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Management Strategy
Achieving Sustained Competitive Advantage
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Management Strategy
Achieving Sustained Competitive Advantage
Third Edition
Alfred A. Marcus
Anne N. Cohen
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MANAGEMENT STRATEGY: ACHIEVING SUSTAINED COMPETITIVE ADVANTAGE, THIRD EDITION
Published by McGraw-Hill Education, 2 Penn Plaza, New York, NY 10121. Copyright © 2017 by McGraw-Hill
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Library of Congress Cataloging-in-Publication Data
Marcus, Alfred Allen, 1950- author | Cohen, Anne N., author.
Management strategy: achieving sustained competitive advantage/Alfred A. Marcus, University of
Minnesota, Anne N. Cohen, University of Minnesota.
Third edition. | New York, NY : McGraw-Hill Education, [2017]
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To my wife, Judy, and to my sons, David
Isaac and Ariel Jonathan, philosophically
inclined and always questioning everything.
Alfred A. Marcus
To my wonderful husband, Dwayne, and to
our charming sons, Brendan and Christopher.
Anne N. Cohen
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About the Authors
Alfred A. Marcus
Alfred A. Marcus is currently the Edson Spence Chair of Strategy and Technological
Leadership at the University of Minnesota, Carlson School of Management and the
Center for Technological Leadership. He has been on the faculty at Minnesota since
1984. His articles have appeared in the Strategic Management Journal, Academy of
Management Journal, Academy of Management Review, and Organization Science,
among other places. He is the author or co-author of many other books including Innovations in Sustainability, published by Cambridge University Press, The Future of
Technology Management and the Business Environment: Lessons on Innovation, Disruption, and Strategy Execution, published by Pearson, Financial Times, Strategic
Foresight, published by Palgrave MacMillan, and Big Winners and Big Losers, published by Wharton School Press. His PhD is from Harvard, and he has undergraduate
and graduate degrees from the University of Chicago. Prior to joining Minnesota’s faculty he taught at the University of Pittsburgh Graduate School of Business and was a
research scientist at the Battelle Human Affairs Research Centers in Seattle, Washington. He has consulted or worked with many corporations including 3M, Corning, Excel
Energy, Medtronic, General Mills, and IBM and spent a sabbatical year at the Sloan
School of Management, MIT. Besides teaching in the Carlson School and the Technological Leadership Institute at the University of Minnesota, he teaches in the Technion
MBA program in Israel. He also has taught strategy or management courses in Norway,
Hungary, the Czech Republic, Romania, and Costa Rica and was involved in a multinational research project sponsored by the NSF involving companies in the U.S., Finland,
Israel, and India.
Anne N. Cohen
Anne N. Cohen is a Senior Lecturer at the Carlson School of Management, an active
consultant to businesses, an executive coach, and a board member for medium to
large private enterprises. After receiving an undergraduate degree in mathematics,
she began her professional career in the insurance and transportation industries. Her
roles focused on the development and managerial oversight of critical information
technologies and infrastructures supporting actuarial, purchasing, logistics, and fuel
hedging functions. Upon receiving her MBA, Anne launched her own business
which served both the residential and commercial market for furnishings and
­finishes. Her client base included individuals around the globe as well as various
hotels, offices, institutions, municipalities, and resellers. The success of this firm
­p ermitted both her transition to the classroom, and the launch of her current
­consulting business.
vii
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viii About the Authors
Anne currently teaches courses at both the undergraduate and MBA levels in
s­ trategic management, entrepreneurial management, and strategic leadership. She has
also been active on campus as a mentor to a number of startups, as a member of the
Carlson School’s ­ethics coursework committee, as a summa cum laude advisor, and as
the public and nonprofit program advisor. Off campus, she is highly engaged in the
­business c­ ommunity, focused on providing strategic guidance to senior leaders, helping build high-­performance ­leadership teams, and serving on the local economic
­development authority.
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Preface
This is a practical book ­designed to assist those who engage in the art and practice of
strategy in organizations large and small in countries throughout the world.
Strategy is probably the most basic and at the same time the most advanced discipline
in management. It is a discipline whose principles need to be considered by managers at
the most advanced levels of the private sector, understood by individuals pursuing
­careers in institutions in the public and non-for-profit sectors who regularly come into
contact with business, and absorbed by undergraduates just starting out in their
­business career.
Instruction in strategy takes place in the world’s leading business schools in executive, MBA, and undergraduate programs and in in-house corporate programs designed
for managers and executives, and this text has been designed to comfortably support the
rigors of such programs with copious lessons and examples.
Yet, it is also critical to recognize that employees at all levels, and within all sectors,
should be provided with a common language of strategy. All must understand the basic
principles of strategy so that they can be more fully attuned to the many competitive factors that can be most easily monitored from the organization’s front lines. So, this text
aims to provide a reference that is accessible to key employees at all levels of the organization, to offer clear frameworks for strategic thinking and action, and to help these
employees formulate effective arguments for strategic change when they sense shifts in
today’s dynamic marketplace.
This book is the third edition of a previously published text. The main change in this
edition is that the book now has a co-author, Anne N. Cohen., a full-time instructor in
strategy at the Carlson School of Management and a long-time practitioner of strategy as
a consultant and employee of major U.S. companies. Anne is an enthusiastic and knowledgeable teacher with real-world savvy. Her contribution has made possible vast improvements in the organization and structure of each of the chapters of this book and the
insertion of numerous new examples and other materials. This edition has been vastly
improved by Anne’s contributions, which are very much appreciated.
The new edition has been thoroughly updated. Material no longer relevant has been
discarded and new material introduced. This book remains short and to the point. It is
conceptual in nature, although it has numerous examples, and it should be used in conjunction with the many fine cases available in strategic management.
Many books purport to give instruction in the fundamentals of strategy; however, as
the academic discipline of strategy has evolved in arcane and specialized ways, these
books often miss the most basic ideas in strategy. For example, in his classic and
­landmark 1980s books on strategy Michael Porter of the Harvard Business School established that sustained competitive advantage is strategy’s basic purpose, but even Porter
failed to clearly define what sustained competitive advantage actually meant—and as a
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x Preface
consequence, his methods were over determined and ultimately too complex for most
practicing managers. He never provided a simple analytical method or series of steps the
strategist could employ.
The definition of sustained competitive advantage used in this book, therefore, is that
of consistent superior performance in comparison to key competitors over a long period
of time. It is not about winning one championship, but about being a dynasty that always
performs substantially better than other companies in an industry. Achieving this goal is
never easy, so this book provides its readers with a simple but disciplined approach to
engage in the effort to attain sustained competitive advantage.
After establishing in Chapter 1 that the goal of strategy is to achieve sustained competitive advantage (SCA), each subsequent chapter takes up in turn the remaining elements of a model or formula for achieving SCA.
∙ Specifically, Chapter 2 presents three approaches to doing external analysis (EA),
including classic industry analysis, an assessment of the macro-environment, and the
application of stakeholder analysis to managing the external environment.
∙ Chapter 3 then takes up various methods for doing internal analysis (IA) including
frameworks like the 7 Ss and the value chain, and a newer method for analyzing
strengths and weaknesses that came to prominence in the 1990s, the resourcebased view (RBV). RBV will introduce you to ideas about an organization’s
­capabilities and competencies as well as its resources. With these tools in hand for
external and internal analysis, you can approach the formidable problem of actually making moves (M).
Once you have a clear perspective of the firm’s external and internal environments,
the book introduces four types of general moves that you might consider. These moves
are not discrete and separate choices but can be and often are carried out together or as a
sequence of moves depending on the situation. That is, one move may very well hinge
on or follow another as in chess or war where a series of moves have to be made to
achieve victory.
∙ Chapter 4 is a pivotal chapter inasmuch as it treats both the timing of moves that your
organization can make by going over the elementary principles of game theory and
the actual content of moves at the business level—generic positioning or Porter’s
ideas about “low cost” and “differentiation” and the space in-between, which Porter
maintains is to be avoided, but which this book considers essential territory to occupy
and labels “best value.” Chapter 4 is about business strategy (BS).
∙ Chapter 5 is also pivotal in that it treats not competition within an established business as Chapter 4 does, but introduces you to competition at the corporate level where
the main questions are: what are the businesses in which an organization should participate, and what should be the scope of its activities? The main tools for determining the outcome of these decisions are mergers, acquisitions, and divestitures. Chapter
5 is about corporate strategy (CS).
∙ Chapter 6 builds on and deepens central concepts of business and corporate-level
strategy by considering another type of move, that is, globalization, or how to best
align a firm’s resources, capabilities, and competencies to meet competition in a hotly
contested global marketplace. Chapter 6 is about global strategy (GS).
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Preface xi
∙ The final type of general move that the strategist can make is to be entrepreneurial
and to innovate. The perils and pitfalls of being entrepreneurial and innovating are
the subject of Chapter 7. Chapter 7 is about innovation strategy (IS). The last two
chapters cover implementation (I) and reinvention (R).
The final chapters of this text are focused on the implementation of strategy and the necessity of continual reinvention. Good moves must be well implemented, and Chapter 8
provides solid and practical advice on how to best implement a strategy. Chapter 9 emphasizes that the strategic management process is an iterative one. It has to be repeated again
and again. A firm does not simply once have its employees scan the external and internal
environment and take a series of moves, but it has to be constantly engaged in these activities, refining, refocusing, and repositioning itself over time. There is nothing more common
in business than a stale strategy whose basic assumptions have not been criticized based on
performance feedback, and that has not been thoroughly reexamined and reset so that the
firm is repositioned and better equipped to withstand ongoing competitive challenges. This
final chapter also provides a summary of the strategic management process in its entirety.
In short, the strategic model that is central to this book is the following:
SCA
=
[EA + IA]
+
[BS + CS + GS + IS]
+
I+R
Analysis
Moves
Implementation &
Reinvention
Thus, this book has nine basic chapters very tightly and logically linked with a goal
in mind, SCA, and a series of steps laid out to help the strategist reach that goal. For
those teaching strategy at any level, this is an ideal book as these relatively short but
deep chapters can be assigned with one or two cases that can come from any number of
sources. As indicated, the use of cases to supplement the chapters is critical, for it is essential that those who wish to gain mastery of the art and craft of strategy practice it.
Each chapter begins with a profile of an executive or academic who has made a significant contribution to strategy (Andy Grove, Michael Porter, Michael Dell, Michael
Eisner, Gary Hamel, and Bill Gates), or a short vignette of a situation that illustrates the
main chapter theme (KFC goes to Japan). Each chapter also portrays the main concepts
with which it deals with discussion of businesses that have been competitors (e.g.,
­Intel versus AMD, Amazon.com versus Barnes & Noble, Dell versus Gateway, Best Buy
versus Circuit City, Disney versus AOL Time Warner, Coke versus Pepsi, and Walmart
versus Spartan Foods.). This book is rich in examples and practical applications.
To sum it up, the rationale for the book is the following:
∙ Most strategy books have lost sight of the basic purpose of strategy—making a series
of moves, which are designed to achieve sustained competitive advantage.
∙ Most books fail to relate moves back to their outcomes—the extent to which these
moves actually affect business performance.
∙ This book is focused on the moves corporations can make and the types of analyses
required to make these moves effective.
∙ It shows managers how to undertake an analysis of the industry environment and an
analysis of a company’s internal resources before making moves.
∙ It provides solid advice on how to implement a strategy, once it is formulated.
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xii Preface
The main moves that flow from the analysis are positioning of the firm in relation to
its competitors in terms of the cost and quality of its products, positioning it in terms of
the scope of businesses in which it is involved, positioning it in terms of its global versus
domestic reach, and positioning it with respect to the extent to which it will strive to be
an innovator as opposed to a follower.
The exhibit below indicates in detail how the third edition compares with the book’s
prior edition.
EXHIBIT Main Changes from Edition Two to Edition Three
Chapter 1
WINNING MOVES
New examples. Added a step to making winning moves called ongoing evaluation and implementation;
removed sections on balanced scorecard and industry boundaries which are covered elsewhere.
Chapter 2
EXTERNAL ANALSYSIS
New examples. Started with broader picture of external analysis (macro-analysis) and then discussed the specifics of industrial organization analysis, the five forces, with emphasis on the five-force dynamism. Updated
discussion of pharmaceutical and airline industries, added entirely new section on strategic group analysis
with mobile phone and restaurant examples. Extended discussion of scenario analysis and system analysis.
Chapter 3
INTERNAL ANALSYSIS
New examples. Reversed the order of discussion with the resource-based view coming first. Emphasized
examples like Moneyball more. Showed systematically how resources, capabilities, and competencies are
linked and emphasized the need for their replenishment. Integrated financial analysis with value chain analysis. Reorganized section called management theory under title of assuring accounting and ended the chapter
with a summary of how to do a SWOT (strengths, weakness, opportunities, threats) analysis.
Chapter 4
POSITIONING, TACTICS,
AND TIMING
New examples. Reversed the order of discussion with positioning coming before timing and a new section
on tactics coming between positioning and timing. Section on tactics, offensive and defensive is quite unique
and special. Discuss life-cycles in section on timing. Game theory comes at end and not beginning of chapter.
Updated early/late mover discussion.
Chapter 5
CORPORATE-LEVEL
STRATEGY AND
DIVERSIFICATION
New examples. Retitled chapter Corporate-Level Strategy and Diversification as opposed to Mergers, Acquisitions, and Divestitures. Introduced new section on tactics short of full-scale merger and acquisition. Put
greater emphasis on examples of good deal making and effective management. Further developed section
on why mergers and acquisitions fail. Maintained discussion of portfolio models and more explicitly featured
transaction cost reasoning in section on vertical integration.
Chapter 6
GLOBALIZATION
New examples. More managerial with section on options for global expansion and global success factors.
Landscape of future discussion is more succinct and up to date.
Chapter 7
INNOVATION AND
ENTREPRENEURSHIP
New examples. Reorganized to make more managerially relevant. Introduced distinction between incremental and radical (seismic) innovation and provided extended examples from smartphone and other industries.
Explicated uniqueness of Apple and its accomplishments. New section on process of innovation with four factors discussed: the innovator, the organization, finance, and government. New section on the business model
with managerially relevant process laid out of how to determine opportunities to pursue, external and internal
consideration, vetting ideas, creating prototypes and pilots, and scaling up. Extended discussion of barriers
to innovation to diffusion curves, time, flawed processes as well as risk and uncertainty. Moved leading edge
industries and environment as business opportunity to last chapter.
Chapter 8
IMPLEMENTATION
New examples. Changed order with this chapter coming before last chapter and not being last chapter. Chapter remains very managerial with bad examples followed by a 10-step process for effective implementation.
Chapter 9
CONTINUOUS
REINVENTION
New examples. New sections develop idea that strategy is about preparing for inevitable turmoil and uncertainty; it involves a portfolio of initiatives that must be managed, and requires a regular reinvention of the
business model. Open sources, minimally viable models, and eco-system are introduced as part of what can
be used to reinvent the business models. Discussion of leading-edge industries is now found here. Continued
to wrap up book with recapitulation of model strategy as external, internal analysis, moves, implementation, and reassessment. Incorporated judo strategy discussion in final examples of Microsoft and retail
food ­industry.
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Acknowledgments
So much of what I know about strategy I have learned from my colleagues in the Strategic
Management and Organization Department at the Carlson School of Management. They let
me serve as department chair from 1994 to 2000 (I kept urging them to have a coup d’etat),
and in that capacity, I read their papers and came to especially value and appreciate their
work. Fundamental to my thinking about strategy are ideas about the external environment
and how to analyze it. At Minnesota, we always have been strong in this area, and I would
like to especially thank my colleagues Aks Zaheer, Andrew Van de Ven, Shaker Zahra, Joel
Waldfogel, Myles Shaver, Mary Benner, Paul Vaaler, Sri Zaheer, Dan Forbes, Stu Albert,
Jiao Luo, Russell Funk, Aseem Kaul, Harry Sapienza, Gurneeta Vasudevia, Ian Maitland,
and Sunasair Dutta. Past colleagues such as Margie Peteraf (Dartmouth), Bala Chakravarthy
(IMD), Phil Bromiley (University of California, Irvine), P. K. Toh (University of Texas),
Richard Wang (Babson), and Stefanie Lenway (University of St. Thomas) also have influenced me. I have learned an enormous amount from Ari Ginberg at NYU. I owe debts of
gratitude to former PhD students such as Adam Fremeth at Western Ontario, Bill McEvily
at the University of Toronto, Sumit Majumdar at University of Texas–Dallas, Marc Anderson, who is at Iowa State, Tim Hargrave, who is at Simon Fraser University, Mazhar Islam,
who teaches at Tulane, and especially to Joel Malen at Hitotsubashi University in Tokyo.
In addition to teaching at the Carlson School, I have taught strategy in the Management of Technology program at the University of Minnesota. This program is sponsored
by the engineering school of the University of Minnesota and is mainly composed of
mid-career engineers from local companies. From my students in this program I have
learned and continue to learn a great deal. The head of this program, Massoud Amin, is
a true gem and a great colleague. Other faculties there are in the same category. The
students have to write capstone papers, and they must present them to faculty committees. The capstones involve real-world company problems, and I have learned a great
deal from how the students have approached these problems and tried to solve them. The
staff at the Carlson School and at the Management of Technology program are superb
and have assisted me a great deal in all the work that I have done there.
I teach part of the year at the Technion in Israel. Eitan Naveh of the Technion in
­Israel, who was a post-doc at Minnesota who worked with me for a number of years, is
an excellent colleague. I also want to acknowledge Mia Erez and Dovev Lavie as excellent Technion colleagues from whom I have learned a great deal as well as PhD student
Ella Glickson and the many superb Technion students who have been in my classes.
And of course, there is my wife who has not complained (or has not complained a lot)
about my constantly working. My older son David has become a writer and editor of
note himself. He co-edits Dissent Magazine. My younger son, Ariel, works for Spotify,
which brings us sweet music by which to live. Ariel has a keen sense for the strategies of
startups, and I have learned a great deal from him as well.
Alfred A. Marcus
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xiv Acknowledgments
Nanos gigantum humeris insidentes . . . It is at times like these that I realize I am but a
dwarf standing on the shoulders of giants, and that I’m extremely fortunate to have so
many “giants” in my life—those that have contributed to my formation and have helped
me along the way:
∙ I’m indebted to those that have shaped my journey to the front of the classroom, from
my initial inspiration, David Stenson, who could hold the rapt attention of math
­students with his graphs of 3D rotations (all done in chalk pastels in those days), to
Tim Robertson, my first teaching mentor, to Phil Anderson, my first department chair
who first informed me that I had caught “the teaching bug,” to Myles Shaver, Harry
Sapienza, Steve Spruth and Svetlana Madzar, who served on my hiring committee at
Carlson School.
∙ I’m humbled by the talents of my co-author, Alfred Marcus, who invited me to participate in the writing of this edition. It has been a joy to engage and collaborate with
such a gifted and prolific strategist as we developed this edition’s topics. He has been
a wonderful colleague.
∙ I am also thankful to all those that helped us cross the finish line with this edition’s
­manuscript. Thank you Merav Levkowitz, Arpana Kumari, Ann Cutaia, Jenilynn Mcatee,
Laura Spell and the many dedicated professionals on this book’s production team.
∙ I’m grateful for my clients, students and wonderful team of assistants. They energize
me and teach me just as much as I teach them by sharing their perspectives, their
goals, their challenges and their talents.
∙ I’m also greatly blessed with a loving family that provides unwavering support: Dwayne,
my husband, and Brendan and Christopher, my two sons. Dwayne, who started his
­career as an aircraft engineer, now serves as regional manager for Eaton. Brendan works
on multi-billion-dollar energy infrastructure projects at Xcel. ­Christopher, our car nut,
works for Audi in sales. My extended family—as anchored by my Aunt Pat in Ohio
(Sr. Patricia Conway), Aunt Jane in California (Mrs. David Volz), and cousin Lynn
Conway in Florida—has also been a source of great love and strength. Life is good.
∙ Lastly, I will always remember my very first giants, two great parents, Jordan and
Agnes Ussai, who throughout their lives so selflessly gave our family countless and
enduring gifts of knowledge, courage and faithfulness.
Anne N. Cohen
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Brief Contents
Preface
1
ix
Winning Moves 1
PART ONE
External and Internal Analysis
2
External Analysis
3
Internal Analysis 52
PART TWO
Making Moves
4
24
81
Positioning, Tactics, and
Timing 82
23
5
Corporate-Level Strategy and
Diversification 109
6
Globalization
7
Innovation and Entrepreneurship 157
139
PART THREE
Implementation and Reinvention 185
8
Implementation
186
9
Continuous Reinvention 203
GLOSSARY 229
INDEX 237
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Contents
Preface
ix
Scale Economies and Learning Curves 32
Government Policies 32
Demographics, Natural Resources, Technology,
and Culture 33
Chapter 1
Winning Moves 1
Introduction 1
Sustained Competitive Advantage
Making Winning Moves 4
The Five Forces
2
Step 1: Analysis 5
Step 2: Moves 5
Step 3: Implementation and Ongoing
Reinvention 6
Understanding Management Strategy: Three
Analogies 6
A Chess Analogy 6
A War Analogy 11
A Sports Analogy 16
Measures of Overall Dominance 19
Summary 20
Reflections for the Practitioner 21
An Assignment for the Traditional Student 21
Endnotes 21
PART ONE
EXTERNAL AND INTERNAL
ANALYSIS 23
Chapter 2
External Analysis 24
Introduction 24
Industry Definitions 25
External Pressures Lead to Industry
Movement 27
Industry Moves, Implications, and
Trade-Offs 28
A Framework for External Analysis 29
Deciding If the Game “Is Good” 30
The Best Game 31
33
Rivals 34
New Entrants 34
Substitutes 35
Suppliers and Customers 35
Sustained Competitive Advantage 36
Industry Dynamics
36
Pharmaceuticals—A Five-Star Industry
under Fire 37
Airlines—A No-Star Industry
Redeemed 38
Transient Industry Attractiveness 40
Stakeholders 40
Strategic Group Analysis
Mobile Phones 42
Restaurants 43
Scenarios
42
45
Simple Extrapolation 45
Defining Bookends 46
Leading Indicators 47
Systems Analysis 47
Summary 49
Exercises for the Practitioner and
the Student 50
Endnotes 51
Chapter 3
Internal Analysis
52
Introduction 53
The Resource-Based View
53
Resources, Capabilities, and Competencies 55
The VRIO Test 58
From Capabilities to Competencies 60
An Organization’s Distinctive Competence 62
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xviii Contents
Replenishing Resources, Capabilities, and
Competencies 64
Value Chain Analysis and a Firm’s
Financials 64
Value Chain Linkages 66
Virtual Integration and Outsourcing Schemes 66
Value More than Costs 67
Three Levels of Important Financial
Considerations 68
Assuring Accountability 71
Task- and Team-Oriented Organization 72
Contingency Theory 73
The Seven S’s 75
Strengths, Weaknesses, Opportunities, and
Threats (SWOT) 76
Summary 77
Exercises for the Practitioner and
the Student 77
Endnotes 78
PART TWO
MAKING MOVES
81
Chapter 4
Positioning, Tactics, and Timing 82
Introduction 82
Positioning 83
Low-Cost Positions 84
Differentiation Positions 86
Are Low Cost and Differentiation
Compatible? 88
Repositioning 90
Many Ways to Differentiate 93
Exercises for the Traditional
Student 106
Exercises for the Practitioner
Endnotes 107
Chapter 5
Corporate-Level Strategy and
Diversification 109
Introduction 109
Reasons for Diversification
Why Do Mergers and Acquisitions
Fail? 124
Why Do Acquisitions and Mergers
Succeed? 126
Mergers of Equals 126
Effective Multi-Business Management 127
Portfolio Models
129
The BCG Matrix 129
The GE/McKinsey Model 130
Breaking Down the Corporate Hierarchy 131
Is Vertical Integration the Answer?
Transaction Costs 135
Summary 136
Exercises for the Practitioner and
the Student 137
Endnotes 137
94
Chapter 6
Globalization 139
Timing
96
Introduction 139
Reasons for Globalization
Life Cycles 96
Early Movers versus Late Starters 97
The Value of Rapid Adjustment 99
Game Theory 100
Expanding the Assumptions 103
Learning from Game Theory 104
Summary
106
110
Types of Diversification 112
Tactics Short of Full-Scale Merger and
Acquisition 114
Merger, Acquisition, and Divestiture Results 115
A Shifting Landscape 117
Examples of Good Deal Making 120
The Global Economic Meltdown 122
Tactics
Offensive Tactics 95
Defensive Tactics 96
107
Life Cycle Factors 141
140
Options for Global Expansion
143
Product-Market Approaches 145
Local Adaptation 146
Deciding Where to Invest 148
Global Success Factors 150
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The Landscape of the Future
151
PART THREE
Labor, Capital, and Technology 151
Open Economies 153
Insecurity 153
Youth 154
IMPLEMENTATION AND
REINVENTION 185
Chapter 8
Implementation
Summary 155
Exercises for the Student 156
Exercises for the Practitioner 156
Endnotes 156
186
Introduction 186
The Anatomy of Failure
187
The Root Causes of Failure 189
Chapter 7
Innovation and Entrepreneurship
157
Introduction 157
Reasons for Innovation and
Entrepreneurship 158
Incremental Changes 159
Seismic Shifts 159
Both Incremental Changes and Seismic Shifts 160
The Process of Innovation 161
Passionate and Determined Innovators 162
Organizations That Transform Innovative
Ideas into Reality 164
The Performance/Innovation Gap 165
Patient Capital 166
Other Funding Sources for New Ventures 167
Government Support 168
The Business Model
169
Determining the Opportunities
to Pursue 170
External Sources of Opportunity 170
Internal Sources of Opportunity 173
Vetting Ideas 174
Creating Prototypes and Pilots
Concepts 176
Scaling Up and a Full Rollout 177
Barriers to Innovation
177
Long S-Shaped Diffusion Curves 178
Many-Year Investments 178
Flawed Processes 180
Risk and Uncertainty 180
Summary 182
Exercises for the Practitioner 183
Exercises for the Student 184
Endnotes 184
A Comprehensive Implementation
Framework 190
Step 1: Assess Change Readiness 190
Step 2: Install Integrative Leadership 192
Step 3: Create a Consistent Message 193
Step 4: Appoint Cross-Functional Program
Teams 193
Step 5: Solicit Change Program
Proposals 194
Step 6: Select and Prioritize Proposed Change
Programs 194
Step 7: Assign Process Owners and Align
Resources 195
Step 8: Secure Funding, Formalize Operational
Objectives, and Design Incentives 197
Step 9: Advance and Continually Monitor
Initiatives 198
Step 10: Fortify Gains and Refine the
Implementation Process 199
Summary 200
Questions for the Practitioner 201
Questions for the Student 201
Endnotes 201
Chapter 9
Continuous Reinvention
203
Introduction 203
Preparing for Inevitable Turmoil and
Uncertainty 204
A Portfolio of Initiatives 204
Managing the Portfolio 207
Public-Private Partnership Models 209
Reinventing the Business Model
Open Source Options 212
Minimally Viable Models 213
210
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Eco-System Development 214
Technology Push versus Market Pull 214
Finding Technological Opportunities
215
Leading-Edge Industries 215
Biotechnology 216
Low-Cost Environmental Solutions 217
High-Value Environmental Solutions 218
Wrapping Up: The Dilemma of Strategic
Change 219
Sustained Competitive Advantage 220
Moves after External and Internal Analysis 222
Recognizing Customer Needs 223
Summary 226
Questions for the Practitioner 226
Questions for the Student 227
Endnotes 227
Glossary
Index
229
237
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C H A P T E R
O N E
Winning Moves
“A key warning sign [of] a strategic inflection point is when … all of a
sudden, the company … you worry about has shifted. You … dealt with
one … competitor all your life, and all of [a] sudden you do not care about
them, you care about … somebody else. A mental silver bullet test [is] if
you had one bullet, whom would you shoot with it? If you change the
­direction of the gun, that … signals … you may be dealing with … more
than an ordinary shift in the competitive landscape.”1
Andy Grove, former CEO of Intel Corporation
Chapter Learning Objectives
• Understanding strategy as a set of both planned and reactive moves taken in the pursuit of
competitive advantage.
• Identifying inflection points—extraordinary shifts in the competitive landscape that change the basis
for sustained competitive advantage (SCA).
• Comprehending that SCA is the result of making winning moves over the long term, not just producing
a few years of good performance.
• Using analogies from chess, war, and sports to help understand the many facets of making winning
moves, including knowing the enemy and yourself, attending to the rules, concentrating forces,
relying on teamwork, staying agile, and keeping score.
• Being aware that firms are simultaneously located in the past, striving to achieve their current mission,
while, at the same time, trying to move toward a vision of the future where they desire to excel.
• Understanding the strategic management process—an approach designed to help an organization
better understand the strategic context within which it operates, select the best moves in light of its
situation, and successfully execute these moves.
Introduction
A strategic inflection point occurs when a company faces major changes in its
­competitive environment. These changes may arise from new technologies, different
regulatory conditions, or transformations in customer values and preferences. In the
1
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2 Chapter 1 Winning Moves
21st century, such inflection points occur at a more rapid pace and come from many
­directions. Here are but a few examples:
∙ Digital mobile media have changed how consumers access information and how they
shop. They have revolutionized every industry from publishing to dating. Gartner
Group forecasts that there will be 7.3 billion smartphones, tablets and PCs, and
26 billion other Internet-connected products by 2020.2 This growing base of devices
is having multiple impacts on just about every business.
∙ Regulatory changes in the U.S. health care system have quickly shifted the tides for
medical practices, hospital systems, medical device manufacturers, developers of information technologies, and employers. Health care and health care–related industry players
have to react to these extraordinary and dramatic shifts in the competitive environment.
∙ An increased desire for healthier living is providing opportunity for producers of
­organic foods, suppliers of alternative fuels/transport, and pioneers in customized
genomic medicine.
Companies that fail to react appropriately to strategic inflection points will struggle,
while savvy and agile firms will recognize these points, modify their strategies, and gain
market share.
It is incumbent on everyone in an organization to be alert to these strategic inflection
points as top management teams often are isolated and do not see them coming.3 Lowerlevel employees on a company’s front lines frequently are the ones that detect the inflections
first. Their job is to bring the inflection point to the organization’s attention and mobilize
support for changes in a company’s strategy. Gaining recognition for spotting inflection
points and introducing strategic change in a company is a method for career advancement.
Those who notice and help make the needed changes can be rewarded for their efforts.
This book, therefore, is meant for everyone in a company, not just top management. It
is meant to sensitize everyone in an organization to the need to identify inflection points.
It provides its readers with the tools for strategic analysis and emphasizes that the goal of
strategy is to achieve long-term or sustained competitive advantage (SCA). These tools
permit readers to make sound arguments for changes that put their companies in a better
position to meet these challenges, and move them from the realm of threats to the organization to that of opportunities.
This first chapter is meant to acquaint readers with the basics of strategic management. It establishes the framework for strategic assessment and analysis that is used in
the book. The framework provides a means to better understand and evaluate a firm’s
external environment and its inner strengths, to weigh its strategic options, and to make
and carry out recommendations for strategic adjustment. This chapter compares strategy
to three analogous activities—chess, war, and sports—where the goal is also long-term
strategic advantage.
Sustained Competitive Advantage
The goal of strategy is sustained competitive advantage (SCA) or above-average performance in an industry for a period of ten years or more.4 Though many firms perform
better than their main competitors for a short time, very few companies have consistently
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Chapter 1 Winning Moves 3
outperformed their industry for more than 10 years.5 Dominant winners are rare, and the
companies that achieve SCA in most industries are outliers.
Natural parity is the condition found in most industries. Over a long period, the
performance in most industries converges toward a mean. Many top management teams
have no better aspiration than to keep up with industry norms. They benchmark what
others are doing, rather than trying to be industry leaders. The inability of companies to
maintain competitive advantage for long periods suggests that firms have not typically
recognized inflections and change within their industries. They must adjust existing
models to novel circumstances.
According to one study, only about 5 percent of firms achieve sustained competitive
advantage with respect to an indicator of profitability (return on assets), and only about
2 percent do so with respect to an indicator of stock market performance.6 Surprisingly,
these high performers are not regularly cited in the business press as exemplars. They
often operate under the radar, and their stories are not told. How do these companies
achieve SCA?
Choosing a route to sustained competitive advantage depends on being in a strong
industry or having the resources and capabilities to compete effectively in industries that
are waning. A company must scan the external environment to find good industries in
which to compete, and it must build internal resources and capabilities to be a strong
competitor within the industries it chooses.
Some companies achieve SCA by choosing industries with high mean returns and
trying to dominate them. All the firms in such an industry thrive, and thus the industry is
an attractive one in which to compete. The implication of this route to success is to
choose a successful industry or industry niche and ride its overall success. Take advantage of the good economic conditions in such a segment to grow revenues and profits.
The path to success is to select the right industry or industry niche in which to operate.
If the segment does not exist, play a leading role in its creation.
Not all companies have the freedom to move from industry to industry, however, they
too can achieve SCA by being the dominant player in a consolidating or declining
­industry. Such an industry has low mean returns, and the deviation in these returns is
high. If the deviation is high, there is still room for some companies to excel. Companies
that achieve SCA in this type of setting stand out by means of their superior resources
and capabilities. They dominate industries in decline. Being a dominant player in a weak
industry means possessing the unique resources or capabilities that permit a company to
win in a demanding setting of market shrinkage. The moves companies make to achieve
SCA then must be backed up by moves to protect their leadership position once it has
been achieved. The path to SCA consists of choosing the market segments in which to
compete which fit well with a company’s strengths and weaknesses.
In order to help companies realize SCA, Chapter 2 introduces external analysis (EA)
and Chapter 3 discusses internal analysis (IA). EA permits you to identify the opportunities and threats a company confronts in its industry, and IA allows you to analyze the
strengths an organization can utilize to take advantage of the opportunities and to defend
itself from the threats.
Industry structure is the main focus of Chapter 2. If an industry is very concentrated,
some firms have high market share, and there are strong barriers to entry, then the industry’s prospects are promising and long-term above-average returns are more likely.
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4 Chapter 1 Winning Moves
A company’s strengths and weaknesses are the main focus of Chapter 3. Peculiar
configurations of resources, capabilities, and competencies make the positions of leading firms especially hard to copy and highly valuable. These firms maintain an advantage because of their rare, nonsubstitutable internal assets. However, even these assets
can be challenged. Organizations must be perpetually vigilant against competitors that
devise better business models. Thus, it is incumbent on all firms to continuously adjust
their business and corporate strategies.
Smart strategic moves can help a business compete by positioning it with respect to
the cost and quality of the goods and services it offers. That is the domain of business
strategy (BS). Continuous positioning and repositioning via moves a company makes is
the main focus of Chapter 4. An understanding of external and internal environments
also helps with the decision about which types of businesses in which to compete. That
is the domain of corporate strategy (CS). Changing businesses via mergers, acquisitions, divestitures, and alliances is the main focus of Chapter 5.
Company moves also entail choices about globalization and innovation. Global
­strategy (GS) is essential for any business today. What will be the scope of its activities?
Where will a company sell its products? Where will it source its raw materials, design
and make its products, and do research and development? Chapter 6 focuses on the
­opportunities and threats offered by globalization.
Companies also must be ready to abandon existing products and business models,
find new opportunities, and make the leap into fresh fields of endeavor. Having a vigorous innovation strategy (IS) that rests on the understanding that today’s markets are
not permanent is also essential. Chapter 7 is about entrepreneurship and the striving
for innovation.
Implementation (I) is the alignment of a strategy with the management systems and
tools to carry it out successfully. Management may have a bold and exciting vision about
where to go next, but if it lacks the means to carry out its vision, its creativity and imagination in establishing that vision are likely to be in vain. Chapter 8 emphasizes the tools
managers need to successfully implement strategy.
Firms must constantly position and reposition themselves in relation to their
­competitors. This process is not a one-time event. Repositioning (R) is the constant
­adjustment and revisiting of strategy that are essential for every firm. In repositioning, a
firm can engage in tactics borrowed from judo to keep its opponents off balance. ­Chapter 9
focuses on the role that judo strategy plays in repositioning.
Altogether, this book brings you the formula for making winning moves diagrammed in the following section. First, do EA and IA; then choose from a repertoire of moves that include BS, CS, GS, and IS; and finally engage in continuous
I and R. Thus, SCA = EA + IA followed by some combination of BS + CS + GS + IS,
which is to be followed by I + R.
Making Winning Moves
The main message of the book is that in response to changing external circumstances, an
organization constantly must endeavor to find new sources of competitive advantage. This
requires that the organization make a sequence of short-term maneuvers and ­long-term
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Chapter 1 Winning Moves 5
EXHIBIT 1.1
Three-Step
Model for
Sustained
Competitive
Advantage
(SCA)
EA
External Analysis
General Environment
Competitive Forces
1
IA
Internal Analysis
Resources, Capabilities
& Competencies
Selection of Options
Business, Global and Corporate Level
Strategies & Tactics
BS + GS + CS + IS
2
Evaluation of
Performance
&
Continuous
Reinvention
3
Implementation
Marshalling Resources & Making Moves
SCA = [EA + IA] + [BS + CS + GS + IS] + [I + R]
Analysis
Moves
Implementation
&
Reinvention
changes in directions that add up to a unique position against which competitors cannot make
serious inroads. Critical to an organization’s long-term advantage is positioning its products
and markets in a space free from competitors. In strategizing, a three-step process is needed,
which involves analysis, moves, ongoing evaluation, and implementation (see Exhibit 1.1).
Step 1: Analysis
Before exploring the various moves a company can make to achieve SCA, it is important
to do the types of analyses that will increase the chances that the moves a company
makes will yield success. The two types of analysis needed are (1) an analysis of the
company’s external environment, EA (see Chapter 2), and (2) an analysis of its internal
environment, IA (see Chapter 3). Assessing a company’s external opportunities and
threats and matching them with its internal strengths and weaknesses provide it with the
ability to make better moves. How to estimate and match these factors is covered in
­detail in the book’s next two chapters.
Step 2: Moves
The moves that flow from such analyses better position a company to prevail in the
­ongoing competitive challenges it confronts. This book explores moves that position the
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Chapter 1 Winning Moves
firm in relation to its competitors with respect to the cost and quality of the products and
services the firm provides in Chapter 4 (BS); the scope of its activities in Chapter 5
(CS); its global, as opposed to domestic, reach in Chapter 6 (GS); and the extent to
which it innovates and searches for new business opportunities as opposed to exploiting
existing ones in Chapter 7 (IS).
Step 3: Implementation and Ongoing Reinvention
The need to implement a strategy well once it is chosen is the lesson of Chapter 8, while
repeated repositioning of a company vis-à-vis its competitors is emphasized in ­Chapter 9.
The whole process of deliberating how to achieve SCA as a function of EA, IA, moves,
and sound implementation must be continuous. The analytical process cannot come to a
halt. Distinct stages of formulation and implementation should not be separated out, but
rather ongoing evaluations, adjustment of strategies, and continuous reinvention should
be the norm.
Understanding Management Strategy: Three Analogies
The tools of strategic management are best understood through analogies with other
­areas in life in which competition is fierce, such as chess, war, and sports. Each of these
bears important resemblances to strategy.
A Chess Analogy
Strategy is like chess in that the goal may be seen as checkmate, or thwarting an opponent so that escape is nearly impossible (see Exhibit 1.2). In driving Borders and Circuit
City to bankruptcy, Barnes and Noble and Best Buy came close to this goal, but in business, the results are rarely so definitive. Rather, the best companies can hope for is sustained dominance, similar to that achieved by Microsoft and Intel in their markets during
the 1990s. In disabling their competitors, Microsoft and Intel each captured more than
90 percent of the market in operating systems and microprocessors, respectively.
EXHIBIT 1.2
Strategy and
Chess
©Anne Cohen.
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Chapter 1 Winning Moves 7
Operating by the Rules
In both business and chess, dominance has to be achieved according to rules. Following
the rules and playing fairly guarantee that the results are a consequence of skill rather
than of illegal or unfair practices. In the world of commerce, skill means being better
able than one’s opponents to meet customer needs.
The rules of chess are very well defined and have remained the same for centuries, so
few questions arise about the legality or ethics of the moves. In strategy, by contrast,
companies operate with a legal framework that is less precise and static, so it is sometimes difficult to ascertain what is permissible. As a result, firms may believe that their
job is to test the laws’ limits. Managers may have the view that innovative theories promoted by consulting firms and management theorists give them the license to stretch
what the law allows. However, when gains are achieved by questionable moves, the
­extent to which these gains endure depends on how the legal system judges them. The
courts may reverse apparent victories. The stories of Enron, Arthur Andersen, WorldCom, Adelphia, and other companies that came to light after 2000 provide stunning
­examples and warnings against engaging in illegal activities. They show that society will
not tolerate some moves. Blatant cheating, when detected, does not go unpunished.
Therefore, the moves firms make must be above board and in accord with prevailing
­legal doctrine and ethics.
Milton Friedman, who maintained that it was the purpose of managers to maximize
shareholder returns, held that doing so must occur within the confines of law and ethics.7
However, the law is not always clear regarding some strategic issues. The judgments of
legal authorities clarify what the law says and establish precedents for how the game is
played. Regulations dealing with competition, for instance, have shifted over time,
­depending on who the legal authorities were and how they interpreted the law. The
­Kennedy administration’s view of antitrust law was much stricter than today’s understanding of this phenomenon. The European Union (EU) struck a major blow against
Intel in 2009 when it imposed a huge fine on the company for violating its antitrust laws.
Microsoft has been treated similarly by the EU, and the EU has been preparing action
against Google for quite some time, while U.S. antitrust laws have moderated. Companies must take into account not only the rules in their countries of origin, but the rules
globally in every nation in which they operate.
According to legal doctrine in the United States in the early 1960s, simply having
very high market share was proof of possible illegality. Today, high market share does
not have this connotation in the United States, but it may in other countries. The United
States requires proof of actual anticompetitive behavior. For example, when Microsoft
was sued by antitrust authorities it was not because it had more than 90 percent of the
market in operating software, but because it was alleged to have taken specific actions to
exclude a competitor, Netscape, from installing a browser on newly manufactured personal computers. The legal challenges Microsoft faced threatened to reverse the gains
the company had made in the 1990s. To continue as the world’s leading software company, it had to defend itself in the courts. In the face of this challenge, Microsoft almost
was broken up into several firms.
Intel, too, has been embroiled in frequent legal controversies in the United States with
major competitors such as AMD. It tried, for example, to use the legal system to block
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Via Technologies, a Taiwanese company and AMD’s primary chipset partner, from making chipsets that would be compatible with Intel’s Pentium 4 chips. Via turned around
and sued Intel for trying to abridge its rights to operate.
Changing the Rules
Legal suits and countersuits affect the strategic battles in which companies are engaged.
Microsoft’s opponents, including Sun and Oracle, pressured federal officials to be tough
on the software giant. This pressure was a primary reason antitrust authorities acted
against Microsoft.
Thus, companies must be aware that the rules of the “game” of strategy tend to shift
over time. These shifts occur not only because of variations in the legal and ethical climate, but also because of changes in technology and economics. These shifts in the
­environment in which firms operate are the types of inflection points to which reference
was previously made. To some extent, the forces that change the rules of the game are
outside the control of a company, but often companies have influence over the rules
­under which they operate. Nonetheless, the forces of external changes are not entirely
within the control of companies. Some of the changes are hard to direct or block entirely.
Once they gain momentum, they can have overwhelming power to change an industry,
and a company and its employees have no choice but to adjust.
At the start of the 21st century, executives of Microsoft, Intel, and other leading hightech companies discovered how strong these forces were when the bubble burst in their
industry, terror struck, global security became an overriding issue, and extremely tough
economic conditions set in. Plus, as these events occurred, users were starting to install
Linux, a virtually free operating system that could replace Windows.
Fundamental new forces in the external environment such as these require an alteration in firm strategy. All of the employees in a company must analyze these changes and
consider the moves a company can make to better position itself in the face of challenges. For example, employees can promote the idea that a company should shift all or
some of its resources to areas in which it can compete better. Companies can be prospectors, aggressively pursuing new growth opportunities, or defenders, clinging to their
existing niche and trying to protect their turf. They also can be analyzers, both searching
for new market opportunities and protecting an existing position. In the worst case, they
can be reactors, incoherently responding to the changed circumstances.
The success of the moves a company makes ultimately depends on how much
flexibility it has to maneuver. Companies always find themselves between two
poles—the past and the future. Their mission typically represents the company’s current purpose and what it has been good at in the past, while their vision, on the other
hand, normally is based on their future—what they would like to be good at next
(see Exhibit 1.3).
Envisioning Where to Go Next
In chess, it’s critical to think several moves ahead, but even if the employees in a company have a vision of where they would like the company to go, it may not be possible
to achieve this vision quickly. Because of fixed physical or human assets, bureaucracy,
or the inflexible worldviews of top managers, the company might not easily make the
transition from where it is now to where it would like to be next.
