Strategic Management: Creating Competitive Advantages

Strategic Management: Creating Competitive Advantages
chapter 1

Learning Objectives After reading this chapter, you should have a good understanding of: LO1.1 The definition of strategic management and its four key attributes. LO1.2 The strategic management process and its three interrelated and principal activities. LO1.3 The vital role of corporate governance and stakeholder management as well as how “symbiosis” can be achieved among an organization’s stakeholders.

Learning Objectives After reading this chapter, you should have a good understanding of: LO1.4 The importance of social responsibility, including environmental sustainability, and how it can enhance a corporation’s innovation strategy. LO1.5 The need for greater empowerment throughout the organization. LO1.6 How an awareness of a hierarchy of strategic goals can help an organization achieve coherence in its strategic direction.

The Importance of Leadership
Consider… Maintaining competitive success or even surviving over long periods of time is difficult for companies of any size. SO how much credit (or blame) does a leader deserve? Introduces the concepts of romantic leadership vs the resource perspective.

Two Perspectives of Leadership
Romantic View External Control Perspective Leader is the key force in the organization’s success i.e. Steve Jobs External forces determine the organization’s success i.e. economic downturns Romantic view of leadership = situations in which the leader is the key force determining the organization’s success – or lack thereof. External control view of leadership = situations in which external forces – where the leader has limited influence – determine the organization’s success. OR?

Leaders can make a difference
Must be proactive - anticipate change Continually refine strategies Be aware of external opportunities and threats Thoroughly understand their firm’s resources and capabilities Make strategic management both a process and a way of thinking throughout the organization BUT leaders CAN make a difference.

Defining Strategic Management
Strategic Management involves Analysis Strategic goals (vision, mission, strategic objectives) Internal and external environment Decisions - Formulation What industries should we compete in? How should we compete in those industries? Actions - Implementation Allocate necessary resources Design the organization to bring intended strategies to reality Strategic management = the analyses, decisions, and actions an organization undertakes in order to create and sustain competitive advantages. Strategic management is the study of why some firms outperform others. Strategy = the ideas, decisions, and actions that enable a firm to succeed.

Two Fundamental Questions
How should we compete in order to create competitive advantages in the marketplace? How can we create competitive advantages in the marketplace that are unique, valuable, and difficult for rivals to copy or substitute? NOTE: Operational effectiveness is not enough to sustain a competitive advantage. Competitive advantage = a firm’s resources and capabilities that enable it to overcome the competitive forces in its industry(ies). Operational effectiveness = performing similar activities better than rivals; sustainable competitive advantage is possible only by performing different activities from rivals, or performing similar activities in different ways.

Strategic Management Key Attributes of strategic management
Directs the organization toward overall goals and objectives. Includes multiple stakeholders in decision making. Needs to incorporate short-term and long- term perspectives. Recognizes trade-offs between efficiency and effectiveness. Stakeholders = individuals, groups, and organizations who have a stake in the success of the organization, including owners (shareholders in a publicly held corporation), employees, customers, suppliers, and the community at large. Efficiency = performing actions at a low cost relative to a benchmark, or “doing things right”. Effectiveness = tailoring actions to the needs of an organization rather than wasting effort, or “doing the right thing”.

Strategic Management Trade-offs
Managers need to be ambidextrous Focusing on short-term efficiency Aligning resources to take advantage of existing product markets Focusing on long- term effectiveness Expanding product-market scope by proactively exploring new opportunities While also Ambidexterity = the challenge managers face of both aligning resources to take advantage of existing product markets as well as proactively exploring new opportunities.

Question? According to Henry Mintzberg, the realized strategies of a firm are a combination of deliberate and emergent strategies. are a combination of deliberate and differentiation strategies. must be based on a company’s strategic plan. must be kept confidential for competitive reasons. Answer: A. See pg Henry Mintzberg, a management scholar at McGill University, argues that viewing the strategic management process as one in which analysis is followed by optimal decisions and their subsequent meticulous implementation neither describes the strategic management process accurately nor prescribes ideal practice. He sees the business environment as far from predictable, thus limiting our ability for analysis. For a variety of reasons, the intended strategy rarely survives in its original form. Unforeseen environmental developments, unanticipated resource constraints, or changes in managerial preferences may result in at least some parts of the intended strategy remaining unrealized. Thus, the final realized strategy of any firm is a combination of deliberate and emergent strategies.

Intended vs Realized Strategies
The Business Environment is far from predictable. Intended Strategy Realized Strategy Organizational decisions are determined only by analysis Intended strategy rarely survives in its original form Decisions are determined by both analysis (deliberate) & unforeseen environmental developments, unanticipated resource constraints, and/or changes in managerial preferences (emergent) versus Intended strategy = strategy in which organizational decisions are determined only by analysis. Realized strategy = strategy in which organizational decisions are determined by both analysis and unforeseen environmental developments, unanticipated resource constraints, and/or changes in managerial preferences.

Strategic Management Process
The final realized strategy of any firm is a combination of deliberate and emergent strategies. Exhibit 1.2 Realized Strategy and Intended Strategy: Usually Not the Same Source: Mintzberg, H. & Waters, J.A., “Of Strategies: Deliberate and Emergent,” Strategic Management Journal, Vol. 6, 1985, pp Copyright © John Wiley & Sons Limited. Reproduced with permission.

Example: Failure of Intended Strategy
BORDERS bookstore focused on its intended strategy – a physical retail presence. Sticking to what you know best can be very dangerous. BORDERS found the consumer shift away from brick & mortar book stores to online book buying and digital books an overwhelming environmental force against which they had few defenses. Unanticipated developments can often have very negative consequences for businesses regardless of how well formulated their strategies are. See the Sidebar – Learning from Mistakes, at the beginning of the chapter.

Strategic Management Process
The Strategic Management Process involves strategy analysis, strategy formulation, and strategy implementation Exhibit 1.3 The Strategic Management Process

Strategy Analysis Starting point in the strategic management process
Precedes effective formulation and implementation of strategies Involves careful analysis of the overarching goals of the organization Requires a thorough analysis of the organization’s external and internal environment Strategy Analysis = study of firms’ external and internal environments, and their fit with organizational vision and goals. Consider using Case 1: Robin Hood, or Case 11: QVC to illustrate how the whole strategic management process works, starting with strategy analysis.

Strategy Analysis cont.
Analyzing Organizational Goals & Objectives Establish a hierarchy of goals Vision Mission Strategic Objectives Analyzing the External Environment of the Firm Managers must monitor & scan the environment as well as analyze competitors The General Environment The Industry Environment Chapter 1 = Analyzing Organizational Goals and Objectives Chapter 2 = Analyzing the External Environment of the Firm

Strategy Analysis cont.
Assessing the Internal Environment of the Firm Analyzing strengths & relationships among activities that constitute a firm’s value chain Can uncover potential sources of competitive advantage Assessing a Firm’s Intellectual Assets Knowledge workers & other intellectual assets drive competitive advantage & wealth creation Networks & relationships plus technology enhances collaboration, accumulates & stores knowledge Chapter 3 = Assessing the Internal Environment of the Firm Chapter 4 = Assessing a Firm’s Intellectual Assets

Strategy Formulation Based on strategy analysis
Developed at several levels Involves decisions that can create and sustain competitive advantage Investment decisions Commitment of resources Operational synergies Recognizing viable opportunities Strategy Formulation = decisions made by firms regarding investments, commitments, and other aspects of operations that create and sustain competitive advantage. Involves questions about what businesses to compete in, and how to manage these businesses in order to achieve synergy – how they can create more value by working together than by operating as stand-alone businesses.

Strategy Formulation cont.
Formulating Business-Level Strategy Successful firms develop bases for sustainable competitive advantage through Cost leadership and/or Differentiation, as well as Focusing on a narrow or industrywide market segment Formulating Corporate-Level Strategy Addresses a firm’s portfolio (or group) of businesses What business(es) should we compete in? How can we manage this portfolio of businesses to create synergies? Chapter 5 = Formulating Business-Level Strategy Chapter 6 = Formulating Corporate-level Strategy

Strategy Formulation cont.
Formulating International Strategy What is the appropriate entry strategy? How do we go about attaining competitive advantage in international markets? Entrepreneurial Strategy and Competitive Dynamics How do we recognize viable opportunities? How do we formulate effective strategies? Chapter 7 = Formulating International Strategy Chapter 8 = Entrepreneurial Strategy and Competitive Dynamics

Strategy Implementation
Implements the formulated strategy Ensures proper strategic control systems Establishes an appropriate organizational design - coordinates & integrates activities within the firm Coordinates activities with suppliers, customers, alliance partners Leadership ensures organizational commitment to excellence & ethical behavior Promotes learning & continuous improvement Acts entrepreneurially in creating new opportunities Strategy Implementation = actions made by firms that carry out the formulated strategy, including strategic controls, organizational design, and leadership.

Strategy Implementation cont.
Strategic Control & Corporate Governance Informational control Monitor & scan the environment Respond effectively to threats & opportunities Behavioral control Proper balance of rewards & incentives Appropriate cultures & boundaries (or constraints) Effective corporate governance Chapter 9 = Strategic Control and Corporate Governance

Creating Effective Organizational Designs Organizational structures must be consistent with strategy Organizational boundaries must be flexible & permeable Strategic alliances must capitalize on capabilities of other organizations Chapter 10 = Creating Effective Organizational Designs

Creating a Learning Organization & an Ethical Organization Effective leaders Set a direction Design the organization Develop an organization committed to excellence & ethical behavior Create a “learning organization” Benefit from individual & collective talents Chapter 11 = Creating a Learning Organization and an Ethical Organization

Fostering Corporate Entrepreneurship Firms must continually improve & grow Firms must find new ways to renew themselves Entrepreneurship & innovation provide for new opportunities Enhance a firm’s innovative capacity Allow autonomous entrepreneurial behavior Chapter 12 = Fostering Corporate Entrepreneurship

Corporate Governance & Stakeholder Management
Corporate Governance: the relationship among various participants in determining the direction and performance of corporations. Primary participants: The shareholders The management (led by the Chief Executive Officer) The Board of Directors (BOD) According to economist Milton Friedman, the overall purpose of a public corporation is to maximize the long-term return to the owners (shareholders). But who is really responsible for fulfilling this purpose?

Corporate Governance cont.
Board of Directors Elected representatives of the owners Ensure interests & motives of management are aligned with those of the owners Need an effective and engaged Board Shareholder activism Proper managerial rewards & incentives External control mechanisms The board of directors (BOD) provides detailed procedures for formal evaluation of directors and the firm’s top officers. Such guidelines serve to ensure that management is acting in the best interests of shareholders. Exhibit 1.4 The Key Elements of Corporate Governance

Stakeholder Management
In addition to shareholders, there are other stakeholders (e.g. suppliers, customers) who must be taken into account in the strategic management process. A stakeholder can be defined as an individual or group, inside or outside the company, that has a stake in and can influence an organization’s performance. Each stakeholder group makes various claims on the company. Stakeholder management = a firm’s strategy for recognizing and responding to the interests of all its salient stakeholders. Exhibit 1.5 An Organization’s Key Stakeholders & the Nature of Their Claims

Stakeholder Management
Two views of stakeholder management Zero Sum Symbiosis Stakeholders compete for attention & resources Gain of one is a loss to the other Stakeholders are dependent upon each other for success & well- being Receive mutual benefits OR? One example of how stakeholders can fulfill multiple roles is “crowdsourcing”. Crowdsourcing = practice wherein the Internet is used to tap a broad range of individuals and groups to generate ideas and solve problems. In this way, customers, employees, suppliers, industry watchdog groups (among others) can come together and receive mutual benefits.

Question? Outback Steakhouse has developed a sophisticated quantitative model and found that there were positive relationships between employee satisfaction, customer satisfaction, and financial results. According to the text, this is an example of ___________. zero-sum relationship among stakeholders stakeholder symbiosis rewarding stakeholders emphasizing financial returns Answer: B. There will always be conflicting demands on organizations. However, organizations can achieve mutual benefit through stakeholder symbiosis, which recognizes that stakeholders are dependent upon each other for their success and well-being.

Social Responsibility
Social responsibility: the expectation that businesses or individuals will strive to improve the overall welfare of society. Firms have multiple stakeholders and must go beyond a focus solely on financial results Firms must create shared value – identify & expand connections between societal & economic progress Firms can measure a triple bottom line Assessing financial, social, AND environmental performance Embracing environmental sustainability. Social responsibility recognizes that businesses must respond to society’s expectations regarding their obligations to society. Shared value = policies and operating practices that enhance the competitiveness of a company while simultaneously advancing the economic and social conditions in which it operates. Social responsibility is not just an added cost to business. Instead businesses are creators of value that they then share with society in a mutually beneficial relationship. Triple bottom line = assessment of a firm’s financial, social, and environmental performance – accounting for the environmental and social costs of doing business. Environmental sustainability implies an economy that the planet is capable of supporting indefinitely.

Example: Making Sustainability Profitable
Rapidly developing economies are often seen as sustainability laggards, due to weak regulatory bodies, resource shortages, competition from more industrialized countries & firms. Yet Sekem’s leadership had a vision: as Egypt’s first organic farm, of growing organic cotton. Sekem’s farming techniques reclaimed arable land from the Sahara, and decreased greenhouse gases. It also meant cotton needed 20%-40% less water. Responding to worldwide demand, from 2006 until the Arab Spring of 2011, Sekem improved cotton yields by 30%, & increased revenues by 14%. Sekem took the long-term view of strategy & it paid off. This story illustrates how visionary leadership plus an awareness of the triple bottom line – economic, environmental and social goals – can pay off. From “Making Sustainability Profitable”, by Knut Haanaes, David Michael, Jeremy Jurgens, & Subramanian Rangan, Harvard Business Review, March Executive Summary available at “Organic products were a luxury with little market to speak of when Ibrahim Abouleish founded Sekem, Egypt’s first organic farm, in Cairo in The years Sekem spent honing sustainable cultivation practices paid off, though, in 1990, when it moved into growing organic cotton. Organic produce was entering mainstream Western stores then, and worldwide demand for all things organic began to surge. There were other advantages to the organic approach as well: Sekem’s farming techniques helped reclaim arable land from the Sahara, which had been spreading into the Nile delta. With them, the soil absorbed more carbon dioxide from the atmosphere, decreasing greenhouse gases, and cotton crops needed 20% to 40% less water. In the bargain, organic techniques lowered the farm’s costs, improved average yields by almost 30%, and produced a raw cotton that was more elastic than its conventionally grown counterpart. So, far from being an expensive indulgence, organic cotton offered Sekem a business model that was more sustainable—not just environmentally but financially. In recent years that model has generated healthy revenue growth: From 2006 until the disruptions of the Arab Spring in 2011, the business posted 14% annual increases, and Sekem is now one of Egypt’s largest organic food producers.” “Rapidly developing economies are often portrayed as sustainability laggards—focused more on raising their citizens out of poverty than on protecting the environment. It’s true that their regulatory bodies can be weak, hesitant to impose restrictions on newly liberalized markets, or resentful of pressure from industrialized nations. But the developed world has never had a monopoly on visionaries, as Sekem’s story illustrates. And in markets where the pressures of resource depletion are felt most keenly, corporate sustainability efforts have become a wellspring of innovation…. many, like Sekem, took a long view, investing in initially more-expensive methods of sustainable operation that eventually led to dramatically lower costs and higher yields…. Collectively, these companies vividly demonstrate that trade-offs between economic development and environmentalism aren’t necessary. Rather, the pursuit of sustainability can be a powerful path to reinvention for all businesses facing limits on their resources and their customers’ buying power.”

Empowered Strategic Management
Strategic management requires an integrative view of the organization ALL functional areas & activities must fit together to achieve goals & objectives Leaders are needed throughout: Local line leaders – have profit & loss responsibility Executive leaders – champion & guide ideas Internal networkers – hold little positional power, but have conviction & clarity of ideas An organization can’t succeed if only the top managers in the organization take an integrative, strategic perspective of issues facing the firm and everyone else “fends for themselves” in their independent, isolated functional areas. Instead, people throughout the organization must strive toward overall goals. No longer can organizations be effective if the top “does the thinking” and the rest of the organization “does the work.” Everyone must be involved in the strategic management process.

Coherence in Strategic Direction
Organizations express priorities best through stated goals & objectives that form a hierarchy of goals Vision – evokes powerful & compelling mental images of a shared future Mission – encompasses the organization’s current purpose, basis of competition, & competitive advantage Strategic Objectives – operationalize the mission statement with specific yardsticks Hierarchy of goals = organizational goals ranging from, at the top, those that are less specific yet able to evoke powerful and compelling mental images, to, at the bottom, those that are more specific and measureable. A hierarchy of strategic goals can help an organization achieve coherence in its strategic direction. Vision = organizational goal(s) that evoke(s) powerful and compelling mental images, i.e. “Connecting the world through games” (Zynga), or “To be the happiest place on earth” (Disney) Mission statement = a set of organizational goals that include both the purpose of the organization, its scope of operations, and the basis of its competitive advantage. Strategic Objectives = a set of organizational goals that are used to operationalize the mission statement and that are specific and cover a well-defined time frame.

The hierarchy of goals has a relationship to two attributes: general versus specific (from vision to objectives), and time horizon (long-term to short-term). Exhibit 1.6 A Hierarchy of Goals

Organizational Vision A “massively inspiring” goal Overarching, long term A destination driven by & evoking passion Developed & implemented by leadership A fundamental statement of an organization’s values, aspirations, and goals Captures both the minds & hearts of employees Vision = organizational goal(s) that evoke(s) powerful and compelling mental images, i.e. “Connecting the world through games” (Zynga), or “To be the happiest place on earth” (Disney)

Organizational Visions can backfire The Walk Doesn’t Match the Talk Irrelevance Not the Holy Grail Too Much Focus Leads to Missed Opportunities An Ideal Future Irreconciled with the Present Walk doesn’t match the talk = idealistic vision can arouse employee enthusiasm but can be quickly dashed if employees find senior management’s behavior is not consistent with the vision. Irrelevance = vision created in a vacuum unrelated to environmental threats or opportunities, or not a match for organization’s resources & capabilities. Not the holy grail = managers continually search for the ONE elusive solution that will solve their firm’s problems. Too much focus = by directing people & resources toward a grandiose vision, losses can be devastating. Ideal future irreconciled with the present = visions should be anchored in current reality, need to account for the often hostile environment in which the firm competes.

Mission Statement States the purpose of the company & builds a common understanding of that purpose More specific than the vision Focused on the means by which the firm will compete Incorporates stakeholder management Communicates why an organization is special & different Can & should change when competitive conditions change Mission statement = a set of organizational goals that include both the purpose of the organization, its scope of operations, and the basis of its competitive advantage.

Strategic Objectives Used to operationalize the mission statement Provide guidance on how to fulfill mission & vision Are measurable, specific, appropriate, realistic & timely Can be short-term “action plans” Can be both financial and nonfinancial Should be challenging, yet help resolve conflicts Provide a yardstick for rewards & incentives Strategic Objectives = a set of organizational goals that are used to operationalize the mission statement and that are specific and cover a well-defined time frame. Short-term objectives can become essential components of a firm’s “action plan”, and therefore can be critical in implementing the firm’s chosen strategy. See Chapter 9 for more details. Also see Case 1: Robin Hood for an example!

Analyzing the External Environment of the Firm: Creating Competitive Advantages
chapter 2

Learning Objectives After reading this chapter, you should have a good understanding of: LO1.1 The importance of developing forecasts of the business environment. LO1.2 Why environmental scanning, environmental monitoring, and collecting competitive intelligence are critical inputs to forecasting. LO1.3 Why scenario planning is a useful technique for firms competing in industries characterized by unpredictability and change.

Learning Objectives After reading this chapter, you should have a good understanding of: LO1.4 How forces in the competitive environment can affect profitability, and how a firm can improve its competitive position by increasing its power vis- à-vis these forces. LO1.5 How the Internet and digitally based capabilities are affecting the five competitive forces and industry profitability. LO1.6 The concept of strategic groups and their strategy and performance implications.

The Importance of External Environment
Consider… If a company does not keep pace with changes in the external environment, it becomes difficult to sustain competitive advantages and deliver strong financial results. Recall the story of Borders’ demise in Chapter 1.

Creating the Environmentally Aware Organization
So how do managers become environmentally aware? By doing scanning, monitoring, and gathering competitive intelligence, and using these inputs to develop forecasts. Then scenario planning and SWOT analysis can be used to help anticipate major future changes in the external environment, preparing the firm to do more extensive analysis of the forces in the general environment and the industry or competitive environment. Exhibit 2.1 Inputs to Forecasting

Environmental Scanning & Monitoring
Environmental scanning involves surveillance of a firm’s external environment Predicts environmental changes to come Detects changes already under way Allows firm to be proactive Environmental monitoring tracks evolution of environmental trends Hard trends – measurable facts/events Soft trends – estimated, probable events Environmental scanning = surveillance of a firm’s external environment to predict environmental changes and detect changes already under way. Is a BIG PICTURE viewpoint of the industry/competition, looking for key indicators of emerging trends – what catches your eye? Alerts the firm to critical trends before changes have developed a discernible pattern and before competitors recognize them. Environmental monitoring = a firm’s analysis of the external environment that tracks the evolution of environmental trends, sequences of events, or streams of activities. Monitor the trends that have the potential to change the competitive landscape – what do you want to track? Firms need to CHOOSE the trends identified via the scanning activity, and regularly monitor or track these specific trends to evaluate the impact of these trends on their strategy process, i.e. Johnson & Johnson tracking % of GDP spent on health care, or # of active hospital beds. Hard trends = a projection based on measurable facts, events, or objects. It is something that WILL happen. Soft trends = something that MIGHT happen; and the probability with which it might happen can be estimated.

Competitive Intelligence
Helps firms define & understand their industry Identify rivals’ strengths & weaknesses Collect data on competitors Interpret intelligence data Helps firms avoid surprises Anticipate competitors’ moves Decrease response time Beware of the potential for unethical behavior while gathering intelligence Competitive intelligence = a firm’s activities of collecting and interpreting data on competitors, defining and understanding the industry, and identifying competitors’ strengths and weaknesses. Be careful - aggressive efforts to gather competitive intelligence may lead to unethical or illegal behaviors. Note Strategy Spotlight on Ethical Guidelines on Competitive Intelligence: United Technologies.

Example: Using Competitive intelligence
Startups have a disadvantage – it takes a lot of time to be ready for the market - someone else can get there first. How to find out if your competitor will beat you to launch? Do competitive intelligence: Monitor the competitor’s blog posts, blasts, the CEO's Twitter messages, changes to the LinkedIn profile Track the dates of each dispatch on a spreadsheet and look for patterns When the company’s chatter becomes more frequent, broadcasting more and more positive messages about its new product, "It led me to believe they were entering launch mode” so “we put together a limited version of our software and released it to get the Qworky name out first.” This story illustrates how a startup company can try to beat the competition with a new product launch. Seattle entrepreneur Mikal Lewis has an M.B.A. from Florida A&M and spent four years at Microsoft working in product planning and strategy. In 2011 he tried launch a company selling software - a Web application designed to improve company meetings. Although he was able to get the name, Qworky, in the press, the company never really got any traction. This demonstrates that competitive intelligence is important, but not sufficient for competitive success. See the story at – “How to use competitive intelligence to gain an advantage” by Burt Helm, April 2011, Inc. Magazine.

Environmental Forecasting
Environmental forecasting predicts change Plausible projections about Direction of environmental change? Scope of environmental change? Speed of environmental change? Intensity of environmental change? Scenario analysis involves detailed assessments of the ways trends may affect an issue & development of alternative futures based on these assessments Environmental forecasting = the development of plausible projections about the direction, scope, speed, and intensity of environmental change. Scenario analysis = an in-depth approach to environmental forecasting that involves experts’ detailed assessments of societal trends, economics, politics. technology, or other dimensions of the external environment. Asks what would happen if the environment should change dramatically? Addresses the need to consider a wider context than the narrow, traditional markets, laying down guidelines for at least 10 years in the future to anticipate rapid change.

Question? A danger of forecasting discussed in the text is that
in most cases, the expense of collecting the necessary data exceeds the benefit. forecasting’s retrospective nature provides little information about the future. managers may view uncertainty as “black and white” while ignoring important “gray areas”. it can create legal problems for the firm if regulators discover the company is making forecasts. Answer: C. Some forecasting issues are much more specific to a particular firm and the industry in which it competes. Consider how important it is for Motel 6 to predict future indicators, such as the number of rooms, in the budget segment of the industry. If its predictions are low, it will build too many units, creating a surplus of room capacity that would drive down room rates. A danger of forecasting is that managers may view uncertainty as black and white and ignore important gray areas. The problem is that underestimating uncertainty can lead to strategies that neither defend against threats nor take advantage of opportunities.

SWOT Analysis SWOT analysis is a basic technique for analyzing firm and industry conditions Firm or internal conditions = Strengths & Weaknesses Where the firm excels or where it may be lacking Environmental or external conditions = Opportunities & Threats Developments that exist in the general environment Activities among firms competing for the same customers Once environmental scanning, monitoring, intelligence gathering, and forecasting have been done, the firm must do a more in-depth analysis to see how all this affects its strategy. SWOT analysis = a framework for analyzing a company’s internal and external environment and that stands for strengths, weaknesses, opportunities, and threats. The firm’s strengths come from within, and are where your firm excels; while the weaknesses are where your firm is lacking relative to competitors. The opportunities and threats can come from the general environment and/or from the specific industry’s competitive environment.

SWOT Analysis SWOT analysis
Forces managers to consider both internal & external factors simultaneously Makes firms act proactively Raises awareness about role of strategy A firm’s strategy must build on its strengths, Remedy the weaknesses or work around them, Take advantage of the opportunities presented by the environment, and Protect the firm from the threats. SWOT’s conceptual simplicity is achieved without sacrificing analytical rigor. (However, see limitations of a SWOT in Chapter 3)

Example: SWOT Analysis
Southwest Airlines SWOT Strengths Strong culture, employee relationships Weaknesses Lack of cultural fit with new AirTran employees Opportunities Consolidation in the airline industry means more routes or acquisition targets might be available Threats Economic conditions/jet fuel prices might affect profitability in the future For more information, see Case 21 on Southwest Airlines.

The General Environment
The general environment is composed of factors that are both hard to predict and difficult to control: Demographic Sociocultural Political/Legal Technological Economic Global General environment = factors external to an industry, and usually beyond a firm’s control, that affect a firm’s strategy. Although the effects of these factors can vary across industries, EVERY industry has to anticipate the affect of each factor on its firm’s long-term strategies. See Exhibit 2.3 for effects of these various trends on certain industries. In addition, there are many reciprocal relationships among the various elements. For instance, the aging of the U.S. population has important implications for the economic segment.

The Demographic Segment
Demographics are easily understandable & quantifiable: Aging population Rising affluence Changes in ethnic composition Geographic distribution of population Greater disparities in income levels Demographic segment of the general environment = genetic and observable characteristics of a population, including the levels and growth of age, density, sex, race, ethnicity, education, geographic region, and income.

The Sociocultural Segment
Sociocultural forces influence the values, beliefs, and lifestyles of a society: More women in the workforce Dual-income families Increase in temporary workers Greater concern for healthy diets & physical fitness (increasing levels of obesity) Greater concern for the environment Postponement of marriage & family formation, having children Sociocultural segment of the general environment = the values, beliefs, and lifestyles of a society. These forces might enhance the sales of products and services in many industries but depress sales in others. For instance, increase of women in the workforce enhances the sale of women’s business attire (see Case 9: Ann Taylor) but reduces demand for backing products and cooking staples (see Case 33: Campbell Soup).

The Political/Legal Segment
Political/Legal processes & legislation influence environmental regulations with which industries must comply: Tort reform Americans with Disabilities Act (ADA) Deregulation of utilities & other industries Increases in minimum wages Taxation at local, state, federal levels Legislation on corporate governance reforms Affordable Health Care Act Political/legal segment of the general environment = how a society creates and exercises power, including rules, laws, and taxation policies. Federal legislation such as Sarbanes-Oxley and Dodd-Frank not only affected how corporations managed their corporate governance processes, but helped create new businesses such as professional accounting services. The Affordable Care Act (Obama-care) will have the same effect on health care delivery mechanisms. Any immigration reform will affect how businesses find and keep needed employees.

The Technological Segment
Technological developments lead to new products & services; can create new industries & alter existing ones: Genetic engineering Computer-aided design/computer-aided manufacturing systems (CAD/CAM) Research in synthetic & exotic materials Pollution/global warming Wireless communications Nanotechnology Technological segment of the general environment = innovation and state of knowledge in industrial arts, engineering, applied sciences, and pure science; and their interaction with society.

The Economic Segment Economic forces affect all industries:
Interest rates Unemployment Consumer Price Index Trends in GDP & net disposable income Changes in stock market valuations Economic segment of the general environment = characteristics of the economy, including national income and monetary conditions.

The Global Segment Global forces offer both opportunities & risks:
Increasing global trade Currency exchange rates Emergence of the Indian & Chinese economies Trade agreements among regional blocs (NAFTA, EU, ASEAN) Creation of WTO (leading to decreasing tariffs/free trade in services) Increased risks associated with terrorism Global segment of the general environment = influences from foreign countries, including foreign market opportunities, foreign-based competition, and expanded capital markets. Globalization provides both opportunities to access larger potential markets and a broad base of production factors such as raw materials, labor, skilled managers, and technical professionals. (See Heineken Case 10, or Case 13, eBay’s challenges in China.) However, such endeavors also carry many political, social, and economic risks.

The Competitive Environment
The competitive environment consists of factors in the task or industry environment that are particularly relevant to a firm’s strategy: Competitors (existing or potential) Including those considering entry into an entirely new industry Customers (or buyers) Suppliers Including those considering forward integration Competitive environment = factors that pertain to an industry and affect a firm’s strategies. Industry = a group of firms that produce similar goods or services. Forward integration = a form of vertical integration whereby a firm expands activities to include control of the direct distribution of its products, e.g. a farmer sells his/her crops at the local market rather than to a distribution center for eventual sale to a supermarket (This definition is not in the textbook, but comes from See more about vertical integration in Chapter 6. )

Porter’s Five-Forces Model of Industry Competition
Porter’s five-forces model of industry competition = a tool for examining the industry-level competitive environment, especially the ability of firms in that industry to set prices and minimize costs. Includes the threat of new entrants; the bargaining power of buyers; the bargaining power of suppliers; the threat of substitute products and services; the intensity of rivalry among competitors in an industry. Each of these forces affects a firm’s ability to compete in a given market. Together they determine the profit potential for a particular industry. Exhibit 2.4 Porter’s Five-Forces Model of Industry Competition Source: Adapted and reprinted with permission of The Free Press, a division of Simon & Schuster Adult Publishing Group, from Competitive Strategy: Techniques for Analyzing Industries and Competitors by Michael E. Porter. Copyright © 1980, 1998 by The Free Press. All rights reserved.

The Threat of New Entrants
The threat of new entrants - possibility that the profits of established firms in the industry may be eroded by new competitors. Depends on existing barriers to entry: Economies of scale Product differentiation Capital requirements Switching costs Access to distribution channels Cost disadvantages independent of scale Threat of new entrants = the possibility that the profits of established firms in the industry may be eroded by new competitors. Economies of scale = decreases in cost per unit as absolute output per period increases. Forces the new entrant to come in at a large scale and risk strong reaction from existing firms, or come in at a small scale and accept a cost disadvantage. Product differentiation = the degree that a product has strong brand loyalty or customer loyalty. New entrants must spend heavily to overcome existing customer loyalties. Switching cost = one-time costs that a buyer/supplier faces when switching from one supplier/buyer to another. In some industries, large financial resources or access to distribution channels are required in order to set up operations. Other advantages that existing competitors might have include proprietary products; favorable access to raw materials; government subsidies; or favorable government policies.

Question? If you are considering opening a new pizza restaurant in your community, what would be the threat of new entrants? How would you evaluate Porter’s other forces for this industry? Explain. Answer: The threat of new entrants in the food industry is very high, which is why a majority of new food restaurants fail within their first year. The minimum requirements to open a pizza shop are an oven and a small amount of capital. The potential number of competitors is unlimited due to these factors. Based on other forces also, this industry is not very attractive: for instance there is no industry growth, and a lack of differentiation among competitor’s products, so competition is based on cost or service, and the industry has low profit margins as it is.

The Bargaining Power of Buyers
Buyers have bargaining power: Buyers can force down prices, bargain for higher quality or more services, play competitors against each other. Buyer groups are powerful when: Purchasing standard products in large volumes Profits are low & switching costs are few Backward integration is possible Quality is not affected by industry product Bargaining power of buyers = the threat that buyers may force down prices, bargain for higher quality or more services, and play competitors against each other. Backward integration = A form of vertical integration that involves the purchase of suppliers. Companies will pursue backward integration when it will result in improved efficiency and cost savings. For example, backward integration might cut transportation costs, improve profit margins and make the firm more competitive. An example of backward integration would be if a bakery business bought a wheat processor and a wheat farm. An example of backward integration would be if a bakery business bought a wheat processor and a wheat farm. (Definition is not in the textbook. Comes from NOTE there’s a difference between customers/buyers, and CONSUMERS. Consumers rarely have any “buyer power” – can you negotiate the price of a movie ticket? Yet the chain of “buyers” in the movie industry is multi-layered – from production studio to distributor to theater owner., with each buyer group having different degrees of power. See Case 16, the Movie Exhibition Industry.

The Bargaining Power of Suppliers
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 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 Bargaining power of suppliers = the threat that suppliers may raise prices or reduce the quality of purchased goods and services. See Case 16, the Movie Exhibition Industry. Forward integration = a form of vertical integration whereby a firm expands activities to include control of the direct distribution of its products, e.g. a farmer sells his/her crops at the local market rather than to a distribution center for eventual sale to a supermarket (This definition is not in the textbook, but comes from )

The Threat of Substitute Products & Services
Substitute products & services limit the potential returns of an industry by placing a ceiling on the prices that firms can profitably charge. Substitutes come from another industry Can perform the same function as the industry’s offerings The more attractive the price/performance ratio, the more the substitute erodes industry profits. Threat of substitute products and services = the threat of limiting the potential returns of an industry by placing a ceiling on the prices that firms in that industry can profitably charge without losing too many customers to substitute products. Substitute products and services = products and services outside the industry that serve the same customer needs as the industry’s products and services. Example is ice cream – an expensive summer time treat. Frozen fruit smoothies are a substitute. See Case 17 Dippin’ Dots vs. Case 8 Jamba Juice.

The Intensity of Rivalry Among Competitors in an Industry
Rivalry tactics include price competition, advertising battles, new product introductions, increased customer service or warranties Interacting factors lead to intense rivalry: Numerous or equally balanced competitors Slow industry growth High fixed or shortage costs Lack of differentiation or switching costs Capacity augmented in large increments High exit barriers Intensity of rivalry among competitors in an industry = the threat that customers will switch their business to competitors within the industry. Rivalry occurs when competitors sense the pressure or act on an opportunity to improve their position. Rivalry differs across industries. See Case 5 the Casino Industry for cutthroat tactics.

How the Internet and Digital Technologies Affect Competitive Forces
The Internet = a global network of linked computers that use a common transmission format, exchange information and store date. The Internet and other digital technologies have fundamentally changed the ways businesses interact with each other and with consumers. These changes have affected industry forces in ways that have created many new strategic challenges.

Using Industry Analysis: A Few Caveats
Managers must not always avoid low profit industries – these can still yield high returns for players who pursue sound strategies Five forces analysis implicitly assumes a zero- sum game – yet mutually beneficial relationships can still be established with buyers & suppliers Five forces analysis is essentially a static analysis – yet external forces can still change the structure of all industries See the value net Vertical dimension = suppliers & customers Horizontal dimension = substitutes & complements Industry analysis helps a firm evaluate the profit potential of an industry and consider various ways to strengthen its competitive position. However, strategists must be wary – it’s not always simple. Zero-sum game = a situation in which multiple players interact, and winners win only by taking from other players. Complements = products or services that have an impact on the value of a firm’s products or services. For instance, Apple’s iTunes was software that made the iPod hardware such a popular product. See Case 6: Apple.

The Value Net Exhibit 2.6 The Value Net
The value net is based on game-theory, and represents all the players in the game, analyzing how their interactions affect a firm’s ability to generate and appropriate value. The vertical dimension of the net includes suppliers and customers. The firm has direct transactions with them. On the horizontal dimension are substitutes and complements, players with whom a firm interacts but may not necessarily transact. Yet complements are products or services that have a potential impact on the value of a firm’s own products or services. A firm must acknowledge its potential partnerships here. See the Strategy Spotlight 2.8 on Apple and the iPod. Exhibit 2.6 The Value Net Source: reprinted by permission of Harvard Business Review. Exhibit from “The Right Game: Use Game Theory to Shape Strategy,” by A. Brandenburger and B.J. Nalebuff, July-August Copyright © 1995 by the Harvard Business School Publishing Corporation. All rights reserved.

Doing a Good Industry Analysis
Good industry analysis looks rigorously at the structural underpinnings & root causes of profitability Must choose the appropriate time frame Consider the industry business life cycle Average profitability over 3-5 years or longer Must consider quantitative factors as well as qualitative Get numbers to quantify five forces factors Percentages of cost or sales, actual switching costs Michael Porter cautions that good industry analysis needs to yield an understanding of the structural underpinnings and root causes of profitability within the industry by choosing the appropriate time frame and doing a rigorous quantification of the five forces.

Strategic Groups Within Industries
Two unassailable assumptions in industry analysis: No two firms are totally different No two firms are exactly the same Strategic groups – clusters of firms that share similar strategies: Breadth of product & geographic scope Price/quality Degree of vertical integration Type of distribution Some groups of firms are more similar to each other than other firms. Rivalry will be greater in firms that are alike. Strategic groups = clusters of firms that share similar strategies. Dimensions should be considered that reflect the variety of strategic combinations in an industry.

Here is a strategic grouping of the worldwide auto industry. Note not all firms are included, only the four major groups: high-end luxury (those with exclusive clientele, and little rivalry from other groups), low-price/quality (those with a narrow market of bargain shoppers who aren’t that concerned with quality), high-price/quality (with some product-line breadth), and firms with a broad range of products/multiple price points (products that compete at both the lower end and higher end of the market). Consider how Ford (Case 32) and General Motors (Case 31) must monitor trends in this industry. The movement of the various strategic groups can help predict the future volatility and intensity of competition. Members of a strategic group can consider overcoming mobility barriers and migrate to other groups that they find attractive if they are willing to commit time and resources. (Also consider the Boston Beer Company Case 20 - which strategic group does Sam Adams belong to these days?!) Exhibit 2.7 The World Automobile Industry: Strategic Groups Note: Members of each strategic group are not exhaustive, only illustrative.

Strategic groups as an analytical tool Helps identify barriers to mobility that protect a group from attacks by other groups Helps identify groups whose competitive position may be marginal or tenuous Helps chart the future direction of firms’ strategies Helps to think through the implications of each industry trend for the strategic group as a whole The question is how to group firms in an industry on the basis of similarities in their resources and strategies. Identifying the strategic group your organization is in helps to decide where threats or opportunities may lie.

Assessing the Internal Environment of the Firm
chapter 3

Learning Objectives After reading this chapter, you should have a good understanding of: LO3.1 The benefits and limitations of SWOT analysis in conducting an internal analysis of the firm. LO3.2 The primary and support activities of a firm’s value chain. LO3.3 How value-chain analysis can help managers create value by investigating relationships among activities within the firm and between the firm and its customers and suppliers.

Learning Objectives LO3.4 The resource-based view of the firm and the different types of tangible and intangible resources, as well as organizational capabilities. LO3.5 The four criteria that a firm’s resources must possess to maintain a sustainable advantage and how value created can be appropriated by employees and managers. LO3.6 The usefulness of financial ratio analysis, its inherent limitations, and how to make meaningful comparisons of performance across firms. LO3.7 The value of the “balanced scorecard” in recognizing how the interests of a variety of stakeholders can be interrelated.

The Importance of the Internal Environment
Consider… Which activities must a firm effectively manage and integrate in order to attain competitive advantages in the marketplace? Which resources and capabilities must a firm create and nurture in order to sustain a competitive advantage? What if two firms compete in the same industry and both have many strengths in a variety of functional areas: marketing, operations, logistics, etc. However, one of these firms outperforms the other by a wide margin over a long period of time. How can this be? The value-creating activities that the firm manages well, and the bundles of resources and capabilities that the firm has created and nurtured over time are crucial to answering this question.

The Limitations of SWOT Analysis
Strengths may not lead to an advantage SWOT’s focus on the external environment is too narrow SWOT gives a one-shot view of a moving target SWOT overemphasizes a single dimension of strategy SWOT is a good starting point, but it doesn’t give enough guidance regarding the specific action steps needed to enact strategic change. For instance, a firm may have a capability that is a strength, but that, by itself, cannot create or sustain competitive advantage. It’s too easy to become preoccupied with a single dimension or element of what is, essentially, a moving target…MORE analysis is necessary, which is where the value chain comes in. See Strategy Spotlight 3.1

Value-Chain Analysis Value-chain analysis looks at the sequential process of value-creating activities Value is the amount buyers are willing to pay for what a firm provides How is value created within the organization? How is value created for other organizations in the overall supply chain or distribution channel? The value received must exceed the costs of production Value-chain analysis = a strategic analysis of an organization that uses value-creating activities. Value is the amount that buyers are willing to pay for what a firm provides them and is measured by total revenue, a reflection of the price a firm’s product commands, and the quantity it can sell. A firm is profitable when the value it receives exceeds the total costs involved in creating its product or service. Creating value for buyers that exceeds the costs of production (i.e. margin) is a key concept used in analyzing a firm’s competitive position.

