiencebetweenanacquirerandatargetfirm
intermsofR&D,manufacturing,ormarketingalliancesimprovesthelikelihoodofasuccess
fulacquisition.57Realizingthatanacquiredcompanymustbecarefullyassimilatedintothe
acquiringfirmsoperations,Ciscousesthreecriteriatojudgewhetheracompanyisasuitable
candidatefortakeover:
{
{
{
Itmustberelativelysmall.
Itmustbecomparableinorganizationalculture.
Itmustbephysicallyclosetooneoftheexistingaffiliates.58
STABILITY STRATEGIES
Acorporationmaychoosestabilityovergrowthbycontinuingitscurrentactivitieswithoutany
significantchangeindirection.Althoughsometimesviewedasalackofstrategy,thestability
familyofcorporatestrategiescanbeappropriateforasuccessfulcorporationoperatingina
reasonablypredictableenvironment.59Theyareverypopularwithsmallbusinessownerswho
havefoundanicheandarehappywiththeirsuccessandthemanageablesizeoftheirfirms.
Stabilitystrategiescanbeveryusefulintheshortrun,buttheycanbedangerousiffollowed
fortoolong.Someofthemorepopularofthesestrategiesarethepause/proceedwithcaution,
nochange,andprofitstrategies.
Pause/ProceedwithCautionStrategy
Apause/proceedwithcautionstrategyis,ineffect,atimeoutanopportunitytorestbe
forecontinuingagrowthorretrenchmentstrategy.Itisaverydeliberateattempttomake
onlyincrementalimprovementsuntilaparticularenvironmentalsituationchanges.Itistyp
icallyconceivedasatemporarystrategytobeuseduntiltheenvironmentbecomesmorehos
pitableortoenableacompanytoconsolidateitsresourcesafterprolongedrapidgrowth.This
wasthestrategyDellfollowedafteritsgrowthstrategyhadresultedinmoregrowththanit
couldhandle.ExplainedCEOMichaelDell,Wegrew285%intwoyears,andwerehav
ingsomegrowingpains.SellingpersonalcomputersbymailenabledDelltounderprice
competitors,butitcouldnotkeepupwiththeneedsofa$2billion,5,600employeecom
panysellingPCsin95countries.Delldidnotgiveuponitsgrowthstrategy;itmerelyputit
temporarilyinlimbountilthecompanywasabletohirenewmanagers,improvethestruc
ture,andbuildnewfacilities.60Thiswasapopularstrategyinlate2008duringaU.S.finan
cialcrisiswhenbankswerefreezingtheirlendingandawaitingarescuepackagefromthe
federalgovernment.
NoChangeStrategy
Anochangestrategyisadecisiontodonothingnewachoicetocontinuecurrentopera
tionsandpoliciesfortheforeseeablefuture.Rarelyarticulatedasadefinitestrategy,ano
changestrategyssuccessdependsonalackofsignificantchangeinacorporationssituation.
Therelativestabilitycreatedbythefirmsmodestcompetitivepositioninanindustryfacing
littleornogrowthencouragesthecompanytocontinueonitscurrentcourse,makingonly
smalladjustmentsforinflationinitssalesandprofitobjectives.Therearenoobviousoppor
tunitiesorthreats,noristheremuchinthewayofsignificantstrengthsorweaknesses.Fewag
gressivenewcompetitorsarelikelytoentersuchanindustry.Thecorporationhasprobably
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foundareasonablyprofitableandstablenicheforitsproducts.Unlesstheindustryisunder
goingconsolidation,therelativecomfortacompanyinthissituationexperiencesislikelyto
encouragethecompanytofollowanochangestrategyinwhichthefutureisexpectedtocon
tinueasanextensionofthepresent.Manysmalltownbusinessesfollowedthisstrategybefore
WalMartmovedintotheirareasandforcedthemtorethinktheirstrategy.
ProfitStrategy
Aprofitstrategyisadecisiontodonothingnewinaworseningsituationbutinsteadtoactas
thoughthecompanysproblemsareonlytemporary.Theprofitstrategyisanattempttoartifi
ciallysupportprofitswhenacompanyssalesaredecliningbyreducinginvestmentandshort
termdiscretionaryexpenditures.Ratherthanannouncethecompanyspoorpositionto
shareholdersandtheinvestmentcommunityatlarge,topmanagementmaybetemptedtofol
lowthisveryseductivestrategy.Blamingthecompanysproblemsonahostileenvironment
(suchasantibusinessgovernmentpolicies,unethicalcompetitors,finickycustomers,and/or
greedylenders),managementdefersinvestmentsand/orcutsexpenses(suchasR&D,mainte
nance,andadvertising)tostabilizeprofitsduringthisperiod.Itmayevenselloneofitsprod
uctlinesforthecashflowbenefits.
Theprofitstrategyisusefulonlytohelpacompanygetthroughatemporarydifficulty.It
mayalsobeawaytoboostthevalueofacompanyinpreparationforgoingpublicviaanini
tialpublicoffering(IPO).Unfortunately,thestrategyisseductiveandifcontinuedlong
enoughitwillleadtoaseriousdeteriorationinacorporationscompetitiveposition.Theprofit
strategyistypicallytopmanagementspassive,shortterm,andoftenselfservingresponseto
adifficultsituation.Insuchsituations,itisoftenbettertofacetheproblemdirectlybychoos
ingaretrenchmentstrategy.
RETRENCHMENT STRATEGIES
Acompanymaypursueretrenchmentstrategieswhenithasaweakcompetitivepositionin
someorallofitsproductlinesresultinginpoorperformancesalesaredownandprofitsare
becominglosses.Thesestrategiesimposeagreatdealofpressuretoimproveperformance.In
anattempttoeliminatetheweaknessesthataredraggingthecompanydown,managementmay
followoneofseveralretrenchmentstrategies,rangingfromturnaroundorbecomingacaptive
companytosellingout,bankruptcy,orliquidation.
TurnaroundStrategy
Turnaroundstrategyemphasizestheimprovementofoperationalefficiencyandisprobably
mostappropriatewhenacorporationsproblemsarepervasivebutnotyetcritical.Research
showsthatpoorlyperformingfirmsinmatureindustrieshavebeenabletoimprovetheirper
formancebycuttingcostsandexpensesandbysellingoffassets. 61Analogoustoaweight
reductiondiet,thetwobasicphasesofaturnaroundstrategyarecontractionandconsolidation. 62
Contractionistheinitialefforttoquicklystopthebleedingwithageneral,acrossthe
boardcutbackinsizeandcosts.Forexample,whenHowardStringerwasselectedtobeCEO
ofSonyCorporationin2005,heimmediatelyimplementedthefirststageofaturnaroundplan
byeliminating10,000jobs,closing11of65plants,anddivestingmanyunprofitableelectron
icsbusinesses.63Thesecondphase,consolidation,implementsaprogramtostabilizethenow
leanercorporation.Tostreamlinethecompany,plansaredevelopedtoreduceunnecessary
overheadandtomakefunctionalactivitiescostjustified.Thisisacrucialtimefortheorganiza
tion.Iftheconsolidationphaseisnotconductedinapositivemanner,manyofthebestpeople
leavetheorganization.Anoveremphasisondownsizingandcuttingcostscoupledwithaheavy
CHAPTER 7
219
handbytopmanagementisusuallycounterproductiveandcanactuallyhurtperformance. 64If,
however,allemployeesareencouragedtogetinvolvedinproductivityimprovements,thefirm
islikelytoemergefromthisretrenchmentperiodamuchstrongerandbetterorganizedcom
pany.Ithasimproveditscompetitivepositionandisableonceagaintoexpandthebusiness. 65
CaptiveCompanyStrategy
Acaptivecompanystrategyinvolvesgivingupindependenceinexchangeforsecurity.Acom
panywithaweakcompetitivepositionmaynotbeabletoengageinafullblownturnaroundstrat
egy.Theindustrymaynotbesufficientlyattractivetojustifysuchaneffortfromeitherthecurrent
managementorinvestors.Nevertheless,acompanyinthissituationfacespoorsalesandincreas
inglossesunlessittakessomeaction.Managementdesperatelysearchesforanangelbyoffer
ingtobeacaptivecompanytooneofitslargercustomersinordertoguaranteethecompanys
continuedexistencewithalongtermcontract.Inthisway,thecorporationmaybeabletoreduce
thescopeofsomeofitsfunctionalactivities,suchasmarketing,thussignificantlyreducingcosts.
Theweakercompanygainscertaintyofsalesandproductioninreturnforbecomingheavilyde
pendentonanotherfirmforatleast75%ofitssales.Forexample,tobecomethesolesupplierof
anautoparttoGeneralMotors,SimpsonIndustriesofBirmingham,Michigan,agreedtoleta
specialteamfromGMinspectitsenginepartsfacilitiesandbooksandinterviewitsemployees.
Inreturn,nearly80%ofthecompanysproductionwassoldtoGMthroughlongtermcontracts. 66
SellOut/DivestmentStrategy
Ifacorporationwithaweakcompetitivepositioninanindustryisunableeithertopullitselfup
byitsbootstrapsortofindacustomertowhichitcanbecomeacaptivecompany,itmayhave
nochoicebuttosellout.Theselloutstrategymakessenseifmanagementcanstillobtaina
goodpriceforitsshareholdersandtheemployeescankeeptheirjobsbysellingtheentirecom
panytoanotherfirm.Thehopeisthatanothercompanywillhavethenecessaryresourcesand
determinationtoreturnthecompanytoprofitability.Marginalperformanceinatroubledindus
trywasonereasonNorthwestAirlineswaswillingtobeacquiredbyDeltaAirlinesin2008.
Ifthecorporationhasmultiplebusinesslinesanditchoosestoselloffadivisionwithlow
growthpotential,thisiscalleddivestment.ThiswasthestrategyFordusedwhenitsoldits
strugglingJaguarandLandRoverunitstoTataMotorsin2008for$2billion.Fordhadspent
$10billiontryingtoturnaroundJaguarafterspending$2.5billiontobuyitin1990.Inaddi
tion,Fordhadpaid$2.8billionforLandRoverin2000.Fordsmanagementhopedtousethe
proceedsofthesaletohelpthecompanyreachprofitabilityin2009. 67GeneralElectricsman
agementusedthesamereasoningwhenitdecidedtosellorspinoffitsslowgrowthappliance
businessin2008.
Divestmentisoftenusedafteracorporationacquiresamultiunitcorporationinorderto
shedtheunitsthatdonotfitwiththecorporationsnewstrategy.ThisiswhyWhirlpoolsold
MaytagsHoovervacuumcleanerunitafterWhirlpoolpurchasedMaytag.Divestmentwas
alsoakeypartofLegosturnaroundstrategywhenmanagementdecidedtodivestitstheme
parkstoconcentratemoreonitscorebusinessofmakingtoys. 68
Bankruptcy/LiquidationStrategy
Whenacompanyfindsitselfintheworstpossiblesituationwithapoorcompetitiveposition
inanindustrywithfewprospects,managementhasonlyafewalternativesallofthemdis
tasteful.Becausenooneisinterestedinbuyingaweakcompanyinanunattractiveindustry,
thefirmmustpursueabankruptcyorliquidationstrategy.Bankruptcyinvolvesgivingup
managementofthefirmtothecourtsinreturnforsomesettlementofthecorporationsobli
gations.Topmanagementhopesthatoncethecourtdecidestheclaimsonthecompany,the
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companywillbestrongerandbetterabletocompeteinamoreattractiveindustry.Facedwith
arecessionaryeconomyandfallingmarketdemandforcasualdining,restaurantslikeBenni
gansGrill&TavernandSteak&Ale,thatoncethrivedbyofferingmidpricedmenuswithpo
tatoskinsandthickhamburgers,filedforbankruptcyinJuly2008.Withinthetroubledairline
industry,atleast30airlineswentbankruptduringjustthefirsthalfof2008with30morebank
ruptciesexpectedbytheendoftheyear.69AcontroversialapproachwasusedbyDelphiCor
porationwhenitfiledforChapter11bankruptcyonlyforitsU.S.operations,whichemployed
32,000highwageunionworkers,butnotforitsforeignfactoriesinlowwagecountries. 70
Incontrasttobankruptcy,whichseekstoperpetuateacorporation,liquidationistheter
minationofthefirm.Whentheindustryisunattractiveandthecompanytooweaktobesold
asagoingconcern,managementmaychoosetoconvertasmanysaleableassetsaspossibleto
cash,whichisthendistributedtotheshareholdersafterallobligationsarepaid.Liquidationis
aprudentstrategyfordistressedfirmswithasmallnumberofchoices,allofwhichareprob
lematic.71ThiswasCircuitCityssituationin2008,whenitliquidateditsretailstores.Theben
efitofliquidationoverbankruptcyisthattheboardofdirectors,asrepresentativesofthe
shareholders,togetherwithtopmanagementmakethedecisionsinsteadofturningthemover
tothebankruptcycourt,whichmaychoosetoignoreshareholderscompletely.
Attimes,topmanagementmustbewillingtoselectoneoftheselessdesirableretrench
mentstrategies.Unfortunately,manytopmanagersareunwillingtoadmitthattheircompany
hasseriousweaknessesforfearthattheymaybepersonallyblamed.Evenworse,topmanage
mentmaynotevenperceivethatcrisesaredeveloping.Whenthesetopmanagerseventually
noticetrouble,theyarepronetoattributetheproblemstotemporaryenvironmentaldistur
bancesandtendtofollowprofitstrategies.Evenwhenthingsaregoingterriblywrong,top
managementisgreatlytemptedtoavoidliquidationinthehopeofamiracle.Topmanagement
entersacycleofdecline,inwhichitgoesthroughaprocessofsecrecyanddenial,followedby
blameandscorn,avoidanceandturfprotection,endingwithpassivityandhelplessness. 72
Thus,acorporationneedsastrongboardofdirectorswho,tosafeguardshareholdersinter
ests,cantelltopmanagementwhentoquit.
7.3
PortfolioAnalysis
Chapter6dealtwithhowindividualproductlinesandbusinessunitscangaincompetitivead
vantageinthemarketplacebyusingcompetitiveandcooperativestrategies.Companieswith
multipleproductlinesorbusinessunitsmustalsoaskthemselveshowthesevariousproducts
andbusinessunitsshouldbemanagedtoboostoverallcorporateperformance:
{
{
Howmuchofourtimeandmoneyshouldwespendonourbestproductsandbusiness
unitstoensurethattheycontinuetobesuccessful?
Howmuchofourtimeandmoneyshouldwespenddevelopingnewcostlyproducts,most
ofwhichwillneverbesuccessful?
Oneofthemostpopularaidstodevelopingcorporatestrategyinamultiplebusinesscor
porationisportfolioanalysis.Althoughitspopularityhasdroppedsincethe1970sand1980s,
whenmorethanhalfofthelargestbusinesscorporationsusedportfolioanalysis,itisstillused
byaround27%ofFortune500firmsincorporatestrategyformulation. 73Portfolioanalysis
putscorporateheadquartersintotheroleofaninternalbanker.Inportfolioanalysis,topman
agementviewsitsproductlinesandbusinessunitsasaseriesofinvestmentsfromwhichitex
pectsaprofitablereturn.Theproductlines/businessunitsformaportfolioofinvestmentsthat
topmanagementmustconstantlyjuggletoensurethebestreturnonthecorporationsinvested
money.AMcKinsey&Companystudyoftheperformanceofthe200largestU.S.corporations
CHAPTER 7
221
foundthatcompaniesthatactivelymanagedtheirbusinessportfoliosthroughacquisitionsand
divestiturescreatedsubstantiallymoreshareholdervaluethanthosecompaniesthatpassively
heldtheirbusinesses.74Giventheincreasingnumberofstrategicalliancesintodayscorpora
tions,portfolioanalysisisalsobeingusedtoevaluatethecontributionofalliancestocorpo
rateandbusinessunitobjectives.
TwoofthemostpopularportfoliotechniquesaretheBCGGrowthShareMatrixandGE
BusinessScreen.
BCG GROWTH-SHARE MATRIX
UsingtheBCG(BostonConsultingGroup)GrowthShareMatrixdepictedinFigure73
isthesimplestwaytoportrayacorporationsportfolioofinvestments.Eachofthecorpora
tionsproductlinesorbusinessunitsisplottedonthematrixaccordingtoboththegrowthrate
oftheindustryinwhichitcompetesanditsrelativemarketshare.Aunitsrelativecompetitive
positionisdefinedasitsmarketshareintheindustrydividedbythatofthelargestothercom
petitor.Bythiscalculation,arelativemarketshareabove1.0belongstothemarketleader.The
businessgrowthrateisthepercentageofmarketgrowth,thatis,thepercentagebywhichsales
ofaparticularbusinessunitclassificationofproductshaveincreased.Thematrixassumesthat,
otherthingsbeingequal,agrowingmarketisattractive.
Thelineseparatingareasofhighandlowrelativecompetitivepositionissetat1.5times.
Aproductlineorbusinessunitmusthaverelativestrengthsofthismagnitudetoensurethatit
willhavethedominantpositionneededtobeastarorcashcow.Ontheotherhand,aprod
uctlineorunithavingarelativecompetitivepositionlessthan1.0hasdogstatus. 75Each
productorunitisrepresentedinFigure73byacircle.Theareaofthecirclerepresentsthe
relativesignificanceofeachbusinessunitorproductlinetothecorporationintermsofassets
usedorsalesgenerated.
FIGURE 73
BCG Growth-
Share Matrix
BusinessGrowthRate
(Percentage)
22
20
18
16
14
12
10
8
6
4
2
0
Stars
Question Marks
Cash Cows
Dogs
0.5x0.4x0.3x
10x
2x1.5x
0.2x
RelativeCompetitivePosition
(Market Share)
SOURCE:ReprintedfromLongRangePlanning,Vol.10,No.2,1977,Hedley,StrategyandtheBusinessPortfolio,
p.12.Copyright1977withpermissionfromElsevier.
0.1x
4x
1x
222
PART 3
StrategyFormulation
TheBCGGrowthShareMatrixhasalotincommonwiththeproductlifecycle.Asa
productmovesthroughitslifecycle,itiscategorizedintooneoffourtypesforthepurposeof
fundingdecisions:
{
{
Questionmarks(sometimescalledproblemchildrenorwildcats)arenewproducts
withthepotentialforsuccess,buttheyneedalotofcashfordevelopment.Ifsuchaprod
uctistogainenoughmarketsharetobecomeamarketleaderandthusastar,moneymust
betakenfrommorematureproductsandspentonthequestionmark.Thisisafishorcut
baitdecisioninwhichmanagementmustdecideifthebusinessisworththeinvestment
needed.Forexample,afteryearsoffruitlesslyexperimentingwithanelectriccar,General
Motorsfinallydecidedin2006totakeachanceondevelopingtheChevroletVolt. 76To
learnmoreofGMsdecisiontobuildtheelectriccar,seetheEnvironmentalSustainabil
ityIssuefeature.