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Chapter 1 Winning Moves 9
EXHIBIT 1.3
A Company’s
Mission and
Vision
Int Ext
er ern
na a
lF l&
or
ce
s
Vision
Proactive &
Reactive
Moves
Mission
Andy Grove recommends that companies be “agile giants.”8 They need agility to
move quickly to new competitive ground (this is their vision), but once they occupy that
ground, they must be giants, capable of defending it (this is when their vision becomes a
mission). In the mid-1980s, Intel’s main product was computer memory. When Intel
could no longer compete with large and better-capitalized Japanese firms in this business, its employees realized the company had to concentrate on the one thing it did best:
focus on an area in which it had comparative advantage. So, Intel shifted to microprocessors based on the reasoning that it was better to be positioned as the top player in
microprocessors than to be a mediocre player in both microprocessors and memory.
Comparative advantage means that a company pursues what it does best. This is the
foundation for sustained competitive advantage. Doing what a firm does best, doing
what no other firm can do as well in meeting customer needs and expectations, is the key
to sustained competitive advantage.
A company incorporates these strengths into its mission but, while pursuing its mission, it must also have a vision for where it wants to go next, as conditions do change.
Companies such as Intel and Microsoft constantly balance between what they have
proven good at in the past and what they would like to be good at in the future. They are
trying to develop new options they might use to achieve advantage when their current
businesses slacken. Another firm that has been grappling with how to adjust its strategies to react to changing conditions is Medtronic. Its recent moves are summarized
in Exhibit 1.4.
In business, it is also possible to create new games. A company can redefine the game
that is in process, play a different game, or walk away from a game and refuse to c­ ompete.
Usually, change is gradual and incremental, but it can also be massive and sudden, like
Andy Grove’s inflection points. Because change cannot be predicted with great certainty, employees must be alert to a variety of different contingencies. They need to
­develop and propose options that will give their firms the flexibility to move in a number
of directions regardless of how external conditions evolve.
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10 Chapter 1 Winning Moves
EXHIBIT 1.4
Where
Medtronic Is
Headed Next
The Medtronic mission has endured for many years. It is so deeply engrained that every new employee at the
company receives a medallion with this mission as a reminder of the honor and responsibility that they have in
“contributing to human welfare by the application of biomedical engineering to alleviate pain, restore health, and
extend life.”
Yet, even this biomedical giant understands the importance of developing new options for maintaining competitive
advantage. An external analysis (EA) reveals that the med-tech industry is plagued by several issues, including
pricing concerns, hospital admission and procedural volume pressure, Medicare reimbursement issues, and
­regulatory overhang. An internal analysis (IA) shows that the firm has a portfolio of market-leading products, deep
clinical knowledge, global in-hospital footprint, health care economics expertise, lean sigma resources, and a
strong financial position.
In response, Medtronic has made the following moves:
1. Forming a Hospital Solutions business unit after successful pilot ($6 million saved per year) at Maastricht
­University Medical Center in The Netherlands.
2. Securing contracts to manage catheterization labs for the University Hospital of South Manchester and Imperial
College Healthcare in London.
3. Purchasing NGC (which manages Italian hospital heart imaging facilities), and plans to expand NGC’s business
into additional markets.
4. Undergoing a major merger with Covidien for the tax advantages and increased market scope.
Medtronic has recognized inflection points on the horizon and diversified its lines of business in response to
threats to its core device business. The essence of its strategy is to achieve a balance between the company’s
past and its future, to adhere to a core mission while trying to realize a new vision for tomorrow.
Weathering Reversals of Fortune
In business, as in chess, one player dominates for a period but then is replaced by another.
Dynasties do not last that long. Many companies during the 1990s seemed to have a lock
on the top position, only to see reversals of fortune in the early 2000s. Coca-Cola, for
­instance, lost its dominance over PepsiCo, General Electric over United Technologies,
and Nike over Reebok. In each instance, the reversal was caused by moves the companies
made: Despite 80 percent of its profits coming from overseas, Coca-Cola stumbled in
Europe as a result of product recalls; PepsiCo, in contrast, bought Gatorade from Quaker
and introduced numerous new beverage products, including bottled water, earlier than
Coca-Cola did. PepsiCo beat both the average stock performance of soft-drink companies
and the stock performance of Coca-Cola in this period. General Electric’s financial division, GE Capital, which had been its star business unit, went downhill in the early 2000s.
United Technologies’ (UT) stock performance was better because of the defense buildup
and the strategic initiatives the company took in areas such as quality and globalization.
UT performed at about the same level as companies in its industry, while GE did much
worse. Nike encountered a public outcry against foreign sweatshops and lost its sponsorship of professional sports leagues and its contracts with well-known athletes. Reebok
picked up these sponsorships. Its stock performance was far better than the average footwear company in the early 21st century, whereas Nike performed at about the average.
Dominant companies can stumble, while companies that are behind can move ahead.
Some firms cannot recover after a stumble and find themselves swept into a downward
vortex, which leads to failure (see Exhibit 1.5). They lose market share to rivals, which
reduce profitability levels. Lower profits begin to strain their finances. Their range of
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Chapter 1 Winning Moves 11
EXHIBIT 1.5
Key Strategies Fail
The Vortex of
Failure
Loss of
Market Share
Loss of
Profitability
Loss of
Flexibility
Employee
Reductions
Employees Lose
Confidence
Investors
Withdraw
Funds
Bankruptcy
Liquidation
strategic options is thus reduced. Sometimes a firm will reduce employees or pay in
order to sustain margins and keep investors happy. The firm’s best employees will then
begin to look for opportunities outside the firm—and some will be hired by smart
­rivals. The mass exodus of employees then leads to operational and productivity
­issues. Investors take note and begin to withdraw funds. The firm runs out of options
and may seek the courts’ protection. Finally, some firms that seek the courts’ protection fail to emerge from bankruptcy and liquidate their assets. Other firms, such as
IBM, have escaped the vortex and have come roaring back from the brink under strong
strategic leadership. Yet IBM again faces the prospect of continued declines in
­revenue. Thus, strategy is as much about the ability to make comebacks as it is about
achieving dominance in the first place.
Making Moves That Matter
As in chess, the premise of strategy is that the moves companies make matter. The outcomes are determined by moves that may be negative as well as positive. Enron, for
­instance, made notoriously wrong moves, despite the fact that they were grounded and
rationalized in the thinking of the best management consultants of the time. Just as right
moves lead to success, the wrong moves can destroy a company. Of course, Enron selfdestructed for many reasons including fraud, deception, and greed.
Many contests are undecided. The superiority of the players is not apparent, and the
games are in a stalemate. Many companies have been neck and neck for a long period,
and it is unclear which company will prevail, which will fall, and why. That is why it so
important for employees to continually observe the external environment to determine
what opportunities their companies have and what threatens their companies, to analyze
the significance of changes they see, and to always try to break the stalemate by making
recommendations for changes in their company’s strategic direction.
A War Analogy
Another useful analogy in strategy is war. Though perhaps extreme, it provides several
principles of importance, from knowing your enemy to hedging against uncertainties.
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12 Chapter 1 Winning Moves
Know Your Enemy, and Know Yourself
Sun-Tzu’s Art of War was published more than 2,500 years ago. In it, he wrote: “If you
know the enemy and know yourself, you need not fear the result of a hundred battles. If
you know yourself but not the enemy, for every victory gained you will also suffer a
­defeat. If you know neither the enemy nor yourself, you will succumb in every battle.”9
During World War II, Winston Churchill echoed this principle of “knowing your enemy,”
when he warned against “the treachery of numbers in calculations” that did not “include
the great unknown variable of the enemy’s reaction.”10 Napoleon, too, said, “A general
should say to himself many times a day: If the hostile army were to make its a­ ppearance
in front, on my right, or on my left, what should I do? And if he is embarrassed, his
­arrangements are bad; there is something wrong, he must rectify his mistake.”11
In strategy, therefore, employees must examine the external situation in which their
company finds itself, and understand its strengths and weaknesses. The moves a ­company
makes must be designed to strengthen its competitive position either by changing the
external circumstances or by upgrading its internal resources and capabilities.
Knowing the enemy “goes beyond tabulation of numbers and capabilities; it requires
an understanding of culture, values, intentions, customs, organizational doctrines, and
operational preferences as well as the personalities of key commanders and staff
­officers.”12 Knowing an enemy’s idiosyncrasies can provide great leverage if properly
­exploited. Some enemies, for instance, act according to reason; others according to
­emotion. Some wait for events to happen; others make them happen. Some act primarily
out of self-interest; others act selflessly. All are creatures of habit; only the habits differ.
Some can think clearly through shock; most cannot. All act on the basis of what they
believe the situation to be—not necessarily on what the situation is. Most are influenced
by what they want to believe.
According to military doctrine, knowing the enemy must be supplemented by insights
into one’s own characteristics and traits. These insights “aid efforts to unify action, concentrate strengths, and offset vulnerabilities.”13 These two principles, “knowing the
­enemy” and “knowing yourself,” are fundamental in both war and strategy.
Not Just Detailed Planning
Like warfare, management strategy also is not just about detailed planning.14 According
to Napoleon, “War consists of nothing but accidents and a commander should never
overlook anything that might enable him to exploit these accidents.”15 The Prussian military strategist Carl von Clausewitz wrote in his book On War, published in 1832, that
detailed planning necessarily fails “due to the inevitable frictions encountered: chance
events, imperfections in execution, and the independent will of the opposition.”16 The
Prussian general staff “did not expect a plan of operations to survive beyond the first
contact with the enemy. It set only the broadest of objectives and emphasized seizing
unforeseen opportunities as they arose.”17
Strategy is not necessarily a lengthy action plan. It is the evolution of a general idea
through continually changing circumstances. The results are a consequence of actionresponse cycles: Both sides (one’s enemy and oneself) act and both respond.18 The outcomes are not likely to be the intended ones; they materialize from actual encounters
with the enemy.
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Chapter 1 Winning Moves 13
Strategy is as much about this process as it is about design.19 As design, strategy
means planning, rationally choosing alternatives, and implementing the alternatives as
close as possible to how they were devised, a model that is unrealistic because it ignores
competitors’ responses. Competitors react to intended strategies in ways that negate what
the firm wishes to do. Then it becomes a matter of adjusting to the actual situation on the
ground. The original plans no longer match reality as the situation unfolds, and rigid
adherence to the plans is not fruitful.
Realized and Intended Strategies
Realized strategies differ from intended ones. They incorporate the response and
­counter-response of other decision makers that affect the result. In many circumstances,
the situation changes so much that one would not want to achieve what was originally
­intended. Strategy as a process introduces flexibility, which strategy as a formal planning exercise eliminates.
Implementing a strategy is not entirely different from formulating one (see
­Chapter 8). Both require on-the-spot adjustment. In Strategies for Change, James Brian
Quinn, professor of management at Dartmouth College, argues that strategies should
“develop around a few key concepts and thrusts” that provide “cohesion, balance, and
focus.”20 The essence is to build a posture that is flexible enough and strong enough for
a company to accomplish what it aims to achieve no matter what occurs.
Concentrating Forces
In a letter to one of his generals, Napoleon advised to always keep in mind concentration of strength.21 Concentrating one’s forces, as illustrated in Exhibit 1.6 is the
method to follow in achieving winning strategies over time. In an ever-shifting battlefield, one must apply superior resources where needed to achieve victory. Even a
smaller and weaker foe can win if it has mobility to define how encounters take place.
If it can mobilize superior means and apply them at critical junctures, the smaller force
can win. Thus, speed and flexibility in mobilization and application of resources are as
important as possession of these resources.
EXHIBIT 1.6
Concentrating
and Deploying
Forces Rooted
in Firm’s
Distinctive
Competencies
Distincti
ve Comp
etence
Distinctive Competence
ce
ctiv
Distin
peten
e Com
Time
RIVAL
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14 Chapter 1 Winning Moves
The corporation’s management, therefore, must:
∙ Determine what confers superiority.
∙ Create a distinctive competence in which the company has comparative advantage.
∙ Apply this competence decisively at the proper time and place to increase the chances
of winning.
This approach may mean conceding certain positions to concentrate forces where the
chances of success are greater. Surprise, speed, and secrecy are needed to move forces to
a favorable position. A company may also have to keep capabilities in reserve to be
­deployed in the face of unexpected contingencies.
Outwitting competitors not only means knowing when, where, and how to fight,
but it also means knowing when not to fight and when to retreat. An excellent example
is Intel’s switch from computer memory to microprocessors as its main product. As
mentioned earlier, under Andy Grove’s leadership, the company realized it would
never be able to compete with Japanese manufacturers in the computer-memory
­market. It did not have access to enough financial capital to build the huge factories it
would need. It could never keep up with the low costs of production that other manufacturers such as NEC, with its attention to detail and incremental process improvement, were capable of attaining. Although computer memory had been the basis of
Intel’s business until about 1985, the company no longer had a comparative advantage
in this product. It had to concede defeat in this market and fight a different battle. The
company switched to microprocessors, where it concentrated forces and achieved
­superiority. The decision, according to Grove, was whether to be a weak and mediocre
producer in both computer memory and microprocessors and risk losing on both fronts
or to focus all the company’s resources in the one area where it had the chance of
­being dominant.22
Redeploying Assets
In his book Only the Paranoid Survive, Grove discusses the importance of being able to
recognize key turning points and redeploy assets.23 Major changes occur in the competitive environment at these inflection points. Conditions change because of shifts in
technologies, government regulations, customer values, and other factors.
According to Grove, people at the top of corporations have difficulty recognizing
such changes and responding. Just as generals may not get the signals emanating from
the battlefield in time to respond effectively, top managers might also not recognize, or
be willing to acknowledge, what is actually occurring. Thus, employees throughout the
company must be enlisted to provide their insights into the signals that are changing
conditions on the frontlines and their recommendations for altering the strategic moves
a company is making.
Obtaining good signals is not just a matter of having good intelligence; it also ­involves
being receptive to that intelligence. As Grove points out, despite emotional resistance to
change, a company must be willing to shed preconceptions and redeploy company ­assets,
see where a new opportunity lies and know how the corporation’s existing base of assets
can be reconfigured to meet it. These insights do not belong to people at the top of a firm
alone. They are insights had by all employees, and their knowledge of conditions the
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Chapter 1 Winning Moves 15
company confronts must be brought to the attention of decision makers. Thus, employees at all levels need the tools of strategic analysis to make forceful and persuasive
­arguments about what a company should do.
Hedging Against Uncertainties
How does a company respond to changing circumstances? As times become more uncertain and the future less predictable, hedging against uncertainty becomes increasingly
important. The economist Frank Knight distinguished risk from uncertainty based on the
capacity to place objective odds on conditions such as flipping a coin or rolling dice.24
Risk can be objectively calculated—and planned for—as opposed to conditions of
­uncertainty where the odds are subjectively assigned, where they essentially are made up
based on judgment. According to Knight, competitive advantage and superior economic
performance emanate mainly from bets placed under conditions of uncertainty. When
the risk is known, all rivals can effectively grasp the situation, and the competition is too
intense to earn anything but the most mundane returns.
As Exhibit 1.7 indicates, hedging strategies depend on whether an outcome can be
well described and/or quantitative odds can be assigned.25 A brief discussion of these
strategies follows.
Gamble on the “Most Probable” Outcome Companies may act based on what they
perceive to be a likely outcome. They make bets with confidence, only to be surprised
later if the world does not evolve as they assumed. A prime example of a company that
made a large bet based on what it believed to be the most probable future was Iridium’s
$5 billion investment in its satellite network. When it made this bet it was reasonable to
assume that demand would be large, but events did not turn out as Iridium expected.
However, making bets of this kind is reasonable in some instances. Investments in new
stores by established companies like a McDonald’s or a Home Depot are good examples
of extending the scope of proven business models and winning by virtue of superior
execution without being concerned about the risk of serious upheaval.
Take the Robust Route Rather than bet on a single future, companies can choose a
robust strategy, or one that is viable regardless of what occurs. This kind of strategy may
EXHIBIT 1.7
Hedging
Strategies and
Levels of
Uncertainty
HEDGING STRATEGIES
Extreme
Uncertainty
Qualitative
outcomes cannot
be described
Moderate
Uncertainty
Qualitative
outcomes can be
described
Moderate
Risk
Quantitative odds
can be ascribed
to the outcomes
Low
Risk
A single best
forecast can be
made
Gamble on “most probable”
outcomeX
Take the robust route
X
X
Delay until further clarity
emerges
X
X
Commit with fallbacks
X
X
X
Shape the future
X
X
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16 Chapter 1 Winning Moves
be referred to as “no regrets.” Often regulated utilities have taken this route. They hedge
their bets against a number of possibilities. For instance, the key future question may be
about the relative cost of different fuel sources. Utilities create scenarios in which natural gas or wind is the low-cost fuel and invest in both.
Delay until Further Clarity Emerges In the face of uncertainty, a firm may decide to
stay the course for now. It delays taking action until the situation becomes clearer. While
waiting, the firm makes flexible commitments that minimize downside losses should
worst-case situations take place. It can divide its investments into small increments, not
fully committing at once but gradually over time in accord with additional clarity it
gains and confidence it acquires from moving forward slowly in trial-and-error fashion.
The risk is that when the firm decides to fully put its stake in the ground it may be too
late. Its competitors will already be there, and it will not be able to dislodge them. Such
was the case with both Xerox and Kodak in their slow adjustments to a digital world.
Delay, on the other hand, may work in the case of Boeing’s decision not to pursue the
super-jumbo-jet option.
Commit with Fallbacks An alternative is to fully commit, but with fallbacks, should
the plans be unrealistic. This path is not a refusal to commit. It is not avoidance of going
full thrust. Instead, the company can justify the risk it is taking because it is convinced
that its initial position and capabilities provide it with a long-run competitive advantage.
It thoroughly analyzes the risk on this basis. Do its initial position and capabilities justify
the action? Major petroleum companies created fallback positions in renewable energy
in the event that fossil fuel supply is severely constrained. BP’s “beyond petroleum”
initiative was not just a public relations gimmick, but a fallback position meant to preserve the company’s flexibility. Committing to fallbacks works best if there is a payoff
structure such that investments that fail entail tiny losses, while those that succeed yield
very high returns.
Shape the Future Another alternative is not to be passive in the face of diverse futures,
but to try to actively drive and influence what takes place.26 A firm uses the resources it
commands to increase the odds that the most desirable outcome, the one it wants the
most, prevails. A shaping strategy revolves around a point of view of where an industry
will evolve—where the company wants to see itself in five or ten years. Examples include
FedEx’s overnight delivery methods, Southwest Airlines’ no-frills model for domestic air
travel, and the pioneering efforts of Amazon and eBay in Internet commerce. Trying to
shape the future makes the most sense when there is rapid discontinuous change and the
future is very hard to forecast. The returns may be great, but so are the risks.
A Sports Analogy
Another useful analogy for strategy is sports. In sports, the goal is not to win just one
championship, but to be perpetually successful, to create a dynasty. The goal is not
achieving a fluke triumph—the one-time trip to the Super Bowl.
There are coaches who have created dynasties such as Vince Lombardi, who steered
the Packers to five NFL Championships, and John McGraw whose MLB teams finished
815 games over .500. These coaches are certainly great strategists and have much to
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Chapter 1 Winning Moves 17
teach the business strategist. They are masters of their team’s capabilities, the rules of
the game, and the competitive environment. They understand each player’s strengths and
weaknesses and concentrate on eliminating weakness. They leverage the full breadth of
the team’s strengths and insist on team play (whereas weaker coaches rely on just a
handful of stars and recycled plays).
Excellent coaches also know their rivals extremely well. They attend rivals’ games,
filming them, and analyzing the films for weaknesses to exploit. They carefully craft and
select strategies pre-game but are also quick to react and effectively modify tactics based
on the ever-changing dynamics of each game. They leverage their success as they recruit
for the future. The models to emulate are the perennial powerhouses in sports.
Building Early Momentum
How can such long-term success be accomplished? A sports team that is the first to
­introduce a system can stay ahead of its competitors by refining that system before they
make headway against it. San Francisco’s National Football League dynasty during the
1980s and 1990s was built on innovations in a West Coast offense that other teams tried
unsuccessfully to copy; the other teams were unable to keep up with the refinements and
adjustments made by Bill Walsh and his successors.
The same principle can hold in management strategy. A company that is the first to
introduce a product or idea—a company that “gets it” early—may be able to build the
momentum to win title after title. When a company gets one thing right, it creates
­momentum that enables it to get other things right. Exhibit 1.8 depicts the chain of benefits set in motion: Because a company has attracted favorable attention from customers,
investors come on board. Because the customers and investors have come on board,
highly talented people think the company would be a good place to work, and thus it
becomes easier to recruit top-notch individuals. With more highly talented people in
place, it is easier to get more customers on board, and the investment community
­becomes more excited and pours more money into the company. A virtuous cycle is
­created. In contrast, vicious cycles are also possible: A company’s failures can snowball
into defeat. Being first is not always the surest route to success, however, as will be
EXHIBIT 1.8
Investors
The Chain of
Benefits:
Customers →
Investors →
Talent
Customers
Value
Source: Adapted from
Profit Patterns, by
Adrian J. Slywotzky,
David J. Morrison,
Ted Moser, Kevin A.
Mundt, and James A.
Quella. Times Books/
Random House, New
York: 1999.
Talent
Investors
Customers
Investors
Talent
Customers
Time
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18 Chapter 1 Winning Moves
EXHIBIT 1.9
Leveraging the Full Breadth of Team Strengths
©Anne Cohen.
shown in Chapter 4. Often, fast followers, such as Microsoft, prevail over the early leaders.
They learn from what has been done before, concentrate superior forces, and counterattack. An early leader can never be sure that its lead will stand.
Relying on Teamwork
Management can learn another lesson from sports. Accomplishment comes as much
from teamwork as from outstanding stars. Most sports teams have great individual
stars, but winning persists because of how teams recruit, socialize, and motivate all
players to work together (see Exhibit 1.9). Coaches play a significant role. Their
­understanding of the contributions of superstars and role players is as critical as their
philosophies of preparing for a game and calling the plays. A team’s management
keenly analyzes the situation and makes the right moves that bring together the parts
needed for success.
Championship teams do not have to excel at everything, but they have to be able to
blend the different parts to create a winning combination. The best teams have a
unique character. One will win with an innovative offense and just an adequate d­ efense.
Another will dominate because its defense is superior, while its offense barely gets the
job done.
Planning and Improvising
Winning involves a mix of planning and improvising. A football coach scripts the first
10 to 15 offensive plays of the half, but then changes plans in response to what happens.
A pitcher adjusts to the way batters have been reacting to his pitches. Plays that have
been run to perfection in practice can break down in actual games. Some options in a
possible breakdown are anticipated and practiced; others are made up on the spot, so
players must be creative. How well such improvising works is often the difference
­between winning and losing.
Keeping Score—Performance Measurement
Another sports analogy of relevance is keeping score. Companies have economic, legal,
and ethical obligations to many stakeholders who affect and are affected by what the
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Chapter 1 Winning Moves 19
firm does. Poor strategies and ill-advised moves obviously affect the employees of a
firm, but the repercussions of failure travel beyond organizational boundaries—to suppliers, customers and the community at large. An unsuccessful strategy that leads to
bankruptcy, for example, reduces or eliminates employment opportunities not only
within the firm, but also within the firm’s suppliers and the community at large. Imagine
being a key supplier to an organization, and finding out that a bankruptcy court has
­determined that your company will receive only 5 cents on every dollar that it has billed
the firm. Many airline suppliers suffered this fate during the recent economic crisis and
airline industry shakeout.
To assess how well they are meeting these responsibilities, therefore, companies
must constantly measure their performance. There are various ways to do so.
Companies evaluate strategic plans on the basis of growth in revenues and market
share. They assess product lines and individual businesses by calculating gross margins
and cash flows. They appraise individual business units in terms of return on assets.
Capital investments are analyzed according to net present value, and prospective
acquisitions are examined on the basis of their likely contribution to earnings. Several
of the most important approaches to the measurement of company performance are
discussed below.
Measures of Overall Dominance
Overall dominance is typically measured by two means:
∙ Accounting data, which are based on past performance.
∙ Stock market data, which is typically a reflection of the firm’s outlook.
Both have their limits. Accounting data, despite the best efforts of the accounting profession and legal authorities to prevent distortion, can be skewed. Firms can manipulate
accounting results by recording revenue too soon or too late, recording revenue of questionable quality or of a bogus nature, boosting income with one-time gains, shifting current expenses to later or earlier time periods, and failing to record liabilities or improperly
reducing them. Companies such as Cendant, Sunbeam, Waste Management, Lucent,
Dynegy, and Global Crossing, as well as Enron and WorldCom, have been caught engaging in accounting fraud.
Without adequate accounting data, investors can be fooled and stock prices can be
based on inaccurate information. Investors do not always have the analytical capability to
accurately assess a company’s likely future performance. Stock market data depend on
investor psychology, and investors are not entirely rational; they become caught up in
fads and get swayed by irrational fears as well as enthusiasms.
Economic Value Added
Another method of “keeping score” in business came to prominence in the 1990s: evaluating its economic value added (EVA). EVA is defined as net operating profit minus the
opportunity cost of capital. It measures how much better or worse a company’s earnings
are than the amount investors could obtain by putting their money in alternative investments of comparable risk. Typically, more than 50 percent of the top U.S. companies do
not have a positive EVA, which means they did not earn more than their cost of capital.
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20 Chapter 1 Winning Moves
Investors probably would have done better if they put their money in Treasury bonds.
Surpassing the rate of return from Treasury bonds is a minimal test of the performance
of a company’s strategy.
Investor’s Business Daily’s Rankings
The newspaper Investor’s Business Daily (IBD) aims to provide a more balanced, composite score for firms by combining a number of elements:
1. Accounting performance (earnings per share).
2. Market performance (relative price strength in the past 12 months compared to all
other firms).
3. Industry performance (a market rating).
4. An amalgam of accounting components (sales plus profit margins plus return on
­equity).
5. Investor psychology (amount of buying and selling of the company’s shares in the
last 12 months) and stock price.
The IBD ratings rely on accounting (number 1) and stock market performance (number 2), both of which are relevant to strategy. The use of an industry index (number 3) is
also relevant in that strategy is based on the premise that industry matters. A large
­element of the success of a company can be predicted on the basis of its industry (see
Chapter 2). Similarly, the use of sales and profit margins (number 4) is relevant; the two
main positions a business can occupy are low cost, which necessitates a high level of
sales, or differentiation, which rests on high profit margins (see Chapter 3). Investor
psychology plays a role in determining stock market returns (number 5). Thus, overall,
the IBD ratings provide good surrogates for strategic performance. However, they are
based on past performance and say nothing about how well a company will do next.
Summary
Sustained competitive advantage is achieved through a series of strategic moves over
time. To make winning moves, a company must be aware of the rules of the game and
changes in the rules of the game, and have a vision of where to go next. It must ­anticipate
inflection points—major transformations that require adjustments in strategy—and
­develop contingency moves to meet different external conditions. SCA typically involves
competing in more than one area at a time and dealing with likely reversals in fortune.
To win, employees in a firm must know their enemies—those against whom they
compete—and themselves. They engage in action-response cycles with their competitors, in which focus and flexibility are needed. They have to recognize patterns that
emerge during the competition and adjust accordingly in order to create a winning
­dynasty. Doing so means instituting systems for both planning and improvisation and
relying on performance measurement systems that are as accurate as possible. SCA
­involves not just doing well for a few years, but having persistent performance that is
superior to that of competitors.
This chapter has used analogies from chess, war, and sports to help you think about
how to achieve SCA. Some of the lessons to be learned are to concentrate forces and rely
on teamwork. Companies must be conscious of the connection between SCA and
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Chapter 1 Winning Moves 21
c­ omparative advantage. Employees must also know how to keep score. They—and the
sum total of the firm’s stakeholders—are all impacted by the successes or failures of
their firm’s strategies. Some of the more important measures of SCA have been presented in the chapter.
A firm is simultaneously located in the past, striving to achieve what it was good at
previously (its mission), and at the same time moving toward a vision of what it would
like to excel at next. To consistently receive strong returns, it has to make better moves
than its competitors. To do so, its employees have to develop the ability to analyze
­external opportunities and threats and internal strengths and weaknesses. The frameworks and methodologies you can use to conduct this type of analysis are the subject of
the next two chapters.
Reflections for the Practitioner
1. What is your firm’s mission? Its vision?
2. Does it effectively scan the horizon for inflection points that may pose either opportunities or threats?
3. Which strategy analogy—war, chess or sports—resonates the most with your own
experience? Why?
4. How would you characterize your firm’s strategic planning process?
5. Are employees at your firm equipped to analyze the environment and recommend
strategic change?
An Assignment for the Traditional Student
Select a firm from the Fortune 500 that interests you and visit its Investor Relations site. Scan
their most recent Annual Report and collect evidence of the following within the firm:
∙ Clear mission and vision for the future.
∙ Awareness of both its external and internal environment.
∙ Adjustments to its strategy based upon the situation that it faces.
Endnotes
1. A. Grove, “On Competitiveness,” Academy of Management Executive 13, no. 1 (1999), p. 16.
2. “Gartner Says the Internet of Things Installed Base Will Grow to 26 Billion Units By 2020,”
December 12, 2013, http://www.gartner.com/newsroom/id/2636073.
3. A. Marcus, Strategic Foresight (New York: Palgrave-MacMillan, 2009).
4. M. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New
York: Simon and Schuster, 2008).
5. R. Wiggins and T. Ruefli, “Sustained Competitive Advantage: Temporal Dynamics and the
Incidence and Persistence of Superior Economic Performance,” Organization Science 13,
no. 1 (2002), pp. 82–107; G. Hawawini, V. Subramanian, and P. Verdin, “Is Performance
Driven by Industry or Firm- Specific Factors?” Strategic Management Journal 24, no. 1
(2003), pp. 1–17; and T. Powell, “Varieties of Competitive Parity,” Strategic Management
Journal 24, no. 1 (2003), pp. 61–87.
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22 Chapter 1 Winning Moves
6. Hawawini, Subramanian, and Verdin, “Is Performance Driven by Industry or Firm-Specific
Factors?”
7. M. Friedman, “The Social Responsibility of Business Is to Increase Its Profits,” in The
­Management of Values, ed. C. McCoy (Boston: Pitman, 1985), pp. 253–60.
8. “Taking Risks at Intel: Andy Grove, CEO, Intel Corp.,” PBS video, Hedrick Smith, The View
from the Top: Managing Change in the Global Marketplace, 1994.
9. See E. Luttwak, Strategy: The Logic of War and Peace (Cambridge, MA: Harvard University
Press, 1987), p. 55.
10. See J. Quinn, Strategies for Change: Logical Incrementalism (Burr Ridge, IL: Richard D.
­Irwin, 1980).
11. J. Toth, handout, Industrial College of the Armed Forces, 2001, www.ndu.edu/icaf/.
12. Ibid.
13. Ibid.
14. H. Mintzberg, B. Ahlstrand, and J. Lampel, Strategy Safari: A Guided Tour through the Wilds
of Strategic Management (New York: Simon and Schuster, 1998).
15. Ibid.
16. “The Return of von Clausewitz,” The Economist 362, no. 8263 (September 2002), pp. 18–21.
17. Ibid.
18. C. Grimm and K. Smith, Strategy for Action: Industry Rivalry and Coordination (Mason, OH:
South-Western College Publishers, 1997).
19. Mintzberg, Ahlstrand, and Lampel, Strategy Safari.
20. Quinn, Strategies for Change.
21. “The Return of von Clausewitz.”
22. “Taking Risks at Intel.”
23. A. Grove, Only the Paranoid Survive (New York: Random House, 1996).
24. F. Knight, Risk, Uncertainty, and Profit (New York: Houghton Mifflin, 1921).
25. See A. Marcus, Strategic Foresight (New York: Palgrave MacMillan, 2009); H. Courtney,
20/20 Foresight (Boston: Harvard Business School Press, 2001); and M. Raynor, The Strategy
Paradox (New York: Doubleday, 2007).
26. On shaping the future, see G. Hamel and C. Prahalad, Competing for the Future (Boston:
Harvard Business School Press, 1994).
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P A R T
O N E
External and Internal
Analysis
EA
External Analysis
General Environment
Competitive Forces
1
IA
Internal Analysis
Resources, Capabilities
& Competencies
Selection of Options
Business, Global and Corporate Level
Strategies & Tactics
BS + GS + CS + IS
2
Implementation
Marshalling Resources & Making Moves
Evaluation of
Performance
&
Continuous
Reinvention
3
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C H A P T E R
T W O
External Analysis
“The essence of strategy … is … competition. Yet it is easy to view
­competition too narrowly … Competition is not manifested only in the
other players … competitive forces exist … well beyond the established
combatants. The corporate strategist’s goal is to find a position in the
­industry where his or her company can best ­defend itself against
(the sum of ) these forces or can influence them in its favor.”1
Michael Porter, professor of strategy, Harvard Business School
“The airline industry is a volatile industry, but … if you think about the
global economy, many industries are subject to external volatility. The
question is what you do about your business model to buffer and make
the enterprise successful.”2
Richard Anderson, Former CEO, Delta Airlines
Chapter Learning Objectives
• Understanding how to analyze the external environment of the firm.
• Being aware that the external environment consists of several layers—from the broader general
environment to the more immediate competitive environment, which is comprised of both rival and
stakeholder groups.
• Taking note of the many dramatic changes that can occur within the external environment and can
reshape an industry over time.
• Using your analysis of an industry’s characteristics and trends to identify the inflection points and
other opportunities and threats a firm faces.
• Understanding how stakeholder relations, strategic group analysis, scenarios of possible futures, and
response repertoires can be used to construct moves to counter divergent contingencies.
Introduction
Like the chess player described in Chapter 1, a skilled strategist will also “scan the board”
and analyze an organization’s strategic situation prior to making moves. This analysis
24
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Chapter 2 External Analysis 25
EXHIBIT 2.1
The External
Environment
St
a
ke
The Firm
ho
ld
er
Gr
ou
ps
Industry
Environment
Macro-environment
t­ypically begins with a careful look at the dynamic external environment within which the
firm ­operates.
The external environment consists of several elements—from the immediate industry
environment, where the presence of rivals, customers, and suppliers can impact the
­day-to-day moves a firm makes, to the broader macro-environment, where shifts in ­politics,
laws, technology, demography, society, and economy can fundamentally alter the rules of
the game. The strategist must also examine stakeholder groups and groups that affect and
are ­affected by the firm’s activities, and determine how the firm will relate to these groups.
The sum of these three assessments—of the industry environment, the macro-­
environment, and stakeholder relations—constitute external analysis (see Exhibit 2.1).
This chapter provides a working knowledge of external analysis and explains how it can
be used along with internal analysis (Chapter 3) to make better moves.
Industry Definitions
An industry refers to a group of companies offering products or services that satisfy
similar customer needs. This definition highlights important rivalries that exist between
products and services that are substitutes for each other. For example, a metropolitan
restaurant does not just compete with other eating establishments in a city. From the
customer’s point of view, a traditional restaurant provides only one means by which to
satisfy the basic need for food. The restaurant competes with many dining options,
­including company cafeterias, food trucks, fast food eateries, bistros, cafes, convenience
stores, and groceries.
Industries can also be “defined” by various classifying systems. The North American
Industry Classification System (NAICS) is the standard that Federal statistical agencies
use to group similar businesses into clear categories and subcategories. Businesses
within each category share similar characteristics and are subject to similar market
forces. For example, the major classification of transportation contains a subclass for
scheduled airline businesses. These airlines all face similar FAA regulations, fuel supply
risks, and customer pressures. Use of the system, therefore, can help ­analysts mine for
competitively important data. Exhibit 2.2 compares the NAICS, which is hosted by the
U.S. Census Bureau, the International Standard Industrial Classification (ISIC), part of
the UN Statistics Division. Many similarities exist, but there are also differences in the
detailed subcategories that the two systems use. For example, the ISIC has scheduled
and nonscheduled categories that the U.N. Statistics division does not use.
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26 Part One External and Internal Analysis
EXHIBIT 2.2
A Comparison
of Classification
Systems for
the Air
Transportation
Industry
NAICS Classifications for
Air Transport
481 Air TransportationT
4811 Scheduled Air TransportationT
48111 Scheduled Air TransportationT
481111 Scheduled Passenger Air Transportation
481112 Scheduled Freight Air Transportation
4812 Nonscheduled Air TransportationT
48121 Nonscheduled Air TransportationT
481211 Nonscheduled Chartered Passenger Air
Transportation
481212 Nonscheduled Chartered Freight Air
­Transportation
481219 Other Nonscheduled Air Transportation
ISIC Classifications for
Air Transport
Structure
Hierarchy
•Section: I - Transport, storage and communications
• Division: 62 - Air transport
Breakdown:
This Division is divided into the following Groups:
• 621 - Scheduled air transport
• 622 - Non-scheduled air transport
In fact, given their usefulness in analysis, one will find a number of different classifications that have been created by major business newspapers and magazines like
The Wall Street Journal, Financial Times, Fortune, Forbes, Bloomberg Business Week,
and The Economist. Google’s and Yahoo’s finance websites have their own ways of
classifying firms. ­Research organizations like IBIS, MarketLine Reports, and Euromonitor will often point to the NAICS and ISIC systems, but will also create their own
industry classifications in order to keep pace with the continual emergence of new
­industry structures.
It’s important to note that companies generally belong to multiple categories within
these industry classifications and taxonomies. One might ask, for example,
∙ Is General Electric a bank or a manufacturer of industrial equipment?
∙ Is IBM’s main line of business servers, software, or consulting?
∙ How should Dell be classified now that it’s broadened its position from desktop computing to security, service, software, and advice?
∙ Is PepsiCo a soft drink or beverage company, or is it in the snack food business?
∙ Is 3M an automotive and defense industry supplier, a health care and medical products
company, or a maker of innovative tapes, abrasives, adhesives, and special m
­ aterials?
Indeed, these possibilities do not exhaust everything 3M does. It is also active in the
fields of energy and electronics and it has safety, and graphics businesses.
∙ And how does one even start to classify ever-expanding corporations like Apple?
Apple is a PC maker, software company, and designer and seller, but not manufacturer, of mobile devices. It has retail outlets that compete with Best Buy, for example.
At the same time, Best Buy sells Apple products in its stores. To feed these businesses, Apple has created by itself, and in conjunction with software developers,
a nearly seamless personal technology ecosystem. The company has evolved from
­being a desktop PC manufacturer to a firm that spans many businesses. The range of
industries in which Apple now competes is wide-ranging, and it extends from PCs to
mobile devices ­(including smartphones and tablets), to entertainment media and
­mobile payments.
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Chapter 2 External Analysis 27
External Pressures Lead to Industry Movement
Many companies today will migrate from industry to industry. Industry definitions are
dynamic, and industries are hard to pin down because firms’ external environments are
changing so rapidly. This puts pressure on them to create new niches and create new
­industry definitions. Regulatory and competitive forces have quickly blurred the lines
between banks, brokerages, insurance companies, finance companies, and credit card
issuers, for example. Traditional cable operators have seen drastic changes in their industry as well (see Exhibit 2.3).
Another example of the impact of external pressure and opportunity comes from
Medtronic. External pressure and opportunity have compelled this company to move
away from its original heart pacer and stent products. Technological innovation in the
medical device industry has not proceeded fast enough for the company to bring to
­market additional blockbuster products. Government regulations have tightened. Cost
concerns have reduced its margins. As a consequence, the company decided to acquire
Covidien, becoming, in the process, an organization similar in size and diversity to
­Johnson and Johnson. The new Medtronic is competing in such businesses as weightloss surgery and laparoscopy, baby wipes, vitamins, allergy relief, and hospital furniture.
In acquiring Covidien, Medtronic also obtained intellectual property (IP) and service
offerings while hedging its exposure not only to the U.S. regulatory, but also to the U.S.
tax environment. Medtronic no longer is headquartered in the U.S. and is not subject
to U.S. corporate taxes.
Perhaps the most striking example of industry migration is provided by Amazon. In
what industry does Amazon, active in bookselling, online retailing, the streaming and
EXHIBIT 2.3
Comcast and
the Evolution
of the Cable
Industry
Traditionally a cable operator, Comcast has spent the past several years responding to opportunities and threats that
originate in technological change (the ubiquity of the Internet and streaming), government regulation, which favors an
open Internet that does not permit Comcast to prioritize and charge more for some customers’ access, and changes
in customer tastes (cord cutting or the fact that many customers no longer are interested in paying for a full array of
stations on cable television). These developments are not all related but together inasmuch as they take away from
Comcast’s control over its customers, they pose a very strong challenge to the company’s business model.
In a preemptive move it chose to acquire Universal production studios and NBC from GE. In doing so, it sought to
enhance its bargaining position vis-à-vis the providers of the programming it buys from the other studios and
­networks. Comcast is trying to compensate for its loss of control over its customers with greater control over its
suppliers. If customers are going to have more choices, Comcast is going to try to ensure that its suppliers, the
studios from whom it buys programming, have fewer choices. By owning its own network, Comcast is making the
statement that it is going to be less dependent on these studios.
In making this move Comcast has pushed the limits of conventional industry boundaries. It is now itself a studio as
well as a provider of cable and Internet services. Comcast has pushed industry boundaries several times as it has
evolved from its roots as a cable TV operator to phone, Internet, and content provider because of opportunities
and threats that arose in the external environment.
Yet how easy will it be for Comcast to manage its diverse businesses? Companies that have gone through a similar
evolution have not always fared well. When Westinghouse bought TV network CBS and Sony bought movie studio
Columbia, their fortunes declined. They were neither strong competitors in their existing industries nor in the new
industries into which they had drifted.
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28 Part One External and Internal Analysis
production of entertainment, the running of large warehouses, and the operation of one
of the world’s most sophisticated logistic systems, not compete? The company’s most
profitable unit rents space to large organizations like the U.S. Defense Department on
the cloud. In an article in the New Yorker, George Packer describes it as a global
­superstore like Walmart, a hardware manufacturer like Apple, a utility like Con
­Edison, a video d­ istributor like Netflix, a book publisher like Random House, a production studio like Paramount, a literary magazine like The Paris Review, and a grocer
like FreshDirect.3
The company is moving in the direction of one day possibly becoming a package service
deliverer like United Parcel Service (UPS), bringing goods to homes not via truck but via
drone. Amazon founder and chief executive, Jeff Bezos, also owns the Washington Post.
Other than the firms already mentioned, its rivals also include Barnes & Noble, eBay,
Google, and Time Warner.
Amazon is sui generis or a category of one. Though nearly every firm competes with
it, none is quite like it. It has established its own niche, one without direct competitors,
but what it lacks in direct competitors it makes up for in indirect competitors. Is it better
for a company to be locked in to competition with a few major rivals or to be spread out
like Amazon and engaged in separate battles with many competitors? Today, with nearly
every firm straddling industry boundaries, migrations across industry boundaries may
place fast-moving, flexible firms like Amazon in unique positions to achieve competitive advantage.
Industry Moves, Implications, and Trade-Offs
The opportunities and threats entailed in industry hopping are best understood via an
analysis of a firm’s external environment. Tough questions must be confronted. For
­instance, given the state of the economy and changing demographics, how should a firm
position itself for success across the breadth of industries it has created or joined over the
long term? What is the best way to grapple with emerging technologies and rivals?
Should a company remain focused and increase its own R&D efforts? in order to become
a technology leader? Or should it seek economies of scale and the relative safety of
­acquiring a firm in a similar or an adjacent industry instead?
These choices mandate trade-offs. Which strategic moves should a firm emphasize?
Should it aim for radical and disruptive innovation or more modest, incremental innovation, or emphasize dominance in an already well-established and even stagnant industry
space? Each of these moves can lead to growth or decline in revenue and profitability.
Each has consequences for the character of a business, the type of employees it attracts,
and company identity.
Consider the consequences of making the wrong move. An example would be
­Target. Rather than further differentiating itself from mass market rival Walmart and
developing its chic fashion-based image, the company chose to expand into Canada,
where it failed miserably. Had its top management made a different choice, the company might not have incurred a vast amount of debt and put itself in the position where
it had to lay off thousands of employees. Target responded wrongly to the economic
downturn that began with the Great Recession of 2007. It concluded that it had to
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Chapter 2 External Analysis 29
compete based on price and economies of scale rather than on further differentiating its
products. The macro-environmental shock of the financial decline elicited what, in
retrospect, was the wrong response from its top managers. Competitive advantage can
be lost as well as gained by choices top executives make in response to changes in
macro-­environmental conditions.
A thorough external analysis is needed to address the opportunities and threats that
emanate from changes in the macro-environment, but it must be applied carefully and
systematically and used thoughtfully, knowing that the perfect adjustment to changing
external conditions is unlikely to be achieved. Team judgements play a role in what corporations decide to do, and the judgements of teams are far from perfect.
This process is not mechanical. A company must monitor the implementation of its
moves to discover what is resonating with customers, countering competitive forces
and delivering results—and what is not. It has to be willing to make strategic retreats
in a timely manner. Ideas must be tested against reality, and moves must be continually
recalibrated as information is gathered. Hard questions need to be addressed, such as:
How long should a company stick to a course of action that seems to be failing? When
does it know for certain that it cannot achieve desired results if it stays its course?
