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Strategy Formulation

Strategic Choice

Prof. Rushen Chahal

Strategic Choice
Selection of the Best Strategy
of the proposed strategy to deal with strategic factors developed earlier in SWOT analysis. Ability of each alternative to satisfy agreed-on objectives with the least resources and the fewest negative side affects.
Ability

Matching Key Factors to Formulate Alternative Strategies


Key Internal Factor
Excess working capacity (strength)

Key External Factor


20% annual growth in the cell phone industry (opportunity)

Resultant Strategy

Acquire Cellfone, Inc.

Insufficient capacity (weakness)

Exit of two major foreign + competitors form the = industry (opportunity)

Pursue horizontal integration by buying competitor's facilities

Strong R&D (strength)

Decreasing numbers of young adults (threat)

Develop new products for older adults Develop a new employee benefits package

Poor employee morale (weakness)

Strong union activity (threat)

Corporate Scenarios are pro forma balance sheets and income statements that forecast each alternative strategy and its various programs will likely have on division and corporate ROI
In survey of Fortune 500 firms, 84% reported using computer simulation models in strategic planning.

Constructing Corporate Scenarios 3 steps:


Use industry scenarios to develop a set of assumptions about the task environment. Develop common-size financial statements for the companys or business units previous years. Construct detailed pro forma financial statements for each strategic alternative

Industry Scenarios
Examine possible shifts in the societal variables globally. Identify uncertainties in each of the six forces of the task environment. Make a range of plausible assumptions about future trends. Combine assumptions about individual trends into internally consistent scenarios. Analyze the industry situation that would prevail under each scenario. Determine the sources of competitive advantage under each scenario. Predict competitors behavior under each scenario. Select the scenario that are either most likely to occur or most likely to have a strong impact on the future of the company.

Common-size financial statements


Use the historical common-size percentages to estimate the levels of revenues, expenses. Develop for each strategic alternative a set of optimistic, pessimistic, and most likely assumptions. Forecast three sets of sales and cost of goods sold figures for at least five years. Analyze historical data and make adjustments based on environmental assumptions listed earlier. Assume for other figures that they will continue in their historical relationship to sales or other key factor. Consider not only historical trends, but also programs that might be needed to implement each alternative strategy.

Common-size financial statements


Harley-Davidson income statement (fragment)
2004 Net revenue Cost of goods sold Selling, administrative and engineering expense Net income
5 015 190 3 115 655 62,1%

2002
4 090 970 2 673 129 65,3%

1999
2 452 939 1 617 253 65,9%

1996
1 350 466 939 067 69,5%

726 644 889 766

14,5% 17,7%

639 366 580 217

15,6% 14,2%

447 512 267 201

18,2% 10,9%

234 223 112 480

17,3% 8,3%

Z-Value
Altmans Bankruptcy Formula to calculate Z-value: Z= 1.2x1+1.4x2+3.3x3+0.6x4+1.0x5 x1 = Working capital/Total assets(%) x2 = Retained earnings/Total assets(%) x3 = Earnings before interest and taxes/Total assets(%) x4 = Market value of equity/Total liabilities(%) x5 = Sales/Total assets (number of times) A score bellow 1.81 indicates significant credit problems A score above 3.0 healthy firm

Index of Sustainable Growth


The index indicates how much of the growth rate of sales can be sustained by internally generated funds: g*= [P-(1-D)(1+L)]/[T-P(1-D)(1+L)] P= (Net profit before tax/Net sales) x 100 D= Target dividends/Profit after tax L= Total liabilities/Net worth T = (Total assets/Net sales) x 100 If planned growth rate is higher g*, external funds will be needed

Constructing Corporate Scenarios

The actual decision will probably be influenced by several subjective factors: Managements attitude toward risk Pressures from stakeholders Pressure from the corporate culture Needs and desires of key managers

Managements attitude toward risk


Risk is composed of: Probability that strategy will be effective Amount of assets the corporation must allocate to that strategy Length of time the assets will be unavailable for other users The small firms managed by entrepreneur is willing to accept greater risk than would a large firm of diversified ownership run by professional managers

Pressures from stakeholders


Main questions: How will this decision affect each stakeholder? How much of what each stakeholder wants are they likely to get under this alternative? What are they likely to do if they dont get what they want? What is the probability that they will do it? Strategy makers should be better to choose strategic alternatives that minimize external pressures and maximize the probability of gaining stakeholder support

Stakeholder Priority Matrix

8-14

Pressure from the corporate culture


If there is little fit of the strategy and corporate culture, management must decide if it should: Take a chance on ignoring the culture Manage around the culture and change the implementation plan Try to change the culture to fit the strategy Change the strategy to fit the culture.

Needs and desires of key managers


Even the most attractive alternative might not be selected if it is contrary to the needs and desires of top managers as: A persons ego may be tied to a particular proposal to the extent that all other alternatives lobbied against. Industry and cultural backgrounds affect strategic choice. Tendency to maintain status quo, which means that decision makers continue with existing goals and plans beyond the point when an objective observer would recommend a change in course.

Process of Strategic Choice


Strategic choice is evaluation of alternative strategies and selection of the best alternative. The best strategic decisions are not arrived at through consensus. They actually involve a certain amount of heated disagreement and even conflict.

Process of Strategic Choice

Process of Strategic Choice


Techniques to avoid consensus trap: Devils Advocate is assigned to identify potential pitfalls and
problems with a proposed alternative strategy.

Dialectical Inquiry requires two proposals using different


assumptions be generated for each alternative strategy. After advocates of each position present and debate the merits of their arguments either one of the alternatives or a new compromise alternative is selected.

Strategy shadow committee consists of employees at least


2-3 echelons bellow executive-level strategy committee

Process of Strategic Choice


Each resulting alternative must be evaluated due to four criteria: Mutual Exclusivity: Doing any one would preclude doing any other. Success: It must be doable and have a good probability of success. Completeness: It must take into account all the key strategic issues. Internal Consistency: It must make sense on its own as a strategic decision for the entire firm and not contradict key goals, policies, and strategies currently being pursued by the firm or its units.

Development of Policies
After selection of the best alternative the organization must now engage in developing policies. Policies define the board guidelines for implementation. Policies tend to be rather long lived even outlast the particular strategy that created them. The general policies can become part of corporate culture and make the implementation of specific strategies easier but can restrict managements strategic options in future. A change in strategy should be followed quickly by a change in policies.