Starsaremarketleadersthataretypicallyatthepeakoftheirproductlifecycleandare
abletogenerateenoughcashtomaintaintheirhighshareofthemarketandusuallycon
tributetothecompanysprofits.HPsprinterbusinesshasbeencalledHPscrownjewel
becauseofits41%marketshareinprintersanditscontrolofthereplacementcartridge
ENVIRONMENTAL
sustainabilityissue
choices were limited. According to Larry Burns, Vice Presi-
dent of R&D and Strategic Planning, This industry is 98%
dependent on petroleum. GM has concluded that thats
not sustainable.
Chairman and CEO Richard Wagoner, Jr. surprised the
world at the January 2007 Detroit Auto Show with a vow
to start developing an electric car called the Chevrolet Volt.
It would plug into a regular electric outlet, leapfrog the
competition, and be on sale in 2010. The company not
only needed to build a radical new car, but had to convert
as much as 75% of its current fleet to hybrid engines to
meet fuel economy rules taking effect in 2017.
Management created a new team dedicated to getting
hybrid and electric cars to market. The R&D budget was in-
creased from $6.6 billion in 2006 to $8.1 billion in 2007.
Several new models were canceled to free resources. The
battery lab was under pressure to design batteries that
could propel the Volt 40 miles before a small gasoline en-
gine would re-charge the battery and extend the range to
600 miles. Douglas Drauch, battery lab manager, promised
that the batteries would be ready on schedule. Were
making history, he said. Fifty years from now, people will
remember the Voltlike they remember a 53 Corvette.
SOURCES: D. Welch, GM: Live Green or Die, Business Week
(May 26, 2008), pp. 3641; The Drive for Low Emissions, The
Economists Special Report on Business and Climate Change
(June 2, 2007), pp. 2628.
GENERAL MOTORS AND THE ELECTRIC CAR
In 2003, top management
at General Motors (GM) de-
cided to discontinue further
work on its EV1 electric auto-
mobile. Working versions of the
car had been leased to a limited number
of people, but never sold. Environmentalists protested that
GM stopped making the car just to send a message to gov-
ernment policy makers that an electric car was bad busi-
ness. Management responded by stating that the car
would never have made a profit.
In an April 2005 meeting of GMs top management
team, Vice Chairman Robert Lutz suggested that it might
be time to build another electric car. He noted that Toyotas
Prius hybrid had made Toyota look environmentally sensi-
tive; whereas, GM was viewed as making gas hogs. The
response was negative. Lutz recalled one executive saying,
We lost $1 billion on the last one. Do you want to lose
$1 billion on the next one?
Even though worldwide car ownership was growing
5% annually, rising fuel prices in 2005 reduced sales of
GMs profitable SUVsresulting in a loss of $11 billion.
Board members began signaling that it was time for man-
agement to take some riskier bets to get the company out
of financial trouble. In February 2006, management reluc-
tantly approved developmental work on another electric
car. At the time, no one in GM knew if batteries could be
made small enough to power a car, but they knew that
CHAPTER 7
223
market.Onitsown,itaccountedformorethanhalfofHPsoperatingprofit. 77Whena
starsmarketgrowthrateslows,itbecomesacashcow.
{
{
Cashcowstypicallybringinfarmoremoneythanisneededtomaintaintheirmarket
share.Inthisdecliningstageoftheirlifecycle,theseproductsaremilkedforcashthat
willbeinvestedinnewquestionmarks.ExpensessuchasadvertisingandR&Darere
duced.Panasonicsvideocassetterecorders(VCRs)movedtothiscategorywhensales
declinedandDVDplayer/recordersreplacedthem.Questionmarksunabletoobtaindom
inantmarketshare(andthusbecomestars)bythetimetheindustrygrowthrateinevitably
slowsbecomedogs.
Dogshavelowmarketshareanddonothavethepotential(becausetheyareinanunat
tractiveindustry)tobringinmuchcash.AccordingtotheBCGGrowthShareMatrix,
dogsshouldbeeithersoldofformanagedcarefullyforthesmallamountofcashtheycan
generate.Forexample,DuPont,theinventorofnylon,solditstextilesunitin2003be
causethecompanywantedtoeliminateitslowmarginproductsandfocusmoreonits
growingbiotechbusiness.78ThesamewastrueofIBMwhenitsolditsPCbusinessto
ChinasLenovoGroupinordertoemphasizeitsgrowingservicesbusiness.
UnderlyingtheBCGGrowthShareMatrixistheconceptoftheexperiencecurve(dis
cussedinChapter5).Thekeytosuccessisassumedtobemarketshare.Firmswiththehigh
estmarketsharetendtohaveacostleadershippositionbasedoneconomiesofscale,among
otherthings.Ifacompanyisabletousetheexperiencecurvetoitsadvantage,itshouldbeable
tomanufactureandsellnewproductsatapricelowenoughtogarnerearlymarketsharelead
ership(assumingnosuccessfulimitationbycompetitors).Oncetheproductbecomesastar,it
isdestinedtobeveryprofitable,consideringitsinevitablefutureasacashcow.
Havingplottedthecurrentpositionsofitsproductlinesorbusinessunitsonamatrix,a
companycanprojectitsfuturepositions,assumingnochangeinstrategy.Presentandpro
jectedmatrixescanthusbeusedtohelpidentifymajorstrategicissuesfacingtheorganization.
Thegoalofanycompanyistomaintainabalancedportfoliosoitcanbeselfsufficientincash
andalwaysworkingtoharvestmatureproductsindecliningindustriestosupportnewonesin
growingindustries.
TheBCGGrowthShareMatrixisaverywellknownportfolioconceptwithsomeclear
advantages.Itisquantifiableandeasytouse.Cashcow,dog,questionmark,andstarareeasy
toremembertermsforreferringtoacorporationsbusinessunitsorproducts.Unfortunately,
theBCGGrowthShareMatrixalsohassomeseriouslimitations:
{
{
{
{
{
Theuseofhighsandlowstoformfourcategoriesistoosimplistic.
Thelinkbetweenmarketshareandprofitabilityisquestionable. 79Lowsharebusinesses
canalsobeprofitable.80Forexample,Olivettiisstillprofitablysellingmanualtypewrit
ersthroughmailordercatalogs.
Growthrateisonlyoneaspectofindustryattractiveness.
Productlinesorbusinessunitsareconsideredonlyinrelationtoonecompetitor:themar
ketleader.Smallcompetitorswithfastgrowingmarketsharesareignored.
Marketshareisonlyoneaspectofoverallcompetitiveposition.
GE BUSINESS SCREEN
GeneralElectric,withtheassistanceoftheMcKinsey&Companyconsultingfirm,developed
amorecomplicatedmatrix.AsdepictedinFigure74,theGEBusinessScreenincludesnine
cellsbasedonlongtermindustryattractivenessandbusinessstrengthcompetitiveposition.
TheGEBusinessScreen,incontrasttotheBCGGrowthShareMatrix,includesmuchmore
224
PART 3
StrategyFormulation
FIGURE 74
General Electrics
Business Screen
High
C
Winners
A
Winners
B
Question
Marks
D
IndustryAttractiveness
Winners
E
Medium
Average
Businesses
F
Losers
Losers
G
Low
Profit
Producers
H
Losers
WeakStrongAverage
BusinessStrength/CompetitivePosition
SOURCE:AdaptedfromStrategicManagementinGE,CorporatePlanningandDevelopment,GeneralElectric
Corporation,ReprintedbypermissionofGeneralElectricCompany.
datainitstwokeyfactorsthanjustbusinessgrowthrateandcomparablemarketshare.Forex
ample,atGE,industryattractivenessincludesmarketgrowthrate,industryprofitability,size,
andpricingpractices,amongotherpossibleopportunitiesandthreats.Businessstrengthor
competitivepositionincludesmarketshareaswellastechnologicalposition,profitability,and
size,amongotherpossiblestrengthsandweaknesses.81
Theindividualproductlinesorbusinessunitsareidentifiedbyaletterandplottedascir
clesontheGEBusinessScreen.Theareaofeachcircleisinproportiontothesizeofthein
dustryintermsofsales.Thepiesliceswithinthecirclesdepictthemarketsharesoftheproduct
linesorbusinessunits.
ToplotproductlinesorbusinessunitsontheGEBusinessScreen,followthesefoursteps:
1.Selectcriteriatoratetheindustryforeachproductlineorbusinessunit.Assessoverallin
dustryattractivenessforeachproductlineorbusinessunitonascalefrom1(veryunat
tractive)to5(veryattractive).
2.Selectthekeyfactorsneededforsuccessineachproductlineorbusinessunit.Assess
businessstrength/competitivepositionforeachproductlineorbusinessunitonascaleof
1(veryweak)to5(verystrong).
3.Ploteachproductlinesorbusinessunitscurrentpositiononamatrixasthatdepictedin
Figure74.
4.Plotthefirmsfutureportfolio,assumingthatpresentcorporateandbusinessstrategiesre
mainunchanged.Isthereaperformancegapbetweenprojectedanddesiredportfolios?If
so,thisgapshouldserveasastimulustoseriouslyreviewthecorporationscurrentmis
sion,objectives,strategies,andpolicies.
Overall,theninecellGEBusinessScreenisanimprovementovertheBCGGrowth
ShareMatrix.TheGEBusinessScreenconsidersmanymorevariablesanddoesnotleadto
CHAPTER 7
225
suchsimplisticconclusions.Itrecognizes,forexample,thattheattractivenessofanindustry
canbeassessedinmanydifferentways(otherthansimplyusinggrowthrate),anditthusal
lowsuserstoselectwhatevercriteriatheyfeelaremostappropriatetotheirsituation.Thisport
foliomatrix,however,doeshavesomeshortcomings:
{
{
Itcangetquitecomplicatedandcumbersome.
Thenumericalestimatesofindustryattractivenessandbusinessstrength/competitivepo
sitiongivetheappearanceofobjectivity,buttheyareinrealitysubjectivejudgmentsthat
mayvaryfromonepersontoanother.
Itcannoteffectivelydepictthepositionsofnewproductsorbusinessunitsindeveloping
industries.
{
ADVANTAGES AND LIMITATIONS OF PORTFOLIO ANALYSIS

Portfolioanalysisiscommonlyusedinstrategyformulationbecauseitofferscertain
advantages:
{
Itencouragestopmanagementtoevaluateeachofthecorporationsbusinessesindividu
allyandtosetobjectivesandallocateresourcesforeach.
Itstimulatestheuseofexternallyorienteddatatosupplementmanagementsjudgment.
Itraisestheissueofcashflowavailabilityforuseinexpansionandgrowth.
Itsgraphicdepictionfacilitatescommunication.
{
{
{
Portfolioanalysisdoes,however,havesomeveryreallimitationsthathavecausedsome
companiestoreducetheiruseofthisapproach:
{
{
{
{
{
{
Definingproduct/marketsegmentsisdifficult.
Itsuggeststheuseofstandardstrategiesthatcanmissopportunitiesorbeimpractical.
Itprovidesanillusionofscientificrigorwheninrealitypositionsarebasedonsubjective
judgments.
Itsvalueladentermssuchascashcowanddogcanleadtoselffulfillingprophecies.
Itisnotalwaysclearwhatmakesanindustryattractiveorwhereaproductisinitslifecycle.
Naivelyfollowingtheprescriptionsofaportfoliomodelmayactuallyreducecorporate
profitsiftheyareusedinappropriately.Forexample,GeneralMillsChiefExecutiveH.
BrewsterAtwatercitedhiscompanysBisquickbrandofbakingmixasaproductthat
wouldhavebeenwrittenoffyearsagobasedonportfolioanalysis.Thisproductis
57yearsold.Byallrightsitshouldhavebeenovertakenbynewerproducts.Butwiththe
properresearchtoimprovetheproductandpromotiontokeepcustomersexcited,itsdo
ingverywell.82
MANAGING A STRATEGIC ALLIANCE PORTFOLIO
Justasproductlines/businessunitsformaportfolioofinvestmentsthattopmanagementmust
constantlyjuggletoensurethebestreturnonthecorporationsinvestedmoney,strategical
liancescanalsobeviewedasaportfolioofinvestmentsinvestmentsofmoney,time,anden
ergy.Thewayacompanymanagestheseintertwinedrelationshipscansignificantlyinfluence
corporatecompetitiveness.Alliancesarethusrecognizedasanimportantsourceofcompeti
tiveadvantageandsuperiorperformance.83
Managinggroupsofstrategicalliancesisprimarilythejobofthebusinessunit.Itsdeci
sionsmayescalate,however,tothecorporatelevel.TomanCorporation,forexample,has
226
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StrategyFormulation
195internationaljointventurescontaining422alliancepartners.AccordingtoaTomanexec
utive,Ifheadquartersistryingtobringusandsomeothercompanyclosertogether,they
shouldunderstandnotonlyourbusinessunit,butalsootherbusinessunits.Sometimesthe
wholeofourcompanymaybenefit(fromanalliance)butitmaynotbegoodforoneofour
businessunits.Andifitproceeds,headquartersmustgivesomecredittoourbusinessunitso
thatwecanagree.Butitisnotacceptableiftheysaytousthatwearetolosesomethingasa
resultoftheallianceandnowwehavetomakeupthedifferenceinoneofourotherbusi
nesses.Inthisinstancethestageissetfornegotiationsacrossbusinessunitsatthecorporate
leveltoachieveabroadlysupportedalliancenetworkmanagementsystem. 84
Astudyof25leadingEuropeancorporationsfoundfourtasksofmultialliancemanage
mentthatarenecessaryforsuccessfulallianceportfoliomanagement:
1.Developingandimplementingaportfoliostrategyforeachbusinessunitandacor
poratepolicyformanagingallthealliancesoftheentirecompany:Alliancesarepri
marilydeterminedbybusinessunits.Thecorporateleveldevelopsgeneralrules
concerningwhen,how,andwithwhomtocooperate.Thetaskofalliancepolicyisto
strategicallyalignallofthecorporationsallianceactivitieswithcorporatestrategyand
corporatevalues.Everynewallianceisthuscheckedagainstcorporatepolicybeforeitis
approved.
2.Monitoringtheallianceportfoliointermsofimplementingbusinessunitstrategies
andcorporatestrategyandpolicies:Eachallianceismeasuredintermsofachievement
ofobjectives(e.g.,marketshare),financialmeasures(e.g.,profitsandcashflow),con
tributedresourcequalityandquantity,andtheoverallrelationship.Themoreafirmisdi
versified,thelesstheneedformonitoringatthecorporatelevel.
3.Coordinatingtheportfoliotoobtainsynergiesandavoidconflictsamongalliances:
Becausetheinterdependenciesamongallianceswithinabusinessunitareusuallygreater
thanamongdifferentbusinesses,theneedforcoordinationisgreateratthebusinesslevel
thanatthecorporatelevel.Theneedforcoordinationincreasesasthenumberofalliances
inonebusinessunitandthecompanyasawholeincreases,theaveragenumberofpart
nersperallianceincreases,and/ortheoverlapofthealliancesincreases.
4.Establishinganalliancemanagementsystemtosupportothertasksofmultialliance
management:Thisinfrastructureconsistsofformalizedprocesses,standardizedtools
andspecializedorganizationalunits.Allbuttwoofthe25companiesestablishedcenters
ofcompetenceforalliancemanagement.Thecenterswereoftenpartofadepartmentfor
corporatedevelopmentoradepartmentofalliancemanagementatthecorporatelevel.
Inothercorporations,specializedpositionsforalliancemanagementwerecreatedatboth
thecorporateandbusinessunitlevelsoronlyatthebusinessunitlevel.Mostcorporations
preferasysteminwhichthecorporatelevelprovidesthemethodsandtoolstosupport
alliancescentrally,butdecentralizesdaytodayalliancemanagementtothebusiness
units.85
7.4
CorporateParenting
Campbell,Goold,andAlexander,authorsofCorporateLevelStrategy:CreatingValueinthe
MultibusinessCompany,contendthatcorporatestrategistsmustaddresstwocrucialquestions:
{
{
Whatbusinessesshouldthiscompanyownandwhy?
Whatorganizationalstructure,managementprocesses,andphilosophywillfostersupe
riorperformancefromthecompanysbusinessunits? 86
CHAPTER 7
227
Portfolioanalysistypicallyattemptstoanswerthesequestionsbyexaminingtheat
tractivenessofvariousindustriesandbymanagingbusinessunitsforcashflow,thatis,by
usingcashgeneratedfrommatureunitstobuildnewproductlines.Unfortunately,portfo
lioanalysisfailstodealwiththequestionofwhatindustriesacorporationshouldenteror
withhowacorporationcanattainsynergyamongitsproductlinesandbusinessunits.As
suggestedbyitsname,portfolioanalysistendstoprimarilyviewmattersfinancially,re
gardingbusinessunitsandproductlinesasseparateandindependentinvestments.
Corporateparenting,incontrast,viewsacorporationintermsofresourcesandca
pabilitiesthatcanbeusedtobuildbusinessunitvalueaswellasgeneratesynergiesacross
businessunits.AccordingtoCampbell,Goold,andAlexander:
Multibusinesscompaniescreatevaluebyinfluencingorparentingthebusinessesthey
own.Thebestparentcompaniescreatemorevaluethananyoftheirrivalswouldifthey
ownedthesamebusinesses.Thosecompanieshavewhatwecallparentingadvantage. 87
Corporateparentinggeneratescorporatestrategybyfocusingonthecorecompeten
ciesoftheparentcorporationandonthevaluecreatedfromtherelationshipbetweenthe
parentanditsbusinesses.Intheformofcorporateheadquarters,theparenthasagreat
dealofpowerinthisrelationship.AccordingtoCampbell,Goold,andAlexander,ifthere
isagoodfitbetweentheparentsskillsandresourcesandtheneedsandopportunitiesof
thebusinessunits,thecorporationislikelytocreatevalue.If,however,thereisnotagood
fit,thecorporationislikelytodestroyvalue.88Researchindicatesthatcompaniesthat
haveagoodfitbetweentheirstrategyandtheirparentingrolesarebetterperformersthan
thosecompaniesthatdonothaveagoodfit. 89Thisapproachtocorporatestrategyisuse
fulnotonlyindecidingwhatnewbusinessestoacquirebutalsoinchoosinghoweach
existingbusinessunitshouldbebestmanaged.Thisappearstohavebeenthesecrettothe
successofGeneralElectricunderCEOJackWelch.Accordingtooneanalystin2000,
Heandhismanagersreallyaddvaluebyimposingtoughstandardsofprofitabilityand
bydisseminatingknowledgeandbestpracticequicklyaroundtheGEempire.Ifsome
manufacturingtrickcutscostsinGEsaeroenginerepairshopsinWales,heinsistsitbe
appliedacrossthegroup.90
Theprimaryjobofcorporateheadquartersis,therefore,toobtainsynergyamongthe
businessunitsbyprovidingneededresourcestounits,transferringskillsandcapabilities
amongtheunits,andcoordinatingtheactivitiesofsharedunitfunctionstoattain
economiesofscope(asincentralizedpurchasing).91Thisisinagreementwiththecon
ceptofthelearningorganizationdiscussedinChapter1inwhichtheroleofalargefirm
istofacilitateandtransfertheknowledgeassetsandservicesthroughoutthe
corporation.92Thisisespeciallyimportantgiventhat75%ormoreofamoderncom
panysmarketvaluestemsfromitsintangibleassetstheorganizationsknowledgeand
capabilities.93AtProctor&Gamble,forexample,thevariousbusinessunitsareexpected
toworktogethertodevelopinnovativeproducts.CrestWhitestrips,whichcontrols68%
oftheathometoothwhiteningmarket,wasbasedontheP&Glaundrydivisionsknowl
edgeofwhiteningagents.94
DEVELOPING A CORPORATE PARENTING STRATEGY
Campbell,Goold,andAlexanderrecommendthatthesearchforappropriatecorporatestrat
egyinvolvesthreeanalyticalsteps:
1.Examineeachbusinessunit(ortargetfirminthecaseofacquisition)intermsofits
strategicfactors:Peopleinthebusinessunitsprobablyidentifiedthestrategicfactors
whentheyweregeneratingbusinessstrategiesfortheirunits.Onepopularapproachisto
228
PART 3
StrategyFormulation
establishcentersofexcellencethroughoutthecorporation.AccordingtoFrost,Birkin
shaw,andEnsign,acenterofexcellenceisanorganizationalunitthatembodiesasetof
capabilitiesthathasbeenexplicitlyrecognizedbythefirmasanimportantsourceofvalue
creation,withtheintentionthatthesecapabilitiesbeleveragedbyand/ordisseminatedto
otherpartsofthefirm.95
2.Examineeachbusinessunit(ortargetfirm)intermsofareasinwhichperformance
canbeimproved:Theseareconsideredtobeparentingopportunities.Forexample,two
businessunitsmightbeabletogaineconomiesofscopebycombiningtheirsalesforces.