Companies need the flexibility to adjust quickly and to move in and out of initiatives,
yet not to be so agile as to lack the patience to make a go of needed efforts.
A Framework for External Analysis
With the aim of choosing a dominant strategy, and the flexibility to include some
hedges should the dominant strategy not work out, it is good practice to focus on three
key questions:
1. Is the game good? Michael Porter, professor of strategy at the Harvard Business
School and the originator of industry analysis, offers this first and most critical
question.4 The answer to this question lies in each industry’s basic economic features,
its competitive forces (customers, suppliers, competitors, substitutes, and new
entrants), and the influential role that stakeholders play. Together, these elements
reveal whether an industry is inherently more attractive and profitable than others.
Being in a profitable, growing industry provides a unique advantage, as most
academic studies suggest that 20 percent or more of competitive advantage is
determined by industry.5
2. What is our position in this game? Sustained competitive advantage does not arise
simply from being in a good industry. It is critical to position a firm advantageously
relative to its competition, and to capitalize on this advantage. Positioning can determine whether a firm is a laggard or a dominant force.
3. Should we stay in this position for the long term? In the short term, there may be
ample profits and growth in a strong position or segment in a declining industry,
but that position may not be viable in the long term. A company must be able to
plan exit and switching strategies that match different time horizons. This question
requires the strategist to examine the dynamic driving forces shaping an industry
over time.
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30 Part One External and Internal Analysis
Industries are not stable. They are continually transformed by changes in macro-­
environmental conditions, including a fluctuating economy, the vicissitudes of government policies and regulations, developments in technology, changing demographics, and
perturbations in the natural world, such as the availability of resources—air, water, and
land, for example—on which economic activity depends. These macro-environmental
forces alter the relations between a firm, its customers, suppliers, rivals, new entrants, and
substitutes. It is critical to scan for changes in these conditions in different time horizons.
They must be identified and tracked because of their effects on an organization.
Questions a firm should pose are: How long should it stay in the businesses in which
it currently operates, when might it leave these businesses, and where should it go if it
leaves? Where are there better opportunities than the current set in which it operates?
The future cannot be predicted or forecast with certainty, so the best that can be done is
to define a set of likely scenarios that account for the risks and uncertainties an industry
­inevitably will confront.6 ­Consider the likelihood of the best possible outcomes, the
worst possible outcomes, and a set of surprises that might take place. Does a company
have an action plan that will help bring about the best possible outcomes, that will help
avoid the worst possible outcomes, and that will help the organization deal with surprises that could take place?
The organization must be ready for different possibilities. Industry analysis is not
static. Industries are forever changing. Thus, answering these questions is needed to help
prepare for the future, to help decide whether to stay engaged in an industry and segment, or instead to capitalize on opportunities emerging in other industries and segments, and move.
Deciding If the Game “Is Good”
A growing industry offers the average player the chance to realize growth, whereas a declining one provides scant opportunities even for very strong competitors. So, it can be very
helpful to consider the overall size of the industry and where it is in the industry life cycle—
whether it is a growing, maturing, or declining industry (see Exhibit 2.4).
It also is necessary to know a firm’s rivals—how many exist and whether and to what
extent their offerings are similar or different than those of the firm in question. The game
quickly descends into a pricing war if customers do not perceive any differences in the
EXHIBIT 2.4
The Industry
Life Cycle
Introduction
Growth
Maturity
Decline (or Rebirth)
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Chapter 2 External Analysis 31
products and services offered. With many rivals and little differentiation, margins ­narrow
and industry profitability suffers.
Companies in mature and declining markets, such as Hormel, attempt to create
­differentiation. Hormel evolved from a firm that competed as a commodity fresh pork
products producer to a firm that has strong branded presence with numerous valueadded, shelf-stable, ready-to-eat offerings. Such moves allowed it to escape the downward spiral of a declining industry. They allowed for a rebirth with positive effect on the
firm’s stock price and its ability to sustain shareholder dividends. Similarly, Campbell’s
condensed soups were a commodity that struggled against private label brands that
­delivered similar value to customers at lower prices. To fight off decline, Campbell’s
reinvented its soups as chunky, home-style, organic, and convenient.
The Best Game
Industrial organization (IO) economics suggests that the best game is one with virtually
no competition. It instructs a firm to strive to be a monopolist, but do it fairly so that federal
antitrust officials do not bring it to court. Current antitrust doctrine has no problem with
very high market shares so long as there is free entry and a company plays by the rules.
Only if there is evidence that it achieved a high market share by means of anticompetitive
practices is a firm likely to be taken to court. According to IO economics, the best games
have more features of a monopoly than of perfect competition. There are fewer firms,
higher barriers to entry, and fewer homogeneous products. The firm benefits at the expense
of customers and suppliers, who have no choice but to deal with that firm.
To reduce competition, the aim of the firm should be to create highly sought-after,
unique offerings. If customers and suppliers exhibit a need for that category of offerings,
they have nowhere else to turn but to the firm in question. The firm should raise as many
barriers to imitation as possible so that it can maintain its virtual monopoly in its chosen
segment for as long as possible. Consider Intel. It has had a semi-monopoly position of
at least 80 percent of the PC/server microprocessors market for more than 30 years. It
protects this position in many ways including regular innovation, scale economies, and
bringing expensive patent infringement suits against competitors.
In creating barriers to entry, consider also geographic scope. If a firm achieves economies of scale and global scope, it may be in a better position to withstand the competition. Also, if a firm is supported by generous subsidies and favorable government
policies, it is difficult for other firms to mount a challenge against it. Companies that
have achieved a global footprint and have been afforded government protection are more
likely to maintain competitive dominance.
Capacity utilization is another factor that plays a large role in suppressing competition. Firms should build capacity globally and make sure they have sufficient market
demand to use it fully. Firms with idle assets—facilities, people, and so on—bear the
large costs of maintaining idle and unproductive assets and, therefore, are highly motivated to lower prices and engage in aggressive price wars to win business. Under these
conditions, everyone in an industry suffers.
The steel industry provides an example of how low-utilization rates ruin a game (see
Exhibit 2.5). Production has remained fairly consistent while utilization has dipped
­significantly (due to a number of factors). Excess, underutilized capacity has placed a
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32 Part One External and Internal Analysis
90
2,000
85
1,500
80
1,000
75
500
70
0
65
Capacity Utilization
Rate (%)
Excess Capacity
Production
0
20 0
0
20 1
02
20
0
20 3
0
20 4
05
20
0
20 6
0
20 7
08
20
0
20 9
10
20
1
20 1
12
20
13
2,500
20
Source: http://www.
epi.org/publication/
surging-steel-imports/.
Millions of metric tons
Low Utilization
Rates in the
Steel Industry,
2000–2013
Percent
Global Crude Steel Production, Capacity, and Capacity
Utilization, 2000–2013
EXHIBIT 2.5
significant cost burden on manufacturers while prices continue to drop in response to
ever-abundant supplies. As a result of these dynamics, the OECD has predicted that the
operating profitability of steel manufacturers will remain at unsustainable levels since
global capacity utilization is not likely to exceed 75 percent in coming years.7
Scale Economies and Learning Curves
Scale economies and learning curve effects require a company to increase its size and
experience in order to be competitive. These are powerful barriers to industry entrants.
Those without scale or experience find an industry unattractive and unprofitable. They
do not have the leverage needed to obtain good pricing from suppliers, nor can they
match the highly honed and efficient processes of firms with experience.
The ability to learn and achieve scale quickly also has a significant impact on a firm’s
ability to survive and thrive. When McDonald’s invested in Chipotle in 1998, it infused
a 14-store experiment based in Denver with its cash and knowledge. The new chain
flourished. By 2005, there were 460 Chipotle’s restaurants, and the chain was adding
100 restaurants a year. Scale economies and leavening effects contributed to Chipotle’s
rapid ascent. Startups could not easily meet Chipotle’s numbers, which were supported
by McDonald’s size and experience. It is estimated that each outlet brought in yearly
sales of $2.1 million and throws off cash flow of $574,000.8
Government Policies
Government policies can totally change the rules of the game. Some of the most
­noteworthy impacts on industry viability come from them. Regulation and taxation are
especially critical. They can change buyer behavior via subsidies, loan guarantees, price
controls, and other means. Prevailing politics provide industries with opportunities and
hamper their growth, hence the presence of lobbyists at the state and federal levels.
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Chapter 2 External Analysis 33
Governments pick winners and losers when they impose taxes and tariffs; thus, government lobbying strategy is needed.
An interesting example of how firms respond to government policies is the current
trend toward corporate inversions. An inversion takes place when a firm reincorporates
outside of its current national jurisdiction in order to reduce its tax burden. Inversions
point to the significant effects of tax policies. Procter & Gamble and Unilever both
sell detergent all over the world, but their tax situations are quite different because
P&G is based in Ohio in the U.S., and Unilever is based in Rotterdam in the
Netherlands. The U.S. cannot tax Unilever’s non-U.S. profits; meanwhile, Unilever’s
home countries (Britain as well as the Netherlands) have corporate tax systems that
favor big businesses. Simply because of divergent tax policies, Unilever is better
positioned than P&G.9
Some government policies limit access to the game by imposing requirements
smaller businesses cannot meet. High pollution-control costs are a bigger burden on
small businesses, as are costly measures to ensure worker safety and provide ­employee
benefits. Labor laws may make it difficult for businesses to operate in certain countries. For example, facing a 35-hour working week, entrenched union rights within
companies, and a strict 3,500-page labor code, it is hard for companies to operate in
France and other EU countries.10
Demographics, Natural Resources, Technology, and Culture
Demographics, natural resources technology, and culture also differ in the various countries in the world with firms in some industries being impacted more severely than firms
in other industries. Firms in some industries, for example, benefit from the aging of the
population. Pharmaceutical and medical devices companies benefit from greater demand
when populations age. Firms in other industries, like social media and entertainment,
disproportionately ­benefit when the population is young. Energy costs are not the same
everywhere. They disproportionately affect firms in industries like airlines, electric
­utilities, and trucking more than firms in other industries. Firms in some industries do
well when technologies change rapidly, while firms in other industries do well when the
pace of technological changes slows down. Changes in culture, which affect patterns of
­leisure behavior and discretionary spending, disproportionately influence companies in
some industries more than others. These macro-forces affect the structure of an industry
and determine the ­extent to which the game that the players in an industry are playing is
a good one.
The Five Forces
External factors cause inflections to take place in the five forces that determine i­ ndustry
profitability. The five forces framework, a simple, but powerful and elegant, tool for
understanding where the power lies within an industry, best summarizes the factors
­affected.11 Beyond established rivals, an industry consists of four other competitive
forces: substitutes, customers, suppliers, and potential entrants. Only with a clear understanding of these forces is it possible to assess the overall attractiveness of a company’s
industry and to act decisively to improve and strengthen its position (see Exhibit 2.6).
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34 Part One External and Internal Analysis
EXHIBIT 2.6
Entrants
The Five-Forces
Framework
Source: http://hbr.
org/2008/01/the-fivecompetitive-forces-thatshape-strategy/ar/1.
Suppliers
Rivalry
Between
Existing
Competitors
Buyers
Substitutes
Rivals
Rivals are an organization’s existing competitors that engage in repeated and regular
moves against each other. In some industries, rivalry is exceedingly high, and profits are
eroded due to each firm’s competitive moves. In other industries it is not high because
there is mutual forbearance, and exceptional margins and profits are easier to sustain.
Based on the nature of the industry, the moves rivals make to undercut each other include
price cutting, increased advertising, product/service giveaways, and rapid innovation.
Each of these moves adds to a firm’s costs. The presence of aggressive rivals keeps a cap
on prices. If profit margins are squeezed by a high level of competition, the industry is
less than an ideal one.
Factors that increase rivalry are:
∙ A large number of undifferentiated firms competing for the same customers and
­resources.
∙ Low switching costs for customers who shop for the best deals.
∙ Slow or declining industry growth, which, in contrast to rapid growth, requires firms
to seize market share from other companies to improve their top-line revenues.
∙ High overhead that motivates firms to raise their scale of operations to cover fixed costs.
∙ Rapid product perishability and high inventory-storage costs, which necessitate that
firms move their products quickly.
Barriers to exit exist when firms make investments in highly specialized capital
equipment or assets that cannot be easily transferred. Manufacturers, whose equipment
often serves very specialized purposes, face exit barriers. They would rather “fight to the
death” than take a massive loss on the sale of these assets.
New Entrants
Existing rivals are not the only concern. Profitable industries with high growth inevitably attract new entrants. Industries that do not change rapidly provide opportunities for
such entrants to introduce product and service innovations. They can tweak the grounds
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Chapter 2 External Analysis 35
for competition in an industry by offering much cheaper and stripped-down products and
services. An example is ARM Holdings, PLC simplified, low-power architecture for
mobile telephony and other applications. New entrants can also change the grounds for
competition by ­offering much-higher-priced luxury goods. An example is Tesla’s move
into the auto industry with its luxury vehicle offering.
The threat of potential entry is easier when access to supply and distribution is open,
capital investment requirements are minimal, customer loyalty is weak, and existing
competitors are unable to retaliate against new competitors. Powerful, well-capitalized
firms in adjacent industries constantly threaten to break down industry boundaries as
these boundaries become more permeable, and they see opportunities in moving outside
their sphere of influence. Monster Beverage is a good example. Once a fruit juice
company called Hansen’s that was commonly found in health food stores, it saw an
­opportunity in the adjacent industry of energy drinks and transformed itself into a
­company devoted to this beverage type. Monster grew very rapidly in the face of
weakening demand for the conventional soft drinks offered by Coca-Cola and Pepsi.
Substitutes
Monster’s energy drinks became an established player in the energy drinks space, it
­became a viable substitute for the carbonated beverages that Coca-Cola and Pepsi
­offered. The power of substitutes is another factor affecting industry attractiveness.
Other substitutes to soft drinks are milk, tea, juices, water, coffee, beer, and various
­spirits. In many applications, plastic, aluminum, metal, paper, and other materials substitute for each other. There are many substitutes for a person’s leisure time, such as following professional and college sports teams, fitness centers, concerts, movies, books,
TV shows, ­hiking, fishing, churchgoing, and other activities.
Good substitutes lower industry prices and decrease profitability. Customer loyalty is
weakened. Quality and switching costs play a role, but they cannot block the attraction
of substitutes that fulfill similar needs. E-mail and electronic bill paying quickly made a
large inroad on the business of the mail service. ATM machines rapidly encroached on
the space once reserved for local bank branch offices and tellers. The new technologies
are faster and often more secure. Given the presence of technology-based substitutes for
letter-sized deliveries, the U.S. Post Office has had to switch its focus in order to compete with FedEx and UPS for parcel delivery business.
Suppliers and Customers
Suppliers and customers also have major impacts on industry attractiveness. Suppliers
and customers with credible options to turn elsewhere are less dependent on a firm and
can bargain away the profits a company hopes to earn.
Companies that depend on just a few suppliers and have nowhere else to go for critical inputs are in a weak position. Strong suppliers with many options for selling their
goods and services can exact a high price from companies and erode the profits they
hope to earn. A supplier with the right capabilities can move forward in the supply
chain and pose a direct challenge to a business. Rather than provide inputs for products,
it can make the product itself and become direct competitor. If a firm is a retail channel
to customers, manufacturers can sell directly to customers and thereby weaken the
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36 Part One External and Internal Analysis
firm’s position. Dell sold its PCs and servers directly to businesses with the intent of
eliminating the firms in the middle.
If a firm’s customers have many choices and free access to competing products
and services, the firm’s position is weakened. It may have to drastically lower its
prices to maintain sales, thus diminishing its profits. The more choices customers
have, the less power firms have over them. Like suppliers who move forward in the
value chain, customers can move backward when faced with unfavorable conditions,
such as limited supply, high costs, or low quality. If they have the capacity to acquire
critical inputs and the skills to combine them into finished goods, they can threaten to
make these goods themselves. Delta Airlines’ purchase of the Trainer refinery in
2012 was a move designed to reduce its dependence on its suppliers and control its
largest input cost, fuel.
Sustained Competitive Advantage
Within the framework of the five forces, sustained competitive advantage (SCA) consists
of having power over suppliers, customers, competitors, new entrants, and substitutes so
that they are dependent on a company and not vice versa. Power is the key to SCA.
Power in the IO economics framework defines a good industry. With power over the five
forces, a company has competitive advantage. If it holds onto this power for a long
­period of time, it has sustained competitive advantage. Without this power, it is vulnerable. It cannot demand the best input prices, capture and retain the most profitable customers, and insulate itself from the competition, no matter whether the competition is
existing rivals, potential entrants, or substitutes.
Industry Dynamics
Historically, one of the most attractive industries in which to participate was the pharmaceutical industry, and one of the least attractive was the airline industry, but how
times have changed! According to Morningstar, the five-year return on the airline
­industry as of 2015 topped 20 percent while profits were contracting in pharmaceuticals (see ­Exhibit 2.7).12
Industry dynamics, which include the five forces, constantly evolve in the face of
the pressures from the macro-environment and the moves firms make. Industries experience inflections where their directions shift. A company operates with great peril if
it fails to grasp the essential point that i­ ndustries are dynamic.
EXHIBIT 2.7 A Ranking of the Airline and Pharmaceutical Industries by Stock Return,
2010–2015
Source: http://news.morningstar.com/stockReturns/CapWtdIndustryReturns.html.
Total Returns (August 17, 2010–August 17, 2015)
Industry Name
1-Year
3-Year
5-Year
Airlines
Pharmaceuticals
28.19
12.76
36.65
22.16
20.75
19.24
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Chapter 2 External Analysis 37
Pharmaceuticals—A Five-Star Industry under Fire
Pharmaceuticals were once considered a five-star industry because all five forces were
aligned to the industry’s benefit. Historically, companies in this industry were friendly
competitors that did not try to undermine each other through ruthless price cutting.
The competitive positions of pharmaceutical companies were based on small ­differences in
brand and reputation. Within the industry, there was room for each company to earn very high
returns. Barriers to entry into the pharmaceutical industry were high for the f­ ollowing ­reasons:
∙ Pharmaceutical companies had large sales forces of so-called “detail” people, who made
regular visits to physicians, informed them about new drugs, and gave them plenty of
samples, which the physicians valued. The physicians tended to become familiar with
these sales reps and to trust them. It was difficult for an industry newcomer (potential
entrant) to duplicate the relationships the “detail” people had developed with doctors.
∙ The cost of research and development was extremely high. A new entrant could not
easily duplicate the trained staff and laboratories of an established company because
of the difficulties involved in attracting scientific talent and setting up complex and
sophisticated laboratories. Furthermore, a new entrant did not have experience
­obtaining government approval for new drugs, an arduous process that contained
many pitfalls and could constitute more than 60 percent of drug development costs.
∙ Only experienced pharmaceutical companies were likely to have the requisite social
and political capital and the know-how to not only develop a drug, but also get it
­approved. With entry barriers such as these, it was little wonder there were few new
entrants into the industry.
∙ Because the pharmaceutical companies held patents on their new products, substitutes were scarce or nonexistent.
∙ The buyers—doctors, patients, and health insurance companies—were not particularly price sensitive. According to the physician, the patient had to have the drug in
question—there was no choice. If the patient’s illness was life threatening or
­extremely ­debilitating, the patient was not likely to bargain about price. In addition,
because health insurance organizations were increasingly covering the costs of drugs,
many patients had little incentive to protest. Consumer bargaining power was weak.
∙ The bargaining power of suppliers also was weak. The ingredients in most drugs
were not very expensive; they were commodities and accounted for only a fraction of
the cost of finished products. There were many suppliers, so a pharmaceutical company could choose where it would buy ingredients.
But the favorable forces that historically had prevailed in pharmaceuticals began to
erode. Four important changes occurred:
∙ The buyer, who previously had been indifferent about price, became increasingly cost
conscious. With the price of pharmaceuticals rising much more rapidly than the inflation rate, insurance companies and government agencies became concerned and
­began to demand cost containment.
∙ The Food and Drug Administration’s (FDA) approval of new drugs moved at a glacial speed. Just 18 to 24 new drugs were approved per year from 2005 to 2008. This
pace was not sufficient to make up for the large number of looming expiring patents.
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38 Part One External and Internal Analysis
∙ Generic drugs became more widely available as substitutes for brand-name drugs.
­Generic drugs provide the same therapeutic properties and benefits as name brands,
but at a lower cost. Government insurance programs, as a consequence of concern
about the costs of health care, required that generics be dispensed when available,
rather than brand-name drugs.
∙ Advanced research methods lowered the cost of drug development, weakening barriers
to entry. Companies with skills in biotechnology, such as Genentech, were able to enter
the industry. They had the potential to revolutionize the drug development process and
thereby undermine the structure of the industry and lower its overall profitability.
In an effort to improve this situation, companies have unveiled a flurry of mergers or
hostile bids and have cut thousands of jobs. According to consulting firm Challenger,
Gray & Christmas, the pharmaceutical industry has cut 297,650 jobs since 2000.13 Pharmaceutical manufacturers must search for new niches to expand their existing product
pipelines. They are also trying to develop generic biotech drugs, called biosimilars, as a
new type of revenue source. The FDA finally is approving some biosimilars for patient
use. Other generic biotechs, which have been sold in Europe, are just on the cusp of FDA
approval in the U.S. Although the game is still undecided, it is certainly not as great to
be in this industry as it was in the past.
Airlines—A No-Star Industry Redeemed
The deregulation of the airline industry in the 1980s, on the other hand, led to a no-star ranking of the airlines compared to the pharmaceutical industry’s five stars. With the stroke of a
pen, the government permitted new entrants into the industry, prices were no longer fixed,
customer choices and power improved, and airlines were forced to compete on nonessentials,
such as food or the color of their planes. Profits quickly deteriorated for the following ­reasons:
1. Buyer loyalty was low because there was little differentiating one airline from
­another. Thus, ticket price became the main factor determining which airline a
consumer would use.
2. Although travelers had always had the choice of traveling by car, rail, bus, or boat,
­advances in telecommunications enabled further substitution. Business conferences
could be conducted remotely.
3. The main suppliers to the industry also had power. The companies that manufactured
the engines, assembled the planes, and supplied the fuel were large corporations with
clout. The pilots themselves were a highly skilled group with influence.
4. Government meddling with free-market forces persisted for years. As airlines were
considered a critical part of the infrastructure—and those on Capitol Hill feared for
their political lives if routes to their hometowns were cut—many of the U.S.’s large
carriers were propped up and continued to operate despite the fact that there were
significant amounts of excess capacity throughout the system.
5. The airlines had little power over customers, and their rivalry was intense and sometimes bitter. Since carriers were going to make scheduled flights regardless of how
full the planes were, the costs of adding an incremental passenger to sparsely booked
flights were low. Thus, price wars among carriers ensued, and these wars lowered the
profit levels of all the carriers.
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Chapter 2 External Analysis 39
In response to this vexing situation, the industry’s existing carriers began to make a series of moves. Gradually, the government began permitting mergers of major carriers,
and the excess capacity was eradicated from the system through the following:
∙ Carriers created hub-and-spoke systems. A hub is a central airport through which
flights are routed, and spokes are the routes that planes take out of the hub airport. The
hub-and-spoke system attempts to make sure that planes are fuller. In addition to filling planes, these systems give the airlines greater power over customers by limiting
choices. Some cities are served by only a single airline, leaving customers no choice.
∙ The carriers established frequent-flyer programs in an attempt to raise customer
switching costs. In addition, they created sophisticated management information systems used for ticketing and routing. Developing these systems involved huge investments that raised the barriers to entry.
∙ To keep their costs in line, the airlines renegotiated contracts with the powerful pilots,
flight attendants, and mechanics unions. The power dynamics have shifted drastically,
with many carriers outsourcing heavy maintenance to the provider that can offer an
acceptable level of quality work at the lowest price.
∙ Carriers also purchased newer, more fuel-efficient aircraft. The creation of the highly
subsidized European Aeronautic, Defense and Space Company—now called the Airbus Group—provided carriers with an attractive alternative to Boeing aircraft.
∙ Pricing models changed, and seat configurations were optimized. Planes were ­designed
to pack as many revenue passengers as possible per square inch of cabin space. As a
result, carriers commanded a premium for additional legroom and no longer bore the
costs of many amenities. In addition, most baggage fees, booking fees, Internet, and
food service have been passed on to the consumer, allowing airlines to achieve
­competitive base ­pricing while giving customers the freedom to customize their own
flying experience.
∙ Lastly, the push by major carriers for industry consolidation finally began to pay off.
The U.S. Department of Justice began to permit a series of industry mergers. The
U.S. airline industry has been whittled down to four major carriers (see Exhibit 2.8).
These deliberate strategic moves, coupled with the changes in the industry’s macro-­
environment, have increased the power of the airlines over their suppliers and customers.
EXHIBIT 2.8
The
Consolidation
of Major U.S.
Airlines
Source: Based on
infographic provided
at http://money.cnn.
com/infographic/news/
companies/airlinemerger/.
Airline
AMERICAN
TWA
‘00 ‘01
‘02 ‘03 ‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10
‘11
‘12
‘13
‘14
‘15
American
America West
US Airways
DELTA
Northwest
UNITED
Continental
SOUTHWEST
Airtran
Delta
United Continental
Southwest
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40 Part One External and Internal Analysis
Now, potential entrants must also overcome greater barriers to survival as they compete
against carriers with massive scale and market knowledge. Although this game is certainly still a tough one—and carriers are still quite vulnerable to external shocks to the
economy, drastic swings in fuel prices, and disease and terror concerns—the airline
­industry posts much ­stronger profitability, and its players are in a far better position to
weather storms that may come their way.
Transient Industry Attractiveness
Industry attractiveness is inherently transient. Airlines are now among the top performers, while pharmaceutical manufacturers must grapple with a much more challenging
external environment. The same type of twist in fortunes can take place in any industry.
Thus, firms must be on guard and carefully monitor the macro-environment and its
­impacts on the five forces. They must be one step or more ahead of the pack in the moves
they take to counter these trends or to adjust to their inevitability.
The choices are to stick it out and fight for what remains in industries that may be
losing their attractiveness or to make the difficult journey of entering a new industry that
for the time being appears to be more attractive. In the new industry, a firm will have to
contend with the existing players, and unless it brings some fundamental innovation to
customers, it is likely to be crushed by the existing competitors. Yet fundamental disruption is possible if prices are cut drastically, superior features are introduced even at premium prices, or breakthrough technologies are presented.
Thus, though planning and executing a move from industry to industry is far from a
simple matter, it is not impossible. A pharmaceutical company can never easily switch
its assets to the airlines industry nor can an airline company ever easily switch its assets
to the pharmaceutical industry, no matter what the relative attractiveness of the industries is. However, within the domains of their existing industries, firms do have options
for ­revitalizing stagnant business models.
Stakeholders
By positively interacting with its stakeholders, a company may gain the leverage it
needs to make difficult industry transitions. A stakeholder is any group that affects,
and is affected by, a firm. External stakeholders include not only the five forces and
many elements contained in the macro-environment as discussed previously, but also
scientific and technical organizations, local communities, the media, the general
­public, and representatives from the many groups in society. A company must also be
heedful of internal stakeholder groups, such as shareholders, board members, managers, and employees.
Agency theorists hold that the primary stakeholder—the one that corporations must
serve first—is the owner/shareholder.14 This group, they argue, takes on the biggest
risk: In the event of bankruptcy, owners are residual claimants and are the last to be
paid back. These theorists, therefore, maintain that the sole purpose of managing relations with other stakeholders is to maximize returns to shareholders. A firm has legal
and ethical, as well as economic, obligations to each of its stakeholders, but the obligation to shareholders comes first.
Agency theorists also caution that giving managers latitude to prioritize other
stakeholder needs over those of the owners and investors can lead to abuse: Managers
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Chapter 2 External Analysis 41
can say they are serving the interests of other stakeholders when, in fact, they are
­operating the corporation for their own benefit and enriching themselves at the ­expense
of shareholders. Despite the role that boards are supposed to play on behalf of shareholders in controlling corporate management, these abuses have been common. The
top management in companies such as Enron, WorldCom, and Tyco were accused of
looting their companies at the expense of s­ hareholders.
Stakeholder theorists, on the other hand, dispute the claim that the primary stakeholder has to be the shareholder.15 They hold that a firm’s management can actually
choose which group it would like to be the primary stakeholder—and that the firm will
see a benefit when it (1) fully understands the relative impact of each of its stakeholders
and (2) can effectively prioritize the management of these groups. The actual approach
that organizations take toward their stakeholder groups varies across the globe. Japanese
firms, for example, tend to have a more balanced view of their responsibilities and the
groups they serve than do U.S. firms. They often mention employees and society before
shareholders, while most U.S. firms continue to declare that their primary obligation is
to shareholders. Under legal structures called co-determination in law, European firms
have obligations to both shareholders and workers.
In the U.S., firms incorporated in Delaware, the most common state for incorporation, are, within certain limits, required to put shareholders first. However, some
states, like ­Minnesota, have a broader conception of the relations between a firm and
its stakeholders and give firms the right to serve the interests of multiple stakeholders.
What firms are ­legally required to do, what they proclaim they do, and how they
­behave are not necessarily consistent. Typically, corporate publications put customers
first, not shareholders.
Yet r­ egardless of whether a firm chooses to place top priority on shareholders or on
other stakeholders, it is prudent for a business corporation to carefully consider the needs
of all stakeholder groups. Some groups have to be managed very closely and handled
carefully, while others can simply be monitored. A tool such as an influence/impact matrix can help organizations assign priorities to the stakeholder groups that vie for their
attention. Exhibit 2.9 shows how such a matrix could be used to prioritize a medical device manufacturer’s external stakeholders.
EXHIBIT 2.9
The Needs of a
Medical Device
Manufacturer’s
External
Stakeholders
HMO’s
& Insurers
Community
at Large
Low Interest
High Influence
Keep
Satisfied
High Interest
High Influence
Manage
Closely
Low Interest
Low Influence
Monitor
High Interest
Low Influence
Keep Informed
Doctors &
Regulatory
Authorities
Interest
Level
Patients
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42 Part One External and Internal Analysis
Establishing strong ties of reciprocity with stakeholders where incentives are given
for them to ally and affiliate with a firm and contribute to its success is one way of countering competitive threats and mastering the five forces. Strong ties of this nature may
also allow a company to establish itself within a weak industry as a strong player. Within
a rising ­industry, it can assist a company in becoming a leader.
Strategic Group Analysis
The second question of this chapter’s external analysis framework is “What’s our position in this game?” Conducting a strategic group analysis can provide valuable answers
to this question—and it can also help a firm grapple with the transiency of competitive
advantage over time.
A strategic group map can help answer these key questions:
∙ Where are the relevant players positioned in an industry?
∙ Is our firm in a crowded group—one of many firms competing in similar ways for the
exact same set of customers?
∙ Or, does the company hold a unique position that allows it to stand out from the crowd?
∙ What strategies and/or events have led to the unique position each holds?
∙ Between which groups is rivalry the greatest?
∙ Which players are strongest or weakest?
∙ Do external pressures favor some groups over others?
∙ Which strategic moves are the rivals with strategic groups likely to make next?
∙ With the above in mind, does our firm’s current position provide it with relative
­advantage or disadvantage in comparison to its competitors?
Mobile Phones
The strategic group map shown in Exhibit 2.10 provides an understanding of how the
mobile phone industry evolved between 2011 and 2014. During that time, the industry
EXHIBIT 2.10 A Strategic Group Map of the Mobile Phone Industry, 2011 and 2014
2011
2014
High
RIM
APPLE
NOKIA
Samsung
ZTE
HTC
Huawei
LG
Sony
Reliance on Proprietary
OS Platform
Reliance on Proprietary
OS Platform
High
APPLE
BB
Huawei
Xiaomi
Lenovo
ZTE NOKIA
Samsung
LG
Low
Low
Narrow
Corporate-Level Diversification
Broad
Narrow
Corporate-Level Diversification
Broad
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Chapter 2 External Analysis 43
included firms that were narrowly focused on telecommunications and others that were
broadly diversified, like Samsung. Samsung’s product families, for example, ranged
from smartphones to appliances. Its position along the x-axis of the strategic group map
(representing corporate-level diversification) was farthest to the right.
Industry participants were also differentiated based on the operating systems that
they utilized—some chose to create proprietary software, while others did not. This
choice has been mapped on the y-axis. The players and positions that claimed the greatest shares of the market inhabit the circles with the largest areas. Revenue changes are
shown by the dotted line and solid line comparisons. The insertion of arrows indicates
directional shifts.
In 2011, Research in Motion, the maker of Blackberry phones, had a unique position
in this industry. The company focused on a fairly narrow range of products and placed
bets that its phone’s proprietary operating system would provide a sustainable advantage
across business and government segments of the market. The rapid acceptance of
­Apple’s iOS and the sheer size of Nokia with its proprietary Symbian platform seemed
to suggest that these companies, which had unique platforms, would be successful.
­Samsung, too, began to move in this direction with the introduction of the Bada operating system for its mid-to-higher-end phones.
Unfortunately for Blackberry, its proprietary platform and narrow focus hampered its
ability to adapt to the industry’s competitive dynamics. Its market share was quickly
eroded by competitors that offered more functionality, more user applications, and better
cross-platform integration. Nokia, Samsung and others abandoned their proprietary
­operating systems, ­embracing the Android open source operating system instead. Phones
that used Android captured almost 85 percent of the market. Recent upstarts, such as
Xiaomi, began to flood into the lower end of the market, offering cheap Android-based
alternatives to Samsung’s higher-end offerings. Samsung was feeling the pinch. Its market share declined from 32.1 percent to 24.4 percent in the smartphone segment in
2015.16 Apple’s was the only truly proprietary system left and did well mainly because
of the product ecosystem the company had built around it. The question facing all the
firms in this industry concerned what to do next.
Restaurants
An examination of strategic groups within the restaurant industry also reveals interesting
dynamics. In the heart of the recent Great Recession, local fine dining establishments
­suffered.17 They began offering lower priced options in order to survive. McDonald’s and
other bargain fast food options seemed to fare much better, but franchisees complained that
popular dollar-menu offerings did not provide sufficient profit margins. The best position
was occupied by fast casual restaurants, such as Panera and Chipotle, which offered midcost, high-value menu items, prompt service, and fresh décor (see ­Exhibit 2.11).
By 2015, the fine dining establishments were regaining their strength, but the fast c­ asual
position continued to be the most attractive. It expanded and thrived as trends toward convenience and healthy options remained strong. Traditional fast food restaurants and new
industry entrants were to join this thriving strategic group. By 2013, fast casual had gained
control of 8 percent of the total market, from just 1 percent in 2000.
However, the industry as a whole remained weak and the market was not growing,
and fast casual stood as a strong segment in a weak industry (see Exhibit 2.12). It took
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44 Part One External and Internal Analysis
EXHIBIT 2.11
High
P/Q Mix
A Strategic
Group Map of
the Restaurant
Industry, 2014
Individual Fine
Dining
Establishments
Individual
Family
Restaurants
Fine Dining Chains–
McCormick & Schmick,
Ruth’s Chris, etc.
Fast
Casual
McD’s and
other fastfood
Brands
Low
Local
International
Geographic Reach
market share away from other categories rather than expanding the market as a whole.
Companies like McDonald’s, Wendy’s, and Subway tried to mimic what companies in
the fast casual category had done. McDonald’s created a build-your-own-burger,
­Wendy’s remodeled restaurants in an effort to make them more comfortable, and Subway
generated a healthy narrative that incorporated ingredients like avocado associated with
higher-end offerings. These reactions were not successful. They went against the grain of
what these companies previously stood for. The transition was not an easy one for them
to make. In McDonald’s case, to recover in an industry that no longer was attractive, the
company would have to create an entirely different segment with renewed customer
­appeal, perhaps one based on the successful Shake Shack or Chipotle experience. However, if even it does so, McDonald’s will be a latecomer and will have to overcome severe
image problems related to its history as an unhealthy fast food establishment.
EXHIBIT 2.12
2013
Restaurant
Traffic Growth
by Segment
10
8%
8
6%
6
4
2
0%
–1%
–2%
0
–2
–4
QSR
Fast Casual Casual Dining Midscale
Fine Dining
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Chapter 2 External Analysis 45
The key takeaway is that the most favorable position is that of a strong segment in a
growing industry (Apple). If this type of positioning is not possible, the next best
choices are to be in a weak segment in an expanding industry (Samsung in the nonproprietary space) or a strong segment in a tough industry (Panera and Chipotle in the
cyclical restaurant business). Yet even in expanding industries like mobile phones, there
are companies that lose out because they are in the wrong segment (Blackberry and
Nokia). They are in the wrong segment because they are not quick enough to move into
the rapidly taking off smartphone, which is dominated by new competitors Apple and
­Samsung. Each takes hold of a key segment within this rapidly changing industry.
Scenarios
Maneuvering around strategic groups within an industry is only the start. The external
analysis framework is not complete without asking, “should we stay in this position for
the long term?” Where, for ­instance, do Panera, Chipotle, and Apple, intend to go next?
How do they intend to build on their success? With Apple, the next product launch was
a watch, a wearable device. Was this wearable device only the beginning of establishing
an entirely new category of c­ onsumer electronics, the Internet of Things, in which nearly
everything is wired into and able to communicate with nearly everything else?
Understanding how an industry is likely to evolve over the long term and what the
strategist can do to shape its future direction are ongoing challenges with no easy
­answers. Scenarios are but one of several techniques used to create a range of possible
futures. A range is necessary because a company cannot predict or forecast with certainty what is likely to happen next. Other techniques used to create scenarios include
simple extrapolation, bookends, leading indicators, and systems analysis.
Simple Extrapolation
Simple extrapolation—a “back of the napkin” exercise—is most helpful in short-range
planning when industry conditions are stable, and demand is relatively smooth over
time. Some firms just don’t feel the same pinch as others when faced with turbulent
­conditions. Demand for their products and services plods along well during the best and
worst of times. One e­ xample of such an industry is waste disposal. Neighborhoods and
businesses certainly will not allow trash to pile up around their establishments, no matter
the external conditions. The demand, therefore, is relatively smooth and simple forecasts
are considered generally reliable.
Power generation is another critical service that cannot be shut off. Thus, utility planners may be convinced that future growth in demand will be relatively smooth. However,
electrical demand is heavily impacted by economic conditions, technological ­advances,
people’s willingness to conserve electricity, the social acceptability of different forms of
power generation, public subsidies to different forms of power generation, and other factors not considered in simple trend extrapolations (see Exhibit 2.13). In the 1970s, projections of smooth demand growth for electricity did not materialize and many
large-scale investments in nuclear power had to be abandoned with very large economic
losses. So, instead of simple straight-line projections, it is much better to subject certain
projections to stress tests at the extremes.
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46 Part One External and Internal Analysis
EXHIBIT 2.13
Demand
Extrapolations
in the Electric
Power Industry
Aug 2012 - Updated Need Forecast
800 MW
452 MW
600 MW
319 MW
400 MW
25 MW
200 MW
0 MW
–200 MW
552 MW
2015
–117 MW
2016
Updated Need
121 MW
Uncertainty Range
2017
2018
2019
2020
–400 MW
Defining Bookends
Defining bookends, or extreme possibilities in terms of where the future may lead, can
provide insights when demand and prices are highly volatile, as they have been in the oil
and gas industry. Over time, the price swings have been substantially more than
$50/­barrel, and there are reasons to believe that price swings of this nature will continue
into the f­ uture. Players in this industry must be able to sustain operations when prices
swing either to the lower bookend or to the upper one. Frackers who made calculations
based on the upper end faced liquidation when prices shot down.
The Shell Oil Company prominently displays scenarios on its web page. It bookends
two types of worlds that could come into existence, which offers both opportunities and
dangers of various kinds:
∙ The first scenario, labeled “mountains,” sees a strong role for government and the
introduction of far-reaching policy measures. These help to develop more compact
cities and transform the global transport network. New policies unlock plentiful natural gas resources—making it the largest global energy source by the 2030s—and
­accelerate carbon capture and storage technology, supporting a cleaner energy
­system. For Shell, this world has many positive implications. It requires that the company build its ­capacity as a supplier of natural gas.
∙ The second scenario, called “oceans,” describes a more prosperous, but also a more volatile, world. Energy demand surges due to strong economic growth. Power is more widely
distributed, and governments take longer to make major decisions. M
­ arket forces, rather
than policies, shape the energy system: oil and coal remain part of the energy mix, but
renewable energy also grows. By the 2070s, solar becomes the world’s largest energy
source. For Shell, this world can be a threat as it implies that fossil fuels play less of a role.
Given these widely divergent scenarios, shell must figure out its place in such a world
and build an alternate strategy around it. It can have a primary commitment to fossil
­fuels, but at the same time, must hedge its bets that a world dominated by fossil fuels
may come to an end.
Another example would be pharmaceuticals and stem cell research centers. Four
­futures may come into existence without companies in this industry knowing for sure
which one is most likely and with a need to make bets now even though what is likely to
take place next is nearly impossible to fathom. On the one hand, a lack of social acceptance of stem cell ­research and therapies may make any of its stem-cell related
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Chapter 2 External Analysis 47
EXHIBIT 2.14
Pharmaceutical
Research
Scenarios
Four possible outcomes for stem-cell
related technologies.
Social
Acceptance
Without
Technological
Viability
Social
Acceptance
With
Technological
Viability
Social
Rejection
Without
Technological
Viability
Social
Rejection
With
Technological
Viability
investments a money loser. Without social acceptance, no matter how quickly the technology advances and how far it goes, the possibility of commercializing stem cell treatments is likely to be low. On the other hand, society may tolerate stem cell research and
treatment and open the door to potential advancements in stem-cell related therapies.
However, if the ­science stalls and goes n­ owhere, making investments in this technology
will still be a money loser. If both social ­acceptance is low, and the science does not
­develop, surely the future is dim for this technology. The only scenario with a big payoff
is one where both society accepts the technology, and the technology itself makes sufficient progress that it is a useful cure for various ­ailments. Pharmaceutical companies
have to consider all of these scenarios in their planning (see Exhibit 2.14).
Leading Indicators
A company can go beyond simple projections and examine the leading indicators and driving forces that can create a range of possible outcomes. Construction equipment manufacturers like Caterpillar, for example, closely observe indicators such as new home starts,
while cement manufacturers like CEMEX watch for accelerations in GDP, which come
before the need for roads, bridges, and other infrastructure.
A company must continually scan the environment for the driving forces behind the
changes that are creating new ­engagement rules for the bets it is placing on the future.
Ecolab is a firm that has been on the lookout for such forces at play. The company is carefully examining the i­mplications of an aging baby boomer generation. In 2015, 10,000 of
the nation’s 76 million baby boomers were reaching age 65 every day, an indicator of
change that is expected to continue until 2029. What meaning should be attached to this
phenomenon? Ecolab has identified a business opportunity in offering sanitizers, detergents, and disinfectants and services for senior housing. The 19 million 85-year-olds
­expected to live in ­assisted-living centers throughout the U.S. in 2050 are ripe targets for an
expansion of Ecolab’s business.
Systems Analysis
However, even following such leading indicators and driving forces of change is not
­sufficient. To really get a grasp on what might happen next, a company must do systems
analysis to have insights about changes that are likely to occur on multiple fronts. In constructing scenarios, elements in the external environment must be seen as a system with
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48 Part One External and Internal Analysis
multiple linkages. Changes in one element in the external environment (such as global
security, energy prices, and the environment) induce changes in another (the economy),
which in turn bring about changes in a third (public policies), which, in turn, change the
culture and society, and so on. These changes are interconnected. Complex systems can
be in equilibrium for certain periods, but countervailing forces exist and systems, therefore, migrate quickly in surprising directions. The financial meltdown of the end of the
first decade of the 21st century is an example of a system in disequilibrium whose disintegration was felt in many domains. Three types of uncertainty a­ lways exist:18
∙ State uncertainty refers to incomplete knowledge about the components in the model
(e.g., oil supply and demand, the world economy, technology, social forces, and the
environment) and how they relate to each other. There also is uncertainty about how
macro-elements affect the five forces in the industry model. What is their impact on
the structure of an industry? Does the industry become more or less attractive?
∙ Effect uncertainty refers to the impacts on a particular firm. Even with near-perfect
information about the macro-environment and an industry, a company still may not
be certain what the effects will be on it.
∙ Response uncertainty refers to lack of knowledge about a firm’s response ­options.
This type of uncertainty is the most profound, for even if a company has perfect grasp
of the macro-environment, the industry, and the impact, it may not have ­sufficient
imagination and creativity to craft adequate responses, predict the likely consequences
of response choices, and secure backing for them from people in the organization.
Companies, therefore, should ask:
∙
∙
∙
∙
Which elements of the external environment currently appear to be most important?
Which emerging trends may turn around these elements?
What might the scope, direction, speed, and intensity of the changes be?
What are a company’s choices for coping with this type of changes?
Scenarios require a picture of a romantic future with better-than-expected outcomes, a
tragic future with worse-than-currently-imaginable outcomes, and a comedic future with
many surprises. Companies should have plans of action for each of these possibilities—
plans to bring about a romance, avoid a tragedy, and cope with surprises. Scenarios are
not predictions but goads to action to shape the future so that an organization does reasonably well regardless of the future events that take place.