Example: Streamlining the Value Chain
IBM & SAP have teamed up to help firms reduce value chain inefficiencies & improve operational effectiveness Benefits of value chain streamlining: Commonality between parts & suppliers Integration of sales forecasting & inventory management Lowered transaction, infrastructure & operating costs Deliver products to market faster When Philips Consumer Electronics needed to quickly improve customer satisfaction and business profitability, they looked to IBM to create a future-focused supply chain strategy. IBM launched a multifaceted initiative to address all process and infrastructure elements of the supply chain from procurement through manufacturing and order fulfillment. Best-in-class warehouse and transportation management were integrated in to Philip's SAP system: Production schedules now meet inventory specs—improving customer satisfaction while avoiding penalties for missed delivery dates. Savings in transportation and warehouse management is expected to exceed US$8M. Overall benefits include reducing operating costs by automating buy and supply processes. Increasing efficiency by integrating business processes such as sales forecasting and inventory management. Decreasing production cycle by building a responsive and flexible supply chain. See

Value-Chain Analysis Primary activities contribute to the physical creation of the product or service; the sale & transfer to the buyer; and service after the sale: Inbound logistics Operations Outbound logistics Marketing & sales Service Primary activities = sequential activities of the value chain that refer to the physical creation of the product or service, its sale and transfer to the buyer, and its service after sale, including inbound logistics, operations, outbound logistics, marketing and sales, and service.

Question? In assessing its primary activities, an airline would examine: Employee training programs Baggage handling Criteria for lease versus purchase decisions The effectiveness of its lobbying activities Answer: B – baggage handling involves transfer of service to buyer, and is part of airline operations

Value-Chain Analysis Support activities either add value by themselves or add value through important relationships with both primary activities & other support activities: Procurement Technology development Human resource management General administration Support activities = activities of the value chain that either add value by themselves or add value through important relationships with both primary activities and other support activities; including procurement, technology development, human resource management, and general administration.

The Value Chain To get the most out of value-chain analysis, view the concept in its broadest context, without regard to the boundaries of your own organization – place your organization within a more encompassing value chain that includes your firm’s suppliers, customers, and alliance partners. This helps identify how value is created for other organizations in the overall supply chain or distribution channel. For an interesting example, see Case 16: The Movie Exhibition Industry, or look at Case 31: General Motors (remember the strategic groups discussion from Chapter 2? What does GM have to do to compete with other groups in its industry? How important might the value chain be in this industry?) Exhibit 3.1 The Value Chain: Primary and Support Activities Source: Reprinted with permission of The Free Press, a division of Simon & Schuster Inc., from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1998 by The Free Press. All rights reserved.

Primary Activity: Inbound Logistics
Inbound logistics is primarily associated with receiving, storing & distributing inputs to the product: Material handling Warehousing Inventory control Vehicle scheduling Returns to suppliers Inbound logistics = receiving, storing, and distributing inputs of a product. Example = Toyota’s just-in-time (JIT) inventory systems where parts deliveries arrive at the assembly plants only hours before they are needed. This allows Toyota to fill a buyer’s new car order in just 5 days. Inbound logistics includes location of distribution facilities, design of material and inventory control systems, warehouse layout and design, and efficient systems to return products to suppliers.

Primary Activity: Operations
Operations include all activities associated with transforming inputs in to the final product form: Machining Packaging Assembly Testing or quality control Printing Facility operations Operations = all activities associated with transforming inputs into the final product form. Example = Shaw Industries’ ability to reduce expenses associated with the disposal of dangerous chemicals used in the manufacture of floor coverings. Operations includes assessment of efficiency of plant operations, incorporation of appropriate process technology, efficient plant layout and workflow design, degree of automation, extent of appropriate quality control systems.

Primary Activity: Outbound Logistics
Outbound logistics includes collecting, storing, & distributing the product or service to buyers: Finished goods Warehousing Material handling Delivery vehicle operation Order processing Scheduling & distribution Outbound logistics = collecting, storing, and distributing the product or service to buyers. Example = Campbell Soup uses an electronic network so retailers can inform Campbell of product needs and inventory levels. This allows Campbell to forecast future demand and determine which products to replenish, delivering inventory the same day. The retailer gains efficiency, and therefore has an incentive to carry a broader line of Campbell products. Outbound logistics includes effective shipping processes to provide quick delivery and minimize damages, efficient finished goods warehousing processes, the ability to ship goods in large lot sizes to minimize transportation costs, and the use of quality material handling equipment. (See also Case 33: Campbell Soup)

Primary Activity: Marketing & Sales
Marketing & sales activities involve purchases of products & services by end users and includes how to induce buyers to make those purchases: Advertising Promotion Sales force management Pricing & price quoting Channel selection Channel relations Marketing and sales = activities associated with purchases of products and services by end users and the inducements used to get them to make purchases. Example = the BMW supercar used in the Mission Impossible: Ghost Protocol movie got premiere “product placement” as Tom Cruise drove it in a race through Mumbai traffic. Marketing and sales includes the development of a highly motivated and competent sales force, innovative approaches to promotion and advertising, selection of the most appropriate distribution channels, proper identification of customer sergments and needs, and effective pricing strategies.

Primary Activity: Service
Service includes all actions associated with providing service to enhance or maintain the value of the product: Installation Repair Training Parts supply Product adjustment Service = actions associated with providing service to enhance or maintain the value of the product. Example = Nordstrom service reps can take control of the customer’s Web browser and lead her to the specific product she wants. Service includes effective use of procedures to solicit customer feedback and to act on information, quick response to customer needs and emergencies, ability to furnish replacement parts, effective management of parts and equipment inventory, quality of service personnel and ongoing training, and warranty and guarantee policies.

Support Activity: Procurement
Procurement involves how the firm purchases inputs used in its value chain: Procurement of raw material inputs Optimizing quality & speed Minimizing associated costs Development of collaborative win-win relationships with suppliers Analysis & selection of alternative sources of inputs to minimize dependence on one supplier SUPPORT ACTIVITIES are those functions that support the value chain – each industry might have distinct value activities that are unique to that industry, but here are some common ones. Procurement = the function of purchasing inputs used in the firm’s value chain, including raw materials, supplies, and other consumable items as well as assets such as machinery, laboratory equipment, office equipment, and buildings. Example = Microsoft does formal reviews of its outside suppliers, including a feedback system that helps clarify expectations. LG electronics centralized purchasing decisions for all divisions, and gained substantial cost savings over competitors. See Strategy Spotlight 3.3. In addition to the above activities, procurement includes effective procedures to purchase advertising and media services, and the ability to make proper lease versus buy decisions.

Support Activity: Technology Development
Technology development is related to a wide range of activities: Effective R&D activities for process & product initiatives Collaborative relationships between R&D and other departments State-of-the-art facilities & equipment Excellent professional qualifications of personnel Organizational culture to enhance creativity & innovation Technology development = activities associated with the development of new knowledge that is applied to the firm’s operations. The array of technologies employed in most firms is very broad, ranging from technologies used to prepare documents and transport goods, to those embodied in processes and equipment or the product itself. Technology development related to the product and its features supports the entire value chain, while other technology development is associated with particular primary or support activities. Example = Honeywell merger with Allied Signal brought together 13,000 scientists and an $870 million R&D budget to create innovative performance materials and control systems. Technology development includes activities related to the process as well as the product, such as enhancing the ability to meet critical deadlines.

Support Activity: Human Resource Management
Human resource management consists of activities involved in recruitment, hiring, training & development, & compensation of all types of personnel: Effective employee retention mechanisms Quality relations with trade unions Reward & incentive programs to motivate all employees Human resource management = activities involved in the recruiting, hiring, training, development and compensation of all types of personnel. It supports both individual primary and support activities such as the hiring of engineers and scientists, as well as supporting the entire value chain through activities such as negotiations with labor unions. Example = JetBlue recruited flight attendants with a one-year contract so they could travel, meet lots of people, then decide what else they might like to do. Human resource management includes creating a quality work environment to maximize overall employee performance and minimize absenteeism.

Support Activity: General Administration
General administration involves Effective planning systems to attain overall goals & objectives Excellent relations with diverse stakeholder groups Effective information technology to coordinate & integrate value-creating activities across the value chain Ability of top management to anticipate & act on key environmental trends & events, create strong values, culture & reputation General administration = general management, planning, finance, accounting, legal and government affairs, quality management, and information systems; activities that support the entire value chain and not individual activities. These activities can be among the most important activities for competitive advantage. Example = how a telephone operating company effectively negotiates and maintains ongoing relations with regulatory bodies. General administration also includes, for instance, the ability to obtain low-cost funds for capital expenditures and working capital.

Interrelationships Among Value-Chain Activities
Managers must not ignore the importance of interrelationships among value-chain activities Interrelationships among activities within the firm Relationships among activities within the firm and with other stakeholders such as customers & suppliers Interrelationships = collaborative and strategic exchange relationships between value-chain activities either (a) within firms or (b) between firms. Strategic exchange relationships involve exchange of resources such as information, people, technology, or money that contribute to the success of the firm. Example = within the firm, how CarMax’s proprietary information system tracks car inventory with every car test drive and purchase. See Strategy Spotlight 3.4. Example = between the firm and stakeholders, how Proctor & Gamble involved customers and suppliers in growing its fragrance business through a “prosumer” or crowdsourcing relationship.  Expand the value chain by exchanging resources

Example: The Value Chain in Service Organizations
The value chain might be configured differently depending on the type of business a firm is engaged in. For instance a travel agent adds value by creating an itinerary that includes transportation, accommodations, and activities customized to the client’s budget and travel dates, while a law firm provides services specific to the client’s circumstances. Both involve work “operations” dependent on the application of specialized knowledge based on the specifics, the “inputs” of the situation, and the outcome, the “output” the client desires. In retail, a firm adds value by developing expertise in the procurement of finished goods and by displaying these goods in stores in a way that enhances sales. Therefore procurement is a primary activity rather than a support activity. In an engineering services firm, research and development are primary activities, providing inputs to the engineering process, while innovative designs are the outputs. How the primary and support activities of a given firm are configured and deployed will often depend on industry conditions and whether the company is service and/or manufacturing oriented. (For more discussion in a service context, see Case 34: United Way) Exhibit 3.4 Some Examples of Value Chains in Service Industries

Resource-Based View of the Firm
The resource-based view of the firm (RBV) Combines an internal analysis of phenomena within a company With an external analysis of the industry & its competitive environment Resources can lead to a competitive advantage If they are valuable, rare, hard to duplicate When tangible resources, intangible resources, & organizational capabilities are combined A firm’s strengths and capabilities – no matter how unique or impressive – do NOT necessarily lead to a competitive advantage. Resource-based view of the firm = perspective that firms’ competitive advantages are due to their endowment of strategic resources that are valuable, rare, costly to imitate, and costly to substitute. Without these unique resources, the firm can only attain competitive parity. RBV goes beyond a SWOT analysis to integrate internal and external perspectives in a broader competitive context. RBV can reveal how core competencies embedded in a firm can help it exploit new product and market opportunities.

Types of Firm Resources
Tangible resources are assets that are relatively easy to identify: Physical assets: plant & facilities, location, machinery & equipment Financial assets: cash & cash equivalents, borrowing capacity, capacity to raise equity Technological resources: trade secrets, patents, copyrights, trademarks, innovative production processes Organizational resources: effective planning processes & control systems Firm resources are all assets, capabilities, organizational processes, information, knowledge, etc. controlled by a firm – resources that enable it to develop and implement value-creating strategies.Tangible resources = organizational assets that are relatively easy to identify, including physical assets, financial resources, organizational resources, and technological resources. These include assets that the firm uses to create value for its customers: physical resources such as the plant’s proximity to customers and suppliers; financial resources such as accounts receivables; organizational resources such as employee development, evaluation and reward systems; technological resources such as trade secrets and patents.

Intangible resources are difficult for competitors to account for or imitate – are embedded in unique routines & practices: Human resources: trust, experience & capabilities of employees; managerial skills & effectiveness of work teams Innovation resources: technical & scientific expertise & ideas; innovation capabilities Reputation resources: brand names, reputation for fairness with suppliers; reliability & product quality with customers Intangible resources = organizational assets that are difficult to identify and account for, and are typically embedded in unique routines and practices, including human resources, innovation resources, and reputation resources. Example = Harley-Davidson’s strong brand image. A firm’s specific practices and procedures, and the firm’s culture, may also be resources that provide competitive advantage.

Organizational capabilities are competencies or skills that a firm employs to transform inputs into outputs; the capacity to combine tangible & intangible resources to attain desired ends Outstanding customer service Excellent product development capabilities Superb innovation processes & flexibility in manufacturing processes Ability to hire, motivate, & retain human capital Organizational capabilities = the competencies and skills that a firm employs to transform inputs into outputs. Capabilities involve an organization’s capacity to deploy tangible and intangible resources over time and generally in combination, and to leverage those capabilities to bring about a desired end. Example = Apple’s ability to combine and package technological components in new and innovative ways while also seeking to integrate the value chain. See Case 6: Apple.

Question? Gillette combines several technologies to attain unparalleled success in the wet shaving industry. This is an example of their tangible resources. intangible resources. organizational capabilities. strong primary activities. Answer: C, organizational capabilities in combining technologies in innovative ways

Firm Resources and Sustainable Competitive Advantages
Strategic resources have four attributes: Valuable in formulating & implementing strategies to improve efficiency or effectiveness Rare or uncommon; difficult to exploit Difficult to imitate or copy due to physical uniqueness, path dependency, causal ambiguity, or social complexity Difficult to substitute with strategically equivalent resources or capabilities Strategic resources (also firm resources or organizational resources) = firms’ capabilities that are valuable, rare, costly to imitate, and costly to substitute. Firm attributes must be valuable in order to be considered resources and potential sources of competitive advantage. These valuable resources enable a firm to formulate and implement strategies that improve its efficiency or effectiveness. If competitors or potential competitors also possessed the same valuable resource, it is not a source of competitive advantage unless it is uncommon or rare. Inimitability or being difficult to imitate is the key to value creation because it constrains competition. Having a resource that competitors can easily copy generates only temporary value. Non-substitutability means there is no strategically equivalent valuable resources that are themselves not rare or inimitable.

Sources of Inimitability
Physical uniqueness: resources that are physically unique Path dependency: scarce because of all that has happened along the path followed in a resource’s development and/or accumulation Causal ambiguity: impossible to explain what caused it to exist or how to re-create it Social complexity: a result of social engineering such as interpersonal relations Physical uniqueness = a beautiful resort location, mineral rights, or patents. Path dependency = a characteristic of resources that is developed and or accumulated through a unique series of events. Causal ambiguity = a characteristic of the firm’s resources that is costly to imitate because a competitor cannot determine what the resource is and/or how it can be re-created. Social complexity = a characteristic of a firm’s resources that is costly to imitate because the social engineering required is beyond the capability of competitors, including interpersonal relations among managers, organizational culture, and reputation with suppliers and customers.

Criteria for Sustainable Competitive Advantage
Resources and capabilities must be rare and valuable as well as difficult to imitate or substitute in order for a firm to attain competitive advantages that are sustainable over time. If resources and capabilities do not meet any of the four criteria it would be difficult to develop any type of competitive advantage in the short or long run. If resources and capabilities are not difficult for competitors to imitate or substitute firms could attain some level of competitive parity. Only when all four criteria are satisfied will competitive advantages be sustained over time. Exhibit 3.7 Criteria for Sustainable Competitive Advantage and Strategic Implications Source: Adapted from Barney, J.B Firm Resources and Sustained Competitive Advantage. Journal of Management, 17:99 – 120.

The Generation and Distribution of the Firm’s Profits
Four factors help explain the extent to which employees and managers will be able to obtain a proportionately high level of the profits that they generate: Employee bargaining power Employee replacement cost Employee exit costs Manager bargaining power The resource based view of the firm is useful in determining when firms will create competitive advantages and enjoy high levels of profitability. These profits can be retained or appropriated by employees or managers (and not owners or shareholders) by various methods: employee bargaining power allows employees to earn disproportionately high wages; if employee skills are rare it will be costly to replace them; if an employee’s expertise is firm-specific or of limited value it would be difficult for the employee to explain his or her specific contribution to the firm, therefore would be costly for that employee to exit; if managers have sources of information that may not be readily available to others they will have bargaining power. See chapter 9 for a discussion of how corporate governance can be a critical control mechanism here.

Evaluating Firm Performance
Financial Ratio Analysis Balanced Scorecard Stakeholder Perspective Balance sheet Income statement Market valuation Historical comparison Comparison with industry norms Comparison with key competitors Employees Owners Customer satisfaction Internal processes Innovation, learning & improvement activities Financial perspectives Financial ratio analysis = a technique for measuring the performance of a firm according to its balance sheet, income statement, and market valuation. When performing a financial ratio analysis, you must take into account the firm’s performance from a historical perspective (not just at one point in time) as well as how it compares with both industry norms and key competitors. Balanced scorecard = a method of evaluating a firm’s performance using performance measures from the customers’, internal, innovation and learning, and financial perspectives.

Financial Ratio Analysis
Five types of financial ratios Short-term solvency or liquidity Long-term solvency measures Asset management or turnover Profitability Market value Meaningful ratio analysis must include: Analysis of how ratios change over time How ratios are interrelated Financial ratio analysis = a technique for measuring the performance of the firm according to its balance sheet, income statement, and market valuation. A meaningful ratio analysis must go beyond the calculation and interpretation of financial ratios. It must include how ratios change over time as well as how they are interrelated. A firm’s financial position should not be analyzed in isolation: historical comparisons, comparisons with industry norms, and comparisons with key competitors make financial analysis more meaningful.

Five Types of Financial Ratios
Appendix 1 to chapter 13 (the case analysis chapter) provides detailed definitions for and discussions of each of these types of ratios as well as examples of how each is calculated. Exhibit 3.9 A Summary of Five Types of Financial Ratios

The Balanced Scorecard
A meaningful integration of many issues that come into evaluating performance Four key perspectives: How do customers see us? (customer perspective) What must we excel at? (internal perspective) Can we continue to improve and create value? (innovation & learning perspective) How do we look to shareholders? (financial perspective) Balanced scorecard = a method of evaluating a firm’s performance using performance measures from the customers’, internal, innovation and learning, and financial perspectives. It includes financial measures that reflect the results of actions already taken, but it complements these indicators with measures of customer satisfaction, internal processes, and the organization’s innovation and improvement activities – operational measures that drive future financial performance. The balanced scorecard approach recognizes how the interests of a variety of stakeholders can be interrelated.

Customer Perspective Managers must articulate goals for four key categories of customer concerns: Time Quality Performance and service Cost Customer perspective = measures of firm performance that indicate how well firms are satisfying customers’ expectations. Managers must translate their general mission statements on customer service into specific measures that reflect the factors that really matter to customers.

Internal Business Perspective
Managers must focus on those critical internal operations that enable them to satisfy customer needs: Business processes Cycle time, quality, employee skills, productivity Decisions Coordinated actions Key resources and capabilities Internal business perspective = measures of firm performance that indicate how well a firm’s internal processes, decisions, and actions are contributing to customer satisfaction. Customer-based measures are important, however they must be translated into indicators of what the firm must do internally to meet customer’s expectations. The internal measures should reflect business processes that have the greatest impact on customer satisfaction.

Innovation and Learning Perspective
Managers must make frequent changes to existing products & services as well as introduce entirely new products with extended capabilities. This requires: Human capital (skills, talent, knowledge) Information capital (information systems, networks) Organization capital (culture, leadership) Innovation and learning perspective = measures of firm performance that indicate how well firms are changing their product and service offerings to adapt to changes in the internal and external environments. A firm’s ability to improve, innovate, and learn is tied directly to its value. Simply put, only by developing new products and services, creating greater value for customers, and increasing operational efficiencies can a company penetrate new markets, increase revenues and margins, and enhance shareholder value. A firm’s ability to do well from an innovation and learning perspective is more dependent on its intangible than tangible assets.

Financial Perspective
Managers must measure how the firm’s strategy, implementation, and execution are indeed contributing to bottom line improvement. Financial goals include: Profitability, growth, shareholder value Improved sales Increased market share Reduced operating expenses Higher asset turnover Financial perspective = measures of firms financial performance that indicate how well strategy, implementation and execution are contributing bottom-line improvement. Periodic financial statements remind managers that improve quality, response time, productivity, and innovative products benefit the firm only when they result in improved sales, increased market share, reduced operating expenses, or higher asset turnover.

Limitations of the Balanced Scorecard
Not a “quick fix” – needs proper execution Needs a commitment to learning Needs employee involvement in continuous process improvement Needs cultural change Needs a focus on nonfinancial rather than financial measures Needs data on actual performance There is general agreement that there is nothing inherently wrong with the concept of the balanced scorecard. The key limitation is that some executives may view it as a “quick fix” that can be easily installed. Implementing a balanced metrics system is an evolutionary process. It is not a one-time task that can be quickly checked off as completed. If managers do not recognize this from the beginning and fail to commit to it long-term, the organization will be disappointed. Poor execution becomes the cause of such performance outcomes. And organizational scorecards must be aligned with individuals’ scorecards to turn the balanced scorecards into a powerful tool for sustained performance. (For a variation on the balanced scorecard concept, see the Malcolm Baldrige National Quality Award at This award encourages organizations to focus on critical aspects of managing and performing as an organization, using an integrated performance management framework that addresses innovation management, intelligent risk, and strategic priorities; social media; operational effectiveness; and work systems and core competencies. Through a self-study process, organizations can submit their findings for the award in business/non profit, education, and healthcare categories.)

Recognizing A Firm’s Intellectual Assets: Moving Beyond a Firm’s Tangible Resources
chapter 4

Learning Objectives After reading this chapter, you should have a good understanding of: LO4.1 Why the management of knowledge professionals and knowledge itself is so critical in today’s organizations. LO4.2 The importance of recognizing the interdependence of attracting, developing, and retaining human capital. LO4.3 The key role of social capital in leveraging human capital within and across the firm.

Learning Objectives LO4.4 The importance of social networks in knowledge management and in promoting career success. LO4.5 The vital role of technology and leveraging knowledge and human capital. LO4.6 Why “electronic” or “virtual” teams are critical in combining and leveraging knowledge in organizations and how they can be made more effective. LO4.7 the challenge of protecting intellectual property and the importance of a firm’s dynamic capabilities.

The Central Role of Knowledge
Consider… A company’s value is not derived solely from its physical assets. Rather it is based on knowledge, know-how, and intellectual assets – all embedded in people. Today, more than 50% of the gross domestic product (GDP) in developed economies is knowledge based; it is based on intellectual assets and intangible people skills. Human capital is the foundation of intellectual capital, but the attraction, development, and retention of human capital is a necessary but not sufficient condition for organizational success. Social capital, the appropriate use of technology, and protection of physical and intellectual property is also critical.

In the knowledge economy, wealth is increasingly created by effective management of knowledge workers instead of by the efficient control of physical & financial assets. Knowledge economy = an economy where wealth is created through the effective management of knowledge workers instead of by the efficient control of physical and financial assets. Investing in a company is, in essence, buying a set of talents, capabilities, skills, and ideas – intellectual capital – not physical and financial resources. Example = Merck has been a “most admired” company in Fortune’s annual survey not because it can manufacture pills, but because its scientists can discover new medicines.

Ratio of Market Value to Book Value
What’s a company worth? Financial statements are useful for investors and can establish a company’s market value, but this may not be the same as the value that accountants ascribe to it – the book value of the firm. The gap between a firm’s market value and book value is far greater for knowledge intensive corporations than for firms with strategies based primarily on tangible assets. The market value of a firm is equal to the value of a share of its common stock times the number of shares outstanding. The book value of the firm is primarily a measure of the value of its tangible assets. It can be calculated by the formula: total assets minus total liabilities. Example = Apple, Google, Oracle, and Microsoft have very high market value to book value ratios because of their high investment in knowledge resources and technological expertise. Nucor and Southwest Airlines have relatively low market to book values because of their greater investments in physical resources and lower investment in knowledge resources. Intel has a market to book value ratio that falls between the above two groups of firms. This is because their high level of investment in knowledge resources is matched by a correspondingly huge investment in plant and equipment. Exhibit 4.1 Ratio of Market Value to Book Value for Selected Companies Source: Note: The data on market valuations are as of January 4, All other financial data are based on the most recently available balance sheets and income statements.

Intellectual capital is a measure of the value of a firm’s intangible assets – the difference between a firm’s market value & book value. It includes these assets: Reputation Employee loyalty & commitment Customer relationships Company values Brand names Experience & skills of employees Intellectual capital = the difference between the market value of the firm and the book value of the firm, including assets such as reputation, employee loyalty and commitment, customer relationships, company values, brand names, and the experience and skills of employees. How do companies create value in the knowledge–intensive economy? The general answer is to attract and leverage human capital (intangible assets) effectively through mechanisms that create products and services of value over time.

Human capital includes the individual capabilities, knowledge, skills, and experience of the company’s employees and managers. Social capital includes the network of relationships that individuals have throughout the organization. Human capital = the individual capabilities, knowledge, skills, and experience of a company’s employees and managers. This knowledge is relevant to the task at hand, and also includes the ability to add to this reservoir of knowledge, skills, and experience through learning. Social capital = the network of friendships and working relationships between talented people both inside and outside the organization. Relationships are critical in sharing and leveraging knowledge and in acquiring resources. Social capital can extend beyond the organizational boundaries to include relationships between the firm and its suppliers, customers, and alliance partners.

Knowledge management is critical to organizational success. Knowledge includes: Explicit knowledge – codified, documented, easily reproduced, and widely distributed. Tacit knowledge – in the minds of employees, based on their experiences and backgrounds. Explicit knowledge = knowledge that is codified, documented, easily reproduce, and widely distributed. Tacit knowledge = knowledge that is in the minds of employees and is based on their experiences and backgrounds. New knowledge is constantly created through the continual interaction of explicit and tacit knowledge. Another important issue is the role of “socially complex processes”, which include leadership, culture, and trust. These processes play a central role in the creation of knowledge. They represent the glue that holds the organization together and helps to create a working environment where individuals are more willing to share their ideas, work in teams, and, in the end, create products and services of value.

Question? Mary Stinson was required to take over a project after the entire team left the company. She was able to reconstruct what the team had accomplished through reading s exchanged by the previous teams members. This is an example of using explicit knowledge. inefficient use of information management. using tacit knowledge. all of the above. Answer: A. Explicit knowledge gained through reading the s.

Human Capital Hiring is only the first of three processes in which all successful organizations must engage to build and leverage their human capital. Firms must also develop employees to fill their full potential to maximize their joint contributions. Finally, the first two processes are for naught if firms can’t provide the working environment and intrinsic and extrinsic rewards to retain their best and brightest. Exhibit 4.2 Human Capital: Three Interdependent Activities

Attracting Human Capital
Hire for attitude, train for skill Emphasis on: General knowledge & experience Social skills Values Beliefs Attitudes The first step in building superior human capital is input control: attracting and selecting the right person. Some human resource professionals argue that firms can identify top performers by focusing on key employee mind-sets, attitudes, social skills, and general orientations. If they get these elements right, the task-specific skills can be learned quickly.

Attracting Human Capital
Sound recruiting approaches to attract human capital: Building a pool of qualified candidates The challenge becomes having the right job candidates, not the greatest number of them Networking Current employees may be the best source of new ones Provide incentives for referrals Companies that take hiring seriously must also take recruiting seriously. The challenge becomes having the right job candidates, not the greatest number of them.

Example: Creative Hiring Practices
Online retailer Zappos had 55,000 applicants for 200 jobs in 2010, but only hired a few people: Only about one out of 100 applicants passes a hiring process that is weighted 50 percent on job skills and 50 percent on the potential to mesh with Zappos’ culture. Gallup estimates the cost of a disengaged worker to be more than $300 billion in lost productivity alone. (See “Targeting soft skills yields hard returns for employers”, by Lisa V. Gillespie, April 15, 2012, Employee Benefit News, Zappo’s Tony Hsieh points out how if you add up the cost of all the bad decisions bad hires have made over the course of Zappo’s history, it cost Zappos well over $100 million. Now Hsieh says don’t just get warm bodies, and hire as fast as possible. Don’t hire quickly and fire slowly, do it in reverse – high slowly and fire quickly. ( See more: “At Zappos, Culture Pays: The thriving Internet shoe retailer has made its name and a lot of money by being eccentric”, by Dick Richards, strategy+business, 8/24/2010,

Developing Human Capital
Training and development must take place at all levels of the organization Requires the active involvement of leaders at all levels Includes mentoring & sponsoring lower- level employees Monitoring progress & tracking development Evaluating human capital It’s not enough to hire top level talent and expect that the skills and capabilities of those employees remain current throughout the duration of their employment. Rather, training and development must take place at all levels of the organization. Mentoring is traditionally viewed as a program to transfer knowledge and experience from more senior managers to up-and-comers. Mentoring can help recruit qualified managers, decrease turnover, fill senior level positions with qualified professionals, enhance diversity initiatives with senior-level management, and facilitate organizational change efforts. A sponsor is someone in a senior position who’s willing to advocate for and facilitate career moves, make introductions to the right people, translate and teach the secret language of success to their protégé. Systems for monitoring progress and tracking development need to evaluate the softer dimensions of communications and social skills, values, beliefs, and attitudes.

360-degree evaluation and feedback systems address the limitations of the traditional approach to performance evaluation. Superiors, direct reports, colleagues, and even internal and external customers rate a person’s performance. 360-degree feedback systems complement teamwork, employee involvement, and organizational flattening. Traditional top-down appraisal systems become insufficient as organizations continue to push responsibility downward. 360-degree evaluation and feedback systems = superiors, direct reports, colleagues, and even external and internal customers rate a person’s performance. Employees must share knowledge and work together, collectively, to reach organizational goals. Evaluation systems must ensure that a manager’s success does not come at the cost of compromising the organization’s core values.

Note: this evaluation system from General Electric consists of 10 “characteristics” – vision, customer/quality focus, integrity, and so on. Each of these characteristics has four “performance criteria”. For illustrative purposes, the four performance criteria of “Vision” are included. Exhibit 4.3 An Excerpt from General Electric’s 360-Degree Leadership Assessment Chart Source: Adapted from Slater, R Get Better or Get Beaten: Burr Ridge, IL: Irwin Professional Publishing Note: This evaluation system consists of 10 “characteristics” - Vision, Customer/Quality Focus, Integrity, and so on. Each of these characteristics has four “performance criteria.” For illustrative purposes, the four performance criteria of “Vision” are included.

Retaining Human Capital
Retention mechanisms must prevent the transfer of valuable and sensitive information outside the organization: Help employees identify with an organization’s mission and values Provide challenging work and a stimulating environment Offer financial and nonfinancial rewards & incentives Money is not the most important reason why people take or leave jobs Leaders can either provide the work environment and incentives to keep productive employees and management from wanting to bail out, or they can use legal means such as employment contracts and noncompete clauses. Firms must prevent the transfer of valuable and sensitive information outside the organization. Failure to do so would be the neglect of the leaders fiduciary responsibility to shareholders. Exodus of employees can erode a firm’s competitive advantage. A cohesive culture, challenging work, and valued rewards are all vital organizational control mechanisms for retaining human capital. (See more about this in chapter 9.)

Enhancing Human Capital: The Role of Diversity
Sound management of diverse workforces can improve an organization’s effectiveness & competitive advantages by making the following arguments: Cost Resource acquisition Marketing Creativity Problem solving Organizational flexibility A combination of demographic trends and accelerating globalization of business has made the management of cultural differences a critical issue. Workforces, which reflect demographic changes in the overall population, will be increasingly heterogeneous along dimensions such as gender, race, ethnicity, and nationality. The effective management of diversity can enhance the social responsibility goals of an organization. Cost: firms effective in managing diversity will have a cost advantage over those that are not. Resource acquisition: firms with excellent reputations as prospective employers for women and ethnic minorities will have an advantage in the competition for top talent. Marketing: the insight and cultural sensitivity that members with roots in other countries bring to marketing efforts will be very useful. Creativity: less emphasis on conformity to norms of the past and diversity of perspectives will improve the level of creativity. Problem solving: heterogeneous groups typically produce better decisions because of the wider range of perspectives. Organizational flexibility: with effective programs to enhance workplace diversity, systems become less determinate, less standardized, and therefore more fluid. Such fluidity should lead to greater flexibility to react to environmental changes. See Strategy Spotlight 4.3.

Social Capital Social capital – the friendships and working relationships among talented individuals – helps tie knowledge workers to a given firm. Interaction, sharing, and collaboration will help develop firm-specific ties, with a higher probability of retaining key knowledge workers. Successful firms are well aware that the attraction, development, and retention of talent is a necessary but not sufficient condition for creating competitive advantages. In the knowledge economy, it is not the stock of human capital that is important, but the extent to which it is combined and leveraged. The development of social capital – the friendships and working relationships among talented individuals – helps tie knowledge workers to a given firm. Competitive advantages tend to be harder for competitors to copy if they are based on “unique bundles” of resources. So, if employees are working effectively in teams and sharing their knowledge and learning from each other, not only will they be more likely to add value to the firm, but they also will be less likely to leave the organization, because of the loyalties and social ties they develop over time.

How Social Capital Helps Attract and Retain Talent
Hiring via personal (social) networks: Some job candidates may bring other talent with them – the Pied Piper effect Talent can emigrate from an organization to form startup ventures Social networks can provide a mechanism for obtaining resources and information from outside the organization See the example of the Pied Piper effect at Third Millennium Communications.

Social Networks Social network analysis depicts the pattern of interactions among individuals and helps to diagnose effective and ineffective patterns Who links to whom within the network or cluster? Who communicates to whom and how effective is this communication? Social network analysis = analysis of the pattern of social interactions among individuals. Analysis of communication patterns is helpful because the configuration of group members’ social ties within and outside the group affects the extent to which members connect to individuals who: convey needed resources, have the opportunity to exchange information and support, have the motivation to treat each other in positive ways, and, have the time to develop trusting relationships that might improve the group’s effectiveness. Developing social capital requires interdependence among group members. Social capital erodes when people in the network become independent. And increased interactions between members aid in the development and maintenance of mutual obligations in a social network.

Social Network Analysis
In this diagram the links are used to depict informal relationships among individuals involving communication flows, personal support, and advice networks. There may be some individuals with literally no linkages, such as Fred. These individuals are typically labeled “isolates”. However, most people do have some linkages with others. There are two primary types of mechanisms through which social capital flows: closure relationships depicted by Bill, Frank, George, and Susan, where one member is central to the communication flows in a group; and bridging relationships, depicted by Mary, where one person bridges or brings together groups that would have otherwise been unconnected. Exhibit 4.4 A Simplified Social Network

Social Network Analysis
Closure Relationships Bridging Relationships The degree to which all members of the social network have relationships with other group members. Relationships in a social network that connect otherwise disconnected people Structural holes Both closure and bridging relationships have important implications for the effective flow of information in organizations and for the management of knowledge. Closure = the degree to which all members of the social network have relationships or ties with other group members. Through closure, group members develop strong relationships with each other, high levels of trust, and greater solidarity. Bridging relationships = relationships in a social network that connect otherwise disconnected people. Employees who bridge disconnected people tend to receive timely, diverse information because of their access to a wide range of heterogeneous information flows. Structural holes = social gaps between groups in a social network where there are few relationships bridging the groups. Example = sales and engineering are two groups where members traditionally interact more with their peers than across group boundaries.

Overcoming Barriers to Collaboration
Effective collaboration requires overcoming barriers: The not-invented-here or hoarding barrier (people aren’t willing to provide help) The search barrier (people are unable to find what they’re looking for) The transfer barrier (people are unable to work with people they don’t know well) Social capital within a group or organization develops through repeated interactions among its members and the resulting collaboration. However, collaboration does not just happen. People don’t collaborate for various reasons. Barriers need to be overcome before effective collaboration can take place. Different barriers require different solutions. Motivational barriers require leaders to pull levers that make people more willing to collaborate. Ability barriers mean that leaders need to pull levers that enable motivated people to collaborate throughout the organization.

Overcoming Barriers to Collaboration
To encourage collaboration, leaders can choose a mix of three levers: Unification levers create compelling common goals & articulate a strong value of cross- company teamwork People levers get the right people to collaborate on the right projects through T-shaped management Network levers build nimble interpersonal networks across the company Unification lever = method for making people more willing to collaborate by crafting compelling common goals, articulating a strong value of cross-company teamwork, and encouraging collaboration in order to send strong signals to lift people’s sites beyond their narrow interests toward a common goal. This is useful when motivation is a problem. People lever = method for making people more willing to collaborate by getting the right people to work on the right projects. This means cultivating what may be called T-shaped management = people who simultaneously focus on the performance of their unit (the vertical part of the T) and across boundaries (the horizontal part of the T). Network lever = method for making people more willing to collaborate by building nimble interpersonal networks across the company. However, there is a dark side to networks: when people spend more time networking than getting work done, collaboration can adversely affect results.

Social Networks: Implications for Career Success
Effective social networks provide advantages for the firm AND for an individual’s career advancement: Access to private information communicated in the context of personal relationships Access to public information from sources such as the Internet Access to diverse skill sets – trading information or skills with people whose experiences differ from your own Access to power Private information = information that is not available from public sources, and is usually communicated in the context of personal relationships. Public information = information that is available from public sources such as the Internet. Success is also tied to the ability to transcend natural skill limitations through others. Training information or skills with people whose experiences differ from your own provides you with unique, exceptionally valuable resources. You can also gain power by being a network broker, or someone who bridges multiple networks. Network brokers can adapt to changes in the organization, develop clients, and synthesize opposing points of view. Brokers are especially powerful because they connect separate clusters, thus stimulating collaboration among otherwise independent specialists.

Social Capital: Limitations
Social capital does have some potential downsides: Groupthink Dysfunctional human resource practices Expensive socialization processes (orientation, training) Individuals may distort or selectively use information to favor their preferred courses of action Groupthink = a tendency in an organization for individuals not to question shared beliefs. Groupthink may occur in networks with high levels of closure where there is little input from people outside of the network. If there are deep-rooted mindsets, there could be a tendency to develop dysfunctional human resource practices. The organization could continue to hire, reward, and promote like-minded people who tend to further intensify organizational inertia and erode innovation. Socialization processes such as orientation and training can be expensive in terms of both financial resources and managerial commitment. A cost-benefit analysis is encouraged. Individuals may also use the contacts they develop to pursue their own interests and agendas in ways that may be inconsistent with the organization’s goals and objectives – engaging in unethical or illegal acts. (Chapter 9 contains discussion of behavioral control mechanisms that reduce such dysfunctional behaviors and actions.)

Using Technology to Leverage Human Capital and Knowledge
Sharing knowledge and information throughout the organization Conserves resources Develops products and services Creates new opportunities Technology can leverage human capital & knowledge Within the organization With customers With suppliers Sharing knowledge and information throughout the organization can be a means of conserving resources, developing products and services, and creating new opportunities. Technology can be used to leverage human capital and knowledge within organizations as well as with customers and suppliers beyond their boundaries.

Using Technology to Leverage Human Capital and Knowledge
Using networks to share information and develop products and services Through Through an intra-company news feed Through electronic teams or e-teams Advantages: few geographic constraints; access to multiple social contacts Challenges: failure to identify team members with the most appropriate knowledge and resources; low cohesion, low trust, lack of shared understanding creates “process loss” is an effective means of communicating a wide variety of information. It is quick, easy, and almost costless, however it can be excessive, and embarrassing if one is not careful. Electronic teams = a team of individuals that completes tasks primarily through communication. However, such teams require members who can identify those among them with the most appropriate knowledge and resources; and members need to know how to combine individual contributions in the most effective manner for a coordinated and appropriate response. “Process losses” prevent teams from reaching high levels of performance because of inefficient interaction dynamics among team members.

Question? Which of the following is NOT an advantage of electronic teams (e-teams)? They can facilitate communication. They have the potential to acquire a broader range of human capital. They can be effective in generating social capital. They’re less flexible in responding to unanticipated work challenges. Answer: D. if e-team leaders and team members do not know how to combine individual contributions in the most effective manner they will not be able to create a coordinated appropriate response

Codifying Knowledge For Competitive Advantage
Tacit knowledge Embedded in personal experience Shared only with the consent and participation of the individual Explicit (codified) knowledge Can be documented Can be widely distributed Can be easily replicated Can be reused many times at very low cost One of the challenges of knowledge-intensive organizations is to capture and codify the knowledge and experience that, in effect, resides in the heads of its employees. Has the organization effectively used technology to codify knowledge for competitive advantage?

Protecting Intellectual Assets
Intellectual property rights are more difficult to define and protect than property rights for physical assets. Unlike physical assets, intellectual property can be stolen. If intellectual property rights are not reliably protected by the state, there will be no incentive to develop new products and services. Firms can use technology, attract human capital, or tap into research and design networks to get access to information. However employees can become disgruntled and patents can expire. Where is the firm’s sustainable competitive advantage then? Intellectual property rights = intangible property owned by a firm in the forms of patents, copyrights, trademarks, or trade secrets. Protecting a firm’s intellectual property requires a concerted effort on the part of the company. Effective protection of intellectual property is necessary before any investor will finance such an intricate undertaking. Intellectual property is characterized by significant development costs and very low marginal costs. Once developed, though, the reproduction and distribution cost (or variable costs) may be almost zero. (See Case 19: Zynga, for a discussion of how one company has struggled with this.)

