Fiche cours – Strategic Management

Chapter 1 - The Concept of Strategy

The four factors of the Successful Strategy

Strategy as the Link between the Firm and its Environment

Strategic Fit
Strategic Fit refers to the consistency of a firm's strategy:
1. With the firm's external environment
2. With the firm's internal environment, especially with its goals, values, resources and
capabilities

A major reason for the decline and failure of some companies comes from their having a
strategy that lacks consistency with either the internal or the external environments.
The notion of “Internal Fit” is central to Michael Porter's conceptualization of the firm as an
”Activity System”.
Michael Porter states that “Strategy is the creation of a unique and differentiated position
involving a different set of activities.” The key is how these activities fit together to form a
consistent, mutually reinforcing system.

The purpose of Strategy

Achieving superior performance

• The purpose of strategy is to achieve superior performance
• Basic to this is the need to survive and to prosper, which in turn requires that over the
long term the firm earn a rate of return on its capital that exceeds its cost of capital
• There are two possible ways of achieving this:
1. By choosing to locate within industries where overall rates of return are attractive
(Corporate Strategy)
2. By attaining a position of advantage compared to its competitors within an
industry, allowing it to earn a return that exceeds the industry average (Business
Strategy)

Sources of Superior Profitability

Strategic choices can be distilled into two basic questions:
1. Where to compete?
2. How to compete?

Corporate Strategy : Includes choices over Diversification, Vertical Integration, Acquisitions,

and new ventures, and the allocation of resources between the different businesses of the
firm. Who is in charge? (Top) Corporate Managers

Business Strategy : Includes choices over establishing a Competitive Advantage over rivals.
Who is in charge? Division or BU Senior Managers
How do Corporate & Marketing Strategies relate?

Describing Strategy includes Current Positioning & Future Direction

Strategic Making: Design or Process?

In practice, “Strategy Making” involves both thought and action. The design aspect of
strategy comprises a number of organizational processes through which strategy is
deliberated, discussed, and decided. In larger companies these include board meetings and a
formalized process of strategic planning supplemented by more broadly participative events,
such as strategy workshops.

The decentralized, bottom-up process of strategy emergence often precedes more

formalized top-down strategy formulation. Very often “strategy making” combines design
and emergence - a process that is referred to as “planned emergence”. The balance between
the two depends greatly upon the stability and predictability of the organization's business
environment

As the business environment becomes more turbulent and less predictable, so strategy
making becomes less about detailed decisions and more about guidelines and general
direction.

Applying Strategy Analysis

Summary
The role of strategy in success
• Strategy important to the success of individuals and organizations
• Successful strategies embody clear goals; insight into the external environment;
appraisal of internal resources; sound implementation
The framework for strategy analysis
• Links the firm to its external environment
The evolution of strategic management
• Strategy was concerned with detailed planning; now its is about direction, identity,
and exploiting the sources of superior profitability
What is strategy? How do we describe it?
• Strategy describes where a firm is competing, how it is competing, and the direction
in which it is developing
How is strategy made?
• Through combining purposeful planning (rational design) and flexible responses to
changing circumstances (emergence).
Strategic management of not-for-profit organizations
• Most of the tools of strategy analysis are applicable

Chapter 2 - Goals, Values, and Performance

The Value Creation & Value - Maximization Process

How is value created?

Value can be created in two ways: by production and by commerce
• Production creates value by physically transforming products that are less valued by
consumers (material inputs) into products that are more valued by consumers
(Finished goods)
• Commerce/Trade creates value not by physically transforming products but by
repositioning them in space and time

The Value added is the difference between the value of a firm's output and the cost of its
material inputs:
Value Added = Sales revenue from output − Cost of material inputs
Profit & Profit maximization
Profit Maximization will be about Maximizing the benefits for the customers and thus
Maximizing the Value of the Firm.

How should we understand Profit maximization?

• Should we maximize “Total profit” or “Rate of profit” ?
• Accounting profit or Economic profit ?
 • Over what time period?
• What measure of profit?

ROS = Return on Sales (capacity to generate profit from Sales)

ROE = Return on Equity (capacity to generate profit from Equity)
ROA = Return on Assets (capacity to generate profit from Assets)
Types of Profit
1. Accounting Profit/loss (Net Income): profit after various explicit costs and expenses are
subtracted from total revenue (GAAP)

Explicit Costs include:

• Labor costs such as wages
• Inventory needed for production
• Raw materials
• Transportation costs
• Sales and marketing costs
• Production costs and overhead

Typically, accounting profit is reported on a quarterly and annual basis and is used to measure
the financial performance of a company.

2. Economic Profit/loss is the surplus available after deducting opportunity cost (or implicit
costs) from Accounting Profit

Implicit costs:
• Any cost associated with not taking a certain action
• Represent the opportunity cost the business has foregone as it has invested in its
existing, current project

They do not appear on financial statements as no transaction occurred. Typically, Economic

profit/loss is used to compare different business economic situations such as exiting or
entering a business or forgoing some strategic alternatives.

Why Economic Profit matters to Strategic Management?