A cross-impact matrix is a useful tool for creating scenarios. It shows how one trend
may intersect with another. In Exhibit 2.15, four scenarios were developed around possible regime changes in Saudi Arabia. In the first scenario, the United States–Saudi relationship remained fairly stable. In the second scenario, radicalization increase in Saudi
Arabia. The third scenario consider what could happen if the government were taken over
by ­religious extremists. The fourth scenario developed what would take place were
Saudi Arabia to modernize relatively rapidly and develop institutions similar to those of
Western Europe and the U.S. Potential changes in oil supply and demand, the world economy, technology, ­social forces, and the environment were considered, with the final rows
being reserved for estimates about world oil prices in different time periods. With oil
prices in 2016 so low, these projections might miss the mark.
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Chapter 2 External Analysis 49
EXHIBIT 2.15 Four Scenarios of Future Oil Prices Based on Regime Change in Saudi Arabia
1. Saudi Status Quo
2. Saudi Arabia Radicalized
3. Saudi Arabia with
Iranian Style Revolution
4. Saudi Arabia
Modernization
U.S. Politics
U.S.-Saudi relations
basically the same
U.S.-Saudi relations
rupture
U.S.-Saudi relations
totally break down;
2 nations become
­implacable enemies
U.S.-Saudi renewed friendship
Oil supply & demand
World demand increases due to developing countries
Demand up, supply
decreases; no new
sources discovered
Demand rises sharply;
no new sources discovered & worldwide
embargo on supplies
to western nations
Adequate supply to
meet demand
World Economy
Does not substantially
go down
Recession
Massive slump in
world economy
­accompanied by high
levels of inflation;
­return of 1970-like
stag-flation
Flourishes
Technology
No big breakthroughs
Drivers appear for
possible substitutes
Intense pressures to
develop substitutes to
fossil fuels; some
­become commercially
ready
Alternative energy
technologies in
widespread use
Social Forces
Gradual but contained
Middle East radicalization
Further radicalization
in many countries
Entire Middle East inflamed; anti-western
sentiment grows in
non-Islamic countries
Increased global
harmony & celebration of diversity
as positive force
Environment
Degrades gradually
Negative effects of
global warming start
to appear
Severe climate
change impacts felt in
many places in world,
especially poorer
countries
Environment improves because
new technologies
in widespread use
2013 $/barrel
$85
$100
$175
$75
2018 $/barrel
$95
$115
$190
$65
2023 $/barrel
$115
$140
$235
$100
Summary
When examining the external environment, the strategist should aim to seize opportunities that present themselves and work to counter forces that are expected to have a negative impact. Unfortunately, the “game” is not always good. The structures of some
industries may be such that the forces cannot be influenced for the better. There may be
fundamental changes in industry structure brought on by changes in macro-­environmental
conditions such as society, politics, the economy, technology, and the natural world over
which a firm and its leadership have little control. Often, the only options are shift
­positions or migrate to a new industry altogether. If neither exiting nor defensive
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50 Part One External and Internal Analysis
r­epositioning is possible, as is often the case, the strategist must be careful that the
moves chosen do not cause the industry structure to deteriorate further. For example, a
favorite category of moves—price ­cutting—can be ruinous. The actions a strategist
takes can just as easily weaken an industry as they can strengthen it. The moves proposed must be tested. Will they ­improve the conditions in an industry?
The tools presented for analyzing the external environment in this chapter are related,
supplement each other, and can be used together for assessing external opportunities and
threats. Industry definitions and boundaries shift. New industries are created. Old industries lose their appeal. These are the important swings, some predictable and some not,
in the attractiveness of industries to be aware of. Analysis of the five forces and the
macro-environment can lead to understanding of change. It can yield insight into inflection points a company confronts. It can also shape the recommendations of moves the
firm can make. Among other examples in this chapter, the pharmaceutical and airline
industries provided examples of industry changes and moves firms can make to alter
industry conditions, but there are limitations to these moves in fundamentally changing
industry prospects.
In the end, stakeholder relations, strategic group analysis, and the creation of scenarios that point to possible outcomes that may come into being because of the effects of
the macro-environment on industry conditions are useful tools for giving indications of
­possible futures a company may confront. With this type of understanding, a company
can build repertoires of moves it can take to meet different challenges. It can better
hedge its bets ­accordingly and rehearse various responses to the different possibilities it
could confront. The internal environment, the subject of the next chapter, also must be
understood and analyzed.
Exercises for the Practitioner and the Student
Reflect on your own employer’s external environment. If you are a student, please select
a publicly held firm to analyze.
1. How would you define this industry?
2. Search for relevant NAICS codes at http://www.census.gov/eos/www/naics/.
3. Are industry boundaries shifting over time?
4. What are the basic economic features of this industry?
5. Which of the five forces are most significant for industry participants? Which are the
least significant? How would your answers vary if you were conducting this analysis
for a larger or smaller industry participant? What types of tactics can an industry
player use to push back against the strongest forces?
6. Identify the key external and internal stakeholders for this company and industry.
7. How do your industry’s players differ in their approach to the market? How have
their positions and shares been changing/trending over time? How does the profit
potential of each strategic group vary? Sketch a strategic group map to clearly illustrate how industry participants are positioned.
8. Which driving forces are at work in your industry? Are they expected to grow or
shrink? Where are the trends pointing?
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Chapter 2 External Analysis 51
9. Which of the techniques presented provides the most useful long-term perspectives
for your industry? Define a couple of scenarios describing how your industry may
evolve over time. What types of issues could unfold over time for your company, its
rivals, and the industry as a whole? How can you utilize this analysis to prepare for
the future and increase the agility of your organization?
Endnotes
1. M. Porter, “How Competitive Forces Shape Strategy,” Harvard Business School Press,
March–April 1979, p. 137; also see M. Porter, Competitive Strategy: Techniques for Analyzing Industries and Competitors (New York: Free Press, 1980); M. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New York: Free Press, 1985).
2. “Richard Anderson–Delta Air Lines,” Flightglobal, http://www.flightglobal.com/interviews/
year/14/richard-anderson/interview/, accessed August 15, 2015.
3. George Packer, “Cheap Words: Amazon Is Good for Customers, But Is It Good for Books?”
New Yorker, February 17, 2014, http://www.newyorker.com/magazine/2014/02/17/cheap-words.
4. Porter, “How Competitive Forces Shape Strategy.”
5. G. Hawawini, V. Subramanian, and P. Verdin, “Is Performance Driven by Industry or Firm­Specific Factors?” Strategic Management Journal 24, no. 1 (2003).
6. A. Marcus, Strategic Foresight (New York: Palgrave-MacMillan, 2009); also see P. Schwartz,
The Art of the Long View, 2nd ed. (New York: Currency Doubleday, 1996).
7. T. Stewart, E. Drake, J. Wang M. Bell, and R Scott, “Surging Steel Imports Put Up to Half a
­Million U.S. Jobs at Risk,” Economic Policy Institute, May 13, 2014, http://www.epi.org/
publication/surging-steel-imports/.
8. Robin Farzad, “Chipotle: The One That Got Away from McDonald’s,” Bloomberg Businessweek, October 3, 2013, http://www.businessweek.com/articles/2013-10-03/chipotle-the-onethat-­got-away-from-mcdonalds.
9. Josh Barro, “Inverting the Debate over Corporate Inversions,” the New York Times, August 6,
2014, http://www.nytimes.com/2014/08/07/upshot/inverting-the-debate-over-corporateinversions.html?_r=0.
10. “Not What It Seemed,” The Economist, April 14, 2014, http://www.economist.com/blogs/
charlemagne/2014/04/frances-6pm-e-mail-ban.
11. Porter, “How Competitive Forces Shape Strategy.”
12. “Domestic Airlines in the US: Market Research Report,” IBISWorld, May 2015, http://www.
ibisworld.com/industry/default.aspx?indid=1125.
13. Frank Vinluan, “Pharma Jobs Report Card: 297,650 Jobs Cut in the Last Decade,” MedCity
News, April 15, 2011, http://medcitynews.com/2011/04/pharma-jobs-report-card-297650jobs-cut-in-the-last-decade-morning-read/.
14. M. Jensen and W. Meckling, “Theory of the Firm, Managerial Behavior, Agency Costs, and
Ownership Structure,” Journal of Economics 3 (1976), pp. 225–39.
15. R. Freeman, Strategic Management: A Stakeholder Approach (Boston: Pitman, 1984).
16. “Gartner Says Sales of Smartphones Grew 20 Percent in Third Quarter of 2014,” Gartner
Newsroom, December 15, 2014, http://www.gartner.com/newsroom/id/2944819.
17. R. Ferdman, “The Chipotle Effect,” Washington Post, February 2, 2014, http://www.washingtonpost.com/news/wonkblog/wp/2015/02/02/the-chipotle-effect-why-america-is-obsessedwith-fast-casual-food/.
18. F. Milliken, “Three Types of Perceived Uncertainty about the Environment: State, Effect, and
Response Uncertainty,” Academy of Management Review 12, no. 1 (1987), pp. 133–43.
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C H A P T E R
T H R E E
Internal Analysis
“Core competencies are the collective learning in organizations, especially how to coordinate diverse production skills and integrate multiple
streams of technologies. … Core competence is communication,
­involvement, and a deep commitment to working across organizational
boundaries. … Few companies are likely to build world leadership in
more than five or six fundamental competencies. A company that compiles a list of 20 to 30 capabilities has probably not produced a list of
core competencies. Still, it is probably a good discipline to generate a
list of this sort and to see aggregate capabilities as building blocks.”1
C. K. Prahalad and Gary Hamel, “The Core Competence of the Corporation”
Chapter Learning Objectives
• Providing a process for analyzing a firm’s internal situation that includes both qualitative and
quantitative approaches.
• Understanding the resource-based view (RBV) framework and how it differs from the industrial
organization (IO) viewpoint introduced in Chapter 2.
• Identifying key resources, capabilities, and competencies that are embedded across the firm’s value
chain.
• Using VRIO analysis (is a resource valuable, rare, costly to imitate, and is the firm organized to
capture the value of the resource?) to determine where the firm’s resources are most (or least) likely
to provide sustained competitive advantage (SCA).
• Through value chain analysis, delving into a firm’s financials for further insights into its strengths and
weaknesses.
• Understanding mechanisms of accountability including the hierarchical, organic, and contingency
approaches to management.
• Examining strategic options/moves that take into consideration both the internal and external
environments of the firm.
52
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Chapter 3 Internal Analysis 53
Introduction
Walmart, Target, and Kmart all compete in a similar industry environment. Over the past
several decades, they have had access to many of the same opportunities and have faced
the same general threats. They have occupied similar strategic spaces in the world of
retailing as well-known discounters. So, why does their performance differ so greatly?
This question can only be answered by examining the internal resources and capabilities
that each firm has developed over time. Their resource and capabilities are different, and
these differences have influenced their performance and the degree to which they have
been able to achieve SCA.
The book Moneyball and the subsequent movie about the Oakland Athletics provides
another clear example of how firms leverage their unique capabilities. The story
­explains how an organization with a relatively small resource endowment in comparison
to teams like the New Yankees and Los A
­ ngeles Dodgers could develop the internal
­capabilities to compete with these baseball teams that were far better endowed than
­itself.2 The internal strengths on which the ­Oakland Athletics built its competitive success did not come just from the, resources which it had but in how these resources were
deployed and used as a unique competence in player selection and talent development.
Other teams initially did not understand what Oakland was doing and could not copy the
distinctive way that Oakland chose and developed its players. Oakland broke the old
rules with respect to assessing its internal strengths in comparison to its competitors, and
by breaking the rules of internal analysis it achieved many years of success that objective
observers would have predicted were beyond its reach.
Internal analysis (IA) is the process of examining an organization’s strengths and
weaknesses in order to bolster an organization’s competitiveness and enable it to achieve
SCA. IA focuses on the question of how organizations can go beyond the resources they
have been bestowed with and enhance their competitive capabilities. It provides insights
regarding what can be done to ensure that firms survive and thrive in the long term by
using the resources they have to their utmost.
Both external (EA) and internal (IA) analyses are necessary to select options and craft
a firm’s strategy. In chess, the strategist examines how his or her own pieces are aligned
as well as how those pieces can be maneuvered versus an external opponent. In the
­military, one must “know the enemy, but also know oneself” to win battles. In strategy
making, winning moves depend on alignment between internal strengths and external
opportunities. The purpose of this chapter, therefore, is to provide tools for carrying out
internal analysis that enables a firm to utilize its resources to succeed within the external
environment in which it finds itself.
The Resource-Based View
The resource-based view (RBV) of the firm, partially derived from ideas originally
formulated by C. K. Prahalad and Gary Hamel, is examined in this chapter.3 It is the
foundation for internal analysis. Michael Lewis applied this theory in analyzing the
Oakland Athletics success. An alternative to the industrial organization (IO) economics
approach to strategy that was the focus of the last chapter, RBV emphasizes internal
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54 Part One External and Internal Analysis
strengths rather than industry conditions as the main factors driving sustained competitive advantage (SCA). RBV sees the organization as a combination of resources, capabilities, and competencies and attempts to understand how these factors influence the
firm’s performance.
Though academic research has not determined exactly what percentage of competitive advantage derives from internal strengths and weaknesses, and what percentage
­derives from the external environment, it has established that internal strengths are critically important. How a firm’s resources, capabilities, and competencies are arrayed is
essential for establishing the foundation for a firm’s long-term success.
RBV starts with the assumption that organizations differ in the resources that they
command. The Moneyball example focuses on the differences between the resources that
teams like the New York Yankees and the Los Angeles Dodgers had in comparison to
the Oakland Athletics. Yet despite these resource differences, the Athletics were competitive with these better-endowed teams. While these teams faced similar competitive
conditions—they all played 164 games against a similar group of opponents—they
achieved different results because of the different way they acquired and configured the
internal resources they had. Based on the way internal resources are managed, performance differences within a category of organizations like industry groups and industry
segments can be as significant as those between them. Thus, for a company it is not sufficient to just choose the most attractive industry group or segment. It must develop the
internal capabilities to manage the resources it has effectively and thereby to stand out in
whatever industry group or segment it chooses.
The central conclusion of Chapter 2 was that by analyzing the organization of an industry, companies can choose the best industry groups and segments in which to compete. This model of the industrial organization (IO) route to SCA needs to be compared
with the RBV model. Exhibit 3.1 summarizes the key differences between the IO and
RBV models. Because of their differences, IO and RBV put emphasis on different areas
regarding how to achieve superior performance. IO economics starts with e­ xternal analysis and proposes that the most important action a firm can take is to move to an attractive
industry or i­ndustry segment. Then it analyzes the main internal means a corporation
must acquire to support a strong external position. RBV, in contrast, starts with internal
analysis. It proposes that a corporation’s most important actions involve bolstering its
internal strengths. It then calculates the best external position to occupy given the firm’s
array of internal strengths and weaknesses. In other words, IO fits the firm to the external threats, and opportunities it confronts, whereas RBV molds the external environment
around the opportunities generated through what the firm does best.
According to RBV, if no external niche exists for what the firm does best, then the
firm can leverage its internal resources and capabilities to create a new niche that is more
to its liking. The firm can be a first or early mover and occupy a new competitive space
where it will face little or no serious competition. For instance, before Dell’s arrival,
the direct marketing model was not believed to be a viable model for long-term success
in the personal computer business. Thus, IBM ceded first-mover advantage to Dell,
which developed the capabilities necessary to compete in the niche of direct marketing.
Dell’s competitors had to copy its capabilities—no easy task—and then become direct
marketers after Dell already was well entrenched.
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Chapter 3 Internal Analysis 55
EXHIBIT 3.1
A Comparison
of IO and RBV
Approaches
Industrial Organization Economics
•
•
•
•
The external environment is the primary determinant of organizational strategy—not the internal
decisions of managers.
Assumptions: 1. Resources are highly mobile
­between firms. 2. All competing organizations
control or have equal access to resources.
The environment presents threats and opportunities
that must be addressed.
Organizational success is achieved by offering
goods and services at lower costs than competitors,
or by differentiating products to bring premium
prices.
Resource-Based View
•
•
•
•
An organization’s deployment of its resources
and capabilities have the greatest impact on firm
­performance—not external environmental conditions.
Assumptions: 1. Resources and capabilities are
not highly mobile across organizations and, once
acquired, are retained. 2. Valuable resources are
costly to imitate and nonsubstitutable.
Organizations can deploy internal strengths to
mold their external environment.
Competitive advantage is gained through the
acquisition and value of organizational resources
and capabilities.
In stressing the centrality of internal analysis, RBV helps to explain the continued blurring of industry boundaries and the creation of new industry categories as
Chapter 2 discusses. New industry categories, according to RBV, arise out of unique
internal strengths. The way firms structure their resources, capabilities, and competencies in comparison to other firms is a source of innovation. It can be the basis for
­industry transformation.
To fully understand a firm’s internal strengths, it is necessary to grapple with a
­number of key questions:
1. Does the firm currently have the resources, capabilities, and competencies necessary
to compete and win?
2. If it lacks resources, capabilities, and competencies that it needs, does it have the capacity to acquire or develop them?
3. What combination of acquisition and developmental activities is needed in order to
possess the resources, capabilities, and competencies to address critical threats and
seize important opportunities?
4. How can the firm become dynamic enough to continuously acquire and develop the
resources, capabilities, and competencies to succeed in the long term?
For a firm to understand whether it has the current resources, capabilities, and competencies needed to compete and win, it must understand which are needed and how to
combine and use a full set of these elements to deliver value to the marketplace.
Resources, Capabilities, and Competencies
The distinction between resources, capabilities, and competencies has been described as
“subtle at best.”4 Yet this distinction is fundamental to understanding what an
­organization needs to achieve sustained competitive advantage. Every organization is a
combination of resources, capabilities, and competencies, and each of them plays a role
in determining an organization’s strengths and weaknesses.
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56 Part One External and Internal Analysis
Resources are a firm’s basic financial, physical, and human capital. Based on a company’s line of business, its resources may include tangible assets, such as cash, buildings,
machinery, and people, and intangibles, such as patents, trademarks, brand reputation,
and so on. Resources are best characterized by the fact that (1) they are protected by
­legal rights of ownership, and (2) they can be bought and sold.
Capabilities are what allow a firm to exploit resources, for without the ability to
­exploit them they have little economic value and are instead just a series of separate
­resources that can be transferred and traded in the market. An organization needs the
managerial skills to exploit these resources. It must be able to orchestrate their use and
conduct productive business activities based on their possession.
For example, having a computer has little value if a person does not know how to use
it. Based on the computer skills they have, different people are able to extract different
levels of value from their computer ownership. Owning the rights to a baseball player
offers another example of the distinction between resources and capabilities. The player’s value to a team arises from the role the player is assigned, the position he plays, his
spot in the batting order, and the capabilities the team’s management has in synchronizing the player’s talents with other players and maximizing the player’s usefulness. Without these managerial interventions, an assembly of very talented players, no matter how
gifted individually, does not create a consistent winner. The capability of management to
forge together the talents of many players and develop a winning approach based on their
complementary endowments gives them value. The analogies in Exhibit 3.2 help to clarify the differences between resources and capabilities.
Organizations must have many capabilities to succeed. For a football team to become
a consistent winner, its players must be able to run, block, tackle, punt, pass, catch the
ball, and so on. Its coaching staff must be able to select and call plays, organize practices, motivate, watch tapes of past games, and extract useful lessons from these tapes.
The coaching staff must also evaluate and choose talent and keep the team’s morale high
even in the face of adversity. Intangible capabilities like restraining the egos of talented
but insecure individuals and eliciting high levels of team spirit and effort at critical junctures in games are needed as well. The organization must take the human resources it has
collected and display an aptitude for uniting disparate individuals for successful collective action.
As exceptional as the capabilities are that allow a group of individuals to cohere into a
winning team, the competencies that describe the distinct manner in which a team wins
are rarer still. In a dictionary, the terms capabilities and competencies have the same
meaning. They refer to aptitudes, proficiency, and know-how, but in the arcane language of
the RBV, they are different. Competencies link capabilities together into a distinct style of
winning. To revert to the football analogy, some teams win thanks to a tight defense that
rises to the occasion with game-winning turnovers and goal-stopping stands, while
EXHIBIT 3.2
The
Differences
between
Resources and
Capabilities
Resources are like ingredients, while capabilities are like recipes.
Resources are like hardware, while capabilities are like software.
Resources are like an artist’s brushes, canvases, and paint,
while capabilities are like an artist’s sensibility and technique.
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Chapter 3 Internal Analysis 57
other teams win with an explosive offense. Some teams carry out methodical and timeconsuming comebacks at a game’s close. Others rely on big plays early in a game that
blow an opponent away with large leads. Some teams squeak by with victory after victory because they have an uncanny ability to deal with pressure, while others regularly
collapse even if they play superbly early in a game. These character traits of winning
teams show up again and again. The ability of coaches and managers to adjust a winning
style to the talent they have is the supreme competence. The organization’s ­capabilities
are channeled in a distinct way to achieve victory. They harness key capabilities to create
a style and method of winning that the organization is able to reproduce again and again.
The distinct way organizations harness capabilities to satisfy customers sets them
apart from their rivals. For instance, some restaurants satisfy their customers with a
combination of capabilities that provide a special atmosphere, with music and lighting
and particularly good service. The food is more than adequate, but it does not necessarily
stand out from the food other restaurants serve. Other restaurants focus mainly on the
quality and taste of the food. That is where they apply their capabilities. Perhaps they
cultivate a competence in a particular type of ethnic food. Perhaps, they hire especially
inspired, imaginative, and well-regarded cooks whose original creations are regularly
reviewed in upscale publications. In each case, the competence is different and is based
on the combination of a different set of capabilities.
Given that a competence is based on this combination of separate capabilities, it is
very hard for competitors to imitate it. Since competitors cannot easily copy it, it can
serve as the basis for sustainable competitive advantage. No competitor, for instance, can
quite capture the distinct taste of a creole fried shrimp soup served with local flair and
organically grown vegetables. No competitor can match the gourmet status of an upscale
French restaurant whose cooks are world renowned, whose service is impeccable, and
whose wines are vintage varieties that are hard to get anywhere else. The ability to consistently make money supplying cheap food to budget-minded families also requires the
competence of uniting disparate capabilities in an overall eating experience that is not
just about the food.
RBV sees organizations as collections of primary productive resources and capabilities that can be combined into different types of hard-to-imitate competencies, which
have enduring marketplace value. How these resources and capabilities are combined
depends on the choices managers make.
Resources and capabilities, then, are bundles of services that can contribute to the
production of different goods and services that customers value. Organizations are distinguished by how they convert these resources and services into experiences customers
appreciate. The organization’s leaders can combine its resources and capabilities in different ways that yield different outcomes. For instance, the Oakland Athletics General
Manager Billy Beane could not buy extremely gifted athletic players with the muscle
power to regularly hit homeruns, the rocket arms to mow down hitters, and the exceptional swiftness to steal base after base. Beane and his staff were confined to a more
limited resource base than their competitors. So, they had to devise methods to get more
out of the players they could assemble with the fewer dollars they had to spend. Thus,
they relied on their capabilities in statistics to select low-paid, young talent with potential for development, and veteran over-the-hill eccentric players that had some remaining
special abilities. Then they combined these less well-regarded players by conventional
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58 Part One External and Internal Analysis
standards into teams with a distinct approach to winning that went against the prevailing
wisdom in other baseball front offices of the late 1990s.
RBV’s understanding of the firm brings the managerial creativity required to transform resources into distinct competencies to the forefront. The strategic challenge managers of business corporations face lies in taking the disparate resources and capabilities
an organization has collected and forging them into entities with unique identities that
consistently provide customers with valuable goods and services. From this perspective,
the value organizations deliver to customers represents only one of several ways in which
an organization can use its resources and capabilities. Resources and capabilities can be
combined in many different ways with better management figuring out how to extract
the most value from the resources and capabilities they have. With greater and more
creative understanding of the market, resources and capabilities can be reconstituted to
yield something greater than their returns they currently achieve in an existing configuration. The need is to innovate and go beyond the obvious and prevailing wisdom in how
an organization’s resources and capabilities are used in order to develop a unique
­approach to winning.
To again use a football example, New England Patriot coach Bill Belichick reassembles the talent on his team each year and gives it a different emphasis depending on the
types of players he has, none of whom typically are high draft picks. He reconfigures the
resources and capabilities he has to give his teams a unique edge. The same can be said
of symphony orchestras. Each is assembled from slightly different talent pools and
molded together in a unique way by conductors to create distinctive sounds that give
pleasure to listeners.
The takeaway is that an organization’s performance does not result from the mere
possession of resources and capabilities, but from the ingenuity its managers apply in
combining these resources and capabilities in novel and improved ways, for example, by
a bank allocating financial capital to uses that produce greater returns or in a manufacturing site by assigning workers to areas where they achieve higher productivity.
The VRIO Test
The competitive significance of resources and capabilities can be determined by using
the VRIO test, which poses the following questions:5
1. Are the resources and capabilities the organization has valuable? Do they enable the
organization to exploit an important opportunity—or thwart a significant threat?
2. Are they rare? Are they held by very few firms?
3. Are they inimitable? Are they difficult to copy via development or acquisition?
4. Is the firm organized and ready to exploit them for the benefit of customers?
Exhibit 3.3 provides some examples of how this type of analysis might be used to assess
a restaurant’s internal strengths and determine its relative advantage/disadvantages. A
high-visibility corner location might be valuable to the restaurant; however, if rivals can
also build at high-visibility locations, the best a firm can expect is competitive parity
based on its location. A restaurant that holds a technology patent but has no way of profiting from the use or sale of the technology has an unused advantage. A restaurant with
exclusive access to a rare ingredient that will have customers lining up has more of a
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Chapter 3 Internal Analysis 59
EXHIBIT 3.3
VRIO Analysis
of a Restaurant
Resource or Capability
Valuable?
Rare?
Inimitable?
Organized
to Exploit?
Dilapidated Building
High-Visibility Corner Lot
High-Tech Tabletop
Customer Interface
NO
YES
NO
YES
YES
NO
Technology Patent
YES
YES
YES
NO
Exclusive Access To GroundBreaking Ingredient Used
in Special Recipes by
Gourmet Cook
YES
YES
YES
YES
RESULT
Disadvantage
Parity
Temporary
Advantage
Unused
Advantage
SCA
foundation for sustained advantage, but it is the unique combination of all these elements
that might make the organization stand out and give it the chance to have a distinctive
competence and become a dynasty.
Under optimal conditions, resources and capabilities not only complement each other,
but also increase each other’s competitive significance and value. Consider their interplay in the following ways:
∙ Measurement. If tangible, resources are found in financial statements; they appear on
an organization’s balance sheet and are valued in its books. However, the capabilities
that the organization has developed for combining, recombining, and using its
­resources can propel the value of these resources far beyond their accounting value.
∙ Market exchange. Except for patents, which are based on legally enforceable property rights, intangible resources, such as a reputation for toughness or quality, cannot
be easily traded. They are dependent on particular organizational processes that make
it difficult to remove them from their context. Similarly, capabilities, such as the
­loyalty of dealers and trust of customers, which have been nurtured through a history
of honest dealing cannot be easily transferred.
∙ Difficult to imitate. As mentioned above, an organization’s specialized experience in
combining and using resources should lead to valuable capabilities that cannot be
easily imitated by its rivals. Such capabilities are both complex and path dependent;
that is, they are the cumulative outcomes of historical decisions in which there has
been substantial trial-and-error learning to which key rivals have not been privy.
They require long-term, careful development. They cannot be just purchased off
the shelf.
For a competitor, attempting to imitate the long-term leader in an industry is likely to be
very time-consuming and costly, with little chance of success. That is the aim of leadership, to put plenty of competitive space between an organization and its major rivals.
New entrants are therefore discouraged as well.
An organization’s unique combination of resources and capabilities provides it with a
head start, leaving competitors with the difficult task of trying to catch up quickly (e.g.,
by running crash advertising or R&D programs, which usually are less effective than one
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60 Part One External and Internal Analysis
carried out over a longer period). In addition, even if the needed resources can be
­acquired and the capabilities learned, the competitors still face the major problem of
identifying the precise sequence and pattern for organizing the resources and capabilities
to deliver distinctive customer value.
Thus, a focus in understanding an organization’s internal strengths and weaknesses
should not be on resources and capabilities per se. Nor should an organization be mainly
interested in acquiring more resources and adding additional capabilities. The key question is how an organization combines its resources and capabilities into distinctive competencies that deliver customer value that competitors cannot easily copy.
From Capabilities to Competencies
Capabilities are the essential building blocks for the distinctive competencies an organization wishes to create. The most important of these capabilities are embedded in human
networks within the organization and with other organizations with which employees
regularly interact. In a business context, the most important of these capabilities include
leading, planning, and obtaining feedback; engaging in dialogue; and motivating, compensating, appraising, communicating with, and rewarding employees. They involve the
functional relationships among organizational members as shown in Exhibit 3.4, as well
as outside commitments that have been obtained from customers, suppliers, and financial backers. Such relationships may arise from many different bases—physical, technological, and financial, but they go well beyond when they are combined in unique ways
to deliver value to customers.
Time-consuming, and difficult to cultivate and assemble, capabilities are hard to replicate because they cannot be purchased with money alone. While an organization can
buy a talented employee with a lucrative contract, the right to a promising technology
through licensing the patent, or even money itself by paying interest and taking out a
loan, capabilities are not really up for sale. From the perspective of understanding an
organization’s strengths and weaknesses, they derive from interrelationships and connections that make up the organization’s inner and outer workings. To go back to the football analogy, it is not just a capability for blocking that is important, but also the
coordination and linkages among a series of blockers who apply their skills differently
depending on specific situations in a game.
EXHIBIT 3.4
Valuable
Organizational
Capabilities
Across the
Value Chain
Marketing
Respected
brand image
Strong ads &
promos
Highly
­professional,
customer-­
centric sales
force
Operations
Low-cost
­production
processes
Superior
­quality output
Efficient global
distribution
­capability
R&D
Rapid
­development
of distinctive
products &
­services
Flexible &
­relevant
­invention
­platform
IT
Well-developed
infrastructure
capable of
­delivering info
across
­organization
Attractive
­e-commerce
­interface
HR
Recruitment and
­development
of top talent
Facilitation of
positive, highperformance
culture
Finance
Strong balance
sheet
Steady growth
in income
A sizable “war
chest”
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Chapter 3 Internal Analysis 61
Capabilities are not the individual skills employees bring to the job, but connections
and relationships they have, often outside the team, and it is how these individual skills
get c­ oordinated into a greater collection of value. They include the talents, experience,
judgment, intelligence, insights, and training of individual employees, but only start
there. Relationships, openness to new technologies, and other intangibles are what make
these individual skillsets distinctive and valuable. These elements cannot be owned,
transferred, traded, bought, or sold in the same way that physical and other types of
property can. Thus, an organization’s capabilities, as indicators of its strengths and
weaknesses, are hard to characterize and assess. Retrospectively, they are easier to
understand and identify than prospectively.
Culture as the Backbone of Capabilities
The backbone of the capabilities that get transformed into competencies is culture. A
culture is made up of key managerial values, beliefs, and assumptions about how people
in the organization conduct their business. A culture dictates how an organization treats
its employees, customers, and suppliers, and fosters innovativeness and flexibility in the
relations among them so that the sum of these parts constitutes something far greater
than each of the separate individual inputs.
A culture is imperfectly imitable if other organizations cannot easily duplicate what
the culture has to offer. For this to be the case, the culture cannot be easy to characterize.
It should be idiosyncratic in some ways, a reflection of the organization’s founding,
­development, unique personalities, and experiences. If path-dependent and historically
bound in this way, a culture can contribute to long-term advantage. The qualities that
best capture capabilities are likely to adhere to the people in the organization and how
they relate to each other over time. Google’s culture, as described on its webpage, is
highlighted in Exhibit 3.5.
Note that this description of Google just starts with hiring talented people. It goes on to
tout a distinct set of values, the company’s goals and vision, the importance of diversity and
inclusiveness, openness, idea sharing, communicating, both horizontally and up the hierarchy
to the organization’s top rungs, and the importance of having fun as well as working hard.
From the perspective of RBV, culture is a source of advantage if it contributes to a
competence in low-cost or unique products and services that satisfy customers and that
competitors cannot easily copy. Culture adds value to the organization when it yields
higher sales, greater innovation, lower production costs, and higher margins. When rare,
a culture enables the organization to be something others cannot be or to do things that
EXHIBIT 3.5
Google’s (now
Alphabet’s)
Culture
It’s really the people that make Google the kind of company it is. We hire people who are smart and determined,
and we favor ability over experience. Although Googlers share common goals and visions for the company, we hail
from all walks of life and speak dozens of languages, reflecting the global audience that we serve. And when not
at work, Googlers pursue interests ranging from cycling to beekeeping, from Frisbee to foxtrot.
We strive to maintain the open culture often associated with startups, in which everyone is a hands-on contributor
and feels comfortable sharing ideas and opinions. In our weekly all-hands (“TGIF”) meetings—not to mention over
email or in the cafe—Googlers ask questions directly to Larry, Sergey and other execs about any number of company issues. Our offices and cafes are designed to encourage interactions between Googlers within and across
teams, and to spark conversation about work as well as play.
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62 Part One External and Internal Analysis
cannot be done, or done as well, by other organizations. For example, a strong culture
can result in a fixation with customer service and satisfaction and closeness to the customer that yields timely market information and intense brand loyalty.
An Organization’s Distinctive Competence
As indicated, the many different capabilities the organization possesses are the building
blocks for its competencies; competencies, in turn, integrate and consolidate component
capabilities. Thus, behind every realized competence, there is a blend of many capabilities.
For example, a competence such as low-cost competing (see Chapter 4) is not based
only on efficient production, but also depends on many complementary elements,
­including skilled people, low-cost supply sources, and efficient delivery and ordering
systems. All of these must be brought together and related in complex ways.
Similarly, competing based on a flow of product enhancements and new products
depends not just on product conception, design, and development, but also on timely
information about how customers use products, their level of satisfaction, and their
­future requirements. These, in turn, depend on formal market research, training of the
sales force, feedback, and interaction among engineers, designers, and customers.
­Additionally, it may be necessary to have computer software that facilitates flexible
manufacturing and testing as well as managerial philosophies that espouse patience in
building margins and market share. Exhibit 3.6 shines the spotlight on one of Target’s
valuable competence fro design.
Competencies consist of a management logic and belief about how to harmonize the
organization’s diverse resources and capabilities. They are the patterns the organization
uses to deploy its skills and assets in ways that give value to customers. While their specific
aspects vary from company to company, competencies typically are broad in scope. Because they involve such a complex harmonization of separate parts, competencies are
­difficult to imitate. Indeed, the more complex the integration among discrete elements, the
more difficult it is for competitors to comprehend and copy what the organization does and
thus the easier it is for the organization to sustain a competitive position.
Unlike physical assets, which wear out and deteriorate over time, competencies may
improve. Relatively mobile, they are likely to have important protean qualities; they
can provide access to a wide variety of markets beyond those the organization is currently serving.
For example, 3M built on the capabilities it had in substrates, coatings, and adhesives
to expand into a diverse array of products such as sticky tape, removable notes, magnetic
tape, photographic film, and pressure-sensitive tapes. Canon applied the capabilities it
had in optics, imaging, and microprocessor controls to expand into copiers, laser p­ rinters,
EXHIBIT 3.6
Target’s
Design
Collaborations
Over the past two decades, Target has honed its ability to seek out and secure productive collaborations with a
steady stream of the hottest designers from Joseph Altuzarra to Lilly Pulitzer. The company boasts one of the largest design houses in the country – an organization that is able to design massive collections and provide “exclusivity on a mass scale.”
Target’s Missoni collection, for example, includes everything from sweaters and ties to furniture and bicycles. The
discounter’s is true to its philosophy: Design for all . . . and exclusivity on a mass scale.
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Chapter 3 Internal Analysis 63
cameras, and image scanning. Target put together partnerships and collaborations to
­create exclusivity on a mass scale, such as its collaborations with famous fashion labels
like Missoni and Alexander McQueen.
Competencies represent the coalescing of capabilities in old and new ways. They give
the organization the ability to take advantage of new opportunities and to repulse threats.
Because they can be used for more than a single product or service, they enable the
organization to invent new markets, to quickly enter emerging ones, and to make shifts
in product lines and services.6
A distinctive competence is the unique accumulation of capabilities and rigidities
that an organization has acquired over time. In assessing an organization’s strengths and
weaknesses, it is important to identify the distinctive competence that gives the
organization its special character. An organization develops such a competence by
accepting commitments in the course of adapting to internal and external pressures.
Once institutionalized, the adaptations affect the ability the organization has to frame
and execute desired policies, but they apply more broadly.
A distinctive competence is not only a tool, but also a source of employee gratification, institutional integrity, value, and reason for being. Five elements typically coalesce
in an organization to create a distinctive competence:
1. The knowledge and techniques needed to create useful products and services. The
creation and distribution of goods and services depend on value chain expertise—­
expertise in the flow of inputs, their conversion to outputs, the distribution of the
outputs, and the disposal of waste. The organization is proficient in some combination of R&D, design, manufacturing, physical distribution, retail sales, post-sale service, and handling and minimizing waste.
2. Acquiring and generating resources beyond the supply the organization directly
owns and controls. The organization acquires additional resources through value
chain linkages. Working beyond its boundaries and establishing collaborative arrangements with external entities help it to expand available resources. It must establish strong relationships—not just financial and economic, but also psychological and
emotional—with external groups (see the discussion of stakeholders in Chapter 2).
3. Dealing with novel problems. Capabilities are embedded in routines. However,
excessive reliance on routines poses the problem of inflexibility: An organization
can remain committed to familiar tasks even when the evidence strongly argues
against it. Search procedures to deal with novel problems are themselves based on
existing routines.7
4. Looking toward the future. An organization is a flow of ad hoc adjustments to external conditions, compromises, and best judgments. The present is a moving front, a
transitory position. An organization must look toward the future. How should it redeploy assets to achieve new objectives?
5. Positioning and repositioning. Managerial skills are needed to advantageously position and reposition the organization’s capabilities. For this to be accomplished,
knowledge of competitive relations, the psychology of interfirm rivalries, and evolving social, legal, technical, economic, and political factors are essential. To position
and reposition itself, an organization must be able to adjust to changing conditions.
(Positioning is discussed in Chapter 4.)
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64 Part One External and Internal Analysis
A core competency, according to Prahalad and Hamel, has three main attributes: It
(1) provides access to new markets, (2) gives customers benefits, and (3) is difficult for
competitors to imitate.8 Unlike physical assets, which decline over time, a core competency is the engine for new business growth and development, clearly vital in tough
economic times. A core competency entails learning, coordinating, integrating, and
­operating outside the organization’s boundaries.
Using the organization’s inherited resources, managers can create an image of the
possibilities the organization faces and the obstacles it must overcome. This image,
along with the managers’ views of the organization’s competitive position, affects managerial decisions on ways to combine resources into products and plan for future expansion. These managerial decisions are a key component of an organization’s strengths and
weaknesses.
Replenishing Resources, Capabilities, and Competencies
To adjust to the challenges it faces, an organization must decide which combinations of
resources, capabilities, and competencies should be assembled and reassembled, and in
which sequence. The process of acquiring resources, capabilities, and competencies is
affected by uncertainty. It “cannot be optimally derived from normative theory.”9 Uncertainties exist about possible future states and competitive interactions in those states.
Complexity is inherent in developing an appropriate mix of resources, capabilities,
and competencies. It involves not only identifying and coordinating the needed elements,
but also planning their future deployment. Organizations must continuously reappraise
their resources, capabilities, and competencies, discarding those they no longer need and
acquiring those they do need. Three steps exist in this process:
1. Looking outside the organization for talent and technology and establishing partnerships and alliances.
2. Finding ways to synthesize, harmonize, and integrate the acquisitions within the
­organization.
3. Discarding resources that no longer provide value.
The goal is not simply to accumulate disparate resources, capabilities, and competencies, but to join them in a tapestry that creates a greater whole. A company must continuously identify, acquire, build, deploy, and discard resources, capabilities, and
competencies. Clearly, some organizations are better at this process than others. To the
extent that they are better, they are stronger and more likely to achieve sustained competitive advantage.
Value Chain Analysis and a Firm’s Financials
Digging deeper into a firm’s strength and weaknesses requires financial analysis. One
approach is to start with the value chain. The set of activities that the firm performs in
order to deliver value to the marketplace—as illustrated in Exhibit 3.7—is called the
value chain. Each element in this chain should deliver profits—that is, the returns from
the activities should exceed the costs. Each activity should have a positive margin. Each
of these activities together should have a positive return.
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Chapter 3 Internal Analysis 65
EXHIBIT 3.7
Resource Procurement
The Value
Chain
ar
*M
Technology Development
n
gi
Human Resource Management
Administration
Marketing
& Sales
Customer
Service
n
gi
Outbound
Logistics
ar
Operations
M
Inbound
Logistics
*Margin = Value – Cost
The primary activities shown across the base of the value chain illustration are:
∙ Inbound logistics—receiving, storing, and internally transporting product inputs.
Dock scheduling, raw materials inventory control, and any necessary returns to suppliers fit in this category.
∙ Operations—transforming product inputs into product outputs via assembly, machining, packaging, testing, etc.
∙ Outbound logistics—distributing goods to customers. Tasks such as finished goods
warehousing, order processing, and delivery scheduling fit in this category.
∙ Marketing and sales—making the product known to buyers and persuading them to
buy. This category includes advertising, pricing, product promotion, sales force work,
and channel selection.
∙ Customer service—providing customers with after-sales service to keep up or
­improve the value of the product. Tasks such as installation, training, repair, and
­supplying of parts are in this category.
The support activities listed at the top of the chain are:
∙ Resource procurement—buying inputs such as machinery, buildings, office and labequipment, raw materials, supplies, and other items that are used in all value-creating
activities including support activities. These purchases are made according to rules
for dealing with vendors and require information systems for record keeping.
∙ Technology development—developing the know-how to carry out the firm’s many
­activities and tasks from running equipment to writing documents, from making products
to transporting goods, from designing products to enhancing their reliability, and so on.
Technology development may depend on a variety of scientific disciplines and subspecialties such as nanotechnology, precision mechanics, fine optics, and bioengineering.
∙ Human resource management—recruiting, hiring, training, developing, and compensating the firm’s personnel. These practices have an important effect on employee
socialization and their motivation and skills.
∙ Administration—finance, accounting, legal affairs, public affairs, planning, and strategy.
Some of these activities may be carried out at the business-unit level, and some may
be carried out at the corporate level.
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66 Part One External and Internal Analysis
EXHIBIT 3.8
Value Chain
Linkages
Manufacturers
Distributors
Retailers
Shippers
Each firm conducts a different set of value-creating activities based on its mission and
purpose. Thus, the option of purchasing versus carrying out the activity within an
organization exists. An organization can specialize in activities in which its margins are
highest and outsource the rest. If the return from an activity is higher if it is outsourced
than if it is done internally, it is incumbent on a company to consider purchasing the
activity from an outside provider; likewise if the external transaction costs are less than
the internal production costs. With few exceptions based on concepts that will be covered
later in this text, the financials of each activity should be positive.
Value Chain Linkages
Value chain linkages exist (see Exhibit 3.8). Manufacturers create value by transforming raw materials into more useful end-products. They typically deal in the businessto-­business world, selling their outputs to distributors who add value by stocking
sufficient i­ nventories and filling orders. Retailers add value when they manage most of
the end-customer relationship—presenting a desirable range of products, selling them
in appropriate quantities, and supporting them in a way that greatly appeals to the
­end-customer.
Service providers add value when they can provide their customers with benefits
faster, better, and/or more economically than the customer’s creation of such benefits
alone. Shipping firms such as UPS count on their ability to make package deliveries
more effectively and efficiently than if their customers arranged them without their service. A multitude of online retailers across the globe count on their logistics services to
safely transport their products to their customers’ doorsteps.
Thus, it is clear that the value chain of one firm is not isolated from the value chain of
many other firms—and that these linkages between firms can be a source of strength or
weakness. Coalitions of firms functioning together bring value to customers. Therefore,
firms need to assess not only their own internal strengths and weaknesses, but also those
of the companies in their value chain and choose where they want to place themselves in
the value chain based on a comparative assessment of which activities they perform best.
Which value chain activities for them are the most valuable?
Virtual Integration and Outsourcing Schemes
Dell’s direct model is based on virtual, as opposed to vertical, integration. It acts as a
broker between manufacturers and end-customers, and when it sells to institutions, it
eliminates the role that a retail channel partner can play. It made this choice at the very
start of its existence because it understood that the highest margins it could earn were not
in manufacturing or elsewhere in the value chain, but by being a broker among the
­activities that typical vertically organized corporations, like IBM, at the time a major
­competitor, would play. Though Dell did some light assembly, its role primarily was as a
distributor, which eliminated the role of retailers in the value chain.