Example: Dippin’ Dot’s Patent Challenge
Dippin' Dots are tiny beads of ice cream, yoghurt, sherbet and flavored ice, created by microbiologist and founder Curt Jones 10 years after its founding, Dippin’ Dots lost the patent for its product, allowing its competition to copy the process Three years later, Dippin’ Dots filed for bankruptcy Dippin’ Dots was founded in 1987 by Curt Jones, a microbiologist who decided to apply his scientific know-how to ice cream. He pioneered the use of “cryogenic encapsulation,” a process that shaped ice cream into microbeads that melted on (and sometimes, stuck to) the tongue. The company faced a setback in 2007, when its patent for cryogenic encapsulation was invalidated by a federal court jury. Competitor Frosty Bites (Mini Melts) argued that Dippin’ Dots had been selling ice cream for more than a year before applying for a patent, a technicality that would invalidate its exclusive claim to the technology under a patent law provision. The jury sided with Frosty Bites. In November, 2011, Dippin Dots filed for Chapter 11 bankruptcy in federal court in Kentucky. In its filing, Dippin’ Dots listed $20.2 million in assets and $12 million in liabilities. In the filing, Dippin’ Dots said it planned to reorganize its debt and lift itself out of bankruptcy. But in preparation for the worst, its fans may want to begin exploring other exotic frozen confections… (See Case 17: Dippin’ Dots. Other information from “Dippin’ Dots, ‘Ice Cream of the Future,’ Files for Bankruptcy”, by Kevin Roose & Michael De La Merced, The New York Times, November 4, 2011,

Protecting Intellectual Assets
Dynamic capabilities involve the capacity to build and protect a competitive advantage. This requires knowledge, assets, competencies, and complementary assets & technologies This also requires the ability to sense & seize new opportunities, generate new knowledge, and reconfigure existing assets & capabilities. Dynamic capabilities include internal processes & routines that enable product development, strategic decision-making, alliances, or acquisitions. Dynamic capabilities = a firm’s capacity to build and protect a competitive advantage, which rests on knowledge, assets, competencies, complementary assets, and technologies. Dynamic capabilities include the ability to sense and seize new opportunities, generate new knowledge, and reconfigure existing assets and capabilities. Dynamic capabilities may be one of the best ways that a firm can protect its intellectual property. Dynamic capabilities are related to the entrepreneurial side of the firm and are built within a firm through its environmental and technological sensing apparatus, its choices of organizational form, and its collective ability to strategize. Dynamic capabilities are about the ability of an organization to challenge the conventional wisdom within its industry and market, learn and innovate, adapt to the changing world, and continuously adopt new ways to serve the evolving needs of the market.

Recognizing Intellectual Assets: Intangible Resources
Human capital: does the organization effectively attract, develop, and retain talent? Does the organization value diversity? Social capital: does the organization have positive personal and professional relationships among employees? Do the social networks within the organization have the appropriate levels of closure and bridging relationships? Technology: does the organization effectively use technology to transfer best practices across the organization, codify knowledge, and develop dynamic capabilities for competitive advantage? Intellectual assets or intangible resources are critical to organizational success. The growing importance of knowledge, coupled with the move by labor markets to reward knowledge work, tells us that investing in a company is, in essence, buying a set of talents, capabilities, skills, and ideas – intellectual capital – not physical and financial resources. Here are some questions organizations should ask.

Business Level Strategy: Creating and Sustaining Competitive Advantages
chapter 5

Learning Objectives After reading this chapter, you should have a good understanding of: LO5.1 The central role of competitive advantage in the study of strategic management, and the three generic strategies: overall cost leadership, differentiation, and focus. LO5.2 How the successful attainment of generic strategies can improve the firm’s relative power vis- à-vis the five forces that determine an industry’s average profitability. 4-153

Learning Objectives LO5.3 The pitfalls managers must avoid in striving to attain generic strategies. LO5.4 How firms can effectively combine the generic strategies of overall cost leadership and differentiation. LO5.5 What factors determine the sustainability of a firm’s competitive advantage. LO5.6 How Internet-enabled business models are being used to improve strategic positioning.

Learning Objectives LO5.7 the importance of considering the industry life cycle to determine a firm’s business-level strategy and its relative emphasis on functional area strategies and value-creating activities. LO5.8 The need for turnaround strategies that enable a firm to reposition its competitive position in an industry.

Sustaining a Competitive Advantage
Consider… The viability of a firm’s success is driven by both the internal operations of the firm and the desires and preferences of the market. Firms that succeed have the appropriate resources and cost structure to meet the needs of the environment. They also have a strategy… How firms compete with each other and how they attain and sustain competitive advantages go to the heart of strategic management. In short, the key issue becomes: why do some firms outperform others and enjoy such advantages over time? This subject, business level strategy, is the focus of this chapter.

Sustaining a Competitive Advantage
Business-level strategies require a choice: How to overcome the five forces and achieve competitive advantage? Suggestion - use Porter’s three generic strategies: Overall cost leadership Differentiation Focus Business-level strategy = a strategy designed for firm or a division of the firm that competes within a single business. Generic strategies = an analysis of business strategy into basic types based on breadth of target market (industrywide versus narrow market segment) and type of competitive advantage (low-cost versus uniqueness).

Three Generic Strategies
The overall cost leadership and differentiation strategies strive to attain advantages industrywide, while focusers have a narrow target market in mind. Generic strategies are plotted on two dimensions: competitive advantage and strategic target. Exhibit 5.1 Three Generic Strategies Source: Adapted and reprinted with the permission of The Free Press, a division of Simon & Schuster Inc. from Competitive Strategy: Techniques for Analyzing Industries and Competitors. Michael E Porter. Copyright © 1980, 1998 by The Free Press. All rights reserved.

Overall cost leadership is based on: Creating a low-cost position relative to a firm’s peers Managing relationships throughout the entire value chain to lower costs Differentiation implies: Products and/or services that are unique & valued Emphasis on nonprice attributes for which customers will gladly pay a premium Overall cost leadership = a firm’s generic strategy based on appeal to the industrywide market using a competitive advantage based on low-cost. Differentiation = a firm’s generic strategy based on creating differences in the firms product or service offering by creating something that is perceived industrywide as unique and valued by customers.

A focus strategy requires: Narrow product lines, buyer segments, or targeted geographic markets Advantages obtained either through differentiation or cost leadership Focus strategy = a firm’s generic strategy based on appeal to a narrow market segment within an industry.

Examples: Three Generic Strategies
Companies pursuing an overall cost leadership strategy: McDonalds Wal-Mart Companies pursuing a differentiation strategy: Apple Target Companies pursuing a focus strategy: Ikea Costco Both McDonald’s and Wal-Mart have paid attention to the value chain. Both have made sourcing of product and distribution of material a key focus of their long-term strategy. By cutting costs of procurement and distribution they have been able to pass these costs along to consumers. (See Case 15: McDonald’s) and Both Apple and Target have made names for themselves by creating products that are unique and desired by the marketplace. Take a look at the TV commercials for both brands. These commercials are creative and innovative: mirroring the attributes of the products they sell. (See Case 6: Apple) Both Ikea – a maker of furniture targeting first-time buyers – and Costco – a big-box retailer targeting the small business owner – have used cost leadership and a focus on a specific consumer to excel in their respective industries. (For a possible example in the grocery industry, see Case 30: Fresh Direct)

Both casual observation and research supports the notion that firms that identify with one or more of the forms of competitive advantage outperform those that do not. According to the above study, businesses combining multiple forms of competitive advantage (differentiation and overall cost leadership) outperformed businesses that used only a single form. The lowest performers were those that did not identify with any type of advantage. They were classified as “stuck in the middle”. Exhibit 5.2 Competitive Advantage and Business Performance

Overall Low-Cost Leadership
Cost leadership involves Aggressive construction of efficient scale facilities Vigorous pursuit of cost reductions from experience Tight cost & overhead control Avoidance of marginal customer accounts Cost minimization in all activities in the firm’s value chain, such as R&D, service, sales force, & advertising Overall cost leadership = a firm’s generic strategy based on appeal to the industrywide market using a competitive advantage based on low-cost. Cost leadership requires a tight set of interrelated tactics, including close scrutiny of the value chain. See Exhibit 5.3.

Overall Low-Cost Leadership
Cost leadership requires Learning to lower costs through experience: the experience curve With experience, unit costs of production processes decline as output increases This strategy also requires competitive parity Being “on par” with competitors with respect to low-cost, differentiation, or other strategic product characteristics Permits cost leaders to translate cost advantages directly into higher profits Experience curve = the decline in unit costs of production as cumulative output increases. A business can learn to lower costs as it gains experience with production processes. Among the most common factors producing the experience curve are workers getting better at what they do, product designs being simplified as the product matures, and production processes being automated and streamlined. However experience curve gains will only be the foundation for a cost advantage if the firm knows the source of the cost reduction and can keep those gains proprietary. Competitive parity = a firm’s achievement of similarity or being “on par” with competitors with respect to low-cost, differentiation, or other strategic product characteristics. Competitive parity on the basis of differentiation permits the cost leader to translate cost advantages directly into higher profits than competitors. Thus, the cost leader earns above-average returns. A business that strives for a low-cost advantage must attain an absolute cost advantage relative to its rivals. This is typically accomplished by offering a no-frills product or service to a broad target market using standardization to derive the greatest benefits from economies of scale and experience. However such a strategy may fail if the firm is unable to attain parity on important dimensions of differentiation such as quick responses to customer requests for services or design changes.

Improving Competitive Position vis-à-vis the Five Forces
An overall low-cost position Protects a firm against rivalry from competitors Protects the firm against powerful buyers Provides more flexibility to cope with demands from powerful suppliers who want to increase input costs Provides substantial entry barriers due to economies of scale and cost advantages Puts the firm in a favorable position with respect to substitute products An overall low cost position enables the firm to achieve above average returns despite strong competition. It protects a firm against rivalry from competitors, because lower costs allow a firm to earn returns even if its competitors eroded their profits through intense rivalry. Buyers can exert power to drive down prices only to the level of the next most efficient producer, because there are relatively few competitors that can provide a comparable cost/value proposition. A low-cost position puts the firm in a favorable position with respect to substitute products introduced by new and existing competitors because the cost advantage is able to be applied across all operations.

Pitfalls of Cost Leadership
Too much focus on one or a few value chain activities. Increase in the cost of the inputs on which the advantage is based The strategy is imitated too easily A lack of parity on differentiation Reduced flexibility Obsolescence of the basis of a cost advantage Firms need to pay attention to all activities in the value chain. Managers should explore all value chain activities, including relationships among them, as candidates for cost reductions. Firms can also be vulnerable to price increases in the factors of production. A firm’s strategy may consist of value-creating activities that are easy to imitate. Firms striving to attain cost leadership advantages must obtain a level of parity on differentiation. Building a low-cost advantage often requires significant investments in plant and equipment, distribution systems, and large, economically scaled operations. As result, firms often find that these investments limit their flexibility. As a result they have difficulty responding to changes in the environment. Ultimately, the foundation of the firm’s cost advantage may become obsolete. In these circumstances, other firms develop new ways of cutting costs, leaving the old cost-leaders at a significant disadvantage. See Cases 31 & 32: General Motors, & Ford.

Differentiation A differentiation strategy can take many forms:
Prestige or brand image Technology Innovation Features Customer service Dealer network Differentiation strategy = a firm’s generic strategy based on creating differences in the firm’s product or service offering by creating something that is perceived industrywide as unique and valued by customers. Firms may differentiate themselves in both primary and support activities (see Exhibit 5.4). Firms achieve and sustain differentiation advantages and attain above-average performance when their price premiums exceed the extra costs incurred in being unique.

Differentiation Differentiation requires:
A level of cost parity relative to competitors Integration of multiple points along the value chain Superior material handling operations to minimize damage Accurate and responsive order processing Personal relationships with key customers Rapid response to customer service requests Differentiation along several different dimensions at once Firms achieve and sustain differentiation advantages and attain above-average performance when their price premiums exceed the extra costs incurred in being unique, but a differentiator cannot ignore cost. Differentiators must reduce costs in all areas that do not affect differentiation.

An overall differentiation strategy Creates higher entry barriers due to customer loyalty Provides higher margins that enable the firm to deal with supplier power Reduces buyer power because buyers lack suitable alternatives Establishes customer loyalty and hence less threat from substitutes Differentiation provides protection against rivalry since brand loyalty lowers customer sensitivity to price and raises customer switching costs. Higher entry barriers result because of customer loyalty and the firm’s ability to provide uniqueness in its products or services. By increasing the firm’s margins, differentiation also avoids the need for a low-cost position, and also enables the firm to deal with supplier power. Suppliers would also probably desire to be associated with prestige brands, thus lessening their incentives to drive up prices. Differentiation reduces buyer power, because buyers lack comparable alternatives and are therefore less price sensitive. Differentiation enhances customer loyalty, thus reducing the threat from substitutes.

Pitfalls of Differentiation
Uniqueness that is not valuable Too much differentiation Too high a price premium Differentiation that is easily imitated Dilution of brand identification through product line extensions Perceptions of differentiation may vary between buyers and sellers It’s not enough just to be different. A differentiation strategy must provide unique bundles of products and/or services that customers value highly. Firms may also strive for quality of service that is higher than customers desire thus they become vulnerable to competitors who provide an appropriate level of quality at a lower price. In addition customers may desire the product but are repelled by the price premium. Differentiation advantages can be eroded through imitation. Firms may also erode their quality brand image by adding products or services with lower prices and less quality, thus confusing the customer. (For instance, see Case 9: Ann Taylor – what IS the difference between Ann Taylor and LOFT?) Companies must also realize that although they may perceive their products and services as differentiated, their customers may view them as commodities.

Focus A focus strategy is based on the choice of a narrow competitive scope within an industry. A firm selects a segment or group of segments (or niche) and tailors its strategy to serve them A firm achieves competitive advantages by dedicating itself to these segments exclusively Focus strategy = a firm’s generic strategy based on appeal to a narrow market segment within an industry. A firm following this strategy selects a segment or group of segments and tailors its strategy to serve them. The essence of focus is the exploitation of a particular market niche.

Focus A focus strategy has two variants: Cost focus
Creates a cost advantage in its target segment Exploits differences in cost behavior Differentiation focus Differentiates itself in its target market Exploits the special needs of buyers A narrow focus by itself is not sufficient for above average performance. Firms must choose either a cost or a differentiation focus. But both variants of the focus strategy rely on providing better service than broad-based competitors who are trying to serve the focuser’s target segment. Cost focus exploits differences in cost behavior in some segments, while differentiation focus exploits the special needs of buyers in other segments.

An overall focus strategy Creates higher entry barriers due to cost leadership or differentiation or both Can provide higher margins that enable the firm to deal with supplier power Reduces buyer power because the firm provides specialized products or services Focused niches are less vulnerable to substitutes Focus requires that a firm either have a low cost position with its strategic target, high differentiation, or both. These positions provide defenses against each competitive force because of higher margins or more specialized products or services. Focus is also used to select niches that are least vulnerable to substitutes or where competitors are weakest.

Pitfalls of Focus Erosion of cost advantages within the narrow segment
Highly focused products and services are still subject to competition from new entrants & from imitation Focusers can become too focused to satisfy buyer needs The advantages of a cost focus strategy may be fleeting if the cost advantages are eroded over time. Dell is given as an example. Some firms adopting a focus strategy may enjoy temporary advantages because they select a small niche with few rivals. However, this strategy can be imitated. Finally, some firms attempting to attain advantages through a focus strategy may have too narrow a product or service.

Combination Strategies: Integrating Low-Cost & Differentiation
Integration of low-cost and differentiation strategies makes it difficult for competitors to duplicate or imitate strategy The goal of a combination strategy is to provide unique value in an efficient manner Combination strategies = firms’ integrations of various strategies to provide multiple types of value to customers. A combination low-cost and differentiation strategy enables a firm to provide two types of value to customers: differentiated abilities ( e.g., high quality, brand identification, reputation) and lower prices (because of the firm’s lower costs in value creating activities). For example, superior quality can lead to lower costs because of less need for rework in manufacturing, fewer warranty claims, a reduced need for customer service personnel to resolve customer complaints, and so forth.

Combination Strategies
Combining overall low-cost and differentiation strategies can take several forms: Automated & flexible manufacturing systems allow for mass customization Exploitation of the profit pool concept creates a competitive advantage Using information technology, firms can integrate activities throughout the extended value chain Mass customization = a firm’s ability to manufacture unique products in small quantities at low cost. This is facilitated by advances in manufacturing technologies such as CAD/CAM. Nike, Land’s End, Cannondale, and Andersen Windows are given as examples. Profit pool = the total profits in an industry at all points along the industry’s value chain. The structure of the profit pool can be complex. The potential pool of profits will be deeper in some segments of the value chain than others, and the depths will vary within an individual segment. Segment profitability may vary widely by customer group, product category, geographic market, or distribution channel. Additionally, the pattern of profit concentration in an industry is often very different from the pattern of revenue generation. Many firms have also achieved success by integrating activities throughout the extended value chain by using information technology to link their own value change with the value chains of their customers and suppliers.

An integrated overall low-cost & differentiation strategy Creates higher entry barriers due to both cost leadership & differentiation Can provide higher margins that enable the firm to deal with supplier power Reduces buyer power because of fewer competitors An overall value proposition reduces threat from substitutes Firms that successfully integrate both differentiation and cost advantages create an enviable position. This dominant competitive position serves to erect high entry barriers to potential competitors that have neither the financial nor physical resources to compete head-to-head. The organization’s larger size can provide enormous bargaining power over suppliers. Low pricing and wide selection can reduce the power of buyers because there are relatively few competitors that can provide a comparable cost/value proposition. This overall value proposition also makes potential substitute products a less viable threat. Walmart is given as an example.

Pitfalls of Combination Strategies
Firms that fail to attain both overall low-cost & differentiation strategies may end up with neither and become “stuck in the middle” Firms can also underestimate the challenges & expenses associated with coordinating value-creating activities in the extended value chain Firms can also miscalculate sources of revenue and profit pools in the firm’s industry A key issue in strategic management is the creation of competitive advantages that enable the firm to enjoy above average returns. Some firms may become “stuck in the middle” if they try to attain both cost and differentiation advantages. While integrating activities across a firm’s value chain, firms must consider the expenses linked to technology and investment, managerial time and commitment, and the involvement and investment required by the firm’s customers and suppliers. The firm must be confident that it can generate a sufficient scale of operations and revenues to justify all associated expenses. Finally, firms may fail to accurately assess sources of revenue and profits in their value chain.

Question? Which statement regarding competitive advantages is true?
If several competitors pursue similar differentiation tactics, they may all be perceived as equals in the mind of the consumer. With an overall cost leadership strategy, firms need not be concerned with parity on differentiation. In the long run, a business with one or more competitive advantages is probably destined to earn normal profits. Attaining multiple types of competitive advantage is a recipe for failure. Answer: A. Recall the discussion of competitive advantage and business performance, Exhibit 5.2, and reflect on whether competitive strategies can be sustained. See the case example in the textbook of Atlas Door, a company that, so far, has been able to sustain a competitive advantage over time.

Internet-Enabled Low-Cost Leader Strategies
The Internet and digital technologies lower transaction costs: No in-person sales calls Paperless transactions Disintermediation or removing intermediaries also lowers transaction costs Reduced search costs No need for a permanent retail location Digital technologies = information that is in numerical form, which facilitates its storage, transmission, analysis and manipulation. Transaction costs refer to all the various expenses associated with conducting businesses. It applies not just to buy/sell transactions but to the costs of interacting with every part of the firm’s value chain, within and outside the firm. Disintermediation = the process of bypassing buyer channel intermediaries such as wholesalers, distributors, and retailers. Removing intermediaries lowers transaction costs. The Internet reduces the costs to search for a product or service. Not only is the need for travel eliminated but so is the need to maintain a physical address or permanent retail location. However most of the advantages associated with lower transaction costs can be duplicated quickly and without threat of infringement on proprietary information. Companies can also become overly enamored with using the Internet for cost cutting and thus jeopardize customer relations or neglect other cost centers.

Internet-Enabled Differentiation Strategies
The Internet and digital technologies have created new ways of differentiating by enabling mass customization Customers can judge the quality & uniqueness of a product or service by their ability to be involved in its planning & design Lowered transaction costs allow firms to achieve parity on cost while providing a unique experience Mass customization has changed how companies go to market. Online customer interaction has replaced the showroom floor. Customers can be involved in planning and design of products and then receive these products quickly with reliable results. Differentiators can make exceptional products and achieve superior service at a reasonable cost, therefore allowing firms to achieve parity on the basis of overall cost leadership as well as differentiation. However, traditional differentiation strategies such as building strong brand identity and prestige pricing have been undermined by Internet-enabled capabilities such as the ability to compare product features side-by-side or bid online for competing services.

Internet-Enabled Focus Strategies
The Internet and digital technologies have created new ways of competing in a narrow market segment Customers can access markets less expensively, and small firms can extend their reach Social media allows niche firms to solicit input and respond quickly to customer feedback The Internet offers companies with a focus strategy the ability to access markets less expensively (low-cost) and provide more services and features (differentiation). Niche players can access small markets in a highly specialized fashion. With social media tools, these companies can solicit input, respond quickly to customer feedback, and provide overall improved customer service. However, focusers can misread the scope and interests of their target markets. This can cause them to focus on segments that are too narrow to be profitable, or to lose their uniqueness in an overly broad niche, making them vulnerable to imitators or new entrants. Focusers can also over extend their niche. Offering additional services can cause the company to lose the cost advantages associated with a limited product or service offering.

Internet-Enabled Combination Strategies
The Internet and digital technologies have provided all companies with greater tools for managing costs With lower costs for all, the net effect is fewer rather than more opportunities for sustainable advantage The ease of comparison shopping also erodes differentiation advantages The Internet has provided all companies with greater tools for managing costs. However, for individual companies, it may shave critical percentage points off profit margins and create a climate that makes it impossible to survive, much less achieve sustainable above-average profits. The differentiation advantage is also diminished by the Internet because of the ability to comparison shop. A combination strategy challenges a company to carefully blend alternative strategic approaches and remain mindful of the impact of different decisions on the firm’s value-creating processes and its extended value chain entities. Strong leadership is needed to coordinate the multiple dimensions of a combination strategy.

Industry Life Cycle Stages
The industry life cycle Introduction Growth Maturity Decline Generic strategies, value-creating activities, & overall objectives all vary over the course of an industry life cycle Industry life cycle = the stages of introduction, growth, maturity, and decline that typically occur over the life of an industry. Managers must become even more aware of their firm’s strengths and weaknesses in many areas to attain competitive advantages. Factors such as generic strategies, market growth rate, intensity of competition, and overall objectives can change over the course of an industry life cycle. Managers must strive to emphasize the key functional areas during each of the four stages and to attain a level of parity in all functional areas and value-creating activities. Note: products and services go through many cycles of innovation and renewal. Typically, only fad products have a single lifecycle. Maturity stages of an industry can be transformed or followed by the stage of rapid growth if consumer tastes change, technological innovations take place, or new developments occur.

Industry Life Cycle Stages
Industry life cycle = the stages of introduction, growth, maturity, and decline that typically occur over the life of an industry. Exhibit 5.7 Stages of the Industry Life Cycle

Strategies in the Introduction Stage
The introduction stage is when: Products are unfamiliar to consumers Market segments are not well-defined Product features are not clearly specified Competition tends to be limited Strategies: Develop a product and get users to try it Generate exposure so the product becomes “standard” Introduction stage = the first stage of the industry life cycle, characterized by (1) new products that are not known to customers, (2) poorly defined market segments, (3) unspecified product features, (4) low sales growth, (5) rapid technological change, (6) operating losses, and (7) a need for financial support. Since there are few players and not much growth, competition tends to be limited. Success requires an emphasis on research and development and marketing activities to enhance awareness. The challenge becomes one of developing the product and finding a way to get users to try it, and generating enough exposure so the product emerges as the “standard” by which all other rivals’ products are evaluated. There’s an advantage to being the “first mover” in a market.

Strategies in the Growth Stage
The growth stage is: Characterized by strong increases in sales Attractive to potential competitors When firms can build brand recognition Strategies: Create branded differentiated products Stimulate selective demand Provide financial resources to support value- chain activities Growth stage = the second stage of the product life cycle, characterized by (1) strong increases in sales; (2) growing competition; (3) developing brand recognition; and (4) a need for financing complementary value-chain activities such as marketing, sales, customer service, and research and development. In the growth stage, the primary key to success is to build consumer preferences for specific brands. This requires strong brand recognition, differentiated products, and the financial resources to support a variety of value chain activities such as marketing and sales, and research and development. Efforts in the growth stage are directed towards stimulating selective demand in which a firm’s products offerings are chosen instead of a rival’s. Revenues can increase at an accelerating rate because new consumers are trying the product and a growing proportion of satisfied consumers are making repeat purchases.

Strategies in the Maturity Stage
The maturity stage is when: Aggregate industry demand slows Market becomes saturated, few new adopters Direct competition becomes predominant Marginal competitors begin to exit Strategies: Create efficient manufacturing operations Lower costs as customers become price- sensitive Adopt reverse or breakaway positioning Maturity stage = the third stage of the product life cycle, characterized by (1) slowing demand growth, (2) saturated markets, (3) direct competition, (4) price competition, and (5) strategic emphasis on efficient operations. As markets become saturated, there are few new adopters. Rivalry among existing rivals intensifies because of fierce price competition at the same time that expenses associated with attracting new buyers are rising. Advantages based on efficient manufacturing operations and process engineering become more important for keeping costs low as customers become more price sensitive. It also becomes more difficult for firms to differentiate their offerings, because users have a greater understanding of products and services. Firms can affect consumers’ mental shifts through (A) reverse positioning = a break in industry tendency to continuously augment products, characteristics of the product life cycle, by offering products with fewer product attributes and lower prices; or (B) breakaway positioning = a break in industry tendency to incrementally improve products along specific dimensions, characteristic of the product life cycle, by offering products that are still in the industry but that are perceived by customers as being different.

Strategies in the Decline Stage
The decline stage is when: Industry sales and profits begin to fall Price competition increases Industry consolidation occurs Strategies: Maintaining the product position Harvesting profits & reducing costs Exiting the market Consolidating or acquiring surviving firms Decline stage = the fourth stage of the product life cycle, characterized by (1) falling sales and profits, (2) increasing price competition, and (3) industry consolidation. Firms must face up to the fundamental strategic choices of either exiting or staying and attempting to consolidate their position in the industry. In the decline stage, a firm’s strategic options become dependent on the actions of rivals. If many competitors leave the market, sales and profit opportunities increase. On the other hand, prospects are limited if all competitors remain. Maintaining refers to keeping a product going without significantly reducing marketing support, technological development, or other investments, in the hope that competitors will eventually exit the market. A harvesting strategy = a strategy of bringing as much profit as possible out of the business in the short to medium term by reducing costs. Exiting the market involves dropping the product from the firm’s portfolio. A consolidation strategy = a firm’s acquiring or merging with other firms in an industry in order to enhance market power and gain valuable assets. Firms can also resurrect old technologies by retreating to more defensible ground, using the new to improve the old, or improving the price-performance trade-off.

Question? As markets mature, costs continue to increase.
applications for patents increase differentiation opportunities increase. there is increasing emphasis on efficiency. Answer: D. See stages in the maturity cycle.

Turnaround Strategies
A turnaround strategy involves reversing performance decline & reinvigorating growth toward profitability through Asset & cost surgery Selected market & product pruning Piecemeal productivity improvements Example = Ford Motor Company Example = Jamba Juice Turnaround strategy = a strategy that reverses a firm’s decline in performance and returns it to growth and profitability. The need for turnaround may occur at any stage in the life cycle but is more likely to occur during maturity or decline. Most turnarounds require a firm to carefully analyze the external and internal environments. The external analysis leads to identification of market segments and customer groups that may still find the product attractive. Internal analysis results in actions aimed at reduced costs and higher efficiency. See Case 32: Ford, and Strategy Spotlight 5.7 for how Alan Mulally lead Ford’s turnaround. See Case 8: Jamba Juice for how CEO James White revamped the product line and put the company on the path to profitability.

Corporate-Level Strategy: Creating Value through Diversification
chapter 6

Learning Objectives After reading this chapter, you should have a good understanding of: LO6.1 The reasons for the failure of many diversification efforts. LO6.2 How managers can create value through diversification initiatives. LO6.3 How corporations can use related diversification to achieve synergistic benefits through economies of scope and market power.

Learning Objectives LO6.4 How corporations can use unrelated diversification to attain synergistic benefits through corporate restructuring, parenting, and portfolio analysis. LO6.5 The various means of engaging in diversification – mergers and acquisitions, joint ventures/strategic alliances, and internal development. LO6.6 Managerial behaviors that can erode the creation of value.

Corporate-Level Strategy
Consider… What businesses should a corporation compete in? How can these businesses be managed so they create “synergy” – that is, create more value by working together than if they were freestanding units? Corporate-level strategy = a strategy that focuses on gaining long-term revenue, profits, and market value through managing operations in multiple businesses. Determining how to create value through entering new markets, introducing new products, or developing new technologies is a vital issue in strategic management, but maintaining a focus on “creating value” is essential to long-term success. Therefore, these questions must be continually asked and answered…

Making Diversification Work
Diversification initiatives must create value for shareholders through Mergers and acquisitions Strategic alliances Joint ventures Internal development Diversification should create synergy Diversification = the process of firms expanding their operations by entering new businesses. Diversification initiatives – whether through mergers and acquisitions, strategic alliances and joint ventures, or internal development – must be justified by the creation of value for shareholders. But this is not always the case. Firms typically pay high premiums when they acquire a target firm. So why should companies even bother with diversification initiatives? The answer is synergy, which means “working together”, and synergistic effects should be multiplicative – one plus one should equal more than two. Business 1 Business 2 More than two

Making Diversification Work
A firm may diversify into related businesses Benefits derive from horizontal relationships Sharing intangible resources such as core competencies in marketing Sharing tangible resources such as production facilities A firm may diversify into unrelated businesses Benefits derive from hierarchical relationships Value creation derived from the corporate office Leveraging support activities in the value chain Related businesses are those that share resources. Unrelated businesses have few similarities in products or industries, however the corporate office can add value through such activities as robust information systems or superb human resource practices. Benefits derived from horizontal (related diversification) and hierarchical (unrelated diversification) relationships are not mutually exclusive. Many firms that diversify into related areas benefit from information technology expertise in the corporate office. Similarly, unrelated diversifiers often benefit from the “best practices” of sister businesses even though their products, markets, and technologies may differ dramatically. An example would be a corporate parent with strong support activities in the value chain such as information systems or human resource practices.

Related Diversification
Related diversification enables a firm to benefit from horizontal relationships across different businesses Economies of scope allow businesses to: Leverage core competencies Share related activities Enjoy greater revenues Related businesses gain market power by: Pooled negotiating power Vertical integration Related diversification = a firm entering a different business in which it can benefit from leveraging core competencies, sharing activities, or building market power. Economies of scope = cost savings from leveraging core competencies or sharing related activities among businesses in a corporation. A firm can also enjoy greater revenues if two businesses attain higher levels of sales growth combined than either company could attain independently (this is the synergistic effect). Market power = firms’ abilities to profit through restricting or controlling supply to a market or coordinating with other firms to reduce investment.

Question? Sharing core competencies is one of the primary potential advantages of diversification. In order for diversification to be most successful, it is important that the similarity required for sharing core competencies must be in the value chain, not in the product. the products use similar distribution channels. the target market is the same, even if the products are very different. the methods of production are the same. Answer: A. See the discussion of core competencies and the criteria for success.

Related Diversification: Leveraging Core Competencies
Core competencies reflect the collective learning in organizations. Can lead to the creation of value and synergy if… They create superior customer value The value chain elements in separate businesses require similar skills They are difficult for competitors to imitate or find substitutes for Core competencies = a firm’s strategic resources that reflect the collective learning in the organization. This collective learning includes how to coordinate diverse production skills, integrate multiple streams of technologies, and market diverse products and services. Core competencies = the glue that binds existing businesses together, achieved by transferring accumulated skills and expertise across business units in a corporation. Core competencies can lead to the creation of value and synergy, but these core competencies must enhance competitive advantage(s) by creating superior customer value – by building on existing skills and innovations in a way that appeals to customers, as at Apple. Different businesses in the firm must also be similar in at least one important way related to the core competence. It’s not essential that products or services themselves be similar, it is essential that one or more elements in the value chain require similar essential skills – IBM’s computing power is an example. Finally, core competencies must be difficult for competitors to imitate or find substitutes for. Specialized technical skills acquired during a company’s work experience, such as at Amazon, are an example.

Related Diversification: Sharing Activities
Corporations can also achieve synergy by sharing activities across their business units. Sharing tangible & value-creating activities can provide payoffs: Cost savings through elimination of jobs, facilities & related expenses, or economies of scale Revenue enhancements through increased differentiation & sales growth Sharing activities = having activities of two or more businesses’ value chains done by one of the businesses. Tangible value-creating activities can include common manufacturing facilities, distribution channels, and sales forces. Cost savings are generally highest when one company acquires another from the same industry in the same country. Sharing activities inevitably involve costs that the benefits must outweigh such as the greater coordination required to manage a shared activity. Sharing activities can also increase the effectiveness of differentiation strategies. For instance, a shared order-processing system may permit new features and services that a buyer will value.

Related Diversification: Market Power
Market power can lead to the creation of value and synergy through… Pooled negotiating power Gaining greater bargaining power with suppliers & customers Vertical integration - becoming its own supplier or distributor through Backward integration Forward integration Market power = firms’ abilities to profit through restricting or controlling supply to a market or coordinating with other firms to reduce investment. Pooled negotiating power = the improvement in bargaining position relative to suppliers and customers. Similar businesses working together or the affiliation of the business with a strong parent can strengthen an organization’s purchasing clout. However, managers must carefully evaluate how the combined businesses may affect relationships with actual and potential customers, suppliers, and competitors – they may retaliate! Vertical integration = an expansion or extension of the firm by integrating preceding or successive production processes. Vertical integration occurs when a firm becomes its own supplier or distributor. The firm can incorporate more processes toward the original source of raw materials (backward integration) or toward the ultimate consumer (forward integration).

Example: Question? Shaw Industries, a giant carpet manufacturer, increases its control over raw materials by producing much of its own polypropylene fiber, a key input into its manufacturing process. This is an example of leveraging core competencies. pooled negotiating power. vertical integration. sharing activities. Answer: C. See Strategy Spotlight 6.2 and Exhibit 6.3. See their website at The logo provided shows some of the firms Shaw has successfully acquired over the years.

Related Diversification: Vertical Integration
Vertical integration can be a viable strategy for many firms. See Strategy Spotlight 6.2. Shaw Industries is a carpet maker that has attained a dominant position in the industry via a strategy of vertical integration. Shaw has successfully implemented strategies of both forward AND backward integration. Exhibit 6.3 Simplified Stages of Vertical Integration: Shaw Industries

It is the company satisfied with the quality of the value that its present suppliers & distributors are providing? Are there activities in the industry value chain presently being outsourced or performed independently by others that are a viable source of future profits? Is there a high level of stability in the demand for the organization’s products? Does the company have the necessary competencies to execute the vertical integration strategies? Will the vertical integration initiatives have potential negative impacts on the firm’s stakeholders? In making vertical integration decisions, five issues should be considered. If the performance of organizations in the vertical chain is satisfactory, it may not, in general, be appropriate for a company to perform these activities itself. However, even if a firm IS outsourcing value chain activities to companies that are doing a credible job, it may be missing out on substantial profit opportunities. Note: high demand or sales volatility are not that conducive to vertical integration. With a high level of fixed costs in plant and equipment as well as operating costs that accompany endeavors toward vertical integration, widely fluctuating sales demand can either strain resources (in times of high demand) or result in unused capacity (in times of low demand). Finally, successfully executing strategies of vertical integration can be very difficult and can require significant competencies. In addition, managers must carefully consider the impact that vertical integration may have on existing and future customers, suppliers, and competitors.

The transaction cost perspective Every market transaction involves some transaction costs: Search costs Negotiating costs Contract costs Monitoring costs Enforcement costs Need for transaction specific investments Administrative costs Transaction cost perspective = a perspective that the choice of a transaction’s governance structure, such as vertical integration or market transaction, is influenced by transaction costs, including search, negotiating, contracting, monitoring, and enforcement costs, associated with each choice. Transaction costs are the sum of the above costs. These transaction costs can be avoided by internalizing the activity in other words, by producing the input in-house. However, vertical integration gives rise to administrative costs as well. Coordinating different stages of the value chain now internalized within the firm causes administrative costs to go up. Decisions about vertical integration are, therefore, based on a comparison of transaction costs and administrative costs. If transaction costs are lower than administrative costs, it is best to resort to market transactions and avoid vertical integration. On the other hand, if transaction costs are higher than administrative costs, vertical integration becomes an attractive strategy.

Unrelated Diversification
Unrelated diversification enables a firm to benefit from vertical or hierarchical relationships between the corporate office & individual business units through… The corporate parenting advantage Providing competent central functions Restructuring to redistribute assets Asset, capital, & management restructuring Portfolio management BCG growth/share matrix Unrelated diversification = a firm entering a different business that has little horizontal interaction with other businesses of a firm. Benefits of unrelated diversification come from the vertical or hierarchical relationships, or creation of synergies from the interaction of the corporate office with the individual business units. The corporate office can contribute to parenting and restructuring of often acquired businesses or can add value by viewing the entire corporation as a family or portfolio of businesses and allocating resources to optimize corporate goals of profitability, cash flow, and growth. Parenting advantage = the positive contributions of the corporate office to a new business as a result of expertise and support provided, and not as a result of substantial changes in assets, capital structure, or management. Restructuring = the intervention of the corporate office in a new business that substantially changes the assets, capital structure, and/or management, including selling off parts of the business, changing the management, reducing payroll and unnecessary sources of expenses, changing strategies, and infusing the new business with new technologies, processes, and reward systems. Portfolio management = a method and of assessing the competitive position of a portfolio of businesses within a corporation, suggesting strategic alternatives for each business, and identifying priorities for the allocation of resources across the businesses.

Unrelated Diversification: Parenting & Restructuring
Parenting allows the corporate office to create value through management expertise & competent central functions In restructuring the parent intervenes: Asset restructuring involves the sale of unproductive assets Capital restructuring involves changing the debt–equity mix, adding debt or equity Management restructuring involves changes in the top management team, organizational structure, & reporting relationships Parenting relates to the positive contributions of the corporate office to a new business as a result of expertise and support provided in areas such as legal, financial, human resource management, procurement, and the like. Corporate parents also help subsidiaries make wise choices in their own acquisitions, divestitures, and new internal development decisions. With a restructuring strategy the corporate office tries to find either poorly performing firms with unrealized potential or firms in industries on the threshold of some significant, positive change. The parent intervenes, often selling off parts of the business; changing the management; reducing payroll and unnecessary sources of expenses; changing strategies; and infusing the company with new technologies, processes, reward systems, and so forth. When the restructuring is complete, the firm can either “sell high” and capture the added value or keep the business and enjoy financial and competitive benefits. In order for this to work, the corporate parent must have the requisite skills and resources to turn the businesses around, even if they may be in new and unfamiliar industries.

Unrelated Diversification: Portfolio Management
Portfolio management involves a better understanding of the competitive position of an overall portfolio or family of businesses by… Suggesting strategic alternatives for each business Identifying priorities for the allocation of resources Using Boston Consulting Group’s (BCG) growth/share matrix The key purpose of portfolio models is to assist a firm in achieving a balanced portfolio of businesses. A balanced portfolio consists of businesses whose profitability, growth, and cash flow characteristics complement each other and add up to a satisfactory overall corporate performance. Portfolio analysis allows the corporation (1) to allocate resources among the business units according to prescribed criteria (use cash flows from the “cash cows” to fund promising “stars”); (2) identify attractive acquisitions; (3) provide financial resources on favorable terms; (4) provide high – quality review and coaching for the individual businesses; (5) provide a basis for developing strategic goals and rewards/evaluation systems for business managers.

Each circle represents one of the firm’s business units. The size of the circle represents the relative size of the business unit in terms of revenue. In the BCG approach, each of the firm’s strategic business units (SBUs) is plotted on a two-dimensional grid in which the axes are relative market share and industry growth rate. Relative market share is measured by the ratio of the business units size to that of its largest competitor. Growth rate is estimated from market data. The four quadrants of the grid include stars: firms with long-term growth potential that should continue to receive substantial investment funding; question marks: SBUs operating in high-growth industries with relatively weak market shares where resources should be invested in them to enhance their competitive positions; cash cows: SBUs with high market shares in low-growth industries that have limited long-run potential but represent a source of current cash flows to fund investments in “stars” and “question marks”; dogs: SBUs with weak positions and limited potential - most analysts recommend that they be divested. Exhibit 6.5 The Boston Consulting Group (BCG) Portfolio Matrix

Limitations of portfolio models: SBUs are compared on only two dimensions & each SBU is considered a standalone entity Are these the only factors that really matter? Can every unit be accurately compared on that basis? What about possible synergies? An oversimplified graphical model substitutes for managers’ experience Following strict & simplistic rules for resource allocation can be detrimental to a firm’s long-term viability Limitations of portfolio models: comparing SBUs on only two dimensions, viewing each SBU as a stand-alone entity and ignoring synergies, treating the process as largely mechanical, relying on strict rules for resource allocation, making overly simplistic prescriptions and ignoring a firm’s potential long-term viability.