Economic profit has two main advantages over Accounting profit as a performance measure:
• First, it sets a more demanding performance discipline for managers
• At many capital-intensive companies seemingly healthy profits disappear once cost of
capital is taken into account

Economic Value Added (EVA)

Helps looking for the most economically valuable project to pursue among several options:
EVA = Earnings – Opportunity Cost of Capital
Where Earnings is the Net Operating Profit After Taxes (NOPAT)
And where Opportunity Cost of Capital is: Invested Capital x WACC

Putting Performance Analysis into Practice

How do we apply these principles to appraise and develop business strategies?
There are four key areas where our analysis of profit performance can guide strategy:
1. Appraising a firm's current performance
2. Diagnosing the sources of poor performance
3. Selecting strategies on the basis of their profit prospects
4. Setting performance targets

If profit performance is unsatisfactory, we need to identify the sources of poor performance

so that management can take corrective action. The main tool of diagnosis is disaggregation
of ROA (or ROCE) in order to identify the fundamental value drivers (ROS & Capital turnover).

ROCE = Profit / Capital Employed

ROA = Profit / Assets

We can then further disaggregate both ROS and capital turnover into their component items.

Disaggregating ROA
Disaggregating ROCE

Strategy Formulation
• Performance Diagnosis of a firm provides a useful input into strategy formulation
• If we can establish why a company has been performing badly, then we have a basis
for Corrective Actions
• These corrective actions are likely to be both Strategic (with a medium to long-term
focus) and Operational (focused on the short term)
• The worse a company's performance the greater the need to concentrate on the
short term
Also, as the world of business is one of constant change and the role of strategy is to help the
firm to adapt to change. The challenge is to look into the future and identify factors that
threaten performance or create new opportunities for profit.

Role of Profit, Beyond and Above Profit

Although profitability is the most useful indicator of firm performance, shall we acknowledge
that firms are motivated by goals other than profit?
“Profits are to business as breathing is to life. Breathing is essential to life, but is not the
purpose for living. Similarly, profits are essential for the existence of the corporation, but
they are not the reason for its existence.” (Dennis Bakke)

Businesses set other goals than profit:

• Indeed, the pursuit of these alternative goals may be conducive to a superior
generation of profit
• “Profit as a goal” does not inspire organizational members to outstanding
achievement
• Moreover, for a firm to survive and generate profit over the long run requires
responsiveness and adaptability to its social, political, and natural environments

What is motivating many entrepreneurs?

There is more to business than only making a profit. For the entrepreneurs who create
business enterprises, personal wealth appears to be a less important motivation than the wish
for autonomy, the desire for achievement, and lust for excitement

Every business has a unique purpose—typically this reflects the motives of the entrepreneurs
who created these businesses.
➢ Common to every business enterprise: the desire & need to create value

Purpose as a Profit Drivers

In relation to profit maximization, setting profit targets may induce behavior that undermines
that goal's attainment.
➢ Lesson: Long-run profitability is achieved not by pursuing profit, but by pursuing the
factors that create profit.

While each of our individual companies serves its own corporate purpose, we share a
fundamental commitment to all of our stakeholders. We commit to:
• Delivering value to our customers with environmentally and socially sustainable
products and services
• Investing in our employees, fostering diversity and equal opportunities for all
• Dealing fairly and ethically with our suppliers
• Supporting the communities in which we work
• Generating long-term value for shareholders, who provide the capital that allows
companies to invest, grow and innovate
All this means setting and acting on emissions-reduction and other sustainability targets
that are science-based and meet the needs of all human society, not just those within the
corporate world.
Balanced Scorecard
The balanced scorecard methodology provides an integrated framework for “balancing
financial and strategic goals” and cascading performance measures down the organization to
individual BUs and departments. The performance measures included in the balanced
scorecard derive from answers to four questions:

1. How do we look to shareholders?

The financial perspective is composed of measures such as cash flow sales and income growth,
and Return on Equity.
2. How do customers see us?
The customer perspective comprises measures such as goals for new products, on-time
delivery, and defect and failure levels.
3. What must we excel at?
The internal business perspective relates to internal business processes such as productivity,
employee skills, cycle time, yield rates, and quality and cost measures.
4. Can we continue to improve and create value?
The innovation and learning perspective includes measures related to new product
development cycle times, technological leadership, and rates of improvement.

By balancing a set of Strategic and Financial goals, the scorecard methodology allows the
strategy of the business to be linked with the creation of shareholder value while providing a
set of measurable targets to guide this process

Moreover, because the balanced scorecard allows explicit consideration of the goals of
customers, employees, and other interested parties, scorecards can also be used to
implement.

Value for Whom? Shareholders vs Stakeholders

CSR
Strategic Management aims at helping organizations achieve long-term profitability.
But what about situations when the pursuit of profit conflicts with the social good or with
widely held ethical principles?

Efficacy Arguments for Corporate Social Responsibility

Michael Porter and Mark Kramer about the concept of “Shared Value” say that firms should
“ create economic value in a way which also creates value for society.” The benefits to the
firm include:
• By sustaining its natural and social environment, the firm improves its opportunities
for survival and growth Enhancing the firm’s reputation
• Endowing the firm with a license-to-operate

Conventional thinking suggests that:

• Producing more means more Pollution
• Safe & healthy workplace means higher cost so less profit

The new thinking suggests that businesses can make profit by helping solve social problems
by creating « Shared value ».
➢ Share Value = Creating benefit for customers and for Society (selling a product and
solving a social problem)

How are profits used?