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Chapter 3 Internal Analysis 67
As emphasized, when certain activities can be done more effectively outside the
o­ rganization, those activities should be outsourced. Others examples from the computer
industry are HP’s and Apple’s contractual agreements with low-cost global manufacturers that can produce their finished goods in a more cost-effective manner and with equivalent or better quality than the firm could produce internally. Service provider ADP
counts on its ability to process payrolls and manage a firm’s payroll-and-benefits administration activities more efficiently and effectively than most firms can manage i­ nternally.
The successful outsourcing of noncore activities can allow a firm to focus on its most
strategically important activities while reducing production costs and general overhead
and increasing bottom-line profits.
Many U.S. firms have become basically design and marketing firms and do the bulk
of their raw material acquisition and manufacturing abroad. Increasingly, they even have
chosen to outsource some of their R&D. These decisions are based on calculations of
which activities in the value chain bring them the highest margins and which can be
­better purchased from outside vendors.
On the other hand, there are times that a firm’s partnerships become overly
costly, ineffective, or inefficient because the relations with the outside vendors lower
­quality. Dell had this problem when it outsourced customer support. Consumer complaints ­skyrocketed.
Such negative impacts can ripple through the value chain, sap profits, and potentially damage customer relationships. Suppliers can fail to deliver quality raw materials on time causing a work stoppage and a shortage of finished goods. Under these
conditions, it makes sense to have greater control and predictability and to maintain
activities in the value chain within the firm even if they are not profitable or not as
profitable as buying them from outside vendors. A firm may decide to maintain some
of these activities internally simply as an insurance policy should an outside vendor
not be fully reliable.
An organization must continually evaluate its outside vendors. In response to poor
external performance, a firm may choose to change providers or even conduct most of
the activity internally. Rather than risk having their products be poorly represented to the
end-customer, high-end luxury brands frequently sell wares in settings in which they
have had complete control over all activities in the value chain, such as at high-priced
retail boutiques.
Value More than Costs
No matter whether activities are conducted inside or outside a firm, a firm is profitable
only if the total value that it creates and captures is greater than the costs that it incurs
while creating that value.
Profit margin = Value created & captured – Cost to create value
An organization must be able to deliver superior value, lay claim to that value, and
convince customers to pay for this full value. A key to SCA, therefore, is to understand
how each of the individual and the sum of the firm’s activities can create products and
services that provide superior value for customers. When an organization is capable of
providing more value than its rivals can, it builds sustained competitive advantage.
­Delving into a firm’s financials, therefore, is critical.
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68 Part One External and Internal Analysis
Three Levels of Important Financial Considerations
As shown in the example from Medtronic below, at least three levels of analysis are
needed in order to understand a firm’s financial strengths and weaknesses.
Level One At the broadest level, a firm must determine how it compares to its industry
and the marketplace as a whole. For public firms, such research can be conducted quickly
utilizing a variety of financial sites such as YahooFinance or MSNMoney. Private firms
also can be benchmarked; however, the quantity and quality of readily available data are
limited. Nevertheless, it is very important for managers of both public and private entities
to understand how the firm stacks up. The following are some basic questions to ask:
∙ How do a company’s revenues and profits compare with the broader industry and
marketplace? (Exhibit 3.9)
∙ Are they growing faster, slower, or at the same pace? (See Exhibit 3.10.)
∙ At the broadest level, does a company seem to be providing a solid investment
­opportunity as compared to other options available to the public? (See Exhibit 3.11.)
EXHIBIT 3.9 Medtronic Margins versus Medical Device Industry Averages
PROFIT MARGINS %
Gross Margin
Pre-Tax Margin
Net Profit Margin
COMPANY
INDUSTRY
74.32
21.14
17.35
64.39
15.4
13.31
EXHIBIT 3.10 Medtronic Growth Rates versus Medical Device Industry Averages
INDUSTRY: Medical Devices
GROWTH RATES %
COMPANY
INDUSTRY
4.7
2.66
Sales (Qtr vs year ago qtr)
EXHIBIT 3.11
Medtronic,
St. Jude,
and Boston
Scientific
and the S&P
since 2009
90%
85.86
Sep 18, 2009–Sep 12, 2014
BSX
MDT
STJ
!SPX
75%
60%
74.03
64.06
45%
30%
15%
13.95
0%
–15%
–30%
–45%
–60%
2009
2010
2011
2012
2013
2014
5847
1477
349
1069
117
0
8859
Selling, General and Administrative2
Research and Development3
Depreciation, Amortization and Depletion
Special Income/Charges
Acquisition Expense
Interest Income/Expense, Net-Operating
Total Operating Expenses
22.4%
2.1%
6.3%
0.7%
0.0%
52.1%
8.7%
34.4%
100.0%
25.5%
74.5%
%comp
4402
331
525
49
0
8062
1557
5698
16590
4126
12464
26.5%
2.0%
3.2%
0.3%
0.0%
48.6%
9.4%
34.3%
100.0%
24.9%
75.1%
%comp
4145
335
541
12
−149
8150
1490
5623
16184
3889
12295
2011
25.6%
2.1%
3.3%
0.1%
−0.9%
50.4%
9.2%
34.7%
100.0%
24.0%
76.0%
%comp
3664
339
614
14
−278
8144
1472
5427
15508
3700
11808
2010
23.6%
2.2%
4.0%
0.1%
−1.8%
52.5%
9.5%
35.0%
100.0%
23.9%
76.1%
%comp
3969
0
424
23
−246
8036
1460
5415
15817
3812
12005
2009
25.1%
0.0%
2.7%
0.1%
−1.6%
50.8%
9.2%
34.2%
100.0%
24.1%
75.9%
%comp
2
2011–2013 shows >1% increase in cost of revenues as a percent of total revenues.
SG&A percents are similar at Medtronic and St. Jude.
3
Medtronic’s R&D in absolute terms exceeds all competitors; however, in relative terms, they are able to capture some scale economies in R&D and spend at lower %.
4
The industry as a whole is facing some headwinds. Operating income is down for all competitors this year… All players are impacted.
1
NOTES:
Operating Income
3813
17005
4333
12672
Total Revenue
Cost of Revenue1
Gross Profit
4
2013
MEDTRONIC (MDT)
2012
Trend Analysis of Key Financial Indicators of Medtronic, St. Jude, and Boston Scientific
Part A—Level 2 Analysis of Medtronic’s Income Statement
Exhibit 3.12
−1.0%
2.5%
26.0%
50.2%
0.3%
1.9%
1.8%
3.3%
1.4%
CAGR
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Chapter 3 Internal Analysis 69
1884
691
0
2876
1051
Selling, General and Administrative
Research and Development 6
Special Income/Charges
Total Operating Expenses
Operating Income
19.1%
34.2%
12.6%
12.6%
52.3%
%comp
100.0%
28.6%
71.4%
1100
1891
676
0
2865
2012
5503
1538
3965
20.0%
34.4%
12.3%
12.3%
52.1%
%comp
100.0%
27.9%
72.1%
1115
2084
709
171
2964
2011
5612
1533
4079
19.9%
37.1%
12.6%
12.6%
52.8%
%comp
100.0%
27.3%
72.7%
1277
1818
643
17
2477
2010
5165
1410
3755
24.7%
35.2%
12.5%
12.5%
48.0%
%comp
100.0%
27.3%
72.7%
1113
1675
560
80
2315
2009
4681
1253
3428
23.8%
35.8%
12.0%
12.0%
49.4%
%comp
100.0%
26.8%
73.2%
2013
7,143
2,174
4,969
2,814
861
410
764
4,849
120
BOSTON SCIENTIFIC (BSX)
Total Revenue
Cost of Revenue7
Gross Profit
Selling, General and Administrative8
Research and Development9
Depreciation, Amortization and Depletion
Special Income/Charges
Operating Expenses
Operating Income10
−3,868
395
4,799
8,768
886
2,688
2012
7,249
2,349
4,900
−53.4%
5.4%
66.2%
121.0%
12.2%
37.1%
%comp
100.0%
32.4%
67.6%
904
421
84
4,059
895
2,659
2011
7,622
2,659
4,963
11.9%
5.5%
1.1%
53.3%
11.7%
34.9%
%comp
100.0%
34.9%
65.1%
−656
513
1,646
5,863
939
2,765
2010
7,806
2,599
5,207
−8.4%
6.6%
21.1%
75.1%
12.0%
35.4%
%comp
100.0%
33.3%
66.7%
−894
511
2,118
6,506
1,035
2,826
2009
8,188
2,576
5,612
−10.9%
6.2%
25.9%
79.5%
12.6%
34.5%
%comp
100.0%
31.5%
68.5%
9
8
Boston Scientific is obviously struggling with declining revenues and gross profits—and higher COR% than rivals Medtronic and St. Jude.
Boston Scientific also has significantly higher SG&A% than rivals Medtronic and St. Jude.
R&D is being trimmed faster than SG&A (another cause for concern).
10
Tiny 2013 margins and recent wild swings in operating income indicates the the firm is still “in the woods” as of 2013... Special charges = restructuring charges, net,
certain litigation charges, net, acquisition-related items, or certain tax adjustments.
7
1.7%
5.7%
10.7%
67.9%
12.1%
39.4%
%comp
100.0%
30.4%
69.6%
Part C—Level 2 Analysis of Boston Scientific’s Income Statement
2011–2013 shows >1% increase in cost of revenues as percent of total revenues for St. Jude as well... Gross profit % lags Medtronic, but growth in GP exceeds Medtronic.
St. Jude is focusing on the future with relative increase in R&D.
NOTES:
6
5
NOTES:
2013
5501
1574
3927
ST JUDE MEDICAL (STJ)
Total Revenue
Cost of Revenue5
Gross Profit
Part B—Level 2 Analysis of St. Jude’s Income Statement
NA
−5.4%
−22.5%
−7.1%
−4.5%
−0.1%
CAGR
−3.4%
−4.2%
−3.0%
−1.4%
5.6%
3.0%
5.4%
CAGR
4.1%
5.9%
3.5%
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70 Part One External and Internal Analysis
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Chapter 3 Internal Analysis 71
Level Two Strategists must also understand how components of the firm’s revenues and
costs compare to those that are being realized by other firms in the industry. How do the
company’s profit margins, ratios, and other financial indicators (including credit rating) stack
up against its rivals? Is it beating (or falling behind) the trends? Such an analysis can highlight differences in a firm’s revenue composition, its research and plant investment priorities,
and exactly where a firm is seeing stronger or weaker results than its rivals.
See ­Exhibits 3.12 for a comparative analysis of three major medical device firms’ income
statements. This analysis shows the lead that Medtronic and St. Jude have leads over rival
Boston Scientific in a number of key areas including cost of revenue and selling, general, and
administrative expenses. St. Jude alone has the lead in R&D, while Medtronic has the lead in
operating income.
Answers to the questions are much more readily available to analysts researching
publicly held firms, while those attempting to gather such information on privately held
firms must craft estimates based on information that can be gleaned from public sources.
Level Three Analysis This most granular level of quantitive analysis is designed to help
leaders benchmark the firm’s key activities and outcomes. Oftentimes, these measures
­offer important insights into a firm’s relative advantage and the behavior of its bottom line
Are the company’s products per channel getting stronger? Are its brand families gaining
popularity? Can the company demonstrate continuous improvement of internal processes
such as inventory management, employee productivity, delivery times, defect rates, safety/
compliance, employee satisfaction, and engagement? At level three, managers must be
aware of important measures for their specific lines of business and unique internal process requirements. For example, supply chain traceability—a critical success factor that
is closely monitored in the medical device industry—is not a meaningful factor to track
for a retailer or an airline. Retailers closely track sales per square foot and inventory
turns, while airlines monitor measures of delayed departures and lost baggage claims.
Assuring Accountability
The ultimate accountability for a company’s performance lies with the board and top
management. The classic ideas of management theory are hierarchical. Managers are the
agents of the owners. Owners in publicly traded corporations are stockholders. Managers
are not supposed to pursue their own interests at shareholders’ expense.10 A company
needs a strong top leadership team headed by a talented, experienced, and accomplished
chief executive officer (CEO) who can deliver high returns. Quantifiable financial ­results
motivate the top management team, which is held accountable by the board of directors,
who represent shareholder interests.
To achieve these quantifiable goals, the top management team must continually rearticulate the company’s mission (what it has been good at in the past) as well as the vision
of where the company should be going (see Chapter 2). It has to establish structure and
values for assuring that the company’s strategy is carried out.
Accountability comes from the top down in response to shareholder needs. The board
of directors monitors, controls, and advises the top management team. It approves its
strategy and aligns strategy with the interests of shareholders. A sufficient number of
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72 Part One External and Internal Analysis
independent outsiders should be on the board to bring fresh ideas and perspectives and
to ensure accountability.
This type of accountability closely corresponds to Frederick Taylor’s scientific
method of dividing the work based on the specific tasks involved and investigating systematically the best way to carry out each task.11 Top management assigns to everyone in
the organization a specific role and function that best serves shareholder interests.
­According to classic management theory, the organization, therefore, must have:
∙
∙
∙
∙
A well-defined hierarchy.
A division of labor to allow high degrees of specialization.
A very specific and well-defined set of assignments of authority and responsibility.
Unity of command and direction so that there is subordination of individual interests
to the good of shareholders.
Accountability is best understood in terms of the top management team and its interaction with the board and employees.
Task- and Team-Oriented Organization
Because of its suppression of bottom-up initiatives and individual creativity, this type of
accountability has limitations. In its rigidity, it is a caricature of bureaucracy run wild.
Not all organizations are likely to thrive under this model; thus, for example, advertising
agencies, consultancies, and movie studios typically do not organize themselves in this
fashion. More democratic, task- and team-oriented, each project on which they work is
somewhat different. Organizations of this nature provide ample opportunity for e­ mployee
participation. They need employees to feel free of arbitrary constraint, so they can
­express their originality.
Firms that operate in fast-moving environments understand that there is no one best
way to assure accountability. The work that they do requires resourcefulness and responsiveness to unpredictable demands, which a rigid hierarchy will stifle. Accountability
depends more on the extent to which the individual creativity of employees is set free. Is
the organization flexible and capable of rapid adjustment to shifting external demands?
Does it innovate quickly?
Because of the drawbacks of this approach to accountability, it has been supplemented by a variety of approaches. For instance, the human relations approach to management theory is considered by proponents to be more employee-friendly.12 It stresses
motivation and values. It asserts that:
∙
∙
∙
∙
Informal coordination in groups should replace centralized controls.
Communications between employees and managers should be two-way.
Compensation should be based on performance, not on following orders.
Management should foster an environment that is conducive to employees’ development and learning.
An indicator of organizations’ strengths and weaknesses might be the extent to which
­employees are given an ownership stake through employee stock ownership plans
(ESOPs). This model is not just confined to small firms. Walmart, for example, is one
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Chapter 3 Internal Analysis 73
company that has tried to install it. While Walmart forbids unionization and stifles
­attempts at unionizing, it also tries to avoid antagonism between employees and management by means of a servant leadership model in which employees are provided with the
tools they need to succeed and are given substantial leeway to carry out their tasks.
Though Walmart expects employees to work hard for low wages, it incents them to do so
by making them partial owners. Employees share in the profits when the company’s
stock price goes up.
Contingency Theory
Contingency theory holds that depending on the external environment a company faces,
there are two models it can follow: mechanistic and organic.13 The mechanistic model
relies on hierarchy, functional specialization, and a formal and impersonal structure. Employee rewards are primarily economic, in the form of wages; employees rarely have ownership rights. The organic form, in contrast, is less rigid and hierarchical than the
mechanistic. It relies more on decentralization, participation, and a democratic personal
structure. Employee motivation is less dependent on economic rewards; it arises from
employees’ sense of belonging and their identification with the organization’s mission
and values. The task of analyzing an organization’s strengths and weaknesses comes
down to understanding which of these forms is most appropriate, given external demands.
Contingency theorists argue that the mechanistic model works better in stable organization environments, while the organic model works better in turbulent environments. A
problem with the theory has been how to best distinguish a stable from a turbulent environment. Turbulence might be a regular occurrence in highly creative industries that are
always changing like advertising or movie production, while stability might be more
common in manufacturing industries trying to achieve high levels of quality or efficiency and reliability (for example oil refining), but even these industries are not pure
types, with some aspects of the movie business being mechanistic and some aspects of
manufacturing being organic because they are constantly changing. The theory’s basic
proposition is that corporate performance is a consequence of a fit between the external
environment and the organization’s internal characteristics, yet e­ xternal environments
are hard to describe and an appropriate fit must be regularly ­adjusted if it is to be
achieved. Accountability depends on whether the appropriate level of fit has been
achieved. However, this is hard to determine. The precise meaning of fit with an
organiza­tion’s external environment is unclear, and the process of clearly identifying and
measuring external and internal environments is problematic.
With regard to the external environment, a number of questions arise: Is it best to
­assess it in terms of industry variables (the five forces), macroeconomic factors (government, economics, technology, social structure, and the natural environment), strategic
group analysis, and/or stakeholder relations? (see Chapter 2) In what ways do these
­interact to define an organization’s external environment? Similarly, what is the best way
to assess an organization’s internal environment? Such an analysis could be based on
many factors. For instance, an organization’s capabilities can be described in terms of:
∙ Leadership. The leadership style in an organization includes the types of motivation
systems used, patterns of communication in the organization, and interpersonal interactions and relations.
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74 Part One External and Internal Analysis
∙ Decision making. This includes not only the way in which decisions are made, but
also the goals that are pursued and the control systems that are in place to ensure that
these goals are met.
∙ Performance mechanisms. These are the mechanisms used for performance assessment, training, and socialization.
∙ Division of labor. How is labor divided? Is it divided on the basis of products, markets
(industrial, commercial, and government), functions (production, sales, marketing,
finance, administration, and R&D), technologies, or geographic locations? Indeed,
many firms have a hybrid structure, with some divisions devoted to functions, some
to ­clients, and some to geographic areas. Other organizations have a matrix structure,
in which employees have dual reporting arrangements on the basis of functional
­expertise, customers served, and/or geographic area. Which of these involve a better
fit and constitute a strength rather than a weakness?
∙ Integrating mechanisms. They determine how the organization brings together people, products, and processes, rather than separating them into different roles and functions. These mechanisms are important. In each organization, they tend to vary and
might include informal contacts among employees, the use of task forces, and/or permanent and temporary coordinating teams. How do the integrating mechanisms contribute or fail to contribute to an organization’s strengths and weaknesses?
∙ Culture. An organization’s culture also can be a key strength. As discussed, cultures
are a building block for an organization’s capabilities. Cultures vary from strong to
weak, depending on a variety of attributes: attitudes toward customers and competitors, levels of individual autonomy and management support, achievement orientation, compensation equity, moral and ethical integrity, professionalism, and tolerance
for risk and conflict. Some corporate cultures are obsessed with product quality; others consider product innovation or market growth more important than product quality. Which culture is a best fit with external conditions?
Contingency analysis is hindered by the presence of multiple contingencies. Under
what circumstances are a mix of organizational components appropriate in different environments? When are different combinations a strength rather than a weakness? Given
economic uncertainty, for instance, it is unclear how organizations should respond.
When resources are shrinking, job mobility is slim, and layoffs are common, what
should organizations do?
The best way to organize is hard to determine. Meanwhile, “Dilbert” cartoons that
represent people’s growing frustration with dysfunctional organizations proliferate. Many
organizations, allegedly including high-tech leader Amazon, have overworked and
stressed-out personnel and hostile, counterproductive work climates. According to a New
York Times article, at Amazon, workers are encouraged to tear apart one another’s ideas in
meetings, toil long and late (e-mails arrive past midnight, followed by text messages asking why they were not answered), and held to standards that the company boasts are “unreasonably high.” The internal phone directory instructs colleagues on how to send secret
feedback to one another’s bosses. Employees say it is frequently used to sabotage others.14
In many organizations, a lack of coordination among key divisions also exists. There is
excessive decision making at the top and inexplicable duplication among functions.
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Chapter 3 Internal Analysis 75
The Seven S’s
The popular business book of the 1980s, Tom Peters and Robert Waterman’s In Search
of Excellence, brought together elements of the mechanistic and organic model. The 7S
framework in the book came from McKinsey & Company, where Peters and Waterman
had worked as consultants.15
According to this approach, there are seven attributes (seven S’s) or basic levers that
management can manipulate to steer large and complex organizations. Anchored by
shared values, these integrated attributes are depicted in Exhibit 3.13.
1. Strategy—the extent to which an organization has a logical sense of the actions it
must take to gain sustainable competitive advantage over the competition, improve its position in relation to customers, and allocate resources to high-return
activities.
2. Structure—the extent to which an organization has a coherent form for dividing
­labor, allocating responsibilities, coordinating tasks, and ensuring accountability.
3. Systems—the extent to which an organization has explicit descriptions in place to
show how processes work and tasks are accomplished in critical areas such as capital
budgeting, manufacturing, customer and supplier relations, accounting and performance measurement, and carrying out mergers and acquisitions.
4. Style—the degree to which there is tangible evidence that the time, attention, and
behavior of management and employees actually are devoted to, and aligned with, the
organization’s real strategic needs (not just lip service, but real action).
5. Staffing—the degree to which management and employee expertise and experience
match the jobs that have to be carried out, the extent to which the personalities in
EXHIBIT 3.13
The 7S
Framework
Structure
Strategy
Systems
Shared
Values
Skills
Style
Staff
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76 Part One External and Internal Analysis
place are capable of working together, and the degree to which there is sufficient
­diversity among staff to allow opposing and dissenting voices to be heard.
6. Skills—the extent to which an organization as a whole, as opposed to its employees,
has the capabilities not only to compete in existing businesses, but also to develop
new businesses and generate corporate growth.
7. Shared values—the extent to which there is unity of purpose behind a common vision
and culture that is taking the organization to where it should be going.
Peters and Waterman faulted U.S. managers for tending to focus almost exclusively on the mechanistic elements or the tighter side of organizations—strategy,
structure, and systems—while missing the importance of the soft, organic stuff—
style, staffing, skills, and shared values. The qualities that arose from the blending
of these elements were:
∙
∙
∙
∙
∙
∙
∙
∙
A bias for action.
Closeness to the customer.
Autonomy and entrepreneurship.
Productivity through people.
Hands-on and value-driven operations.
A willingness to stick to the knitting.
A simple form and lean staff.
Simultaneous loose-tight properties
Peters and Waterman defined an excellent company as one in the top half of its
industry on financial indicators and identified eight qualities shared by companies
they considered excellent. Unfortunately, the 7S approach proved to be a very
unreliable indicator of future performance. Many of the “excellent” companies
Peters and Waterman analyzed did not survive or became poor performers, including
Digital Equipment, Westinghouse, Xerox, Kodak, Wang Laboratories, Polaroid, and
Kmart. Over time, these firms were unable to sustain their excellence and focus on
these attributes.
Strengths, Weaknesses, Opportunities, and Threats (SWOT)
Ultimately, internal analysis comes down to adjusting a firm’s strengths (S) and weaknesses (W) to the opportunities (O) and threats (T) it confronts (see Exhibit 3.14). SWOT
analysis enables an organization to grasp the strategic choices it faces and generate
­options that the firm could pursue. Doing this is not easy.
∙ Strengths and Opportunities (SO) – How can a company use its strengths to take advantage of the opportunities?
∙ Strengths and Threats (ST) – How can it take advantage of its strengths to avoid real
and potential threats?
∙ Weaknesses and Opportunities (WO) – How can it use opportunities to overcome the
weaknesses it is experiencing?
∙ Weaknesses and Threats (WT) – How can it minimize the weaknesses and avoid the
threats?
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Chapter 3 Internal Analysis 77
EXHIBIT 3.14
SWOT
Analysis
Internal Strengths (S)
Internal Weaknesses (W)
Summary
External Opportunities (O)
External Threats (T)
SO
Strategies that use strengths to
maximize opportunities
ST
Strategies that use strengths
to minimize threats
WO
Strategies that minimize
weaknesses by taking
advantage of opportunities
WT
Strategies that minimize
weaknesses and avoid
threats
A number of different approaches are available to analyze a firm’s strengths and
weaknesses. This chapter has focused first on the resource-based view (RBV). This
approach, as emphasized in this chapter, has many qualitative elements. It differs in
fundamental ways from the IO approach introduced in the last chapter. These
differences have been highlighted. A more quantitative approach is to dig down into a
firm’s financials by taking apart the activities in the value chain and comparing the
firm’s performance of these activities with that of other firms. The aim is to determine
the profitability of the activities in comparison to costs and returns if they were to be
performed outside the firm.
Once a firm understands its financial situation, it is incumbent on it to improve its
situation. Assuring accountability for improvement was another subject of this chapter.
Classic theories of hierarchical management have been contrasted to the human relations
and contingency approaches.
The failed attempt by Peters and Waterman to bring together mechanistic and organic
management in the 7S framework has been discussed. Ultimately, accountability arises
from doing SWOT analysis and assuring that there is alignment between the firm’s external environment and its internal strengths and weaknesses, which leads to sustained
competitive advantage.
Exercises for the Practitioner and the Student
Reflect on your own employer’s external environment. If you are a student, please select
a publicly held firm to analyze.
1. Do a SWOT analysis of the company:
a. Start with the main opportunities and threats that the company faces.
b. List the types of resources and capabilities the company has to take advantage of
the opportunities and avoid the threats.
2. To what extent do these resources and capabilities add up to a distinctive competence
that meets a VRIO test?
3. To what extent must the company acquire or develop new resources and capabilities
to meet a VRIO test?
4. How should it go about acquiring and developing these resources and capabilities?
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78 Part One External and Internal Analysis
5. Trace the company’s value chain and its value chain linkages, and conduct a financial
analysis of the firm.
a. Where are its margins the highest and lowest?
b. Where might the company be better off if it sourced key functions from outside
vendors?
6. Describe the company’s top management and board structure. How strong is corporate governance in the company?
7. Has the company attained the right balance between a top-down hierarchical structure
and a bottom-up team-based structure? Where can improvements be made given the
key tasks the company faces?
Endnotes
1. C. Prahalad and G. Hamel, “The Core Competence of Corporations,” Harvard Business
­Review, May–June 1990, pp. 79–91.
2. M. Lewis, Moneyball (New York: Norton, 2004).
3. See Prahalad and Hamel, “The Core Competence of Corporations.” RBV has had nearly
40 years of development, starting with Edith Penrose’s 1955 classic, Theory of the Growth of
the Firm, and culminating in a flurry of attention in the past 15 years. E. Penrose, The Theory
of the Growth of the Firm (Oxford, England: Basil Blackwell, 1959); R. Amit and
P. Schoemaker, “Strategic Assets and Organizational Rent,” Strategic Management Journal 14
(1993), pp. 333–46; J. Barney, “Strategic Factor Markets: Expectations, Luck, and Business
Strategy,” Management Science 32, no. 10 (1986), pp. 1231–41; J. Barney, “Organization
Culture: Can It Be a Source of Sustained Competitive Advantage?” Academy of Management
Review 11, no. 3 (1986), pp. 656–65; J. Barney, Gaining and Sustaining Competitive Advantage
(Reading, MA: Addison-Wesley, 1997); A. Brumagin, “A Hierarchy of Corporate Resources,”
Advances in Strategic Management 10 (1994), pp. 81–112; I. Dierickx and K. Cool, “Asset
Stock Accumulation and Sustainability of Competitive Advantage,” Management Science 35,
no. 12 (1989), pp. 1504–13; G. McGrath, R. MacMillan, and S. Venkatraman, “Defining and
Developing Competence,” Strategic Management Journal 16 (1995), pp. 251–75; R. Hall,
“A Framework Linking Intangible Resources and Capabilities to Sustainable Competitive
Advantage,” Strategic Management Journal 14 (1993), pp. 607–18; A. Lado, A. Boyd, and
P. Wright, “A Competency-Based Model of Sustainable Competitive Advantage: Toward a
Conceptual Integration,” Journal of Management 18, no. 1 (1992), pp. 77–91; R. Nelson and
S. Winter, An Evolutionary Theory of Economic Change (Cambridge, MA: Harvard University
Press, 1982); R. Reed and R. DeFillippi, “Causal Ambiguity, Barriers to Imitation, and
Sustainable Competitive Advantage,” Academy of Management Review 5, no. 1 (1990),
pp. 88–102; B. Wernerfelt, “Resource-Based View of the Firm,” Strategic Management
Journal 5 (1989), pp. 171–80. D. Miller and J. Shamsie, “The Resource-Based View of the
Firm in Two Environments,” Academy of Management Journal 39, no. 3 (1997), pp. 519–43.
4. Barney, Gaining and Sustaining Competitive Advantage, p. 144.
5. J. Barney and W. Hesterly, Strategic Management and Competitive Advantage: Concepts and
Cases (Upper Saddle River, NJ: Pearson/Prentice Hall, 2008).
6. Prahalad and Hamel, “The Core Competence of Corporations.”
7. Nelson and Winter, An Evolutionary Theory of Economic Change.
8. Prahalad and Hamel, “The Core Competence of Corporations.”
9. Amit and Schoemaker, “Strategic Assets and Organizational Rent.”
10. F. Hayek, “The Corporation in a Democratic Society: In Whose Interests Ought It and Will It
Be Run,” in Business Strategy, ed. H. Ansoff (New York: Penguin, 1977), pp. 225–39.
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Chapter 3 Internal Analysis 79
11. F. Taylor, The Principles of Scientific Management (New York: Harper, 1911).
12. F. Roethlisberger and W. Dickson, Management and the Worker (Cambridge, MA: Harvard
University Press, 1939); F. Herzberg, Work and the Nature of Man (New York: Crowell,
1966).
13. J. Woodward, Industrial Organization (London: Oxford University Press, 1965); S. Ellis, T.
Almor, and O. Shenkar, “Structural Contingency Revisited: Toward a Dynamic System
Model,” Emergence 4, no. 4 (2002), pp. 51–84.
14. Jodi Kantor and David Streitfeld, “Inside Amazon: Wrestling Big Ideas in a Bruising Workplace,” New York Times, August 15, 2015, http://www.nytimes.com/2015/08/16/technology/
inside-amazon-wrestling-big-ideas-in-a-bruising-workplace.html?_r=0.
15. T. Peters and R. Waterman, In Search of Excellence (New York: Warner Books, 1982).
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P A R T
T W O
Making Moves
EA
External Analysis
General Environment
Competitive Forces
1
IA
Internal Analysis
Resources, Capabilities
& Competencies
Selection of Options
Business, Global and Corporate Level
Strategies & Tactics
BS + GS + CS + IS
2
Implementation
Marshalling Resources & Making Moves
Evaluation of
Performance
&
Continuous
Reinvention
3
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C H A P T E R
F O U R
Positioning, Tactics,
and Timing
“The art of war teaches us to rely not on the likelihood of the enemy’s
not coming, but on our own readiness to receive him; not on the chance
of his not attacking, but rather on the fact that we have made our position unassailable.”
Sun Tzu, The Art of War1
Chapter Learning Objectives
• Defining the five generic strategic positions that can be occupied by firms.
• Understanding how a firm can leverage its value chain in order to gain advantage at its
chosen position.
• Recognizing the increasing importance of the best-value position.
• Being aware of the variety of ways a product or service can be segmented.
• Viewing strategy in a dynamic sense—as a continual series of tactical offensive and defensive maneuvers.
• Appreciating the importance of timing in making strategic and tactical moves.
• Gaining an elementary comprehension of game theory and its contribution to strategy.
• Recognizing examples of company repositioning over time.
Introduction
This book has suggested several ways to achieve sustained competitive advantage thus far,
largely focusing on creating unassailable positions. In Chapter 2, it was shown that the most
profitable industry positions could be sought out, and barriers to entry could be raised, in
order to secure an advantage. Chapter 3 showed that the firm could also m
­ arshal its own
internal resources and build competencies that would provide ­advantage. These traditional
models, however, are largely static. They pay insufficient attention to the dynamic element
in strategy—how the external and internal environments of the firm are constantly changing, and how new moves must be always be made in order to win over the long term.
82
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Chapter 4 Positioning, Tactics, and Timing 83
As the book segues into Part 2, it examines such moves in detail. The integrated
model introduced in Chapter 1 suggests that flexibility, rapidity of movement,
­concentration of resources, and choosing the best battle venue are important. This
­chapter illustrates the importance of picking which battles to fight and timing the firm’s
moves, knowing that its competitors are poised to challenge it.2
Therefore, this chapter focuses on three key areas:
1. The generic strategic position a company selects given its internal strengths and
­external contexts, and how that position can be built and strengthened across the
value chain.
2. The offensive and defensive tactics the company can utilize to claim and defend its
position, and with which specific rivals it should engage. As Richard D’Aveni ­argues,
“The value, risks, and effectiveness of every move must be seen in relation to the
­actions of competitors.”3 When a firm makes a move, it must anticipate the countermoves of its competitors. The firm must be vigilant and ask, “What will our
competitors do next?” Game theory’s elementary principles are used to assist with
this analysis.
3. The timing of the firm’s moves given the state of the industry and the presence of
­rivals simultaneously seeking advantage. Once a firm’s position is clarified—and
the firm is experiencing some success in that position—rivals may take notice
and try to copy what the firm has done. Some may try to leapfrog a leading company’s position. Addressing such competitive threats is important—and the careful timing of a firm’s moves dictates whether it will maintain advantage over the
long term.
These three elements—positioning, tactics, and timing—define business-level strategy
(BS), and provide the firm with a foundation for broader moves at the corporate level
and across its global frontiers. Indeed, all of the firm’s strategies must be aligned and all
moves must be coordinated; the quest for advantage cannot be approached in a piecemeal fashion.
Positioning
To determine the position of a firm, it’s critical to understand how it can utilize its
strengths to secure profitable customer relationships. Understanding the threats and
­opportunities from the external environment helps the firm select a defensible position
and clarify exactly where it should set its sights:
∙ Should the firm aim to utilize its capabilities to provide distinctive benefits to
its customers and charge a premium for the increased value that it delivers, or
should it opt to drive costs down while merely maintaining an acceptible level of
quality instead?
∙ Should it serve a broad swath of customers and offer a wide variety of products or is
it better suited to specialize in a particular type of product, customer, or geography?
Answers to these questions can be mapped on a two-by-two matrix (see Exhibit 4.1) that
reveals five generic positions.4
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84 Part Two Making Moves
Generic
Strategic
Positions
Kinds of Customers,
Products or Geographies
EXHIBIT 4.1
Broad
Low Cost
Broad
Differentiation
Best Value
Focused
Low Cost
Focused
Differentiation
Product/Service Premium
at Each Link on Value Chain
Key to this analysis is a solid understanding of the firm’s current and potential
c­ apabilities. Strategies poorly matched to capabilities cannot secure advantage. It would
be like a slow 60-year-old trying to compete in the 100 yard dash in the Olympics. That
60-year-old must find an appropriate venue in which to compete.
If there is not an existing “venue” in which the firm can stand out, can it create a new
one where its strengths are applicable? These strengths must not all be internal to the
firm. The firm can leverage its strengths across the value chain, relying on a network of
relationships, contacts, and alliances to bolster its capabilities and then make choices
about where to compete.
Low-Cost Positions
A firm seeking to claim one of the low-cost positions found in the leftmost quadrants of
­Exhibit 4.1 intends to win the game by driving down costs across the value chain, building high volumes and selling at thin margins. Such firms offer products that are typically no frills, but still meet consumer needs and basic quality standards.
Superior advantage in a low-cost position comes from creating a significant and sustainable cost gap relative to competitors. Low-cost aspirants will make moves to reduce
the cost of inputs and devise more efficient supply chains with less input variation. They
go to great lengths when working with suppliers to identify and eliminate unnecessary
input costs. They are demanding and accomplished negotiators who apply relentless
pressure. Walmart, for example, insists that suppliers keep costs low, and that any shipments are delivered reliably. They have also developed unmatched expertise in forecasting and inventory logistics.
Moving forward on the value chain to production activities, the low-cost leader may
also limit the firm’s product lineup and streamline operations, knowing that large
numbers of stock keeping units (SKU) and tasks only add complexity and cost.
Southwest Airlines, a pioneer in low-cost airline operations, chooses to fly only Boeing
737 aircraft for this reason. Focusing on only one aircraft type lowers the costs of
maintenance and training, reduces costly aircraft parts inventories, and greatly simplifies
key operating activities. While limiting product lineups, the low-cost player seeks to
accelerate ­learning to become more efficient, to boost scale to capture economies, and to
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Chapter 4 Positioning, Tactics, and Timing 85
right-size production to maximize the utilization of existing capacity. When capacity is
underutilized, each unit produced bears the costs of unproductive assets and those
saddled with such idle assets quickly fall behind.
At the distribution end of the value chain, low-cost leaders continue to trim costs.
Packaging can be designed to reduce bulk for economical shipping, firms can opt for
lower-cost transport options, such as sea and rail container, and economical decisions
can even be made about the format of the product that customers receive. IKEA’s
­practices, as outlined in Exhibit 4.2, provide an excellent example of the low-cost
­strategy in action.
The Unique Advantage of Low-Cost Leadership
Firms that are able to attain low-cost leadership have two powerful options. They can
­either market their products at or near industry pricing averages and reap superior profit
margins, or they can reduce prices to levels that cannot be matched by rivals over the long
term. When prices are set at industry average, the low cost leader builds a “war chest” that
can be deployed in future competitive battles. When prices are lowered to just above the
EXHIBIT 4.2
IKEA
A quick visit to IKEA reveals the company’s low-cost position and its highly disciplined approach to cost c­ ontainment:
•
•
•
•
•
•
Products are shipped to carefully procured store locations in major cities only. Deal-hungry shoppers make a
trip to one of IKEA’s stores even if it means a lengthy car ride.
None of the company’s locations are underutilized. IKEA merchandise is flat-packed without excess padding,
and the cardboard is just thick enough to protect the contents.
Inside each package, customers find products that are sourced from across the globe—wherever prices and
capabilities are most competitive.
Product-assembly instructions, such as those shown below, are wordless and feature simplistic drawings. Such
instructions are universally understandable and require no multilingual translations.
Store layouts are strictly utilitarian with clear signage, centralized checkouts, and often long pickup lines that
are minimally staffed.
Standardized hinges and other spare parts are readily available to consumers so that customer service personnel
do not have to be burdened by simplistic and repetitive requests and can attend to only the most critical tasks.
Yet customers leave the store happy. They receive what they perceive to be a great deal on their furniture, accessories, and even Swedish meatballs.
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86 Part Two Making Moves
EXHIBIT 4.3
Strategic
Options
Available to
True Low-Cost
Leader
Set price near industry
average, and build financial
advantage on superior margins
Co. A Price
Company A
Costs
OR
Set lowball price
and drive rivals away
Co. B Price
Company B
Costs
Co. B Price
Co. A Price
Company A
Costs
Company B
Costs
low-cost leader’s costs, rivals are driven out of business. (see Exhibit 4.3). A particularly
interesting ­example of the second option plays out whenever OPEC opts to flex its muscles as a low-cost leader in oil production.5 Its costs have been estimated at $23/barrel,
while crude from fracking in the Dakotas costs an average of $45/barrel. In 2015, Saudi
Arabia’s oil minister, Ali al-Naimi, saw low prices as a strategic weapon. His philosophy
was that oil-producing countries could accept “temporary pain” to drive down prices to
the point where fracking becomes unprofitable. Under this scenario, OPEC achieves a
win when highly leveraged North American producers go out of business.
Differentiation Positions
To claim differentiated positions in the rightmost quadrants of Exhibit 4.1, a company
must examine the value chain to determine where and how it can emphasize uniqueness
and add value. A company’s differentiators come at a cost, however, so to win via differentiation, a company must offer differentiated benefits only where a substantial number of customers are willing to pay a significant premium for a unique product.
While there are many ways for the low-cost player to reduce costs, there are even
more ways for the differentiator to add customer value. A company can examine the
­entire value chain to find tangible and intangible benefits that appeal to both emotion
and practicability:
∙ Tangible benefits can be created by melding superior engineering, top-quality materials, and exacting manufacturing into high-performance equipment.
∙ Intangible benefits that customers crave can be created via exclusivity, brand mystique, and “high-sheen, high-service” selling environments.
The tangible aspects include all the observable product characteristics, such as size,
color, and materials used to make the product, packaging, and complementary services.
The intangible aspects include unobservable and subjective qualities—image, status,
exclusivity, and identity. The total value of a product to the customer is conveyed not just
by the functions the product performs, but by the entire relationship a firm has with the
customer. There are many ways to bundle or separate aspects of the product or service to
create exclusive categories.
A company must appeal to the elementary need that all people have for status, identity, and image, as it is an excellent source of differentiation. People define themselves in
terms of what they buy. Those who shop at Target as opposed to Walmart, Kmart, or
­Family Dollar say something different about the type of person they are. Harley-­Davidson
is more than a motorcycle company, and Starbucks is more than a coffee shop. They are
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Chapter 4 Positioning, Tactics, and Timing 87
EXHIBIT 4.4
Types of
Differentiators:
Tangible and
Intangible
Benefits
Perceived by
the Target
Customer
Emotional
Benefits
Great Deal or ROI
Low Cost Ownership
Saves Time
Reduces Errors
Style & Self Expression
Affiliation (w/cool crowd)
Freedom/Independence
Power/Control
The
Customer
Economic
Benefits
Functional
Benefits
Raw Capabilities
Interoperability
Upgradability
Flexibility
Reliability
near cults in the type of loyalty they command and commitment they obtain. Brands reinforce the identities people already have and appeal to people with these identities.
Those who use alternative medicines make a different statement about their identity than
do those who rely on conventional medicines. Those who buy Ivory soap express different views of themselves than do those who use perfumed or deodorant soap.
Differentiators, whose products often lack the broader, utilitarian appeal of low-cost
­offerings—only succeed when their customers recognize the benefits of their products
and services, and are willing to pay a price that is high enough to generate a more significant margin. For example, a high-performance, exclusive automobile can command
a much higher price and margin than a compact, mass-market model. Such a margin
permits the differentiator to remain in business and continue to serve the discerning
buyer despite a low volume of sales.
Segmenting the Market
The ability to find new opportunities for differentiation comes from observing product
attributes that are not well covered in the market. The evolution of pain relievers provides an interesting example. At one time, there was the high-on-effectiveness, lowgentleness cluster, which consisted of Excedrin, Anacin, and Bufferin. Of these, Excedrin
was highest on effectiveness and lowest on gentleness, while Bufferin was highest on
gentleness and lowest on effectiveness, and Anacin was somewhere in between (see
­Exhibit 4.5). All three were considered to be an improvement over plain aspirin. Tylenol
had the gentleness space to itself, although it was not perceived to be as effective as the
other analgesics. The highly effective, extremely gentle pain reliever segment remains an
open target. The search for a product to fill this segment continues.
Buyers—like products—can be segmented in many ways.6 For example, Industrial
buyers can be divided by industry, strategies that these firms pursue in their industry (lowcost or differentiation), size and type of ownership, decision-making unit or process, order
pattern, technical sophistication, and the extent to which they serve original equipment
manufacturers (OEM) or the replacement market. Household buyers can be divided by
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88 Part Two Making Moves
EXHIBIT 4.5
Perceptions of
Painkillers
Source: Adapted from
R. Grant,
Contemporary
Strategy Analysis, 4th
ed. (Oxford:
Blackwell, 2002),
p. 284.
High
Meditation
?
Tylenol
Massage
Acupuncture
Bayer
Low
High
Private
label
aspirin
Bufferin
EFFECTIVENESS
Anacin
Excedrin
Ibuprofen
Low
Darvon
GENTLENESS
demographics, lifestyle, physical size, price level, packaging, promotion, color, a­ ppearance,
physical feel, and other product features, technology, design, inputs or raw materials
needed to use the product or service (e.g., an ink cartridge for a printer), actual performance characteristics in comparison to other products or services of its type, or the presale
and post-sale services provided. Products and services can be grouped in this way to meet
different customer needs. Distribution channels can be partitioned in many ways. They can
be divided into direct distributors, wholesalers, brokers, and other intermediaries, as well
as retail, mail order, phone, and the Internet. These channels can be exclusive or nonexclusive, generalists or specialists. Each has appeal to a different customer segment.
Even geographic areas can be segmented. They can divided by locality, region,
­nation, blocs of nations, continents, weather zones, and other distinguishing features.
Industrial buyers can be divided by industry, strategies that the firms pursue, size and
type of ownership, decision-making unit or process, order pattern, technical sophistication, and the extent to which they serve a different market. There are many ways to
bundle and separate aspects of the product or service mix to create different categories.
Are Low Cost and Differentiation Compatible?
Porter argues that it is important for the managers of a company to understand which
position to occupy—low cost or differentiation. He maintains that the internal resources
and ­capabilities needed to support one are not compatible with the internal resources and
capabilities needed to support the other (see Exhibit 4.6).7 In retailing, for example,
Walmart’s disciplined cost cutting philosophy is worlds apart from that of luxury retailer
Neiman Marcus. Companies such as, Sears and JCPenney, have struggled to stake a clear
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Chapter 4 Positioning, Tactics, and Timing 89
EXHIBIT 4.6
The
Incompatible
Capabilities of
Cost Leaders
and
Differentiators
Cost Leadership
Differentiation
Scale-efficient plants/locations
Standardization
Control of overhead
Tight process controls
Branding and advertising
Custom design and special services
Unique features
Emphasis on creativity
position in the middle because the resources and capabilities needed to maintain a middle position are not compatible.