Example: Goal of Diversification = Risk Reduction?
Diversification can reduce variability in revenues & profits over time. However… Stockholders can diversify portfolios at a much lower cost & economic cycles are difficult to predict, so why diversify? Example = General Electric’s businesses: Aircraft engines, power generation equipment, locomotive trains, large appliances, healthcare products, financial products, lighting, mining, oil & gas Why is GE in so many businesses? See GE is widely diversified, although not as greatly as they once were – they used to own NBC – the National Broadcasting TV group, which GE merged with Vivendi to form NBC Universal – but divested this entity in With this divestiture, it could be argued that GE is in the business of “imagination”, since all its remaining products, except for the financial services business, can be considered offshoots of founder Thomas A. Edison’s inventions that made life easier through technology. As the chapter says, GE’s range of diversification has resulted in stable earnings over time, and a very low risk profile. This allows them to borrow money at very favorable rates, money that they, in turn, use to provide financing to buyers of their products –hence the financial services division! So GE’s level of diversification DOES help the company reduce risk.

Means of Diversification
Diversification can be accomplished via Mergers & acquisitions And divestment Pooling resources of other companies with a firm’s own resource base through Strategic alliances & joint ventures Internal Development through Corporate entrepreneurship Diversification, either related or unrelated, allows a firm to achieve synergies and create value for its shareholders. There are three basic means by which a firm can diversify. Mergers = the combining of two or more firms into one new legal entity. Acquisitions = the incorporation of one firm into another through purchase. Through mergers and acquisitions, corporations can directly acquire another firm’s assets and competencies. A firm can also divest previous acquisitions. Divestment = the exit of a business from the firm’s portfolio. By using a joint venture or strategic alliance, corporations can pool the resources of other companies with their own resource base. Joint ventures = new entities formed within a strategic alliance in which two or more firms, the parents, contribute equity to form the new legal entity. Strategic alliance = a cooperative relationship between two or more firms. Finally, corporations may diversify into new products, markets, and technologies through internal development. Called corporate entrepreneurship, it involves the leveraging and combining of the firm’s own resources and competencies to create synergies and enhance shareholder value. Internal development = entering a new business through investment in new facilities, often called corporate entrepreneurship and new venture development.

Mergers and Acquisitions
Mergers involve a combination or consolidation of two firms to form a new legal entity: Are relatively rare The two firms are on a relatively equal basis Acquisitions involve one firm buying another either through stock purchase, cash, or the issuance of debt The most visible and often costly means to diversify is through acquisitions.

Mergers and Acquisitions
Exhibit 6.6 illustrates the dramatic volatility in worldwide M&A activity over the last several years. Increase in merger and acquisition activity can indicate market optimism. It’s an indication that markets are willing to finance these transactions. Government policies such as regulatory actions and tax policies can also make the M&A environment more or less favorable. Finally, currency fluctuations can influence the rate of cross-border acquisitions with firms in countries with stronger currencies being in a stronger position to acquire. Exhibit 6.6 Global Value of Mergers and Acquisitions ($ trillion) Source: Thomson Financial, Institute of Mergers, Acquisitions, and Alliances (IMAA) analysis

Mergers and Acquisitions: Motives
In high-technology & knowledge- intensive industries, speed is critical: acquiring is faster than building. M&A allows a firm to obtain valuable resources that help it expand its product offerings & services. M&A helps a firm develop synergy: Leveraging core competencies Sharing activities Building market power In certain industries speed is critical, so acquiring is faster than building. Example = Apple acquiring Siri Inc. Acquisitions can quickly add new technology to product offerings and meet changing customer needs. Example = Cisco Systems. Acquisitions can help a firm leverage core competencies, share activities, and build market power. Example = eBay’s acquisition of GSI Commerce, PayPal, and Zong allows it to become a full-service provider of online retailing systems.

Mergers and Acquisitions: Motives
M&A can lead to consolidation within an industry, forcing other players to merge. Corporations can also enter new market segments by way of acquisitions. M&A can lead to consolidation within an industry, forcing other players to merge. Example = consolidation in the airline industry: Delta – Northwest, United – Continental. Corporations can also enter a new market segments by way of acquisitions. Example = Fiat acquired Chrysler to gain access to the U.S. auto market.

Mergers and Acquisitions: Limitations
Takeover premiums for acquisitions are typically very high Competing firms can imitate advantages Competing firms can copy synergies Managers’ egos get in the way of sound business decisions Cultural issues may doom the intended benefits By estimates, 70 to 90% of acquisitions destroy shareholder value. See Strategy Spotlight 6.3. Two times out of three, the stock price of the acquiring company falls once the deal is made public. Since the acquiring firm often pays a 30% or higher premium for the target company, the acquirer must create synergies and scale economies that result in sales and market gains exceeding the premium price. This is sometimes hard to do. Because competing firms can often imitate advantages or copy synergies, investors may not be willing to pay a high premium for the stock. M&A costs are paid for upfront. Conversely, firms pay for R&D, ongoing marketing, and capacity expansion over time. This stretches out the payments needed to gain new competencies, but investors want to see immediate results. If the M&A does not perform as planned, managers who pushed for the deal may find their reputation tarnished. Finally, creating a singular organizational culture from multiple national or business cultures can be very difficult. Example = SmithKline and the Beecham Group.

Question? Divestment can be the common result of an acquisition. Divesting businesses can accomplish many different objectives. These include enabling managers to focus their efforts more directly on the firm’s core businesses. providing the firm with more resources to spend on more attractive alternatives. raising cash to help fund existing businesses. all of the above. Answer: D. Divestment = the exit of a business from the firm’s portfolio. See limitations of mergers and acquisitions, and how divesting a business can accomplish many different objectives, as on the next slide. .

Mergers and Acquisitions: Divestment
Divestment objectives include: Cutting the financial losses of a failed acquisition Redirecting focus on the firm’s core businesses Freeing up resources to spend on more attractive alternatives Raising cash to help fund existing businesses Divestments, the exit of the business from the firm’s portfolio, are quite common. Large, prestigious U.S. companies may have divested more acquisitions than they have kept. Investing can enhance a firm’s competitive position only to the extent that it reduces its tangible (e.g., maintenance, investments, etc.) or intangible (e.g., opportunity costs, managerial attention) costs without sacrificing a current competitive advantage or the seeds of future advantages. To be effective, divesting requires a thorough understanding of the business unit’s current ability and future potential to contribute to a firm’s value creation. Modes of divestment include sell-offs, spin-offs, equity carve-outs, asset sales/dissolution, and split-ups.

Mergers and Acquisitions: Divestment
Successful divestiture involves: Removing emotion from the decision Knowing the value of the business you’re selling Timing the deal right Maintaining a sizable pool of potential buyers Telling a story about the deal Running divestitures systematically through a project office Communicating clearly and frequently Successful divestment involves establishing objective criteria for determining divestment candidates. Clearly, firms should not panic and sell for a song in bad times. Since the decision to divest involves a great deal of uncertainty, it’s very difficult to make such evaluations. In addition, because of managerial self interests and organizational inertia, firms often delay investments of underperforming businesses. The Boston Consulting Group has identified the above seven principles for successful divestiture.

Strategic Alliances & Joint Ventures: Motives
Strategic alliances & joint ventures are cooperative relationships with potential advantages: Ability to enter new markets through Greater financial resources Greater marketing expertise Ability to reduce manufacturing or other costs in the value chain Ability to develop & diffuse new technologies Strategic alliances and joint ventures are assuming an increasingly prominent role in the strategy of leading firms, both large and small. A strategic alliance can help firms better understand customer needs, acquire know-how for promoting the product, acquire access to the proper distribution channels. Example = Zara cooperating with Tata in India. Strategic alliances enable firms to pool capital, value-creating activities, or facilities in order to reduce costs. Example = SAB Miller and Molson Coors combined brewery and distribution operations, benefiting from economies of scale and better facility utilization. Strategic alliances may also be used to build jointly on the technological expertise of two or more companies, enabling them to develop products beyond the capability of other companies acting independently. Example = Verizon Wireless and ILS technology can now securely transmit data to and from various devices, including mobile devices and main office operations.

Strategic Alliances & Joint Ventures: Limitations
Need for the proper partner: Partners should have complementary strengths Partner’s strengths should be unique Uniqueness should create synergies Synergies should be easily sustained & defended Partners must be compatible & willing to trust each other Despite their promise, many alliances and joint ventures fail to meet expectations for a variety of reasons. The proper partner is essential. However, unfortunately, often little attention is given to nurturing the close working relationship and interpersonal connections that bring together the partnering organizations.

Internal Development Corporate entrepreneurship & new venture development motives: No need to share the wealth with alliance partners No need to face difficulties associated with combining activities across the value chains No need to merge diverse corporate cultures Limitations: Time-consuming Need to continually develop new capabilities Internal development is such an important means by which companies expand their businesses that there’s a whole chapter devoted to it – see chapter 12. Compared to mergers and acquisitions, firms that engage in internal development capture the value created by their own innovative activities without having to share the wealth with alliance partners or face the difficulties associated with combining activities across the value chains of several firms or merging corporate cultures. On their own, firms can often develop new products or services that are relatively lower cost, and thus rely on their own resources rather than turning to external funding. However this may be time-consuming, so firms may forfeit the benefits of speed that growth through mergers or acquisitions can provide. In addition, firms that choose to diversify through internal development must develop capabilities that allow them to move quickly from initial opportunity recognition to market introduction.

Managerial Motives Managerial motives: Managers may act in their own self interest – eroding rather than enhancing value creation through Growth for growth’s sake Top managers gain more prestige, higher rankings, greater incomes, more job security It’s exciting and dramatic! Excessive egotism Use of antitakeover tactics We cannot assume that CEOs and top executives are rational beings. They made not always act in the best interests of shareholders to maximize long-term shareholder value. In the real world they may often act in their own self interest. Managerial motives = managers acting in their own self interest rather than to maximize long-term shareholder value. (See Case 12: World Wrestling Entertainment for a discussion of how this might affect long-term success.) Growth for growth’s sake = managers’ actions to grow the size of their firms not to increase long-term profitability but to serve managerial self-interest. There is a “tremendous allure to mergers and acquisitions”, which can lead to desperate moves by top managers to satisfy investor demands for accelerating revenues, sometimes by engaging in unethical behavior. Egotism = managers’ actions to shape their firms’ strategies to serve their selfish interests rather than to maximize long-term shareholder value. Egos can get in the way of a synergistic corporate marriage. Examples = Tyco’s ex-CEO Dennis Kozlowski’s $6,000 shower curtain, John Thain’s $35,000 commode. Antitakeover tactics = managers’ actions to avoid losing wealth or power as a result of a hostile takeover.

Managerial Motives: Antitakeover Tactics
Antitakeover tactics include: Green mail Golden parachutes Poison pills Can benefit multiple stakeholders – not just management Can raise ethical considerations because the managers of the firm are not acting in the best interests of the shareholders Unfriendly or hostile takeovers can occur when a company’s stock becomes undervalued. A competing organization can buy the outstanding stock of a takeover candidate in sufficient quantity to become a large shareholder. Then it makes a tender offer to gain full control of the company. If the shareholders accept the offer, the hostile firm buys the target company and either fires the target firm’s management team or strips them of their power. There are several antitakeover tactics. Greenmail = a payment by a firm to a hostile party for the firm’s stock at a premium, made when the firm’s management feels that the hostile party is about to make a tender offer. Golden parachute = a prearranged contract with managers specifying that, in the event of a hostile takeover, the target firm’s managers will be paid a significant severance package. Poison pill = used by a company to give shareholders certain rights in the event of takeover by another firm.

International Strategy: Creating Value in Global Markets
chapter 7

Learning Objectives After reading this chapter, you should have a good understanding of: LO7.1 The importance of international expansion as a viable diversification strategy LO7.2 The sources of national advantage; that is, why an industry in a given country is more (or less) successful than the same industry in another country. LO7.3 The motivations (or benefits) and the risks associated with international expansion, including the emerging trend for greater off shoring and outsourcing activity. 6-228

Learning Objectives LO7.4 The two opposing forces – cost reduction and adaptation to local markets – that firms face when entering international markets. LO7.5 The advantages and disadvantages associated with each of the four basic strategies: international, global, multidomestic, and transnational. LO7.6 The difference between regional companies and true global companies. LO7.7 The four basic types of entry strategies and the relative benefits and risks associated with each of them.

International Strategy
Consider… The global marketplace provides many opportunities for firms to increase their revenue base and their profitability. However, managers face many opportunities and risks when they diversify abroad. What should a firm do in order to attain a competitive advantage in this global marketplace? The trade among nations has increased dramatically in recent years and it is estimated that by 2015, the trade across nations will exceed the trade within nations. This makes international expansion a viable diversification strategy. In a variety of industries such as semiconductors, automobiles, commercial aircraft, telecommunications, computers, and consumer electronics, it is almost impossible to survive unless firms scan the world for competitors, customers, human resources, suppliers, and technology. Firms need to know how to be successful and create value when diversifying into global markets. Some of the questions that need to be answered include: what explains the level of success of a given industry in a given country? What are some of the major motivations and risks associated with international expansion? How can firms handle the opposing forces of cost reduction and local adaptation – should firms pursue international, global, multidomestic, or transnational strategies? What entry strategies should a firm choose in order to enter a foreign market?

Globalization has to do with the rise of market capitalization around the world: International exchanges have increased Trade in goods & services Exchange of money, information, & ideas Laws, rules, norms, values, and ideas are growing more similar across countries Challenges include balancing between emerging markets & developed markets How to meet the needs of customers at very different income levels Globalization = has two meanings. One is the increase in international exchange, including trade in goods and services as well as exchange of money, ideas, and information. Two is the growing similarity of laws, rules, norms, values, and ideas across countries. Globalization has undeniably created tremendous business opportunities for multinational corporations. One of the challenges with globalization is determining how to meet the needs of customers at very different income levels. In many developing economies, distributions of income remain much wider than they do in the developed world, leaving many impoverished even as the economies grow. The concept “bottom of the pyramid” refers to the practice of a multinational firm targeting its goods and services to the nearly 5 billion poor people in the world who inhabit developing countries. See Strategy Spotlight 7.1.

The rapid rise in global capitalism has had dramatic effects on the growth in different economic zones. The growth experienced by developed economies in the first decade of the 2000s was anemic, while the growth in developing economies was robust. This trend is continuing, with emerging markets growing 4% faster than developed markets in 2011 and This has resulted in a dramatic shift in the structure of the global economy. As of 2013, over half the world’s output will come from emerging markets. This fact affects a firm’s international strategy. Exhibit 7.1 Growth in GDP per Person from 2001 to 2011 by Region Source: A game of catch-up. The Economist, September 24: 3-6.

Factors Affecting a Nation’s Competitiveness
Michael Porter’s diamond of national advantage explains why some nations and their industries outperform others: Factor endowments Demand conditions Related and supporting industries Firm strategy, structure, & rivalry Some nations and their industries are more competitive than others. Understanding these differences helps a firm create a competitive advantage when it expands internationally. Diamond of national advantage = a framework for explaining why countries foster successful multinational corporations, consisting of four factors – factor endowments; demand conditions; related and supporting industries; and firm strategy, structure, and rivalry. These four attributes jointly determine the playing field that each nation establishes and operates for its industries. Factor endowments = a nation’s position in factors of production. Demand conditions = the nature of home-market demand for the industry’s product or service. Related and supporting industries = the presence, absence, and quality in the nation of supplier industries and other related industries that supply services, support, or technology to firms in the industry value chain. Firm strategy, structure, and rivalry = the conditions in the nation governing how companies are created, organized, and managed, as well as the nature of domestic rivalry.

Factor endowments involve factors of production: Land Capital Labor Factors of production must be industry & firm specific Must be rare, valuable, difficult to imitate, and rapidly & efficiently deployed Factors of production are the building blocks that create usable consumer goods and services. Companies and advanced nations seeking competitive advantage over firms and other nations create many of these factors of production. For example, a country or industry dependent on scientific innovation must have a skilled human resource pool to draw upon. This resource pool is not inherited; it is created through investment in industry–specific knowledge and talent. The actual pool of resources is less important than the speed and efficiency with which these resources are deployed. Thus, firm-specific knowledge and skills created within a country that are rare, valuable, difficult to imitate, and rapidly and efficiently deployed are the factors of production that ultimately lead to a nation’s competitive advantage. The island nation of Japan is given as an example.

Demand conditions refer to the demands that consumers place on an industry Demanding consumers drive firms in that country to: Meet high standards Upgrade existing products and services Create innovative products and services Better anticipate future global demand Proactively respond to product & service requirements Consumers who demand highly specific, sophisticated products and services force firms to create innovative, advanced products and services to meet the demand. This consumer pressure presents challenges to a country’s industries. Countries with demanding consumers drive firms in that country to meet high standards, upgrade existing products and services, and create innovative products and services. The conditions of consumer demand influence how firms view a market. This, in turn, helps the nation’s industries to better anticipate future global demand conditions and proactively respond to product and service requirements. Denmark is given as an example.

Related and supporting industries enable firms to manage inputs more effectively: A competitive supplier base Reduces manufacturing costs Close working relationships with suppliers Allows for joint research & development Development of related industries Forces existing firms to practice cost control, product innovation, better distribution methods A home country’s industries can become a source of competitive advantage when related and supporting industries are developed. Countries with a strong supplier base benefit by adding efficiency to downstream activities. A competitive supplier base helps a firm obtain inputs using cost effective, timely methods, thus reducing manufacturing costs. Also, close working relationships with suppliers provide the potential to develop competitive advantages through joint research and development and the ongoing exchange of knowledge. Related industries create the probability that new companies will enter the market, increasing competition and forcing existing firms to become more competitive through efforts such as cost control, product innovation, and novel approaches to distribution. Combined, these give the home country’s industries a source of competitive advantage. The Italian footwear industry is given as an example.

Firm strategy, structure, & rivalry due to Strong consumer demand Strong supplier base High new entrant potential from related industries Domestic rivalry leads to a search for new markets Rivalry is a strong indicator of global competitive success Rivalry is particularly intense in nations with conditions of strong consumer demand, strong supplier bases, and high new entrant potential from related industries. This competitive rivalry in turn increases the efficiency with which firms develop, market, and distribute products and services within the home country. Domestic rivalry thus provides a strong impetus for firms to innovate and find new sources of competitive advantage. This intense rivalry forces firms to look outside their national boundaries for new markets, setting up the conditions necessary for global competitiveness. Domestic rivalry is perhaps the strongest indicator of global competitive success. Firms that have experienced intense domestic competition are more likely to have designed strategies and structures that allow them to successfully compete in world markets.

Question? All of the factors below have made India’s software services industry extremely competitive on a global scale except a large pool of skilled workers. a large network of public and private educational institutions. tax and antitrust legislation that protect the dominant players in the industry. A large, growing market, and sophisticated customers. Answer: C. See the discussion of Porter’s diamond of national advantage. Factor conditions, demand characteristics, and the existence of related and supporting industries are all factors that affect a nation’s competitiveness. Policies that protect the nation’s domestic competitors do not lead to a nation’s competitive advantage on the worldwide stage.

Example: Factors Affecting a Nation’s Competitiveness
Firms that succeed in global markets have first succeeded in intensely competitive home markets. Competitive advantage for global firms typically grows out of relentless, continuing improvement, and innovation. The Indian software industry offers a clear example of how the attributes in Porter’s “diamond” interact to lead to the conditions for a strong industry to grow. See Strategy Spotlight 7.2 for information on how mutually reinforcing elements work in this market. Exhibit 7.2 India’s Diamond in Software Source: From Kampur D.,and Ramamurti R., “India’s Emerging Competition Advantage in Services,” Academy of Management Executive: The Thinking Managers Source. Copyright © 2001 by Academy of Management. Reproduced with permission of Academy of Management via Copyright Clearance Center..

International Expansion: Motivations
A company decides to become a multinational firm in order to: Increase market size Attain economies of scale Take advantage of arbitrage opportunities In every stage of the value chain Enhance a product’s growth potential Reinvigorating the product life cycle Multinational firms = firms that manage operations in more than one country. Companies pursue international expansion in order to increase the size of potential markets for firms’ products and services. Expanding a firm’s global presence also automatically increases its scale of operations, providing it with a larger revenue and asset base, which potentially enables the firm to attain economies of scale. This can also spread fixed costs such as R&D over a larger volume of production. Arbitrage opportunities = an opportunity to profit by buying and selling the same good in different markets. In its simplest form, arbitrage involves buying something from where it is cheap and selling it somewhere where it commands a higher price. Arbitrage can be applied to virtually any factor of production and every stage of the value chain. Walmart is an example. Enhancing the growth rate of a product that is in its maturity stage in a firm’s home country, but that has greater demand potential elsewhere is another benefit of international expansion.

International Expansion: Motivations
A company decides to become a multinational firm in order to: Optimize the location of value chain activity To enhance performance To reduce cost To reduce risk Explore reverse innovation Design & manufacture products locally Export no-frills products to developed markets A firm has to decide where to locate the various activities that it must engage in to produce products and services. Primary activities, such as inbound logistics, operations, and marketing, as well as support activities, such as procurement, R&D, and human resource management must be located in areas where the firm can see performance enhancement, cost reduction, and risk reduction. Location decisions can affect the quality with which any activity is performed in terms of the availability of needed talent, speed of learning, and the quality of external and internal coordination. Location decisions can affect the cost structure in terms of local manpower and other resources, transportation and logistics, and government incentives and the local tax structure. Nike’s manufacture of shoes in Asia is an example. Erratic swings in the exchange ratios between global currencies requires firms to manage these currency risks by spreading the high cost elements of their manufacturing operations across a few select and carefully chosen locations around the world. Reverse innovation = new products developed by developed country multinational firms for emerging markets that have adequate functionality at a low cost. Many leading companies are discovering that developing products specifically for emerging markets can pay off in a big way. When products can deliver adequate functionality at a fraction of the cost, these products can subsequently find success in value segments in wealthy countries as well. See Strategy Spotlight 7.3.

International Expansion: Risks
Multinational firms also encounter risks: Political risk due to social unrest, military turmoil, demonstrations, terrorism, absence of the rule of law can lead to Destruction of property Disruption of operations Non-payment for goods and services Arbitrary government decisions Economic risk due to piracy and counterfeiting Political risk = potential threat to a firm’s operations in the country due to ineffectiveness of the domestic political system. Countries that are viewed as high risk are less attractive for most types of businesses. Another source of political risk in many countries is the absence of the rule of law. Rule of law = a characteristic of legal systems where behavior is governed by rules that are uniformly enforced. The absence of rules or the lack of uniform enforcement of existing rules leads to what might often seem to be arbitrary and inconsistent decisions by government officials. This can make it difficult for foreign firms to conduct business. The laws, and the enforcement of laws, associated with protection of intellectual property rights can be a major potential economic risk in entering new countries. Economic risk = potential threat to a firm’s operations in the country due to economic policies and conditions, including property rights laws and enforcement of those laws. Firms rich in intellectual property have encountered financial losses as piracy or imitations of their products have grown due to a lack of law enforcement of intellectual property rights. Counterfeiting = selling of trademarked goods without the consent of the trademark holder. Counterfeiting, a direct form of theft of intellectual property rights, is a significant and growing problem.

Multinational firms also encounter risks: Currency risk due to fluctuations in the local currency’s exchange rate Affects cost of production or net profit Management risk due to culture, customs, language, income level, customer preferences, distribution systems Could lead to the need for local adaptation of apparently standard products Currency risk = potential threat to a firm’s operations in the country due to fluctuations in the local currency’s exchange rate. Even a small change in the exchange rate can result in a significant difference in the cost of production or net profit when doing business overseas. An example includes the U.S. dollar appreciating against other currencies, making U.S. goods more expensive to consumers in foreign countries. Management risk = potential threat to a firm’s operations in a country due to the problems that managers have making decisions in the context of foreign markets. Managers must respond to the inevitable differences that they encounter when doing business in multiple countries. Cultural differences can pose unique challenges. Even in the case of apparently standard products, some degree of local adaptation may become necessary.

When the company expands its international operations, it does so to increase its profits or revenues. As with any other investment, however, there are also potential risks. To help companies assess the risk of entering foreign markets, rating systems have been developed to evaluate political, economic, as well as financial and credit risks. Euromoney magazine publishes a semi annual “country risk rating” that evaluates political, economic, and other risks that entrants potentially face. Exhibit 7.3 presents a sample of country risk ratings, published by the World Bank, from the 178 countries that Euromoney evaluates. Note that the lower the score, the higher the country’s expected level of risk. Exhibit 7.3 A Sample of Country Risk Ratings, January 2013 Source: euromoneycountryrisk.com

Example: Risks from Corruption
The Transparency International Corruption Perceptions Index (CPI) reveals the most corrupt countries in the world The scores range from 100 (very clean) to 0 (highly corrupt). The most corrupt countries are: Somalia, North Korea, & Afghanistan (CPI scores: 8) Sudan (CPI score: 13) Myanmar (CPI score: 15) Uzbekistan & Turkmenistan (CPI scores: 17) See Looking at the Corruption Perceptions Index 2012, it's clear that corruption is a major threat facing humanity. Corruption destroys lives and communities, and undermines countries and institutions. It generates popular anger that threatens to further destabilise societies and exacerbate violent conflicts. The Corruption Perceptions Index scores countries on a scale from 0 (highly corrupt) to 100 (very clean). While no country has a perfect score, two-thirds of countries score below 50, indicating a serious corruption problem. Corruption translates into human suffering, with poor families being extorted for bribes to see doctors or to get access to clean drinking water. It leads to failure in the delivery of basic services like education or healthcare. It derails the building of essential infrastructure, as corrupt leaders skim funds. Corruption amounts to a dirty tax, and the poor and most vulnerable are its primary victims.

International Expansion: Managing Risks
Managing political risk through Market diversification Developing stakeholder coalitions Wooing key influencers Putting key stakeholders on their boards Managing economic risk through global dispersion of value chains Outsourcing Offshoring Strategy Spotlight 7.4 discusses how firms can manage the risks from political instability and adverse actions by governments. Competing in a range of geographic markets lessons the risk of actions by a single government or turmoil in a single nation. Firms can also develop coalitions with other multinationals investing within the country. Smart firms identify key influencers such as legislative leaders, regulators, and local officials who can become political supporters. These key stakeholders can be invited to join the firm’s board. This gives the locals a stake in the company’s success. To manage economic risk, firms can disburse their value chains across several countries and continents. Outsourcing = using other firms to perform value-creating activities that were previously performed in-house. The firm may be perfectly capable of doing this activity but chooses to have someone else perform it for cost or quality reasons. Outsourcing can be to either a domestic or foreign firm. Offshoring = shifting a value-creating activity from a domestic location to a foreign location. Value-creating activities should be performed in the location where the cost is lowest or where the quality is the best.

International Expansion: Managing Risks
Offshoring may be costly Common savings from offshoring include: Lower wages, benefits, energy costs, regulatory costs, taxes Hidden costs from offshoring include: Higher total wage & indirect costs Increased coordination costs Increased inventory due to longer lead time Reduced market responsiveness Cost of protecting intellectual property In the 1990s, for manufacturing industries especially, the rapid decline in transportation and coordination costs enabled firms to disperse their value chains over different locations. Yet while offshoring offers the potential to cut costs in corporations across a wide range of industries, many firms are finding the benefits of offshoring to be more elusive and the costs greater than they anticipated. For instance, labor cost per hour may be significantly lower in developing markets, but this may not translate into lower overall costs. If there are problems with the skill level of workers, the firm will find the need for more training and supervision of workers, more raw material and greater scrap due to the lower skill level, and greater rework to fix quality problems. Wages in developing markets can be volatile and spike unexpectedly. For instance, wages in China have been increasing recently. Due to longer delivery times, firms often need to tie up more capital in work in progress and inventory. The long supply lines from low-cost countries may make firms less responsive to shifts in customer demands. The cost of coordinating product development and manufacturing with operations undertaken in different countries can hamper innovation. Finally, firms operating in countries with weak intellectual property protection can wind up losing their trade secrets or taking costly measures to protect these secrets. Firms need to take into account all of these costs in determining whether or not to move their operations offshore.

International Strategies: Opposing Pressures
Cost reduction or adaptation to local markets? Strategies that favor global products & brands should do the following: Standardize all products for all markets Reduce overall costs by spreading investments over a larger market Assumes: Homogenous customer needs & interests People prefer lower prices at high quality Global markets produce economies of scale Firms face two opposing forces when they expand into global markets: cost reduction and adaptation to local markets. Many years ago, the famed marketing strategist Theodore Levitt advocated strategies that favored global products and brands. He suggested that firms should standardize all of their products and services for all of their worldwide markets. Such an approach would help a firm lower its overall costs by spreading its investments over as large a market as possible. This approach rested on three key assumptions: 1. Customer needs and interests are becoming increasingly homogenous worldwide. 2. People around the world are willing to sacrifice preferences in product features, functions, design, and the like for lower prices at high quality. 3. Substantial economies of scale in production and marketing can be achieved through supplying global markets.

Cost reduction or adaptation to local markets? Assumptions may be incorrect: Product markets DO vary widely between nations – local adaptations work. There is a growing interest in multiple product features, product quality, & service. Technology permits flexible production; cost of production may not be critical to product cost; and a firm’s strategy should not be solely product driven. “One size fits all” does NOT generally apply. Theodore Levitt’s assumptions may be incorrect. Regarding the homogeneity of customer needs and interests, yes, companies have identified global customer segments and developed products and brands targeted to those segments, but other companies have successfully adapted product lines to idiosyncratic country preferences and developed local brands targeted to local market segments. Pineapple and ham pizza is an example. Second, while there is invariably a price sensitive segment in many product markets, there is no indication that this is increasing. In contrast, there is a growing interest in products with multiple features, quality, and service. Third, although standardization may lower manufacturing costs, such a perspective does not consider three critical and interrelated points: technological developments in flexible factory automation enable economies of scale to be obtained at lower levels of output; cost of production is only one component in determining the total cost of a product; and the firm’s strategy should not be solely product driven. Based on the above, we would have a hard time arguing that it is wise to develop the same product or service for all markets throughout the world.

The opposing pressures that managers face place conflicting demands on firms as they strive to be competitive. On the one hand, competitive pressures require that firms do what they can to lower unit costs so that consumers will not perceive their product and service offerings as too expensive. This may lead them to consider locating manufacturing facilities where labor costs are low and developing products that are highly standardized across multiple countries. In addition to responding to pressures to lower costs, managers must also strive to be responsive to local pressures in order to tailor their products to the demand of the local market in which they do business. This requires differentiating their offerings and strategies from country to country to reflect consumer tastes and preferences and making changes to reflect differences in distribution channels, human resource practices, and governmental regulations. However, since the strategies and tactics to differentiate products and services to local markets can involve additional expenses, a firm’s costs will tend to rise. The two opposing pressures result in four different basic strategies that companies can use to compete in the global marketplace: international, global, multidomestic, and transnational. The strategy that a firm selects depends on the degree of pressure that it is facing for cost reductions and the importance of adapting to local markets. See the following Cases for examples of various international strategies: 10: Heineken, 13: Ebay in Asia, 23: Beiersdorf, and 24: Louis Vuitton. Exhibit 7.4 Opposing Pressures and Four Strategies

An international strategy requires diffusion & adaptation of the parent company’s knowledge & expertise to foreign markets. The primary goal is worldwide exploitation of the parent firm’s knowledge & capabilities. All sources of core competencies are centralized. Pressure for both local adaptation & low costs are rather low International strategy = a strategy based on a firm’s diffusion and adaptation of the parent company’s knowledge and expertise to foreign markets, used in industries where the pressures for both local adaptation and lowering costs are low. With an international strategy, country units are allowed to make some minor adaptations to products and ideas coming from the head office, but they have far less independence and autonomy compared to multidomestic companies. There are only a small number of industries in which this strategy still applies. With increasing pressures to reduce costs due to global competition, especially from low-cost countries, opportunities to successfully employ international strategy are becoming more limited. This strategy is most suitable in situations where a firm has distinctive competencies that local companies in foreign markets lack.

Although an international strategy does leverage and diffuse a parent firm’s knowledge and core competencies, leading to lower costs because of less need to tailor products and services, it does mean a firm has a limited ability to adapt to local markets, and therefore it cannot take advantage of new ideas and innovations occurring in that market. The international strategy, with its tendency to concentrate most of its activities in one location, fails to take advantage of the benefits of an optimally distributed value chain. The lack of local responsiveness may result in the alienation of local customers, and the firm’s inability to be receptive to new ideas and innovation from its foreign subsidiaries may lead to missed opportunities globally. Exhibit 7.5 Strengths and Limitations of International Strategies in the Global Marketplace

Global Strategy A global strategy implies a firm is interested in lowering costs: Competitive strategy is centralized & controlled by the corporate office Products are standardized, operations centralized, producing economies of scale Worldwide volume supports R&D There’s a standard level of quality worldwide Pressure for reducing cost is high; pressure for adaptation to local markets is weak Global strategy = a strategy based on firms’ centralization and control by the corporate office, with the primary emphasis on controlling costs, and used in industries where the pressure for local adaptation is low and the pressure for lowering costs is high. Since the primary emphasis is on controlling costs, the corporate office strives to achieve a strong level of coordination and integration across the various businesses. Firms following a global strategy strive to offer standardized products and services as well as to locate manufacturing, R&D, and marketing activities in only a few locations. Although costs may be lower, the firm following a global strategy may, in general, have to forgo opportunities for revenue growth since it does not invest extensive resources in adapting product offerings from one market to another. Many industries requiring high levels of R&D, such as pharmaceuticals, semiconductors, and jet aircraft, follow global strategies.

Global Strategy A global strategy is most appropriate when there are strong pressures for reducing costs and comparatively weak pressures for adaptation to local markets. Economies of scale becomes an important consideration. However a firm can enjoy scale economies only by concentrating scale-sensitive resources and activities in one or a few locations. This may result in higher transportation and tariff costs when output must be exported to other markets. The geographic concentration of any activity may also tend to isolate that activity from the target markets, making the rest of the firm dependent on that location. Such dependency implies that, unless the location has world-class competencies, the firm’s competitive position can be eroded if problems arise. Finally, many firms have learned through experience that products that work in one market may not be well received in other markets. Apple is given as an example. See Case Six: Apple Inc., for more details. Exhibit 7.6 Strengths and Limitations of Global Strategies

Multidomestic Strategy
A multidomestic strategy puts emphasis on differentiating products & services to adapt to local markets Decisions are decentralized Products & services are tailored to local use Consider language, culture, income levels, customer preferences, distribution systems Markets can expand rapidly Prices are differentiated by market Pressure for local adaptation is high; pressure for lowering costs is low Multidomestic strategy = strategy based on firms differentiating their products and services to adapt to local markets, used in industries where the pressure for local adaptation is high and the pressure for lowering costs is low. Decisions involving from a multidomestic strategy tend to be decentralized to permit the firm to tailor its products and respond rapidly to changes in demand. This enables the firm to expand its markets and to charge different prices in different markets. For firms following this strategy, differences in language, culture, income levels, customer preferences, and distribution systems are only a few of the many factors that must be considered. Even in the case of relatively standardized products, at least some level of local adaptation is often necessary. See Strategy Spotlight 7.7 for how Proctor & Gamble has done this in Vietnam.

Multidomestic Strategy
A multidomestic strategy is appropriate where the pressure for local adaptation is high and the pressure for lowering costs is low. The firm emphasizes differentiation of products and service offerings in order to adapt to local markets. This can result in enhanced revenue due to a firm’s carve-out of attractive niches in a given market. However, local adaptation of products and services may increase a company’s cost structure, so managers must determine the trade-off between adaptation and cost. In addition, the optimal degree of local adaptation evolves over time. In many industry segments, a variety of factors, such as the influence of global media, greater international travel, and declining income disparities across countries, may lead to increasing global standardization. Firms must recalibrate the need for local adaptation on an ongoing basis; excessive adaptation extracts a price as surely as underadaptation. Exhibit 7.7 Strengths and Limitations of Multidomestic Strategies

Transnational Strategy
A transnational strategy seeks global competitiveness via trade-offs: Efficiency versus local adaptation versus organizational learning Assets & capabilities are disbursed according to the most beneficial location for a specific activity; some value chain activities are centralized, some are decentralized. Economies of scale, increased knowledge flows Pressures for both local adaptation and lowering costs are high Transnational strategy = a strategy based on firms optimizing the trade-offs associated with efficiency, local adaptation, and learning, used in industries where the pressures for both local adaptation and lowering costs are high. The firm seeks efficiency not for its own sake, but as a means to achieve global competitiveness. It recognizes the importance of local responsiveness, but as a tool for flexibility in international operations. Innovations are regarded as an outcome of a larger process of organizational learning that includes the contributions of everyone in the firm. In a transnational model, a firm’s assets and capabilities are disbursed according to the most beneficial location for each activity. Thus, managers avoid the tendency to either concentrate activities in a central location (a global strategy) or disperse them across many locations to enhance adaptation (a multidomestic strategy). Typically, primary activities that are “downstream” (marketing and sales, and service), or closer to the customer, tend to require more decentralization in order to adapt to local market conditions. Primary activities that are “upstream” (logistics and operations), or further away from the customer, tend to be centralized. This is because there is less need for adapting these activities to local markets and the firm can benefit from economies of scale. A central philosophy of the transnational organization is enhanced adaptation to all competitive situations as well as flexibility by capitalizing on communication and knowledge flows throughout the organization. A principal characteristic is the integration of the unique contributions of all units into worldwide operations. Nestlé is given as an example.

Transnational Strategy
A transnational strategy is appropriate in industries where the pressures for both local adaptation and lowering costs are high. When an organization adopts a transnational strategy, it can adapt to all competitive situations by capitalizing on communication and knowledge flows throughout the organization. It also achieves economies of scale by locating activities in optimal locations. However the choice of a seemingly optimal location cannot guarantee that the quality and cost of factor inputs (labor and materials) will be optimal. Managers must ensure that the relative advantage of the location is actually realized, not squandered because of weaknesses in productivity and the quality of internal operations. Also, although knowledge transfer can be a key source of competitive advantage, it does not take place automatically. For knowledge transfer to take place from one subsidiary to another, it is important for the source of the knowledge, the target units, and the corporate headquarters to recognize the potential value of such unique know-how. Firms must create mechanisms to systematically and routinely uncover the opportunities for knowledge transfer. Exhibit 7.8 Strengths and Limitations of Transnational Strategies

Question? In order to realize the strongest competitive advantage, firms engaged in worldwide competition must require that all of their various business units follow the same strategy regardless of location. ensure that all business units follow a strategy strictly tailored to their respective locations. pursue a strategy that combines the uniformity of a global strategy and the specificity of a multidomestic strategy in order to achieve optimal results. attempt to use the strategy that was most successful in their home country. Answer: C. See the trade-offs between adaptation and cost.

International Strategies: Global or Regional?
It may be unwise for companies to rush into full-scale globalization Regionalization may be more reasonable Distance still matters Commonalities of language, culture, economics, legal & political systems, and infrastructure all make a difference Trading blocs and free trade zones ease trade restrictions, taxes, & tariffs Alan Rugman and Alain Verbeke argue that there is a stronger case to be made in favor of regionalization than globalization. Regionalization = increasing international exchange of goods, services, money, people, ideas, and information; and the increasing similarity of culture, laws, rules, and norms within a region such as Europe, North America, or Asia. Distance matters. The effects of geographic distance can be multiplied by distance in terms of culture, language, religion, and legal and political systems between two countries. U.S. and Australia are geographically distant yet the “true” distance is less than that between U.S. and China. In addition, a number of regional agreements have been created that facilitate the growth of business within these regions by easing trade restrictions, taxes, and tariffs. These trading blocs and free trade zones include the European Union (EU), the North American Free Trade Agreement (NAFTA), the Association of Southeast Asian Nations (ASEAN), and MERCOSUR, a south American trading block. Trading blocs = groups of countries agreeing to increase trade between them by lowering trade barriers. Regional economic integration has progressed at a faster pace than global economic integration, and trade and investment patterns of the largest companies reflect this reality.

Example: International Strategies - Regional Difficulties
eBay has successfully expanded into Europe & Latin America through joint ventures & acquisitions Appropriate partners allow quick adaptation to local needs eBay has struggled in Asia Limited local market know-how, lack of innovative products & processes in the local market, centralized management style Are these insurmountable local market differences? See and Case 13: eBay in Asia. Properly balancing its global and local market strategies will define eBay’s future success in the region.

Question? A domestic corporation considering expanding into international markets for the first time will typically start off by implementing a wholly-owned foreign subsidiary so it can maintain standards identical to those at home. consider licensing or franchising its operations. consider implementing a low risk/low control strategy such as exporting. form a joint venture with a reputable foreign producer. Answer: C. See the continuum of entry options ranging from exporting (low investment and risk, low control) to a wholly owned subsidiary (high investment and risk, high control).