Summary
1. Strategy as a quest for value
• Creating value is the core purpose of business, but value for whom: shareholders or
all stakeholders?
• For the purpose of strategy formulation is that it’s helpful to view firms as seeking to
maximize lifetime profits—or equivalently, enterprise value
2.Putting performance analysis into practice
• Starting point for strategy formulation is to appraise the firm’s current performance
and diagnose sources of underperformance
• Setting performance targets: better to target the drivers of long-term performance
than the performance indicators themselves
3.Beyond profit: values and corporate social responsibility
• Values and principles valuable in shaping an organization’s character and identity,
motivating employees, and reinforcing unity and direction
• CSR not only a goal in itself, it help a firm create long-term profit through
• Enhancing adaptability, reputation, and legitimacy

Chapter 3 Industry Analysis & Industrial Organization Economics

Industry represents Supply & Market represents Demand.

Strategic segmentation of an Industry Integrates Resources, Customers & Competitors

Market Segmentation involves pairing Customers with Products to better target needs.

Economies of scale

Input – Output relationships:

• Is generally about spreading the costs of inputs (resources) over larger volumes of
output
• In many activities, increases in output do not require proportionate increases in input
In R&D, new product development and advertising market leaders tend to have much lower
costs as a percentage of sales than their smaller rivals. When product development is very
costly, volume is essential to profitability.

Industry value chain

External Analysis

Layers of the business External Environment

The industry environment :

• The national/International economy
• Technology
• Government & Politics
• The natural environment
• Legal context
• Social & Demographic structure

The importance of the External Environment

Best CEOs are always aware of what’s going on outside their company. Their perceptual acuity
allows them to sense what’s coming. Perceptual acuity is the ability to sense what is coming
before the fog clears. Detecting early warning signals, keeping pace with changes in the
external. Environment can sustain a competitive advantage.
Environmental scanning involves surveillance of a firm’s external environment:
• Knowing the Mega-trends
• Looking for inflection points (downturns or growth)
• Detection of early signs of change (weak signals)

Goal: Considering different scenarios that strategic planning would take into Account

Environmental monitoring tracks some trends identified via the scanning activity: monitor the
trends that have the potential to change/impact your competitive landscape.

Competitive intelligence
• Helps firms define & understand their industry
 • Identifies rivals’ strengths & weaknesses
o Collect data on competitors
o Interpret intelligence data

• Helps firms avoid (competitive) surprises

o Anticipate competitors’ moves
o Decrease response time

But potential for unethical behavior while gathering intelligence.

Objectives of Industry Analysis

• To understand how industry structure drives competition, which determines the
level of industry profitability
• To assess industry attractiveness
• To use evidence on changes in industry structure to forecast future profitability
• To formulate strategies to change industry structure to improve industry profitability
• To identify Key Success Factors

Industry Analysis: How?

• The first stage of any industry analysis is to identify the key elements of the industry's
structure
It requires:
o identifying who are the main players: producers, the buyers, the suppliers of
inputs, and the producers of substitute goods
o distinguishing the key structural characteristics of each that will impact
competition and bargaining power

The Determinants of Industry Profitability

Some industries consistently earn high rates of profit, others fail to cover their cost of capital.
The level of industry profitability is neither random nor the result of entirely industry-specific
influences: it is determined by the systematic influences of the industry's structure.

3 key influences:
1. The value of the product to customers
2. The intensity of competition
3. Relative bargaining power at different stages of the value chain
The Spectrum of Industry Structures
• The Herfindahl-Hirschman Index (HHI) is a common measure of market
concentration and is used to determine market competitiveness, often pre and post-
M&A transactions
• The U.S. Department of Justice uses the HHI for evaluating potential mergers issues:
o HHI < 1,500 : competitive industry
o 1,500 < HHI < 2,500 : moderately concentrated
o HHI > 2,500 : highly concentrated

Michael Porter’s Five Forces of Competition

The Structural Determinants of Competition

Rivalry Between Established Competitors

The extent to which industry profitability is depressed by aggressive price competition
depends upon:
• Concentration (number and size distribution of firms)
• Diversity of competitors (cultures, goals, histories, and philosophies)
• Product differentiation

Cost conditions:
• Ratio of Fixed to Variable Costs
• Extent of scale economies (may encourage companies to compete aggressively on
price in order to gain the cost benefits of greater volume)
• Excess capacity (In Airline industry excess capacity drives to price war: Reflects low
variable costs of filling empty seats)
• Exit barriers (Specific assets, High capital investments)

As a general rule:
• if rivalry is intense and based on price, profitability will decrease
• if rivalry is based on features, differentiation, brand and service, then it can support
higher profitability
Bargaining Power of Buyers