Inanotherinstance,aunitmayhavegood,butnotgreat,manufacturingandlogistics
skills.Aparentcompanyhavingworldclassexpertiseintheseareascouldimprovethat
unitsperformance.Thecorporateparentcouldalsotransfersomepeoplefromonebusi
nessunitwhohavethedesiredskillstoanotherunitthatisinneedofthoseskills.People
atcorporateheadquartersmay,becauseoftheirexperienceinmanyindustries,spotareas
whereimprovementsarepossiblethatevenpeopleinthebusinessunitmaynothaveno
ticed.Unlessspecificareasaresignificantlyweakerthanthecompetition,peopleinthe
businessunitsmaynotevenbeawarethattheseareascouldbeimproved,especiallyif
eachbusinessunitmonitorsonlyitsownparticularindustry.
3.Analyzehowwelltheparentcorporationfitswiththebusinessunit(ortargetfirm):
Corporateheadquartersmustbeawareofitsownstrengthsandweaknessesintermsofre
sources,skills,andcapabilities.Todothis,thecorporateparentmustaskwhetherithas
thecharacteristicsthatfittheparentingopportunitiesineachbusinessunit.Itmustalso
askwhetherthereisamisfitbetweentheparentscharacteristicsandthecriticalsuccess
factorsofeachbusinessunit.
HORIZONTAL STRATEGY AND MULTIPOINT COMPETITION
Ahorizontalstrategyisacorporatestrategythatcutsacrossbusinessunitboundariestobuild
synergyacrossbusinessunitsandtoimprovethecompetitivepositionofoneormorebusiness
units.96Whenusedtobuildsynergy,itactslikeaparentingstrategy.Whenusedtoimprovethe
competitivepositionofoneormorebusinessunits,itcanbethoughtofasacorporatecompet
itivestrategy.Inmultipointcompetition,largemultibusinesscorporationscompeteagainst
otherlargemultibusinessfirmsinanumberofmarkets.Thesemultipointcompetitorsarefirms
thatcompetewitheachothernotonlyinonebusinessunit,butalsoinanumberofbusiness
units.Atonetimeoranother,acashrichcompetitormaychoosetobuilditsownmarketshare
inaparticularmarkettothedisadvantageofanothercorporationsbusinessunit.Althougheach
businessunithasprimaryresponsibilityforitsownbusinessstrategy,itmaysometimesneed
somehelpfromitscorporateparent,especiallyifthecompetitorbusinessunitisgettingheavy
financialsupportfromitscorporateparent.Inthisinstance,corporateheadquartersdevelopsa
horizontalstrategytocoordinatethevariousgoalsandstrategiesofrelatedbusinessunits.
Forexample,P&G,KimberlyClark,ScottPaper,andJohnson&Johnson(J&J)compete
withoneanotherinvaryingcombinationsofconsumerpaperproducts,fromdisposabledia
perstofacialtissue.If(purelyhypothetically)J&Jhadjustdevelopedatoilettissuewithwhich
itchosetochallengeProcter&GambleshighshareCharminbrandinaparticulardistrict,it
mightchargealowpriceforitsnewbrandtobuildsalesquickly.P&Gmightnotchoosetore
spondtothisattackonitssharebycuttingpricesonCharmin.BecauseofCharminshighmar
ketshare,P&GwouldlosesignificantlymoresalesdollarsinapricewarthanJ&Jwouldwith
itsinitiallylowsharebrand.Toretaliate,P&GmightthuschallengeJ&Jshighsharebaby
CHAPTER 7
229
shampoowithP&Gsownlowsharebrandofbabyshampooinadifferentdistrict.OnceJ&J
hadperceivedP&Gsresponse,itmightchoosetostopchallengingCharminsothatP&G
wouldstopchallengingJ&Jsbabyshampoo.
Multipointcompetitionandtheresultinguseofhorizontalstrategymayactuallyslowthe
developmentofhypercompetitioninanindustry.Therealizationthatanattackonamarket
leaderspositioncouldresultinaresponseinanothermarketleadstomutualforbearancein
whichmanagersbehavemoreconservativelytowardmultimarketrivalsandcompetitiveri
valryisreduced.97Inoneindustry,forexample,multipointcompetitionresultedinfirmsbe
inglesslikelytoexitamarket.Liveandletlivereplacedstrongcompetitiverivalry. 98
Multipointcompetitionislikelytobecomeevenmoreprevalentinthefuture,ascorporations
becomeglobalcompetitorsandexpandintomoremarketsthroughstrategicalliances. 99
EndofChapterSUMMARY
Corporatestrategyisprimarilyaboutthechoiceofdirectionforthefirmasawhole.Itdeals
withthreekeyissuesthatacorporationfaces:(1)thefirmsoverallorientationtoward
growth,stability,orretrenchment;(2)theindustriesormarketsinwhichthefirmcompetes
throughitsproductsandbusinessunits;and(3)themannerinwhichmanagementcoordi
natesactivitiesandtransfersresourcesandcultivatescapabilitiesamongproductlinesand
businessunits.Theseissuesaredealtwiththroughdirectionalstrategy,portfolioanalysis,
andcorporateparenting.
Managersmustconstantlyexaminetheircorporationsentireportfolioofproducts,busi
nesses,andopportunitiesasiftheywereplanningtoreinvestallofitscapital. 100Oneexample
isCummins,Inc.in2003whenmanagementdecidedtoinvestheavilyinthefirmspowergen
erationbusiness.Managementrealizedatthetimethattheglobalappetiteforpowerwasgrow
ingfarfasterthanlocalpowergridscouldprovide,especiallyinthefastgrowingdeveloping
countries.Unfortunately,powergenerationwastheonlyoneofCumminsfourbusinessunits
tolosemoney.TomLinebarger,CumminsCFO,tookoverthepowergenerationunit,cut
costs,andreorganizedthedivisionaroundproductlinesratherthanterritories.Overthenext
fouryears,salesofthecompanyspowergenerators,rangingfromportablesforRVstohouse
sizedmachinesforfactories,morethantripledto$3billion20%ofthecompanystotal
sales.Cumminsachievedsecondplace,behindCaterpillar,intheglobalpowergeneratormar
ket.ManagementdecidedtogrowhorizontallybybuildingplantsinChinaandIndiaandmak
ingsmallhomegeneratorstosellthroughmassmerchandisers. 101
ECO-BITS
BoschAppliances,theGermanmultinationalcorpora
tion,wastheonlyU.S.appliancemanufacturerwhose
entirelineofmajorappliancesin2008wasEnergyStar
qualifiedinthecategoriesthattheprogramrates.Ac
cordingtoBosch,ifthemorethan8millionU.S.con
sumerswhopurchasedanewdishwasherin2007had
boughtaBosch800modelinsteadofaconventional
unit,thelifetimeenergysavingswouldbeequaltopre
venting21billionpoundsofCO2emissions.102
Thegreenbuildingindustryisprojectedtogrowfrom
$2.2billionin2006to$4.7billionby2011.103
230
PART 3
StrategyFormulation
1.Howdoeshorizontalgrowthdifferfromverticalgrowth
asacorporatestrategy?Fromconcentricdiversification?
2.Whatarethetradeoffsbetweenaninternalandanexter
nalgrowthstrategy?Whichapproachisbestasaninter
nationalentrystrategy?
3.Isstabilityreallyastrategyorjustatermfornostrategy?
4.CompareandcontrastSWOTanalysiswithportfolio
analysis.
5.Howiscorporateparentingdifferentfromportfolio
analysis?Howisitalike?Isitausefulconceptinaglobal
industry?
OnMarch14,2000,StephenKing,thehorrorwriter,published
hisnewbook,RidingtheBullet,ontheInternetbeforeitap
pearedinprint.Within24hours,around400,000peoplehad
downloadedthebookeventhoughmostofthemneededto
downloadsoftwareinordertoreadthebook.Theunexpected
demandcrashedservers.AccordingtoJackRomanos,presi
dentofSimon&Schuster,Idontthinkanybodycouldhave
anticipatedhowmanypeoplewereouttherewhoarewilling
toacceptthewrittenwordinapaperlessformat.Tomany,this
announcedthecomingoftheelectronicnovel.Environmental
istsapplaudedthatebookswouldsoonreplacepaperbooks
andnewspapers,thusreducingpollutioncomingfrompaper
millsandlandfills.TheKingbookwaseasytodownloadand
tooklesstimethanatriptothebookstore.Criticsarguedthat
theKingbookusedtheInternetbecauseat66pages,itwastoo
shorttobeastandardprintednovel.Itwasalsofree,sothere
wasnothingtodiscouragenaturalcuriosity.Somepeoplein
theindustryestimatedthat75%ofthosewhodownloadedthe
bookdidnotreadit.104
By2008,HarperCollinsandRandomHousewereoffer
ingfreeonlinebookcontent.Amazonwassellinga$399Kin
dleebookreaderfordownloadablebookscosting$10each,
butAppleCEOSteveJobsdescribedtheKindleassomething
thatfillednovoidandwouldgonowhere.Salesinelectronic
tradebooksincreasedfrom$5.8millionin2002to$20million
in2006comparedtototal2006booksalesof$25$30billion.
Borderswasmarkettestingthedownloadingofdigitalpur
chases.TimOReilly,coinerofthetermWeb2.0,hadbeen
urgingpublisherstogodigitalsincetheearly1980s,butpub
lishersandauthorswerestillconcernedwithhowtheywould
bepaidfortheintellectualpropertytheycreated.OmMalik,
seniorwriterforBusiness2.0magazinereportedthatthe
moneyearnedfromadvertisingclicksrelatedtotheirblogcon
tentwasbarelyenoughtocoverthecostsofblogging.Flat
WorldKnowledge,anewentrepreneurialdigitaltextbookpub
lisher,announcedthatin2009itplannedtoofferfreeonline
textbookswiththehopethatthefirmwouldmakemoneysell
ingsupplementarymaterialslikestudyguides.Publishers
wonderedhowanindustrybuiltona15thcenturypapertech
nologycouldmakeaprofitabletransitiontoa21stcenturypa
perlesselectronictechnology.105
1.Formintosmallgroupsintheclasstodiscussthefuture
ofInternetpublishing.
2.Considerthefollowingquestionsasdiscussionguides:
{ Whataretheprosandconsofelectronicpublishing?
{ Whatistheimpactofelectronicpublishingonthe
environment?
{ Shouldnewspaperandbookpublisherscompletely
converttoelectronicpublishingoverpaper?(The
WallStreetJournalandotherspublishinbothpaper
andelectronicformats.Isthisasuccess?)
{ Wouldyoupreferthistextbookandothersinanelec
tronicformat?Howwouldyouprefertoreadthe
book?
{ Whatbusinessmodelshouldpublishersusetomake
moneypublishingontheInternet?
3.Presentyourgroupsconclusionstotheclass.
CHAPTER 7
231
KEY TERMS
acquisition(p.208)
backwardintegration(p.208)
bankruptcy(p.219)
BCG(BostonConsultingGroup)
GrowthShareMatrix(p.221)
BOT(Build,Operate,Transfer)
concept(p.214)
captivecompanystrategy(p.219)
cashcows(p.223)
concentration(p.208)
concentricdiversification(p.214)
conglomeratediversification(p.215)
corporateparenting(p.227)
corporatestrategy(p.206)
directionalstrategy(p.207)
diversification(p.208)
divestment(p.219)
dogs(p.223)
exporting(p.211)
forwardintegration(p.208)
franchising(p.212)
fullintegration(p.209)
GEbusinessscreen(p.223)
greenfielddevelopment(p.213)
growthstrategy(p.207)
horizontalgrowth(p.211)
horizontalintegration(p.211)
horizontalstrategy(p.228)
jointventure(p.212)
licensing(p.212)
liquidation(p.220)
longtermcontracts(p.210)
managementcontracts(p.214)
merger(p.207)
multipointcompetition(p.228)
nochangestrategy(p.217)
parentingstrategy(p.206)
pause/proceedwithcautionstrategy
(p.217)
portfolioanalysis(p.220)
productionsharing(p.213)
profitstrategy(p.218)
quasiintegration(p.209)
questionmarks(p.222)
retrenchmentstrategies(p.207)
selloutstrategy(p.219)
stabilitystrategy(p.207)
stars(p.222)
synergy(p.214)
taperintegration(p.209)
transactioncosteconomics(p.209)
turnaroundstrategy(p.218)
turnkeyoperations(p.213)
verticalgrowth(p.208)
verticalintegration(p.208)
NOTES
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69.
70.
71.
72.
73.
87.
88.
89.
90.
91.
92.
93.
74.
75.
76.
77.
78.
79.
80.
81.
82.
83.
94.
95.
96.
97.
84.
98.
CHAPTER 7
99.J.GimenoandC.Y.Woo,MultimarketContact,Economiesof
Scope,andFirmPerformance,AcademyofManagementJour
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100.L.Carlesi,B.Verster,andF.Wenger,TheNewDynamicsof
ManagingtheCorporatePortfolio,McKinseyQuarterlyOn
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235
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theEraofHype?EDUCAUSEReview(March/April2008),
pp.4056.
CHAPTER
8
strategyformulation:
functionalstrategyand
StrategicChoice
For almost 150 years, the Church & Dwight Company has been building
market share on a brand name whose products are in 95% of all U.S.
households. Yet if you asked the average person what products this company
makes, few would know. Although Church & Dwight may not be a household
name, the companys ubiquitous orange box of Arm & Hammer1 brand baking
soda is common throughout North America. Church & Dwight provides a classic
example of a marketing functional strategy called market developmentfinding new uses/
markets for an existing product. Shortly after its introduction in 1878, Arm & Hammer Baking
Soda became a fundamental item on the pantry shelf as people found many uses for sodium
bicarbonate other than baking, such as cleaning, deodorizing, and tooth brushing. Hearing of
the many uses people were finding for its product, the company advertised that its baking soda
was good not only for baking but also for deodorizing refrigeratorssimply by leaving an open
box in the refrigerator. In a brilliant marketing move, the firm then suggested that consumers
buy the product and throw it awaydeodorize a kitchen sink by dumping Arm & Hammer
baking soda down the drain!
The company did not stop there. It initiated a product development strategy by looking for
other uses of its sodium bicarbonate in new products. Church & Dwight has achieved consistent
growth in sales and earnings through the use of brand extensions, putting the Arm & Hammer
brand first on baking soda and then on laundry detergents, toothpaste, and deodorants. By the
beginning of the 21st century, Church & Dwight had become a significant competitor in mar-
kets previously dominated only by giants such as Procter & Gamble, Unilever, and Colgate-
Palmoliveusing only one brand name. Was there a limit to this growth? Was there a point at
which these continuous line extensions would begin to eat away at the integrity of the Arm &
Hammer name?
LearningObjectives
{
Identify a variety of functional strategies

that can be used to achieve organizational
goals and objectives
Understand what activities and functions
are appropriate to outsource in order to
gain or strengthen competitive advantage
Recognize strategies to avoid and
understand why they are dangerous
{
{
{
{
Construct corporate scenarios to evaluate

strategic options
Use a stakeholder priority matrix to aid in
strategic decision making
Develop policies to implement corporate,
business, and functional strategies
{
Environmental
Scanning:
Gathering
Information
Strategy
Formulation:
Developing
Long-range Plans
Strategy
Implementation:
Putting Strategy
into Action
Evaluation
and Control:
Monitoring
Performance
External:
Opportunities
and Threats
Mission
Reason for
existence
Objectives
What
results to
accomplish
by when
Natural
Environment:
Resources and
climate
Strategies
Plan to
achieve the
mission &
objectives
Policies
Broad
guidelines
for decision
making
Societal
Environment:
General forces
Programs
Activities
needed to
accomplish
a plan
Task
Environment:
Industry analysis
Budgets
Cost of the
programs
Procedures
Sequence
of steps
needed to
do the job
Internal:
Strengths and
Weaknesses
Performance
Actual results
Structure:
Chain of command
Culture:
values
Resources:
Assets, skills,
competencies,
knowledge
237
238
PART 3
StrategyFormulation
8.1
FunctionalStrategy
Functionalstrategyistheapproachafunctionalareatakestoachievecorporateandbusiness
unitobjectivesandstrategiesbymaximizingresourceproductivity.Itisconcernedwithdevel
opingandnurturingadistinctivecompetencetoprovideacompanyorbusinessunitwitha
competitiveadvantage.Justasamultidivisionalcorporationhasseveralbusinessunits,each
withitsownbusinessstrategy,eachbusinessunithasitsownsetofdepartments,eachwithits
ownfunctionalstrategy.
Theorientationofafunctionalstrategyisdictatedbyitsparentbusinessunitsstrategy. 2
Forexample,abusinessunitfollowingacompetitivestrategyofdifferentiationthroughhigh
qualityneedsamanufacturingfunctionalstrategythatemphasizesexpensivequalityassurance
processesovercheaper,highvolumeproduction;ahumanresourcefunctionalstrategythat
emphasizesthehiringandtrainingofahighlyskilled,butcostly,workforce;andamarketing
functionalstrategythatemphasizesdistributionchannelpull,usingadvertisingtoincrease
consumerdemand,overpush,usingpromotionalallowancestoretailers.Ifabusinessunit
weretofollowalowcostcompetitivestrategy,however,adifferentsetoffunctionalstrategies
wouldbeneededtosupportthebusinessstrategy.