Why is it so difficult to occupy the middle? Think of the differences between a
­famous artist, who has to sell only a few paintings at very high margins to survive, and a
pin manufacturer, which must sell millions of pins at very low margins to survive. Now,
imagine trying to combine both approaches successfully. Pablo Picasso would never
punch a time clock at the pin manufacturer. Only the most capable organizations can
strike the right balance and successfully stake out a best value position.
Best Value
Contrary to Porter’s argument, some firms have found success “in the middle.” Such
best value competitors will draw customers from lower- and higher-end rivals by casting
a wide net and offering a selection of products and services that appeal to bargain seekers
and that luxury buyers also find special enough to meet their needs. Best-value companies
often take advantage of behind-the-scenes low-cost processes while providing high-­
quality interactions that end-customers especially appreciate.
One of the most successful best value players today is Trader Joe’s. The firm has
parsed its value chain, ruthlessly cutting behind-the-scenes costs that most customers do
not notice while elevating the shopping experience in their stores. Trader Joe’s adheres
to a limited selection, high-volume model that yields significant cost reductions. Their
peanut butter is an example. The company sells 10 types, while most supermarkets sell
about 40. If both a typical supermarket and a Trader Joe’s store sell 40 jars a week,
Trader Joe’s sells an average of four of each type, while the average supermarket might
sell only one. With high turnover on few items, Trader Joe’s can purchase large quantities at deep discounts. The whole business, therefore, from stocking shelves to checking
out customers, operates according to a very simple model.
Trader Joe’s management keeps costs down by minimizing the number of product transactions. It purchases directly from manufacturers, not through wholesalers, who ship their
wares directly to the company’s distribution centers. Attention to costs also is evident in
Trader Joe’s store design. To show that more help is needed at the registers, simple lowtech bells ring to alert employees. The purchasing space is not cluttered with a conveyor
belt or scale. Perishables are sold by unit and not by weight, adding to speedy checkout.
Though all these features simplify the selling experience, product quality and customer
service remain paramount. Customers accept that the selection for particular product categories is limited, but they trust that those few items have unique and special features that
they otherwise could not access in a conventional grocery. To find these items, Trader Joe’s
searches the world. Its biggest R&D expense is travel to find new and unique products.
Finally, compensation at Trader Joe’s encourages employees to deliver outstanding
service. Store managers have six-figure incomes, and the full-time crew members can earn
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90 Part Two Making Moves
up to the $60,000 range in starting salaries and benefits. On top of the pay, Trader Joe’s
annually contributes more than 15.4 percent of its workers’ gross incomes to tax-deferred
retirement accounts. This best-value combination of outstanding attention to customer
service and product quality coupled with disciplined behind-the-scenes operations and
well-compensated staff has allowed this German-owned grocer to rapidly grow its revenues.
The Impact of Position on Margin
The adoption of a clear position with appeal to a company’s target market yields per-unit
profit margin advantages. The low-cost leader has greater margins than the average industry competitor even if its prices are low due to its ability to trim costs across the value
chain. The differentiator has greater per-unit margins than the low-cost leader as it commands higher prices for the additional value it delivers. Best-value players have better
margins when the benefits that their products and services justify higher prices, and their
disciplined operations reduce costs. Exhibit 4.7 summarizes each position and illustrates
the trade-offs.
Repositioning
Companies have the capacity to regularly reposition their products and services. The
positions they hold in the market are not stable. Companies are dynamic: Over time, in
response to competitive challenges, they switch positions. A major challenge a company
faces is knowing when and how to make these switches. Best Buy moved from a narrow
differentiated position to a narrow low-cost one (see Exhibit 4.8).8 It started as a highquality stereo store for audiophiles, with a few stores in Minneapolis/St. Paul, ­Minnesota,
before it moved to its current niche as a low-cost electronics outlet, but it did not stop
there. Concept One was introduced in 1983 because the company feared extinction and
involved Best Buy expanding its floor space and selection, pricing competitively, and
creating a very exciting store environment. Best Buy wanted to be the “fun place to
shop” for the 18-to-25-year-old male. In 1989, the company rolled out Concept Two. No
longer satisfied with its position as a low-cost leader, it combined mass-market and specialty retailing. It offered value products in select categories without the selling pressure
of a commissioned sales force. Best Buy was, in a sense, returning to its roots as a specialty store—the Sound of Music, which was its previous name.
EXHIBIT 4.7
Trade-Offs
among
Strategic
Positions
14
12
10
Price
8
Cost
Margin
6
4
2
0
Average Industry Low Cost Leader
Competitor
Successful
Differentiator
Savvy Best Value
Player
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Chapter 4 Positioning, Tactics, and Timing 91
EXHIBIT 4.8
Kinds of Customers,
Products or Geographies
Best Buy has repositioned itself several times:
Broad
Low Cost
3
Broad
Differentiation
Best Value
2
1
Focused
Low Cost
1. Founded as specialty “Sound of Music”
store in focused differentiation position’
2. Shifted to narrow low-cost position as it
grew into electronics superstore
3. Currently in best value position, serving
mass market selling both commodity and
specialty items at very competitive prices
Focused
Differentiation
Product/Service Premium
at Each Link on Value Chain
Kinds of Customers,
Products or Geographies
Schwab & Morgan Stanley have both moved
toward the middle:
Broad
Low Cost
1
2
Broad
Differentiation
Best Value
Focused
Low Cost
1
Focused
Differentiation
1. Schwab was a traditional low cost player,
while Morgan Stanley held a differentiated
position
2. Schwab moved to the middle upon the
emergence of (lower cost) online brokers…
Morgan Stanley also saw best value opportunities with purchase of Dean Witter
Product/Service Premium
at Each Link on Value Chain
Even the iconic Ivory brand has moved:
Kinds of Customers,
Products or Geographies
Movement
among
Strategic
Positions at
Best Buy,
Schwab and
Morgan
Stanley, and
Ivory
Broad
Low Cost
Broad
Differentiation
Best Value
2
Focused
Low Cost
1. Ivory was a differentiator before Dial, and
Dove challenged their position
2. They moved to a low cost position after
they were challenged
1
Focused
Differentiation
Product/Service Premium
at Each Link on Value Chain
Concept Two was extremely successful, allowing Best Buy to overtake Circuit City in
sales, but the run-up in sales was not matched by a concomitant growth in earnings.
Concept Three was designed to address the earnings problem by positioning the ­company
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92 Part Two Making Moves
as even more of a hybrid. Best Buy offered both high-margin myth products and lowmargin commodity elements. This strategy mixed low cost and differentiation and
moved the company closer to the middle. Each phase in Best Buy’s development built on
the previous one. As it repositioned again and again, the company held on to elements of
its old position even while it branched out and developed a new ones. Fast movement
allowed Best Buy to widen the gap between itself and Circuit City. Customers liked the
company because it offered everyday low prices, and its stores were bright, fun, and
leading edge.
Considerable repositioning has occurred in the securities industry as well (see
Exhibit 4.8). Schwab moved from its low-cost position as a discount broker to a middle
position by offering full services to high-net-worth individuals. At the same time that
Schwab was undergoing its transformation, full-service brokers, such as Morgan Stanley,
also made changes. Morgan Stanley made its move toward the middle by purchasing
Dean Witter in 1997. It obtained more than 10,000 brokers whose clients were not the
high-net-worth individuals to whom Morgan Stanley traditionally had catered. The
­culture of exclusivity had to give way to a more common appeal as the firm merged two
powerful, very different organizations.
Porter provides an extremely interesting example of historical product repositioning
(see Exhibit 4.8).9 Ivory started as a differentiated soap. In 1879, when more than
300 companies produced crude, inexpensive soaps, Ivory was the first to offer a pure and
mild product. It had no harsh ingredients, and it floated. Ivory was heavily advertised,
and the company’s message was purity (“99.44 percent” pure). It aggressively used comparison ads and the endorsements of chemists and physicians to certify the pure image.
Early on, it adopted the image of a baby and the slogan “mild enough for a baby.” Ivory
sold at a premium price and commanded a leading share of the market until it was challenged by Dial, the first deodorant soap, and by Dove, the first beauty bar. In response to
these challenges, Procter & Gamble decided not to add these features but to reposition
Ivory as a basic, good-value soap.
Ivory went from differentiation to cost leadership (see Exhibit 4.8). It quickly established itself in a leading market position as the simple, no-frills soap that was sold in the
package with no shiny paper or garish colors. Procter & Gamble pioneered the idea of
bundling bars of soap by selling six bars of Ivory together. Its advertising stressed that
Ivory was a great soap for the money: “We probably should charge more for great soap
like Ivory.” Contributing to Ivory’s low cost was its air bubbles, which not only allowed
it to float, but also reduced the material needed to manufacture it. It also lacked expensive additives like those in Dial’s and Dove’s products. Its simple packaging was inherently cheaper, and its long and consistent brand image controlled advertising costs. Since
the brand was well-known and had such a long history, it also was a traffic builder for
retailers, so Procter & Gamble did not have to spend much on trade promotion.
The history of Ivory as well as the other companies demonstrates the idea of a product life cycle in which maturity is not inevitable. Companies can change position to
prolong the product life cycle. There are many changes, but the changes are based on
continuity and a product’s past history and inherited qualities. Brands are like
­personalities that move and change over time, but also have stable features. They have a
set of traits that consumers immediately recognize and to which they relate because of
a company’s or product’s history.
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Chapter 4 Positioning, Tactics, and Timing 93
Many Ways to Differentiate
As these examples suggest, there are many ways to differentiate. The analyst’s job is to
identify the principal variables that distinguish strategic groups (see earlier discussion in
Chapter 2) that follow similar strategies. In the pharmaceutical industry, there are price
and R&D distinctions. Companies high on both attributes sell patented medicines, while
companies with the opposite tendencies sell generic medicines. These are the two most
important strategic groups in the pharmaceutical industry (see Exhibit 4.9). The
­resources, capabilities, and competencies needed to compete in these groups are different; thus, the barriers to entering them are not alike. Movement from segment to segment is not necessarily easy, as doing so requires the acquisition of new resources,
capabilities, and competencies.
Nonetheless, Forest Labs did make this move. It moved from the generic drug group
to the proprietary (patented-drug) group on the basis of its successful antidepressant
drug Celexa. Forest Labs was a very agile company. It started in 1956 as a vitamin and
candy company. Then, it moved into generic drugs, competing with the likes of Watson
Pharmaceuticals. Next, it started marketing an angina drug (Tiazac) in Europe, followed
by its marketing of Celexa, a Danish-produced, high-efficacy antidepressant with few
side effects—a move that brought Forest into competition with the large pharmaceutical
companies. Forest Labs moved into this position in a relatively short time. In 2003, it
achieved a 9.8 percent market share in the very lucrative U.S. antidepressant market,
with sales of Celexa accounting for 70 percent of the company’s revenues. Its small size
in comparison to the pharmaceutical giants allowed it to make a rapid thrust into a new
competitive space. Forest was very focused; it vigorously marketed only a few drugs at a
time, and it started to engage in large-scale R&D in competition with the major drug
companies like Merck and Pfizer. The drugs in its pipeline focused on diseases of the
elderly, a strong future market. A segment, while it can be very competitive within,
should be protected from outside by entry barriers, but Forest Labs demonstrated that the
standard entry barriers in the pharmaceutical industry could be breached.
Within every segment, positioning leaves empty spaces for new players. In low-cost,
mass-merchandise retailing, Target tries to be more upscale, Kmart tries to compete as
the low-cost alternative, and Walmart is in the middle—nonetheless, opportunities still
EXHIBIT 4.9
Forest Labs hurdled typical entry barriers with
its moves:
Kinds of Customers,
Products or Geographies
Forest Labs’
Move to a New
Strategic
Group
Broad
Low Cost
Broad
Differentiation
Best Value
1
Focused
Low Cost
2
Focused
Differentiation
Product/Service Premium
at Each Link on Value Chain
1. The firm entered the pharma industry in the
low cost (generics) space – competing
against firms, such as Barr Labs and Biovail
2. It then proceeded to challenge
­differentiated incumbents Merck,
Pfizer and GlaxoSmithKline
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94 Part Two Making Moves
exist for differentiation. Family Dollar went after low-income families by opening small
neighborhood stores. It created a new segment based on a different business model, one
that matched buyers and products in a novel way: a discount chain that offers customers
value via low-cost, basic merchandise in stores less than one-tenth the size of a typical
Walmart. The first store opened in 1959 in Charlotte, North Carolina; by 2002, Family
Dollar operated 4,693 stores in 41 states and employed more than 25,000 people. The
company expanded solely by relying on retained earnings—it had zero debt. The stores
are in both rural and urban areas, but the company’s recent expansion has been concentrated in inner-city, urban neighborhoods. The stores offer a variety of products including clothing, blankets, sheets, towels, household chemical and paper products, candy,
and health and beauty aids. All stores are similar in appearance, and they have the same
policies (e.g., none accepts credit cards or extends credit).
Tactics
Once a firm has staked a strategic position, it attracts the attention of industry rivals that have
a company’s customers in their sights. A company must attend to these emerging threats. Yet
not all threats are equal. Some rivals are smarter and more capable. Others are very easily
neutralized. Thus, a company must pick its battles with care to engage where it is most likely
to win—and to avoid becoming entangled in hopeless conflicts that leave all combatants
worse off. Battles are not always won by firms that have clear advantages. Better capabilities
alone do not guarantee victory. New entrants often beat large established players.
Therefore, competitive intelligence is needed to understand a company rival’s
­abilities, their motivations, and whether it’s wise or foolish to make a move against them.
Exhibit 4.10 outlines several questions that a company should answer before it launches
an attack against its rivals. Possessing such intelligence reduces strategic risk and
­increases the likelihood that the company will prevail in competitive battles.
Aggressive organizations know their rivals well, choose their battles carefully, and
take full advantage of their r­ivals’ misfortune. AT&T and Verizon, for example, have
moved against a weakened Sprint for many years. They lowered prices right after Sprint’s
EXHIBIT 4.10
Getting to
Know a
Company’s
Rivals
•
•
•
•
What are my rivals’ capabilities?
Where are they stronger/weaker than us? Are they agile?
How’s their financial war chest? Can they survive a sustained attack?
Do they hold fortified positions in other markets or lines of business?
•
•
•
How are my rivals’ track records?
Do they tend to react swiftly and effectively to competitive threats?
How predictable are they? Do I know enough about those that lead these firms?
•
•
•
•
Do I understand my rivals’ motivations?
What compels them to act aggressively?
What do they stand to gain if they make a move against my firm?
Can I forecast with certainty the moves they will make?
•
•
•
To what extent are my rivals aware of our firm and its capabilities?
If we choose to pursue our rivals’ key customers, can we fly under their radar and evade detection?
How are they likely to retaliate?
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Chapter 4 Positioning, Tactics, and Timing 95
disastrous Nextel merger, when Sprint could ill afford to lose more customers, and lobbied against Sprint’s Softbank merger, which offered its main hope for rebuilding its fortunes as a strong competitor.
Once a company knows its rivals’ intentions, it is able to select offensive tactics to
advance a company position, but in doing so, it should not neglect having defensive tactics to protect it. Eight classic moves can be utilized as standalone tactics or combined
into powerful, coordinated maneuvers to provide a company with continual advantage.
Five are offensive tactics, and three are defensive tactics.
Offensive Tactics
1. Direct frontal assaults—where a firm moves to match or exceed the strengths of a
rival—should be launched with caution. A firm’s resources, capabilities, and competencies must be clearly superior. Frontal assaults fought on all fronts can be a losing
proposition. Before XM and Sirius merged, they were engaged in tremendous collision with each other. Each raced to launch more satellites than the other and added
stations in rapid succession to woo the same target customers. They spent a half
dozen years battling for subscribers, bidding up programming costs, and putting each
other out of business in a lot of ways. This battle was characterized by a long series of
frontal assaults that left both firms bloodied and almost on the brink of extinction.
2. Given the difficulty of winning frontal engagements, it makes more sense to engage in
a flanking attack, where a company capitalizes on the weakness of its rival. Numerous
TV and Internet-based ads are very thinly veiled attempts to attack the flanks of rivals.
When iMovie was introduced in the mid-1990s, Apple launched a series of amusing ads
mocking its rival iMovie as the “PC Home Movie.” When Android phones were introduced, Google launched a series of ads that pointed out Apple’s relative disadvantages,
from not having a removable battery to not allowing the open development of apps.
3. The pre-emptive strike is an offensive maneuver that aims to seize an opportunity
before a rival can act upon it. Global consumer businesses, such as P&G, have raced
to establish themselves in emerging markets before their rivals can enter. Hoteliers
hurry to secure the best vistas for up-and-coming vacation destinations. Prospectors
hustle to lock up mining and drilling rights before others arrive on the scene. Preemptive strikes are designed to thwart those that might be planning for a late arrival.
4. The bypass (also called the end-run or blue ocean strategy) is designed to minimize
direct conflict. Firms adopting this approach aim to set new standards that create a
unique and uncontested space. Examples of this tactic can be seen across a variety of
industries. Cirque du Soleil created a new space in the live entertainment industry as it
melded the best in theatrics with traditional circus elements. NetJets led the way in
creating an answer to those not satisfied with any of the commercial airlines, yet unwilling to purchase their own aircraft. Nintendo’s Wii had smashing success by avoiding the highly intense battles for the adolescent male gamer. It chose to appeal to a
much broader audience with its low-tech but highly user-friendly gaming interface.
5. Guerilla moves have traditionally been deployed by only the smallest and weakest of
competitors. They are designed for maximum impact at low cost. Beer maker Kirin
Ichiban engaged in such a maneuver. Anheuser-Busch spent millions to secure
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96 Part Two Making Moves
o­ fficial sponsorship rights for the 2002 FIFA World Cup. Inside the stadium, fans
could see only the brewing giant’s Budweiser banners, colors, and beer. Yet right
outside of the stadium, Ichiban had carefully procured the most visible billboards
declaring their beer as the “un-Official beer.” Ichiban representatives passed out free
samples to thirsty fans as they approached the stadium. Their low-cost guerilla tactics
won the hearts of soccer fans that day. Large firms have taken notice of how effective
guerilla tactics can be and now mimic this approach. Social media campaigns, previously the guerilla tactic of choice for small firms, today are regularly used by large
firms. There are few companies today that do not have and invest in a significant social media presence.
Defensive Tactics
Defensive maneuvers are needed to respond to a rival’s offensive moves and to react to
threatening situations:
1. The most obvious of defensive maneuvers is retaliation. Price wars are sparked in the
airline industry when one carrier launches a fare reduction, and their rivals retaliate
by matching or beating the rival’s price. In response to Android’s attack on the
iPhone, Apple launched a series of retaliatory ads mocking Android’s shortcomings.
2. Blocking can be another effective defensive tactic as it prevents a rival from moving
in the first place. As moats and massive doors have protected ancient castles from
marauding enemies, blocking maneuvers aim to raise barriers to industry entry. Lobbying for tariffs against foreign competitors is an example of such a blocking maneuver. Blocks can also lock up supply and distribution channel access or limit access to
intellectual property. Pharmaceutical firms employ blocking when they reformulate
drugs just before patent expiration. New, more customer-friendly branded formulations pose an effective block to the advances of generic producers.
3. A final defensive tactic is retrenchment, primarily a move of “last resort” pursued
when a firm is in distress and must shift to survival mode. Retrenching firms pare
their businesses down to the core and rid themselves of unnecessary overhead. A firm
may discontinue unprofitable operations, sell noncore assets, and eliminate nonessential employees. When it is weak and bloated—and survival of the firm is at
stake—retrenchment takes hold. It is a form of divestment discussed further in
­Chapter 5 on corporate strategies.
Timing
Examine the external environment, assess a company firm’s internal strengths and weaknesses, and be ready to make moves, but also be aware that timing matters. It makes a
difference if a company chooses to be an early or late mover. Some maneuvers are better
suited to earlier or later stages in the industry life cycle.
Life Cycles
The moves a company decides to pursue are related to its stage in the industry life cycle
as introduced in Chapter 2 (see Exhibit 2.4 to review its characteristic curve). Earlier
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Chapter 4 Positioning, Tactics, and Timing 97
stages call for different moves than later stages. Companies in younger industries make
different competitive moves than companies in more mature industries. They make different strategic choices because each phase in the industry life cycle has a different type
of product, customer, and competitor. A company must gauge where its products are and
react to its special circumstances.
The life cycle implies that products evolve through four stages: introduction, growth,
maturity, and decline.
∙ Firms in the introductory stage favor offensive moves that capitalize on the weaknesses of the status quo, while their new concept is being proven. This stage inspires
defensive moves to block entrants via locking up sources of supply, building network
effects, and patenting products, while a company proves that its business models and
technologies are viable opportunities. The introductory stage, by its nature, calls for a
pre-emptive approach.
∙ The growth stage offers firms across the industry an opportunity for unfettered progress. Industry participants need not attack each other in order to grow and claim a
sizeable piece of the pie. In this phase, companies race to set standards to trump their
rivals. They work to improve processes. They try to fill the pipeline through modularizaton and the creation of adjacent products and/or services. The larger the footprint,
the stronger their brand is. Companies stake out clearly defined, broader, market positions in preparation for the unavoidable industry shakeout that takes place next as
the industry matures.
∙ Firms reaching the maturity stage see their growth hit an inflection point. Demand
has begun to level out. Maturity is characterized by intense direct rivalry and industry
consolidation. Incumbents launch offensives to steal profitable customers from rivals.
Mergers and acquisitions enable former competitors to join forces, combine top-line
revenues, trim organizational redundancies to reduce costs, and realize greater profits. Firms move to prune marginal product lines. Those that survive the shakeout no
longer have the luxury to attend to unprofitable business.
∙ Firms in the decline stage have few choices. They can exit quickly, remain until industry death, or revitalize an industry via globalization and/or innovation. Those that
choose to exit quickly might see the greatest profit opportunity in selling to a stronger, more committed rival. Others may choose to stop investing in a dying business,
but still harvest profits from the sales that remain. If there is to be revitalization, it
hinges on the efforts of globalizers who expand industry scope and innovators who
bring to market new products and services. Without these forms of renewal, an industry can decline and die.
Early Movers versus Late Starters
Timing makes a difference. First movers are the aggressive newcomers that take early
risks in anticipation of high returns. If their new ventures and undertakings work as
expected, they gain a head start on the competition and enjoy many of the advantages
summarized in Exhibit 4.11, but in moving first they also incur high development
costs and assume risks. If these risks are not acceptable, a company may choose to
delay and allow its competitors to occupy this position with the knowledge that it
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98 Part Two Making Moves
EXHIBIT 4.11
The
Advantages
and
Disadvantages
of Moving First
Pros
Cons
•
•
•
•
•
•
•
•
•
Ability to create/protect intellectual property
­(patents, trademarks, etc.)
Ability to set standards
Head start on competitors
Early market share and customer loyalty
Head start on learning and scale economies
Can tie up strategic resources
Can erect some early barriers – raise switching
costs for customers and producers
•
•
•
•
Higher R&D costs than later movers
First to make mistakes from which the rivals can
benefit
Higher market entry expenses
Need to blaze trail in establishing supply chains, etc.
IP can sometimes be circumvented
Higher risk of missing the product, service, or process expectations of the customer
might be able to catch up later. Through reverse engineering, second movers can copy
what first movers do and avoid costly and expensive errors that the first movers make.
If second movers move very aggressively, they can overtake the first movers. First
movers can lose their initial advantage if they fail to effectively respond to the second
movers’ challenges.
Being the first company to make a move, whether introducing a new product or a new
business practice, creates a hard-to-challenge advantage. However, being a first mover is
risky, and aggressive second movers often succeed where first movers fail. Consider
Best Buy. In 1991, Best Buy’s sales were $0.66 billion, substantially behind Circuit
City’s sales of $2.36 billion. But in 1996, Best Buy overtook Circuit City, with sales of
$7.21 billion compared to Circuit City’s $7.02 billion. Best Buy surpassed Circuit City
by rapidly making strategic moves that Circuit City did not match:
∙ Best Buy made its stores exciting, fun places to shop.
∙ Best Buy removed its high-pressure, commissioned sales force and replaced it with a
more laidback, salaried sales force. Circuit City stuck with commissioned sales.
∙ Best Buy’s policy of everyday low pricing meant it offered good values at different
price points. It did not mean that everything in its stores was sold at a rock-bottom
price; Best Buy carried so-called myth items (exciting, high-energy, leading-edge) as
well as commodity ones. Over time, Best Buy increased its emphasis on the myth
items so that it would continue to appeal to techno-savvy shoppers, who by their very
presence gave Best Buy stores a certain allure.
∙ Best Buy attacked its competitor at its core—after-sale service. Circuit City had
achieved 75 percent of its operating profit from the sale of extended warranties, so
Best Buy offered competing “performance service plans” at 30 percent less than
­Circuit City’s prices.
As a second mover, Best Buy was very aggressive. By taking these steps, Best Buy
differentiated itself from Circuit City. More nimble and strategically adroit than Circuit
City, it devised a series of innovative moves that stymied its larger rival. When Circuit
City failed to respond effectively, Best Buy surpassed it. When the 2008 economic meltdown struck, Circuit City went bankrupt. Best Buy checkmated its opponent, and Circuit
City went out of existence. For the first movers, sustaining the initial benefits of being a
first mover can be very difficult. In some cases, they ultimately triumphed, but in many
other cases, victory was claimed by fast followers (see Exhibit 4.12).
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Chapter 4 Positioning, Tactics, and Timing 99
EXHIBIT 4.12
Leaders,
Followers, and
Winners—Can
the Leader
Win?
Source: Adapted from
R. Grant,
Contemporary
Strategy Analysis, 4th
ed. (Oxford:
Blackwell, 2002),
p. 347.
Product
First Mover
(Innovator)
Later Mover
(Follower)
Ultimate Winner
Commercial Jets
Ball Point Pen
Light Beer
CAT Scan Imaging
Float Glass Panes
Fiber Optics
Diet Cola
Video Games
Copiers
Windows-Type Op System
Internet Browser
Digital Music Player
deHavilland
Reynolds
Rheingold
EMI
Pilkington
Corning
R.C.
Atari
Xerox
Apple
Netscape
Several
Boeing/Airbus
Bic
Miller
GE
Corning
Several Followers
Coca Cola
Nintendo
Canon
Microsoft
Microsoft
Apple
Followers
Follower
Follower
Follower
Innovator
Innovator
Follower
Follower
Unclear
Follower
Follower
Follower
The Value of Rapid Adjustment
The ability to rapidly adjust to changing circumstances is a competency each firm should
endeavor to acquire. For most firms, the competitive landscape alters rapidly because of
the moves made by its competitors and transformations in factors, such as the global
economy, government regulation, technology, and knowledge. The relentless pace of
change blurs traditional industry boundaries. For example, the computer, telecommunications, and entertainment industries have been merging such that companies like
­Microsoft, Comcast, AT&T, and Time Warner compete against each other in many different domains. Commercial and investment banking, brokerage, and insurances industries also have amalgamated, turning giant firms, such as Citigroup and Goldman Sachs
into competitors operating in similar realms.
After the Great Depression, the U.S. Congress required that banks engage in only one
type of banking activity. Commercial banks provided checking accounts, savings accounts, and money market accounts. They accepted time deposits. Investment banks
raised capital, traded in securities, and managed corporate mergers and acquisitions.
Under the Glass-Steagall Act of 1933, such combinations had been illegal. The GrammLeach-Bliley Act of 1999, however, allowed banks to carry out functions of both commercial and investment banks. As the competition between commercial and investment
banks picked up, they competed actively for real estate loans. They acquired mortgages
by purchasing them from mortgage bankers or dealers. Many of the mortgages issued
were to subprime borrowers with little ability to repay. Investment banks securitized
these loans; however, when U.S. house prices began to decline in 2006–07, and mortgage delinquencies soared, many of the securities backed with subprime mortgages lost
most of their value, and the upshot was a huge capital crisis. This crisis had its roots in
weak financial regulation. In response, almost all of the major investment banks became
commercial banks, so they could receive Troubled Asset Relief Program (TARP) money.
External shocks transform many industries. The key attributes for ongoing business
success are flexibility, innovation, and speed. The ability of firms to experiment and
achieve new resource configurations more rapidly than their competitors is a dynamic
capability.10 Their ability to renew, augment, adapt, and reinvent themselves over time is
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100 Part Two Making Moves
a rare and valuable factor that helps them sustain competitive advantage. Of the top 25
U.S. corporations in 1900, only two remain today. In a typical year, more than 150,000
business bankruptcies occur, most of them involving firms that have failed to react adequately to change. Of the many reasons for firms’ lack of response, inertia and prior
strategic commitments stand out. The Icarus paradox highlights the effects of failing to
adapt.11 Icarus, a figure in Greek mythology, was being held hostage on a besieged island. To help him escape, his father made him wings of wax and feathers. Because flying
saved his life, Icarus loved to fly. He soared higher and higher until he came too close to
the sun, which melted the wax in the wings, and Icarus plunged to his death.
Similarly, many companies become so committed to the existing business models that
brought them success that they continue to use them despite new conditions that make
these models obsolete. Their absorption in what they once did well keeps them from
learning and adapting and leads to their undoing. A good example is Xerox, which chose
not to make the changes that could have ensured future prosperity. Today, consumers do
not associate Xerox with the personal computer revolution; the names that come to mind
are Apple, Microsoft, Intel, and Dell. Yet Xerox’s research division in Palo Alto, California,
pioneered almost all the elements that ultimately went into PCs, from the mouse to the
printer. Steve Jobs picked up ideas from Xerox researchers, but years after its ­involvement
in this revolution, Xerox was still in the copying business, and even in this business,
which it should have dominated, its rivals were overtaking it. Though Xerox’s managers
had the potential to be first in the personal computer market, they made a conscious
choice to stay out of it, reasoning that PCs were not the firm’s line of business. Their
timing was notoriously bad.
Douglas Smith and Robert Alexander document the company’s choice to forgo PCs in
a wonderful look at Xerox called Fumbling the Future.12 By examining company records
and interviewing executives, the authors show how bureaucratic infighting killed the PC
business at Xerox. Factions in the firm that favored being first in the PC market lost out
to factions that favored sticking to Xerox’s existing lines of business. Xerox’s inability to
react is a classic example of how a company can miss a once-in-a-lifetime opportunity.
The Xerox example illustrates that the timing of moves is highly important. Determining
the optimal timing depends on competitors’ timing as well as one’s own. This game is
not carried out in isolation. A way to conceptualize the dilemma is to use game theory.
Game Theory
There are two types of games—simultaneous ones, like online fantasy football, and sequential ones, like chess.13 In a simultaneous game, two or more players act at the same
time; in a sequential game, one player goes first and the other player gets to observe the
results before making his or her move. In both types of games, a decision not to go forward is just as important as a decision to go forward. The choice, in business terms, is
whether to stick with an old product, practice, or business model, like Xerox sticking
with the copier, or to start rolling out a new one, like Xerox developing the PC while
continuing with the old. Such choices are timing dilemmas.
Simultaneous Game
In a simultaneous game with two players (here, two firms), each has the choice of producing only its old product or going with the old one plus a new product. The payoffs
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Chapter 4 Positioning, Tactics, and Timing 101
EXHIBIT 4.13
Simultaneous
Game: Payoff
Matrix. (My
Payoff/My
Rival’s Payoff)
MY RIVAL
Old Product
Old & New Product
MY COMPANY
Old Product
Old & New Product
$100 / $100
$250 / −$30
−$30 / $250
$0 / $0
vary depending on what the other party does. In Exhibit 4.13, if both parties stick with
the old product, their payoff is $+100 each; if they both innovate and go with old and
new products, their payoff is $0 each. When two parties make the same move at the same
time, each one cancels out the gains the other could have achieved. The two parties, in
essence, neutralize each other.
So far, the choice seems clear. It is safer to stay with the old product than to innovate
and add a new one when the other party might do the same. However, what if one party
innovates, producing both the old and the new products, and the other does not? Then
the payoff is $+250 to the innovating party, while the party that holds to the status quo
loses $30. Now the choice is between possibly winning $+250 or possibly losing $−30.
Assuming that each side is just as likely to innovate as it is to stay the course, the odds
favor innovation: Staying with the old product yields payoffs of $+100 and –$30, for an
average gain of $+35, while innovating yields payoffs of $+250 or $0, for an average
gain of $+125. Both parties, being rational, will choose to innovate, and in doing so,
each will cancel out the other’s gain. Where both could have achieved $+100 if they had
been satisfied with staying the course, now both get nothing from innovating.
In game theory, this kind of situation is called the prisoner’s dilemma. In such a game
the two partners in crime Dorothy and Alberto have been arrested for robbing the Left
Wing People’s Saving Bank. In the classic example, both accused persons get a one-year
sentence if each refuses to squeal on the other. If one testifies against the other, she or he
goes free and the other accused party faces a sentence of six years. If both parties testify
against each other, both go to prison for three years. In the prisoner’s dilemma, as long
as the parties are unable to communicate with each other, it is rational for both of them
to squeal. When these criminals rat on their partners in crime, society benefits, but the
two prisoners suffer. Neither achieves an outcome that is in her or his best interest. In the
example of the new-product dilemma, society also benefits because the innovation is
pursued and the new product comes to market, but neither of the innovating parties
gains. Companies, such as Xerox or Circuit City, may have understood the downside of
playing this game and thus chose to be cautious about innovating. Their deliberations
may have led them to a bias against change. Why should a company innovate if a gamelike scenario indicates that neither it nor its rival is likely to be better off?
In the real world, the payoffs are not known in advance; they can be only roughly
­approximated. The analyst must calculate the probability of gain or loss times the magnitude of that gain or loss, but both calculations are estimates and, if they are off by even
a small amount, can compound the errors. To make these calculations, the analyst may
need to use some type of confidence interval. For example, there may be an 80 percent
chance that the payoffs are as specified and a 60 percent chance that the parties will act
in accord with the model’s assumptions of rationality. But not all rivals are likely to be
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102 Part Two Making Moves
perfectly rational. It may even serve their purposes to surprise one another by being intentionally irrational.
In making estimates about the payoffs and what the two sides will do, the analyst has
to consider motivations and level of awareness. A good question, for instance, is: why
wasn’t Circuit City more aggressive in responding to Best Buy’s moves? The analyst
would also have to investigate organizational politics because they are likely to play a role,
as they did in the Xerox case. A sensitivity analysis based on different assumptions about
motivations, levels of awareness, and organizational politics may be needed to establish
odds for a number of outcomes.14 Without precise numbers for the probable gains and
losses and the various moves a competitor might make, the range of results may be so
great as to be uninterpretable. These uncertainties plague managers trying to make timing
decisions. The longer they work on resolving the uncertainties, the more time they lose.
Sequential Game
As mentioned, in a sequential game, the parties alternate their moves in a series of
rounds rather than moving simultaneously in a one-time event. With each round, the parties understand the game and the tendencies of their opponents better. Since the parties
know that they will be dealing with each other repeatedly and recognize that mutual selfdestruction is foolhardy, the likelihood of their cooperating should increase. With cooperation, the prisoner’s dilemma can be solved to each of the parties’ benefit. Both realize
that they walk away with a shorter prison sentence if neither party squeals. Simulations
with the prisoner’s dilemma have shown that when one party introduces cooperative
behavior, the other parties are likely to respond in a tit-for-tat fashion, but these simulations have not been supported by experiments showing that in repeated games cooperators learn from defectors and copy their behavior. The sequential game concept is a
useful model for repeated interactions because its iterative cycles introduce realism.
However, as with the simultaneous game model, the payoffs and the odds of what each
side will do must be estimated, and their estimation is hampered by uncertainty. Indeed,
with an iterative process, there are more calculations and thus greater chances of error.
To illustrate this, let’s return to the original example: First, one company decides
whether to innovate or not. The payoffs of its decision have to be calculated on the basis
of what its rival is likely to do next. As shown in Exhibit 4.14, there are four payoffs, or
outcomes (O), to be calculated—O1, O2, O3, and O4. So far, the sequential game is
similar to a simultaneous game. However, the sequential game enables modeling what
will occur after the initial payoff, as the assumption is that the game will continue with
additional rounds. Suppose that in the first round a company decides that it is going to
stick with its old product, and its rival then decides it will not innovate. The company has
to decide whether to innovate or not in the next round, so it must calculate the secondround payoffs on the basis of the first-round results. These outcomes are represented by
O5 and O6 in Exhibit 4.15. Now suppose that in the first round the company decides it is
going to stick with its old product and its rival then decides to innovate. The company
must decide its round-two move and calculate the payoffs on the basis of this result.
These additional outcomes are represented by O7 and O8.
More rounds will occur, and more outcomes will have to be estimated and compared.
The sequential-game model helps prepare the analyst for the repeated character of
­competitive interactions by forcing the analyst to think several steps ahead, rather than
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Chapter 4 Positioning, Tactics, and Timing 103
EXHIBIT 4.14
My Company (05)
Maintains Old Product Line
Sequential
Game Decision
Tree
My Rival (01)
Maintains Old Product Line
My Company (06)
Adds a New Line
My Company
Maintains Old Product Line
My Company (07)
Maintains Old Product Line
My Rival (02)
Adds a New Line
My Company (08)
Adds a New Line
My Rival (03)
Maintains Old Product Line
My Company
Adds a New Line
My Rival (04)
Adds a New Line
one step at a time. The timing of a move is not a one-only decision for either party. As
the rounds continue, important decisions will need to be made at each interval. In a sequential game, the payoffs and the odds of what a player might do must be recomputed
often. These repeated calculations compound the possibility of error.
Expanding the Assumptions
The examples discussed above show some of the problems that occur in conceptualizing
strategy as a game. A number of assumptions should be questioned. One is that rivals
have only two options—to innovate or not to innovate. Obviously, the real world ­provides
more possibilities than this schematic choice. There are other options than a company
abandoning its old product, or hedging its bets with some proportion of new and old
products. The choices depend on a company’s creativity. Decision making is not limited
to either-or, yes-or-no thinking. It encompasses more than totally supporting or opposing
innovation. Moreover, with each iteration in the game, the company can become more or
less committed to innovating or to sticking with what it had been doing previously.
Another assumption to be questioned is that only two parties are competing. Most
real-world situations involve competition between more than two parties. For instance, in
a game between cereal makers General Mills and Kellogg, the two sides can go two
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104 Part Two Making Moves
rounds, first matching each other by offering the right to buy a box of cereal and get one
free and then matching each other by removing this promotion. Neither really gains from
this game. The moves of one party are neutralized by the moves of the other. The game
ends in stalemate. However, there are two other cereal makers in this game. If Post and
Ralcorp continue offering the promotion after General Mills and Kellogg have stopped
offering it, they may be able to gain market share. As weaker players in the industry, they
may prefer market share over profitability. Their actions, as well as those of General
Mills and Kellogg, affect the outcome. Games that have more than two players are more
common than games involving only two players, but they are harder to model. Sophisticated game theorists understand this problem and have explored complicated games that
have many players over much iteration.15
Learning from Game Theory
Though it has these limitations, game theory presents a number of enduring lessons.16 It
emphasizes the importance of considering the timing of the moves of one’s competitors
along with the timing of one’s own moves. The strategist must:
∙ Identify the competitors in a game.
∙ Try to understand their options.
∙ Try to compute the payoffs from the various decisions that can be made by combining options.
∙ Try to understand the sequence of possible moves.
∙ The timing and ordering of strategic moves can significantly affect their outcome.
Using these methods, a company can make better, if not optimal, strategic choices.
Every strategic move has a timing dimension—the firm can act first or wait. In the real
world, however, timing decisions rarely are formally modeled. The decisions are reasoned
through verbally without the full elegance of a formal game-like model. The protagonists
often resort to historical analogy. They recall prior experience and base their claims on
prior successes and failure.
Yet arguments made based on past successes and failures are only sometimes right.
Wang Laboratories, for instance, was a pioneer in creating word-processing software
and office equipment to replace the typewriter, but it was unable to reason through
what it should do next. It did not maintain the momentum of the prior moves it made
and lost out when PCs became common. In contrast, pharmaceutical giant HoffmanLaRoche repeatedly has reinvented itself, moving from vitamins at its origins to sulfa
drugs in the 1930s and later into the tranquilizers Librium and Valium. There is no
evidence that e­ ither company used a formal game-theory-like model to argue about
what it should do next.
The lesson any company should learn is that being a first mover once is not enough.
A company must repeatedly assess whether it should be a leader. The arguments for
leadership include:
∙ The lags in time it will take a follower to catch up, during which time the leader can
earn substantial profits.
∙ The ability during these lags to erect learning and scale barriers to entry.
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Chapter 4 Positioning, Tactics, and Timing 105
∙ The ability to establish a reputation and to erect switching costs that make it hard for
customers to abandon the firm.
∙ The preemption of scarce assets and resources, such as raw materials and distribution
channels, which a follower cannot obtain.
However, followers are not without adequate defenses, such as:
∙ If they can reverse-engineer what the leader has accomplished and do it better, or if
they can avoid high development costs and learn from the leader’s mistakes, they
actually may be in a better position than a first mover.
∙ They have options, such as adding “bells and whistles” to a stripped-down product or
service. They can outflank a first mover by creating products that are smaller or
larger, more convenient, or lower-priced.
∙ They can reconceptualize products in ways that may not be open to the leader, which
may find it hard to do anything other than what it has so far perfected. Followers may
be able to leapfrog the first mover’s accomplishments.
Not all first movers dominate, and few dominate forever. Intel made a name for itself by
being a leader in computer memory and microprocessors, whereas Microsoft has never
been a first mover but, rather, has been an aggressive follower that invaded and conquered markets pioneered by other firms (operating systems and browsers).
As D’Aveni points out, a leader can “retain the initiative throughout each interaction,
the follower can seize the initiative and retain it or can move back and forth.”17 To paraphrase Abraham Lincoln, who said during his run for the presidency that he had to focus
on his competitor’s moves even more than his own moves,18 the key is not to view the
situation exclusively from a company’s perspective but to be cognizant of competitors.
Slip into their “shoes,” and understand how they view the situation. Effectiveness is
­determined not by the company’s moves alone, but by how it anticipates and addresses
the moves and countermoves of competitors.
Be aware that a company can win a game but still lose. In weakening a stronger
­opponent, it can bring ruin upon itself. When Monsanto’s patent on NutraSweet, the artificial sweetener pioneered by Searle, a division of Monsanto, expired in 1987, H
­ olland
Sweetener attacked (see Exhibit 4.15).19 In Europe, it introduced a cheap g­ eneric substitute. Monsanto had to lower the price of a pound of NutraSweet from $100 to $26. In
Europe, Holland Sweetener brought a successful antidumping suit against Monsanto. It
also made an aggressive bid for Monsanto’s Coca-Cola and ­PepsiCo contracts, forcing
Monsanto to give the cola companies combined savings of more than $200 million on
their contracts for artificial sweeteners. Monsanto’s actions forced Holland Sweetener
out of the U.S. market and drove the Dutch company to near bankruptcy. Monsanto
EXHIBIT 4.15
Nutrasweet—A
Losing Game
Monsanto
Holland Sweetener
•
•
•
•
•
Patent expires 1987
Lowers price from $100 a pound to $26
Forced to give Coke & Pepsi combined savings of
$200 million
•
Attacks in Europe
Brings successful antidumping suit; makes aggressive bid for Coke & Pepsi contracts
Exits U.S. market near bankruptcy
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106 Part Two Making Moves
protected its NutraSweet franchise, but neither company came out a winner. How much
better would it have been, at least for the companies, if not consumers, if the companies
had been able to cooperate, but that would have been against antitrust laws. Competitive
moves and countermoves can be harmful to the competitors involved.
In the end, game theory’s lesson is that one company’s success is critically dependent
on what other companies do. Best Buy’s success depended on what Circuit City did;
Circuit City’s failure depended on what Best Buy did. The fates of Monsanto and
­Holland Sweetener were linked. Charles Schwab’s success has relied on what Morgan
Stanley did; Morgan Stanley’s success has depended on what Charles Schwab is doing.
Coca-Cola’s success is tied into the actions of PepsiCo; PepsiCo’s success depends on
what Coca-Cola does. Competitors exist in an interdependent world, as companies do
not operate in a vacuum. The actions of one firm elicit responses from its competitors,
which, in turn, elicit responses from the original firm. Even when a firm decides to do
nothing, it is making a conscious decision, with the decision not to make a move being
as important as the decision to make one.
Summary
Making moves is a serious business. This chapter provides an understanding of some of
the positions a company can occupy, and how it can move from position to position.
Low cost and differentiation are not the only options. There are many ways to segment
an industry. Best-value positions can be very attractive. Positioning is dynamic. Firms
regularly change positions on their own initiative and in response to the moves made by
other firms. Sometimes all the firms in an industry are forced to switch positions because
of changes in law, regulation, technology, and other macro-forces. Where once they
were not rivals they become rivals. New groups of competitors form in new niches
where competition did not previously exist. Firms stretch beyond their existing niches
and move into the spaces that other firms previously dominated.