Suppliers can exert bargaining power by threatening to raise prices or reduce the quality of
purchased goods and services. Supplier groups are powerful when:
• Only a few firms dominate the industry
• There is no competition from substitute products
• Suppliers sell to several industries
• Buyer quality is affected by industry product
• Products are differentiated & have switching costs
• Forward integration is possible

Threat of Substitutes
Substitute of products & services:
• Can perform the same function as the industry’s offerings
• Come from another industry
• Limit the potential returns of an industry

Substitutes place a ceiling on prices that firms in an industry can profitably charge.
The more attractive the price/performance ratio, the more the substitute erodes industry
profits:
• The price that customers are willing to pay for a product depends, in part, on the
availability of substitute products
• The absence of close substitutes for a product, as in the case of gasoline or cigarettes,
means that consumers are comparatively insensitive to price (demand is inelastic with
respect to price)
• The existence of close substitutes means that customers will switch to substitutes in
response to price increases for the product (demand is elastic with respect to price)

The internet has provided a new source of substitute competition that has proved
devastating for a number of established industries. Travel agencies, newspapers, and
telecommunication providers have all suffered severe competition from internet-based
substitutes.

Threat of New Entry

Entrants’ threat to industry profitability depends upon the height of barriers to entry.
The principal sources of barriers to entry are:
• Capital requirements
• Economies of scale
• Absolute cost advantage (ownership of low-cost inputs)
• Product differentiation (incumbents have established brand loyalty)
• Access to suppliers and/or distribution channels
• Legal and regulatory barriers
• Retaliation (by established firms)

How Digital technologies affect competitive forces?

Should governments intervene in corporate strategy decisions?

In a liberal economy, governments are expected to intervene in order to encourage or
discourage corporate behavior not strategy:
• Externalities (positive or negative impacts of corporate activities on society such as
pollution, CSR, …)
• Investment (provide subsidies to boost R&D in areas such as infrastructures,
techology, health, …)
• Regulating employment to prevent massive layoffs that would damage Economy
Identifying Key Success Factors

Summary
From Environmental Analysis to Industry Analysis
• The industry is the core of a firm’s external environment. Political, economic, social,
and technological forces impact the firm through its industry
Forecasting Industry Profitability
• Past profitability a poor indicator of future profitability
• If we can forecast changes in industry structure we can predict likely impact on
competition and profitability
Strategies to Improve Industry Profitability
• Influencing industry structure by individual or collective strategies
• Positioning the firm to shelter from the forces of competition
Defining Industry Boundaries
• Key criterion: substitution
• Industry definition depends upon the strategic issues being considered
Key Success Factors
• Gateway to the analysis of competitive advantage

Chapter 4 - Further Topics in Industry and Competitive Analysis

Competition as a Dynamic Process

Michael Porter’s framework assumes:
1. industry structure drives competitive behavior
2. Industry structure is (fairly) stable.
But, competition also changes industry structure:
• Schumpeterian Competition: A “perennial gale of creative destruction” – market
leaders overthrown by innovation
• Hypercompetition: it’s about intense and rapid competitive moves…. continuously
creating new competitive advantages and destroying existing competitive
advantages

Under dynamic competition: Industry attractiveness becomes irrelevant in industries where

great disparities exist between firms: the winner-takes-all.
Complementary products might play a major role (missing in the Porter’s forces)

Five Forces or Six? Introducing Complements

The suppliers of complements create value for the industry and can exercise bargaining
power. The presence of substitutes reduces the value of a product, complements increase its
value
• The essence of strategic competition is the interaction among players, such that the
decisions made by any one player are dependent on the actual and anticipated
decisions of the other players
• Game theory allows us to model this competitive interaction

The Contribution of Game Theory to Competitive Analysis

1. Frames strategic decisions as interactions between competitors
2. Predicts outcomes of competitive situations involving a few, evenly matched players
(duopolies)
3. Provides key insights into the nature and determinants of interactions among
competitors, for example:
o Competition and Cooperation: Game theory can show conditions where cooperation
is more advantageous than competition
o Deterrence: changing the payoffs in the game in order to deter a competitor from
certain actions
o Commitment: irrevocable deployments of resources that give credibility to threats
o Changing the structure of the game: changing the structure of the industry, increasing
the size of the market and overall profit potential
o Signaling: communication to influence a competitor's decision Game theory enables
to encompass both competition and cooperation. A key deficiency of the five forces
framework is in viewing interfirm relations as exclusively competitive in nature

Competitive Interactions: Cooperation

Forms of cooperation:
1. Formal collusive agreements or Cartel behavior (illegal)
2. Tacit collusion

Signs of Formal collusion as a result of coordination between sellers are:

• Equally distributed (and not varying) market-shares
• Lack of ad spending
Typically, competition results in inferior outcomes for participants than cooperation.
Competitive Interactions: Deterrence
The principle behind deterrence is to impose costs on the other players for actions deemed
to be undesirable.

Competitive Interactions: Commitment

For deterrence to be credible, it must be backed by commitment.