Justascompetitivestrategiesmayneedtovaryfromoneregionoftheworldtoanother,
functionalstrategiesmayneedtovaryfromregiontoregion.WhenMr.Donutexpandedinto
Japan,forexample,ithadtomarketdonutsnotasbreakfast,butassnackfood.Becausethe
Japanesehadnobreakfastcoffeeanddonutcustom,theypreferredtoeatthedonutsintheaf
ternoonorevening.Mr.Donutrestaurantswerethuslocatednearrailroadstationsandsuper
markets.AllsignswereinEnglishtoappealtotheWesterninterestsoftheJapanese.
MARKETING STRATEGY
Marketingstrategydealswithpricing,selling,anddistributingaproduct.Usingamarket
developmentstrategy,acompanyorbusinessunitcan(1)capturealargershareofanexisting
marketforcurrentproductsthroughmarketsaturationandmarketpenetrationor(2)develop
newusesand/ormarketsforcurrentproducts.ConsumerproductgiantssuchasP&G,Colgate
Palmolive,andUnileverareexpertsatusingadvertisingandpromotiontoimplementamar
ketsaturation/penetrationstrategytogainthedominantmarketshareinaproductcategory.As
seemingmastersoftheproductlifecycle,thesecompaniesareabletoextendproductlifeal
mostindefinitelythroughnewandimprovedvariationsofproductandpackagingthatap
pealtomostmarketniches.Acompany,suchasArm&Hammer,followsthesecondmarket
developmentstrategybyfindingnewusesforitssuccessfulcurrentproduct,bakingsoda.
Usingtheproductdevelopmentstrategy,acompanyorunitcan(1)developnewprod
uctsforexistingmarketsor(2)developnewproductsfornewmarkets.Church&Dwighthas
hadgreatsuccessbyfollowingthefirstproductdevelopmentstrategydevelopingnewprod
uctstoselltoitscurrentcustomersinitsexistingmarkets.Acknowledgingthewidespreadap
pealofitsArm&Hammerbrandbakingsoda,thecompanyhasgeneratednewusesforits
sodiumbicarbonatebyreformulatingitastoothpaste,deodorant,anddetergent.Inanotherex
ample,OceanSpraydevelopedcraisans,mockberries,lightcranberryjuices,andjuiceboxes
inordertomarketitscranberriestocurrentcustomers. 3Usingasuccessfulbrandnametomar
ketotherproductsiscalledbrandextension,anditisagoodwaytoappealtoacompanyscur
rentcustomers.Smith&Wesson,famousforitshandguns,hastakenthisapproachbyusing
licensingtoputitsnameonmenscologneandotherproductsliketheSmith&Wesson
357MagnumWoodPelletSmoker(forsmokingmeats).4Arm&Hammerhassuccessfully
followedthesecondproductdevelopmentstrategy(newproductsfornewmarkets)by
CHAPTER 8
StrategyFormulation:FunctionalStrategyandStrategicChoice
239
developingnewpollutionreductionproducts(usingsodiumbicarbonatecompounds)forsale
tocoalfiredelectricutilityplantsaverydifferentmarketfromgrocerystores.
Therearenumerousothermarketingstrategies.Foradvertisingandpromotion,forexam
ple,acompanyorbusinessunitcanchoosebetweenpushandpullmarketingstrategies.
ManylargefoodandconsumerproductscompaniesintheUnitedStatesandCanadafollowa
pushstrategybyspendingalargeamountofmoneyontradepromotioninordertogainorhold
shelfspaceinretailoutlets.Tradepromotionincludesdiscounts,instorespecialoffers,andad
vertisingallowancesdesignedtopushproductsthroughthedistributionsystem.TheKellogg
Companydecidedafewyearsagotochangeitsemphasisfromapushtoapullstrategy,inwhich
advertisingpullstheproductsthroughthedistributionchannels.Thecompanynowspends
moremoneyonconsumeradvertisingdesignedtobuildbrandawarenesssothatshopperswill
askfortheproducts.Researchhasfoundthatahighlevelofadvertising(akeypartofapullstrat
egy)isbeneficialtoleadingbrandsinamarket. 5Strongbrandsprovideacompetitiveadvantage
toafirmbecausetheyactasentrybarriersandusuallygeneratehighmarketshare. 6
Othermarketingstrategiesdealwithdistributionandpricing.Shouldacompanyusedistrib
utorsanddealerstosellitsproducts,orshoulditselldirectlytomassmerchandisersorusethe
directmarketingmodelbysellingstraighttotheconsumersviatheInternet?Usingmultiplechan
nelssimultaneouslycanleadtoproblems.Inordertoincreasethesalesofitslawntractorsand
mowers,forexample,JohnDeeredecidedtoselltheproductsnotonlythroughitscurrentdealer
networkbutalsothroughmassmerchandiserssuchasHomeDepot.Deeresdealers,however,
werefurious.TheyconsideredHomeDepottobeakeycompetitor.Thedealerswereconcerned
thatHomeDepotsabilitytounderpricethemwouldeventuallyleadtotheirbecominglittlemore
thanrepairfacilitiesfortheircompetitionandleftwithinsufficientsalestostayinbusiness. 7
Whenpricinganewproduct,acompanyorbusinessunitcanfollowoneoftwostrategies.
Fornewproductpioneers,skimpricingofferstheopportunitytoskimthecreamfromthe
topofthedemandcurvewithahighpricewhiletheproductisnovelandcompetitorsarefew.
Penetrationpricing,incontrast,attemptstohastenmarketdevelopmentandoffersthepioneer
theopportunitytousetheexperiencecurvetogainmarketsharewithalowpriceandthen
dominatetheindustry.Dependingoncorporateandbusinessunitobjectivesandstrategies,ei
therofthesechoicesmaybedesirabletoaparticularcompanyorunit.Penetrationpricingis,
however,morelikelythanskimpricingtoraiseaunitsoperatingprofitinthelongterm. 8The
useoftheInternettomarketgoodsdirectlytoconsumersallowsacompanytousedynamic
pricing,apracticeinwhichpricesvaryfrequentlybasedupondemand,marketsegment,and
productavailability.9
FINANCIAL STRATEGY
Financialstrategyexaminesthefinancialimplicationsofcorporateandbusinesslevelstrate
gicoptionsandidentifiesthebestfinancialcourseofaction.Itcanalsoprovidecompetitive
advantagethroughalowercostoffundsandaflexibleabilitytoraisecapitaltosupportabusi
nessstrategy.Financialstrategyusuallyattemptstomaximizethefinancialvalueofafirm.
Thetradeoffbetweenachievingthedesireddebttoequityratioandrelyingoninternal
longtermfinancingviacashflowisakeyissueinfinancialstrategy.Manysmallandmedium
sizedfamilyownedcompaniessuchasUrschelLaboratoriestrytoavoidallexternalsourcesof
fundsinordertoavoidoutsideentanglementsandtokeepcontrolofthecompanywithinthe
family.Fewlargepubliclyheldfirmshavenolongtermdebtandinsteadkeepalargeamount
ofmoneyincashandshortterminvestments.OneoftheseisApple,Inc.AccordingtoApples
ChiefFinancialOfficer,PeterOppenheimer,Ourpreferenceistomaintainastrongbalance
sheetinordertopreserveourflexibility.10Manyfinancialanalystsbelieve,however,thatonly
byfinancingthroughlongtermdebtcanacorporationusefinancialleveragetoboostearnings
240
PART 3
StrategyFormulation
persharethusraisingstockpriceandtheoverallvalueofthecompany.Researchindicates
thathigherdebtlevelsnotonlydetertakeoverbyotherfirms(bymakingthecompanylessat
tractive)butalsoleadtoimprovedproductivityandimprovedcashflowsbyforcingmanage
menttofocusoncorebusinesses.11Highdebtcanbeaproblem,however,whentheeconomy
faltersandacompanyscashflowdrops.
Researchrevealsthatafirmsfinancialstrategyisinfluencedbyitscorporatediversifica
tionstrategy.Equityfinancing,forexample,ispreferredforrelateddiversification,whereas
debtfinancingispreferredforunrelateddiversification. 12Thetrendawayfromunrelatedtore
latedacquisitionsexplainswhythenumberofacquisitionsbeingpaidforentirelywithstock
increasedfromonly2%in1988to50%in1998.13
Averypopularfinancialstrategyistheleveragedbuyout(LBO).During2006and2007,for
example,thetotalvalueofLBOswas$1.4trillion,aboutonethirdofallthebuyoutseverdone. 14
Inaleveragedbuyout,acompanyisacquiredinatransactionfinancedlargelybydebt,usually
obtainedfromathirdparty,suchasaninsurancecompanyoraninvestmentbanker.Ultimately
thedebtispaidwithmoneygeneratedfromtheacquiredcompanysoperationsorbysalesofits
assets.Theacquiredcompany,ineffect,paysforitsownacquisition.ManagementoftheLBOis
thenundertremendouspressuretokeepthehighlyleveragedcompanyprofitable.Unfortunately,
thehugeamountofdebtontheacquiredcompanysbooksmayactuallycauseitseventualde
clinebyfocusingmanagementsattentiononshorttermmatters.Forexample,oneyearafterthe
buyout,thecashflowofeightofthelargestLBOsmadeduring20062007wasbarelyenough
tocoverinterestpayments.15OnestudyofLBOs(alsocalledMBOsManagementBuyOuts)
revealedthatthefinancialperformanceofthetypicalLBOusuallyfallsbelowtheindustryaver
ageinthefourthyearafterthebuyout.Thefirmdeclinesbecauseofinflatedexpectations,uti
lizationofallslack,managementburnout,andalackofstrategicmanagement. 16Oftentheonly
solutionsaretosellthecompanyortoagaingopublicbysellingstocktofinancegrowth. 17
Themanagementofdividendsandstockpriceisanimportantpartofacorporationsfi
nancialstrategy.Corporationsinfastgrowingindustriessuchascomputersandcomputersoft
wareoftendonotdeclaredividends.Theyusethemoneytheymighthavespentondividends
tofinancerapidgrowth.Ifthecompanyissuccessful,itsgrowthinsalesandprofitsisreflected
inahigherstockprice,eventuallyresultinginaheftycapitalgainwhenshareholdersselltheir
commonstock.Othercorporations,suchasWhirlpoolCorporation,thatdonotfacerapid
growth,mustsupportthevalueoftheirstockbyofferingconsistentdividends.Insteadofrais
ingdividendswhenprofitsarehigh,apopularfinancialstrategyistouseexcesscash(oreven
usedebt)tobuybackacompanysownsharesofstock.During2005,forexample,1,012U.S.
basedpubliclytradedcompaniesdeclared$446billionworthofstockrepurchaseplans.Be
causestockbuybacksincreaseearningspershare,theytypicallyincreaseafirmsstockprice
andmakeunwantedtakeoverattemptsmoredifficult.Suchbuybacksdosignal,however,that
eithermanagementmaynothavebeenabletofindanyprofitableinvestmentopportunitiesfor
thecompanyorthatitisanticipatingreducedfutureearnings. 18
Anumberoffirmshavebeensupportingthepriceoftheirstockbyusingreversestock
splits.Contrastedwithatypicalforward2for1stocksplitinwhichaninvestorreceivesan
additionalshareforeveryshareowned(witheachsharebeingworthonlyhalfasmuch),ina
reverse1for2stocksplit,aninvestorssharesaresplitinhalfforthesametotalamountof
money(witheachsharenowbeingworthtwiceasmuch).Thus,100sharesofstockworth$10
eachareexchangedfor50sharesworth$20each.Areversestocksplitmaysuccessfullyraise
acompanysstockprice,butitdoesnotsolveunderlyingproblems.AstudybyCreditSuisse
FirstBostonrevealedthatalmostall800companiesthathadreversestocksplitsinafiveyear
periodunderperformedtheirpeersoverthelongterm.19
Arathernovelfinancialstrategyisthesellingofacompanyspatents.Companiessuchas
AT&T,Bellsouth,AmericanExpress,KimberlyClark,and3Comhavebeensellingpatentsfor
productsthattheynolongerwishtocommercializeorarenotapartoftheircorebusiness.
CHAPTER 8
241
Theyuseanintermediary,likeChicagobasedOceanTomo,togroupthepatentsintolotsre
latedtoacommonareaandsellthemtothehighestbidder. 20
RESEARCH AND DEVELOPMENT (R&D) STRATEGY
R&Dstrategydealswithproductandprocessinnovationandimprovement.Italsodealswith
theappropriatemixofdifferenttypesofR&D(basic,product,orprocess)andwiththeques
tionofhownewtechnologyshouldbeaccessedthroughinternaldevelopment,externalac
quisition,orstrategicalliances.
OneoftheR&Dchoicesistobeeitheratechnologicalleader,pioneeringaninnovation,
oratechnologicalfollower,imitatingtheproductsofcompetitors.Portersuggeststhatdecid
ingtobecomeatechnologicalleaderorfollowercanbeawayofachievingeitheroveralllow
costordifferentiation.(SeeTable81.)
OneexampleofaneffectiveuseoftheleaderR&Dfunctionalstrategytoachieveadif
ferentiationcompetitiveadvantageisNike,Inc.Nikespendsmorethanmostintheindustry
onR&Dtodifferentiatetheperformanceofitsathleticshoesfromthatofitscompetitors.As
aresult,itsproductshavebecomethefavoriteofseriousathletes.Anexampleoftheuseofthe
followerR&DfunctionalstrategytoachievealowcostcompetitiveadvantageisDeanFoods
Company.Wereabletohavethecustomercometousandsay,IfyoucanproduceX,Y,and
Zproductforthesamequalityandservice,butatalowerpriceandwithoutthatexpensivela
belonit,youcanhavethebusiness,saysHowardDean,presidentofthecompany. 21
Anincreasingnumberofcompaniesareworkingwiththeirsupplierstohelpthemkeepup
withchangingtechnology.Theyarebeginningtorealizethatafirmcannotbecompetitivetech
nologicallyonlythroughinternaldevelopment.Forexample,ChryslerCorporationsskillful
useofpartssupplierstodesigneverythingfromcarseatstodriveshaftshasenabledittospend
consistentlylessmoneythanitscompetitorstodevelopnewcarmodels.Usingstrategictech
nologyalliancesisonewaytocombinetheR&Dcapabilitiesoftwocompanies.MaytagCom
panyworkedwithoneofitssupplierstoapplyfuzzylogictechnologytoitsIntelliSense
dishwasher.ThepartnershipenabledMaytagtocompletetheprojectinashorteramountoftime
thanifithadtriedtodoitalone.22OneUKstudyfoundthat93%ofUKautoassemblersand
componentmanufacturersusetheirsuppliersastechnologysuppliers. 23
AnewapproachtoR&Disopeninnovation,inwhichafirmusesalliancesandconnec
tionswithcorporate,government,academiclabs,andevenconsumerstodevelopnewprod
uctsandprocesses.Forexample,Intelopenedfoursmallscaleresearchfacilitiesadjacentto
universitiestopromotethecrosspollinationofideas.ThirteenU.S.universitylabsengaging
TABLE 81
Research and
Development
Strategy and
Competitive
Advantage
CostAdvantage
Technological Leadership
Pioneerthelowestcostproduction
design.
Bethefirstdownthelearningcurve.
Createlowcostwaysofperforming
valueactivities.
Pioneerauniqueproductthatincreases
buyervalue.
Innovateinotheractivitiestoincrease
buyervalue.
Technological Followership
Lowerthecostoftheproductor
valueactivitiesbylearningfromthe
leadersexperience.
AvoidR&Dcoststhrough
imitation.
Adapttheproductordelivery
systemmorecloselytobuyerneeds
bylearningfromtheleaders
experience.
Differentiation
SOURCE:ReprintedwiththepermissionofTheFreePress,aDivisionofSimon&Schuster,fromCOMPETITIVE
ADVANTAGE.CreatingandSustainingSuperiorPerformancebyMichaelE.Porter.Copyright1985,1988by
TheFreePress.Allrightsreserved.
242
PART 3
StrategyFormulation
innanotechnologyresearchhaveformedtheNationalNanotechnologyInfrastructureNetwork
inordertooffertheirresourcestobusinessesforafee.24Mattel,WalMart,andothertoyman
ufacturersandretailersuseideabrokerssuchasBigIdeaGrouptoscoutfornewtoyideas.Big
IdeaGroupinvitesinventorstosubmitideastoitsWebsite(www.bigideagroup.net).Itthen
refinesandpromotestoitsclientsthemostpromisingideas. 25IBMadoptedtheopenoperat
ingsystemLinuxforsomeofitscomputerproductsandsystems,drawingonacorecodebase
thatiscontinuallyimprovedandenhancedbyamassiveglobalcommunityofsoftwaredevel
opers,ofwhomonlyafractionworkforIBM.26Toopenitsownlabstoideasbeinggenerated
elsewhere,P&GsCEOArtLafleydecreedthathalfofthecompanysideasmustcomefrom
outside,upfrom10%in2000.P&Ginstitutedtheuseoftechnologyscoutstosearchbeyond
thecompanyforpromisinginnovations.By2007,theobjectivewasachieved:50%ofthe
companysinnovationsoriginatedoutsideP&G.27
AslightlydifferentapproachtotechnologydevelopmentisforalargefirmsuchasIBM
orMicrosofttopurchaseminoritystakesinrelativelynewhightechentrepreneurialventures
thatneedcapitaltocontinueoperation.Investingcorporateventurecapitalisonewaytogain
accesstopromisinginnovationsatalowercostthanbydevelopingtheminternally. 28
OPERATIONS STRATEGY
Operationsstrategydetermineshowandwhereaproductorserviceistobemanufactured,
thelevelofverticalintegrationintheproductionprocess,thedeploymentofphysicalre
sources,andrelationshipswithsuppliers.Itshouldalsodealwiththeoptimumleveloftech
nologythefirmshoulduseinitsoperationsprocesses.SeetheGlobalIssuefeaturetoseehow
differencesinnationalconditionscanleadtodifferencesinproductdesignandmanufacturing
facilitiesfromonecountrytoanother.
AdvancedManufacturingTechnology(AMT)isrevolutionizingoperationsworldwide
andshouldcontinuetohaveamajorimpactascorporationsstrivetointegratediversebusi
nessactivitiesbyusingcomputerassisteddesignandmanufacturing(CAD/CAM)principles.