International Strategies: Entry Modes
Options for international market expansion include: Exporting Licensing or Franchising Strategic Alliance or Joint Venture Wholly-Owned Subsidiary A firm has many options available to it when it decides to expand into international markets. Exporting = producing goods in one country to sell to residents of another country. This strategy enables the firm to invest the least amount of resources in terms of its product, its organization, and its overall corporate strategy. However, the firm has a limited ability to tailor its products to meet local market needs. Licensing = a contractual arrangement in which a company receives a royalty or fee in exchange for the right to use its trademark, patent, trade secret, or other valuable intellectual property. Franchising = a contractual arrangement in which a company receives a royalty or fee in exchange for the right to use its intellectual property; it usually involves a longer time than licensing and includes other factors, such as monitoring of operations, training, and advertising. Franchising has the advantage of limiting the risk exposure that a firm has in overseas markets while, at the same time, the firm is able to expand the revenue base of the company. An advantage of licensing is that the firm granting a license incurs little risk, since it does not have to invest any significant resources into the country itself. In turn, the licensee (the firm receiving the license) gains access to the trademark, patent, and so on, and is able to potentially create competitive advantages. However, the licensor gives up control of its product and forgoes potential revenues and profits. Strategic alliances and joint ventures allow firms to increase revenues and reduce costs as well as enhance learning and diffuse technologies. However, trust is a vital element. (Remember the discussion of this in Chapter 6.) Wholly Owned Subsidiary = a business in which a multinational company owns 100% of the stock. A firm can establish a wholly owned subsidiary by acquiring an existing company in the home country or developing a totally new operation, often referred to as a “greenfield venture”. This can be expensive and risky, and is most appropriate where a firm already has the appropriate knowledge and capabilities that it can leverage rather easily through multiple locations.

International Strategies: Entry Modes
Given the challenges associated with entry into international markets, many firms first start on a small-scale and then increase their level of investment and risk as they gain greater experience with the overseas market in question. The various types of entry form a continuum ranging from exporting (low investment and risk, low control) to a wholly owned subsidiary (high investment and risk, high control). Exhibit 7.9 Entry Modes for International Expansion

Example: International Strategies - Does Size Matter?
Small & Medium-sized Business Enterprises (SMEs) should engage in cross-border trade SO, is an international strategy a viable means of diversification? Does having an international strategy help a firm gain a competitive advantage? YES, and the size of the business doesn’t matter… As reported by a recent global survey conducted for DHL Express by consulting firm IHS Global Insight posits that International trade and cooperation are key drivers for small business success. The study which surveyed 410 small and medium-sized enterprises (SMEs) in so-called G7 economies – the U.S., U.K., France, Germany, Italy, Canada, and Japan – along with firms in Brazil, Russia, India, China and Mexico (BRICM) revealed that companies engaged in international markets are twice as likely to be successful as those that only operate domestically, based on three-year compound annual growth rates. Of the SMEs surveyed by IHS on behalf of DHL, 26% of those that traded internationally also significantly outperformed the market, while only 13% of domestic-only SMEs also outperformed the market. DHL’s study also discerned that inadequate business infrastructure can constrain a company’s competitiveness due to the reduction of business efficiency. For example, SMEs have to work harder to overcome infrastructure inefficiencies, particularly compared to larger companies with greater resources. The main challenges in this arena are: a lack of available information on foreign markets; high customs duties; the difficulty of establishing contacts with foreign partners; and ability to successfully generate an overseas customer base. See also SMEs that trade internationally are twice as likely to outperform those that don’t

Entrepreneurial Strategy and Competitive Dynamics
chapter 8

Learning Objectives After reading this chapter, you should have a good understanding of: LO8.1 The role of opportunities, resources, and entrepreneurs in successfully pursuing new ventures. LO8.2 Three types of entry strategies – pioneering, imitative, and adaptive – commonly used to launch a new venture. LO8.3 How the generic strategies of overall cost leadership, differentiation, and focus are used by new ventures and small businesses.

Learning Objectives LO8.4 How competitive actions, such as the entry of new competitors into a marketplace, may launch a cycle of actions and reactions among close competitors. LO8.5 The components of competitive dynamics analysis – new competitive action, threat analysis, motivation and capability to respond, types of competitive actions, and likelihood of competitive reaction.

Entrepreneurial Strategy
Consider… New technologies, shifting social and demographic trends, and sudden changes in the business environment can create opportunities for entrepreneurship. However, business opportunities can disappear as quickly as they appear. What do new ventures and entrepreneurial firms need to do to achieve a competitive advantage? New ventures often face unique strategic challenges if they’re going to survive and grow. Whether the firm is an entrepreneurial startup, a small business, or an existing business entering a market or industry for the first time, it must rely on sound strategic principles to be successful. Entrepreneurial activity influences a firm’s strategic priorities and intensifies the rivalry among an industry’s close competitors. Even with a strong initial resource base, entrepreneurs are unlikely to succeed if their business ideas are easily imitated or the execution of the strategy falls short. Not only is it important for a firm to recognize an entrepreneurial opportunity, a firm must understand the competitive dynamics that are at work in the business environment in order to succeed with a growth opportunity. It’s important to have an effective competitive strategy.

Entrepreneurship involves value creation and the assumption of risk New value can be created in many contexts: Startup ventures Major corporations Family owned businesses Nonprofit organizations Established institutions Entrepreneurship = the creation of new value by an existing organization or new venture that involves the assumption of risk. Even though entrepreneurial activity is usually associated with startup companies, new value can be created in many different contexts.

Start-up venture ideas can come from Current or past work experiences Hobbies or suggestions by friends or family For established firms, opportunities can come from Existing customers Suggestions by suppliers Technological developments For all firms, change or chance events can uncover unmet consumer needs The starting point for any new venture is the presence of an entrepreneurial opportunity. Opportunities can come from many sources, however all entrepreneurial firms must make the most of changes brought about by new technology, socio-cultural trends, and shifts in consumer demand.

Question? Three ingredients are critical in order for an entrepreneurial startup to be successful. What are they? Good ideas, a team of investors, and a business plan. A viable opportunity, available resources, and a qualified and motivated founding team. An opportunity, a marketing plan, and office space. Management, marketing, and money. Answer: B. See the discussion that follows.

For an entrepreneurial venture to create new value, three factors must be present – an entrepreneurial opportunity, the resources to pursue the opportunity, and an entrepreneur or entrepreneurial team willing and able to undertake the opportunity. The entrepreneurial strategy that an organization uses will depend on these three factors. Thus, beyond merely identifying a venture concept, the opportunity recognition process also involves organizing the key people and resources that are needed to go forward. Exhibit 8.1 Opportunity Analysis Framework Source: Based on Timmons, J.A., & Spinelli, S New Venture Creation (6th edition). New York: McGraw Hill/Irwin; and Bygrave, W.D The Entrepreneurial Process. In W.D. Bygrave (Ed.), The Portable MBA in Entrepreneurship (2nd edition). New York: Wiley.

Entrepreneurial Opportunities
Entrepreneurial opportunities require opportunity recognition Two phases of activity Discovery Becoming aware of a new business concept Evaluation Analyzing the opportunity to determine whether it is viable or feasible to develop further Opportunity recognition = the process of discovering and evaluating changes in the business environment, such as a new technology, socio-cultural trends, or shifts in consumer demand, that can be exploited. Changes in the external environment can lead to new business creation, but the discovery of these new ideas is not enough. They then need to be evaluated to find out if they’re strong enough to become new ventures. Entrepreneurs must go through a process of identifying, selecting, and developing potential opportunities.

Discovery phase - Becoming aware of the new business concept Can be spontaneous and unexpected Can also result from a deliberate search Where are the new venture opportunities? What might be a creative solution to a business problem? The discovery phase refers to the process of becoming aware of a new business concept. Many entrepreneurs report that their idea for a new venture came through some unexpected insight, often based on their prior knowledge, that gave them an idea for a new business. The discovery of new opportunities is often spontaneous and unexpected. Opportunity discovery may also occur as the result of a deliberate search for new venture opportunities or creative solutions to business problems. Viable opportunities often emerge only after a concerted effort. To stimulate the discovery of new opportunities, companies often encourage creativity, out-of-the-box thinking, and brainstorming.

Evaluation phase - Analyzing the viability of an opportunity Talk to potential target customers Identify operational requirements Conduct a feasibility analysis What is the market potential? Is the idea strong enough to create value, and therefore profits ? The evaluation phase occurs after an opportunity has been identified, and involves analyzing this opportunity to determine whether it is viable and strong enough to be developed into a full-fledged new venture. Ideas developed by new product groups or in brainstorming sessions are tested by various methods, including talking to potential target customers and discussing operational requirements with production or logistics managers. Feasibility analysis is used to evaluate these and other critical success factors. This type of analysis often leads to the decision that a new venture project should be discontinued. Only if the venture concept continues to seem viable would a more formal business plan be developed.

Viable opportunities have the following qualities: They are attractive They are achievable They are durable They are value-creating Among the most important factors to evaluate is the market potential for the product or service. New ventures must first determine whether a market exists for the product or service they are contemplating. For an opportunity to be viable, it needs to have four qualities. The opportunity must be attractive in the marketplace; that is, there must be market demand for the new product or service. The opportunity must also be achievable: it must be practical and physically possible. The opportunity must be durable or attractive long enough for the development and deployment to be successful; that is, the window of opportunity must be open long enough for it to be worthwhile. And finally the opportunity must be value-creating and potentially profitable; that is, the benefits must surpass the cost of development by a significant margin. If a new business concept meets these criteria, two other factors must be considered before the opportunity is launched as a business: the resources available to undertake it, and the characteristics of the entrepreneur pursuing it.

Example: The Feasibility of Frozen Treats
Dippin’ Dots was based on an innovative idea In 1987, product testing showed it was attractive to consumers Operational facilities were developed to maintain the low temperatures necessary for production By 2007, competitors such as Frosty Bites (Mini Melts) had stolen market share – the product idea was no longer that innovative By 2011, Dippin’ Dots was bankrupt Ice cream of the future?? We’ve already talked about Dippin’ Dots Ice Cream. (See Case 17.) Dippin’ Dots was founded in 1987 by Curt Jones, a microbiologist who decided to apply his scientific know-how to ice cream. He pioneered the use of “cryogenic encapsulation,” a process that shaped ice cream into microbeads that melted on (and sometimes, stuck to) the tongue. The company faced a setback in 2007, when its patent for cryogenic encapsulation was invalidated by a federal court jury. Competitor Frosty Bites (Mini Melts) argued that Dippin’ Dots had been selling ice cream for more than a year before applying for a patent, a technicality that would invalidate its exclusive claim to the technology under a patent law provision. The jury sided with Frosty Bites. This was a signal that the “market opportunity” had passed Dippin’ Dots by – the idea was no longer feasible – but Dippin’ Dots didn’t seem to get the message, and had difficulty adapting to the new competitive reality. In November, 2011, Dippin Dots filed for Chapter 11 bankruptcy in federal court in Kentucky. In its filing, Dippin’ Dots listed $20.2 million in assets and $12 million in liabilities. In the filing, Dippin’ Dots said it planned to reorganize its debt and lift itself out of bankruptcy. But in preparation for the worst, its fans may want to begin exploring other exotic frozen confections… (See information from “Dippin’ Dots, ‘Ice Cream of the Future,’ Files for Bankruptcy”, by Kevin Roose & Michael De La Merced, The New York Times, November 4, 2011,

Entrepreneurial Resources
Resources are essential for entrepreneurial success Financial resources Human capital Social capital Government resources Resources are an essential component of a successful entrepreneurial launch. For startups, the most important resource is usually money because a new firm typically has to expend substantial sums just to start the business. However, financial resources are not the only kind of resource a new venture needs. Human capital and social capital are also important. Many firms also rely on government resources to help them thrive.

Financial resources depend on stage of venture development & venture scale Initial, start up financing Personal savings, family, and friends Crowdfunding Early stage financing Bank financing, angel investors Later stage financing Commercial banks, venture capitalists equity financing Entrepreneurial firms must have financing. In fact, the level of available financing is often a strong determinant of how the business is launched and its eventual success. Cash finances are, of course, highly important, but access to capital, such as a line of credit or favorable payment terms with the supplier, can also help a new venture succeed. The types of financial resources that may be needed depend on two factors: the stage of venture development and the scale of the venture. The majority of new firms are low-budget startups launched with personal savings and the contributions of family and friends, and can also appeal to the public through a crowdfunding website such as Kickstarter. (See Case 26: Kickstarter, and Strategy Spotlight 8.3.) Crowdfunding = funding a venture by pooling small investments from a large number of investors, often raised on the internet. Angel investors = private individuals who provide equity investments for seed capital during the early stages of a new venture. These outside investors favor companies that already have a winning business model and dominance in a market niche. Once a venture has established itself as a going concern, other sources of financing become readily available, such as commercial loans taken out by the business. Venture capitalists = companies organized to place their investors’ funds in lucrative business opportunities. Through venture capitalists, entrepreneurs can raise money by selling shares in the new venture. Businesses with extensive development costs or firms on the brink of rapid growth are likely to turn to venture capitalists.

Human capital Strong, skilled management Social capital Extensive social contacts & strategic alliances Technology, manufacturing, or retail alliances Federal, state, & local government resources Government contracting Loan guarantee programs Training, counseling, & support services Bankers, venture capitalists, and angel investors agree that the most important asset an entrepreneurial firm can have is strong and skilled management. Managers need to have a strong base of experience and extensive domain knowledge, as well as an ability to make rapid decisions and change direction as shifting circumstances may require. Startups with multiple partners are more likely to succeed. New ventures founded by entrepreneurs who have extensive social contacts are also more likely to succeed. In addition, strategic alliances can provide a key avenue for growth. By partnering with other companies, through technology, manufacturing, or retail licensing agreements, young or small firms can expand or give the appearance of entering numerous markets or handling a range of operations. In the U.S., the federal, state, and local government provides support for entrepreneurial firms in two key areas – financing and government contracting. Through government contracting, small businesses have the opportunity to bid on contracts to provide goods and services to the government. Regarding financing, the small business administration (SBA) has several loan guarantee programs designed to support the growth and development of entrepreneurial firms. The government itself does not typically lend money but underwrites loans made by banks to small businesses, thus reducing the risk associated with lending to firms with unproven records. Local offices offer training, counseling, and support services.

Entrepreneurial Leadership
Entrepreneurial leadership is needed Courage Belief in one’s convictions Energy to work hard Leadership characteristics Vision Dedication and drive Commitment to excellence Launching a new venture requires a special kind of leadership. Entrepreneurial leadership = leadership appropriate for new ventures that requires courage, belief in one’s convictions, and the energy to work hard even in difficult circumstances; and embodies vision, dedication and drive, and commitment to excellence. However, ventures built on the charisma of a single person may have trouble growing “from good to great” once that person leaves. Thus, the leadership that is needed to build a great organization is usually exercised by a team of dedicated people rather than a single leader. The leadership team must attract members who fit with the company’s culture, goals, and work ethic. For a venture’s leadership to be a valuable resource and not a liability it must be cohesive in its vision, drive and dedication, and commitment to excellence.

Question? Why is vision such an important element of entrepreneurial leadership? Because the entrepreneur has to envision realities do not yet exist. Because a vision statement must be part of the documentation used to obtain venture financing. Because organizations cannot function without a detailed and operational vision. All of the above. Answer: A. See the discussion that follows.

Vision is an entrepreneur’s most important asset Requires transformational leadership Ability to envision realities that do not yet exist Ability to share this vision with others Vision may be an entrepreneur’s most important asset. Entrepreneurs envision realities that do not yet exist. With vision, entrepreneurs are able to exercise a kind of transformational leadership that creates something new and, in some way, changes the world. In order to develop support, get financial backing, and attract employees, entrepreneurial leaders must share their vision with others.

Drive & dedication are necessary Involves internal motivation Intellectual commitment Patience Stamina, willingness to work long hours Enthusiasm that attracts others Drive and dedication are reflected in hard work. Drive involves internal motivation; dedication calls for intellectual commitment that keeps an entrepreneur going even in the face of bad news or poor luck. They both require patience, stamina, and a willingness to work long hours. The dedicated entrepreneur’s enthusiasm is also important – it attracts others to the business to help with the work.

Commitment to excellence is required Commit to knowing the customer Providing quality goods and services Paying attention to details Continuously learning Connecting the dots Hiring people smarter than themselves Excellence requires entrepreneurs to commit to knowing the customer, providing quality goods and services, paying attention to details, and continuously learning. Entrepreneurs who achieve excellence are sensitive to how these factors work together. The most successful entrepreneurs often report that they owed their success to hiring people smarter than themselves.

Example: Lessons from a Young Entrepreneur
Create massive value Trust people, but verify credentials Psychology is important – don’t ignore personal needs Be willing to make the tough decisions Be a manager, not a technician Invest back into the company Integrity is everything Get comfortable being uncomfortable Startup Weekend is a registered 501(c)(3) not-for-profit organization based in Seattle, Washington, USA, that organizes 54-hour weekend events during which groups of developers, business managers, startup enthusiasts, marketing gurus, graphic artists and more pitch ideas for new startup companies, form teams around those ideas, and work to develop a working prototype, demo, or presentation by Sunday evening. (See Startup Weekend has grown into an organization with a global presence. As of April 2013, 1068 events had been held, involving over 100,000 entrepreneurs across more than 400 cities in over 100 countries and over 8190 startups have been created. The Kauffman Foundation, Google, and Microsoft are sponsors. (From Beginning with experience partly gained during a Startup Weekend event, in two years, young entrepreneur Guy Morita built a business with less than $1,000 and no funding, grew it to over $700,000 in revenue, and created over 16 full-time jobs worldwide in 4 countries. From 2012, here are some of the lessons he learned along the way. See Morita’s story at He says, “Many people that talk about starting companies but don’t end up following through don’t truly understand that often times in entrepreneurship starting is more important than planning. Take action now. If you have an idea, create an name for it Monday. Buy a domain on Tuesday. Research all the companies in the industry Wednesday through Friday. Take action now. Today. Not plan. If you think more planning is going to make the future more certain, it’s just an illusion. Planning in entrepreneurship is often only useful as an exercise. The business model will likely change many many times over the development of the company. Build a solid team and vision, and like Columbus, set sail west.”

New ventures require an entrepreneurial strategy What are the industry conditions? Five-forces analysis - barriers to entry? What is the competitive environment? Retaliation by established firms? What are the market opportunities? Entry strategies Generic strategies Combination strategies Entrepreneurial strategy = strategy that enables the skilled and dedicated entrepreneur, with a viable opportunity and access to sufficient resources, to successfully launch a new venture. To be successful, new ventures must evaluate industry conditions, the competitive environment, and market opportunities in order to position themselves strategically. However, a traditional strategic analysis may have to be altered somewhat to fit the entrepreneurial situation. For instance, a five-forces analysis can be applied to the analysis of new ventures to assess the impact of industry and competitive forces. First, the new entry needs to examine barriers to entry. A second important factor is the threat of retaliation by market incumbents. Part of any decision about what opportunity to pursue is a consideration of how a new entry will actually enter a new market, and, once it’s there, how it will compete.

Entry Strategies New venture entry strategies need to:
Quickly generate cash flow Build credibility Attract good employees Overcome the liability of newness Pioneering new entry Imitative new entry Adaptive new entry One of the most challenging aspects of launching a new venture is finding a way to begin doing business that quickly generates cash flow, builds credibility, attracts employees, and overcomes the liability of newness. The entry strategy will vary depending on how risky and innovative the new business concept is. New entry strategies typically fall into one of three categories – pioneering new entry, imitative new entry, or adaptive new entry. Pioneering new entry = a firm’s entry into an industry with a radical new product or highly innovative service that changes the way business is conducted. Imitative new entry = a firm’s entry into an industry with products or services that capitalize on proven market successes and that usually has a strong marketing orientation . Adaptive new entry = a firm’s entry into an industry by offering a product or service that is somewhat new and sufficiently different to create value for customers by capitalizing on current market trends.

Entry Strategies Pioneering new entry
Creating new ways to solve old problems Meeting customers’ needs in a unique new way Will it be accepted by consumers? Will it be disruptive to the status quo of an industry? Will it be sustainable? New entrants with a radical new product or highly innovative service may change the way business is conducted in an industry. This kind of breakthrough – creating new ways to solve old problems or meeting customers’ needs in a unique new way – is referred to as a pioneering new entry. See the example of Pandora in Strategy Spotlight 8.4. If the product or service is unique enough, a pioneering new entrant might actually have little direct competition. However, there is a strong risk that the product or service will not be accepted by consumers. A pioneering new entry is also potentially disruptive to the status quo of an industry. If it is successful, other competitors will rush into copy it. This can create issues of sustainability for entrepreneurial firms. For a new entrant to sustain its pioneering advantage, it may be necessary to protect its intellectual property, advertise heavily to build brand recognition, form alliances with businesses that will adopt its products or services, and offer exceptional customer service.

Entry Strategies Imitative new entry
Imitators have a strong marketing orientation Capitalizing on proven market successes Introducing the same basic product or service in another segment of the market Can we do it better than an existing competitor? Will someone then imitate us? Imitators usually have a strong marketing orientation. They look for opportunities to capitalize on proven market successes. An imitative new entry strategy is used by entrepreneurs who see products or business concepts that have been successful in one market niche or physical locale and introduce the same basic product or service in another segment of the market. Sometimes the key to success with an imitative strategy is to fill a market space where the need had previously been filled inadequately. Entrepreneurs are also prompted to be imitators when they realize that they have the resources or skills to do a job better than an existing competitor. But success triggers imitation. See the example of Square.

Entry Strategies Adaptive new entry
Capitalizes on current market trends Offers a product or service that is somewhat new and sufficiently different Creates new value for customers Captures market share Is it sufficiently unique and different? Can it be easily imitated? How can we continue to keep it fresh and new? Most new entrants use a strategy somewhere between pure imitation and pure pioneering. That is, they offer a product or service that is somewhat new and sufficiently different to create new value for customers and capture market share. Such firms are adaptive in the sense that they are aware of marketplace conditions and conceive entry strategies to capitalize on current trends. An adaptive new entry involves taking an existing idea and adapting it to a particular situation. However, unless potential customers believe the product or service does a superior job of meeting their needs, they will have little motivation to try it. Second, there is nothing to prevent a close competitor from mimicking the new firm’s adaptation as a way to hold onto its customers. Third, once an adaptive entrant achieves initial success, the challenge is to keep the idea fresh. If the attractive features of the new business are copied, the entrepreneurial firm must find ways to adapt and improve the product or service offering.

Entry Strategies Exhibit 8.3 Examples of Adaptive New Entrants
An adaptive new entry approach does not involve “reinventing the wheel,” nor is it merely imitative either. It involves taking an existing idea and adapting it to a particular situation. Exhibit 8.3 presents examples of four young companies that successfully modified or adapted existing products to create new value. Exhibit 8.3 Examples of Adaptive New Entrants Source: Bryan, M Spanx Me, Baby! December 10, np.; Carey, J Perspiration Inspiration. Business Week, June 5: 64; Palanjian, A A Planner Plumbs for a Niche. September 30, np.; Worrell, D Making Mint. Entrepreneur, September: 55; Buss, D The Mothers of Invention. Wall Street Journal, February 8: R7; Crook. J Mint.com Tops 10 Million Registered Users, 70% Use Mobile. Techcrunch.com, August 29: np.; and

Generic Strategies for New Ventures
Overall cost leadership Simpler organizational structure Quicker decision-making to upgrade technology & integrate marketplace feedback Differentiation Using new technology Deploying resources in a radical new way Focus Using niche strategies that fit the small business mold A new entrant must decide what type of strategic positioning will work best as the business goes forward. One of the ways entrepreneurial firms achieve success is by doing more with less. By holding down costs or making more efficient use of resources than larger competitors, new ventures are often able to offer lower prices and still be profitable. Thus, under the right circumstances, a low-cost leader strategy is a viable alternative for new ventures. Compared to large firms, new ventures often have simple organizational structures that make decision-making both easier and faster. The smaller size also helps young firms change more quickly when upgrades in technology or feedback from the marketplace indicates that improvements are needed. They are also able to make decisions at the time they are founded that help them deal with the issue of controlling costs. Both pioneering and adaptive entry strategies involve some degree of differentiation. That is, the new entry is based on being able to offer a differentiated value proposition. However, differentiation successes are sometimes built on superior innovation or use of technology, which is challenging for young firms to implement relative to established competitors. Focus strategies work for small businesses because there is a natural fit between the narrow scope of the strategy and the small size of the firm. If a start-up wants to succeed, it has to take business away from an existing competitor. Young firms can often succeed best by finding a market niche where they can get a foothold and make small advances that erode the position of the existing competitors. From this position, they can build a name for themselves and grow.

Question? When an industry is mature, a _________ strategy may be considered to be an effective approach for a new entrant. focus differentiation overall low-cost small business Answer: A. If a start-up wants to succeed, it has to take business away from an existing competitor. Young firms can often succeed best by finding a market niche where they can get a foothold and make small advances that erode the position of the existing competitors. From this position, they can build a name for themselves and grow.

Combination Strategies for New Ventures
Pursuing combination strategies Combine the best features of low-cost, differentiation, and focused strategies Hold down expenses by having a simple structure Create high-value products & services by being flexible & innovative One of the best ways for young and small businesses to achieve success is by pursuing combination strategies. By combining the best features of low-cost, differentiation, and both strategies, new ventures can often achieve something truly distinctive. Entrepreneurial firms are often in a strong position to offer a combination strategy because they have the flexibility to approach situations uniquely. They can often enact combination strategies in ways that the large firms cannot copy. For example, holding down expenses can be difficult for big firms because each layer of bureaucracy adds to the cost of doing business across the boundaries of a large organization. Also, large firms often find it difficult to offer highly specialized products or superior customer services, while entrepreneurial firms can create high-value products and services through their unique differentiating efforts. However, one of the major dangers is that either a large firm with more resources or a close competitor will copy what the new entry is doing. A carefully crafted and executed combination strategy may be the best answer.

Competitive Dynamics New entry threatens existing competitors
Competitive dynamics helps explain why strategies evolve and how to respond: New competitive action Threat analysis Motivation and capability to respond Types of competitive action Likelihood of competitive reaction New entry into markets, whether by startups or by incumbent firms, nearly always threatens existing competitors. As a result, the competitive actions of the new entrants are very likely to provoke negative response from companies that feel threatened. Competitive dynamics = intense rivalry, involving actions and responses among similar competitors vying for the same customers in a marketplace. Intense rivalry among similar competitors has the potential to alter a company’s strategy. New entry is among the most common reasons why a cycle of competitive actions and reactions gets started. It might also occur because of threatening actions among existing competitors, such as aggressive cost-cutting. Thus, studying competitive dynamics helps explain why strategies evolve and reveals how, why, and when to respond to the actions of close competitors. New competitive action = acts that might provoke competitors to react, such as new market entry, price-cutting, imitating successful products, and expanding production capacity. Threat analysis = a firm’s awareness of its closest competitors and the kinds of competitive actions they might be planning.

Competitive Dynamics Exhibit 8.4 Model of Competitive Dynamics
Exhibit 8.4 identifies the factors competitors need to consider when determining how to respond to a competitive act. Exhibit 8.4 Model of Competitive Dynamics Source: Adapted from Chen, M.J Competitor Analysis and Interfirm Rivalry: Toward a Theoretical Integration. Academy of Management Review, 21(1): ; Ketchen, D.J., Snow, C.C., & Hoover, V.L Research on Competitive Dynamics: Recent Accomplishments and Future Challenges. Journal of Management, 30(6): ; and Smith, K.G., Ferrier, W.J., & Grimm, C.M King of the Hill: Dethroning the Industry Leader . Academy of Management Executive, 15(2):

Competitive Dynamics Why do companies launch new competitive actions?
To improve market position To capitalize on growing demand To expand production capacity To provide an innovative new solution To obtain first mover advantages To strengthen financial outcomes & capture profits To grow the business When a company enters a market for the first time, it is an attack on existing competitors. In addition, price-cutting, imitating successful products, or expanding production capacity are all examples of competitive acts that might provoke a reaction. Companies are motivated to launch competitive challenges because they want to strengthen financial outcomes, capture some of the extraordinary profits that industry leaders enjoy, and grow the business. They also may want to build their reputation for innovativeness or efficiency. The likelihood that a competitor will launch an attack depends on many factors. Some of these factors include competitor analysis, market conditions, types of strategic actions available, and the resource endowments and capabilities companies need in order to take this competitive action.

Competitive Dynamics Competition among incumbent rivals can involve “hardball” strategies: Devastating rivals’ profit sanctuaries Plagiarizing with pride Deceiving the competition Unleashing massive & overwhelming force Raising competitors’ costs Competitive attacks can come from many sources besides new entrants. Some of the most intense competition is among incumbent rivals intent on gaining strategic advantages. According to Boston Consulting Group authors George Stalk, Jr. and Rob Lachenauer, “winners in business play rough and don’t apologize for it.” Exhibit 8.5 outlines their five strategies for playing “hardball”. While the “big boys” are competing, it’s possible an entrepreneur might be able to take advantage of some of these activities.

Competitive Dynamics Threat analysis involves an assessment of
Market commonality Resource similarity How serious is the threat? What is the intent of the competitive response? What resources are needed to fend off a competitive attack? Which action should I take? Awareness of the threats posed by industry rivals allows a firm to understand what type of competitive response, if any, may be necessary. Competitive dynamics are likely to be most intense among companies that are competing for the same customers or who have highly similar sets of resources. Market commonality = the extent to which competitors are vying for the same customers in the same markets. Resource similarity = the extent to which rivals draw from the same types of strategic resources. When any two firms have both a high degree of market commonality and highly similar resource bases, a stronger competitive threat is present. Once attacked, competitors are faced with deciding how to respond. Before deciding, however, they need to evaluate not only how they will respond, but also their reasons for responding and their capability to respond.

Types of competitive actions include:
Competitive Dynamics Types of competitive actions include: Strategic actions Entering new markets New product introductions Changing production capacity Mergers/alliances Tactical actions Price cutting (or increases) Product/service enhancements Increased marketing efforts New distribution channels Once an organization determines whether it is willing and able to launch a competitive action, it must determine what type of action is appropriate. The actions taken will be determined by both its resource capabilities and its motivation for responding. Two broadly defined types of competitive action include strategic actions and tactical actions. Strategic actions = major commitments of distinctive and specific resources to strategic initiatives. Tactical actions= refinements or extensions of strategies usually involving minor resource commitments. See Exhibit 8.6 for some examples.

Competitive Dynamics Likelihood of competitive reaction
Market dependence Competitor’s resources The reputation of the firm that initiates the action – the actor’s reputation Choosing not to respond Forbearance Co-opetition Working together behind the scenes to achieve industrywide efficiencies The final step before initiating a competitive response is to evaluate what a competitor’s reaction is likely to be. Evaluating potential competitive reactions helps companies plan for future counterattacks. How a competitor is likely to respond will depend on three factors: market dependence, the competitor’s resources, and the reputation of the firm that initiates the action. Market dependence = degree of concentration of a firm’s business in a particular industry. If a company has a high concentration of its business in a particular industry, it has more at stake because it must depend on that industry’s market for its sales. Young and small firms with a high degree of market dependence may be limited in how they respond due to resource constraints. The competitor’s resources must also be considered. For instance, if the competitor is a small firm, it may be unable to mount a serious attack due to lack of resources. As a result, it is more likely to react to tactical actions such as incentive pricing or enhanced service offerings because they are less costly to attack than large-scale strategic actions. Finally, whether a company should respond to a competitive challenge will also depend on who launched the attack against it. Compared to relatively smaller firms with less market power, competitors are more likely to respond to competitive moves by market leaders. Competitors can also choose not to react at all. Forbearance = a firm’s choice of not reacting to a rival’s new competitive action. Co-opetition = a firm’s strategy of both cooperating and competing with rival firms.

Question? Which of the following might best describe the motivations and actions of small firms as they respond to competitive attacks? Because they lack legitimacy in the marketplace, small firms need to signal their competitive actions long before they launch those actions Small firms typically have more resources available as they undertake competitive attacks. Small firms are more nimble and can respond quickly to competitive attacks. All of the above. Answer: C. Smaller size makes them more nimble compared to large firms so they can respond quickly to competitive attacks. Because they are not well known, startups also have the advantage of the element of surprise in how and when they attack. Innovative uses of technology, for example, allow small firms to deploy resources in unique ways. Because they are young, however, startups may not have the financial resources needed to follow through with a competitive response. In contrast, older and larger firms may have more resources and a repertoire of competitive techniques they can use in a counterattack. Large firms, however, tend to be slower to respond.

Competitive Dynamics & Entrepreneurial Strategies
Entrepreneurial strategy involves new value creation, which Threatens existing competitors Changes the competitive dynamics of the marketplace Entrepreneurial activity involves risk How should I enter a market? How should I compete? How should I deal with the competitor’s reaction? The entry of a startup into a market for the first time, an attack by a lower-ranked incumbent on an industry leader, or the launch of a breakthrough innovation can all disrupt an industry structure. Such actions forever change the competitive dynamics of the market place. Entrepreneurial strategy must deal with the risk of these cycles of actions and reactions that occur in business every day.

Strategic Control and Corporate Governance
chapter 9

Learning Objectives After reading this chapter, you should have a good understanding of: LO9.1 The value of effective strategic control systems in strategy implementation. LO9.2 The key difference between “traditional” and “contemporary” control systems. LO9.3 The imperative for “contemporary” control systems in today’s complex and rapidly changing competitive and general environments.

Learning Objectives LO9.4 The benefits of having the proper balance among the three levers of behavioral control: culture, rewards and incentives, and boundaries. LO9.5 The three key participants in corporate governance: shareholders, management (led by the CEO), and the board of directors. LO9.6 The role of corporate governance mechanisms in ensuring that the interests of managers are aligned with those of shareholders from both the United States and international perspectives.

Strategic Control Consider…
Once strategy is formulated, it must be implemented, and part of implementation is establishing a mechanism for monitoring and correcting organizational performance. This control mechanism must be consistent with the strategy the firm is following. How does a firm make sure all key stakeholders are moving in the right direction? Organizations must have effective strategic controls, mechanisms for monitoring and correcting organizational performance, if they are to successfully implement their strategies. Control systems must exercise both informational and behavioral control – employees and managers must know what the goals are, what the rules and procedures are, and what the rewards for performance will be. These controls must be consistent with the strategy that the firm is following. When individuals in the firm internalize goals and strategies, there is less need for monitoring behavior, and efforts are focused more on important organizational goals and objectives. In addition, a firm must promote sound corporate governance to ensure that the interests of managers and shareholders are aligned. As both general and competitive environments become more unpredictable and complex, the need for effective strategic control systems increases.

Strategic Control Strategic control involves monitoring performance toward strategic goals and taking corrective action when needed via effective systems: Informational control systems Behavioral control systems Corporate governance Strategic control = the process of monitoring and correcting a firm’s strategy and performance. An organization does a strategic analysis of the external environmental conditions, evaluates its internal capabilities for responding to those conditions, formulates a strategy for sustaining a competitive advantage, and then implements this strategy. Once implemented, this strategy must be monitored and adjusted as needed. Effective strategic control systems allow for corrective action to be taken.

Strategic Control: Traditional Approach
The traditional approach to strategic control is sequential Strategies are formulated, goals are set Strategies are implemented Performance is measured against goals Traditional approach to strategic control = a sequential method of organizational control in which (1) strategies are formulated and top management sets goals, (2) strategies are implemented, and (3) performance is measured against the predetermined goal set. Exhibit 9.1 Traditional Approach to Strategic Control

Strategic Control: Traditional Approach
Control = feedback loop from performance measurement to strategy formulation Involves lengthy time lags, “single-loop” learning Most appropriate when Environment is stable and relatively simple Objectives can be measured with certainty Little need for complex measures of performance The traditional approach to strategic control is based on a feedback loop from performance measurement to strategy formulation. This process typically involves lengthy time lags, often tied to a firm’s annual planning cycle. Such traditional control systems, termed “single–loop” learning by Harvard’s Chris Argyris, simply compare actual performance to a predetermined goal. They are most appropriate when the environment is stable and relatively simple, goals and objectives can be measured with a high level of certainty, and there is little need for complex measures of performance. Sales quotas, operating budgets, production schedules, and similar quantitative control mechanisms are typical. The appropriateness of the business strategy or standards of performance is seldom questioned. This traditional approach does not work well for firms competing in highly unpredictable competitive environments. Sometimes strategies need to change frequently and opportunistically. An inflexible commitment to predetermined goals and milestones can prevent the very adaptability that is required of a good strategy.

Strategic Control: Contemporary Approach
Relationships between strategy formulation, implementation, & control are highly interactive, utilizing Informational control Behavioral control The contemporary approach to strategic controls allows managers to adapt to and anticipate changes in both the internal and external environment. The relationships between strategy formulation, implementation, and control are highly interactive. This approach utilizes two different types of strategic control: informational control and behavioral control. Informational control = a method of organizational control in which a firm gathers and analyzes information from the internal and external environment in order to obtain the best fit between the organization’s goals and strategies and the strategic environment. Behavioral control = a method of organizational control in which a firm influences the actions of employees through culture, rewards, and boundaries. Exhibit 9.2 Contemporary Approach to Strategic Control

Strategic Control: Contemporary Approach
Informational control = concerned with whether or not the organization is “doing the right things” Behavioral control = concerned with whether or not the organization is “doing things right” in the implementation of its strategy Both types of control are necessary, but not sufficient, conditions for success Informational control is primarily concerned with whether or not the organization is obtaining the best fit between its goals and strategies and the external strategic environment – is the organization “doing the right things”, given the external situation and the internal capabilities of the organization. Behavioral control, on the other hand, is a mechanism for making sure the employees of the firm are doing things correctly while implementing strategy – are the employees “doing things right”. Both the informational and behavioral components of strategic control are necessary, but not sufficient, conditions for success. What good is a well conceived strategy that cannot be implemented? Or what use is an energetic and committed workforce if it is focused on the wrong strategic target?

Question? Top managers at ABC Company meet every Friday to review daily operational reports and year-to-date data. This is an example of behavioral control. informational control. strategy formulation. strategy implementation. Answer: B. The information reviewed will be used to assess the effectiveness of the strategy’s implementation. This is a key role of informational control.

Informational Control
Informational control deals with both the internal & external environment Do the organization’s goals and strategies still “fit” within the context of the current strategic environment? Two key issues: Scan & monitor the external environment Continuously monitor the internal environment Remember, informational control is primarily concerned with whether or not the organization is obtaining the best fit between its goals and strategies and the external strategic environment – is the organization “doing the right things”, given the external situation and the internal capabilities of the organization. Informational control addresses the assumptions and premises that provide the foundation for an organization’s strategy and, depending on the type of business, such assumptions may relate to changes in technology, customer tastes, government regulation, and industry competition. Therefore, managers must scan and monitor the external environment, both the general environment and the industry environment. In addition, conditions can change in the internal environment of the firm, requiring changes in the strategic direction of the firm. Changing internal conditions can include the resignation of key executives or delays in the completion of major production facilities.

Informational Control
Informational control = ongoing process of organizational learning Focus on constantly changing information - continuous monitoring, testing, review Updates & challenges assumptions, so Time lags are shortened Changes are detected earlier Speed & flexibility of response is enhanced In the contemporary approach, information control is part of an ongoing process of organizational learning that continuously updates and challenges the assumptions that underlie the organization’s strategy. In such “double-loop” learning, the organization’s assumptions, premises, goals, and strategies are continuously monitored, tested, and reviewed. The benefits of continuous monitoring are evident – time lags are dramatically shortened, changes in the competitive environment are detected earlier, and the organization’s ability to respond with speed and flexibility is enhanced.

Question? Which of the following is not one of the characteristics of a contemporary control system? It is a key catalyst for an ongoing debate about underlying data, assumptions, and action plans. It must focus on constantly changing information that is strategically important. It circumvents the need for face-to-face meetings among superiors, subordinates, and peers. It generates information that is important enough to demand regular and frequent attention. Answer: C. One of the key components of a contemporary control system is the ongoing feedback loop between strategic formulation and strategic implementation: the ongoing debate about the underlying data and assumptions about strategic action given current information. This feedback loop requires a significant degree of communication between superiors, subordinates, and peers. An executive’s decision to use the control system interactively – in other words, to invest the time and attention to review and evaluate new information – sends a clear signal to the organization about what is important. The dialogue and debate that emerge from such an interactive process can often lead to new strategies and innovations.

Behavioral Control Behavioral control = focused on implementation – “doing things right” Influences the actions of employees via: Culture Rewards Boundaries Remember, behavioral control is a mechanism for making sure the employees of the firm are doing things correctly while implementing strategy – are the employees “doing things right”. Behavioral control is a method of organizational control in which a firm influences the actions of employees through culture, rewards, and boundaries. There are two compelling reasons for increased emphasis on culture and rewards in a system of behavioral controls. First, as firms deal with an increasingly complex and unpredictable environment, there is a need for increased coordination across organizational barriers. Therefore, a control system based primarily on rigid strategies, rules, and regulations is dysfunctional. The use of rewards and culture to align individual and organizational goals becomes increasingly important. Second, as younger managers become more focused on a career rather than on a job, the role of culture and rewards in building organizational loyalty gains greater importance. Each of the three levers – culture, rewards, and boundaries – must work in a balanced and consistent manner. Exhibit 9.3 Essential Elements of Behavioral Control

Behavioral Control: Culture
Organizational culture is a system of Shared values (what is important) Beliefs (how things work) Organizational culture shapes a firm’s People Organizational structures Control systems Organizational culture produces Behavioral norms (the way we do things around here) Organizational culture = a system of shared values and beliefs that shape the company’s people, organizational structures, and control systems to produce behavioral norms. Culture has a powerful influence on what goes on within organizations and how they perform. Effective leaders understand culture’s importance and strive to shape and use it as one of their important levers of strategic control.