Competitive Interactions: Changing the structure of the game

• Creative strategies can change the structure of the competitive game
• A company may seek to change the structure of the industry within which it is
competing in order to increase the profit potential of the industry or to appropriate a
greater share of the available profit

Competitive Interactions: Signaling

Competitive reactions depend on how the competitor perceives its rival's initiative
• The term Signaling is used to describe the selective communication of information to
competitors (or customers) designed to influence their perceptions and hence
provoke or suppress certain types of reaction
• The Credibility of Threats is critically dependent on reputation
• The benefits of building a reputation for aggressiveness may be particularly great for
diversified companies where reputation can be transferred from one market to
another

How the Game Theory can help Strategic Management?

Game theory provides a set of tools that allows us to structure our view of competitive
interactions and to explore and understand the dynamics of competition
• However, in its empirical applications, game theory does a better job of explaining
the past than of predicting the future
• The application of game theory by US and European governments to design auctions
for wireless spectrum has even produced some undesirable and unforeseen results

How to predict future behavior of competitors?

• Competitive intelligence involves the systematic collection and analysis of
information about rivals for informing decision making
• It has three main purposes:
o Forecasting competitors' future strategies and decisions
o Predicting competitors' likely reactions to a firm's strategic initiatives
o Determining how competitors' behavior can be influenced to make it more favorable
• It is important to be informed about competitors: legitimate competitive intelligence
and illegal industrial espionage, distinction between public and private information
A Framework for Competitor Analysis

Chapter 5 - Analyzing Resources and Capabilities

The Links between Resources, Capabilities, and Competitive Advantage

Rationale for the Resource-based Approach to Strategy

As firms' industry environments have become unstable (since 1990s), internal resources and
capabilities rather than external market focus have been viewed as representing a more
secure base for formulating strategy and a more stable basis on which to define firm’s
identity.

The Resource-Based-View (RBV) of the firm has emerged as a key foundation for modern
strategy analysis (Wernerfelt). It has become increasingly apparent that capabilities rather
than industry attractiveness is the primary source of superior profitability.

The Resource-Based view (RBV) of the firm recognizes that each company possesses a unique
collection of resources and capabilities, key to its competitive advantage and profitability
Basing Strategy upon capabilities
In fast-moving, tech-based industries, basing strategy upon capabilities can help firms to
outlive the life-cycles of their initial products.

Dynamic Capabilities
• The ability of some firms (3M, IBM, Tata Group, NVIDIA) to repeatedly adapt to new
circumstances while others stagnate and die suggests that the capacity for change is
itself an organizational capability
• David Teece introduced the term “Dynamic Capabilities” to refer to a “firm's ability to
integrate, build, and reconfigure internal and external competences to address rapidly
changing environments”

Identifying Resources & Capabilities

• Drawing up an inventory of a firm's resources can be surprisingly difficult
• No such document exists within the accounting or management information systems
of most organization
• The balance sheet provides only a partial view of a firm's resources - it comprises
mainly financial and physical resources
• Our broader view of a firm's resources encompasses three main types of resource:
tangible, intangible, and human

Tangible resources
• The primary goal of resource analysis is to understand their potential for generating
profit
• This requires not just valuation but information on their composition and
characteristics. With that information, we can explore two main routes to create
additional value from a firm's tangible resources:
1. What opportunities exist for economizing on their use? Can we use fewer resources
to support the same level of business or use the existing resources to support a
larger volume of business?
2. Can existing assets be redeployed more profitably?

Intangible resources
• Intangible properties (IPs - Trademarks, Patents, Copyrights, Trade Secrets), inter-firm
relationship, management capabilities, Organizational culture, reputation with
suppliers for fairness and with customers for reliability and product quality
• For most companies, intangible resources are more valuable than tangible resources
• Yet, in companies’ balance sheets, intangible resources tend to be either
undervalued or omitted altogether
• The exclusion or undervaluation of intangible resources is a major reason for the
large and growing divergence between companies’ balance-sheet valuations (or
book values) and their stock-market valuations

Human resources
Human resources comprise the skills and productive effort offered by an organization's
employees.
Why don’t HR appear on balance sheet?
Human resources do not appear on the firm's balance sheet as the firm does not own its
employees; it purchases their services under employment contacts.
• Stability of employment relationships allows us to consider human resources as part
of the resources of the firm
• Most companies devote considerable effort to analyzing their human resources -
in hiring new employees, appraising their performance, and planning their
development
• The finding that psychological and social aptitudes are critical determinants of superior
work performance has fueled interest in emotional and social intelligence
• Hence the growing trend to “hire for attitude; train for skills.”

Classifying Capabilities: Michael Porter’s Value Chain Analysis

• Before deciding which organizational capabilities are “distinctive” or “core,” the firms
need to take a systematic survey of its capabilities
• Value Chain Analysis identifies a sequential chain of the main activities that the firm
undertakes
• Michael Porter's generic Value Chain distinguishes between primary activities (those
involved with the transformation of inputs and interface with the customer) and
support activities

Industry Value-Chain
Porter’s Value Chain

• Primary activities contribute to the physical creation of the product or service, its
sale and transfer to the buyer, and its service after the sale
• Support activities either add value by themselves or add value through important
relationships with both primary activities and other support activities

Michael Porter’s Value Chain - Primary activities

Michael Porter’s Value Chain - Secondary activities

Under what conditions Resource & Capabilities can help create Competitive Advantage?