TheuseofCAD/CAM,flexiblemanufacturingsystems,computernumericallycontrolledsys
tems,automaticallyguidedvehicles,robotics,manufacturingresourceplanning(MRPII),op
timizedproductiontechnology,andjustintimetechniquescontributetoincreasedflexibility,
quickresponsetime,andhigherproductivity.Suchinvestmentsalsoacttoincreasethecom
panysfixedcostsandcouldcausesignificantproblemsifthecompanyisunabletoachieve
economiesofscaleorscope.BaldorElectricCompany,thelargestmakerofindustrialelectric
motorsintheUnitedStates,builtanewfactorybyusingthenewtechnologytoeliminate
undesirablejobswithhighemployeeturnover.Withonetenththeemployeesofitsforeign
plants,theplantwascostcompetitivewithmotorsproducedinMexicoorChina. 29
Afirmsmanufacturingstrategyisoftenaffectedbyaproductslifecycle.Asthesalesof
aproductincrease,therewillbeanincreaseinproductionvolumerangingfromlotsizesas
lowasoneinajobshop(oneofakindproductionusingskilledlabor)throughconnectedline
batchflow(componentsarestandardized;eachmachinefunctionssuchasajobshopbutispo
sitionedinthesameorderasthepartsareprocessed)tolotsizesashighas100,000ormore
peryearforflexiblemanufacturingsystems(partsaregroupedintomanufacturingfamiliesto
produceawidevarietyofmassproduceditems)anddedicatedtransferlines(highlyauto
matedassemblylinesmakingonemassproducedproductusinglittlehumanlabor).Accord
ingtothisconcept,theproductbecomesstandardizedintoacommodityovertimein
conjunctionwithincreasingdemand.Flexibilitythusgiveswaytoefficiency. 30
Increasingcompetitiveintensityinmanyindustrieshasforcedcompaniestoswitchfrom
traditionalmassproductionusingdedicatedtransferlinestoacontinuousimprovementpro
ductionstrategy.Amassproductionsystemwasanexcellentmethodtoproducealargenum
beroflowcost,standardgoodsandservices.Employeesworkedonnarrowlydefined,
CHAPTER 8
243
GLOBAL
issue
INTERNATIONAL DIFFERENCES ALTER WHIRLPOOLS
OPERATIONS STRATEGY
ple, material costs may run as much as 200% to 800%
higher than elsewhere, while labor and overhead costs are
comparatively minimal, added Kremer. Another consider-
ation was the garments to be washed in each country. For
example, saristhe 18-foot lengths of cotton or silk with
which Indian women drape themselvesneeded special
treatment in an Indian washing machine, forcing addi-
tional modifications.
Manufacturing facilities also varied from country to
country. Brastemp, Whirlpools Brazilian partner, built its
plant of precast concrete to address the problems of high
humidity. In India, however, the construction crew cast the
concrete, allowed it to cure, and then using chain, block,
and tackle, five or six men raised each three-ton slab into
place. Instead of using one building, Mexican operations
used two, one housing the flexible assembly lines and
stamping operations, and an adjacent facility housing the
injection molding and extrusion processes.
SOURCE: WHEELEN, TOM; HUNGER, J. DAVID, STRATEGIC MAN-
AGEMENT AND BUSINESS POLICY, 9th Edition, 2004, p. 172.
Reprinted by permission of Pearson Education, Inc. Upper Saddle
River, NJ.
To better penetrate the
growing markets in develop-
ing nations, Whirlpool decided
to build a world washer. This
new type of washing machine was to be
produced in Brazil, Mexico, and India. Lightweight, with
substantially fewer parts than its U.S. counterpart, its per-
formance was to be equal to or better than anything on
the world market while being competitive in price with the
most popular models in these markets. The goal was to de-
velop a complete product, process, and facility design
package that could be used in different countries with low
initial investment. Originally the plan had been to make the
same low-cost washer in identical plants in each of the
three countries.
Significant differences in each of the three countries
forced Whirlpool to change its product design to adapt to
each nations situation. According to Lawrence Kremer, Se-
nior Vice President of Global Technology and Operations,
Our Mexican affiliate, Vitromatic, has porcelain and glass-
making capabilities. Porcelain baskets made sense for
them. Stainless steel became the preferred material for the
others. Costs also affected decisions. In India, for exam-
repetitioustasksunderclosesupervisioninabureaucraticandhierarchicalstructure.Quality,
however,oftentendedtobefairlylow.Learninghowtodosomethingbetterwasthepreroga
tiveofmanagement;workerswereexpectedonlytolearnwhatwasassignedtothem.Thissys
temtendedtodominatemanufacturinguntilthe1970s.Underthecontinuousimprovement
systemdevelopedbyJapanesefirms,empoweredcrossfunctionalteamsstriveconstantlyto
improveproductionprocesses.Managersaremorelikecoachesthanlikebosses.Theresultis
alargequantityoflowcost,standardgoodsandservices,butwithhighquality.Thekeyto
continuousimprovementistheacknowledgmentthatworkersexperienceandknowledgecan
helpmanagerssolveproductionproblemsandcontributetotighteningvariancesandreducing
errors.Becausecontinuousimprovementenablesfirmstousethesamelowcostcompetitive
strategyasdomassproductionfirmsbutatasignificantlyhigherlevelofquality,itisrapidly
replacingmassproductionasanoperationsstrategy.
Theautomobileindustryiscurrentlyexperimentingwiththestrategyofmodularmanu
facturinginwhichpreassembledsubassembliesaredeliveredastheyareneeded(i.e.,Just
inTime)toacompanysassemblylineworkers,whoquicklypiecethemodulestogetherinto
afinishedproduct.Forexample,GeneralMotorsbuiltanewautomotivecomplexinBrazil
tomakeitsnewsubcompact,theCelta.Sixteenofthe17buildingswereoccupiedbysuppli
ers,includingDelphi,Lear,andGoodyear.Thesesuppliersdeliveredpreassembledmodules
(whichcomprised85%ofthefinalvalueofeachcar)toGMsbuildingforassembly.Ina
processnewtotheindustry,thesuppliersactedasateamtobuildasinglemodulecompris
ingthemotor,transmission,fuellines,rearaxle,brakefluidlines,andexhaustsystem,which
wastheninstalledasonepiece.GMhopedthatthismanufacturingstrategywouldenableit
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toproduce100vehiclesannuallyperworkercomparedtothestandardrateof30to50autos
perworker.31FordandChryslerhavealsoopenedsimilarmodularfacilitiesinBrazil.
Theconceptofaproductslifecycleeventuallyleadingtoonesizefitsallmassproduc
tionisbeingincreasinglychallengedbythenewconceptofmasscustomization.Appropriate
foraneverchangingenvironment,masscustomizationrequiresthatpeople,processes,units,
andtechnologyreconfigurethemselvestogivecustomersexactlywhattheywant,whenthey
wantit.InthecaseofDellComputer,customersusetheInternettodesigntheirowncomput
ers.Incontrasttocontinuousimprovement,masscustomizationrequiresflexibilityandquick
responsiveness.Managerscoordinateindependent,capableindividuals.Anefficientlinkage
systemiscrucial.Theresultislowcost,highquality,customizedgoodsandservicesappro
priateforalargenumberofmarketniches.
Acontentiousissueformanufacturingcompaniesthroughouttheworldistheavailability
ofresourcesneededtooperateamodernfactory.Theincreasingcostofoilduring2007and
2008drasticallyboostedcosts,onlysomeofwhichcouldbepassedontothecustomersina
competitiveenvironment.Thelikelihoodthatfreshwatercouldbecomeanequallyscarcere
sourceiscausingmanycompaniestorethinkwaterintensivemanufacturingprocesses.To
learnhowcompaniesarebeginningtodealwithincreasingfreshwaterscarcity,seethe
EnvironmentalSustainabilityIssuefeature.
PURCHASING STRATEGY
Purchasingstrategydealswithobtainingtherawmaterials,parts,andsuppliesneededtoper
formtheoperationsfunction.Purchasingstrategyisimportantbecausematerialsandcompo
nentspurchasedfromsupplierscomprise50%oftotalmanufacturingcostsofmanufacturing
companiesintheUnitedKingdom,UnitedStates,Australia,Belgium,andFinland. 32Theba
sicpurchasingchoicesaremultiple,sole,andparallelsourcing.Undermultiplesourcing,the
purchasingcompanyordersaparticularpartfromseveralvendors.Multiplesourcinghastra
ditionallybeenconsideredsuperiortootherpurchasingapproachesbecause(1)itforcessup
plierstocompeteforthebusinessofanimportantbuyer,thusreducingpurchasingcosts,and
(2)ifonesuppliercannotdeliver,anotherusuallycan,thusguaranteeingthatpartsandsup
pliesarealwaysonhandwhenneeded.Multiplesourcinghasbeenonewayforapurchasing
firmtocontroltherelationshipwithitssuppliers.Solongassupplierscanprovideevidence
thattheycanmeettheproductspecifications,theyarekeptonthepurchaserslistofaccept
ablevendorsforspecificpartsandsupplies.Unfortunately,thecommonpracticeofaccepting
thelowestbidoftencompromisesquality.
W.EdwardDeming,awellknownmanagementconsultant,stronglyrecommendedsole
sourcingastheonlymanageablewaytoobtainhighsupplierquality.Solesourcingreliesononly
onesupplierforaparticularpart.Givenhisconcernwithdesigningqualityintoaproductinits
earlystagesofdevelopment,Demingarguedthatthebuyershouldworkcloselywiththesup
plieratallstages.Thisreducesbothcostandtimespentonproductdesignanditalsoimproves
quality.ItcanalsosimplifythepurchasingcompanysproductionprocessbyusingtheJustIn
Time(JIT)conceptofhavingthepurchasedpartsarriveattheplantjustwhentheyareneeded
ratherthankeepinginventories.TheconceptofsolesourcingistakenonestepfurtherinJITII,
inwhichvendorsalesrepresentativesactuallyhavedesksnexttothepurchasingcompanysfac
toryfloor,attendproductionstatusmeetings,visittheR&Dlab,andanalyzethepurchasingcom
panyssalesforecasts.Theseinhousesuppliersthenwritesalesordersforwhichthepurchasing
companyisbilled.DevelopedbyLanceDixonatBoseCorporation,JITIIisalsobeingusedat
IBM,Honeywell,andIngersollRand.KarenDale,purchasingmanagerforHoneywellsoffice
supplies,saidshewasveryconcernedaboutconfidentialitywhenJITIIwasfirstsuggestedto
her.Soonshehadfivesuppliersworkingwithher20buyersandreportedfewproblems. 33
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245
ENVIRONMENTAL
sustainabilityissue
Water is the oil of the 21st century, contends Andrew
Liveris, CEO of the chemical company Dow. Like oil, sup-
plies of clean, easily accessible fresh water are under a
growing strain because of the growing population and
widespread improvements in living standards. Industrial-
ization in developing nations is contaminating rivers and
aquifers. Climate change is altering the patterns of fresh
water availability so that droughts are more likely in many
parts of the world. According to a survey by the Marsh
Center for Risk Insights, 40% of Fortune 1000 companies
stated that the impact of a water shortage on their busi-
ness would be severe or catastrophic, but only 17%
said that they were prepared for such a crisis. Of Nestls
481 factories worldwide, 49 are located in water-scarce re-
gions. Environmental activists have attacked PepsiCo and
Coca-Cola for allegedly depleting groundwater in India to
make bottled drinks.
There are a number of companies that are taking action
to protect their future supply of freshwater. Dow has re-
duced the amount of water it uses by over a third since
1995. During 19972006, when Nestle almost doubled
the volume of food it produced, it reduced the amount of
water used by 29%. By 2008, Coca-Cola had achieved
85% of its objective to clean all of the wastewater gener-
ated at its bottling plants by 2010. Chinas Elion Chemical
is working with General Electric to recycle 90% of its
wastewater to comply with the governments new zero-
liquid discharge rules.
OPERATIONS NEED FRESH WATER AND LOTS OF IT!
The U.S. Department of En-
ergy (DOE) plans to build a rail
line more than 300 miles long
through the Nevada wilderness
to move spent nuclear fuel from
121 sites in 39 states to a geologic repos-
itory at Yucca Mountain. One of the biggest issues to over-
come will be water supply. The DOE estimates that the
construction phase would require 5,500 acre feet of water
for earthwork compaction, 370 acre-feet for construction
personnel, 200 acre-feet for dust control along access roads,
and 30 acre-feet for quarry operations, totaling 6,100 acre-
feet, or two billion gallons, of water to support a four-year
construction period. To meet this need, DOE wants to drill
150 to 176 new wells. The state of Nevada, however, has re-
jected a permit request to use water for drilling on the Yucca
Mountain site, stating that water has to be used for the ben-
efit of the public. Negotiations continue.
This is just one of the ways that organizations need
fresh water for their operations. Nestl, Unilever, Coca-
Cola, Anheuser-Busch, and Danone consume almost
575 billion liters of water a year, enough to satisfy the daily
water needs of every person on the planet. It takes about
13 cubic meters of freshwater to produce a single 200 mm
semiconductor wafer. As a result, chip making is believed to
account for 25% of the water consumption in Silicon Valley.
According to Jose Lopez, Nestls COO, it takes four liters of
water to make one liter of product in Nestls factories, but
3,000 liters of water are needed to grow the agricultural
produce that supplies them. Each year, around 40% of the
freshwater withdrawn from lakes and aquifers in America is
used to cool power plants. Separating one liter of oil from
Canadas tar sands requires up to five liters of water!
SOURCE: K. Kube, Into the Wild Brown Yonder, Trains (Novem-
ber 2008), pp. 6873; Running Dry, The Economist (August 23,
2008), pp. 5354.
Solesourcingreducestransactioncostsandbuildsqualitybyhavingthepurchaserand
supplierworktogetheraspartnersratherthanasadversaries.Withsolesourcing,morecom
panieswillhavelongerrelationshipswithfewersuppliers.Researchhasfoundthatbuyer
suppliercollaborationandjointproblemsolvingwithbothpartiesdependentupontheother
resultsinthedevelopmentofcompetitivecapabilities,higherquality,lowercosts,andbetter
scheduling.34Solesourcingdoes,however,havelimitations.Ifasupplierisunabletodeliver
apart,thepurchaserhasnoalternativebuttodelayproduction.Multiplesupplierscanprovide
thepurchaserwithbetterinformationaboutnewtechnologyandperformancecapabilities.The
limitationsofsolesourcinghaveledtothedevelopmentofparallelsourcing.Inparallelsourc
ing,twosuppliersarethesolesuppliersoftwodifferentparts,buttheyarealsobackupsup
pliersforeachothersparts.Ifonevendorcannotsupplyallofitspartsontime,theother
vendorisaskedtomakeupthedifference. 35
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TheInternetisbeingincreasinglyusedbothtofindnewsourcesofsupplyandtokeepin
ventoriesreplenished.Forexample,HewlettPackardintroducedaWebbasedprocurement
systemtoenableits84,000employeestobuyofficesuppliesfromastandardsetofsuppliers.
Thenewsystemenabledthecompanytosave$60to$100millionannuallyinpurchasing
costs.36ResearchindicatesthatcompaniesusingInternetbasedtechnologiesareabletolower
administrativecostsandpurchaseprices.37
LOGISTICS STRATEGY
Logisticsstrategydealswiththeflowofproductsintoandoutofthemanufacturingprocess.
Threetrendsrelatedtothisstrategyareevident:centralization,outsourcing,andtheuseofthe
Internet.Togainlogisticalsynergiesacrossbusinessunits,corporationsbegancentralizinglo
gisticsintheheadquartersgroup.Thiscentralizedlogisticsgroupusuallycontainsspecialists
withexpertiseindifferenttransportationmodessuchasrailortrucking.Theyworktoaggregate
shippingvolumesacrosstheentirecorporationtogainbettercontractswithshippers.Compa
niessuchasGeorgiaPacific,Marriott,andUnionCarbideviewthelogisticsfunctionasanim
portantwaytodifferentiatethemselvesfromthecompetition,toaddvalue,andtoreducecosts.
Manycompanieshavefoundthatoutsourcinglogisticsreducescostsandimprovesdeliv
erytime.Forexample,HPcontractedwithRoadwayLogisticstomanageitsinboundrawma
terialswarehousinginVancouver,Canada.Nearly140Roadwayemployeesreplaced250HP
workers,whoweretransferredtootherHPactivities.38
ManycompaniesareusingtheInternettosimplifytheirlogisticalsystem.Forexample,
AceHardwarecreatedanonlinesystemforitsretailersandsuppliers.Anindividualhardware
storecannowseeontheWebsitethatordering210casesofwrenchesischeaperthanorder
ing200cases.Becauseafullpalletiscomposedof210casesofwrenches,anorderforafull
palletmeansthatthesupplierdoesnthavetopull10casesoffapalletandrepackagethem
forstorage.Thereislesschancethatloosecaseswillbelostindelivery,andthepaperwork
doesnthavetoberedone.Asaresult,Acestransportationcostsaredown18%,andware
housecostshavebeencut28%.39
HUMAN RESOURCE MANAGEMENT (HRM) STRATEGY
HRMstrategy,amongotherthings,addressestheissueofwhetheracompanyorbusinessunit
shouldhirealargenumberoflowskilledemployeeswhoreceivelowpay,performrepetitive
jobs,andaremostlikelyquitafterashorttime(theMcDonaldsrestaurantstrategy)orhire
skilledemployeeswhoreceiverelativelyhighpayandarecrosstrainedtoparticipateinself
managingworkteams.Asworkincreasesincomplexity,themoresuiteditisforteams,espe
ciallyinthecaseofinnovativeproductdevelopmentefforts.Multinationalcorporationsare
increasinglyusingselfmanagingworkteamsintheirforeignaffiliatesaswellasinhome
countryoperations.40Researchindicatesthattheuseofworkteamsleadstoincreasedquality
andproductivityaswellastohigheremployeesatisfactionandcommitment. 41
Companiesfollowingacompetitivestrategyofdifferentiationthroughhighqualityusein
putfromsubordinatesandpeersinperformanceappraisalstoagreaterextentthandofirms
followingotherbusinessstrategies.42Acomplete360degreeappraisal,inwhichinputisgath
eredfrommultiplesources,isnowbeingusedbymorethan10%ofU.S.corporationsandhas
becomeoneofthemostpopularandeffectivetoolsindevelopingemployeesandnewman
agers.43OneIndiancompany,HCLTechnologies,publishestheappraisalratingsforthetop
20managersonthecompanysintranetforalltosee.44
Companiesarefindingthathavingadiverseworkforcecanbeacompetitiveadvantage.