Organizational culture sets implicit boundaries regarding: Dress Ethical matters The way an organization conducts its business A strong culture Leads to greater employee engagement Provides a common purpose and identity Reduces monitoring costs Culture can play an important role by focusing on those values that sustain the organization’s primary source of competitive advantage. Culture sets implicit boundaries – unwritten standards of acceptable behavior – interests, ethical matters, and the way an organization conducts its business. Strong culture can lead to greater employee engagement and provide a common purpose and identity. By creating a framework of shared values, culture encourages individual identification with the organization and its objectives. Culture acts as a means of reducing monitoring costs.

Effective organizational cultures must be Cultivated Encouraged Fertilized Organizational cultures can be maintained by Storytelling Rallies or pep talks by top executives Powerful organizational cultures just don’t happen overnight, and they don’t remain in place with a strong commitment – both in terms of words and deeds – by leaders throughout the organization. A viable and productive organizational culture can be strengthened and sustained. However it cannot be built or assembled; instead it must be cultivated, encouraged, and fertilized. Storytelling is one way effective cultures are maintained. Rallies or pep talks by top executives also serve to reinforce a firm’s culture. Southwest Airlines’ “Culture Committee” is given as one example = see Case 21: Southwest Airlines: Does LUV last?

Behavioral Control: Rewards
Reward systems & incentive programs: Powerful means of influencing an organization’s culture Focus efforts on high-priority tasks Motivate individual & collective task performance Can be an effective motivator & control mechanism Reward and incentive systems represent a powerful means of influencing an organization’s culture, focusing efforts on high-priority tasks, and motivating individual and collective task performance. Reward system = policies that specify who gets rewarded and why. Just as culture deals with influencing beliefs, behaviors, and attitudes of people with in an organization, the reward system or incentive program – by specifying who gets rewarded and why – is an effective motivator and control mechanism.

Potential downside: Individual actions are not related to compensation; employees are rewarded for the wrong things Different business units have differing rewards systems Behavior reinforced within subcultures may reflect value differences in opposition to the dominant culture Reward systems may lead to information hoarding, working at cross purposes While they can be powerful motivators, reward and incentive policies can also result in undesirable outcomes. If individual workers don’t see how their actions relate to how they are compensated, they can be demotivated. On the other hand, if the incentives are so closely tied to their individual work, this may lead to dysfunctional outcomes. For example, if the sales representative is rewarded for sales volume, she will be incentivized to sell at all costs. This may lead her to accept unprofitable sales or push sales through distribution channels the firm would rather avoid. Reward and incentive systems can also cause problems across organizational units. Subcultures within organizations may reflect differences among functional areas, products, services, and divisions. To the extent that reward systems reinforce such behavioral norms, attitudes, and belief systems, cohesiveness is reduced; important information is hoarded rather than shared, individuals begin working at cross purposes, and they lose sight of overall goals. Conflicts can also arise across divisions when divisional profits become a key compensation criterion.

To be effective, incentive and reward systems need to reinforce basic core values, enhance cohesion and commitment to goals and objectives, and meet with the organization’s overall mission and purpose. Effective reward and incentive systems share a number of common characteristics. The perception that a plan is “fair and equitable” is critically important. The firm must also have the flexibility to respond to changing requirements as its direction and objectives change. Finally, incentive and reward systems don’t all have to be about financial rewards. Recognition can be a powerful motivator. The key is for managers to find a mix of incentives that motivates employees. Exhibit 9.4 Characteristics of Effective Reward and Evaluation Systems

Behavioral Control: Boundaries
Boundaries and constraints can be useful Focusing individual efforts on strategic priorities Providing short-term objectives and action plans to channel efforts Specific, measurable, including a specific time horizon for attainment Achievable, yet challenging enough to motivate Individual managers held accountable for implementation Boundaries and constraints = rules that specify behaviors that are acceptable and unacceptable. Boundaries and constraints play a valuable role in focusing a company’s strategic priorities - concentrating effort and resources in key businesses while closing others can provide the firm with greater strategic focus and the potential for a stronger competitive advantage in the remaining areas. Short-term objectives and action plans represent boundaries that help allocate resources in an optimal manner and channel the efforts of employees at all levels. Performance is enhanced when individuals are encouraged to obtain specific, difficult, yet achievable, goals. Action plans are critical to the implementation of chosen strategies. Unless action plans are specific, there may be little assurance that managers have thought through all of the resource requirements for implementing their strategies. In addition, unless plans are specific, managers may not understand what needs to be implemented or have a clear time frame for completion. Finally, individual managers must be held accountable for the implementation.

Question? Rules and regulations, rather than culture or rewards, would probably be used for strategic control at what type of company? Software developer Stock brokerage firm Manufacturer of mass-produced products High-tech research facility Answer: C. rules and regulations are especially helpful when consistency of product quality is critical.

Behavioral Control: Boundaries
Boundaries and constraints can also Improve efficiency and effectiveness through rule-based controls, appropriate when Environments are stable and predictable Employees are largely unskilled and interchangeable Consistency in product and services is critical The risk of malfeasance is extremely high Minimize improper and unethical conduct via Anti-bribery policies Regulations and sanctions – i.e. Sarbanes-Oxley Rule-based controls are most appropriate in organizations when the environment is stable, predictable; employees are unskilled, interchangeable; product and service consistency is critical; the risk of malfeasance is extremely high (e.g., in banking or casino operations). Guidelines can also be effective in setting spending limits and a range of discretion for employees and managers. Guidelines can be useful in specifying proper relationships with the company’s customers and suppliers, for instance, through anticorruption and anti-bribery policies. Regulations backed up with strong sanctions, for instance, via Sarbanes-Oxley, can also help an organization avoid conducting business in an unethical manner.

Behavioral Control Systems
The focus of a control system is on ensuring that the behavior of individuals at all levels of an organization is directed toward achieving organizational goals and objectives. The three fundamental types of control are culture, rewards and incentives, and boundaries and constraints. An organization may pursue one or a combination of them on the basis of a variety of internal and environmental factors. Not all organizations place the same emphasis on each type of control. Situational factors affect the combination and emphasis on each type of control. Exhibit 9.5 Organizational Control: Alternative Approaches

Behavioral Control Systems
Rewards and incentives, plus a strong culture, reduce the need for external controls, IF organizations Hire the right people Train people in the dominant cultural values Have managerial role models Have reward systems clearly aligned with organizational goals and objectives In most environments, organizations should strive to provide a system of rewards and incentives, coupled with a culture strong enough that boundaries become internalized. This reduces the need for external controls such as rules and regulations under the following conditions: first, hire the right people – individuals who already identify with the organization’s dominant values and have attributes consistent with them; institute training regimens that not only build skills, but also play a significant role in building a strong culture on the foundation of the organization’s dominant values; make sure the organization has managerial role models; make sure the reward systems are clearly aligned with the organization’s goals and objectives.

Example: Building a Strong, Rewarding Culture
Zappos hires only one out of 100 applicants - a hiring process that is weighted 50% on job skills & 50% on the potential to mesh with Zappos’ culture. Call center reps are measured based on how much time they spend with customers, not how many calls they take Rewards include Zollars (Zappos dollars) given by peers to peers for deserving behaviors Because Zappos has a strong culture they can… Run primarily using recognition with few “incentive” programs Eschew traditional programs – use what works for them We’ve already talked about Zappos, how Zappo CEO Tony Hsieh believes it’s important to “high slowly and fire quickly”, that choosing employees who fit with the culture in the beginning will lead to greater retention (91% in the Las Vegas location) and better performance over time. ( See more: “At Zappos, Culture Pays: The thriving Internet shoe retailer has made its name and a lot of money by being eccentric”, by Dick Richards, strategy+business, 8/24/2010, In addition, Zappos call center employees are measured based not on how many calls they can take during their shifts, but on how much time they spend on personal service, or customer-facing activities – goal is 80%. Peer-to-Peer Recognition programs include incentives like Zollars, or Zappos Dollars: Employees can give each other Zollars for any action that they feel is deserving of recognition (if someone helps them carry boxes to their car or holds the door while their hands are full, or helps them to learn something they were having a hard time with, etc...) See and

Corporate Governance Corporate governance controls focus on relationships between The shareholders The management (led by the Chief Executive Officer - CEO) The Board of Directors How can corporations succeed (or fail) in aligning managerial motives with The interests of the shareholders The interests of the board of directors Corporate governance = the relationship among various participants in determining the direction and performance of corporations. The primary participants are (1) the shareholders, (2) the management, and (3) the Board of Directors. The strategic control mechanism known as corporate governance focuses on the need for both shareholders (the owners of the corporation) and their elected representatives, the Board of Directors, to actively ensure that management fulfills its overriding purpose of increasing long-term shareholder value. However, management cannot ignore the demands of other important firm stakeholders such as creditors, suppliers, customers, employees, and government regulators. At times of financial duress, powerful stakeholders can exert strong and legitimate pressures on managerial decisions. In general however, the attention to stakeholders other than the owners of the corporation must be addressed in a manner that is still consistent with maximizing long-term shareholder returns. Sound governance practices often lead to superior financial performance.

Corporate Governance The separation of owners (shareholders) & management in a modern corporation Shareholders (investors) have limited liability & can participate in the profits without taking direct responsibility for operations Management can run the company without personally providing any funds The Board of Directors are elected by shareholders & have a fiduciary obligation to protect shareholder interests Corporation = a mechanism created to allow different parties to contribute capital, expertise, and labor for the maximum benefit of each party. The corporate form of business organization has the ability to draw resources from a variety of groups and establish and maintain its own persona that is separate from all of them. The shareholders (investors) are able to participate in the profits of the enterprise without taking direct responsibility for the operations. The management can run the company without the responsibility of personally providing the funds. The shareholders have limited liability as well is rather limited involvement in the company’s affairs. However, they reserve the right to elect directors who have the to do she hairy obligation to protect their interests. Columbia University professors Berle and Means addressed the divergence of the interests of the owners of the corporation from the professional managers who are hired to run it. They warned that widely dispersed ownership “released management from the overriding requirement that it serve stockholders.” The separation of ownership from management has given rise to a set of ideas called agency theory.

Corporate Governance: Agency Theory
Agency theory deals with the relationship between principals & agents What to do when the goals of the principals and agents conflict? What to do when it is difficult or expensive for the principal to verify what the agent is actually doing? What happens when the principal and the agent have different attitudes and preferences toward risk? Agency theory = a theory of the relationship between principals and their agents, with emphasis on two problems: (1) the conflicting goals of principals and agents, along with the difficulty of principals to monitor the agents, and (2) the different attitudes and preferences toward risk of principals and agents. Principles are owners of the firm (stockholders or investors), and agents are the people paid by principals to perform the job on their behalf (management). Managers, or agents, are insiders with regard to the businesses they operate and thus are better informed than the principals. Thus, managers may act opportunistically in pursuing their own interests to the detriment of the corporation. Regarding risk, executives in a firm may favor additional diversification initiatives, for example, because these initiatives could increase the size of the firm and thus the level of executive compensation. At the same time, such diversification initiatives may erode shareholder value. On the other hand, executives who have large holdings of stock in their firms are more likely to have diversification strategies that are more consistent with shareholder interests, therefore increasing long-term returns. At times, top level managers engage in actions that reflect their self interest rather than the interests of shareholders. Governance mechanisms can minimize the potential for managers to act opportunistically.

Corporate Governance Mechanisms
Corporate governance mechanisms: aligning the interests of owners and managers through A committed and involved Board of Directors Shareholder activism Managerial rewards and incentives Contract-based outcomes CEO duality – should the CEO also be chairman of the board of directors? Governance mechanisms can minimize the potential for managers to act opportunistically. In addressing agency theory concerns, the interests of owners and managers can be aligned via three mechanisms: a committed and involved Board of Directors, the use of shareholder activism, and appropriate managerial rewards and incentives. Board of Directors = a group that has a fiduciary duty to ensure that the company is run consistently with the long-term interests of the owners, or shareholders, of the corporation and that acts as an intermediary between the shareholders and management. A committed and involved Board of Directors can monitor the behavior of managers and act in the best interests of the shareholders. Shareholders can also view themselves as share owners instead of shareholders and become actively engaged in the governance of the corporation. Shareholder activism = actions by large shareholders to protect their interests when they feel that managerial actions of a corporation converge from shareholder value maximization. Finally, there are managerial incentives, sometimes called “contract-based outcomes”, which consist of reward and compensation agreements. Here the goal is to carefully craft managerial incentive packages to align the interests of management with those of the stockholders. Regarding managerial incentives, one of the most controversial issues in corporate governance is CEO duality. Should the CEO also be chairman of the board of directors? In many Fortune 500 firms, the same individual serves in both roles. Is this appropriate?

Duties of the Board of Directors Regularly evaluate, and, if necessary, replace the CEO; determine management compensation; review succession planning. Review & approve financial objectives, major strategies, and plans of the Corporation. Provide advice and counsel to top management. Select & recommend candidates for the Board of Directors; evaluate board processes. Review the adequacy of all compliance systems. The Board of Directors acts as a fulcrum between the owners and controllers of a Corporation. They are the intermediaries who provide a balance between a small group of key managers in the firm based at the corporate headquarters and a sometimes vast group of shareholders. In the United States, the law imposes on the board a strict and absolute fiduciary duty to ensure that a company is run consistent with the long-term interests of the owners – the shareholders.

An effective Board of Directors should Become active, critical participants Ensure that strategic plans undergo rigorous scrutiny Evaluate managers against high performance standards Take control of the succession process Practice director independence No interlocking directorships Insist that directors own significant stock in the company What makes for a good Board of Directors? According to the Business Roundtable, the most important quality is a Board of Directors who are active, critical participants in determining a company’s strategies. That does not mean board members should micromanage or circumvent the CEO. Rather, they should provide strong oversight going beyond simply approving the CEO’s plans. A board’s primary responsibilities are to ensure that strategic plans undergo rigorous scrutiny, evaluate managers against high performance standards, and take control of the succession process. Another key component of top ranked boards is director independence. Governance experts believe that a majority of directors should be free of all ties to either the CEO or the company. That means a minimum of “insiders” (past or present members of the management team) should serve on the board, and that directors and their firms should be barred from doing consulting, legal, or other work for the company. Interlocking directorships – in which CEOs and other top managers serve on each other’s boards – are not desirable. But perhaps the best guarantee that directors act in the best interest of shareholders is the simplest: most companies now insist that directors own significant stock in the company they oversee. There are also several actions that can have a positive influence on board dynamics as the board works to both oversee and advise management. See the list on page 293, and see Exhibit 9.6 for how board structure has changed over the years.

Individual shareholders have rights: To sell stock, vote the proxy, bring suit for damages, get information, receive residual rights following the company’s liquidation Collectively, shareholders have power: To direct the course of corporations, file shareholder action suits, demand key issues be brought up for proxy votes Institutional investors can be aggressive: By reviewing performance, requesting changes in the firm’s governance structure, filing court action, becoming major shareholders Shareholder activism refers to actions by large shareholders, both institutions and individuals, to protect their interests when they feel that managerial actions diverge from shareholder value maximization. There are so many owners of the largest American corporations that it makes little sense to refer to them as “owners” in the sense of individuals becoming informed and involved in corporate affairs. However even individual shareholders have rights, and, collectively, shareholders have the power to direct the course of corporations. Many institutional investors are aggressive in protecting and enhancing their investments. They are shifting from traders to owners. They are assuming the role of permanent shareholders and rigorously analyzing issues of corporate governance. In the process they are reinventing systems of corporate monitoring and accountability.

Boards are responsible for managerial rewards and incentives Boards can require that CEOs become substantial owners of company stock Salaries, bonuses, and stock options can be structured so as to provide rewards for superior performance and penalties for poor performance Dismissal for poor performance should be a realistic threat Incentive systems must be designed to help the company achieve its goals. One of the most critical roles of the Board of Directors is to create incentives that align the interests of the CEO and top executives with the interests of owners of the corporation, and long-term shareholder returns. Shareholders rely on CEOs to adopt policies and strategies that maximize the value of their shares. The above three basic policies can create the right monetary incentives for CEOs to maximize the value of their companies. See Exhibit 9.7 for suggestions on how to build effective compensation packages for executives.

Corporate Governance Mechanisms: CEO Duality?
Unity of Command: (in favor of) Duality Agency Theory: (in favor of) Separation Provides clear focus Eliminates confusion and conflict Enhances a firm’s responsiveness Enables quick decisions based on first-hand knowledge Safeguards against corruption or incompetence Removes conflict of interest, especially regarding CEO succession Improves perceptions of legitimacy OR? CEO duality is one of the most controversial issues in corporate governance. It refers to the dual leadership structure where the CEO acts simultaneously as the chair of the Board of Directors. There are two schools of thought. The unity of command perspective assumes that when one person holds both roles, he or she is able to act more efficiently and effectively. CEO duality provides firms with a clear focus on both objectives and operations as well as eliminates confusion and conflict between the CEO and the chairman. Thus, it enables smoother, more effective strategic decision-making. The agency theory perspective questions whether a board can act as a safeguard against corruption or incompetence when the possible source of that corruption and incompetence is sitting at the head of the table. CEO duality can create a conflict of interest that could negatively affect the interests of the shareholders. Duality also complicates the issue of CEO succession, when, for instance the CEO/Chairman may choose to retire as CEO but keep his or her role as the chairman. This puts the new CEO in a difficult position. Duality also serves to reinforce popular doubts about the legitimacy of the system as a whole and evokes images of bosses writing their own performance reviews and setting their own salaries. Research suggests that there is no one correct answer on duality but that firms should consider their current position and performance trends when deciding whether to keep the CEO and chairman position in the hands of one person.

External governance control mechanisms The market for corporate control The takeover constraint Auditors Enron, WorldCom? Banks and analysts Lehman Brothers, Countrywide? Regulatory bodies Securities and Exchange Commission (SEC) The Sarbanes-Oxley Act Media and public activists Bloomberg Businessweek, Ralph Nader The separation of ownership and control that we discussed earlier requires multiple control mechanisms, some internal and some external, to ensure that managerial actions lead to shareholder value maximization. Further, society at large wants some assurance that this goal is met without harming other stakeholder groups. External governance control mechanisms = methods that ensure that management actions lead to shareholder value maximization and do not harm other stakeholder groups that are outside the control of the corporate governance system. If a board is ineffective in monitoring managers and is not exercising the oversight required of them and the shareholders are passive and not taking any actions to monitor or discipline managers, managers may behave opportunistically. External markets provide one external mechanism that can partially solve these problems. The market for corporate control = an external control mechanism in which shareholders dissatisfied with the firm’s management sell their shares. As more stockholders vote with their feet, the value of the stock begins to decline. As the client continues, at some point the market value of the firm becomes less than the book value. A corporate raider can then take over the company for a price less than the book value of the assets of the company, and then fire the underperforming management. Takeover constraint = the risk to management of the firm being acquired by a hostile raider. Auditors belong to independent organizations staffed by certified professionals who verify the firm’s books of accounts. Audits can unearth financial irregularities and ensure that financial reporting by the firm conforms to standard accounting practices. Banks have lent money to corporations and therefore have to ensure that the borrowing firm’s finances are in order and that the loan covenants are being followed. Stock analysts conduct ongoing in-depth studies of the firms that they follow and make recommendations to their clients. Their rewards and reputation depend on the quality of these recommendations. Public corporations are required to disclose a substantial amount of financial information to external regulatory bodies such as the SBC, and must comply with Sarbanes-Oxley. Finally, the financial press and media play an important indirect role in monitoring the management of public corporations. Public perceptions about a company’s financial prospects and the quality of its management are greatly influenced by the media. Similarly, consumer groups and activist individuals often take a crusading role in exposing corporate malfeasance. Ralph Nader is given as an example.

Example: Corporate Governance & Stakeholder Groups
AIG (American International Group) paid $218 million in bonuses to its financial services division employees AFTER receiving an $85 billion bailout from the U.S. government The U.S. House of representatives complained AIG leadership caved in AIG financial services managers were left without an income Many AIG financial services managers were AIG shareholders Was corporate governance effective? Were external governance control mechanisms inappropriate? See Case 3 = AIG and the Bonus Fiasco. AIG was an insurance company trading in an unregulated industry using credit default swaps. During the 2008 financial crisis, AIG had to pay out, and would have gone bankrupt if the US government had not provided an $85 billion loan. After receiving the government bailout money, AIG then made a series of publicly embarrassing mistakes by treating employees to a lavish retreat in California, and paying $218 million in bonuses to its financial services division employees. Edward M Liddy, AIG’s chief executive, was called before the US House of Representatives to explain. The House moved to limit the bonuses to a 90% tax on the distributions. Jake DeSantis, an AIG financial services vice president, pointed out that only a small portion of financial services managers had worked with these dysfunctional products. Many managers had. agreed to work for a salary of one dollar a year and continued to work 10 to 14 hours a day based on a promise from AIG that they would be compensated through these bonuses. Many managers were also shareholders of AIG stock, and under the 90% taxation provision this left most managers without an income or other means of financial support. Corporate governance refers to the need for a firm’s shareholders and their elected representatives (the board of directors) to ensure that the firm’s executives strive to fill their fiduciary duty of maximizing long-term shareholder value. However stakeholders are dependent upon each other for their success and well-being. Many stakeholders, including current and future employees, customers, creditors, and investors, had to wonder if AIG could be trusted to handle their business in the future. External governance control mechanisms should ensure that managerial actions put in place to safeguard shareholders do not harm other stakeholder groups. In this case, external governance controls might not be as effective as controls put in place by the company itself.

International Corporate Governance
Principal – principal conflicts (vs principal – agent conflicts) involve Concentrated ownership, or family ownership Motivation to engage in expropriation of minority shareholders for personal gain Business groups who can take coordinated action Japanese keiretsus, Korean chaebols Few external regulatory constraints The topic of corporate governance has long been dominated by agency theory and based on the explicit assumption of the separation of ownership and control. The central conflicts are principal – agent conflicts between shareholders and management. However such an underlying assumption seldom applies outside of the US and the UK. In emerging economies and continental Europe there is often concentrated ownership, along with extensive family ownership and control, business group structures, and weak legal protection for minority shareholders. Principal – principal conflicts = conflicts between two classes of principals – controlling shareholders and minority shareholders – within the context of the corporate governance system. (See Exhibit 9.8 for the differences between these two types of conflicts.) Strong family control is one of the leading indicators of concentrated ownership. Family members can become controlling (not necessarily majority) shareholders, and may take actions that decrease aggregate firm performance in order to realize personal gains. Expropriation of minority shareholders = activities that enrich the controlling shareholders at the expense of the minority shareholders. Business groups = a set of firms that, though legally independent, are bound together by a constellation of formal and informal ties and are accustomed to taking coordinated action. Business groups are especially common in emerging economies, and they differ from other organizational forms in that they are communities of firms without clear boundaries. Business groups have many advantages that can enhance the value of the firm. They often facilitate technology transfer or intergroup capital allocation that otherwise might be impossible because of inadequate institutional infrastructure.

International Corporate Governance
In general, three conditions must be met for principal to principal conflicts to occur. (1) the existence of a dominant owner or group of owners who have interests that are distinct from minority shareholders; (2) motivation for the controlling shareholders to exercise their dominant positions to their advantage; (3) few formal (such as legislation or regulatory bodies) or informal constraints that would discourage or prevent the controlling shareholders from exploiting their advantageous positions. Principal – principal conflicts can be problematic because normal corporate governance mechanisms are not available. Specifically, formal institutional protection is often lacking, corrupted, or unenforced, and, internally, informal norms are typically in favor of the interests of controlling shareholders ahead of those of minority investors. The controlling interests of family or business groups means that the only shareholders who see “value maximization” are these controlling shareholders. These issues must be acknowledged when implementing strategy in global firms where these kinds of controlling shareholders may be present. Exhibit 9.9 Principal-Agent Conflicts and Principal-Principal Conflicts: A Diagram Source: Young, M.N., Peng, M.W., Ahlstrom, D., Bruton, G.D., & Jiang, Principal-Principal Conflicts in Corporate Governance. Journal of Management Studies 45(1): ; and Peng, M.V Global Strategy. Cincinnati: Thomson South-Western. We are very appreciative of the helpful comments of Mike Young of Hong Kong Baptist University and Mike Peng of the University of Texas at Dallas.

Creating Effective Organizational Designs
chapter 10

Learning Objectives After reading this chapter, you should have a good understanding of: LO10.1 The growth patterns of major corporations and the relationship between the firm’s strategy and its structure. LO10.2 Each of the traditional types of organizational structure: simple, functional, divisional, and matrix. LO10.3 The implication of a firm’s international operations for organizational structure.

Learning Objectives LO10.4 The different types of boundaryless organizations – barrier-free, modular, and virtual – and their relative advantages and disadvantages. LO10.5 The need for creating ambidextrous organizational designs that enable firms to explore new opportunities and effectively integrate existing operations.

Organizational Structure
Consider… To implement strategy successfully, firms must have appropriate organizational designs. How should a firm coordinate internal operations? And how should a firm integrate its operations with external parties? How can these internal & external boundaries be made both flexible and permeable? To implement strategy successfully, firms must have appropriate organizational designs. These include the processes and integrating mechanisms necessary to ensure that boundaries among internal activities and external parties, such as suppliers, customers, and alliance partners, are flexible and permeable. A firm’s performance will suffer if its managers don’t carefully consider both of these organizational design attributes. Especially in rapidly changing and unpredictable environments, managers typically face two opposing challenges: (1) being proactive and taking advantage of new opportunities, and (2) ensuring the effective coordination and integration of existing operations by managing existing assets and competencies as efficiently as possible. Successful organizations create permeable boundaries among the internal activities as well as between the organization and its external partners. Managers must first decide on the most appropriate type of organizational structure, and then assess the effectiveness of the mechanisms, processes, and techniques that support this structure.

Organizational Structure
Organizational structure refers to formalized patterns of interactions linking Tasks Technologies People Structure provides a balance between The need for division of tasks into meaningful groupings The need to integrate these groupings for maximum efficiency and effectiveness Organizational structure = the formalized patterns of interactions that link a firm’s tasks, technologies, and people. Structures help to ensure that resources are used effectively in accomplishing an organization’s mission. Structure provides a means of balancing two conflicting forces: a need for the division of tasks into meaningful groupings, and the need to integrate such groupings in order to ensure efficiency and effectiveness. Structure identifies the executive, managerial, and administrative organization of a firm and indicates responsibilities and hierarchical relationships. It also influences the flow of information as well as the context and nature of human interactions.

Question? Generally speaking, discussions of the relationship between strategy and structure strongly imply that strategy follows structure. structure follows strategy. strategy can effectively be formulated without considering structural elements. structure typically has a very small influence on a firm’s strategy. Answer: B. A firm’s strategy has implications for how managers need to control and coordinate the firm’s scope of operations, especially as it grows to enter new product-market domains. Such growth places additional pressure on executives to manage the firm’s increasing size and diversity. The most appropriate type of structure that a firm adopts depends on the nature and magnitude of growth.

Organizational Structures
Exhibit 10.1 Dominant Growth Patterns of Large Corporations Source: Adapted from J.R. Galbraith and R.K. Kazanjian. Strategy Implementation: Structure, Systems and Process, 2nd edition. Copyright © 1986. A firm’s strategy and structure change as it increases in size, diversifies into new product markets, and expands its geographic scope. Exhibit 10.1 illustrates the common growth patterns of firms. The choice of structure has to do not only with the direction and magnitude of growth, but also with the degree of integration needed across businesses as this growth occurs.

Organizational Structures: Simple Structure
The simple organizational structure is the oldest & most common organizational form, where The organization is small, with a single or very narrow product line The owner-manager makes most of the decisions The staff is an extension of the top executive’s personality Simple organizational structure = an organizational form in which the owner–manager makes most of the decisions and controls activities, and the staff serves as an extension of the top executive.

Organizational Structures: Simple Structure
Advantages Disadvantages Highly informal Coordination of tasks by direct supervision Centralized decision- making Little specialization Few rules & regulations; informal reward systems Employees may not understand their responsibilities Employees may take advantage of lack of regulations Limited opportunities for upward mobility The simple structure is highly informal and the coordination of tasks is accomplished by direct supervision. Decision-making is highly centralized, there is little specialization of tasks, few rules and regulations, and an informal evaluation and reward system. A simple structure may foster creativity and individualism, however such informality may lead to problems. Employees may not clearly understand their responsibilities, which can lead to conflict and confusion. Employees may also take advantage of the lack of regulations, act in their own self-interest, which can erode motivation and satisfaction and lead to the possible misuse of organizational resources. Small organizations have flat structures that limit opportunities for upward mobility. Without the potential for future advancement, recruiting and retaining talent may become difficult.

Organizational Structures: Functional Structure
The functional organizational structure is where the major functions of the firm are grouped internally The organization is small, with a single or closely related product or service, and high production volume The owner-manager needs specialists in various functional areas The chief executive has responsibility for coordination & integration of the functional areas Functional organizational structure = an organizational form in which the major functions of the firm, such as production, marketing, R&D, and accounting, are grouped internally. When an organization is small (15 employees or less), it is not necessary to have a variety of formal arrangements and groupings of activities. However, as firms grow, excessive demands may be placed on the owner-manager in order to obtain and process all of the information necessary to run the business. Thus, he or she will need to hire specialists in the various functional areas. The coordination and integration of these functional areas becomes one of the most important responsibilities of the chief executive.

Growth in the overall scope and complexity of the business necessitates a functional organizational structure wherein the major functions of the firm are grouped internally. Exhibit 10.2 Functional Organizational Structure

Advantages Disadvantages Impeded communication & coordination due differences in values & orientations – “silos” May lead to short- term thinking Difficult to establish uniform performance standards Enhanced coordination & control Centralized decision- making Enhanced organizational-level perspective More efficient use of managerial & technical talent Facilitated career paths in specialized areas By bringing together specialists into functional departments, a firm is able to enhance its coordination and control within each of the functional areas. Decision-making in the firm will be centralized at the top of the organization. This enhances the organizational level (as opposed to functional area) perspective across the various functions. In addition, the functional structure provides for more efficient use of managerial and technical talent since functional area expertise is pooled in a single department (e.g. marketing) instead of being spread across a variety of product-market areas. Finally, career paths and professional development in specialized areas are facilitated. However, the differences in values and orientations among functional areas may impede communication and coordination, causing the development of “stovepipes” or “functional silos”, in which departments view themselves as isolated, self-contained units with little need for interaction and coordination with other departments. This can erode communication and lead to short-term thinking, and overburden the top executives because they now have to deal with conflicts. Functional structures also make it difficult to establish uniform performance standards across the entire organization.

Organizational Structures: Divisional Structure
The divisional organizational structure is where products, projects, or product markets are grouped internally Divisions are relatively autonomous, consisting of products & services that are different from those of other divisions Each division includes its own functional specialists typically organized into departments Division executives help determine product- market & financial objectives Divisional organizational structure = an organizational form in which products, projects, or product markets are grouped internally. Each of the divisions, in turn, includes its own functional specialists who are typically organized into departments. A divisional structure encompasses a set of relatively autonomous units governed by a central corporate office, and is sometimes called the multidivisional structure or M-form. The operating divisions are relatively independent and consist of products and services that are different from those of other divisions. Operational decision-making in a large business places excessive demands on the firm’s top management. In order to attend to broader, longer-term organizational issues, top level managers must delegate decision-making to lower-level managers. Divisional executives then help determine the product-market and financial objectives for the division.

Increased complexity of the business necessitates a divisional organizational structure wherein the firm is organized around products, projects, or markets. Each of the divisions, in turn, then has its own functional specialists who are typically organized into departments within each division, similar to the functional structure. Exhibit 10.3 Divisional Organizational Structure

Advantages Disadvantages Can be very expensive Can lead to dysfunctional competition among divisions Differences in image & quality may occur across divisions Can focus on short- term performance Separation of strategic & operating control Quicker response to changes in the market environment Minimal problems sharing resources Development of general management talent is enhanced By creating separate divisions to manage individual product markets, there is a separation of strategic and operating control. Divisional managers can focus their efforts on improving operations in the product markets for which they are responsible, and corporate officers can devote their time to overall strategic issues for the entire corporation. This focus on the division’s products and markets gives the firm an enhanced ability to respond quickly to changes in the market environment. Since there are functional departments within each division, the problems associated with sharing resources across functional departments are minimized. Because there are multiple levels of management, the development of talent is enhanced. However, there can be increased costs due to the duplication of personnel, operations, and investment since each division must staff multiple functional departments. There could also be dysfunctional competition among divisions since each division tends to become concerned solely about its own operations. With many divisions providing different products and services, there is the chance that differences in image and quality may occur across divisions. Since each division is evaluated in terms of financial measures such as return on investment and revenue growth, there is often an urge to focus on short-term performance.

Organizational Structures: SBU Structure
The strategic business unit (SBU) structure is where similar products or markets are grouped into units to achieve synergy Variation on the divisional structure Synergies are achieved through related diversification – core competencies, shared infrastructures, market power Each of the SBUs operates as a profit center Strategic business unit (SBU) structure = an organizational form in which products, projects, or product market divisions are grouped into homogenous units. Highly diversified corporations may consist of dozens of different divisions. A purely divisional structure would make it nearly impossible for the corporate office to plan and coordinate activities, because the span of control would be too large. With an SBU structure, divisions with similar products, markets and/or technologies are grouped into homogenous units to achieve synergies, including those available through related diversification such as leveraging core competencies, sharing infrastructures, and market power. Generally the more related businesses are within a corporation, the fewer SBUs will be required. Each of the SBUs in the corporation operates as a profit center.

Organizational Structures: SBU Structure
Advantages Disadvantages Can be difficult to achieve synergies Increased personnel & overhead expenses Corporate office further removed from the divisions Corporate unaware of key changes in market conditions Planning & control done by the corporate office Decentralization of authority Quicker response to changes in the market environment Synergies through sharing core competencies, infrastructures, & market power The SBU structure makes the task of planning and control by the corporate office more manageable. Also, with greater decentralization of authority, individual businesses can react more quickly to important changes in the environment than if all divisions had to report directly to the corporate office. However, since the divisions are grouped into SBUs it may become difficult to achieve synergies across SBUs: if divisions in different SBUs have different potential sources of synergy, it may become difficult for them to be realized. The additional level of management increases the number of personnel and overhead expenses, while the additional hierarchical level removes the corporate office further from the individual divisions. The corporate office may become unaware of key developments that could have a major impact on the corporation.

Example: Challenges of a Divisional Structure
Johnson & Johnson has more than 275 operating companies located in 60 countries, and sells products in virtually all countries around the world. J&J is organized into three business segments: Consumer, Pharmaceutical, and Medical Devices and Diagnostics - a decentralized SBU divisional structure How to keep autonomy while also developing synergies between the business units? How to extend control mechanisms across divisions to better monitor performance? Johnson & Johnson is engaged in the research and development, manufacture and sale of a broad range of products in the health care field. The business of Johnson & Johnson is conducted by more than 275 operating companies located in 60 countries, including the United States, which sell products in virtually all countries throughout the world. The Company's primary focus has been on products related to human health and well-being. The Company is organized into three business segments: Consumer, Pharmaceutical and Medical Devices and Diagnostics. Historically, Johnson and Johnson had had a decentralized SBU divisional structure. There was a need to provide relative autonomy to the business units so the firm could respond swiftly to emerging opportunities. However there was also a need to develop synergies between the various business units across the three divisions. A new corporate office was created to get business units to collaborate on research, development, and marketing efforts. How can J&J get this collaboration without destroying the entrepreneurial spirit that has spearheaded most of the growth of the firm to date? In addition, with looming quality problems, how can control mechanisms be extended across divisions to better monitor performance? Horizontal linking mechanisms were needed. See Case 18: Johnson & Johnson, for more details.

Organizational Structures: Holding Company Structure
The holding company structure is where businesses in a corporation’s portfolio are the result of unrelated diversification Variation on the divisional structure Similarities are few, so synergies are limited Operating divisions have autonomy Corporate staffs are small & have limited involvement, relying on financial controls & incentive programs to obtain performance Holding company structure = an organizational form that is a variation of the divisional organizational structure in which the divisions have a high degree of autonomy both from other divisions and from corporate headquarters. The holding company structure is appropriate when the businesses in a corporation’s portfolio do not have much in common. Plus, the potential for synergies is limited. Holding company structures are most appropriate for firms with the strategy of unrelated diversification, such as with Berkshire Hathaway. Since there are few similarities across the businesses, the corporate offices in these companies provide a great deal of autonomy to operating divisions and rely on financial controls and incentive programs to obtain high levels of performance across the individual businesses. Corporate staffs at these firms tend to be small because of their limited involvement in the overall operation of their various businesses.

Organizational Structures: Holding Company Structure
Advantages Disadvantages Potential for synergies is very limited Corporate office has little control Difficult to replace key divisional executives if they leave Turnaround may be difficult due to limited corporate staff support Cost savings due to fewer personnel and lower overhead Divisional autonomy increases motivation level of divisional executives Quicker response to changes in the market environment The holding company structure has cost savings associated with fewer personnel, and a lower overhead resulting from a small corporate office and fewer hierarchical levels. The autonomy of the holding company structure increases the motivational level of divisional executives and enables them to respond quickly to market opportunities and threats. However, there is an inherent lack of control, and a dependence that corporate level executives have on divisional executives. Major problems could arise if key divisional executives leave the firm, because the corporate office has very little additional managerial talent ready to quickly fill key positions. If problems arise in the division, it may become very difficult to turn around individual businesses because of limited staff support in the corporate office.

Organizational Structures: Matrix Structure
The matrix organizational structure is where functional departments are combined with product groups on a project basis Functional departments, product groups & geographical units are combined Individuals have two managers Project managers & functional managers share responsibility Matrix organizational structure = an organizational form in which there are multiple lines of authority and some individuals report to at least two managers. This approach strives to overcome the inadequacies inherent in the other structures. It is a combination of the functional and divisional structure. Most commonly, functional departments are combined with product groups on a project basis. Some large multinational corporations rely on a matrix structure to combine product groups and geographical units. Personnel may work under the manager of the group for the duration of the project. The individuals who work in a matrix organization become responsible to two managers: the project manager and the manager of their functional area. Product managers may have global responsibility for the development, manufacturing, and distribution of their own line, while managers of geographical regions have responsibility for the profitability of the businesses in their regions.

The matrix structure facilitates the use of specialized personnel, equipment, and facilities. It tries to overcome the inadequacies inherent in the other structures by combining functional and divisional structures on a project basis, under the guidance of a project manager. Employees have dual reporting relationships: they report to the project manager and to the manager of their functional area. Exhibit 10.4 Matrix Organizational Structure

Advantages Disadvantages Dual reporting relationships lead to uncertainty regarding accountability Can lead to power struggles & conflict Human resources are duplicated Decision-making takes longer Increases market responsiveness, collaboration & synergies Allows more efficient utilization of resources Improves flexibility, coordination & communication Increases professional development The matrix structure allows for shared resources instead of duplicating functions, as would be the case in a divisional structure based on products. Individuals with high expertise can divide their time among multiple projects. Such resource sharing and collaboration enables the firm to use resources more efficiently and to respond more quickly and effectively to changes in market conditions. The flexibility inherent in the matrix structure provides professionals with a broader range of responsibility which enables them to develop their skills and competencies. However, the dual reporting structures can result in uncertainty and lead to intense power struggles and conflict over the allocation of personnel and other resources. Working relationships become more complicated. This may result in excessive reliance on group processes and teamwork, along with the diffusion of responsibility, which in turn may erode timely decision-making.

Organizational Structures: International Operations
Firms with international operations must consider a structure based on the following: The type of strategy that is driving the firm’s foreign operations The degree of product diversity The extent to which a firm is dependent on foreign sales In the global marketplace, managers must ensure consistency between their strategies (at the business, corporate, and international levels), and the structure of their organization. As firms expand into foreign markets, they generally follow a pattern of change in structure that parallels the changes in their strategies. The three major contingencies that influence the chosen strategy are (1) the type of strategy that is driving the firm’s foreign operations, (2) product diversity, and 3) the extent to which a firm is dependent on foreign sales. As international operations become an important part of a firm’s overall operations, managers must make changes that are consistent with their firm’s structure.

Multidomestic Strategies use… Global Strategies use… Worldwide functional structure Worldwide product division structure Worldwide holding company structure International division structure Geographic-area division structure Worldwide matrix structure A firm’s international strategy has implications for its chosen structure. Remember from Chapter 7 that a multidomestic strategy is based on a firm’ desire to differentiate its products and services to adapt to local markets, and is usually used in industries where the pressure for local adaptation is high and the pressure for lowering costs is low. The structures consistent with such a strategic orientation are the international division and geographic-area division structures. Here local managers are provided with a high level of autonomy to manage their operations within the constraints and demands of their geographic market. As a firm’s foreign sales increase as a percentage of its total sales, it’ll likely change from an international division to a geographic-area division structure, and, as a firm’s product and/or market diversity becomes large, it is likely to benefit from a worldwide matrix structure. International division structure = an organizational form in which international operations are in a separate, autonomous division. Most domestic operations are kept in other parts of the organization. Geographic-area division structure = a type of divisional organizational structure in which operations in geographical regions are grouped internally. Worldwide matrix structure = a type of matrix organizational structure that has one line of authority for geographic-area divisions and another line of authority for worldwide product divisions. Remember from chapter 7 that global strategies are based on a firm’s need for centralization and control by the corporate office, with the primary emphasis on controlling costs, usually used in industries where the pressure for local adaptation is low and the pressure for lowering costs is high. Economic pressures require managers to handle operations in different geographic areas with overall efficiency. The worldwide functional and worldwide product division structures are consistent with efficiency perspective. Here, division managers view the marketplace as homogenous and devote relatively little attention to local market factors. Firms with relatively low levels of product diversity may opt for a worldwide product division structure. However, if significant product market diversity results from highly unrelated international acquisitions, a worldwide holding company structure should be implemented. Such firms have very little commonality among products, markets, technologies, and have little need for integration. Worldwide functional structure = a functional structure in which all departments have worldwide responsibilities. Worldwide product division structure = a product division structure in which all divisions have worldwide responsibilities.