Rationale for the Resource-based Approach to Strategy

A firm’s resources must be evaluated in terms of how valuable, rare, and hard they are for
competitors to duplicate. Otherwise, the firm attains only competitive parity.

Appraising the Strategic Importance of Resources and Capabilities

Strategically important resources and capabilities are those with the potential to generate
substantial streams of profit for the firm that owns them. This depends on three factors:
1. Their potential to establish a competitive advantage
2. To sustain that competitive advantage
3. To appropriate the returns from the competitive advantage

The Framework for Appraising: Resources and Capabilities

Deriving Strategy Recommendations from Resource/Capability Analysis

Exploiting Key Strengths:
• Target market/customer segments where core strengths have biggest impact, e.g.
Virgin America focuses on long-haul routes where its differentiated offering has
greatest customer
• Replicate in new locations, e.g. Disney theme parks in Tokyo, Paris, Hong Kong,
Shanghai
• Exploit key strengths by diversifying into new markets, e.g. Fuji Film entered
cosmetics to exploit capabilities in coatings, collagen, and nanotechnology

Key Weaknesses
• Invest in weaknesses - but (a) may require investment over a long period; (b) not
effective when weaknesses are based on deep-seated cultural factors
• Outsource to firms with strengths in these activities, e.g. Apple outsources
manufacturing to Foxconn
• Partner with firms with complementary resources and capabilities
• Target market/customer segments where core weaknesses have smallest impact,
e.g. Harley-Davidson’s technological weakness has encouraged its focus on retro-
styled, heavyweight cruiser bikes

Superfluous Strengths
• Seek innovative ways to exploit seemingly unimportant strengths
• Selective divestment
 Chapter 7: The Nature and Sources of Competitive
Advantage

The purpose of Strategy: Achieving superior performance

Basic to this is the need to survive and to prosper, which in turn requires that over the long
term the firm earn a rate of return on its capital that exceeds its cost of capital.
There are 2 possible ways of achieving this:
1. By choosing to locate within industries where overall rates of return are attractive
(Corporate Strategy)
2. By attaining a position of advantage vis-à-vis competitors within an industry,
allowing it to earn a return that exceeds the industry average (Business Strategy)
Sources of Superior Profitability

What is Competitive Advantage?

• Customer requirements and the nature of competition determine the key success
factors (KSFs).
• Potential for the firm’s resources and capabilities to establish and sustain competitive
advantage.
• Viewing competitive advantage as the result of matching internal strengths to external
success factors may convey the notion of competitive advantage as something static
and stable.
• When two or more firms compete within the same market, one firm possesses a
competitive advantage over its rivals when it earns a persistently higher rate of
profit.
As competition has intensified across almost all industries, very few industry environments
can guarantee secure returns. Hence, the primary goal of a strategy is to establish a position
of competitive advantage for the firm.

The Emergence of Competitive Advantage

1. The ability to anticipate changes in the external environment
2. As markets become more turbulent and unpredictable, quick-response capability has
become increasingly important as a source of competitive advantage
Sustaining Competitive Advantage

• Once established, competitive advantage is eroded by competition

• The speed with which competitive advantage is undermined depends on the ability
of competitors to challenge either by Imitation or Innovation
• Imitation is the most direct form of competition; thus, for competitive advantage to
be sustained over time, barriers to imitation must exist: Isolating Mechanisms
For one firm to successfully imitate the strategy of another firm, it must meet 4 conditions:
1. Identify the competitive advantage of a rival
2. Have an incentive to imitate
3. Be able to diagnose the sources of the rival’s competitive advantage
4. Be able to acquire the resources and capabilities necessary for imitation
Once established, Protect your Competitive Advantage Against Imitation

Michael Porter’s Generic Business Strategies

A firm can achieve a higher rate of profit (or potential profit) over a rival in one of two ways:
1. Supplying an identical product or service at a lower cost
2. Supplying a product or service that is differentiated in such a way that the customer
is willing to pay a Price Premium that exceeds the additional cost of the differentiation
By combining the two types of competitive advantage with the firm’s choice of scope - broad
market versus narrow segment - Michael Porter has defined three generic strategies: cost
leadership, differentiation, and focus.
Building Cost Leadership
If a firm can expand its output faster than its competitors, it can move down the experience
curve more rapidly and open up a widening cost differential.
Boston Consulting Group concluded that a firm’s primary strategic goal should be driving
volume growth through maximizing market share (considered as a source of value for the
firm).
Rule of 70
If growth rate is n%, the number of years to double cumulative production is:
Years = 70 / n.
The learning curve formula
A learning curve is geometric with the general form Y = a Xb

• Y = Cumulative average time per unit (or batch)

 • a = Time taken to produce initial quantity
• X = The cumulative units of production (or, if in batches, the cumulative number of
batches)
• b = The learning index, which is calculated as: log learning curve percentage ÷ log 2
Drivers of Cost Advantage

Impact of Cost leadership position on company Value-Chain

Outbound Marketing &
Firm Infrastructure HR Operations
Logistics Sales
Minimize costs associated
Few management layers
with employee turnover Effective use
to reduce overhead Sales-force
through effective policies. of quality Effective
costs. utilization is
control utilization of
maximized by
Effective orientation and inspectors to delivery
Standardized accounting territory
training programs to minimize fleets
practices to minimize management
maximize employee rework
personnel required.
productivity.