Researchrevealsthatfirmswithahighdegreeofracialdiversityfollowingagrowthstrategy
CHAPTER 8
247
havehigherproductivitythandofirmswithlessracialdiversity. 45AvonCompany,forexam
ple,wasabletoturnarounditsunprofitableinnercitymarketsbyputtingAfricanAmerican
andHispanicmanagersinchargeofmarketingtothesemarkets. 46Diversityintermsofage
andnationaloriginalsooffersbenefits.DuPontsuseofmultinationalteamshashelpedthe
companydevelopandmarketproductsinternationally.McDonaldshasdiscoveredthatolder
workersperformaswellas,ifnotbetterthan,youngeremployees.AccordingtoEdwardRensi,
CEOofMcDonaldsUSA,Wefindthesepeopletobeparticularlywellmotivated,withasort
ofdisciplineandworkhabitshardtofindinyoungeremployees. 47
INFORMATION TECHNOLOGY STRATEGY
Corporationsareincreasinglyusinginformationtechnologystrategytoprovidebusinessunits
withcompetitiveadvantage.WhenFedExfirstprovideditscustomerswithPowerShipcomputer
softwaretostoreaddresses,printshippinglabels,andtrackpackagelocation,itssalesjumped
significantly.UPSsoonfollowedwithitsownMaxiShipssoftware.Viewingitsinformationsys
temasadistinctivecompetency,FedExcontinuedtopushforfurtheradvantageoverUPSbyus
ingitsWebsitetoenablecustomerstotracktheirpackages.FedExusesthiscompetencyinits
advertisementsbyshowinghowcustomerscantracktheprogressoftheirshipments.Soonthere
after,UPSprovidedthesameservice.Althoughitcanbearguedthatinformationtechnologyhas
nowbecomesopervasivethatitnolongerofferscompaniesacompetitiveadvantage,corpora
tionsworldwidecontinuetospendover$2trillionannuallyoninformationtechnology. 48
Multinationalcorporationsarefindingthathavingasophisticatedintranetallowsemploy
eestopracticefollowthesunmanagement,inwhichprojectteammemberslivinginonecoun
trycanpasstheirworktoteammembersinanothercountryinwhichtheworkdayisjust
beginning.Thus,nightshiftsarenolongerneeded.49Thedevelopmentofinstanttranslation
softwareisalsoenablingworkerstohaveonlinecommunicationwithcoworkersinother
countrieswhouseadifferentlanguage.50Forexample,Mattelhascutthetimeittakestode
velopnewproductsby10%byenablingdesignersandlicenseesinothercountriestocollabo
rateontoydesign.IBMusesitsintranettoallowitsemployeestocollaborateandimprove
theirskills,thusreducingitstrainingandtravelexpenses.51
Manycompanies,suchasLockheedMartin,GeneralElectric,andWhirlpool,useinforma
tiontechnologytoformcloserrelationshipswithboththeircustomersandsuppliersthroughso
phisticatedextranets.Forexample,GeneralElectricsTradingProcessNetworkallowssuppliers
toelectronicallydownloadGEsrequestsforproposals,viewdiagramsofpartsspecifications,
andcommunicatewithGEpurchasingmanagers.AccordingtoRobertLivingston,GEsheadof
worldwidesourcingfortheLightingDivision,goingontheWebreducesprocessingtimeby
onethird.52Thus,theuseofinformationtechnologythroughextranetsmakesiteasierforacom
panytobuyfromothers(outsource)ratherthanmakeitthemselves(verticallyintegrate). 53
8.2
TheSourcingDecision:LocationofFunctions
Forafunctionalstrategytohavethebestchanceofsuccess,itshouldbebuiltonadistinc
tivecompetencyresidingwithinthatfunctionalarea.Ifacorporationdoesnothaveadistinc
tivecompetencyinaparticularfunctionalarea,thatfunctionalareacouldbeacandidatefor
outsourcing.
Outsourcingispurchasingfromsomeoneelseaproductorservicethathadbeenpreviously
providedinternally.Thus,itisthereverseofverticalintegration.Outsourcingisbecominganin
creasinglyimportantpartofstrategicdecisionmakingandanimportantwaytoincreaseeffi
ciencyandoftenquality.Inastudyof30firms,outsourcingresultedonaverageina9%reduction
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incostsanda15%increaseincapacityandquality.54Forexample,Boeingusedoutsourcingas
awaytoreducethecostofdesigningandmanufacturingitsnew787Dreamliner.Upto70%of
theplanewasoutsourced.Inabreakfrompastpractice,suppliersmakelargepartsofthefuse
lage,includingplumbing,electrical,andcomputersystems,andshipthemtoSeattleforassem
blybyBoeing.OutsourcingenabledBoeingtobuilda787in4monthsinsteadoftheusual12. 55
AccordingtoanAmericanManagementAssociationsurveyofmembercompanies,94%
oftherespondingfirmsoutsourceatleastoneactivity.Theoutsourcedactivitiesaregeneral
andadministrative(78%),humanresources(77%),transportationanddistribution(66%),in
formationsystems(63%),manufacturing(56%),marketing(51%),andfinanceandaccount
ing(18%).Thesurveyalsorevealsthat25%oftherespondentshavebeendisappointedintheir
outsourcingresults.Fiftyonepercentofthefirmsreportedbringinganoutsourcedactivity
backinhouse.Nevertheless,authoritiesnotonlyexpectthenumberofcompaniesengagingin
outsourcingtoincrease,theyalsoexpectcompaniestooutsourceanincreasingnumberof
functions,especiallythoseincustomerservice,bookkeeping,financial/clerical,sales/telemar
keting,andthemailroom.56Itisestimatedthat50%ofU.S.manufacturingwillbeoutsourced
tofirmsin28developingcountriesby2015.57
Offshoringistheoutsourcingofanactivityorafunctiontoawhollyownedcompanyor
anindependentproviderinanothercountry.Offshoringisaglobalphenomenonthathasbeen
supportedbyadvancesininformationandcommunicationtechnologies,thedevelopmentof
stable,secure,andhighspeeddatatransmissionsystems,andlogisticaladvanceslikecon
tainerizedshipping.AccordingtoBain&Company,51%oflargefirmsinNorthAmerica,
Europe,andAsiaoutsourceoffshore.58AlthoughIndiacurrentlyhas70%oftheoffshoring
market,countriessuchasBrazil,China,Russia,thePhillipines,Malaysia,Hungary,theCzech
Republic,andIsraelaregrowinginimportance.Thesecountrieshavelowcostqualifiedla
borandaneducatedworkforce.Theseareimportantconsiderationsbecausemorethan93%
ofoffshoringcompaniesdosotoreducecosts.59Forexample,Mexicanassemblylinework
ersaverage$3.50anhourplusbenefitscomparedto$27anhourplusbenefitsataGMorFord
plantintheU.S.LessskilledMexicanworkersatautopartsmakersearnaslittleas$1.50per
hourwithfewerbenefits.60
Softwareprogrammingandcustomerservice,inparticular,arebeingoutsourcedto
India.Forexample,GeneralElectricsbackofficeservicesunit,GECapitalInternational
Services,isoneoftheoldestandbiggestofIndiasoutsourcingcompanies.Fromonly
$26millionin1999,itsannualrevenuesgrewtoover$420millionby2004.61Aspartofthis
trend,IBMacquiredDaksheServicesLtd.,oneofIndiasbiggestsuppliersofremotebusi
nessservices.62
Outsourcing,includingoffshoring,hassignificantdisadvantages.Forexample,mount
ingcomplaintsforcedDellComputertostoproutingcorporatecustomerstoatechnicalsup
portcallcenterinBangalore,India.63GEsintroductionofanewwashingmachinewas
delayedthreeweeksbecauseofproductionproblemsatasupplierscompanytowhichithad
contractedoutkeywork.Somecompanieshavefoundthemselveslockedintolongtermcon
tractswithoutsidesuppliersthatwerenolongercompetitive. 64Someauthoritiesproposethat
thecumulativeeffectsofcontinuedoutsourcingsteadilyreducesafirmsabilitytolearnnew
skillsandtodevelopnewcorecompetencies.65Onesurveyof129outsourcingfirmsrevealed
thathalftheoutsourcingprojectsundertakeninoneyearfailedtodeliveranticipatedsavings.
ThisisinagreementwithasurveybyBain&Companyinwhich51%oflargeNorthAmer
ican,European,andAsianfirmsstatedthatoutsourcing(includingoffshoring)didnotmeet
theirexpectations.66Anothersurveyofsoftwareprojects,byMIT,foundthatthemedianIn
dianprojecthad10%moresoftwarebugsthandidcomparableU.S.projects. 67During
20072008,taintedgoodsmadebyChinesemanufacturers,rangingfromleadpaintontoys,
contaminatedheparin,andmelaminelacedmilkcausedtheircustomerstoreevaluatethe
CHAPTER 8
249
mannerinwhichtheyengagedinoffshoreoutsourcing.68Theincreasingcostofoilwasmak
ingoffshoringlesseconomical.Since2003,crudeoilincreasedinpricefrom$28toover
$100abarrelin2008,causingthecosttoshipastandard40footcontainertotriple.By2008
itcostabout$100toshipatonofironfromBraziltoChina,morethanthecostofthemin
eralitself.69
Astudyof91outsourcingeffortsconductedbyEuropeanandNorthAmericanfirmsfound
sevenmajorerrorsthatshouldbeavoided:
1.Outsourcingactivitiesthatshouldnotbeoutsourced:Companiesfailedtokeepcore
activitiesinhouse.
2.Selectingthewrongvendor:Vendorswerenottrustworthyorlackedstateoftheart
processes.
3.Writingapoorcontract:Companiesfailedtoestablishabalanceofpowerinthe
relationship.
4.Overlookingpersonnelissues:Employeeslostcommitmenttothefirm.
5.Losingcontrolovertheoutsourcedactivity:Qualifiedmanagersfailedtomanagethe
outsourcedactivity.70
6.Overlookingthehiddencostsofoutsourcing:Transactioncostsoverwhelmedother
savings.
7.Failingtoplananexitstrategy:Companiesfailedtobuildreversibilityclausesintothe
contract.71
Thekeytooutsourcingistopurchasefromoutsideonlythoseactivitiesthatarenotkey
tothecompanysdistinctivecompetencies.Otherwise,thecompanymaygiveuptheveryca
pabilitiesthatmadeitsuccessfulinthefirstplacethusputtingitselfontheroadtoeventual
decline.Thisissupportedbyresearchreportingthatcompaniesthathavemoreexperiencewith
aparticularmanufacturingtechnologytendtokeepmanufacturinginhouse. 72J.P.Morgan
Chase&CompanyterminatedasevenyeartechnologyoutsourcingagreementwithIBMbe
causethebanksmanagementrealizedthatinformationtechnology(IT)wastooimportant
strategicallytobeoutsourced.73
Indeterminingfunctionalstrategy,thestrategistmust:
{
{
{
Identifythecompanysorbusinessunitscorecompetencies
Ensurethatthecompetenciesarecontinuallybeingstrengthened
Managethecompetenciesinsuchawaythatbestpreservesthecompetitiveadvantage
theycreate
Anoutsourcingdecisiondependsonthefractionoftotalvalueaddedthattheactivityun
derconsiderationrepresentsandontheamountofpotentialcompetitiveadvantageinthatac
tivityforthecompanyorbusinessunit.SeetheoutsourcingmatrixinFigure81.Afirm
shouldconsideroutsourcinganyactivityorfunctionthathaslowpotentialforcompetitivead
vantage.Ifthatactivityconstitutesonlyasmallpartofthetotalvalueofthefirmsproductsor
services,itshouldbepurchasedontheopenmarket(assumingthatqualityprovidersoftheac
tivityareplentiful).If,however,theactivitycontributeshighlytothecompanysproductsor
services,thefirmshouldpurchaseitthroughlongtermcontractswithtrustedsuppliersordis
tributors.Afirmshouldalwaysproduceatleastsomeoftheactivityorfunction(i.e.,taperver
ticalintegration)ifthatactivityhasthepotentialforprovidingthecompanysomecompetitive
advantage.However,fullverticalintegrationshouldbeconsideredonlywhenthatactivityor
functionaddssignificantvaluetothecompanysproductsorservicesinadditiontoproviding
competitiveadvantage.74
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ActivitysTotalValueAddedtoFirms
ProductsandServices
Low
High
FIGURE 81
Proposed
Outsourcing
Matrix
ActivitysPotentialfor
CompetitiveAdvantage
High
TaperVertical
Integration:
Produce Some
Internally
FullVertical
Integration:
Produce All
Internally
Outsource
Completely:
Buy on Open
Market
Outsource
Completely:
Purchase with
Long-Term
Contracts
SOURCE:J.D.HungerandT.L.Wheelen,ProposedOutsourcingMatrix.Copyright1996and2005byWheelen
andHungerAssociates.Reprintedbypermission.
8.3
StrategiestoAvoid
Severalstrategies,thatcouldbeconsideredcorporate,business,orfunctionalareverydanger
ous.Managerswhohavemadepooranalysesorlackcreativitymaybetrappedintoconsider
ingsomeofthefollowingstrategiestoavoid:
{
{
{
{
Followtheleader:Imitatingaleadingcompetitorsstrategymightseemtobeagood
idea,butitignoresafirmsparticularstrengthsandweaknessesandthepossibilitythatthe
leadermaybewrong.FujitsuLtd.,theworldssecondlargestcomputermaker,hadbeen
drivensincethe1960sbythesoleambitionofcatchinguptoIBM.LikeIBM,Fujitsu
competedprimarilyasamainframecomputermaker.SodevotedwasittocatchingIBM,
however,thatitfailedtonoticethatthemainframebusinesshadreachedmaturityby1990
andwasnolongergrowing.
Hitanotherhomerun:Ifacompanyissuccessfulbecauseitpioneeredanextremelysuc
cessfulproduct,ittendstosearchforanothersuperproductthatwillensuregrowthand
prosperity.Asinbettingonlongshotsinhorseraces,theprobabilityoffindingasecond
winnerisslight.Polaroidspentalotofmoneydevelopinganinstantmoviecamera,but
thepublicignoreditinfavorofthecamcorder.
Armsrace:Enteringintoaspiritedbattlewithanotherfirmforincreasedmarketshare
mightincreasesalesrevenue,butthatincreasewillprobablybemorethanoffsetbyin
creasesinadvertising,promotion,R&D,andmanufacturingcosts.Sincethederegula
tionofairlines,pricewarsandratespecialshavecontributedtothelowprofitmargins
andbankruptciesofmanymajorairlines,suchasEastern,PanAmerican,TWA,and
United.
Doeverything:Whenfacedwithseveralinterestingopportunities,managementmight
tendtoleapatallofthem.Atfirst,acorporationmighthaveenoughresourcestodevelop
Low
CHAPTER 8
251
{
eachideaintoaproject,butmoney,time,andenergyaresoonexhaustedasthemanyproj
ectsdemandlargeinfusionsofresources.TheWaltDisneyCompanysexpertiseintheen
tertainmentindustryledittoacquiretheABCnetwork.Asthecompanychurnedoutnew
motionpicturesandtelevisionprogramssuchasWhoWantstoBeaMillionaire?itspent
$750milliontobuildnewthemeparksandbuyacruiselineandahockeyteam.By2000,
eventhoughcorporatesaleshadcontinuedtoincrease,netincomewasfalling. 75
Losinghand:Acorporationmighthaveinvestedsomuchinaparticularstrategythattop
managementisunwillingtoacceptitsfailure.Believingthatithastoomuchinvestedto
quit,managementmaycontinuetothrowgoodmoneyafterbad.PanAmericanAirlines,
forexample,chosetosellitsPanAmBuildingandIntercontinentalHotels,themostprof
itablepartsofthecorporation,tokeepitsmoneylosingairlineflying.Continuingtosuf
ferlosses,thecompanyfollowedthisprofitstrategyofsheddingassetsforcashuntilit
hadsoldoffeverythingandwentbankrupt.
8.4
StrategicChoice:SelectingtheBestStrategy
Aftertheprosandconsofthepotentialstrategicalternativeshavebeenidentifiedandevalu
ated,onemustbeselectedforimplementation.Bynow,itislikelythatmanyfeasiblealterna
tiveswillhaveemerged.Howisthebeststrategydetermined?
Perhapsthemostimportantcriterionisthecapabilityoftheproposedstrategytodealwith
thespecificstrategicfactorsdevelopedearlier,intheSWOTanalysis.Ifthealternativedoesnt
takeadvantageofenvironmentalopportunitiesandcorporatestrengths/competencies,andlead
awayfromenvironmentalthreatsandcorporateweaknesses,itwillprobablyfail.
Anotherimportantconsiderationintheselectionofastrategyistheabilityofeachalter
nativetosatisfyagreedonobjectiveswiththeleastresourcesandthefewestnegativesideef
fects.Itis,therefore,importanttodevelopatentativeimplementationplaninordertoaddress
thedifficultiesthatmanagementislikelytoface.Thisshouldbedoneinlightofsocietal
trends,theindustry,andthecompanyssituationbasedontheconstructionofscenarios.
CONSTRUCTING CORPORATE SCENARIOS
Corporatescenariosareproforma(estimatedfuture)balancesheetsandincomestatements
thatforecasttheeffecteachalternativestrategyanditsvariousprogramswilllikelyhaveon
divisionandcorporatereturnoninvestment.(Proformafinancialstatementsarediscussedin
Chapter12.)InasurveyofFortune500firms,84%reportedusingcomputersimulationmod
elsinstrategicplanning.Mostoftheseweresimplyspreadsheetbasedsimulationmodels
dealingwithwhatifquestions.76
Therecommendedscenariosaresimplyextensionsoftheindustryscenariosdiscussedin
Chapter4.If,forexample,industryscenariossuggesttheprobableemergenceofastrong
marketdemandinaspecificcountryforcertainproducts,aseriesofalternativestrategysce
narioscanbedeveloped.Thealternativeofacquiringanotherfirmhavingtheseproductsin
thatcountrycanbecomparedwiththealternativeofagreenfielddevelopment(e.g.,building
newoperationsinthatcountry).Usingthreesetsofestimatedsalesfigures(Optimistic,Pes
simistic,andMostLikely)forthenewproductsoverthenextfiveyears,thetwoalternatives
canbeevaluatedintermsoftheireffectonfuturecompanyperformanceasreflectedinthe
companysprobablefuturefinancialstatements.Proformabalancesheetsandincomestate
mentscanbegeneratedwithspreadsheetsoftware,suchasExcel,onapersonalcomputer.Pro
formastatementsarebasedonfinancialandeconomicscenarios.
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Toconstructacorporatescenario,followthesesteps:
1.Useindustryscenarios(asdiscussedinChapter4)todevelopasetofassumptionsabout
thetaskenvironment(inthespecificcountryunderconsideration).Forexample,3Mre
quiresthegeneralmanagerofeachbusinessunittodescribeannuallywhathisorherin
dustrywilllooklikein15years.Listoptimistic,pessimistic,andmostlikelyassumptions
forkeyeconomicfactorssuchastheGDP(GrossDomesticProduct),CPI(Consumer
PriceIndex),andprimeinterestrateandforotherkeyexternalstrategicfactorssuchas
governmentalregulationandindustrytrends.Thisshouldbedoneforeverycountry/
regioninwhichthecorporationhassignificantoperationsthatwillbeaffectedbyeach
strategicalternative.Thesesameunderlyingassumptionsshouldbelistedforeachofthe
alternativescenariostobedeveloped.
2.Developcommonsizefinancialstatements(asdiscussedinChapter12)forthecom
panysorbusinessunitspreviousyears,toserveasthebasisforthetrendanalysisprojec
tionsofproformafinancialstatements.UsetheScenarioBoxformshowninTable82:
a.Usethehistoricalcommonsizepercentagestoestimatethelevelofrevenues,ex
penses,andothercategoriesinestimatedproformastatementsforfutureyears.
b.DevelopforeachstrategicalternativeasetofOptimistic(O),Pessimistic(P),andMost
Likely(ML)assumptionsabouttheimpactofkeyvariablesonthecompanysfuturefi
nancialstatements.
c.Forecastthreesetsofsalesandcostofgoodssoldfiguresforatleastfiveyearsinto
thefuture.
d.Analyzehistoricaldataandmakeadjustmentsbasedontheenvironmentalassump
tionslistedearlier.Dothesameforotherfiguresthatcanvarysignificantly.