In this dynamic world of shifting positions, a company has to rely on both offensive
and defensive tactics. It has to understand when to move and when not to move. Timing
is critical. Should it go first or be a fast, or even slow, follower? It must monitor changing industry conditions. Are products and markets growing or are they mature and
­declining? Is it best to compete vigorously or to retreat and exit from a position it may
have long occupied? This chapter concludes with some insights from game theory on
how to make these decisions. However illuminating, these games are abstract and
­depend on assumptions that may not prevail in the real world. The real world of moves
is precarious with no certainty; it must be navigated carefully.
Exercises for the Traditional Student
1. Identify the generic strategic position that has been adopted by the makers of your
favorite consumer brand. Is the company’s overall strategic position clear? Or is the
organization “trying to be everything to everybody”?
2. Examine this firm’s recent investor presentations. Look for evidence that this organization is leveraging the breadth of its value chain in order to push for competitive
advantage with its positioning.
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Chapter 4 Positioning, Tactics, and Timing 107
3. Select a few of this firm’s current ads and analyze them to determine which offensive
tactics the firm is choosing to employ.
4. Is the firm a first mover? If so, what advantages has it secured by moving first?
Exercises for the Practitioner
1. Identify the generic strategic position(s) that your employer has adopted within each
of its main business units. Does its position fit its internal/external situation?
2. How do the activities related to your current job support an organization’s desired
position? Do any activities seem to contradict the organization’s stated position?
3. Review the range of offensive and defensive maneuvers that your firm can utilize.
Which of these does your organization utilize most frequently? Do you agree with the
tactical choices that your organization makes? Why or why not?
4. Is your company’s industry new or mature? How do the moves that it is currently
making compare to the moves prescribed in this chapter for each stage in the industry
life cycle?
5. Does your firm tend to move first, or follow its industry rivals?
Endnotes
1 Sun Tzu, The Art of War (London: Luzac, 1910), https://openlibrary.org/books/OL7101974M/
The_art_of_war.
2. On timing, see S. Albert, When: The Art of Perfect Timing (San Francisco: Jossey-Bass,
2013). This book is excellent.
3. R. D’Aveni, Hypercompetition (New York: Free Press, 1994).
4. M. Porter, Techniques for Analyzing Industries and Competitors (New York: Free Press,
1980); M. Porter, Competitive Advantage: Creating and Sustaining Superior Performance
(New York: Free Press, 1985).
5. Jay Solomon and Summer Said, “Why Saudis Decided Not to Prop Up Oil,” The Wall Street
Journal, December 21, 2014, http://www.wsj.com/articles/why-saudis-decided-not-to-propup-oil-1419219182.
6. R. Grant, Contemporary Strategy Analysis, 4th ed. (Oxford, England: Blackwell, 2002),
p. 121.
7. M. Porter, Competitive Strategy.
8. B. Charkravarthy and V. Kasturi, “Best Buy,” Harvard Business School/Strategic Management
Research Center University of Minnesota case 9–598–016, revised October 28, 1967.
9. “Michael Porter on Competitive Strategy,” Harvard Business School video, 1988.
10. K. Eisenhardt and J. Martin, “Dynamic Capabilities: What Are They?” Strategic Management
Journal 21 (2000), p. 1107; D. Teece, G. Pisano, and A. Sheun, “Dynamic Capabilities and
Strategic Management,” Strategic Management Journal 18 (1997), pp. 509–33.
11. D. Miller, The Icarus Paradox (New York: Harper Business, 1990).
12. D. Smith, R. Alexander, and D. Robinson, Fumbling the Future (New York: William
­Morrow, 1988).
13. Oster, Modern Competitive Analysis, 2nd ed. (New York: Oxford University Press, 1994).
On the Web, a game theory simulator can be accessed at http://broadcast.forio.com/
sims/pricing/.
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108 Part Two Making Moves
14. S. Makridakis and S. Wheelwright, The Handbook of Forecasting, 2nd ed. (New York: Wiley,
1987).
15. Readers of this book can consult such works on game theory as Morton Davis’s Game Theory:
A Non-Technical Introduction (Dover Publications, 1997); also see http://www.gametheory.
net/.
16. D. Spulber, Management Strategy (New York: McGraw-Hill/Irwin, 2004).
17. D’Aveni, Hypercompetition., p. 99.
18. A. Brandenburger and B. Nalebuff, Co-Opetition (New York: Currency Doubleday, 1996),
p. 61.
19. Ibid., pp. 72–76.
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C H A P T E R
F I V E
Corporate-Level
Strategy and
Diversification
“When it comes to mergers, some are so successful that we can’t remember
a time when the companies were distinct: Where would Disney be without
Pixar, or J.P. Morgan without Chase? But many mergers fall flat on their
faces. The newly created company goes bankrupt, executives are fired,
and … the merged companies disband in a sort of corporate divorce.”
CNBC, “The Top 10 Best (and Worst) Mergers of All Time”
Chapter Learning Objectives
• Recognizing the difference between business- and corporate-level strategies.
• Understanding why certain firms choose to diversify.
• Being cognizant of the various types of diversification—related and unrelated, horizontal, and vertical.
• Becoming acquainted with many tactics that businesses use to diversify—alliances, joint ventures,
mergers/acquisitions, and internal startups.
• Understanding the risks and outcomes of various corporate-level strategies and tactics.
• Realizing how regulatory factors have altered up the pace of corporate-level structural changes.
• Building familiarity with portfolio management techniques, such as the BCG matrix and the GE/
McKinsey model.
Introduction
This chapter shifts our focus from the business to the corporate level.1 The business-level
strategies discussed in our last chapter indicate how the firm approaches its customers and
deals with its rivals. Should it adopt a low-cost or differentiated position? What types of
competitive tactics should it utilize to secure this position? Corporate-level strategies (CS)
109
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110 Part Two Making Moves
determine the scope of the firm’s involvement across various businesses and industries.
They involve questions, such as the following:
∙ In what businesses should the firm compete?
∙ Which industries should it enter and exit?
∙ How should it enter and exit these businesses?
∙ How narrow or broad should be the range of the businesses in which it competes?
∙ Should the firm’s business units participate across the length of the value chain or
should they concentrate on just a few activities?
∙ How should the firm’s portfolio of businesses fit together and interact with each other
to boost the firm’s overall value?
∙ Might the firm be better off if it sold its poorly performing businesses and redirected
its efforts toward new opportunities?
Boeing, for example, has business-level strategies for each of its main strategic business
units (SBUs)—a separate SBU for the commercial side of its operations and a separate
SBU for the defense side:
∙ The commercial side of the business competes with firms, such as Airbus, Bombardier, and Embraer for the airline customer. Its differentiated position, products, and
services are tailored to the needs of passenger and freight operations around the
globe, and its competitive tactics are industry appropriate.
∙ On the other hand, the defense side of Boeing’s business works to satisfy the needs of
governments to protect their citizens. It operates within a highly competitive environment filled with many rivals that do not compete in commercial aviation, such as
Lockheed Martin, Northrop Grumman, Raytheon, General Dynamics, and BAE Systems. As a competitor in the defense industry, Boeing has to tailor its strategies to
meet a different customer. Government requirements and security constraints are the
main influences on this part of its business.
∙ Boeing’s corporate-level strategy takes place at a higher level and informs its decisions on where the company should invest across these SBUs and whether to further
penetrate its existing commercial and defense markets, develop new markets within
these spaces, or pursue new opportunities.
Boeing corporate also leverages its assets across this commercial–defense divide.
Knowledge of materials and manufacturing methods are shared. Technologies the firm
originally created for military use, such as navigation, heads-up displays, and verbal
warning systems, often get released over time to the commercial side.
This chapter considers why firms decide to be in different businesses. How do they
manage the conflicts between different business units that might arise? How can they enhance the value of their operations if the needs of their different business units conflict?
Reasons for Diversification
There are many reasons that firms decide to enter into new markets or industries. The
typical reasons for diversifying are the following:
1. To grow. If a firm’s industry is maturing and little opportunity for continued organic
growth exists, it has to compete vigorously with other industry players to increase
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Chapter 5 Corporate-Level Strategy and Diversification 111
2.
3.
4.
5.
market share. For example, with a slowdown in the agricultural seed market,
­Monsanto made a play to acquire one of its main competitors, Syngenta (the other
main competitor was DuPont, which merged with Dow Chemical). With a slowdown
in the generic pharmaceutical market, Teva made a play to acquire its main competitor Mylan. Syngenta rebuffed Monsanto’s efforts to acquire it, and Mylan rebuffed
Teva’s efforts; however, Mylan did decide to accept a counteroffer from another
competitor in the generic drug market, Perrigo. Teva, meanwhile, acquired Allergan
Generics, as this market became increasingly concentrated. Rapid growth is often
achieved by such acquisitions, yet growth can also be achieved through internal
­(organic) efforts or external partnerships.
To reduce costs. By combining assets with those of its existing rivals, a firm can realize increased economies of scale. By centralizing value-chain activities, such as
­design, purchasing, production, branding, or distribution, it can eliminate redundancy
and achieve economies of scope. Exxon’s acquisition of Mobil achieved both types
of economies. The combined company had lower per-unit production costs and
­reduced overhead expenses. It closed overlapping gas stations in saturated markets,
consolidated exploration and production activities, and increased its buying power
with suppliers. To compete with Exxon Mobil, Chevron acquired Texaco, and BP
acquired Amoco, Total merged with Petrofina, and Elf Aquitine, and Conoco merged
with Phillips. In each instance, greater economies of scale and scope were achieved.
These companies consolidated to reduce costs, improve efficiency, and defend themselves against larger rivals.
To cross-subsidize. A diversified firm can direct skills and dollars from one strategic
business unit (SBU) to another. Along with accelerating the growth of promising SBUs
by providing fresh ideas, skills, and managerial talent, cross-subsidization may facilitate
the turnaround of ailing SBUs. Hospitals, for example, have to provide a wide range of
services under government regulations, some of them very ­unprofitable. Corporatelevel moves to acquire and merge allow hospitals to find the right mix of profitable and
unprofitable units. The more-profitable units subsidize the less-profitable ones and keep
these units functioning when their continued existence otherwise could not be justified.
To hedge risk and balance industry cyclicality. Diversification also allows firms to
hedge against the risks of seasonal and cyclical businesses. By “not putting all of
their eggs in one basket” they are able to use their resources more fully. A firm that
focuses on selling chemicals wholesale, for example, might decide to offer pesticides and fertilizers to the market in the summer and ice pellets, salt, and sand to
clear snow in the winter. Polaris Industries sell all-purpose recreational vehicles in
the summer, snowmobiles in the winter, and military vehicles all year round.
Hedges against seasonality make firms more recession-proof and protect them from
the business cycle.
To learn and access protected technologies. Diversification provides opportunities to
access the knowledge resources of other firms and to transfer their best practices. Firms
buy other firms for their intellectual capital and patents. In pharmaceuticals, where it
­requires an average of eight to 12 years to achieve profitability and generate cash flow
from new drugs, acquisitions lower new-product cost and development times. Software
companies also find that they save money and shorten development times if they
­purchase firms on the external market rather than develop new software internally. For
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112 Part Two Making Moves
example, Google spent $28 billion acquiring 163 companies between 2001 and 2003,
including Android, YouTube, DoubleClick, Nest Labs, Waze, Boston Dynamics, DeepMind Technologies, Neural Networks, Titan Aerospace, Zagat, and Makani Power.
6. To gain sheer profit. There are times when firms acquire failing or declining companies at depressed prices in the hope that they can fix and sell them for extraordinary
profits. Private equity firms, such as Cerberus Capital Management, have injected
significant amounts of capital and talent in order to bring dying firms back to life—
and their successes have resulted in significant profits. However, such massive
­paydays can also attract some unsavory characters such as Dennis Kozlowski.
Mr. Kozlowski, who gained attention for his lavish lifestyle and ultimately served jail
time, built Tyco, a small New Hampshire company, into a $40-billion-a-year revenue
behemoth by acquiring hundreds of companies that Tyco tried to turn around, including Simplex, Ludlow, Rockwood, James River, All State Fire Protection, Tectron,
Promed, Thorn, Zettler, ADT, CIPE, US Surgical, GSI, and Paragon Trade Brands.
Types of Diversification
There are many ways to diversify (see Exhibit 5.1). A firm can dabble in diversification
and still maintain a dominant business model in which at least 70 percent of its business
comes from a single commercial endeavor, or it can divide up its activities across many
different businesses.2 Another possibility is to expand into closely related enterprises
where its current capabilities can be shared, as, for example, Sony has done in trying to
bring together media content, TVs, and game systems.
Should the firm pursue related or unrelated opportunities? The Tata Group and Virgin
Group have taken the latter route and these firms are comprised of many business units
competing across a variety of industries. Tata is an Indian powerhouse involved in many
sectors from hospitality to steel, tea, and automobiles. The UK multinational Virgin
Group is i­ nvolved in travel, entertainment financial services, transport, health care, food,
drink, and telecommunications. Google is another example of a corporation that is
broadly ­diversified.
Google’s mission is to “organize the world’s information and make it universally
accessible and useful.” To accomplish this mission, it is in a variety of businesses, including
its search engine from which it derives most of its revenue ($45 billion in 2015) from
advertising fees. Yet, Google is not just a web search; it is a browser (Chrome), it provides
EXHIBIT 5.1
Types of
Diversification
A Taxonomy of
CorporateLevel
Diversification
Related
Horizontal
Unrelated
Vertical
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Chapter 5 Corporate-Level Strategy and Diversification 113
software for mobile phones (Android), it supplies analytics to help businesses analyze how
many site visits they get on the Internet, it runs YouTube, it owns Picassa, a service that
allows people to edit and share their photos, it has specialized search engines for scholars,
images, and videos, and it runs Gmail, Google Wallet, and Google Store among other
businesses. It also is developing products for the future including a self-driving car. In
addition, it has been a major investor in solar and wind power energy projects.
Many of these businesses have come to Google via acquisition including Android and
Picassa. Google has been an investor in Nest, the energy saving thermostat company, and
in ride-sharing company Uber. How do all these vast and diverse holdings fit together?
What is the justification for them being in the same company?
In 2015, Google restructured into two main units, one devoted to its “exotic” nonmoney-making ventures like driverless cars and anti-aging research and one dedicated to
its money-making ventures like the search engine. The non-money-making businesses
were spun off as a separate company that has its own CEO. The money-making
businesses stick with the Google name. The name of the overall company is Alphabet.
Whether this restructuring provides Google with a better management logic and structure
is yet to be seen. In making this move, Google is admitting how difficult it is to manage
new ventures, which are not yet profitable with old ventures that are very profitable.
Likewise, most Korean businesses belong to chaebols, global multinationals that own
multiple international enterprises. In 2015, Samsung was the world’s largest information
technology company, second-largest shipbuilder, 14th-largest life insurance company,
15th-largest advertising agency, and 36th-largest construction company. The company also
operated the oldest theme park in South Korea. Would Samsung be better off if it separated
these different businesses from the parent and allowed them to operate independently?
What advantages do these businesses derive from being part of the same o­ rganization?
Very few companies have been successful at melding together such unrelated enterprises.
In fact, the conglomerate strategy has not been broadly adopted because it can be very
difficult to manage such diverse business units. GE, the largest and best-known U.S.
conglomerate, has gradually trimmed its holdings, selling its appliance business and the
bulk of its financial services units to focus on industrial technology.
In fact, most companies, to be successful, strive to find a well-defined focus. Related
businesses try to limit the purchases of other firms to companies that are in the same or
similar industries. Often, they share with these companies technology, size, or culture.
Related acquisitions allow companies to extend their existing product and service
­offerings. When a firm chooses this route, it is able to utilize its existing capabilities in
the newly acquired areas.
In related horizontal acquisitions, firms purchase other companies that are in similar
business lines. For example, Darden Restaurants acquired Yard House, thus bringing yet
an additional popular eating concept into its mix of restaurants.
Another type of related diversification is vertical integration. Vertically integrated
firms operate across several links of the value chain; for example, a firm decides to
­combine production, distribution, and/or sales in the same company. Large petroleum
­companies are classic examples. They simultaneously explore for oil, transport it, refine
it, sell and use the chemical by-products, and operate retail gas stations. A less-obvious
example of vertical integration is Apple. It creates both software and designs devices
that use this software like iPhones and iPads. Microsoft as well creates software and
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114 Part Two Making Moves
designs hardware like the Xbox. Oracle acquired Sun Microsystem in order to integrate
its software capabilities with Sun’s hardware.
Stratasys is a company that relies on both horizontal and vertical integration. It has
acquired competing 3D printer firms and now ­designs and manufactures products for
businesses and end-consumers. Yet, it also provides services, a downstream activity.
Comcast made a vertical move when it acquired content provider, NBC/Universal,
but it was blocked when it then tried to make a horizontal move and acquire Time
­Warner Cable. The Justice Department effectively put a stop to this undertaking.
Tactics Short of Full-Scale Merger and Acquisition
A firm that has decided to pursue diversification has many tactical options besides fullscale merger and acquisition (see Exhibit 5.2). One such option is to form an alliance.
This move entails entering into a contractual agreement with another firm to pursue a
shared objective. For example, an airline code-sharing alliance allows passengers a
seamless flight experience as they transfer from carrier to carrier. Each airline cooperates
and hands off key customer information. It costs very little to forge and participate in this
alliance, while the dissolution of such an agreement is relatively simple as well. Because
it is so easy to exit an agreement, partnerships can be quite short-lived. The Ford-Toyota
alliance, which was designed to help Ford learn about hybrid technology, while Toyota
learned about making trucks, soured quickly, and was dissolved after just, two years.
Another well-known example of such an alliance is Starbucks working with Barnes &
Noble. Inside many Barnes & Noble bookstores, one finds Starbucks coffee shops. Less
well known is an alliance Apple formed with IBM to help it get Apple products into the
large businesses where IBM serves as the trusted consultant. The alliance was meant to
have the IBM consultants promote Apple products in a market in which Apple is relatively weak.
Franchising and licensing agreements allow firms to branch out and diversify their
income sources without taking on the capital expenses required to build retail locations or
EXHIBIT 5.2
The Breadth of
Available
Diversification
Tactics
LO
Alliances,
Franchise/License
Risk & Control
Joint Venture
HI
Takeover, M&A of
Existing Business
Internal
Startup
■
PRO: Cost reductions,
cross-branding via
collaborative contractual
agreements
■
PRO: Aimed at
mutual success while
insulating partners’
core businesses.
■
PRO: Speed of
access to customers,
skills, etc.
■
PRO: Total
control/ownership
■
CON: Least
operational control,
greatest risk of IP losses
■
CON: Less
control, risk of
knowledge losses to
rival
■
CON: “inherited
elements” can cause
trouble
■
CON: timeconsuming and
often very costly
to develop
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Chapter 5 Corporate-Level Strategy and Diversification 115
full-blown production facilities. Restaurant chains like Subway, McDonald’s, KFC,
Burger King, and Pizza Hut all have been built with this model. Franchisees and licensees
gain from franchisers’ brand recognition and their operational and technological prowess,
while franchisers benefit from the use of capabilities, techniques, and their quality methods, selling, and marketing by others. Franchisers minimize their financial risk and have
the potential to maximize their profits. These advantages depend on the ability of franchisers to develop relationships with the franchisees based on trust and control.
Joint ventures (JVs) are business agreements in which companies jointly invest in, and
exercise control over, a new enterprise and share the revenues and expenses needed to pursue
the JV’s objectives. HULU, a joint venture started by Fox, NBC, and ABC, is an example.
All the partners in the venture have a significant interest in finding ways to monetize their
investments in the TV shows they produce. When a customer subscribes to HULU, all its
partners share in the revenue and in any profit earned. The joint venture form of cooperation
protects the partners in that if the JV fails, the partners’ original businesses are not harmed.
Internal startups maximize the control and ownership of outcomes. For example,
MasterCard has been trying to build a platform called Shops, which allow people to buy
products directly from a digital magazine page without leaving that page. It has pursed
this project by itself. GE has a 31-person in-company startup that is attempting to commercialize a cheaper and cleaner type of solid oxide fuel cell, which transforms natural
gas into electricity.
Merger, Acquisition, and Divestiture Results
Firms increasingly rely on options other than mergers, acquisitions, and divestitures
because the record of carrying these options out is not particularly good. While the
share price of firms that are sold in an acquisition usually goes up, the buyer’s share
prices most often go down. The reason is that the buyer’s decision making is often
flawed causing it to pay too much for the firms it acquires, or that it cannot execute on
its designs and effectively integrate the new unit. In a study of acquisitions of greater
than $500 million in value from 1990 to 1995, Mercer Management Consulting found
a success rate of just 17 percent.3
In 2002, BusinessWeek wrote:
The M&A (mergers and acquisition) bonanza during . . . 1995–2001 . . . was five times
greater than any previous M&A boom in U.S. economic history. Why were shareholders left with such a hangover after the binge? The main conclusions of our study: Fully
61 percent of buyers destroyed their own shareholders’ wealth. A year after their deals,
the losers’ average return was 25 percentage points below their industry peers’. The
gains of the winning minority could not make up for the buyers’ losses: The average
­return for all buyers was 4.3 percent below their peers and 9.2 percent below the
S&P4 . . . An army of consultants and bankers has tried to help CEOs improve their
­success rate. But they’ve failed.
In 2012, the consulting company Accenture pegged the success rate of mergers at just
58%.5 Clearly, the M&A process is fraught with obstacles, and these
∙ If the results are so poor, why is this activity so common?
∙ What is the relationship between company motivations for M&As and their outcomes?
∙ What can be learned from the experience that can make M&As more likely to succeed?
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116 Part Two Making Moves
An example of a deal considered nearly the worst acquisition in history was
Sprint’s 2005 $35 billion purchase of Nextel. The iDEN and WiMax networks that
were combined did not fit together well nor were they as strong as those of Sprint’s
competitors, Verizon and AT&T. The marquee phone of the combined company, the
Palm Pre, had no traction. The firms kept separate headquarters, Sprint in Overland
Park, Kansas, and Nextel in Reston, Virginia, and customers were confused. Downloading on Sprint took longer than on the other networks. Sprint’s bureaucratic ­culture
never jelled with ­Nextel’s entrepreneurial culture. Cultural clashes between the two
companies meant that employees did not execute post-integration plans. All of these
factors led to poor performance. The combined firm was dysfunctional and it showed
up in the bottom line.
Another poor deal was Daimler-Benz’s purchase of Chrysler, which also suffered
from culture clash and in the end Daimler divesting Chrysler at a great loss. Promised
synergies and merger-related cost savings never materialized. They were supposed to
amount to $3 billion yearly by 2001, but they were not achieved because of tension
­between Daimler-Benz and Chrysler leadership. In 2007 the German automaker reversed
its mistake by selling the bulk of Chrysler to private equity firm Cerberus because of the
large financial losses it experienced (see Exhibit 5.3). Fiat ultimately bought Chrysler
from the private equity firm.
From 1998 through 2000, nearly $4 trillion was spent on mergers and acquisitions—
more than in the previous 30 years combined.6 Blockbuster deals took place between
Pfizer and Pharmacia, Hewlett-Packard and Compaq, and other companies. The deals
were concentrated in certain industries. The telecommunications and communicationsequipment industries led the way with five out of the top 15 deals in the 1998-to-2000
period. The banking, financial, and insurance industries were not far behind, with four
out of the top 15 deals. The largest deal, valued at $165.9 billion, was between AOL
and Time Warner.
External factors influenced this activity. Competition intensified in the United States
and other countries because of deregulation and privatization, rapid technological
change, and in some instances industry maturity. Globalization played a part, as did the
EXHIBIT 5.3
The Value of a Deal
Share prices, November 12th 1980 = 100
The DaimlerBenz–Chrysler
Deal
140
130
DaimlerChrysler
Source: Primark
Datastream.
120
110
Daimler-Benz
100
90
80
MERGER
70
Chrysler
1996
97
60
98
99
2000
50
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Chapter 5 Corporate-Level Strategy and Diversification 117
development of the Internet. With traditional industry boundaries blurring, searching for
the right mix of businesses to ensure corporate survival was a trial-and-error effort. Because the environment was turbulent, it made sense for firms to restructure.
Much of this restructuring, however, was not successful. For example, AT&T spent
$7.5 billion in 1990 to buy the computer manufacturer NCR, only to dispose of it five
years later, taking a $1.2 billion charge, laying off 10,000 employees, and losing
$500 million. Many firms, including AT&T, ITT, Hanson PLC, W. R. Grace, Sprint,
Tenneco, Sears, and GM, had to reverse steps they had taken. They liquidated assets
and broke up portfolios because the mix of businesses they assembled did not work
well together.
Bad deals are very common. eBay overpaid for the Internet telephone service Skype
in 2005; it had to take a $1.4 billion write-down in 2007. Microsoft bought Skype from
eBay at a very low price. The Time Warner and AOL deal, which never worked as
planned, was also among the worst combinations in history. News Corp’s purchase of
social networking site MySpace once showed promise, but it, too, is now considered a
debacle. The results of News Corp’s purchase of The Wall Street Journal are yet to be
fully seen. In contrast, the 1965 deal that brought together PepsiCo and Frito-Lay is seen
as a great success, as is Disney’s 1996 purchase of Capital Cities.
A Shifting Landscape
Though they frequently fail, mergers, acquisitions, and divestitures shift the corporate
landscape. For example, in the corporate hub of Minneapolis-St. Paul, where many Fortune 500 firms are located, there has been huge turmoil:
∙ Grand Metropolitan Ltd., the large U.K. food conglomerate, acquired Pillsbury;
­Silicon Graphics acquired Cray; Federated Department Stores acquired Fingerhut;
and Conseco acquired Green Tree Financial.
∙ Grand Metropolitan then sold Pillsbury to General Mills, and with the collapse of
Fingerhut’s business, Federated divested it. Nearly the same fate befell what remained of Green Tree Financial.
∙ 3M’s spinoff of its magnetic media division (now called Imation) was notable, as was
Honeywell’s divestiture of Alliant Tech, and Control Data’s breakup into a number
of parts.
∙ Mergers included Norwest Bank with Wells Fargo, First Bank with U.S. Bank,
­Honeywell with Allied Signal, and Northern States Power (NSP) with New Century
Energy (NCE).
∙ United Health, Medtronic, and other companies made steady streams of small acquisitions. United Health became a behemoth by means of its many small acquisitions.
∙ SuperValu and St. Paul Companies, on the other hand, made big acquisitions,
with SuperValu buying Albertsons and the St. Paul Companies buying Travelers.
In 2013, SuperValue had to divest most of what it bought from Albertson, and the
St. Paul Companies left the Twin Cities and relocated to Connecticut, Traveler’s
home state.
∙ Cargill acquired fertilizer manufacturer IMC Global, only to spin it off as a separately
traded company, Mosaic, in which it held a controlling interest.
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118 Part Two Making Moves
An important factor spurring mergers and acquisitions in many industries has been
deregulation. The process started in the United States in 1978 with deregulation of air
transportation and natural gas. It continued in the 1980s and 1990s with deregulation in
railroads, trucking, telecommunications, cable television, financial institutions, and electric utilities. As a result, these formerly protected industries were exposed to competition
and market forces. At first, many new firms flocked into the newly ­deregulated sectors,
but then a series of mergers and acquisitions led to extreme ­consolidation. In telecommunications, for instance, AT&T was broken up into a long-distance company that
­retained the AT&T name, an equipment company (Lucent), and seven “Baby Bells,” or
local service operators. Aggressive new entrants, such as WorldCom, a­ ppeared on the
telecommunications scene, followed by a host of mergers and acquisitions. WorldCom
failed amid a huge financial scandal. Of the original seven Baby Bells, only a few are
left. SBC Communications, one of the seven Baby Bells, ultimately bought AT&T, since
AT&T’s original long distance business model no longer was valid, and took on its
name. Sprint’s purchase of Nextel was described previously.
The role of deregulation also had significant impacts on M&A activity in the airline,
railroad, and banking industries. Critics claimed that lower rates would prevail in an
­unregulated environment, so in 1978, under the Carter administration, the Airline
­Deregulation Act was passed. At the start of 1979, 43 large, certified carriers were in
operation. At the end of that year, there were 60 carriers—22 airlines had entered and
five had exited. The number of carriers continued to grow until 1984, when it reached 86.
Market concentration decreased from 1978 through 1985, but then it started to rise
sharply and has stayed high above its 1978 level since. Initially, deregulation provided
many opportunities for new entrants. Frank Lorenzo created a national airline, Continental, through a series of mergers, reasoning that regional airlines would not survive. The
companies he brought together included Peoples Express, Texas International, and Eastern. By 2002, however, all the major airlines were in trouble with the exception of Southwest, which operated under a different business model. The industry consolidated rapidly.
Delta’s purchase of Northwest in 2008 for a time made it the largest U.S. c­ arrier, until
American Airlines purchased US Airways. United bought Continental. By 2015, there
were only four major airlines left in the U.S.: Delta, American, United, and Southwest.
Before 1980, the federal government set railroad shipping rates through the Interstate
Commerce Commission (ICC).7 The Staggers Act of 1980 partially deregulated the
­industry but left the ICC, replaced by the Surface Transportation Board (STB) in 1995,
with oversight powers to approve mergers and review shipping prices. Because the railroads were in such a weak financial condition, the STB rejected few applications for
mergers. Several reasons existed for the abundance of mergers, but most had as their
main motivation the desire to improve revenue and earnings in a slow-growth industry
that was struggling to maintain market share against inroads made by other means of
transportation (trucks, boats, and planes). After all the merger activity, the railroad
­industry was reduced to five major players that accounted for more than 90 percent of
the traffic by 1999: the Union Pacific, BNSF, CSX, Norfolk Southern, and Canadian
­National (see Exhibit 5.4).
Deregulation in the banking industry occurred gradually, starting at the state level in
the late 1980s and continuing through 1999.8 Before deregulation, the most significant
piece of federal banking regulation had been the 1933 Glass-Steagall Act, which limited
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Chapter 5 Corporate-Level Strategy and Diversification 119
EXHIBIT 5.4
Railroad
Industry’s
Major Players,
1999
Company
Burlington Northern Santa Fe
Union Pacific
CSX
Norfolk Southern
Canadian National
Total Track Routes (miles)
Revenues ($billions)
33,500
33,400
23,000
21,600
17,000
9.1
10.2
6.6
5.2
3.6
banks’ products and prices and disallowed investment banking by commercial banks.
Commercial banks could not sell securities or insurance nor could they integrate checking and investments. In addition, as late as 1975, no state permitted out-of-state commercial banks to own in-state banks, and only 14 states allowed statewide commercial
banking.9 These regulations protected the commercial banks from competition, but also
allowed them to become inefficient and suppressed innovation, thus creating fertile
ground for competitors.
Investment banks saw the opportunity and responded. In 1972, investment banks
­offered the first money market mutual funds. In 1974, they started to offer check-writing
capability. In 1978, they offered cash management accounts (CMAs). Meanwhile, the
product restrictions and geographic limitations imposed on commercial banks by regulation left them vulnerable to bank failures, such as those associated with the 1980s
­savings and loan (S&L) crisis.
To compete with investment banks, the commercial banks found loopholes in the laws.
In 1977, Citibank took advantage of such loopholes to do the first-ever mass mailing of
credit cards. In 1982, Bank of America tried to enter investment services by purchasing
Charles Schwab & Co., a marriage that ended in divorce in 1987. In 1986, Citibank got l­egal
approval to set up its own mutual funds. In 1987, the Federal Reserve allowed Citicorp,
J.P. Morgan, and Bankers Trust to underwrite securities. By 1992, all states except Hawaii
­allowed interstate banking, and all states except Arkansas, ­Minnesota, and Iowa permitted
statewide branching. Further deregulation came in 1993 when Mellon Bank bought Dreyfus
Corp. mutual funds and in 1998 when Citicorp merged with Travelers Group (including
Smith-Barney Investment Banking). In addition, competition grew on the lending side from
such organizations as consumer finance companies, interstate thrifts, GE Capital, and credit
cards. Foreign banks were able to enter U.S. markets as well. By 1997, commercial banks
had lost a significant share of their business, which had dropped from 94 percent of all
­deposits in 1973 to just 50 percent (see Exhibit 5.5).
The Financial Modernization Act, passed in 1999, allowed the commercial banks to
offer a broad range of products, including investment banking, brokerage services, and
insurance, and permitted interstate banking. The act enabled commercial banks to compete on a more equal footing with their many competitors. The Federal Reserve reviewed
M&A proposals of banks but denied few of them.
EXHIBIT 5.5
Banking
Industry
Deposits
(in $ trillions
of assets)
Traditional commercial bank deposits and mutual funds
Investment bank money market funds, bonds and stocks
1973
1981
1990
1997
682
46
1,580
241
3,450
1,060
3,790
3,790
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120 Part Two Making Moves
Substantial consolidation occurred within the banking industry (see Exhibit 5.6). In
1998, Nations Bank merged with California’s BankAmerica, creating Bank of A
­ merica—
at the time, the second-largest U.S. bank holding company. In 2004, Bank One merged
with J.P. Morgan Chase, creating a banking colossus, JPMorgan Chase & Co. Citicorp
merged in 1998 with Travelers Group, a financial institution with a broad array of services,
and the stock price soared. It ultimately divested Travelers Group. Nonetheless, Citicorp,
renamed Citigroup, became one of the largest and most influential banks in the United
States. N
­ orwest Bank bought California’s Wells Fargo Bank in 1998. In 1996, through a
hostile takeover, Wells Fargo acquired a competing California bank, First ­Interstate.
­Norwest ­renamed itself Wells Fargo and the new Wells Fargo continued to purchase ­dozens
of small financial services firms each year as long as the price was reasonable.
After the Great Financial Crisis of 2008, there was even more consolidation in the
­industry. Banks became too big to fail. Lehman Brothers had collapsed. Bear Stearns was
absorbed by JPMorgan Chase. Morgan Stanley and Goldman Sachs changed themselves
into commercial banks in order to reduce their debt levels. Merrill Lynch merged with
Bank of America, and Citigroup, after taking bailout money from the federal government,
had to raise cash by shedding assets in one of the great garage sales in Wall Street’s ­history.
Critics of the U.S. banking system did not consider the situation stable. While in
1990 the 10 largest U.S. financial institutions held 20 percent of total financial assets,
in 2010 they held 54 percent. The number of banks declined from more than 12,500 to
about 8,000.
Examples of Good Deal Making
Some companies, nonetheless, have good track records in making deals. Cisco Systems’
processes for selecting targets and integrating businesses after a deal are outstanding.
The computer network company’s purpose in making acquisitions has been to enhance
its existing lines of business, open new ones in adjacent markets, and obtain promising
technology. Other examples of good deal making follow.
A Consolidator
In 1997, Amphenol merged with NXS Acquisition, a subsidiary of the investment
bank Kohlberg Kravis Roberts & Co. (KKR), which was best known for its 1989 takeover of RJR Nabisco. The capabilities of KKR’s management team provided
­additional capital and provided Amphenol with the chance to be an aggressive consolidator. Through its acquisitions, Amphenol consolidated interconnected companies, an opportunity that e­ xisted because of a fragmented and declining market. The
company’s acquisitions broadened and enhanced its product offerings and expanded
its global reach.
A Move to New Industries
In 1995, SPX designed and made specialty tools, a business that had numerous competitors and low operating margins. To combat the cyclical nature of SPX’s business as well
as low profit margins, the company searched for customers in new industries. U.S. automakers constituted 37 percent of its revenues. By 2002, they constituted less than
20 percent of the company’s revenues. SPX transformed itself through acquisitions. Two
of them were very large. In 1998, it bought General Signal, nearly twice SPX’s size, and
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Chapter 5 Corporate-Level Strategy and Diversification 121
EXHIBIT 5.6 Banking Industry Consolidation, 1996–2009
Source: Federal Reserve; GAO.
1990–1995
1997
1996
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
TRAVELERS GROUP
CITIGROUP
CITICORP
EUROPEAN AMERICAN BANK
CITIGROUP
BANAMEX
WASHINGTON MUTUAL
GREAT WESTERN FINANCIAL
WASHINGTON MUTUAL
H.F. AHMANSON
WASHINGTON MUTUAL
DIME BANCORP
FIRST CHICAGO
BANK ONE
BANC ONE
FIRST COMMERCE
JP MORGAN CHASE
JP MORGAN
JP MORGAN CHASE
CHASE MANHATTAN
CHEMICAL BANKING
CHASE MANHATTAN
BEAR STEARNS
US TRUST
MBNA
CONTINENTAL BANK
BANK AMERICA
SECURITY PACIFIC BANCORP
BANK OF AMERICA
NATIONS BANK
FLEET FINANCIAL GROUP
BANK OF AMERICA
BANC BOSTON HOLDINGS
BAY BANKS
BANK BOSTON
FLEET BOSTON FINANCIAL
SUMMIT BANCORP
UJB FINANCIAL
SUMMIT BANCORP
COUNTRY WIDE FINANCIAL
MERRILL LYNCH
WELLS FARGO
WELLS FARGO
FIRST INTERSTATE BANCORP
WELLS FARGO
NORWEST HOLDING COMPANY
WELLS FARGO
SOUTH TRUST
WACHOVIA
CENTRAL FIDELITY NATIONAL BANK
WACHOVIA
CORESTATES FINANCIAL
FIRST UNION
THE MONEY STORE
WACHOVIA
WACHOVIA
FIRST UNION
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122 Part Two Making Moves
in 2001, it acquired United Dominion flow technology business, a company with revenues roughly equivalent to General Signal’s.
Purchasing Talent
The gaming company Activision aggressively acquired other companies. From 1997 to
2002, it made 14 acquisitions that allowed it not only to diversify its operations, add
channels of distribution, and expand its library of titles, but also to develop a new pool
of talent among the companies it purchased, such as Head Games Publishing, Expert
Software, and Elsinore Multimedia.
Broadening Scope
Insurance company Brown and Brown grew through mergers and acquisitions. From
1992 to 2003, it acquired 118 small insurance companies, broadening its scope and expanding from its base in Florida to include California, Connecticut, Indiana, Michigan,
Minnesota, Nevada, New Jersey, and more. The company’s aim was to acquire small,
profitable companies to branch out into underutilized, niche markets with high margins.
Buying Competitors
The packaging business in which Ball competed was mature and had low profit margins.
Companies in this industry faced intense pricing pressures and the threat of consolidation. To achieve a stronger position, Ball successfully acquired and integrated major
competitor Reynolds Metals in 1998, expanding Ball’s aluminum can business, and in
2002, it acquired Germany-based Schmalbach-Lubeca, the second-largest beverage can
manufacturer in Europe.
The Global Economic Meltdown
M&A activity occurs in waves. Cycles of vast amounts of this activity follow periods
when it slows considerably. The global economic meltdown of 2008 greatly diminished
the prospects for mergers and acquisitions. Thousands of deals were delayed or abandoned. U.S. deal volume plunged because of a tightening in credit markets and lack of
confidence in the direction in which the economy was heading. For instance, Dow
­Chemical’s proposed acquisition of rival Rohm & Haas, which had been considered a
sure thing, stalled when the Kuwaiti government withdrew from a joint venture that
would have provided Dow with funding. To pay for the purchase of Rohm & Haas,
Dow would have had to draw down on a billion-dollar short-term bank loan, sell assets it
would ­acquire in the deal, and lay off thousands of workers. Financing of deals during
the economic meltdown was difficult.
Often deals were done out of necessity. An example is the previously described forced
buyout by Bank of America of troubled investment bank Merrill Lynch. Merrill Lynch
had little choice but to go along with this deal. Another example is Oracle’s purchase of
Sun Microsystems. A high-flying startup and a major seller of high-end servers to the
financial sector, Sun struggled after the dot-com bust and had trouble reorienting its
business to low-cost servers that relied on Intel and AMD chips. Under duress, Sun
­approached HP, Dell, and IBM, hoping to be acquired. IBM was Sun’s preferred choice
for an acquirer, but when IBM decided it could not take the risk of trying to rescue Sun,
Oracle decided to step in and buy the ailing company.
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Chapter 5 Corporate-Level Strategy and Diversification 123
Though the economic difficulties created many opportunities, deals did not happen
because capital was not available, business prospects were poor, and it was uncertain
how the Justice Department would view the proposals. Instead, most companies ­followed
more conservative survival strategies. Instead of trying to expand, they conserved cash,
minimized overhead, and reduced their workforces. Though restructuring was perhaps
needed, most companies were just cutting back.
An industry that has continued to experience major restructuring was pharmaceuticals (see Exhibit 5.7). A drive toward consolidation was spurred by a decrease in the
EXHIBIT 5.7 Pharmaceutical Company Restructuring
Source: Credit Suisse; company reports; Bloomberg The New York Times
Drug Industry Consolidation
A series of mergers has winnowed the drug industry to a few major players.
DATES DEALS WERE ANNOUNCED
'95
'97
'93
'99
'01
American Home Products
'03
'05
'07
Wyeth (renamed 2002)
American Cyanamid
Pfizer
Warner-Lambert
Pharmacia
Pharmacia & Upjohn
Monsanto was spun off as an
agricultural products company.
Monsanto
Upjohn
Monsanto
Wellcome
Glaxo
Glaxo Wellcome
GlaxoSmithKline
SmithKlineBeecham
Synthélabo
Sanofi
Sanofi-Synthélabo
Rhône-Poulenc
Aventis
Sanofi-Aventis
Hoechst
Merck
Schering-Plough
Zeneca
AstraZeneca
Astra
Sandoz
Novartis
Ciba-Geigy
Roche
Genentech (Roche bought most of the company in 1990 but has announced a deal to buy the rest)
'09
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124 Part Two Making Moves
number of patentable products in the pipeline. Pfizer’s purchases of Warner-Lambert in
2000 and Pharmacia in 2003, however, did not replenish its roster of new drugs, and the
company therefore kept making more acquisitions.
Almost all the major players in this ­industry have been involved in consolidation. In
March 2008, Roche successfully purchased Genentech, in a deal that came just a­ fter
Merck’s agreement to acquire Schering-Plough. Earlier in 2008, Pfizer had taken over
Wyeth. The other large drug companies—Eli Lilly, Bristol-Myers Squibb, A
­ straZeneca,
Sanofi-Aventis, and Johnson & Johnson—were not sitting idly on the sidelines in the
wave of consolidation. In 2015, Novartis and GSK, Bayer and Merck, and Roche and
InterMune all closed deals.
Consolidation in the pharmaceutical industry was meant to lower costs for drug companies as they combined research and sales efforts and laid off workers. The prospect of
health care reform by the federal government motivated large pharmaceutical firms to
consolidate, believing they would be better able to bundle products and have more power
in price negotiations with the government. However, an industry dominated by exceptionally large firms raised questions about the future of pharmaceutical research. Would
patients be well served by just a few large giants?
Why Do Mergers and Acquisitions Fail?
Mergers and acquisitions fail for many reasons. When a rapidly growing company uses
its high-price stock to make acquisitions, it can be vulnerable to careless mistakes. For
example, it can easily go beyond its core competency and buy a firm that contributes
little to what it does best. Since the acquisition may lead to an immediate increase in
earnings per share, this type of foolish acquisition is hard to resist.
A comprehensive list of the reasons for failure includes the following:10
Flawed Business Logic
∙ Should not have been acquiring
∙ Wrong strategy
∙ Opportunism
∙ Did not consider the alternatives
The purpose of mergers and acquisitions may be to gain access to sought-after products, services, or technologies, but managers of acquiring companies often do not assess
the target company carefully enough to ensure that the products, services, and
­technologies they are obtaining have sufficient value. This task is often difficult to perform a­ dequately in the time allotted. In merging with Electronic Data Systems (EDS),
for instance, GM expected to get from EDS the ability to automate its factories, but EDS
lacked this kind of experience and was of no real help to GM in this area.
Flawed Understanding of the New Business
∙ Misjudged the market
∙ Did not understand the business model
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Chapter 5 Corporate-Level Strategy and Diversification 125
∙ Overestimated the possible synergies
∙ Problem areas not identified in due diligence
Acquiring companies as well often expect that an acquisition will provide marketing leverage. The acquirer may believe that the new products it has acquired can be
sold to its existing customers. However, the acquirer tends to overestimate the crossselling potential and to underestimate the need to retrain its sales force to sell the
new goods.
Flawed Deal Management
∙
∙
∙
∙
Price too high
Poor negotiation
Hampered by process
Integration plan not developed in advance
A huge problem is paying too high a price for an acquired company. Due diligence
has to occur before the acquisition to ensure that the buyer knows what it is getting,
but even with due diligence, serious mistakes often are madeThe banks discussed
­previously often paid too high a price for other banks, as did Westinghouse for CBS
in 1995. This acquisition contributed mightily to the company’s ultimate breakup
and demise.