A global start-up Uses inputs from around the world Sells its products & services to customers around the world Has communication & coordination challenges Has less resources than well-established corporations Must use less costly administrative mechanisms Frequently chooses a boundaryless organizational design Global start-up = a business organization that, from inception, seeks to derive significant advantage from the use of resources and the sale of outputs in multiple countries. Many firms now expand internationally relatively early in their history, and some firms are “born global” – that is, from the very beginning, many start-ups are global in their activities. Right from the beginning, it uses inputs from around the world and sells its products and services to customers around the world. Geographical boundaries of nation states are irrelevant for a global start-up. Being global necessarily involves higher communication, coordination, and transportation costs. Most global start-ups have far less resources than well-established corporations, so must internalize only a few activities and outsource the rest. Managers of such firms must have considerable prior international experience so that they can successfully handle the inevitable communication problems and cultural conflicts. Another key to success is to keep the coordination and communication costs low. The only way to achieve this is by creating less costly administrative mechanisms. A boundaryless organizational design is particularly suitable for global start-ups because of its flexibility and low cost.

Organizational Structures: Boundaryless Designs
A boundaryless organizational design makes these boundaries more permeable: Vertical boundaries between organizational levels Horizontal boundaries between functional areas External boundaries between the firm and its customers, suppliers, & regulators Geographic boundaries between locations, cultures, & markets Boundaryless designs include barrier-free, modular, & virtual organizations Boundaryless organizational design = organizations in which the boundaries, including vertical, horizontal, external, and geographical boundaries, are permeable. Boundaryless does not imply that all internal and external boundaries vanish completely, but that they become more open and permeable. Boundaryless designs should not replace the traditional forms of organizational structure, but they should complement them. See Strategy Spotlight 10.4 for the four types of boundaries that place limits on organizations: (1) vertical boundaries between levels in the organization’s hierarchy that limit the flow of ideas from employees up to managers, (2) horizontal boundaries between functional areas such as marketing, operations, and customer service (silos), (3) external boundaries between the firm and its customers, suppliers, and regulators that limit flexibility in the value chain, (4) geographic boundaries between locations, cultures, and markets that reduce or inhibit the flow of communication. There are three approaches to making boundaries more permeable, that help to facilitate the widespread sharing of knowledge and information across both the internal and external boundaries of the organization: barrier-free, modular, and virtual types of organizations.

A barrier-free organization has permeable internal & external boundaries and requires: Higher level of trust and shared interests Shift in philosophy from executive development to organizational development Greater use of teams Flexible, porous organizational boundaries Communication flows & mutually beneficial relationships with both internal and external constituencies Barrier-free organization = an organizational design in which firms bridge real differences in culture, function, and goals to find common ground that facilitates information sharing and other forms of cooperative behavior. The barrier-free type of organization involves making all organizational boundaries – internal and external – more permeable. Eliminating the multiple boundaries that stifle productivity and innovation can enhance the potential of the entire organization. For barrier-free organizations to work effectively, the level of trust and shared interests among all parts of the organization must be raised. The organization needs to develop among its employees the skill level needed to work in a more democratic organization. Barrier-free organizations also require a shift in the organization’s philosophy from executive to organizational development, and from investments in high-potential individuals to investments in leveraging the talents of all individuals. Teams are a central building block for implementing a barrier-free organization. In barrier-free organizations, managers must also create flexible, porous organizational boundaries and establish communication flows and mutually beneficial relationships with internal (e.g. employees) and external (e.g. customers) constituencies, as well as potential cooperative relationships with competitors.

Although a barrier-free structure can enhance productivity and innovation, creating and managing this type of organization can be frustrating. For instance, product development time might double as a result of team management, and managers trained in rigid hierarchies might find it difficult to make the transition to the more democratic, participative style that this teamwork requires. Exhibit 10.6 Pros and Cons of Barrier-Free Structures

Question? What advantages does outsourcing provide an organization?
Access to the best-in-class goods and services. The ability to expand rapidly with a relatively low capital investment. The opportunity to focus scarce resources on existing core competencies. All of the above. Answer: D. In some circumstances, firms have received bad press for outsourcing, or more often offshoring, what are perceived as key activities. However an organizational design that allows for outsourcing can provide some significant advantages. A modular design allows the firm to outsource non-core functions, thereby decreasing overall costs and focusing scarce resources on the area where it holds a competitive advantage.

A modular organization requires seamless relationships with external organizations: Outsources nonvital functions or non-core activities to outsiders Activates knowledge & expertise of “best in class” suppliers but retains strategic control Focuses scarce resources on key areas Accelerates organizational learning Decreases overall costs, leverages capital Modular organization = an organization in which nonvital functions are outsourced, which uses the knowledge and expertise of outside suppliers while retaining strategic control. Outsiders may be used to manufacture parts, handle logistics, or perform accounting activities. The value chain can be used to identify the key primary and support activities performed by a firm to create value: which activities do we keep “in-house” and which activities do we outsource to suppliers? The organization becomes a central hub surrounded by networks of outside suppliers and specialists, and parts can be added or taken away. Outsourcing non-core functions allows a firm to decrease overall costs, stimulate new product development by hiring suppliers with superior talent to that of in-house personnel, avoid idle capacity, reduce inventory, and avoid being locked into a particular technology. A company can also focus scarce resources on the area where it holds a competitive advantage. Finally an organization can tap into the knowledge and expertise of its specialized supply chain partners, adding critical skills and accelerating organizational learning. Both manufacturing and service units may be modular. The modular type enables a company to leverage relatively small amounts of capital and a small management team to achieve seemingly unattainable strategic objectives. Nike and Reebok are given as examples.

Although a modular structure can help a firm be effective through efficient use of outside suppliers and specialists, it does require that the company finds loyal, reliable vendors who can be trusted with trade secrets. Firms also need assurances that suppliers will dedicate their financial, physical, and human resources to satisfy strategic objectives such as lowering costs or being first to market. In addition, the modular company must make sure that it selects the proper competencies to keep in-house. An organization must avoid outsourcing components that may compromise its long-term competitive advantage. The main strategic concerns are loss of critical skills or developing the wrong skills, the loss of cross-functional skills, and the loss of control over a supplier. Exhibit 10.7 Pros and Cons of Modular Structures

A virtual organization requires forming alliances with multiple external partners: Continually evolving network of independent companies Linked together to share skills, costs, & access to one another’s markets Coping with uncertainty through cooperative efforts Each gains from resulting individual & organizational learning May not be permanent Virtual organization = a continually evolving network of independent companies that are linked together to share skills, costs, and access to one another’s markets. The members of a virtual organization, by pooling and sharing the knowledge and expertise of each of the component organizations, simultaneously “know” more and can “do” more than any one member of the group could do alone. By working closely together, each gains in the long run from individual and organizational learning. Virtual organizations need not be permanent and participating firms may be involved in multiple alliances. Each company that links up with others to create a virtual organization contributes only what it considers its core competencies. It will mix and match what it does best with the best of other firms by identifying its critical capabilities and the necessary links to other capabilities. Participating firms give up part of their control and accept interdependent destinies. They pursue a collective strategy that enables them to cope with uncertainty through cooperative efforts. Virtual organizations enhance the capacity or competitive advantage of participating firms.

The virtual organization demands that managers build relationships with other companies, negotiating win-win deals for all parties by finding the right partners with compatible goals and values, and providing the right balance of freedom and control. Information systems must be designed and integrated to facilitate communication with current and potential partners. Managers must also be clear about the strategic objectives while forming alliances. The virtual organization is a logical culmination of joint venture strategies of the past. Shared risks, costs, and rewards are the facts of life in a virtual organization. When virtual organizations are formed, they involve tremendous challenges for strategic planning. As with the modular corporation, it is essential to identify core competencies. However, for virtual structures to be successful, a strategic plan is also needed to determine the effectiveness of combining core competencies. The strategic plan must address the diminished operational control and overwhelming need for trust and common vision among the partners. Exhibit 10.8 Pros and Cons of Virtual Structures Source: Miles, R.E. & Snow, C.C Organizations: New Concepts for New Forms. California Management Review, Spring: 62-73; Miles & Snow Causes of Failure in Network Organizations, California Management Review, Summer: 53-72; and Bahrami, H The Emerging Flexible Organization: Perspectives from Silicon Valley. California Management Review, Summer:

Example: A Virtual Organization
This textbook is published by McGraw-Hill Education Putting the textbook and supplemental material together is done by a virtual team The authors live in Texas, Michigan, and New York The editors work in Illinois The text compositors are in India The PowerPoint & Case Teaching Notes author works out of her home in Connecticut Deadlines are coordinated by the MH editors in Illinois, to pull the book together and arrange for distribution On November 26, 2012, The McGraw-Hill Companies (NYSE: MHP) (“the Company”) announced it had signed a definitive agreement to sell its McGraw-Hill Education business to investment funds affiliated with Apollo Global Management, LLC. Once the deal closes, either late this year or early next, McGraw-Hill says it will position itself as “high-growth, high-margin benchmarks, content and analytics company” to be renamed McGraw-Hill Financial. The deal follows by more than a year the company’s announcement that it would separate the capital-intensive textbook operation from the unit that includes Standard & Poor’s. Activist hedge fund Jana Partners and the Ontario Teachers’ Pension Plan Board had pushed for the change saying that McGraw-Hill had become too unfocused as educational publishing diluted earnings. Publishing is a low-margin business, requiring the collaboration of multiple entities with extensive skill-sets. The relationships are temporary, but all share in the resulting gains from this effort. See and for more information.

A boundaryless organization requires Mechanisms to ensure effective coordination and integration Common culture and shared values Horizontal organizational structures Horizontal systems and processes Communications and information technologies Human resource practices Awareness of the benefits and costs of developing lasting internal & external relationships Designing an organization that simultaneously supports the requirements of an organization strategy, is consistent with the demands of the environment, and can be effectively implemented by the people around the manager is a tall order for any manager. The most effective solution is usually a combination of organizational types. That is, a firm may outsource many parts of its value chain to reduce costs and increase quality, engage simultaneously in multiple alliances to take advantage of technological developments or penetrate new markets, and break down barriers within the organization to enhance flexibility. When an organization faces external pressures, resource scarcity, and declining performance, it tends to become more internally focused, rather than directing its efforts toward managing and enhancing relationships with existing and potential external stakeholders. This may be the most opportune time for managers to carefully analyze their value chain activities and evaluate the potential for adopting elements of modular, virtual, and barrier-free organizational types. However managers must be aware of two key issues as they work to design an effective boundaryless organization. First, managers need to develop mechanisms to ensure effective coordination and integration. Second, managers need to be aware of the benefits and costs of developing strong and long-term relationships with both internal and external stakeholders. One mechanism for integration is to develop horizontal organizational structures = organizational forms that group similar or related business units under common management control and facilitate sharing resources and infrastructures to exploit synergies among operating units and help to create a sense of common purpose.

Benefits Costs Agency costs are reduced through the use of relational systems Transaction costs between the firm and its suppliers are reduced Individual participants are less likely to perceive a conflict of interest Relationships between individuals become more important than profits Conflicts are resolved through ad hoc negotiations & processes Relationships are driven more by social connections than by needed competencies Managers must become aware of the costs and benefits of developing lasting internal and external relationships. Rather than relying on strict hierarchical and bureaucratic systems, boundaryless organizations are flexible and coordinate action by leveraging shared social norms and strong social relationships between both internal and external stakeholders. Some of the benefits of relying on relationships and social norms to guide behavior include: (1) agency costs are reduced because managers and employees in relationship-oriented firms are guided more by social norms rather than rules, regulations, and financial incentives; (2) transaction costs between the firm and its suppliers and customers will be reduced because the level of trust that’s built up means less need to write detailed contracts or set up strict bureaucratic rules to outline the responsibilities and define the behavior of each firm; (3) since they feel a sense of shared ownership and goals, individuals within the firm as well as partnering firms will be more likely to search for win-win rather than win-lose solutions – firms with strong relationships with their partners are going to look for solutions that not only benefit themselves but also provide equitable benefits and limited downside for the partnering firms. There are also some substantial costs: (1) as the relationships between individuals and firms strengthen, they are also more likely to fall prey to suboptimal lock-in effects. The problem here is that as decisions become driven by concerns about relationships, economic factors become less important. As a result, firms become less likely to make decisions that could benefit the firm since those decisions may harm employees or partnering firms. (2) Since there are no formal guidelines, conflicts between individuals and units within firms as well as between partnering firms are typically resolved through ad hoc negotiations and processes, rather than legal means or bureaucratic rules that may more effectively guide decision-making. (3) The social capital of individuals and firms can drive their opportunities. For instance, rather than identifying the best person to put in a leadership role or the optimal supplier to contract with, these choices are more strongly driven by the level of social connection the person or supplier has. The solution to these costs may be to effectively integrate elements of formal structure and reward systems with stronger relationships.

Organizational Structures: Ambidextrous Designs
Ambidextrous organizational designs address two contradictory challenges: How to maintain adaptability How to achieve alignment Ambidextrous organizations Are aligned and efficient while they pursue modest, incremental innovations Are flexible enough to adapt to changes in the external environment and create dramatic, breakthrough innovations In chapter 1, the concept of “ambidexterity” was introduced. This concept incorporates two contradictory challenges faced by today’s managers. First, managers must explore new opportunities and adjust to volatile markets in order to avoid complacency. They must ensure that they remain adaptable and proactive in expanding and/or modifying their product-market scope to anticipate and satisfy market conditions. Second, managers must also effectively exploit the value of their existing assets and competencies. They need to have an alignment, which is a clear sense of how value is being created in the short term and how activities are integrated and properly coordinated. Firms that achieve both adaptability and alignment are considered ambidextrous organizations. Ambidextrous organizational designs = organizational designs that attempt to simultaneously pursue modest, incremental innovations as well as more dramatic, breakthrough innovations. Adaptability = managers’ exploration of new opportunities and adjustment to volatile markets in order to avoid complacency. Alignment = managers’ clear sense of how value is being created in the short term and how activities are integrated and properly coordinated.

Question? According to a study by O’Reilly and Tushman, effective ambidextrous structures had all of the following attributes except a clear and compelling vision. managerial efforts that were highly focused on revenue enhancement. cross-fertilization among business units. established units that were shielded from the distractions of launching new businesses. Answer: B. Charles O’Reilly and Michael Tushman investigated companies that attempted to simultaneously pursue modest, incremental innovations as well as more dramatic, breakthrough innovations. The study found that the organizational structure and management practices employed had a direct and significant impact on the performance of both the breakthrough initiative and traditional business. The ambidextrous organizational designs were more effective than either functional organizational structures or team structures. The factors contributing to success included (1) a clear and compelling vision, consistently communicated by the company’s senior management team. (2) The existence of cross-fertilization while avoiding cross-contamination, achieved by tight coordination and integration at the managerial levels. This enabled newer units to share important resources derived from the traditional units such as cash, talent, and expertise. Such sharing was encouraged and facilitated by effective reward systems that emphasized overall company goals. (3) The organizational separation ensured that the new units’ distinctive processes, structures, and cultures were not overwhelmed by the forces of “business as usual”. The established units were shielded from the distraction of launching new businesses, and they continued to focus all of their attention and energy on refining their operations, enhancing their products, and serving their customers.

Organizational Structures: Ambidextrous Designs
Ambidextrous organizational designs Effectively integrate and coordinate existing operations Establish project teams that are structurally independent units Pay attention to each unit’s processes, structures, & cultures Effectively integrate each unit into the existing management hierarchy Successful organizations must ensure that they have the proper type of organizational structure. Furthermore they must ensure that their firms incorporate the necessary integration and processes so that the internal and external boundaries of their firms are flexible and permeable. Such a need is increasingly important as the environments of firms become more complex, rapidly changing, and unpredictable. In today’s rapidly changing global environment, managers must be responsive and proactive in order to take advantage of new opportunities. At the same time, they must effectively integrate and coordinate existing operations. Such requirements call for organizational designs that establish project teams that are structurally independent units, with each having its own processes, structures, and cultures. But, at the same time, each unit needs to be effectively integrated into the existing management hierarchy.

Managing Innovation and Fostering Corporate Entrepreneurship
chapter 12

Learning Objectives After reading this chapter, you should have a good understanding of: LO12.1 The importance of implementing strategies and practices that foster innovation. LO12.2 The challenges and pitfalls of managing corporate innovation processes. LO12.3 How corporations use new venture teams, business incubators, and product champions to create an internal environment and culture that promote entrepreneurial development.

Learning Objectives LO12.4 How corporate entrepreneurship achieves both financial goals and strategic goals. LO12.5 The benefits and potential drawbacks of real options analysis in making resource deployment decisions in corporate entrepreneurship contexts. LO12.6 How an entrepreneurial orientation can enhance a firm’s efforts to develop promising corporate venture initiatives.

Managing Innovation Consider…
To remain competitive, established firms must continually seek out opportunities for growth and develop new methods for strategically renewing their performance. How can entrepreneurial activities become an avenue for achieving competitive advantage? Strategic leaders need to manage change. Changes in customer needs, new technologies, and shifts in the competitive landscape require that companies continually innovate and initiate corporate ventures in order to compete effectively. That is why managing innovation is an important strategic implementation issue. Innovation plays an important role in identifying venture opportunities and creating strategic renewal. Firms need to learn how to successfully manage the innovation process, and develop corporate entrepreneurship activities. A firm’s entrepreneurial orientation can contribute to its growth and renewal as well as enhance the methods and processes strategic managers use to recognize opportunities and develop initiatives for internal growth and development.

Managing Innovation Innovation allows for
Transformation of organizational processes Creation of new & commercially viable products & services Innovation requires new knowledge from The latest technology The results of experiments Creative insights Competitive information Growth opportunities come through innovation. Innovation = the use of new knowledge to transform organizational processes or create commercially viable products and services. The sources of new knowledge may include the latest technology, the results of experiments, creative insights, or competitive information. However it comes about, innovation occurs when new combinations of ideas and information bring about positive change. In fact, the root of the word innovation is the Latin novus, which means new. Innovation involves introducing or changing to something new. Is a critical part of strategic implementation.

Question? Whereas _______ are often associated with the low-cost leader strategy, ________ are frequently an important aspect of the differentiation strategy. process innovations; product innovations product innovations; service innovations radical innovations; instrumental innovations marketing innovations; incremental innovations Answer: A. Managing innovation is an important strategic implementation issue. Once strategic leaders have chosen a strategy to implement, they must then anticipate how to eventually expand or improve their business through innovation or corporate entrepreneurship. If a firm has chosen the low-cost leader strategy, most likely process innovations are required in order to improve the business long-term. On the other hand, if a firm has chosen differentiation as a strategy, then expansion of the business through product innovations will be required in order to grow.

Managing Innovation Types of innovation include Product innovation
Creates new product designs Applies technology to develop new products for end-users Common during early stages of an industry’s life cycle Associated with a differentiation strategy Sometimes even a small innovation can add value and create competitive advantages. Product innovation = efforts to create product designs and applications of technology to develop new products for end-users. Product innovations tend to be more common during the earlier stages of an industry’s lifecycle. Product innovations are also commonly associated with a differentiation strategy. Firms that differentiate by providing customers with new products or services that offer unique features or quality enhancements often engage in product innovation.

Managing Innovation Types of innovation also include
Process innovation Improves the efficiency of an organizational process Improves materials utilization, shortens cycle time, increases quality Common during later stages of an industry’s lifecycle Associated with overall cost leadership strategies Innovation can and should occur throughout an organization – in every department and all aspects of the value chain. Process innovation = efforts to improve the efficiency of organizational processes, especially manufacturing systems and operations. By drawing on new technologies and an organization’s accumulated experience, firms can often improve materials utilization, short cycle time, and increase quality. Process innovations are more likely to occur in the later stages of an industry’s life cycle as companies seek ways to remain viable in markets where demand has flattened out and competition is more intense. As result, process innovations are often associated with overall cost leader strategies, because the aim of many process improvements is to lower the costs of operations.

Managing Innovation Other types of innovation include
Radical innovation A major departure from existing practices Usually as a result of technological change Can be highly disruptive Can transform or revolutionize a whole industry Incremental innovation Can enhance existing practices Make small improvements in products & processes Can create evolutionary applications of earlier innovations; provide new capabilities Another way to view the impact of an innovation is in terms of its degree of innovativeness, which falls somewhere on a continuum that extends from incremental to radical. Radical innovation = an innovation that fundamentally changes existing practices. Radical innovations produce fundamental changes by evoking major departures from existing practices. These breakthrough innovations usually occur because of technological change. They tend to be highly disruptive and can transform a company or even revolutionize the whole industry. They may lead to products or processes that can be patented, giving the firm a strong competitive advantage. Incremental innovation = an innovation that enhances existing practices or makes small improvements in products and processes. Incremental innovations may represent evolutionary applications within existing paradigms of earlier, more radical innovations. Because they often sustain a company by extending or expanding its product line or manufacturing skills, incremental innovations can be a source of competitive advantage by providing new capabilities that minimize expenses or speed productivity.

Managing Innovation Some innovations are highly radical; others are only slightly incremental. But most innovations fall somewhere between these two extremes. Exhibit 12.1 Continuum of Radical and Incremental Innovations

Managing Innovation Additional types of innovation include
Sustaining innovations Extend sales in an existing market Enable new products or services to be sold at higher margins, i.e. via the Internet Disruptive innovations Overturn markets with a new approach to meeting customer needs Are technologically simpler & less sophisticated Appeal to less demanding customers Take time to take effect Harvard professor Clayton Christensen identified another useful approach to characterize types of innovations. Sustaining innovations are those that extend sales in existing market, usually by enabling new products or services to be sold at higher margins. Such innovations may include either incremental or radical innovations. For example, the Internet was a breakthrough technology that transformed retail selling, but rather than disrupting activities of catalog companies, the Internet energized existing business by extending reach and making operations more efficient. Disruptive innovations are those that overturn markets by providing an altogether new approach to meeting customer needs. The features of a disruptive innovation make it somewhat counterintuitive, because they are technologically simpler and less sophisticated than currently available products or services; they appeal to less demanding customers who are seeking more convenient, less expensive solutions; and they take time to take effect and only become disruptive once they have taken root in a new market or low-end part of an existing market. Christiansen says “instead of sustaining the trajectory of improvement that has been established in a market, a disruptive innovation disrupts it and redefines it by bringing to the market something that is simpler.”

Managing Innovation: Challenges
Innovation dilemmas Seeds versus weeds Seeds are likely to bear fruit Weeds should be cast aside Projects may require considerable investment before merit can be determined Experience versus initiative Who should lead an innovation project? Senior managers have experience & credibility, but tend to be more risk averse Mid-level employees may be the innovators themselves, and have more enthusiasm Innovation is essential to sustaining competitive advantages. Only those companies that actively pursue innovation, even though it is often difficult and uncertain, will get a payoff from their innovation efforts. But managing innovation is challenging. The uncertainty about outcomes is one factor that makes innovation so difficult. Companies are often reluctant to invest time and resources into activities with an unknown future. Another factor is that the innovation process involves so many choices. These choices present five dilemmas that companies must wrestle with when pursuing innovation. Seeds versus weeds reflects the fact that most companies have an abundance of innovative ideas. They must decide which of these is most likely to bear fruit and which should be cast aside. This is complicated by the fact that some innovation projects require a considerable level of investment before a firm can fully evaluate whether they are worth pursuing. Firms need a mechanism with which they can choose among various innovation projects. Experience versus initiative reflects the fact that companies must decide who will lead an innovation project. Senior managers may have experience and credibility but tend to be more risk averse. Mid-level employees, who may be the innovators themselves, may have more enthusiasm because they can see first hand how an innovation would address specific problems.

Innovation dilemmas, continued Internal versus external staffing Insiders may have greater social capital, may know the organization’s culture & routines, but may not be able to think outside the box Outsiders are costly to recruit, hire, & train, and may have difficulty building relationships Building capabilities versus collaborating Capabilities may come from internal departments Collaborators may come from other companies Dependencies may inhibit internal skills development or create conflict Other dilemmas that companies must wrestle with when pursuing innovation include the following: internal versus external staffing reflects the fact that innovation projects need competent staffs to succeed. People drawn from inside the company may have greater social capital and know the organization’s culture and routines. But this knowledge may actually inhibit them from thinking outside the box. Staffing innovation projects with external personnel requires that project managers justify the hiring and spend time recruiting, training, and relationship building. Building capabilities versus collaborating implies that innovation projects often require new sets of skills. Firms can seek help from other departments and or partner with other companies that bring resources and experience as well as share costs of development. However, such arrangements can create dependencies and inhibit internal skills development. Further, struggles over who contributed the most or how the benefits of the project are to be allocated may arise.

Innovation dilemmas, final choices Incremental versus preemptive launch An incremental launch is less risky, requires fewer resources, serves as a market test An incremental launch can undermine the project’s credibility if it is too tentative An incremental launch can open the door for a competitive response A large-scale launch requires more resources A large-scale launch can effectively preempt a competitive response A final dilemma that companies must wrestle with when pursuing innovation includes incremental versus preemptive launch. Companies must manage the timing and scale of new innovation projects. An incremental launch is less risky because it requires fewer resources and serves as a market test. But a launch that is too tentative can undermine the project’s credibility. It also opens the door for a competitive response. A large-scale launch requires more resources, but it can effectively preempt a competitive response. Firms need to make funding and management arrangements that allow for projects to hit the ground running and be responsive to market feedback.

Managing Innovation: Improving the Process
Cultivating innovation skills Discovery skills allow leaders to see the potential in innovations Creative intelligence allows individuals to develop more creative, higher potential innovations by means of Associating patterns, information & insights Questioning common wisdom Observing behavior Experimenting with new possibilities Networking with a diverse set of individuals The innovation process can be daunting even for highly successful firms. Some firms regularly produce innovative products and services, while other firms struggle to generate new, marketable ideas. Clayton Christiansen argues it is the innovative DNA of the leaders of some firms, their discovery skills, that allow them to see the potential in innovations and to move the organization forward in leveraging the value of those innovations. The key attribute that firms need to develop in their managers in order to improve their innovative potential is creative intelligence. Creative intelligence is driven by a core skill of associating – the ability to seek patterns in data and integrating different questions, information, and insights – and four patterns of action: questioning, observing, experimenting, and networking. As managers practice the four patterns of action, they will begin to develop the skill of association. As managers build up the ability to ask creative questions, develop a wealth of experiences from diverse settings, and link together insights from different arenas of their lives, they will build the ability to easily see situations creatively and draw upon a wide range of experiences and knowledge to identify creative solutions. See the description and examples of each of these traits in Exhibit 12.2.

Defining the scope of innovation Defining the strategic envelope Focus on a common technology? Focus on a market theme? Evaluating results How much will the innovation initiative cost? How likely is it to actually become commercially viable? How much value will it add; what will it be worth if it works? What will be learned if it does not pan out? Firms must have the means to focus their innovation efforts. Firms must ensure that their innovation efforts are not wasted on projects that are outside the firm’s domain of interest. A strategic envelope defines the range of acceptable projects. Strategic envelope = a firm-specific view of innovation that defines how a firm can create new knowledge and learn from an innovation initiative even if the project fails. The strategic envelope also gives direction to a firm’s innovation efforts, which helps separate seeds from weeds and builds internal capabilities. One way to determine which projects to work on is to focus on a common technology. Then, innovation efforts across the firm can aim at developing skills and expertise in a given technical area. Another potential focus is on a market theme. Companies must be clear not only about the kinds of innovation they are looking for but also the expected results. However a firm envisions its innovation goals, it needs to develop a systematic approach to evaluating its results and learning from its innovation initiatives. It needs to develop a set of questions to ask itself about its innovation efforts.

Managing the pace of innovation Incremental innovations May take six months or two years; May use a milestone approach, goals & deadlines Radical innovations May take 10 years or more; May involve open ended experimentation & time-consuming mistakes “Time pacing” allows for control of the innovation process Along with clarifying the scope of an innovation by defining a strategic envelope, firms also need to regulate the pace of innovation. How long will it take for an innovation initiative to realistically come to fruition? Managing the pace of innovation can be an important factor in long-term success. The project timeline of an incremental innovation may be six months to two years, whereas a more radical innovation is typically long-term – 10 years or more. Radical innovations often begin with a long period of exploration in which experimentation makes strict guidelines unrealistic. In contrast, firms that are innovating incrementally in order to exploit a window of opportunity may use a milestone approach that is more stringently driven by goals and deadlines. Some projects can’t be rushed. Companies that hurry up their research efforts or go to market before they are ready can damage their ability to innovate – and their reputation. “Time pacing” can be a source of competitive advantage because it helps a company manage transitions and develop an internal rhythm. Time pacing does not mean the company ignores the demands of market timing; instead, companies have a sense of their own internal clock in a way that allows them to thwart competitors by controlling the innovation process. With time pacing, the firm works to develop an internal rhythm that matches the buying practices of customers.

Example: Pacing Innovation at Amazon
Amazon is well-known for innovative ideas, but what about selling groceries online? Webvan and others have failed. Amazon is using its recent acquisition of Kiva robotics & former Webvan executives to grow AmazonFresh slowly Limit delivery to areas with a high concentration of potential customers Focus relentlessly on warehouse efficiency through technology Companies must manage the timing and scale of new innovation projects. An incremental launch is less risky because it requires fewer resources and serves as a market test. But a launch that is too tentative can undermine the project’s credibility. The online grocery start-up Webvan may have been the single most expensive flame-out of the dot-com era, blowing through more than $800 million in venture capital and IPO proceeds in just over three years before shutting its doors in Twelve years later, though, Webvan is rising from the dead - in the form of an online grocery business called AmazonFresh. Kiva Systems, the robotics company that Amazon bought last year for $775 million in one of its largest-ever acquisitions, was built on ideas and technologies originally developed at Webvan and is a key part of the AmazonFresh strategy. Four key Amazon.com Inc executives - Doug Herrington, Peter Ham, Mick Mountz and Mark Mastandrea - are former Webvan officials who have spent years analyzing and fixing the problems that led to the start-up's demise. Former Amazon and Webvan officials say Amazon drew three big lessons from the Webvan debacle: expand slowly, limit delivery to areas with a high concentration of potential customers, and focus relentlessly on warehouse efficiency. The opportunity for Amazon is huge. The grocery business in the United States generated $568 billion in retail sales last year, with online accounting for less than 1 percent, and it's among the last major retail sectors that the online giant has yet to tackle. But the risks are large as well. Groceries are a notoriously low-margin business, and the aggressive expansion of discounters like Walmart has made the business even more cutthroat than it was in Webvan's day. And competition in the online grocery business is heating up. FreshDirect and Peapod have been plugging away for years, while traditional grocery chains like Safeway also do online ordering and delivery. Amazon expects to succeed at this innovation by growing slowly, only delivering to densely populated areas of former customers, and leveraging the Kiva robotic warehouse system and Amazon’s existing technology base to keep costs down. To learn more about the challenges in this industry, see case 29: Fresh Direct. See for the full story.

Staffing to capture value from innovation Effective human resource management practices for innovation projects include Use experienced players from diverse areas Require employees serve in the new venture group as part of career development Once people have new venture experience, transfer them to mainstream management positions to revitalize core businesses Separate individual performance from innovation performance so failure is not a stigma People are central to the processes of identifying, developing, and commercializing innovations effectively. People need broad sets of skills as well as experience – experience working with teams and experience working on successful innovation projects. Companies must provide strategic decision-makers with the appropriate staff, and use human resource management practices to capture value from innovation efforts. Firms must create innovation teams with experienced players who know what it is like to deal with uncertainty and can help new staff members learn venture management skills. However, make sure to staff with players who have a diverse experience, not just those from the company’s core business. Require that employees seeking to advance their career with the organization serve in the new venture group as part of their career climb. Don’t just allow in volunteers who want to work on interesting projects. Once people have experience with the new venture group, transfer them to mainstream management positions where they can use their skills and knowledge to revitalize the company’s core business. Separate the performance of individuals from the performance of the innovation. Otherwise strong players may feel stigmatized if the innovation effort they worked on fails. Don’t create a climate where innovation team members are considered second-class citizens. Unless an organization can align its key players into effective new venture teams, it is unlikely to create any differentiating advantages from its innovation efforts.

Corporate Entrepreneurship
Pursuit of new venture opportunities Strategic renewal via “intrapreneuring” How to pursue entrepreneurial projects? Consider corporate culture & leadership Consider supportive structures & systems Consider using teams Consider whether the company is product or service oriented; high-tech or low-tech Is innovation aimed at product or process improvements? Corporate entrepreneurship = the creation of new value for a corporation, through investments that create either new sources of competitive advantage or renewal of the value proposition. The innovation process keeps firms alert by exposing them to new technologies, making them aware of marketplace trends, and helping them evaluate new possibilities. Just as the innovation process helps firms to make positive improvements, corporate entrepreneurship helps firms identify opportunities and launch new ventures. Corporate new venture creation was labeled “intrapreneuring” by Gifford Pinchot because it refers to building entrepreneurial businesses within existing corporations. In a typical corporation, what determines how entrepreneurial projects will be perceived? That depends on many factors, including corporate culture, leadership, structural features that guide and constrain action, organizational systems that foster learning and manage rewards. Firms might also want to consider the use of teams in strategic decision-making, whether the company is product or service oriented, whether it’s innovation efforts are aimed at product or process improvements, and the extent to which it is high-tech or low-tech. Because these factors are different in every organization, some companies may be more involved than others in identifying and developing new venture opportunities.

Focused approaches to corporate entrepreneurship Autonomous corporate venturing workgroup separated from the rest of the firm Frees entrepreneurial team members from constraints imposed by existing norms & routines; facilitates open-minded creativity Does isolate the group from the corporate mainstream via New venture groups Business incubators Two distinct approaches to corporate venturing are found among firms that pursue entrepreneurial aims. The first is focused corporate venturing, in which activities are isolated from the firm’s existing operations and worked on by independent work units. The second approach is dispersed, in which all parts of the organization and every organizational member are engaged in intrapreneurial activities. Focused approaches to corporate entrepreneurship = corporate entrepreneurship in which the venturing entity is separated from the other ongoing operations of the firm. This is when autonomous workgroups pursue entrepreneurial aims independent of the rest of the firm. The advantage of this approach is that it frees entrepreneurial team members to think and act without the constraints imposed by existing organizational norms and routines. The disadvantage is that, because of their isolation from the corporate mainstream, the workgroups that concentrate on internal ventures may fail to obtain the resources or support needed to carry an entrepreneurial project through to completion.

New venture groups Are semi-autonomous units with an informal structure Innovate and experiment Coordinate with other corporate divisions Identify potential venture partners Gather resources & launch the venture Business incubators hatch new businesses Provide funding, physical space, business services, monitoring, networking The new venture group = a group of individuals, or a division within the corporation, that identifies, evaluates, and cultivates venture opportunities. This group may simply be a committee that reports to the president on potential new ventures or it may be organized as a corporate division with its own staff and budget. They usually have a substantial amount of freedom to take risks and the supply of resources to do it with. Their involvement extends beyond a typical research and development department to include innovation and experimentation, coordinating with other corporate divisions, identifying potential venture partners, gathering resources, and actually launching the venture. A business incubator = a corporate new venture group that supports and nurtures fledgling entrepreneurial ventures until they can thrive on their own as stand-alone businesses. Incubators are designed to “hatch” new businesses. Although they often receive support from many parts of the corporation, they still operate independently until they are strong enough to go it alone. Depending on the type of business, they are either integrated into an existing corporate division or continue to operate as a subsidiary of the parent firm. Incubators typically provide funding, physical space, business services, mentoring, and networking.

Dispersed approaches to corporate entrepreneurship Entrepreneurship is spread throughout the firm Ability to change is a core capability Stakeholders can bring new ideas or venture opportunities to anyone in the organization Has three related aspects An entrepreneurial culture Resource allotments to support entrepreneurial activities Product champions Dispersed approaches to corporate entrepreneurship = corporate entrepreneurship in which a dedication to the principles and policies of entrepreneurship is spread throughout the organization. One advantage of this approach is that organizational members don’t have to be reminded to think entrepreneurially or to be willing to change. The ability to change is considered to be a core capability in the organization. This leads to a second advantage. Because of the firm’s entrepreneurial reputation, stakeholders such as vendors, customers, or alliance partners can bring new ideas or venture opportunities to anyone in the organization and expect them to be well received. Such opportunities make it possible for the firm to stay ahead of the competition. However, there are disadvantages as well. Firms that are overzealous about corporate entrepreneurship sometimes feel they must change for the sake of change, causing them to lose vital competencies or spend heavily on R&D and innovation to the detriment of the bottom line. Three related aspects of dispersed entrepreneurship include entrepreneurial cultures that have an overarching commitment to corporate entrepreneurship activities, resource allotments to support entrepreneurial actions, and the use of product champions in promoting entrepreneurial behaviors.

An entrepreneurial culture exists when The search for venture opportunities permeates every part of the organization Every value chain activity is viewed as a source of competitive advantage Top leaders support programs & incentives, allowing ideas to come from the bottom up Strategic leadership & the culture encourages Innovation Risk-taking The search for new venture opportunities With a dispersed approach to corporate entrepreneurship, a dedication to the principles and policies of entrepreneurship is spread throughout the organization. This dispersement is supported by several corporate aspects. Entrepreneurial culture = corporate culture in which change and renewal are a constant focus of attention. A culture of entrepreneurship is one in which the search for venture opportunities permeates every part of the organization. The key to creating value successfully is viewing every value chain activity as a source of competitive advantage. In companies with an entrepreneurial culture, everyone in the organization is attuned to opportunities to help create new businesses. Many such firms use a top-down approach where top leaders support programs and incentives that foster a climate of entrepreneurship. Many of the best ideas for new corporate ventures, however, come from the bottom up. Strategic leadership and culture together generate a strong impetus to innovate, take risks, and seek out new venture opportunities.

Resource allotments involve the firm’s investment in the generation & execution of innovative ideas Time investment – free time to work on developing new products Monetary investment – proposals are submitted for funding; further investments can come from operating divisions With a dispersed approach to corporate entrepreneurship, a dedication to the principles and policies of entrepreneurship is spread throughout the organization. This dispersement is supported by resource allotments which represent the firm’s willingness to invest in the generation and execution of innovative ideas. On the generation side, employees are much more likely to develop these ideas if they have the time to do so. For instance, Google and 3M allow 10-15% of employees’ time to be free and spent thinking up bold new ideas. In addition to time, firms can foster corporate entrepreneurship by providing monetary investments to fund entrepreneurial ideas. J&J, Nike, and Google have review boards that decide which proposals to fund and then can solicit further investments from operating divisions. The availability of these time and financing sources can enhance the likelihood of successful entrepreneurial activities within the firm.

Product champions are useful to Bring entrepreneurial ideas forward Identify what kind of market exists for the product or service Find resources to support the venture Promote the venture concept to upper management A new project must pass two critical stages Project definition Project impetus With a dispersed approach to corporate entrepreneurship, a dedication to the principles and policies of entrepreneurship is spread throughout the organization. Often, innovative ideas emerge in the normal course of business and are brought forth and become part of the way of doing business. Entrepreneurial champions are often needed to take charge of internally generated ventures. Product champion = an individual working within a corporation who brings entrepreneurial ideas forward, identifies what kind of market exists for the product or service, finds resources to support the venture, and promotes the venture concept to upper management. No matter how an entrepreneurial idea comes to light, a new venture concept must pass through two critical stages or may never get off the ground. Project definition implies that an opportunity has to be justified in terms of its attractiveness in the marketplace and how well it fits with the corporation’s other strategic objectives. Project impetus means that in order for a project to gain impetus, it’s strategic and economic impact must be supported by senior managers who have experience with similar projects. It then becomes an embryonic business with its own organization and budget. For a project to advance through the stages of definition and impetus, a product champion is often needed to generate support and encouragement. Champions are especially important during the time after a new project has been defined but before it gains momentum. They form a link between the definition and impetus stages of internal development, which they do by procuring resources and stimulating interest for the product among potential customers. Product champions play an important entrepreneurial role in a corporate setting by encouraging others to take a chance on promising new ideas.