TABLE 82
Scenario Box for Use in Generating Financial Pro Forma Statements
Projections1
200
Factor
GDP
CPI
Other
Salesunits
Dollars
COGS
Advertisingand
marketing
Interestexpense
Plantexpansion
Dividends
Netprofits
EPS
ROI
ROE
Other
NOTE1:O
Optimistic;P
Pessimistic;ML
MostLikely.
200
ML
O
P
ML
O
200
P
ML
Comments
Last
Year
Historical
Average
Trend
Analysis
O
P
SOURCE:T.L.WheelenandJ.D.Hunger.Copyright1987,1988,1989,1990,1992,2005,and2009byT.L.Wheelen.Copyright1993and
2005byWheelenandHungerAssociates.Reprintedwithpermission.
CHAPTER 8
253
e.Assumeforotherfiguresthattheywillcontinueintheirhistoricalrelationshiptosales
orsomeotherkeydeterminingfactor.Pluginexpectedinventorylevels,accountsre
ceivable,accountspayable,R&Dexpenses,advertisingandpromotionexpenses,cap
italexpenditures,anddebtpayments(assumingthatdebtisusedtofinancethe
strategy),amongothers.
f.Considernotonlyhistoricaltrendsbutalsoprogramsthatmightbeneededtoimple
menteachalternativestrategy(suchasbuildinganewmanufacturingfacilityorex
pandingthesalesforce).
3.Constructdetailedproformafinancialstatementsforeachstrategicalternative:
a.Listtheactualfiguresfromthisyearsfinancialstatementsintheleftcolumnofthe
spreadsheet.
b.Listtotherightofthiscolumntheoptimisticfiguresforyears1through5.
c.Gothroughthissameprocesswiththesamestrategicalternative,butnowlistthepes
simisticfiguresforthenextfiveyears.
d.Dothesamewiththemostlikelyfigures.
e.Developasimilarsetofoptimistic(O),pessimistic(P),andmostlikely(ML)pro
formastatementsforthesecondstrategicalternative.Thisprocessgeneratessixdif
ferentproformascenariosreflectingthreedifferentsituations(O,P,andML)fortwo
strategicalternatives.
f.Calculatefinancialratiosandcommonsizeincomestatements,andcreatebalance
sheetstoaccompanytheproformastatements.
g.Comparetheassumptionsunderlyingthescenarioswiththefinancialstatementsand
ratiostodeterminethefeasibilityofthescenarios.Forexample,ifcostofgoodssold
dropsfrom70%to50%oftotalsalesrevenueintheproformaincomestatements,
thisdropshouldresultfromachangeintheproductionprocessorashifttocheaper
rawmaterialsorlaborcostsratherthanfromafailuretokeepthecostofgoodssold
initsusualpercentagerelationshiptosalesrevenuewhenthepredictedstatementwas
developed.
Theresultofthisdetailedscenarioconstructionshouldbeanticipatednetprofits,cash
flow,andnetworkingcapitalforeachofthreeversionsofthetwoalternativesforfiveyears
intothefuture.Astrategistmightwanttogofurtherintothefutureifthestrategyisexpected
tohaveamajorimpactonthecompanysfinancialstatementsbeyondfiveyears.Theresultof
thisworkshouldprovidesufficientinformationonwhichforecastsofthelikelyfeasibilityand
probableprofitabilityofeachofthestrategicalternativescouldbebased.
Obviously,thesescenarioscanquicklybecomeverycomplicated,especiallyifthreesets
ofacquisitionpricesanddevelopmentcostsarecalculated.Nevertheless,thissortofdetailed
whatifanalysisisneededtorealisticallycomparetheprojectedoutcomeofeachreasonable
alternativestrategyanditsattendantprograms,budgets,andprocedures.Regardlessofthe
quantifiableprosandconsofeachalternative,theactualdecisionwillprobablybeinfluenced
byseveralsubjectivefactorssuchasthosedescribedinthefollowingsections.
ManagementsAttitudeTowardRisk
Theattractivenessofaparticularstrategicalternativeispartiallyafunctionoftheamountof
riskitentails.Riskiscomposednotonlyoftheprobabilitythatthestrategywillbeeffective
butalsooftheamountofassetsthecorporationmustallocatetothatstrategyandthelengthof
timetheassetswillbeunavailableforotheruses.Becauseofvariationamongcountriesinterms
ofcustoms,regulations,andresources,companiesoperatinginglobalindustriesmustdealwith
agreateramountofriskthanfirmsoperatingonlyinonecountry. 77Thegreatertheassetsin
volvedandthelongertheyarecommitted,themorelikelytopmanagementistodemandahigh
probabilityofsuccess.Managerswithnoownershippositioninacompanyareunlikelytohave
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muchinterestinputtingtheirjobsindangerwithriskydecisions.Researchindicatesthatman
agerswhoownasignificantamountofstockintheirfirmsaremorelikelytoengageinrisk
takingactionsthanaremanagerswithnostock.78
AhighlevelofriskwaswhyIntelsboardofdirectorsfounditdifficulttovoteforapro
posalintheearly1990stocommit$5billiontomakingthePentiummicroprocessorchip
fivetimestheamountofmoneyneededforitspreviouschip.Inlookingbackonthatboard
meeting,thenCEOAndyGroveremarked,Irememberpeopleseyeslookingatthatchart
andgettingbig.IwasntevensureIbelievedthosenumbersatthetime.Theproposalcom
mittedthecompanytobuildingnewfactoriessomethingIntelhadbeenreluctanttodo.A
wrongdecisionwouldmeanthatthecompanywouldendupwithakillingamountofoverca
pacity.BasedonGrovespresentation,theboarddecidedtotakethegamble.Intelsresulting
manufacturingexpansioneventuallycost$10billionbutresultedinIntelsobtaining75%of
themicroprocessorbusinessandhugecashprofits.79
Riskmightbeonereasonthatsignificantinnovationsoccurmoreofteninsmallfirmsthan
inlarge,establishedcorporations.Asmallfirmmanagedbyanentrepreneurisoftenwillingto
acceptgreaterriskthanisalargefirmofdiversifiedownershiprunbyprofessionalmanagers. 80
Itisonethingtotakeachanceifyouaretheprimaryshareholderandarenotconcernedwith
periodicchangesinthevalueofthecompanyscommonstock.Itissomethingelseifthecor
porationsstockiswidelyheldandacquisitionhungrycompetitorsortakeoverartistssurround
thecompanylikesharkseverytimethecompanysstockpricefallsbelowsomeexternalas
sessmentofthefirmsvalue.
Anewapproachtoevaluatingalternativesunderconditionsofhighenvironmentaluncertainty
istouserealoptionstheory.Accordingtotherealoptionsapproach,whenthefutureishighly
uncertain,itpaystohaveabroadrangeofoptionsopen.Thisisincontrasttousingnetpresentvalue
(NPV)tocalculatethevalueofaprojectbypredictingitspayouts,adjustingthemforrisk,and
subtractingtheamountinvested.Byboilingeverythingdowntoonescenario,NPVdoesntprovide
anyflexibilityincasecircumstanceschange.NPVisalsodifficulttoapplytoprojectsinwhichthe
potentialpayoffsarecurrentlyunknown.Therealoptionsapproach,however,dealswiththese
issuesbybreakingtheinvestmentintostages.Managementallocatesasmallamountoffundingto
initiatemultipleprojects,monitorstheirdevelopment,andthencancelstheprojectsthatarentsuc
cessfulandfundsthosethataredoingwell.81Thisapproachisverysimilartothewayventurecap
italistsfundanentrepreneurialventureinstagesoffundingbasedontheventuresperformance.
Asurveyof4,000CFOsfoundthat27%ofthemalwaysoralmostalwaysusedsomesort
ofoptionsapproachtoevaluatinganddecidingupongrowthopportunities. 82Researchindi
catesthattheuseoftherealoptionsapproachdoesimproveorganizationalperformance. 83
SomeofthecorporationsusingtherealoptionsapproachareChevronforbiddingonpetro
leumreserves,Airbusforcalculatingthecostsofairlineschangingtheirordersatthelast
minute,andtheTennesseeValleyAuthorityforoutsourcingelectricitygenerationinsteadof
buildingitsownplant.Becauseofitscomplexity,therealoptionsapproachisnotworthwhile
forminordecisionsorforprojectsrequiringafullcommitmentatthebeginning. 84
PressuresfromStakeholders
Theattractivenessofastrategicalternativeisaffectedbyitsperceivedcompatibilitywiththe
keystakeholdersinacorporationstaskenvironment.Creditorswanttobepaidontime.
Unionsexertpressureforcomparablewageandemploymentsecurity.Governmentsandinter
estgroupsdemandsocialresponsibility.Shareholderswantdividends.Allthesepressures
mustbegivensomeconsiderationintheselectionofthebestalternative.
Stakeholderscanbecategorizedintermsoftheir(1)interestinthecorporationsactivitiesand
(2)relativepowertoinfluencethecorporationsactivities.AsshowninFigure82,eachstake
holdergroupcanbeshowngraphicallybasedonitslevelofinterest(fromlowtohigh)inacorpo
rationsactivitiesandonitsrelativepower(fromlowtohigh)toinfluenceacorporationsactivities.
CHAPTER 8
FIGURE 82
255
Stakeholder
Priority Matrix
StakeholderInterestinCorporateActivities
High
Creditors
Shareholders
Local
Communities
Customers
Greenpeace
Federal
Government
Low
Low
RelativePowerofStakeholder
High
SOURCE:BasedonC.Anderson,ValuesBasedManagement,AcademyofManagementExecutive(November
1997),pp.2546.
Strategicmanagersshouldaskfourquestionstoassesstheimportanceofstakeholdercon
cernsinaparticulardecision:
1.Howwillthisdecisionaffecteachstakeholder,especiallythosegivenhighandmedium
priority?
2.Howmuchofwhateachstakeholderwantsisheorshelikelytogetunderthisalternative?
3.Whatarethestakeholderslikelytodoiftheydontgetwhattheywant?
4.Whatistheprobabilitythattheywilldoit?
Strategymakersshouldchoosestrategicalternativesthatminimizeexternalpressuresand
maximizetheprobabilityofgainingstakeholdersupport.Managersmay,however,ignoreor
takesomestakeholdersforgrantedleadingtoseriousproblemslater.TheTataGroup,forex
ample,failedtoconsidertheunwillingnessoffarmersinSingur,India,toaccepttheWestBen
galgovernmentscompensationforexpropriatingtheirlandsothatTatacouldbuilditsNano
autoplant.Farmersformedralliesagainsttheplant,blockedroads,andevenassaultedanem
ployeeofaTatasupplier.86
Topmanagementcanalsoproposeapoliticalstrategytoinfluenceitskeystakeholders.A
politicalstrategyisaplantobringstakeholdersintoagreementwithacorporationsactions.
Someofthemostcommonlyusedpoliticalstrategiesareconstituencybuilding,politicalac
tioncommitteecontributions,advocacyadvertising,lobbying,andcoalitionbuilding.Re
searchrevealsthatlargefirms,thoseoperatinginconcentratedindustries,andfirmsthatare
highlydependentupongovernmentregulationaremorepoliticallyactive. 87Politicalsupport
canbecriticalinenteringanewinternationalmarket,especiallyintransitioneconomieswhere
freemarketcompetitiondidnotpreviouslyexist.88
PressuresfromtheCorporateCulture
Ifastrategyisincompatiblewithacompanyscorporateculture,thelikelihoodofitssuccess
isverylow.Footdraggingandevensabotagewillresultasemployeesfighttoresistaradical
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changeincorporatephilosophy.Precedentsfromthepasttendtorestrictthekindsofobjectives
andstrategiesthatareseriouslyconsidered.89Theauraofthefoundersofacorporationcan
lingerlongpasttheirlifetimesbecausetheirvaluesareimprintedonacorporationsmembers.
Inevaluatingastrategicalternative,strategymakersmustconsiderpressuresfromthecor
poratecultureandassessastrategyscompatibilitywiththatculture.Ifthereislittlefit,man
agementmustdecideifitshould:
{
{
{
{
Takeachanceonignoringtheculture
Managearoundthecultureandchangetheimplementationplan
Trytochangetheculturetofitthestrategy
Changethestrategytofittheculture
Further,adecisiontoproceedwithaparticularstrategywithoutacommitmenttochange
thecultureormanagearoundtheculture(bothverytrickyandtimeconsuming)isdangerous.
Nevertheless,restrictingacorporationtoonlythosestrategiesthatarecompletelycompatible
withitsculturemighteliminatefromconsiderationthemostprofitablealternatives.(See
Chapter10formoreinformationonmanagingcorporateculture.)
NeedsandDesiresofKeyManagers
Eventhemostattractivealternativemightnotbeselectedifitiscontrarytotheneedsanddesires
ofimportanttopmanagers.Personalcharacteristicsandexperienceaffectapersonsassessment
ofanalternativesattractiveness.90Forexample,onestudyfoundthatnarcissistic(selfabsorbed
andarrogant)CEOsfavorboldactionsthatattractattention,likemanylargeacquisitionsre
sultingineitherbigwinsorbiglosses.91Apersonsegomaybetiedtoaparticularproposalto
theextentthatallotheralternativesarestronglylobbiedagainst.Asaresult,thepersonmayhave
unfavorableforecastsalteredsothattheyaremoreinagreementwiththedesiredalternative. 92
InastudybyMcKinsey&Companyof2,507executivesfromaroundtheworld,36%responded
thatmanagershide,restrict,ormisrepresentinformationatleastsomewhatfrequentlywhen
submittingcapitalinvestmentproposals.Inaddition,anexecutivemightinfluenceotherpeople
intopmanagementtofavoraparticularalternativesothatobjectionstoitareoverruled.Inthe
sameMcKinseystudyofglobalexecutives,morethan60%ofthemanagersreportedthatbusi
nessunitanddivisionalheadsformallianceswithpeersorlobbysomeonemoreseniorintheor
ganizationatleastsomewhatfrequentlywhenresourceallocationdecisionsarebeingmade. 93
Industryandculturalbackgroundsaffectstrategicchoice.Forexample,executiveswith
strongtieswithinanindustrytendtochoosestrategiescommonlyusedinthatindustry.Other
executiveswhohavecometothefirmfromanotherindustryandhavestrongtiesoutsidethe
industrytendtochoosedifferentstrategiesfromwhatisbeingcurrentlyusedintheir
industry.94Countryoforiginoftenaffectspreferences.Forexample,Japanesemanagerspre
feracostleadershipstrategymorethandoUnitedStatesmanagers. 95Researchrevealsthatex
ecutivesfromKorea,theU.S.,Japan,andGermanytendtomakedifferentstrategicchoicesin
similarsituationsbecausetheyusedifferentdecisioncriteriaandweights.Forexample,Ko
reanexecutivesemphasizeindustryattractiveness,sales,andmarketshareintheirdecisions;
whereas,U.S.executivesemphasizeprojecteddemand,discountedcashflow,andROI. 96
Thereisatendencytomaintainthestatusquo,whichmeansthatdecisionmakerscon
tinuewithexistinggoalsandplansbeyondthepointwhenanobjectiveobserverwouldrec
ommendachangeincourse.97Someexecutivesshowaselfservingtendencytoattributethe
firmsproblemsnottotheirownpoordecisionsbuttoenvironmentaleventsoutoftheircon
trol,suchasgovernmentpoliciesorapooreconomicclimate. 98Forexample,aCEOismore
likelytodivestapoorlyperformingunitwhenitspoorperformancedoesnotincriminatethat
sameCEOwhohadacquiredit.99Negativeinformationaboutaparticularcourseofaction
towhichapersoniscommittedmaybeignoredbecauseofadesiretoappearcompetentor
CHAPTER 8
257
becauseofstronglyheldvaluesregardingconsistency.Itmaytakeacrisisoranunlikelyevent
tocausestrategicdecisionmakerstoseriouslyconsideranalternativetheyhadpreviouslyig
noredordiscounted.100Forexample,itwasntuntiltheCEOofConAgra,amultinationalfood
productscompany,hadaheartattackthatConAgrastartedproducingtheHealthyChoiceline
oflowfat,lowcholesterol,lowsodiumfrozenfoodentrees.
PROCESS OF STRATEGIC CHOICE
ThereisanoldstorytoldatGeneralMotors:
Atameetingwithhiskeyexecutives,CEOAlfredSloanproposedacontroversialstrategicdeci
sion.Whenaskedforcomments,eachexecutiverespondedwithsupportivecommentsandpraise.
Afterannouncingthattheywereallinapparentagreement,Sloanstatedthattheywerenotgoing
toproceedwiththedecision.Eitherhisexecutivesdidntknowenoughtopointoutpotentialdown
sidesofthedecision,ortheywereagreeingtoavoidupsettingthebossanddisruptingthecohe
sionofthegroup.Thedecisionwasdelayeduntiladebatecouldoccurovertheprosandcons. 101
Strategicchoiceistheevaluationofalternativestrategiesandselectionofthebestalterna
tive.AccordingtoPaulNutt,anauthorityindecisionmaking,halfofthedecisionsmadebyman
agersarefailures.102Afteranalyzing400decisions,Nuttfoundthatfailurealmostalwaysstems
fromtheactionsofthedecisionmaker,notfrombadluckorsituationallimitations.Inthesein
stances,managerscommitoneormorekeyblunders:(1)theirdesireforspeedyactionsleadsto
arushtojudgment,(2)theyapplyfailurepronedecisionmakingpracticessuchasadoptingthe
claimofaninfluentialstakeholder,and(3)theymakepooruseofresourcesbyinvestigating
onlyoneortwooptions.Thesethreeblunderscauseexecutivestolimittheirsearchforfeasible
alternativesandlookforquickconsensus.Only4%ofthe400managerssetanobjectiveand
consideredseveralalternatives.Thesearchforinnovativeoptionswasattemptedinonly24%
ofthedecisionsstudied.103Anotherstudyof68divestituredecisionsfoundastrongtendency
formanagerstorelyheavilyonpastexperiencewhendevelopingstrategicalternatives. 104
Thereismountingevidencethatwhenanorganizationisfacingadynamicenvironment,
thebeststrategicdecisionsarenotarrivedatthroughconsensuswheneveryoneagreesonone
alternative.Theyactuallyinvolveacertainamountofheateddisagreement,andeven
conflict.105Manydiverseopinionsarepresented,participantstrustinoneanothersabilitiesand
competences,andconflictistaskoriented,notpersonal. 106Thisiscertainlythecaseforfirms
operatinginglobalindustries.Becauseunmanagedconflictoftencarriesahighemotionalcost,
authoritiesindecisionmakingproposethatstrategicmanagersuseprogrammedconflictto
raisedifferentopinions,regardlessofthepersonalfeelingsofthepeopleinvolved. 107Twotech
niqueshelpstrategicmanagersavoidtheconsensustrapthatAlfredSloanfound:
1.Devilsadvocate:TheideaofthedevilsadvocateoriginatedinthemedievalRoman
CatholicChurchasawayofensuringthatimpostorswerenotcanonizedassaints.One
trustedpersonwasselectedtofindandpresentallthereasonswhyapersonshouldnotbe
canonized.Whenthisprocessisappliedtostrategicdecisionmaking,adevilsadvocate
(whomaybeanindividualoragroup)isassignedtoidentifypotentialpitfallsandprob
lemswithaproposedalternativestrategyinaformalpresentation.