Pitfalls of Cost Leadership Strategies

• Too much focus on one or a few value-chain activities

• Vulnerable to price increases in the factors of production, Currency Exchange Rates
• Exposed to competitors from low-cost countries
• Imitation easier than differentiation
The Nature of Differentiation: Differentiation and Segmentation
Differentiation: concerns choices of how a firm distinguishes its offerings from those of its
competitors to obtain a price premium.

• Broad scope differentiation: Appealing to what is common between different

customers (McDonalds, Honda, Gillette)
 • Focused differentiation: Appealing to what distinguishes different customer groups
(MTV, Harley-Davidson, Armani)
Analysing Differentiation: The Demand Side

Analysing Differentiation on the Supply Side

• Product features and product performance

• Complementary services (such as credit, delivery, repair)
• Intensity of marketing activities (advertising; promotion)
• Technology embodied in design and manufacture
• Quality of purchased inputs
• Procedures that impact the customer experience
• Skill and experience of employees
• Location (e.g. with retail stores)
• Degree of vertical integration (allows control over inputs and intermediate processes)
Impact of differentiation position on company Value-Chain
Outbound Marketing &
Firm Infrastructure HR Operations
Logistics Sales
Programs to attract
Facilities that promote talented engineers and
firm image scientists Low defect Accurate and Creative and
rates to responsive innovative
Widely respected CEO Provision of training and improve order advertising
who enhances firm incentives to ensure a quality processing programs
reputation strong customer service
orientation

Blue Ocean vs. Red Ocean Strategy

Red Oceans represent all the industries in existence today, this is the known market space.
Here companies try to outperform their rivals to grab a greater share of existing demand.
Blue Oceans are defined by untapped market space, demand creation, and opportunity for
highly profitable growth.
Some Blue Oceans are created well beyond existing industry boundaries, most are created
from within Red Oceans by expanding existing industry boundaries.

Features of Cost Leadership and Differentiation Strategies

Strategy trade-offs
Strategy requires trade-offs. In choosing their particular kind of value proposition and the
activities needed to deliver it, these businesses have accepted a set of limits: they do not meet
all the needs of all customers.
Michael Porter recommends businesses to either go for a Cost Leadership or for a
Differentiation strategy and not become Straddlers, trying to adopt both positions at the
same time.
Costs, prices and profits for generic strategies
 Chapter 8 - Industry Evolution and Strategic Change
Strategy & Change
Major sources of change:
• Advancements in science and technology
• Globalization
• Climate change
• World demographics

Everything is in a state of constant change—the business environment especially

• One of the greatest challenges of strategic management is to ensure that the firm
keeps pace with changes occurring within its environment
• We have to recognize that predicting, anticipating, accepting and adapting to change
is not easy:
o For individuals change is disruptive, uncomfortable and stressful
o For businesses, there are sources of inertia that they have to overcome

Industry Evolution and Strategic Change

• Change in the industry environment is driven by the forces of technology, consumer
needs, politics, economic development, and a host of other influences
• For organizations the forces of inertia are even stronger: as a result, the life cycles of
firms tend to be much shorter than the life cycles of industries
• Changes at the industry level tend to occur through the death of existing firms and
the birth of new firms rather than through continuous adaptation by a constant
population of firms
• In some industries, forces for change combine to create massive, unpredictable
changes
o In telecommunications new digital and wireless technologies combined with
regulatory changes have resulted in an industry which in 2015 is almost
unrecognizable from that which existed 25 years ago
o In other industries - food processing, railroads, and car rental - change is more
gradual and more predictable

Change is not only the result of external forces: the competitive strategies of firms are key
drivers of change - industries are being continually re-invented by competition.
Understanding, even predicting change in an industry's environment is difficult. But an even
greater challenge is adapting to change.

Organizational Adaptation and Change: the Sources of Inertia, barriers to change

1. Organizational Routines: existing patterns of coordinated activity make it difficult
to develop new capabilities
2. Social & political structures: change threatens existing social relationships and
power structures
3. Conformity: imitation locks firms into common structures and strategies
(“institutional isomorphism”)
 4. Limited Search: Organizations tend to limit search to areas close to their existing
activities - they prefer exploitation of existing knowledge over exploration for new
opportunities
5. Complementarities between strategy, structure, and systems: firms create unique
configurations of close-fitting organizational features-localized changes tend to be
dysfunctional, while systematic change difficult

The Threat of Technological Change

Some types of technological change are more difficult for established firms to adapt to than
others:
• Competence Enhancing versus Competence Destroying Technological Change -
established firms will have difficulty in adjusting if the new technology requires
different resources and capabilities from those they already possess
• Architectural versus Component Innovation - established firms have greater difficulty
adjusting to innovations that involve a new product architecture than those that relate
to particular components
• Sustaining versus Disruptive Technologies - new technologies that augment existing
performance attributes are easier to adapt than those that incorporate different
performance attributes compared to existing technology