Example: Corporate Entrepreneurship at Samsung
Samsung has gained the reputation of a being a “fast follower” – following Apple’s innovations with rapid product development Samsung tried a dispersed approach to CE, but the culture wasn’t flexible enough In December 2012 it began a more focused approach with the Creative Labs project The South Korean government is even trying to cultivate more individual entrepreneurs by providing funding, access to investment capital, & offering tax break incentives Going into 2013, Samsung cell phones dominated market share. Unlike Apple, Samsung has focused heavily on studying existing markets and innovating inside them. “We get most of our ideas from the market,” says Kim Hyun-suk, an executive vice president at Samsung. Samsung’s internal units are forced to compete with outsiders in order to speed up the process for developing innovative new products. "Samsung is the world best in producing goods or services that others make at cheaper costs and differentiating them by adding new features," said Song Jaeyong, a professor at Seoul National University who has served as an external advisor for Samsung since "But it had not made what doesn't exist in the world, like Apple did.“ Samsung used a dispersed approach to corporate entrepreneurship. As Samsung tries to pack its products with various attractive features, it draws on the knowledge of about 1000 designers with backgrounds in disciplines as diverse as psychology, sociology, economics, and engineering. These designers in turn draw on information that is collected by 60,000 staff members working in 34 research centers across the globe. However, its culture might not be flexible enough to sustain innovativeness. "Samsung's culture is a culture of hierarchy, a culture that emphasizes efficiency, which was great for enhancing competitiveness in manufacturing," said Song. "But for creative innovation, it is important to have diversity, openness, flexibility, open communication and an attitude of learning from failures. Samsung's corporate culture lacks these qualities.“ In December 2012 it began a project, dubbed Creative Labs, which seeking to emulate a startup ethos, allows some employees to take 6 months to a year off their regular work to collaborate on projects that no deadlines, profit targets or rigorous management rules. This may allow the firm to get its products to move quickly to manufacturing with minimal problems and at the lowest possible cost. South Korea's also government says it wants to cultivate more entrepreneurial risk taking as it reckons with diminishing returns from years of reliance on state-favored companies known more for their massive scale and aggressive competitive instincts than bold thinking and creativity. The chaebol, as the conglomerates are known, helped transform South Korea into a wealthy industrialized powerhouse but are increasingly criticized as part of a fraying economic setup based on copycatting innovations from abroad. South Korea is also casting a nervous eye at up-and-coming Chinese companies such as Lenovo and ZTE that aspire to beat South Korean companies at their own game. Among the policies aimed at nurturing a "creative economy," South Korea is pouring more than 3 trillion won ($2.7 billion) into funding startups, establishing a third stock market to help new ventures raise money, and changing laws to lower hurdles for crowd-funding. To increase the chances of a financial payoff for entrepreneurs, it plans to give tax breaks and other incentives to big companies that invest in startups. See Case 27: Samsung Eletronics, and the article at for more information.

Corporate Entrepreneurship: Measuring Success
Is corporate entrepreneurship worth it? Strategic reasons for undertaking a corporate venture include Strengthening competitive position Entering into new markets Expanding capabilities by learning & acquiring new knowledge Building & extending the corporation’s base of resources & experience Corporate venturing, like the innovation process, usually requires a tremendous effort. Is it worth it? Not all corporate venturing efforts are financially rewarding. In terms of financial performance, slightly more than 50% of corporate venturing efforts reach profitability (measured by ROI) within six years of their launch. These results should be expected, because corporate entrepreneurship is riskier than other investments. However, corporations do expect a higher return from corporate venturing projects in the long run. Luckily, financial criteria are not the only means for judging the success of a corporate venture initiative. Most corporate entrepreneurship programs have strategic goals. The strategic reasons for undertaking the corporate venture include strengthening competitive position, entering into new markets, expanding capabilities by learning and acquiring new knowledge, and building the corporation’s base of resources and expertise. There are three questions that can be used to assess the effectiveness of the corporation’s venturing initiatives: (1) are the products or services offered by the venture accepted in the marketplace? If the venture is considered a market success, the financial returns are likely to be satisfactory. The venture may also open doors into other markets and suggest avenues for other venture projects. (2) Are the contributions of the venture to the corporation’s internal competencies and experience valuable? If the venture adds worth to the firm internally, then strategic goals such as leveraging existing assets, building new knowledge, and enhancing firm capabilities are likely to be met. (3) Is the venture able to sustain its basis of competitive advantage? If so, this will insulate it from competitive attack, and place the corporation in a stronger position relative to competitors, providing a base from which to build other advantages. When assessing the success of corporate venturing, it is important to look beyond simple financial returns and consider a well-rounded set of criteria.

Exit champions help avoid costly defeats by Questioning the viability of a venture project Reducing ambiguity by gathering hard data Developing a strong case for why a project should be killed Reasserting decision-making criteria to guide venture decisions Risking loss of status while opposing popular projects Saving a corporation’s finances & reputation Although a culture of championing venture projects is advantageous for stimulating an ongoing stream of entrepreneurial initiatives, many or most ideas will not work out. Sometimes companies wait too long to terminate a new venture and do so only after large sums of resources are used up or, worse, result in a marketplace failure. One way to avoid these costly and discouraging defeats is to support the key role of an exit champion = an individual working within a corporation who’s willing to question the viability of a venture project by demanding hard evidence of venture success and challenging the belief system that carries a venture forward. Exit champions reduce ambiguity by gathering hard data and developing a strong case for why a project should be killed. Exit champions often have to reinstate procedures and reassert the decision-making criteria that are supposed to guide venture decisions. Whereas product champions often emerge as heroes, exit champions run the risk of losing status by opposing popular projects. An exit champion can save a corporation both financially and in terms of its reputation in the marketplace.

Question? Real options analysis is most appropriate when
the total investment required is small, but the environment is uncertain. the investment required could be justified by Discounted Cash Flow (DCF) techniques. a small investment upfront can be followed by a series of subsequent investments. there is no prospect of obtaining additional information before making subsequent investments. Answer: C. One way firms can minimize failure and avoid losses from pursuing faulty ideas is to apply the logic of real options. Options exist when the owner of the option has the right but not the obligation to engage in certain types of transactions. The investment to be made immediately is small, whereas the investment to be made in the future is generally larger. Options offer the prospect of high gains with relatively small up-front investments that represent limited losses.

Real options analysis is an investment tool Helps manage the uncertainty associated with launching new ventures ROA helps the firm decide whether to Invest additional funds to accelerate the activity Delay further investment in order to learn more Shrink the scale of the activity Abandon the activity Requires a series of go or no-go decisions Options exist when the owner of the option has the right but not the obligation to engage in certain types of transactions. Options offer the prospect of high gains with relatively small up-front investments that represent limited losses. The phrase “real options” applies to situations where options theory and valuation techniques are applied to real assets or visible things as opposed to financial assets. Applied to entrepreneurship, real options suggest a path that companies can use to manage the uncertainty associated with launching new ventures. Real options analysis (ROA) = an investment analysis tool that looks at an investment or activity as a series of sequential steps, and for each step the investor has the option of (a) investing additional funds to grow or accelerate, (b) delaying, (c) shrinking the scale of, or (d) abandoning the activity. Many strategic decisions have the characteristic of containing a series of options. The phenomena is called “embedded options,” a series of investments in which at each stage of the investment there is a go/no-go decision. To decide whether to exercise an option, the idea must continue to prove itself at each stage of development. Entrepreneurial decision-making at Johnson Controls is given as an example of how to evaluate ideas by separating winning ideas from losing ones in a way that keeps investments low.

Real options analysis has limitations Agency theory and the back solver dilemma Managers have an incentive to propose projects that might be successful, so Managers may “game the system” by back- solving any formula Managerial conceit: overconfidence and the illusion of control Managers believe they possess superior expertise for managing uncertainty, therefore Managers may believe they can solve any problem Despite the many benefits that can be gained from using real options analysis, managers must be aware of its potential limitations or pitfalls. If you recall, agency problems occur when the managers of the firm are separated from its owners – when managers act as “agents” rather than “principals” (owners). The manager may have something to gain by not acting in the owner’s best interests, where the interests of managers and owners are not co-aligned. Agency theories suggests that as managerial and owner interests diverge, managers will follow the path of their own self-interests. Managers who propose projects may believe that if their projects are approved, they stand a much better chance of getting promoted. So while managers have an incentive to propose projects that should be successful, they also have an incentive to propose projects that might be successful, therefore they will choose variance values that increase the likelihood of approval. If managers know that a certain option value must be met in order for the proposal to get approved, they can back-solve the model to find a variance estimate needed to arrive at the answer that upper management desires. Back-solver dilemma = problem with investment decisions in which managers scheme to have a project meet investment approval criteria, even though the investment may not enhance firm value. Managerial conceit = biases, blind spots, and other human frailties that lead to poor managerial decisions. Managerial conceit occurs when decision-makers who have made successful choices in the past come to believe that they possess superior expertise for managing uncertainty. They believe that their abilities can reduce the risks inherent in decision-making to a much greater extent than they actually can. Employing the real options perspective can encourage decision-makers toward a bias for action, because real options are designed to minimize potential losses while preserving potential gains. Therefore any problems that arise are likely to be smaller at first. When a problem is encountered, managers will assume that this problem is easy to solve and control, and may fail to respond appropriately because they believe they can easily resolve it.

Real options analysis has another limitation Managerial conceit: irrational escalation of commitment occurs when The exercise decision retains some uncertainty An option to exit requires reversing an initial decision Managers are invested in their original decision They feel they will lose face by reversing course They will try to make the existing decision work They will continue an existing project even if it should be ended A strength of the real options perspective is also one of its problems. Real options analysis requires sequential decisions. Simply separating a decision into multiple parts does not guarantee that decisions made will turn out well. This condition is potentially present whenever the exercise decision retains some uncertainty, which most still do. The decision to abandon also has strong psychological factors associated with it that affect the ability of managers to make correct exercise decisions. An option to exit requires reversing an initial decision made by someone in the organization. Organizations typically encourage managers to “own their decisions” in order to motivate them. As managers invest themselves in their decision, it proves harder for them to lose face by reversing course. For managers making the decision, it feels as if they made the wrong decision in the first place, even if it was initially a good decision. Hence, there is a greater likelihood that managers will stick around and try to make an existing decision work. Or engage in irrational escalation of commitment = the tendency for managers to irrationally stick with an investment, even one that is broken down into a sequential series of decisions, when investment criteria are not met.

Entrepreneurial Orientation
An entrepreneurial orientation involves Strategy making practices used to identify & launch new ventures A unique frame of mind A perspective toward entrepreneurship Reflected in a firm’s ongoing processes Reflected in the corporate culture That permeates decision-making styles & practices of the firm’s members Firms that want to engage in successful corporate entrepreneurship need to have an entrepreneurial orientation = the strategy making practices that businesses use in identifying and launching corporate ventures, that represent a frame of mind and a perspective toward entrepreneurship that is reflected in a firm’s ongoing processes and corporate culture. An entrepreneurial orientation has five dimensions that permeate the decision-making styles and practices of the firm’s members: autonomy, innovativeness, proactiveness, competitive aggressiveness, and risk-taking. These factors work together to enhance a firm’s entrepreneurial performance.

Here are the five dimensions of entrepreneurial orientation (EO) and how they have been used to enhance internal venture development. These factors work together to enhance the firm’s entrepreneurial performance. But even those firms that are strong in only a few aspects of EO can be very successful. Exhibit 12.3 Dimensions of Entrepreneurial Orientation Sources: Dess, G.G. & Lumkin, G.T The Role of Entrepreneurial Orientation in Stimulating Effective Corporate Entrepreneurship. Academy of Management Executive, 19(1): ; Covin, J.G. & Slevin, D.P A Conceptual Model of Entrepreneurship as Firm Behavior. Entrepreneurship Theory & Practice, Fall: 7-25; Lumpkin, G.T. & Dess, G.G Clarifying the Entrepreneurial Orientation Construct and Linking It to Performance. Academy of Management Review, 21: ; Miller, D The Correlates of Entrepreneurship in Three Types of Firms. Management Science, 29:

Autonomy refers to a willingness to act independently in order to carry forward an entrepreneurial vision or opportunity, and can be promoted by Using skunk works to foster entrepreneurial thinking Designing organizational structures that support independent action Problems can include duplication of effort & wasting of resources Autonomy = independent action by an individual or team aimed at bringing forth a business concept or vision and carrying it through to completion. The need for autonomy may apply to either dispersed or focused entrepreneurial efforts. Because of the emphasis on venture projects that are being developed outside of the normal flow of business, a focused approach suggests a working environment that is relatively autonomous. But autonomy may also be important in an organization where entrepreneurship is part of the corporate culture. Autonomy represents a type of empowerment that is directed at identifying and leveraging entrepreneurial opportunities. Creating autonomous work units and encouraging independent action may have pitfalls that can jeopardize their effectiveness. Autonomous teams often lack coordination. Excessive decentralization has a strong potential to create inefficiencies, such as duplication of effort and wasting resources on projects with questionable feasibility. For autonomous work units and independent projects to be effective, such efforts have to be measured and monitored. This requires a delicate balance: companies must have the patience and budget to tolerate the explorations of autonomous groups and the strength to cut back efforts that are not bearing fruit. It must be undertaken with a clear sense of purpose – namely, to generate new sources of competitive advantage.

Innovativeness refers to a firm’s efforts to find new opportunities & novel solutions, and can be promoted by Fostering creativity & experimentation Investing in new technology, R&D, & continuous improvement Problems can include Waste of resources if no results Competitors may copy it more profitably The investment may not pay off Innovativeness = a willingness to introduce novelty through experimentation and creative processes aimed at developing new products and services as well as new processes. Innovativeness refers to a firm’s attitude toward innovation and willingness to innovate. It involves creativity and experimentation that result in new products, new services, or improved technological processes. Innovativeness is one of the major components of an entrepreneurial strategy, however, the job of managing innovativeness can be very challenging. Innovativeness requires that firms depart from existing technologies and practices and venture beyond the current state-of-the-art. Inventions and new ideas need to be nurtured even when their benefits are unclear. Innovativeness can be a great source of progress and corporate growth, but there are also some major pitfalls: expenditures on R&D aimed at identifying new products or processes can be a waste of resources if the effort does not yield results. Another danger is related to the competitive climate. Even if a company innovates a new capability or successfully applies a technological breakthrough, another company may develop a similar innovation or find a use for it that is more profitable. R&D and other innovation efforts are also often among the first to be cut back during an economic downturn. Finally, investments in innovations may not pay off.

Proactiveness refers to a firm’s efforts to seize new opportunities, and can be promoted by Introducing new products or technological capabilities ahead of the competition Continuously seeking out new product or service offerings Problems can include First movers are not always successful Brand extensions can go too far Proactiveness = a forward looking perspective characteristic of a marketplace leader that has the foresight to seize opportunities in anticipation of future demand. Proactive organizations monitor trends, identify the future needs of existing customers, and anticipate changes in demand or emerging problems that could lead to new venture opportunities. Proactiveness involves not only recognizing changes but also being willing to act on those insights ahead of the competition. Proactiveness puts competitors in the position of having to respond to successful initiatives. The benefit gained by firms that are the first to enter new markets, establish brand identity, implement administrative techniques, or adopt new operating technologies in an industry is called first mover advantage. First movers usually have several advantages. First, industry pioneers, especially in new industries, often capture unusually high profits because there are no competitors to drive prices down. Second, first movers that establish brand recognition are usually able to retain their image and hold onto the market share gains they earned by being first. First movers are not always successful. The customers of companies that introduce novel products or embrace breakthrough technologies may be reluctant to commit to a new way of doing things. There are also dangers of trying to proactively anticipate demand and take proactiveness efforts too far, for instance, with brand extensions. Careful monitoring and scanning of the environment, as well as extensive feasibility research, are needed for a proactive strategy to lead to competitive advantages.

Competitive aggressiveness refers to a firm’s efforts to outperform its industry rivals, & can be promoted by Entering markets with drastically lower prices Finding successful business models & copying them Problems can include Being overly aggressive & damaging a firm’s reputation Trying to decimate rather than just defeat the competition Competitive aggressiveness = an intense effort to outperform industry rivals characterized by a competitive posture or an aggressive response aimed at improving position or overcoming a threat in a competitive marketplace. Companies with an aggressive orientation are willing to “do battle” with competitors. They might slash prices and sacrifice profitability to gain market share or spend aggressively to obtain manufacturing capacity. Strategic managers can use competitive aggressiveness to combat industry trends that threaten their survival or market position. Sometimes firms need to be forceful in defending the competitive position that has made them an industry leader. Companies can also overcome the competition by making pre-announcements of new products or technologies. This type of signaling is aimed not only at potential customers but also at competitors to see how they will react or to discourage them from launching similar initiatives. Competitive aggressiveness may not always lead to competitive advantages. Some companies have severely damaged their reputation by being overly aggressive. Competitive aggressiveness is a strategy that is best used in moderation. Companies that vigorously exploit opportunities to achieve profitability may, over the long run, be better able to sustain their competitive advantages if their goal is to defeat, rather than decimate, their competitors.

Risk taking refers to a firm’s willingness to act boldly without knowing the consequences, and can be promoted by Researching & assessing risk factors to minimize uncertainty Using techniques that have worked in other domains Problems can include Lack of forethought, research, & planning Failure to evaluate uncertainty Risk taking = making decisions and taking action without certain knowledge of probable outcomes. Some undertakings may also involve making substantial resource commitments in the process of venturing forward. To be successful through corporate entrepreneurship, firms usually have to take on riskier alternatives, even if it means forgoing the methods or products that have worked in the past. To obtain high financial returns, firms take such risks as assuming high levels of debt, committing large amounts of firm resources, introducing new products into new markets, and investing in unexplored technologies. Three types of risk that organizations and their executives face are business risk, financial risk, and personal risk. Even though risk-taking involves taking chances, it is not gambling. The best run companies investigate the consequences of various opportunities and create scenarios of likely outcomes. A key to managing entrepreneurial risks is to evaluate new venture opportunities thoroughly enough to reduce the uncertainty surrounding them. Only carefully managed risk is likely to lead to competitive advantages. Actions that are taken without sufficient forethought, research, and planning may prove to be very costly. Successful entrepreneurs are typically not risk takers. Instead they take steps to minimize risks by carefully understanding them. That is how they avoid focusing on risk and remain focused on opportunity.

Analyzing Strategic Management Cases
chapter 13

Learning Objectives After reading this chapter, you should have a good understanding of: LO13.1 How strategic case analysis is used to simulate real-world experiences. LO13.2 How analyzing strategic management cases can help develop the ability to differentiate, speculate, and integrate when evaluating complex business problems. LO13.3 The steps involved in conducting a strategic management case analysis.

Learning Objectives LO13.4 How to get the most out of case analysis. LO13.5 How integrative thinking and conflict- inducing discussion techniques can lead to better decisions. LO13.6 How to use the strategic insights and material from each of the 12 previous chapters in the text to analyze issues posed by strategic management cases.

Strategic Case Analysis
Consider… To remain competitive, established firms must continually refine their ability to solve business problems. This requires making good decisions. Making a good decision requires choosing among various alternatives, and research is required in order to identify alternatives. Good research requires asking and answering the right questions. It is often said that the key to finding good answers is to ask good questions. Strategic managers and business leaders are required to evaluate options, make choices, and find solutions to the challenges they face everyday. To do so they must learn to ask the right questions.

Case analysis helps us learn how to ask good questions & make good decisions Why do some firms succeed and others fail? Why are some companies higher performers than others? What information is needed in the strategic planning process? How do competing values and beliefs affect strategic decision-making? What skills and capabilities are needed to implement a strategy effectively? The process of analyzing, decision-making, and implementing strategic actions raises many good questions. Case analysis simulates the real world experience that strategic managers and company leaders face as they try to determine how best to run their companies. Case analysis = a method of learning complex strategic management concepts – such as environmental analysis, the process of decision-making, and implementing strategic actions – through placing students in the middle of an actual situation and challenging them to figure out what to do. As one CEO said “if you don’t ask the right questions, then you’re never going to get the right solution.” Case analysis forces you to choose among different options and set forth a plan of action, a potential solution, based on your choices. But even then the job is not done. Strategic case analysis also requires that you address how you will implement the plan and the implications of choosing one course of action over another.

Question? The strategic management process entails three ongoing processes: analysis, actions, and synthesis. analysis, decisions, and actions. analysis, evaluation, and critique. analysis, synthesis, and antithesis. Answer: B. Remember, the strategic management process involves strategy analysis (analysis of the external environment, both general and industry–specific, and an assessment of internal capabilities plus creation of strategic goals - vision, mission, strategic objectives), strategy formulation (decisions regarding what industries should we compete in? How should we compete in those industries?), and strategy implementation (what actions should we take to allocate necessary resources? How can we design the organization to bring intended strategies to reality?)

Strategic management cases include A detailed description of the challenging situation faced by an organization Usually includes a chronology of events Can include financial statements, product lists, interviews with employees Strategic case analysis requires An ability to evaluate business situations Go beyond the textbook & root out essential issues and causes of a company’s problems One of the main reasons to analyze strategic management cases is to develop an ability to evaluate business situations critically. Just as organizational leaders and managers must analyze the overall environment, make decisions about how to compete, and then design the organization in order to implement these decisions and take required action, students must analyze the issues, choose among different options, and set forth a plan of action based on their choices. Students must go beyond memorizing key terms and conceptual frameworks. Case analysis requires a deep look into the information that is provided, and then the ability to root out the essential issues and causes of a company’s problems.

Strategic Case Analysis: Skills
Strategic skills needed include the ability to differentiate: Evaluate many different elements of the situation at once Differentiate between the factors that are influencing the situation Understand that problems are often complex & multilayered Need to dig deep Don’t be too quick to accept an easy solution Case analysis adds to the overall learning experience by helping students acquire or improve skills that may not be taught in a typical lecture course. Three capabilities that can be learned by conducting case analysis are specially useful to strategic managers: the ability to differentiate, speculate, and integrate. The ability to differentiate = isolate critical facts, evaluate whether assumptions are useful or faulty, and distinguish between good and bad information.

Strategic skills also include the ability to speculate: Envision an explanation that might not readily be apparent Imagine different scenarios Contemplate the outcome of the decision Deal with uncertainty & incomplete knowledge Data may be missing Information may be contradictory Details & consequences may be unknown The ability to speculate = being able to imagine different scenarios or contemplate the outcome of the decision without complete knowledge of the circumstances. The ability to speculate about details that are unknown, or anticipate the consequences of an action when the solution is not easily apparent, can be very helpful.

Strategic skills also include the ability to integrate: Consider the impact of various decisions & environmental influences on all parts of the organization Create one set of recommendations that affect the whole company Realize that changes made in one part of the company will affect other parts Need to adopt a holistic perspective The ability to integrate = being able to comprehend how all the factors that influence the organization will interact. Requires looking at the big picture and having an organization-wide perspective. Even though the chapters in this textbook divide the material into various topics that may apply to different parts of an organization, all of this information must be integrated into one set of recommendations. The mark of a good strategic manager is the ability to simultaneously make distinctions and envision the whole, and to imagine a future scenario while staying focused on the present.

Conducting a Case Analysis
Preparation: Investigate the situation Analyze and research possible solutions Gather the advice of others Put yourself in the shoes of an actual participant Are you a strategic decision-maker? Are you the business founder or owner? Are you a member of the board of directors? Are you an outside consultant? The process of analyzing strategic management cases involves several steps. Before beginning, there are two things to keep in mind that will prepare you: clarifying your understanding of the process and making the results of the process more meaningful. First, you need to prepare by immersing yourself in the facts, options, and implications surrounding the problem. This means reading and thoroughly comprehending the case materials before trying to make an analysis. Second, to get the most out of the case analysis you must place yourself “inside” the case – that is, think like an actual participant in the case situation. Envision yourself assuming a role as either the primary strategic decision-maker (CEO, business owner, or strategic manager in a key executive position), or a member of the Board of Directors, or an outside consultant brought in to give advice to a key decision-maker. Note that if you are the business founder or owner, hiring an outside consultant may not be an option.

Example: Preparing a Business Plan
Preparing a case analysis is like crafting a business plan. Here are some questions you should be able to answer: What is the competitive advantage? Is it in a growth market? What will customers pay for it? (How will the business make money?) How will the business be staffed? Is the product innovative? Are the plans and goals realistic? Preparing for a case analysis is similar to preparing to answer questions from an investor in your new business. Crafting the perfect business plan is often a challenge for any number of reasons. However, one of the biggest challenges standing in the way of a good business plan is the fact that oftentimes, no two investors, judges or members of your audience are looking for the same thing when evaluating a business plan. To help, here are six questions every business plan should answer. From 6 Questions Every Business Plan Should Answer By: David Mielach, BusinessNewsDaily Staff, May 13, 2013, These questions might be helpful, for instance, if a business founder wanted to go on the ABC TV show Shark Tank to get investors interested…

Step 1: Become familiar with the material Read quickly through the case one time Assess possible links to strategic concepts Read the case again, making notes Evaluate application of strategic concepts Formulate an initial recommendation Go through the case again to assess the consequences of actions you propose Written cases often include a lot of material. They may be complex and include detailed financials or long passages. Even so, to understand the case and its implications, you must become familiar with its contents. Sometimes key information is not immediately apparent. It may be contained in the footnotes to an exhibit or an interview with a lower-level employee, or even contained in additional material accessed through the endnotes. Here are some techniques to help enhance comprehension.

Step 2: Identify problems Some cases have more than one problem to solve Avoid getting hung up on the case symptoms Try to articulate the case problems Sometimes writing down a problem statement gives you a reference point Some problems will not be apparent until after you do the case analysis When conducting case analysis, one of your most important tasks is to identify the problem, and find a solution. But some cases have more than one problem, and the problems are usually related. When trying to determine the problem, avoid getting hung up on symptoms. Case symptoms = observable and concrete information in the case analysis that indicates an undesirable state of affairs. Case problems = inferred causes of case symptoms. Writing down a problem statement gives you a reference point to turn to as you proceed through the case analysis. This is important because the process of formulating strategies or evaluating implementation methods may lead you away from the initial problem. Make sure your recommendation actually addresses the problems you have identified. Bear in mind that in some cases the problem will be presented plainly, perhaps in the opening paragraph or on the last page of the case, but in other cases the problem does not emerge until after the issues in the case have been analyzed.

Step 3: Conduct strategic analyses Determine which strategic issues are involved Use strategic tools to conduct the analysis Five Forces analysis Value chain analysis Contingency frameworks Financial analysis – Financial Ratio Analysis Test your own assumptions about the case When conducting strategic analysis, determine what strategic issues are associated with the problems you have identified. Remember also that most real-life case situations involve issues that are highly interrelated. Even in cases where there is only one major problem, strategic processes required to solve it may involve several parts of the organization. Once you identify the issues that apply to the case, conduct the analysis. For instance, you may need to conduct a five-forces analysis or dissect the company’s competitive strategy. Perhaps you need to evaluate whether its resources are rare, valuable, difficult to imitate, or difficult to substitute. Financial analysis may be needed to assess the company’s economic prospects. Financial ratio analysis = a method of evaluating a company’s performance and financial well-being through ratios of accounting values, including short-term solvency, long-term solvency, asset utilization, profitability, and market value ratios. Perhaps the international entry mode needs to be reevaluated because of changing conditions in the host country. Employee empowerment techniques may need to be improved to enhance organizational learning. Whatever the case, all the strategic concepts introduced in the text include insights for assessing their effectiveness. Determining how well a company is doing these things is central to the case analysis process. Finally, ask yourself why you have chosen one type of analysis over another. This process of assumption checking can also help determine if you’ve got to the heart of the problem or are still just dealing with symptoms.

Strategic Case Analysis Tools
Exhibit 13.1 Summary of Financial Ratio Analysis Techniques Here is review of financial ratios that can be used to evaluate a company’s performance and financial well-being. See also Appendix 1.

Step 4: Propose alternative solutions Develop a list of options Evaluate the alternatives Can the company afford it? How will competitors respond? Will employees accept the change? How will it affect other stakeholders? How does it fit with the vision, mission & objectives? Will the culture or values of the company change? After conducting strategic analysis and identifying the problem, develop a list of options. Evaluate the alternatives and choices and the implications of those choices. Ask how the choices made will be implemented. Remember that not all cases call for dramatic decisions or sweeping changes. Some companies just need to make small adjustments. In fact, doing nothing may be a reasonable alternative in some cases. When evaluating alternatives, realize that the point of this step is to find a solution that both solves the problem and is realistic. A consideration of the implications of various alternative solutions will generally lead you to a final recommendation that is more thoughtful and complete.

Step 4: Make recommendations Make a set of recommendations supported by your analysis Describe exactly what needs to be done Explain why this course of action will solve the problem Indicate how best to implement the proposed solution Note: the solution you propose must solve the problem you identified Your analysis is not complete until you have recommended a course of action. Make a logical argument that shows how the problem led to the analysis and how the analysis led to the recommendations you are proposing. Remember, an analysis is not an end in itself; it is useful only if it leads to a solution. The recommendation should also include suggestions for how best to implement the proposed solution because the recommended actions and their implications for the performance and future of the firm are interrelated.

Preparing an oral presentation Organize your thoughts Emphasize strategic analysis Background/problem statement = 10-20% Strategic analysis/options = 60-75% Recommendations/action plan = 10-20% Be logical and consistent Defend your position Share presentation responsibilities Your analysis is not complete until you have recommended a course of action. This can be done with an oral presentation or a formal written case analysis. If preparing an oral case presentation, see Exhibit 13.2

Preparing a written presentation Be thorough Provide support for your arguments Reference specific case materials or other facts Coordinate team efforts Avoid restating the obvious Present information graphically Exercise quality control, be professional Good grammar, spelling, consistent style throughout Your analysis is not complete until you have recommended a course of action. This can be done with an oral presentation or a formal written case analysis. If preparing a written case analysis, see Exhibit 13.3

Getting the Most from Case Analysis
Keep an open mind Take a stand for what you believe Draw on your personal experience Participate and persuade Be concise and to the point Think out-of-the-box Learn from the insights of others Apply insights from other case analyses Critically analyze your own performance Conduct outside research One of the reasons case analysis is so enriching as a learning tool is that it draws on many resources and skills besides just what is in the textbook. This is especially true in the study of strategy. Why? Because strategic management itself is a highly integrated task that draws on many areas of specialization at several levels, from the individual to the whole of society. Therefore, to get the most out of case analysis, expand your horizons beyond the concepts in this text and seek insights from your own reservoir of knowledge. Here are some tips for how to do that.

Case Analysis Decision-Making Techniques
Integrative thinking involves making choices by reconciling opposing thoughts Proposing more options & new alternatives Identifying creative solutions Integrative thinking is done in four stages What features of the decision are salient? What are the causal relationships between the features? What might a sequence of decisions look like? What might be the most creative resolution? There are several techniques that can help managers make better decisions and, in turn, enable their organizations to achieve higher performance. These techniques can also be useful when doing case analysis. The first technique comes from a study by Roger L Martin, who contended that people who can consider two conflicting ideas simultaneously, without dismissing one of the ideas or becoming discouraged about reconciling them, often make the best problem solvers because of their ability to creatively synthesize the opposing thoughts. He calls this integrative thinking = A process of reconciling opposing thoughts by generating new alternatives and creative solutions rather than rejecting one thought in favor of another. This is in contrast to conventional thinking, which tends to focus on making choices between competing ideas from a limited set of alternatives. Applied to business, an integrative thinking approach enables decision-makers to consider situations not as forced trade-offs but as a method for synthesizing opposing ideas into a creative solution. The key is to think in terms of “both-and” rather than “either-or”.

Exhibit 13.4 outlines the four stages of the integrated thinking and deciding process, using the example of deciding where to go on vacation to illustrate the stages. Salience involves taking stock of what features of the decision you consider relevant and important. For example: where will you go? What will you see? Where will you stay? What will it cost? Is it safe? Then causality requires making a mental map of the causal relationships between the features, for example, is it worth it to invite friends to share expenses? Will an exotic destination be less safe? In the architecture stage, use the mental map to arrange a sequence of decisions that will lead to a specific outcome. For example, will you make the hotel and flight arrangements first, or focus on which sightseeing tours are available? Finally, in resolution, make your selections. For example, choose which destination, which flight, and so forth. Your final resolution is linked to how you evaluated the first three stages; if you are dissatisfied with your choices, the dotted arrows in the diagram suggest you can go back through the process and revisit your assumptions. Exhibit 13.4 Integrative Thinking: The Process of Thinking and Deciding Source: Reprinted by permission of Harvard Business School Press from R. L. Martin. The Opposable Mind, Copyright 2007 by the Harvard Business School Publishing Corporation; all rights reserved.

Conflict inducing techniques can be very helpful in arriving at better solutions Conflict can help avoid groupthink Failure to critically evaluate alternatives The devil’s advocacy approach assigns someone the role of official critic Ensures the group will take a hard look at its original proposal Dialectical inquiry approaches a problem from two alternative points of view Formal debate using a thesis & an antithesis Conflict can be very helpful as a means for developing new insights as well as for rigorously questioning and analyzing assumptions and strategic alternatives. In fact, if you don’t have constructive conflict, you may only get consensus. When this happens, decisions tend to be based on compromise rather than collaboration. Groupthink = a condition in which group members strive to reach agreement or consensus without realistically considering other viable alternatives. In effect, group norms bolster morale at the expense of critical thinking and decision-making is impaired. See page 428 for some symptoms of groupthink and how to prevent it. Conflict can be incorporated into the decision-making process through formalized debate. Devil’s advocacy = a method of introducing conflict into a decision-making process by having specific individuals or groups act as a critic to an analysis or planned solution. Dialectical inquiry = a method of introducing conflict into a decision-making process by devising different proposals that are feasible, politically viable, and credible, but rely on different assumptions; and debating the merits of each. Both devils advocacy and dialectical inquiry force debate about underlying assumptions, data, and recommendations between subgroups. Such debate tends to prevent the uncritical acceptance of a plan that may seem to be satisfactory after a cursory analysis. The approach serves to tap the knowledge and perspectives of group members and continues until group members agree on both assumptions and recommended actions. Given that both approaches serve to use, rather than minimize or suppress, conflict, higher-quality decisions should result.

This figure briefly summarizes the techniques of devil’s advocacy and dialectical inquiry. Exhibit 13.5 Two Conflict-Inducing Decision-Making Processes

Strategic Case Analysis Process
Analyzing organizational goals & objectives Has the company developed short-term objectives that are inconsistent with its long- term mission? Has the company considered all of its stakeholders equally in making critical decisions? Is the company being faced with an issue that conflicts with one of its long-standing policies? Each of the previous 12 chapters of this book includes techniques and information that may be useful in a case analysis. Here we draw on the material presented in each of the 12 chapters to show how it informs the case analysis process. In chapter 1 we discussed how the company’s vision, mission, and objectives keep organization members focused on a common purpose. These elements also influence how an organization deploys its resources, relates to its stakeholders, and matches its short-term objectives with its long-term goals. The goals may even impact how a company formulates and implements strategies. When exploring issues of goals and objectives, while doing your case analysis you might ask the above questions.

Analyzing the external environment Does the company follow trends and events in the general environment? Is the company effectively scanning and monitoring the competitive environment? Has the company correctly analyzed the impact of the competitive forces in its industry on profitability? In chapter 2 we discussed how the company’s general environment consists of demographic, socio-cultural, political/legal, technological, economic, and global conditions. The competitive environment includes rivals, suppliers, customers, and other factors that may directly affect a company’s success. Strategic managers must monitor the environment to identify opportunities and threats that may have an impact on performance. When investigating a firm’s external environment you might ask the above questions.

Analyzing the internal environment Does the company know how the various components of its value chain are adding value to the firm? Has the company accurately analyzed the source and vitality of its resources? Is the company’s financial performance as good as or better than that of its close competitors? In chapter 3 we discussed how a firm’s internal environment consists of its resources and other value-adding capabilities. Value chain analysis and a resource-based approach to analysis can be used to identify a company’s strengths and weaknesses and determine how they are contributing to its competitive advantages. Evaluating firm performance can also help make meaningful comparisons with competitors. When researching a company’s internal analysis you might ask the above questions.

Assessing a firm’s intellectual assets Does the company have underutilized human capital? Is the company missing opportunities to forge strategic alliances? Has the company developed knowledge- management systems to capture what it learns? In chapter 4 we discussed how human capital is a major resource in today’s knowledge economy. As a result, attracting, developing, and retaining talented workers is a key strategic challenge. Other assets such as patents and trademarks are also critical. How companies leverage their intellectual assets through social networks and strategic alliances, and how technology is used to manage knowledge may be a major influence on a firm’s competitive advantage. When analyzing a firm’s intellectual assets you might ask the above questions.

Formulating business-level strategies Has the company chosen the correct competitive strategy given its industry environment and competitive situation? Does the company use combination strategies effectively? Is the company using a strategy that is appropriate for the industry life cycle in which it is competing? In chapter 5 we discussed how firms use the competitive strategies of differentiation, focus, and overall cost leadership as a basis for overcoming the five competitive forces and developing sustainable competitive advantages. Combinations of these strategies may work best in some competitive environments. Additionally, an industry’s lifecycle is an important contingency that may affect the company’s choice of business-level strategies. When accessing business-level strategies you might ask the above questions.

Formulating corporate-level strategies Is the company competing in the right businesses given the opportunities and threats that are present in the environment? Is the corporation managing its portfolio of businesses in a way that creates synergies among the businesses? Are the motives of the top corporate executives who are pushing diversification strategies appropriate? In chapter 6 we discussed how firms often own and manage portfolios of businesses. Corporate strategies address methods for achieving synergies among these businesses. Related and unrelated diversification techniques are alternative approaches to deciding which business should be added to or removed from a portfolio. Companies can diversify by means of mergers, acquisitions, joint ventures, strategic alliances, and internal development. When accessing corporate-level strategies you might ask the above questions.

Formulating international-level strategies Is the company’s entry into an international marketplace threatened by the actions of local competitors? Has the company made the appropriate choices between cost reduction and local adaption to foreign markets? Can the company improve its effectiveness by embracing one international strategy over another? In chapter 7 we discussed how foreign markets provide both opportunities and potential dangers for companies that want to expand globally. To decide which entry strategy is most appropriate, companies have to evaluate the trade-offs between two factors that firms face when entering foreign markets: cost reduction and local adaptation. To achieve competitive advantages, firms will typically choose one of three strategies: global, multidomestic, or transnational. When evaluating international-level strategies you might ask the above questions.

Formulating entrepreneurial strategies Is the company engaged in an ongoing process of opportunity recognition? Do the entrepreneurs who are launching new ventures have vision, dedication & drive, and a commitment to excellence? Have strategic principles and tools such as five-forces analysis & value-chain analysis been used in the process of developing strategies to pursue the entrepreneurial opportunity? In chapter 8 we discussed how new ventures and jobs can create new wealth. To do so, they must identify opportunities that will be viable in the marketplace as well as gather resources and assemble an entrepreneurial team to enact the opportunity. New entrants often evoke a strong competitive response from incumbent firms in a given marketplace. When examining the role of strategic thinking on the success of entrepreneurial ventures and the role of competitive dynamics you might ask the above questions.

Achieving effective strategic control Is the company employing the appropriate informational control systems? Does the company have a strong and effective culture that aligns its values & rewards system with its goals & objectives? Has the company implemented control systems that match its strategies? In chapter 9 we discussed how strategic controls enable the firm to implement strategies effectively. Informational controls involve comparing performance to stated goals and scanning, monitoring, and being responsive to the environment. Behavioral controls emerge from a company’s culture, reward systems, and organizational boundaries. When assessing the impact of strategic controls on implementation you might ask the above questions.

Creating effective organizational designs Has the company implemented organizational structures that are suited to the type of business it is in? Has the company employed boundaryless organizational designs where appropriate, & do senior managers maintain appropriate control of lower-level employees? Does the company use outsourcing to achieve the best possible results? In chapter 10 we discussed how organizational designs that align with competitive strategies can enhance performance. As companies grow and change, their structures must also evolve to meet new demands. In today’s economy, firm boundaries must be flexible and permeable to facilitate smoother interactions with external parties such as customers, suppliers, and alliance partners. New forms of organizing are becoming more common. When evaluating the role of organizational structure in strategy implementation you might ask the above questions.

Creating a learning organization and an ethical organization Do company leaders promote excellence as part of the overall culture? Is the company committed to being a learning organization and does it capitalize on the individual & collective talents of organizational members? Have company leaders exhibited an ethical attitude in their own behavior? In chapter 11 we discussed how strong leadership is essential for achieving competitive advantages. Two leadership roles are especially important. The first is creating a learning organization by harnessing talent and encouraging the development of new knowledge. Second, leaders play a vital role in motivating employees to excellence and inspiring ethical behavior. When exploring the impact of effective strategic leadership you might ask the above questions.

Fostering corporate entrepreneurship Has the company resolved the dilemmas associated with managing innovation, and is it effectively defining and pacing its innovation efforts? Has the company developed autonomous work units that have the freedom to bring forth new product ideas & has it used product champions to implement new venture initiatives? Does the company have an entrepreneurial orientation? In chapter 12 we discussed how many firms continually seek new growth opportunities and avenues for strategic renewal. In some corporations, autonomous work units such as business incubators and new-venture groups are used to focus corporate venturing activities. In other corporate settings, product champions and other firm members provide companies with the impetus to expand into new arenas. When investigating the impact of entrepreneurship on strategic effectiveness you might ask the above questions.

Example: Why Learn to do a Case Analysis?
Learning to do case analysis will help: Increase your understanding of what managers should and should not do in guiding a business to success. Build your skills in sizing up company resource strengths & weaknesses and in conducting strategic analysis in a variety of industries & competitive situations. Get valuable practice in identifying strategic issues that need to be addressed, evaluating strategic alternatives, & formulating workable plans of action. Enhance your sense of business judgment, as opposed to uncritically accepting the authoritative crutch of the professor or “back-of-the-book” answers. Gain in-depth exposure to different industries & companies, so help you acquire something close to actual business experience. Finally, students may ask why they should do all this work – it’s not real, after all... Here are some reasons, from A Guide to Case Analysis, taken from Charles I. Gragg, “Because Wisdom Can’t Be Told,” in The Case Method at the Harvard Business School, ed. M.P. McNair (New York: McGraw-Hill, 1954), p

Strategic Management: Creating Competitive Advantages

Similar presentations

Presentation on theme: "Strategic Management: Creating Competitive Advantages"— Presentation transcript:

Similar presentations

About project

Feedback

Log in

Auth with social network:

Strategic Management: Creating Competitive Advantages

Similar presentations

Presentation on theme: "Strategic Management: Creating Competitive Advantages"— Presentation transcript:

Similar presentations

About project

Feedback