2.Dialecticalinquiry:Thedialecticalphilosophy,whichcanbetracedbacktoPlatoand
AristotleandmorerecentlytoHegel,involvescombiningtwoconflictingviewsthe
thesisandtheantithesisintoasynthesis.Whenappliedtostrategicdecisionmaking,
dialecticalinquiryrequiresthattwoproposalsusingdifferentassumptionsbegenerated
foreachalternativestrategyunderconsideration.Afteradvocatesofeachpositionpresent
anddebatethemeritsoftheirargumentsbeforekeydecisionmakers,eitheroneoftheal
ternativesoranewcompromisealternativeisselectedasthestrategytobeimplemented.
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Researchgenerallysupportstheconclusionthatthedevilsadvocateanddialecticalin
quirymethodsareequallysuperiortoconsensusindecisionmaking,especiallywhenthe
firmsenvironmentisdynamic.Thedebateitself,ratherthanitsparticularformat,appearsto
improvethequalityofdecisionsbyformalizingandlegitimizingconstructiveconflictandby
encouragingcriticalevaluation.Bothleadtobetterassumptionsandrecommendationsandto
ahigherlevelofcriticalthinkingamongthepeopleinvolved. 108
Regardlessoftheprocessusedtogeneratestrategicalternatives,eachresultingalternative
mustberigorouslyevaluatedintermsofitsabilitytomeetfourcriteria:
1.MutualExclusivity:Doinganyonealternativewouldprecludedoinganyother.
2.Success:Itmustbefeasibleandhaveagoodprobabilityofsuccess.
3.Completeness:Itmusttakeintoaccountallthekeystrategicissues.
4.InternalConsistency:Itmustmakesenseonitsownasastrategicdecisionfortheentire
firmandnotcontradictkeygoals,policies,andstrategiescurrentlybeingpursuedbythe
firmoritsunits.109
8.5
DevelopingPolicies
Theselectionofthebeststrategicalternativeisnottheendofstrategyformulation.Theorga
nizationmustthenengageindevelopingpolicies.Policiesdefinethebroadguidelinesforim
plementation.Flowingfromtheselectedstrategy,policiesprovideguidancefordecision
makingandactionsthroughouttheorganization.Theyaretheprinciplesunderwhichthecor
porationoperatesonadaytodaybasis.AtGeneralElectric,forexample,ChairmanJack
WelchinitiatedthepolicythatanyGEbusinessunitmustbeNumberOneorNumberTwoin
whatevermarketitcompetes.Thispolicygaveclearguidancetomanagersthroughouttheor
ganization.AnotherexampleofsuchapolicyisCaseysGeneralStorespolicythatanewser
viceorproductlinemaybeaddedtoitsstoresonlywhentheproductorservicecanbejustified
intermsofincreasingstoretraffic.
Whencraftedcorrectly,aneffectivepolicyaccomplishesthreethings:
{
{
{
Itforcestradeoffsbetweencompetingresourcedemands.
Itteststhestrategicsoundnessofaparticularaction.
Itsetsclearboundarieswithinwhichemployeesmustoperatewhilegrantingthemfree
domtoexperimentwithinthoseconstraints.110
Policiestendtoberatherlonglivedandcanevenoutlasttheparticularstrategythatcre
atedthem.ThesegeneralpoliciessuchasThecustomerisalwaysright(Nordstrom)or
Lowprices,everyday(WalMart)canbecome,intime,partofacorporationsculture.
Suchpoliciescanmaketheimplementationofspecificstrategieseasier.Theycanalsorestrict
topmanagementsstrategicoptionsinthefuture.Thusachangeinstrategyshouldbefol
lowedquicklybyachangeinpolicies.Managingpolicyisonewaytomanagethecorporate
culture.
CHAPTER 8
259
EndofChapterSUMMARY
Thischaptercompletesthepartofthisbookonstrategyformulationandsetsthestageforstrat
egyimplementation.Functionalstrategiesmustbeformulatedtosupportbusinessandcorpo
ratestrategies;otherwise,thecompanywillmoveinmultipledirectionsandeventuallypull
itselfapart.Forafunctionalstrategytohavethebestchanceofsuccess,itshouldbebuilton
adistinctivecompetencyresidingwithinthatfunctionalarea.Ifacorporationdoesnothavea
distinctivecompetencyinaparticularfunctionalarea,thatfunctionalareacouldbeacandi
dateforoutsourcing.
Whenevaluatingastrategicalternative,themostimportantcriterionistheabilityofthe
proposedstrategytodealwiththespecificstrategicfactorsdevelopedearlier,intheSWOT
analysis.Ifthealternativedoesnttakeadvantageofenvironmentalopportunitiesandcorpo
ratestrengths/competencies,andleadawayfromenvironmentalthreatsandcorporateweak
nesses,itwillprobablyfail.Developingcorporatescenariosandproformaprojectionsforeach
alternativearerationalaidsforstrategicdecisionmaking.Thislogicalapproachfits
Mintzbergsplanningmodeofstrategicdecisionmaking,asdiscussedearlierinChapter1.
Nevertheless,somestrategicdecisionsareinherentlyriskyandmayberesolvedonthebasis
ofonepersonsgutfeel.Thisisanaspectoftheentrepreneurialmodeandmaybeusedin
largeestablishedcorporationsaswellasinnewventurestartups.Variousmanagementstudies
havefoundthatexecutivesroutinelyrelyontheirintuitiontosolvecomplexproblems.Theef
fectiveuseofintuitionhasbeenfoundtodifferentiatesuccessfultopexecutivesandboard
membersfromlowerlevelmanagersanddysfunctionalboards. 111AccordingtoRalphLarsen,
ChairandCEOofJohnson&Johnson,Oftenthereisabsolutelynowaythatyoucouldhave
thetimetothoroughlyanalyzeeveryoneoftheoptionsoralternativesavailabletoyou.Soyou
havetorelyonyourbusinessjudgment.112Formanagerialintuitiontobeeffective,however,
itrequiresyearsofexperienceinproblemsolvingandisfoundeduponacompleteunderstand
ingofthedetailsofthebusiness.113
Forexample,whenBobLutz,PresidentofChryslerCorporation,wasenjoyingafastdrive
inhisCobraroadsteroneweekendin1988,hewonderedwhyChryslerscarsweresodull.I
feltguilty:thereIwas,thepresidentofChrysler,drivingthisgreatcarthathadsuchastrong
Fordassociation,saidLutz,referringtotheoriginalCobrasFordV8engine.ThatMonday,
LutzenlistedalliesatChryslertodevelopamuscular,outrageoussportscarthatwouldturn
headsandstoptraffic.Othersinmanagementarguedthatthe$80millioninvestmentwouldbe
betterspentelsewhere.ThesalesforcewarnedthatnoU.S.automakerhadeversucceededin
sellinga$50,000car.Withonlyhisgutinstinctstosupporthim,hepushedtheprojectforward
withunwaveringcommitment.TheresultwastheDodgeViperacarthatsinglehandedly
changedthepublicsperceptionofChrysler.Yearslater,Lutzhadtroubledescribingexactly
howhehadmadethiscriticaldecision.Itwasthissubconscious,visceralfeeling.Anditjust
feltright,explainedLutz.114
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ECO-BITS
InthetwodayperiodafterjoiningtheU.S.Environ
mentalProtectionAgencysvoluntaryClimateLeaders
initiative,whichrequiresmemberstoreduceoroffset
emissionsoverthenext5to10years,theaveragecom
panysstockpricedropped0.9%morethanitwould
havefromnormalmarketfactors.115
GeneralMotorsstatesthatitsfacilitiesrecycle89%of
thewastetheygenerateandthatGMisoneofthe
worldslargestindustrialusersofsolarpower.116
1.Arefunctionalstrategiesinterdependent,orcantheybe
formulatedindependentlyofotherfunctions?
2.Whyispenetrationpricingmorelikelythanskimpricing
toraiseacompanysorabusinessunitsoperatingprofit
inthelongrun?
3.Howdoesmasscustomizationsupportabusinessunits
competitivestrategy?
4.Whenshouldacorporationorbusinessunitoutsourcea
functionoranactivity?
5.Whatistherelationshipofpoliciestostrategies?
PierreOmidyarfoundedasoleproprietorshipinSeptember
1995calledAuctionWebtoallowpeopletobuyandsellgoods
overtheInternet.Thenewventurewasbasedontheideaofde
velopingacommunitydrivenprocess,whereanorganic,
evolving,selforganizingwebofindividualrelationships,
formedaroundsharedinterests,wouldhandletasksthatother
companieshandlewithcustomerserviceoperations.ByMay
1996,OmidyarhadaddedJeffSkollasapartnerandtheven
turewasincorporatedaseBay.Twoyearslater,Omidyarasked
MegWhitmantodirectcorporatestrategytocontinuetheac
celeratedgrowthrateofthecompany.Whitmanbroughttothe
companyglobalmanagementandmarketingexperienceand
soonbecamePresidentandCEO.Inalmostnotime,thecom
panybecameoneoftheWebsmostsuccessfulsites,with
233millionregisteredusers.By2007,theaverageeBayuser
spentnearlytwohoursamonthonthesitemorethanfive
timesthetimespentonAmazon.com.117
Whitmanexpandedthecompanysoperationsandspent
morethan$6billiontoacquirecompanies,suchasInternet
phoneoperationSkype,onlinepaymentsservicePayPal,
ticketresellerStubHub,propertyrentalandroommatesearch
firmRent.com,comparisonshoppingsiteShopping.com,
WebsiterecommenderStumbleupon,and25%interestin
Craigslist.Expansionanddiversificationprovidedrevenue
andprofitgrowthplusstockpriceappreciation.Althoughfi
nancialanalystswonderedhowallthesebusinesseswouldfit
together,WhitmanarguedthatshewantedeBaytobeevery
whereuserswantedtobe.Atdeveloperconferences,com
panyrepresentativesunveilednewservicesthatletbuyers
shopforandpurchaseeBayitemsoutsideofthecore
eBay.comsite.
By2008,eBaywasintrouble.Itsstockpricehadlosthalf
itsvalueoverthepastthreeyears.Thecoreauctionandretail
businesses,whichaccountedforthemajorityofrevenue,were
showingsignsofweakness.Thenumberofactiveusershad
beenflatforthreequarters,at83million.Thenumberofnew
productslistedonthesitehadincreasedonly4%fromthepre
viousyear.Thenumberofstoressellinggoodsatfixedprices
oneBaydeclinedfromayearearlierto532,000.Thecompany
hadnotdoneagoodjobofintegratingSkypewithitsmain
business.Sinceitsacquisition,Skypesservicehadactually
deteriorated.118CompetitionhadincreasedasrivalWebsites,
particularlyAmazon,nowprovidedsimilarWebservicesand
erodedeBayscompetitiveadvantage.
OnJanuary23,2008,CEOWhitmanannouncedthat
JohnDonahoewouldtakeoverasthecompanysCEO.Dona
hoestatedthathisfirstprioritywouldbetorevitalizeeBays
corebusiness,evenattheexpenseofinvestors.Weneedto
aggressivelychangeourproduct,ourcustomerapproach,and
ourbusinessmodel,announcedthenewCEO.119
1.WhatiseBaysproblem?
2.WhichmarketingstrategywaseBayfollowing:marketde
velopmentorproductdevelopment?Doyouagreewithit?
3.WhatdecisionmakingprocessshouldCEODonahoeuti
lizetomakethedecisionsnecessarytochangethecom
panysproduct,customerapproach,andbusinessmodel?
CHAPTER 8
261
KEY TERMS
consensus(p.257)
corporatescenarios(p.251)
devilsadvocate(p.257)
dialecticalinquiry(p.257)
financialstrategy(p.239)
functionalstrategy(p.238)
HRMstrategy(p.246)
informationtechnologystrategy(p.247)
leveragedbuyout(p.240)
logisticsstrategy(p.246)
marketdevelopment(p.238)
marketingstrategy(p.238)
offshoring(p.248)
operationsstrategy(p.242)
outsourcing(p.247)
politicalstrategy(p.255)
productdevelopment(p.238)
purchasingstrategy(p.244)
R&Dstrategy(p.241)
realoptions(p.254)
risk(p.253)
StakeholderPriorityMatrix(p.255)
strategicchoice(p.257)
technologicalfollower(p.241)
technologicalleader(p.241)
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266
PART 3
StrategyFormulation
EndingCaseforPartThree
KMART AND SEARS:
STILL STUCK IN THE MIDDLE?
OnJanuary22,2002,KmartCorporationbecamethe
largestretailerinU.S.historytoseekbankruptcyprotec
tion.InKmartspetitionforreorganizationunder
Chapter11oftheU.S.BankruptcyCode,Kmartman
agementannouncedthattheywouldoutlineaplanfor
repayingKmartscreditors,reducingitssize,andre
structuringitsbusinesssothatitcouldleavecourtpro
tectionasaviablecompetitorindiscountmassmarket
retailing.EmergingfrombankruptcyinMay2003,
Kmartstilllackedabusinessstrategytosucceedinan
extremelycompetitivemarketplace.
TheU.S.discountdepartmentstoreindustryhad
reachedmaturityby2004andKmartnolongerpos
sessedaclearlydefinedpositionwithinthatindustry.Its
primarycompetitorswereWalMart,Sears,Target,
Kohls,andJ.C.Penney,withsecondarycompetitorsin
certaincategories.WalMart,anextremelyefficientre
tailer,wasknownforconsistentlyhavingthelowest
costs(reflectedinlowprices)andthehighestsalesinthe
industry.HavingstartedinruralAmerica,WalMartwas
nowactivelygrowinginternationally.Sears,withthe
secondhighestannualsales,hadastrongpositionin
hardgoods,suchashomeappliancesandtools.Around
40%ofallmajorhomeappliancesalescontinuedtobe
controlledbySears.Nevertheless,Searswasstruggling
withslumpingsalesascustomersturnedfromSears
mallstorestostandalone,bigboxretailers,suchas
LowesandHomeDepot,tobuytheirhardgoods.Tar
get,thirdinsalesbutsecondinprofits,behindWal
Mart,haddistinguisheditselfasamerchandiserof
stylishupscaleproducts.AlongwithWalMart,Target
hadflourishedtosuchanextentthatDaytonHudson,its
parentcompany,hadchangeditscorporatenametoTar
get.Kohls,arelativelynewentranttotheindustry,op
erated420familyorientedstoresin32states.J.C.
Penneyoperatedmorethan1,000storesinall50states.
BothKohlsandJ.C.Penneyemphasizedsoftgoods,
suchasclothingandrelateditems.
Kmartwasalsochallengedbycategorykillers
thatcompetedinonlyoneorafewindustrycategories,
butingreaterdepthwithinanycategorythancouldany
departmentstore.SomeofthesewereToysRUs,
HomeDepot,Lowes,anddrugstoressuchasRiteAid,
CVS,Eckerd,andWalgreens.
Kmarthadbeenestablishedin1962byitsparent
companyS.S.Kresgeasadiscountdepartmentstoreof
feringthemostvarietyofgoodsatthelowestprices.Un
likeSears,thecompanychosenottolocateinlarge
shoppingmallsbuttoestablishitsdiscountstoresin
highlyvisiblecornerlocations.Duringthe1960s,70s,
and80s,Kmartprospered.By1990,however,when
WalMartfirstsurpassedKmartinannualsales,Kmarts
storeshadbecomedatedandlosttheirappeal.Other
wellknowndiscountstores,suchasKorvettes,Grants,
Woolco,Ames,Bradlees,andMontgomeryWard,had
goneoutofbusinessastheindustryhadconsolidatedand
reachedmaturity.Attemptingtoavoidthisfate,Kmart
managementupdatedandenlargedthestores,added
namebrands,andhiredMarthaStewartasitslifestyle
consultant.NoneofthesechangesimprovedKmartsfi
nancialsituation.Bythetimeitdeclaredbankruptcy,it
hadlostmoneyinfiveofthepast10years.
Outofbankruptcy,Kmartbecameprofitablepri
marilybyclosingorselling(toSearsandHomeDepot)
around600ofitsretailstores.Managementhadbeenun
abletoinvigoratesalesinitsstores.Declaredguiltyofin
sidertrading,MarthaStewartwenttoprisonjustbefore
the2004Christmasseason.Inasurprisemove,Edward
Lampert,KmartsChairmanoftheBoardandacontrol
lingshareholderofKmart,initiatedtheacquisitionof
SearsbyKmartfor$11billioninNovember2004.The
newcompanywastobecalledSearsHoldingsCorpora
tion.Eventhoughmanagementpredictedthatthecom
binedcompanyscostscouldbereducedby$500million
annuallywithinthreeyearsthroughsupplierandadmin
istrativeeconomies,analystswonderedhowthesetwo
strugglingfirmscouldeverbesuccessful.
Bytheendof2007,thestockofSearsHoldingshad
fallento111fromitspeakof195earlierintheyear.Like
manyretailers,bothSearsandKmartstruggledtoattract
shoppersinanovercrowdedindustryandaslumping
economy.SearsHoldingsdid,however,have$1.5bil
lionincash,asignificantadvantageduringleantimes,
andmorethanitsrivalsJ.C.Penney,Kohls,andMacys
combined.Thecompanysdebtloadwasonly25%of
ThiscasewaswrittenbyJ.DavidHungerforStrategicManagementand
BusinessPolicy,12theditionandforConceptsinStrategicManagement
andBusinessPolicy,12thedition.Copyright2008byJ.David
Hunger.Reprintedbypermission.Referencesavailableuponrequest.
CHAPTER 8
267
thetotalcapitalonitsbalancesheet,comparedto46%
forPenneysand53%forMacys.Italsohadsignificant
realestateassetsonitsbalancesheet.Forexample,
Searsownedoutright518ofits816locationsandmany
oftheKmartstoreswerelocatedinstripmallscloseto
largecities.Sincefewershoppingmallswerenowbeing
built,itwasbecominghardertofindspaceforbigbox
retailersinmetropolitanareas.
Themostrecentquarterlyresultsfor2007ofSears
Holdingsreportedthethirdstraightquarterofdeteriorating
profitmarginsandsamestoresales.Aftermonthsof
cuttingthenumberofemployeesandreducingother
expenses,industryanalystsfeltthattherewaslittleleftto
cut.Theywerealsoconcernedthatmanagementhadfailed
toinvestinstoreimprovements.SearsHoldingshadjust
launchedabidinNovember2007topurchaseRestoration
Hardware,ahomegoodsretailer.EventhoughRestora
tionHardwarewasalsofacingsluggishsales,itwas
thoughtthatSearsmanagementcouldusetheacquisition
tocreateanupscaleboutiquewithinitsstores.
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