Managing Strategic Change: Dual Strategies and Organizational Ambidexterity

Combatting Organizational Inertia

• Creating Perceptions of Crisis - a crisis facilitates organizational change. If there’s no
crisis—create the perception of one!
• Establishing Stretch Targets - demanding performance targets can generate ambition
and mobilize effort
• Organizational Initiatives - initiatives launched by the CEO can be useful vehicles for
change e.g. Jack Welch at GE
• Reorganizing Company Structure - restructuring breaks down existing power bases
and creates openings for external hires
 • New Leadership - if an organization is performing poorly, an external CEO tends to be
more effective at leading change than an internal Appointment

Industry life cycle

• One of the best-known and most enduring marketing concepts is the product life cycle
• Products are born, their sales grow, they reach maturity, they go into decline, and
they ultimately die
• If products have life cycles, so the industries that produce them experience an
Industry life cycle

Drivers of industry evolution:

• Demand growth
• Creation and diffusion of knowledge

Product and Process Innovation Over Time

Evolution of Industry Structure over the Life Cycle

How Typical is the Life Cycle Pattern?

• Technology-intensive industries (e.g. pharmaceuticals, semiconductors, computers)
may retain features of emerging industries over time
• Other industries (especially those providing basic necessities, e.g. food processing,
construction, apparel) reach maturity, but not decline
• Life cycle model can help us to anticipate industry evolution—but dangerous to
assume any common, pre-determined pattern of industry development

Industry life cycles & Business Growth Strategies

Common Mistakes
1. Arrogance
2. Excessive Vertical integration (Let’s make everything by ourselves)
 3. Straddling (stuck in the middle): “Mid-range pricing strategy” favors low-cost
players to enter develop Market share in the low-end segment but also eroding
profits in the high-end segment
4. CEOs’ propensity to pay dividends

Business Life Cycle

Chapter 10: Vertical Integration and the Scope of the Firm

Corporate strategy is concerned with the scope of the firm

The dimensions of scope are:

• Vertical
• Geographical
• Product
The Scope of the Firm: Specialization versus Integration in the Packaging Industry
Vertical integration is a strategy that allows a company to streamline its operations by taking
direct ownership of various stages of its production process rather than relying on external
contractors or suppliers.
Diversification: In the case of Product Scope, should aluminium cans, plastic containers, and
paper cartons be produced by three separate companies or are there efficiencies from
merging all three into a single company?
Internationalization (Geographical Scope): Three independent companies producing cans in
the US, Brazil, and the European Union, or a single multinational company owning can-making
plants in all three countries?
Vertical Integration and the Scope of the Firm
Each stage of the vertical value chain typically represents a distinct industry in which a
number of different firms are competing.
Vertical Integration and the Scope of the Firm
The Capitalist Economy is frequently referred to as a Market Economy, however it actually
comprises two forms of economic organizations:
1. Market mechanism (also called price mechanism), where individuals and firms,
guided by market prices, make independent decisions to buy and sell goods and
services
2. Administrative mechanism (also called internal administration & coordination), where
decisions concerning production & resource allocation are made by managers and
carried out through hierarchies
The “Transaction Cost Theory” by O. Williamson (1985)
Transactions using the Markets mechanism are not costless, those Costs include the costs of
searching for a suitable supplier, monitoring the relationship, negotiation, drawing up
contracts, and monitoring and enforcing the terms of contracts.
Conversely, if an activity is internalized within a firm, then the firm incurs Management &
Administrative Costs.
Transaction Costs (TC) are the unobservable costs of using the price mechanism or internal
mechanisms for business transactions. Transaction costs are important to investors because
they are one of the key determinants of net returns. When transaction costs diminish, an
economy becomes more efficient, and more capital and labor are freed to produce wealth.
Transaction Cost Economics (TCE) provide a solid theoretical ground to:

• Analysing the choice of governance structures and organizational forms such as

wholly-owned subsidiaries, Joint Ventures, Strategic Alliances or contracts (licensing,
franchising)
• Acquiring the economic good for the lowest total cost
• Explaining how business models work
• Undertaking the most efficient economic exchange
The “Make or Buy” decision flow
Choosing the appropriate Governance Structure

Not only a matter of cost!

TCT analysis helps find the most efficient form of governance: Cost is central. Besides,
TCT does not consider the role of trust in a supplier-buyer relationship.
The Benefits of Vertical Integration
1. Technical economies from the physical integration of processes e.g., iron ore and
steel production

2. Avoids transactions costs of market contracts in situations where there are

a. Transaction-specific investments
b. High levels of opportunism and/or uncertainty
 c. Taxes and regulations on market transactions

3. Superior coordination and control over the value-chain

a. Greater control over product quality
b. Greater potential for trial and innovation

The challenges of Vertical Integration

1. While vertical integration avoids the transaction costs of using the market, it imposes
an administrative cost
2. Too much vertical integration inhibits development of distinctive capabilities
3. Difficulties of managing strategically different businesses
4. The Profit-incentive problems
5. Vertical integration limits flexibility
6. Compounding of risk
7. Investing in an Unattractive Business

“Make or Buy” decisions: Key Considerations