Flawed Integration Management
∙
∙
∙
∙
Poor communication
Lack of clear leadership
Wrong steps to implement change
Scale of task underestimated
For most acquisitions, it is important that the buyer retain the key personnel in the
acquired company. The failure to do so is particularly a problem when the takeover is
hostile, and the corporate cultures clash, but even in friendly mergers, management has
to keep valuable people. When these people leave, it is much more likely that the merger
or acquisition will fail.
Acquirers often believe they can bring about a rapid turnaround in the acquired company’s performance. However, the managers of the acquiring firm often overestimate
their ability to solve the problems of the acquired company. Unforeseen problems may
arise, such as the discovery of unacceptable accounting procedures. The merger may
also alienate the acquired company’s customers. These factors often are not taken into
account by the overconfident management of the acquiring firm.
Flawed Corporate Development
∙
∙
∙
∙
Changes were inappropriate
Cultural differences/problems
Customers ignored during integration
Own business ignored during integration
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126 Part Two Making Moves
A major difficulty in almost every M&A is combining divergent corporate cultures.
Divergent cultures and management styles present significant barriers to achieving
­success. These differences can impede the process of consolidation and cost cutting,
­result in increased unhappiness among employees, and diminish productivity. The previously mentioned General Motors–EDS merger did not work because it combined
radically different cultures. GM’s elaborate bureaucracy and strong unions clashed
sharply with EDS’s fiercely independent employees. Unfriendly takeovers add to the
problem of merging diverse cultures. When anger and resistance are prevalent, it is hard
to integrate the component pieces.
Why Do Acquisitions and Mergers Succeed?
There is no doubt that acquisitions are risky, yet very few businesses succeed without
them. Today’s strategists are increasingly utilizing techniques, such as retention agreements (for key resources) and contingent earnouts (to mitigate pricing risks).
What factors have to work out for acquisitions and mergers to be successful? Each
proposed acquisition and merger is slightly different and has to be assessed on its
merits. To increase the chances for a success, key issues should be addressed
­beforehand:
∙ Does the acquirer’s management team know enough about the acquired company’s
businesses to competently run them?
∙ Are the businesses of the acquired company more attractive than the businesses in
which the acquiring company is engaged?
∙ Are the costs of entry so high that they will destroy the added income the acquiring
company hopes to gain?
∙ Is it really possible to establish synergies between the new and old businesses?
The synergies (economies of scope) that might be established are critical elements in
successful M&As. Synergies include:
∙ Sharing of tangible resources (research labs, distribution systems) across multiple
businesses.
∙ Sharing of intangible resources (brands, technology) across multiple businesses.
∙ Transferring of functional capabilities (marketing, product development) across
­multiple businesses.
∙ Applying general management capabilities to multiple businesses.
Synergy is crucial, but it may be very hard to achieve.
Mergers of Equals
Mergers of equals are more likely to succeed than mergers of dissimilar firms. ­Exhibit 5.8
compares two utilities that merged in 1999 and had a relatively easy time with their
merger. As the data indicate, the companies were quite similar. Management estimated
net cost savings over 10 years of about $1.1 billion as a result of combining operations.
These potential expense reductions were the result of carefully identifying duplicate
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Chapter 5 Corporate-Level Strategy and Diversification 127
EXHIBIT 5.8
Merger of
Equals:
Northern
States Power
and New
Century
Energies
Total revenues (1998)
Net profits (1998)
1998 Growth rate in number of customers
Allowed rates of return
1998 rate of return
Markets:
Electricity
Generating fuel mix:
Coal
Nuclear
Hydro and other
Natural gas
Purchased electricity
Natural gas
Northern States Power
New Century Energies
$2.82 billion
$282 million
1.4%
MN: 11.47% (1993)
WI: 11.3% (1996)
11.3%
$3.61 billion
$342 million
2.2%
CO: 11.0% (1993)
TX: 15.05% (1986)
13.8%
84% of total sales
75% of total sales
44%
25%
4%
0%
27%
48%
0%
3%
30%
19%
16% of total sales
23% of total sales
7,492
6,375
Total full-time employees (1998):
c­ orporate and administrative functions that could be eliminated by consolidating and
integrating the companies. Substantial cost savings also were derived from the scale
economies of combining production units.
Effective Multi-Business Management
Ultimately, M&A success depends on how effectively the newly merged and acquired
companies are managed. Some companies are very good at this. Their ability to close
deals and manage acquired firms is a core competency at companies that have been
­successful acquirers over time.
In successful M&As, top management’s role is critical. In theory, the top executives
in a company, those in corporate headquarters positions, create value by acquiring new
businesses, restructuring inefficiently managed businesses, and allocating capital and
labor among businesses (see Exhibit 5.9). The executive team transfers skills and capabilities to divisions. It shares activities, establishes linkages, and determines the logic of
integration. The synergies it creates have to consist of more than just sharing corporate
services, such as finance, legal, taxes, research, public relations, and investor relations.
They must also consist of sharing tangible and intangible resources and functional capabilities and applying general management tools and techniques.
In practice, large, complex organizations often are rife with conflict between the
­corporate office and the divisions over strategic and operational issues. Headquarters is
­inclined to favor uniformity, but differences might create advantages. Managing the
­interrelationships among divisions requires intricate systems that push top executives
and people in the divisions to the limit and stretch what they can do effectively. For
­instance, top management may decide to superimpose functional and geographic
­divisions on top of product and market divisions and create matrix structures. These
systems may not work well or may not work as intended. Exhibit 5.9 summarizes the
theory-versus-practice issues in the role of top management.
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128 Part Two Making Moves
EXHIBIT 5.9
Top
Management’s
Role: Theory
and Practice
In Theory
In Practice
Creates value
Acquires new businesses
Is often in conflict with divisions over strategic and
operational issues
Restructures inefficiently managed businesses
May try to impose uniformity despite advantages
of differences
Transfers skills and capabilities to divisions
ay be pushed to limit by complex systems for
M
managing interrelationships
Establishes linkages
Determines logic of integration
Over the past century, management’s corporate strategy role has moved in four
d­ irections largely in response to changes in the external and internal environments of
businesses at the time:
1. Expansion. Starting in the early 20th century, with the growth of the typical firm’s
products and geographic scope, the value chain got bigger, but administrative costs
did not go up. Declining administrative expenses were made possible by advances in
transportation, communication, and information. They were also a consequence of
developments in management sciences in such areas as accounting and finance.
­Organizational capabilities grew. The modern firm with several distinct functions,
such as accounting, finance, marketing, and operations, took shape. These helped
with the management of much larger, more complex entities.
2. The M-form. A new type of structure for the firm, called the M-form, came into
being. This structure improved efficiencies. At the top was a tier of high-level
executives who made strategic choices. They interacted with shareholders and
­allocated resources to separate, independent business units, each with its own
management that made everyday decisions. Thus, the executives at headquarters
offices were not overly involved in the day-to-day activities of the firm’s separate
business units. Instead, they held each unit’s management accountable for its
profitability and performance as measured by such quantitative indicators as
­market share.
3. Portfolio management. In the mid-1970s, many theorists championed an important
extension of the M-form, which was known as portfolio planning. Portfolio-­
planning models helped large, complex organizations manage their separate business units. These models focused on the direction, coordination, control, and
profitability of the different business units. More will be said about portfolio
­models in the next section.
4. Contraction. By the late 1970s, however, serious questions were raised about how
efficient the M-form and portfolio-planning models really were. A large, complex
corporation run in this way could not keep up with small, nimble competitors. It
lacked the flexibility to deal with growing market turbulence, deregulation, and technological change. Many management specialists advocated contraction in the size
and scope of the firm to provide it with speed, flexibility, and responsiveness. The
trend shifted to a preference for a more focused organization.
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Chapter 5 Corporate-Level Strategy and Diversification 129
Portfolio Models
Despite this change, portfolio models in vogue in the mid-1970s have continued to be used
by many companies through today. Once decisions about a firm’s scope are made, the
main task of corporate strategy is to create cohesiveness and direction. Management must
allocate resources to the assembled units and hold them accountable for performance. The
two most commonly used portfolio models corporations have used to achieve these
­purposes have been the BCG matrix, developed by the Boston Consulting Group, and
the GE/McKinsey model.
The BCG Matrix
Large corporations face a significant challenge in determining how resources should be
allocated across their strategic business units. Should they invest in the business units
that show the most upside potential? Should they focus on those that are strong and provide a secure steady flow of business? Is it worth the effort to try to turn ailing units
around? The Boston Consulting Group understood this challenge and, in the 1970s,
­developed a model for managing a portfolio of different business units (or major product
lines) called the BCG growth-share matrix. The matrix attempts to simplify the investment decision process, displaying the firm’s various business units on a graph of the
market growth rate versus market share relative to competitors (see Exhibit 5.10).
BCG argued that investments should be allocated to business units according to
where they are situated on their grid. In the lower-right quadrant, are the “Cash Cows”—
SBUs that have large market shares in mature, slow-growing industries. They serve an
important purpose in that they generate cash that can be invested in other business units
while requiring very little investment for their own continuing operations.
In the upper-right corner are the “Stars” of a corporate portfolio—businesses that
have large market shares in fast-growing industries. They generate cash, but they also
The BCG
Matrix
HI
Market Share Growth Rate
EXHIBIT 5.10
Selectively Hold
Hold/Increase
Harvest/Divest
Hold/Maintain
LO
LO
Relative Market Share
HI
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130 Part Two Making Moves
require significant investment to grapple with rapid industry evolution and to maintain
their lead. If successful, stars become cash cows when the industry matures.
“Question Marks” are found in the upper-left quadrant. These business units have just
a small market share in a high-growth market. Like Stars, these business units also
­require firms to commit resources in order to grow market share. The catch is that a high
level of uncertainty surrounds the Question Marks. The industry may have great potential, but the Question Mark has not yet proven whether it can succeed. If successful,
however, the Question Marks will become Stars.
“Dogs” are business units that have smaller market shares in mature or declining
­industries. They tie up capital that may be better deployed elsewhere. With this in mind,
unless a Dog has the potential to seize market share from rivals—or if it has some other
significant strategic purpose (i.e., its outputs serve as important inputs for Cash Cows or
Stars)—it should be liquidated. Liquidated assets can then be reinvested in ways that will
lead to more profitability across the SBU portfolio.
The BCG matrix is not without faults, however. It has been criticized on a number
of fronts:
∙ Focusing solely on market share versus profitable market share. There have been
companies with high market share, such as General Motors, that were low on profitability, and there have been companies with low market share, like mini mills in the
steel industry, that were high on profitability. The low-cost strategy, which is used to
build high market share, might not translate into a profitable strategy if an industry is
very competitive and prices are declining. Niche strategies that involve differentiation and focus, but low market share can be profitable ones.
∙ Using industry growth rate as the sole indicator of industry attractiveness. The
highest growth rate of nearly any industry in the 1990s was that of Internet companies, but companies like Amazon, though they were thriving in other ways, often lost
money and were not profitable.
∙ Discounting the fact that increasing market share can be very expensive. The BCG
does not provide a way to account for the added costs associated with building share.
∙ Ignoring the potential of declining markets. The focus is entirely on high-growth
markets.
The GE/McKinsey Model
The GE/McKinsey 9-Cell Matrix is a more robust model. It considers market growth
rate to be only one of many factors that make an industry attractive and relative market
share only one of many factors when assessing a business unit’s competitive strength
(see Exhibit 5.11).
Working with the consulting firm McKinsey & Company, General Electric developed
a different approach to assessing competitive strength and industry attractiveness.
­Recognizing that internal strengths and weaknesses are more than just market share and
that external opportunities and threats are more than just market growth, this approach
examines an array of factors. The strength of the GE/McKinsey model is its realism—it
does not see internal strengths and weaknesses as being just market share and external
opportunities and threats as just market growth.
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Chapter 5 Corporate-Level Strategy and Diversification 131
EXHIBIT 5.11
GE/Mckinsey
Model:
Evaluation
Criteria
Competitive Strength
Industry Attractiveness
Market share
Sales force
Marketing
Customer service
R&D
Manufacturing
Distribution
Financial resources
Image
Breadth of product line
Quality/reliability
Managerial competence
Market growth rate
Market size
Cyclicality
Competitive structure
Barriers to entry
Industry profitability
Technology
Inflation
Regulation
Social and environmental issues
Political and legal issues
The weakness of such a model is that it depends on qualitative judgment to determine internal strengths and weaknesses and industry attractiveness. In a firm with
­numerous SBUs, each one wanting to claim a portion of overall corporate resources,
this allocation method opens up the possibility of bitter bureaucratic infighting and
power struggles. ­Unless it is managed carefully, this type of portfolio management can
be very difficult to use.
Nonetheless, portfolio-planning models offer several advantages, including the ability
to see the big picture in a single diagram on which each SBU is positioned and the ability
to apply the same method to many types of businesses. Portfolio models may be a good
starting point for more sophisticated analysis. They can be augmented, but then they lose
an important advantage, their simplicity. They have many problems. They try to reduce
to a minimum the factors that determine internal strengths and industry attractiveness,
they do not eliminate subjective judgment, and they are ambiguous. In addition, they
depend on how a market is defined, and in an environment in which markets and industries are rapidly changing, market definition is difficult to determine.
A huge issue with portfolio-planning models is that they do not consider synergy, or the
interdependencies among SBUs. The Dogs in portfolios may be wagging the Stars’ tails.
Without the Dogs, the Stars would be poorer performers. Corporate performance is a team
effort. In well-managed companies, SBUs are more than separate entities with their own
profit and revenue streams. They share resources, link capabilities, leverage competencies,
and achieve synergies. The corporation as a whole, and not its individual units, develops
sets of skills that have the capacity to open doors and create opportunities for the firm.
Breaking Down the Corporate Hierarchy
In the 1990s a number of new trends in the role of headquarters came to the forefront.
During this period, GE showed that a large diversified conglomerate could be very
­profitable and deliver high returns to shareholders if it was well managed. GE took a
series of steps to reinvent the company. It delayered the organization, from nine or
10 layers of hierarchy down to four or five. It decentralized decision making whenever
possible so that low-level managers had the discretion to respond quickly to emerging
issues. It reformulated strategic planning, changing it from a formal, document-intensive
activity to a series of face-to-face discussions. It tried to redefine the CEO’s role from
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132 Part Two Making Moves
that of checker, inquisitor, and authority to one of facilitator, helper, and supporter. To
some employees, this redefinition that the CEO was a helper and not an antagonist was
believable; to others, it was not.
Jack Welch, the CEO at the time, laid off vast numbers of employees in restructurings
and became known as “neutron Jack,” which led to his losing credibility among some of
his employees. If his purpose was to help them, why was he eliminating so many jobs?
Many companies have followed suit. They have stripped down the central rung of management and laid off many employees. They have eliminated elements in the corporate
hierarchy for the ostensible reason of increasing decision-making speed.
Welch reasserted the importance of the coordinating role played by top executives in
the company. The purpose of breaking down boundaries was to allow ideas to flow
freely and to make innovations common. Top executives were to function as change
agents and be driving forces of renewal. As part of the effort to continually reinvent GE,
Welch held open-ended “workout” sessions with employees at all levels to hear their
concerns and respond to them.
In the first decade of the 21st century, GE’s methods of effectively managing a conglomerate did not succeed as well under Welch’s successor, Jeff Immelt. In 2011, GE’s
stock was down 61 percent from when Immelt took over from Welch 10 years earlier.
After the great financial crisis of 2007, GE’s financial arm, the dominant one in the
company, proved to be a huge liability. The company was forced to withdraw from
­finance and focus on its industrial core, but in that core it often lagged behind stronger
competitors like United Technology and Honeywell. As a conglomerate, GE took hits for
each of the great crises of the 21st century. In addition to the great financial crisis, its
airline business was crippled by 9/11, its industrial sales were flattened by recession, its
oil and gas divisions were hurt by the collapse in oil prices, and it was GE-designed
­reactors that gave way at Japan’s Fukushima nuclear plant. While in theory diversification is supposed to shield a company from risk, at GE it magnified the risk to investors.
Other firms went even further in breaking down the corporate hierarchy in the 1990s.
The Swiss-Swedish firm ABB, a competitor of GE, was also a leader in power and automation technologies. The ABB Group operated companies in hundreds of countries and
­employed thousands of people. In the 1990s, it radically decentralized its operations to rely
on bottom-up management. With a corporate staff of less than 100 people, individual country subsidiaries were encouraged to make their own decisions. The firm was divided into
many small- and medium-sized businesses, which negotiated relations among one another
without central direction. Each business had its own balance sheet by which it was judged.
While ABB initially succeeded with this model, it, too, ran into serious trouble for a
variety of reasons. One was old asbestos-related suits in buildings it had helped to construct. The company approached the brink of bankruptcy in the early 2000s because of
the overall debt it accumulated. While it returned to financial health by settling the
­asbestos liability claims, it never really reestablished its strong footing. In 2015, ­investors
viewed the company as being overexposed to low-margin power generation, transmission, mining, and oil and gas businesses and underexposed in aerospace, nonresidential
construction, building controls, and health care. Its portfolio selection process was
flawed, no doubt because it was so decentralized and placed such little emphasis on
­essential corporate control and ­direction. Between being too top-down and too bottomup, companies have to find a balance.
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Chapter 5 Corporate-Level Strategy and Diversification 133
Is Vertical Integration the Answer?
Instead of using sophisticated portfolio approaches to run firms as conglomerates, might
vertical integration be a better response to the problem of corporate risk? A key question
for the large diversified firm is whether it should move up or down the supply chain and
become vertically integrated.
Vertical integration in industries, such as pharmaceuticals, was once common, but
management soon realized that it was not a good way to achieve sustained competitive
advantage. Both Lilly and Merck purchased distribution arms (PCS Health Systems and
Medco Containment, respectively), but both companies quickly sold these units. Medical
products company Medtronics, however, bought Covidien in 2015 and thereby became a
vertically integrated company, a designer and manufacturer of sensitive heart-related and
other medical devices as well as a manufacturer and distributor of many different types
of medical supplies.
To better understand the pluses and minuses of vertical integration, it is useful to look
at the entertainment industry.11 This industry had converged toward a single model that
combined production of content with multichannel distribution (see Exhibit 5.12). Companies attempted to sell content in many ways, for example, through movies, TV shows,
books, theme parks, and increasingly Internet channels. Some companies bought distribution channels (Disney purchased television network ABC), while others built their
own networks (News Corp started Fox). A new challenge was to combine content with
the added distribution possibilities of the Internet.
In the entertainment industry companies are involved in vertical integration through
direct ownership as well as many alliances via long-term contracts and one-time spot
market transactions. The old studio system tied actors to studios for long periods. In
­today’s industry, actors sign contracts to do “x number of pictures” with a studio. Production companies can be either independent or owned by integrated entertainment
­companies. In either case, production is sold to the highest bidder, not necessarily to the
company that produced the content. Local television affiliates and movie theaters are
sometimes bound by contract, sometimes entirely independent, and sometimes owned by
an entertainment company. This last situation is common in large metropolitan areas,
where the major companies want close links to viewers. Agents and other facilitators
play a role in bringing together the parties in the value chain.
Before government regulation in the 1950s, the large Hollywood studios were
­vertically integrated. A few large studios owned most production and worldwide
­distribution. This system was broken up by government regulation. It was not until
EXHIBIT 5.12
Vertical
Integration:
Entertainment
Industry
CONTENT
DISTRIBUTION
Resources
Creation
Delivery
Retail
Actors
Writers
Television production
Movie production
Broadcast television
networks
Cable television networks
Movie distribution
Local Affiliates
Local cable companies
Local theaters
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134 Part Two Making Moves
the late 1980s that the federal government again allowed companies owning studios
(TV production units) to also own TV broadcast networks (distribution). In recent
years, several rationales have supported vertical integration. One reason has been the
­convergence of computing, telecommunications, information, and entertainment.
Convergence has created a hierarchy in which content, the scarcest commodity, is the
most valuable resource.
Content, however, is a high-overhead, high-risk, and low-margin business. The cost
of making and marketing movies continues to increase; yet the likelihood of success is
more and more a matter of guesswork. The odds are no better in TV production. Thus,
a rationale for joining production and distribution is to guarantee outlets for a firm’s
production. Captive outlets provide a built-in output for content. Networks cut costs by
owning and/or supplying their own prime-time programming. Networks are tolerant
­toward their own production units, but there are limits because production companies
cannot force bad shows on networks, and hot networks can demand high prices for
­airing shows.
Another rationale for vertical integration is that it enables big entertainment companies
to sell content, that is, to market the same character or idea in many ways. The content of
the entertainment companies can originate anywhere—movies, TV, music, publishing,
merchandising, theme parks, and Internet sites. It can be repeatedly recycled in new
­formats to maximize returns. For this to work, synergy must exist along the value chain.
Different parts of the business have to be aligned so that they add value to each other.
Vertical integration can mean lower risk (regardless of where the profits are, the companies have a foothold) and can lock in distribution for high-risk production. But production companies supply all networks and networks access all suppliers, so the motive for
consolidation is as much to gain bargaining leverage as to lock in distribution. All
­companies are aiming for synergies, cross-selling to end users, and cross-platform-­
selling to advertisers.
Each revolution in distribution and transmission has given companies with content
(production) more outlets for their creative products. Compared with network TV, cable
not only gave customers more distinct viewing options, but also provided the owners
with revenues from both subscriptions and advertising like print journalism. The evolution has progressed from broad mass audiences via TV networks, to aggregations of
specific audiences (children, news, movies, comedy) via cable, to individual interests via
direct satellite services and digital cable, to the potential of markets of one and entertainment on demand on Internet sites, such as YouTube. An Internet site like Google thrive
on its ability to capture advertising revenue and now Amazon has discovered the power
of a subscription service, i.e. Amazon Prime.
Entertainment companies have tried to acquire complementary assets (e.g., Viacom
was strong with a young audience, while CBS was strong with an old one). Nonetheless,
much of the consolidation in the industry has not lived up to its billing. It is arguable
whether or not Time Warner and News Corp were better off after their major acquisitions. Viacom, for instance, decided to divest and separate into two units, Viacom and
CBS. After years of mergers and acquisitions, divestitures have been the next major
trend in this industry, with almost every major media company shedding assets and
­becoming leaner and more focused.
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Chapter 5 Corporate-Level Strategy and Diversification 135
Though the entertainment industry offers good examples of the potential for vertical
integration along the value chain, the results have not lived up to expectations. The
great period of vertical merger and acquisition among entertainment companies has
come to an end. A number of conclusions about vertical integration, therefore, can
be reached:
∙ In theory, there are many potential advantages, including risk reduction (regardless of
where profits move, a company is in a position to gain), but these advantages are hard
to achieve.
∙ If distribution is purchased, it makes sense not to lock it in; rather, distribution should be
used as a bargaining tool (ends dependence, provides credible threat to go elsewhere).
∙ On the other hand, an advantage of acquiring distribution is that it provides closeness
to customers. This may translate into the possibility of cross-selling, developing new
products, differentiating existing products, and catering to individual customer needs.
And catering to individual needs can yield higher profit margins than selling an undifferentiated commodity.
∙ Once acquisition of distribution occurs, however, synergy may be hard to achieve.
Management of the complementary assets is a huge challenge, one that has yet to be
effectively carried out by the large entertainment conglomerates.
Transaction Costs
Vertical integration raises a variety of questions. What is more efficient—specialist
firms linked by market exchanges or firms combined under a common ownership? Why
is common ownership needed when in so many industries firms can unite to achieve
common purposes on a project basis? The wool industry, for instance, involves independent spinners, weavers, and merchants coming together to produce final goods for sale to
consumers. The remodeling industry involves builders, plumbers, electricians, and painters working together on a project basis. Movies typically are made in a similar manner.
Why should all these activities come under the purview of one firm?
In deciding whether to combine or leave activities separate, managers must compare
external market transaction costs to internal administrative costs. Which are greater?
High market transaction costs are a good reason to unite activities in one firm, while
high administrative costs are a good reason to keep these activities in separate entities.
The external transaction costs of operating in the market have to be compared with the
internal administrative costs of operating inside the firm.12
Within a firm, managers cannot just command employees to do their bidding. They
incur monitoring and incentive costs when they try to ensure employee compliance.
These costs may be greater than the costs of transacting in the market. Also, the information a firm’s top executives receive from their subordinates may not be better than the
information they receive from outside the firm. Employees may misrepresent situations.
So, why have them as employees? Instead, hire them on an as-needed basis. The cost of
uniting disparate elements in the firm includes the hassles of dealing with potentially
recalcitrant employees who have to be motivated to do the job right. These costs affect
many different stages in the production process, such as manufacturing, marketing, and
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136 Part Two Making Moves
distribution, when they take place in the same firm. Compare them with the discussion
of outsourcing in the chapter on internal strengths and weaknesses.
Between pure market transactions and vertical integration, there are a number of
­hybrid-like options like those discussed earlier in this chapter:
∙ A firm can have long-term contracts and partnerships with suppliers.
∙ It can have franchising agreements with independent or semi-independent distributors rather than incorporate them in the firm.
∙ It can create joint ventures.
These arrangements may compensate for the limits of internalization and for the
l­imits of market exchange. In each instance, the issue is how to best design the arrangement. The parties have to be able to answer questions, such as how to allocate risk and
what are the incentives to work together. These alliance-like options have gained considerable attention in management circles in recent years and frequently are resorted to
­instead of mergers and acquisitions. They may be a preliminary stage, a trial period, in
what later becomes an outright merger and acquisition.
Summary
The reasons for mergers and acquisitions are many. They include getting around antitrust laws, dealing with decline in a corporation’s core business, coping with slow
growth, trying to achieve turnarounds, gaining access to attractive products and technologies, building in distribution or production capacity when they are lacking, and
­taking advantage of a bull market. Deregulation and privatization have played a major
role in the restructuring of many industries. In airlines, railroads, and banking, the
­number of firms has shrunk.
Some firms have coped with this situation much better than others. Merger and acquisition winners have a few characteristics in common. They are good at dealing with the
cultural problems that emerge after a merger or acquisition has been completed. They
don’t overpay for the companies they buy. They make sure they know what they are
­getting. They operate well in the post-merger or acquisition environment, achieving
marketing leverage and other synergies. They make sure to retain the key personnel of
the merged or acquired company. And they strive to gain the benefits from complementary core competencies.
Mergers of equals are more likely to succeed than mergers of vastly different companies.
Still, it is necessary for management to plan carefully before engaging in a merger or acquisition. Synergy is the key, but achieving it is far from easy.
Theories of managing a large, diversified organization have transitioned from encouraging expansion to policies of contraction and focus. Portfolio management tools like
those BCG and GE/McKinsey developed were once very popular. They divided firms
into separate business units and viewed the units as independent entities. Although they
are still popular today, firms more and more are looking for boundary-free arrangements
where capabilities are linked, competencies leveraged, and synergies achieved.
The vertical integration decision, as discussed in this chapter, is a complicated one
since in many instances, it may make more sense for the firm to buy the goods and
­services it needs in the market rather than to produce them itself. The firm’s top
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Chapter 5 Corporate-Level Strategy and Diversification 137
e­ xecutives have to decide where the firm’s comparative advantage lies and concentrate
on this domain rather than spreading the company too thinly. The market transaction
costs of vertical integration have to be compared with the administrative costs of internalizing an additional function in the firm. The complicated nature of the vertical integration decision is apparent in the entertainment industry, where most of the large
acquisitions and mergers of recent years have not worked as well as expected.
Exercises for the Practitioner and the Student
Reflect on your own employer’s external environment. If you are a traditional student,
please select a publicly held firm to analyze.
1. Has the firm recently been involved in a merger, acquisition, or divestiture? How
would you assess the results? What has gone well? What challenges still lie ahead?
2. To what extent is the firm involved in tactics that fall short of full-scale mergers and
acquisitions? Have these tactics succeeded? What are the challenges that lie ahead?
3. In which business or businesses has the firm chosen to participate? Are the businesses
largely related or unrelated? Why has the firm chosen to compete in these businesses?
Are there businesses that the firm should divest? Are there businesses that the firm
should acquire? Identify a number of targets for acquisition. Justify your choices.
Explain how the firm should go about trying to carry out the acquisition.
4. Should the firm look for additional acquisition targets that are vertically or horizontally related to it? Why?
5. What are the external environmental factors and industry changes that should drive
the firm’s merger and acquisition strategy?
6. What capabilities have been required to make its merger and acquisition decisions?
Does the possess the appropriate internal capabilities for M&A-related decision making?
7. What type of corporate managerial model does the firm use to manage its separate
business units? What are the pluses and minuses of this approach? How could the approach be changed for the better?
Endnotes
1. D. Brito and M. Catalao-Lopes, Mergers and Acquisitions: The Industrial Organization
­Perspective (Leiter, Netherlands: Kluwer, 2006).
2. R. Rumelt, Strategy, Structure, and Economic Performance (Boston: Harvard Business
School Press, 1986). Rumelt found that concentrating on a single field was more profitable
than moving boldly into uncharted territory. He blamed unrelated diversification on management fashion and argued that related diversification was a better strategy. He warned against
conglomerates and unrelated acquisitions.
3. A. Fisher, A. Michels, and J. Antony, “How to Make a Merger Work,” Fortune, January 24,
1994, pp. 66–70. Consulting firm McKinsey & Company, in a 1994 study, found that only
23 percent of mergers examined over a 10-year period generated returns in excess of the costs
incurred in the deal. Also see D. Ravenscraft and F. Scherer, Mergers, Sell-Offs, and ­Economic
Efficiency (Washington, DC: Brookings, 1987). Ravenscraft and Scherer, in a study of the
post-acquisition performance of acquired firms, found that profit levels and market shares on
average did not grow.
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138 Part Two Making Moves
4. “Mergers: Why Most Big Deals Don’t Pay Off,” pp. 60–68.
5. “Why ‘One and Done’ M&A Is No Longer Effective,” http://www.accenture.com/us-en/
outlook/Pages/outlook-journal-2012-mergers-acquisitions-create-value.aspx.
6. The 1990s saw even greater activity than did the 1980s. In 1988, the decade’s peak year,
$246.9 billion was invested in M&As. In 1995, the total transaction value was more than
$450 billion, in 1996 more than $470 billion, and in 1999, a staggering $1.4 trillion (the current record)—see BusinessWeek, October 14, 2002.
7. Sources on the railroad industry include Alfred Marcus, The Adversary Economy (Westport,
CT: Quorum Books, 1984); Mercer Management Consulting, The Impact of Deregulation;
and H. Sun, “The Sources of Railroad Merger Gains,” Transportation Journal 39, no. 4,
pp. 14–26.
8. Sources on the banking industry include R. Eisenbeis, “Mergers of Publicly Traded Banking
Organizations Revisited,” Economic Review 84, no. 4 (1999), pp. 26–37; J. Jayaratne and
P. Strahan, “The Benefits of Branching Deregulation,” Regulation, Winter 1999, pp. 8–16;
A. Kover, “Big Banks Debunked,” Fortune, February 21, 2000, pp. 187–94; R. Kroszner,
“The Economics and Politics of Financial Modernization,” Economic Policy Review 6, no. 4
(2000), pp. 25–37; and B. Shull and G. Hanweck, “A New Merger Policy for Banks,” Antitrust
Bulletin 45, no. 3 (2000), pp. 679–711.
9. In the 19th century, branch banking had been regulated to ensure easy access by customers
and prevent local market concentration.
10. See “Why Acquisitions Fail–The 20 Key Reasons,” http://www.pearsoned.co.uk/bookshop/
article.asp?item=439.
11. Sources on the entertainment industry include Marc Gunther, “TV’s Rerun from Hell: Paradise Lost,” Fortune, February 5, 2001, pp. 28–30; “Television Takes a Tumble,” The Economist, January 20, 2001, pp. 59–61; J. Angwin and M. Peers, “The New Media Colossus,” The
Wall Street Journal, December 15, 2000, pp. B1, B7; Stephen Battaglio, “TV Networks Are
More Than Just Survivors,” Fortune, September 18, 2000, pp. 56–57; J. Lipman and
B. ­Orwall, “Who’s Left at the Media Ball?” The Wall Street Journal, September 8, 1999,
pp. B1, B4; Marc Gunther, “Viacom: Redstone’s Remarkable Rise to the Top,” Fortune, April 26,
1999, pp. 130–37; “A Brand New Strategy,” The Economist, November 19, 1998, special
­section; and Frank Rose, “There’s No Business Like Show Business,” Fortune, June 22, 1998,
pp. 86–98.
12. O. Williamson, Economic Institutions of Capitalism: Firms, Markets, Relational Contracting
(New York: Free Press, 1991).
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C H A P T E R
S I X
Globalization
“Conventional wisdom argues that domestic competition is wasteful:
It leads to duplication of effort and prevents companies from achieving
economies of scale. … (Yet) domestic rivalry, like any rivalry, creates
pressure on companies to innovate and improve. Another benefit … is
the pressure it creates for constant upgrading of the sources of ­competitive
advantage … It is also vigorous domestic competition that ultimately
pressures domestic companies to look at global markets and toughens
them … and having been tested by fierce domestic ­competition, the
stronger companies are well equipped to win abroad.”1
Michael Porter, The Competitive Advantage of Nations
Chapter Learning Objectives
• Recognizing that strategic management has a global dimension.
• Appreciating the reasons for a firm’s expansion across national boundaries.
• Seeing how the CAGE framework and Porter’s “diamond” can help shape a firm’s international strategy.
• Being aware of the range of global strategies that can be adopted—from multidomestic to transnational.
• Comprehending the degree of local adaptation required when a firm enters foreign markets.
• Understanding the tactics that support global strategy—such as licensing, franchising, and
greenfield operations.
• Seeing the parallels between global and domestic strategy.
Introduction
Along with decisions about diversification and corporate-level strategy, decisions about
global moves are among the most important ones the strategist makes. This chapter
­examines these moves.
At first glance, it seems that operating abroad only adds to the costs of doing
­business—extra communication and transportation costs, extra costs of training staff and
moving ­individuals to different countries, and the expense and time required to learn
about diverse cultures and languages. In addition, in order to enter and operate in global
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140 Part Two Making Moves
markets, barriers against gaining access to key business and partnerships must be surmounted. Local firms have built-in advantages: They know the situation better than any
foreign firm could, and they have better understanding of the domestic market, business
conditions, and prevailing culture. The liability of foreignness means that firms may
decide to remain domestic players and respond to international threats as they occur
from a more ­focused domestic stance.2
Despite all the hurdles and barriers at hand, however, some firms commit to ­operating
abroad. This chapter outlines reasons these firms decide to “go global.” Life cycle and
other environmental factors, as introduced in Chapter 2, often compel firms to craft a
more global strategy, as do internal factors mentioned in Chapter 3, especially the need
to replenish and expand a firm’s capabilities. Firms entering international m
­ arkets
­succeed only when they possess a unique set of r­ esources, capabilities, and competencies
that they can apply in global markets in ways that domestic firms cannot match.
A firm choosing to pursue international operations has a wide range of strategic o­ ptions—
from a multidomestic to a transnational approach—and an even greater range of tactics
that can be selected based upon the firm’s unique situation. Some international opportunities
are best addressed when a firm utilizes a narrower exporting ­approach, while others demand
a more integrated strategy and more direct foreign i­nvolvement and investment. In the end,
the key to developing a successful international strategy is to understand the unique characteristics and requirements of the markets b­ eing considered and the capabilities of a firm in
light of those factors. Also critical is the capacity to s­ ecure partnerships and resources to
capture a critical mass of profitable business abroad.
This chapter assists in navigating the complex global landscape and formulating moves
for a winning global strategy. A winning global strategy is not carried out in isolation, but
rather must be combined with other moves, including business, c­ orporate, and innovation
strategies undertaken by a firm.
Reasons for Globalization
Given the difficulties firms have in entering foreign markets, why do they do it? In
­today’s world, the scope of the firm and its competition extends well beyond national
boundaries. Inputs—both human and physical resources—come from all over the world.
Potential as well as actual customers are found in every country. The reasons firms
­operate internationally are numerous:
∙ They may be responding to an onslaught of globally positioned rivals—or racing to
secure a foreign market position before a key rival can gain a foothold.
∙ They may be responding to life cycle factors that have led to a diminishment of
­demand domestically.
∙ They may be seeking to capture scale economies, or to simply achieve minimum efficient scale. Domestic markets may no longer be able to absorb production at a minimum efficient scale. To drive the production costs of a unit low enough to be
competitive, some firms have to produce millions of units per year, not thousands.
They can find markets this large only if they operate globally. The costs per unit produced would be too high if these companies sold just to the local market.
∙ They can better exploit their technological advantages or brand name if they diffuse
their wares across the globe to a broader audience.
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Chapter 6 Globalization 141
EXHIBIT 6.1
Reflection of
United 747 at
Frankfurt Gate
©Captain Brian
Cohen.
∙ They may desire better and/or cheaper sources of raw materials and energy from
channels abroad.
∙ They may want to obtain access to low-cost factors of production such as labor.
∙ They may be attracted to certain countries because of the subsidies those countries provide.
∙ They may be seeking opportunities for economies of scope (synergy) and for learning.
Life Cycle Factors
As discussed in Chapter 2, industry structures change in fundamental ways over time,
and this evolution impacts the approach each firm takes to export and other global
­opportunities.3 In an industry’s embryonic stage, when its products are just getting off
the ground, there are likely to be few exports. Efforts to push products across the globe
at this stage are often difficult. Prices tend to be high, and margins and profits low.
­Production runs are short and require skilled labor. Specialized channels are needed for
distribution, and relatively few companies are in the industry. There are many product
variations, no standards, and frequent design changes. Companies face high advertising
and sales costs to persuade buyers to make a purchase.
In the growth stage, exports pick up. Although products continue to have technical
and performance differences, efforts to improve product reliability by standardization
start to pay off. There is a widening group of buyers and a shift to mass production and
distribution. Prices go down and profits up. Competitors enter the industry in increasing
numbers. Rivals start their race for dominant share.
As maturity sets in, exports grow even more to pick up slack. At home, there are few
new buyers; most are repeat buyers. Competitors struggle for the same customers. Overcapacity develops. To extend the life cycle, companies segment the market into more and
more categories across the globe. They provide deals to customers to gain market share
and compete bitterly with regard to price and factors such as packaging. Competitors look
for market opportunities abroad. Coca Cola, for example, recognized long ago that U.S.
consumers could devour only so much soda the domestic carbonated soft drink industry
had hit an inflection point and was maturing (see Exhibit 6.2). In response to the deceleration of demand, the company ­expanded abroad and today is a dominant global player.
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142 Part Two Making Moves
Soda Market
Maturity
About two-thirds of the Coca Cola’s sales and 80 percent of its profits now come from abroad. The hypercompetitive environment in the United States has forced Coca-Cola to look favorably at opportunities
abroad. The company has been locked in a decades-long duel with PepsiCo that involves the pressures of
high-cost advertising and the difficulties of maintaining access to shelf space in supermarkets, keeping
fountain business in restaurants, and developing vending business. Gigantic outlets such as Walmart and
other mass distributors have demanded huge discounts, plus they have developed their own in-house
­labels to ­compete with Coke and Pepsi.
Consumers are no longer as enamored with soft drinks as they once were and are wary of the artificial sweeteners
found in diet varieties. Bottled water, juices, and so-called new-age beverages with captivating names like Escape,
Enrich, Appeal, Allure, and Comfort and unique flavors have been taking domestic share away from both C
­ oca-Cola
and PepsiCo’s core cola and cola-related products. Even the best-case scenarios forecasted by market experts
show negative trends in the domestic soft drink market.
The Declining U.S. Soft Drink Market
50
(billion)
$41.1
45
Best Case (billion)
$41.3
40
Total Sales ($ billions)
EXHIBIT 6.2
Mintel Forecast
(billion) $33.5
35
30
Worst Case (billion)
$25.5
25
20
Confidence Intervals
15
95%
10
90%
70%
5
0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
50%
Est
Actual
Forecast
Ref: Mintel Carbonated Soft Drinks in the U.S., 2014
To keep costs down, both Coca-Cola and PepsiCo have had to carefully manage their relations across their
­supply chains. The inroads that Coca-Cola and PepsiCo have made on smaller soft-drink companies—via
­competition or acquisition—have limits, and restrictions exist on the two companies’ abilities to innovate and
­introduce new products as they seek to differentiate their existing products. They do not want to cannibalize
their existing business.
As PepsiCo keeps making in-roads on Coca-Cola’s U.S. market share, Coca-Cola has recognized that it has to be
even more aggressive in looking abroad for new business, where it has greater brand recognition than PepsiCo.
However, PepsiCo cannot allow Coca-Cola to win market share abroad uncontested or else Coca-Cola could
seriously damage PepsiCo domestically, so it has followed Coca-Cola and challenged it throughout the world.
Although behind Coca-Cola in nearly every market, PepsiCo has made the effort to be a formidable global
competitor so that Coca-Cola does not overtake it domestically.
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Chapter 6 Globalization 143
Beverage Industry Global Market Shares
Coke
18%
Other
63%
Pepsi
11%
Nestle
8%
Data as Reported in the 2015 IBISWorld Soft Drink & Bottle Water Manufacturing Report.
If exports—or other forms of foreign operations—cannot pick up the slack, decline
sets in. In the decline stage, there is less and less product differentiation. Spotty product
quality reemerges. There are falling prices and margins and fewer competitors. The process of commoditization makes once attractive industries much less attractive.
Changes in domestic demand over the life cycle lead firms to operate internationally.
When products become standardized, competitors enter the industry, and firms compete
more on the basis of price. However, whether it is U.S. products sold in foreign markets
or foreign products sold in U.S. markets, products that are common at home are seen as
exotic abroad. Away from the home country, the products become premium, deluxe
goods that command higher margins; they have snob appeal. Consider foreign alcoholic
beverages sold in the U.S. that have cachet simply because they are made abroad. Thus,
the pressure of life cycle competition and the lure of global markets drive companies to
seek markets abroad.
Options for Global Expansion
Similar to the corporate-level tactics for diversification, the methods of international
expansion run the gamut. Prior to committing to a particular avenue, it is necessary to
consider several factors:
∙ From an internal resource perspective, does the firm possess the necessary financial
capabilities? Does it have the capacity to satisfy increased global demand? Does it
have the country-specific knowledge to market and/or operate abroad?
∙ From an external environment perspective, is potential demand sufficient in a firm’s
target markets? Will the product need to be modified? How much will it cost to produce and/or ship abroad? How much political or intellectual property (IP) risk can a
firm endure?
The answer to these questions help determine which tactics make the most sense for
a particular firm.
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144 Part Two Making Moves
The simplest of avenues is to export products identical to those sold domestically. This
option makes the sense when the import policies of a target country are liberal, the sales potential is either limited or unknown, little product adaptation is required, or a country’s production costs are prohibitive. This tactic is also advisable when there is a high degree of
political turmoil or unrest, which would place direct foreign investments at risk. The pros of
this approach are speed of entry and the ability to maximize scale economies at existing
­facilities. In some industries, such as aircraft manufacturing, the maximization of plant utilization is imperative—plus, if the product is an airplane, it can deliver itself directly from the
plant to the customer.
Of course, there are trade-offs to consider. For most firms, the sheer cost of transportation can place it at a disadvantage relative to companies that can produce in closer
proximity to their target customers. Target customers may perceive the exporter as an
“outsider,” and the firm’s access to actionable market intelligence can be severely limited. The risk of inventory slippage or breakage is also increased when finished goods
travel long distances to foreign markets.
In order to address cultural barriers and the perception of foreignness, firms can instead
choose to license their intellectual property for foreign production and sales—or franchise
their business concepts to foreign operators. In such agreements, a foreign firm (the franchisee or licensee) produces the product/service in their own country, have to do most of
the day-to-day work, and bear most of the business risk. The franchisor or licensor who
permits the franchisee/licensee to use its intellectual property assumes much less overall
risk (as illustrated in Exhibit 6.3)—and financially sees only the upside of franchising/­
licensing fees and royalties. However, the franchisor/licensor also forfeits the lion’s share
of potential profits and cedes some control of production and operations. In fact, the foreign firms to whom it licenses the product or franchises the concept may steal or inappropriately utilize the company’s intellectual property. The company also has less ability to
coordinate its international holdings and increase its own operational efficiencies.
Alliances and joint ventures, discussed in Chapter 5, are best pursued when potential returns in a particular market are more certain and great enough to justify the overhead of such
agreements. Their positives are numerous as they help a firm overcome foreign ownership
restrictions and cultural distance. The local company can provide the skills, resources, brand
name and distribution network for the products and services generated. Alliances and joint
ventures combine the resources of two firms and boost the learning potential for all partners.
EXHIBIT 6.3
Potential HIGH END
of Licensee/Franchisee Gains
Profits
Range of
Potential Gains
and Losses for
the Licensor/
Franchisor vs.
the Licensee/
Franchisee
Range of
Licensor/Franchisor Gains
Time
Potential LOW END
of Licensee/Franchisee Losses
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Chapter 6 Globalization 145
The international joint venture between U.S. cereal giant Kellogg and Asia’s leading agribusiness Wilmar has been designed to capitalize on the strengths of each
partner. Wilmar has provided infrastructure, supply-chain scale, an extensive sales
and distribution network in China, and local China market expertise to the joint
­venture. Kellogg contributes a portfolio of globally recognized brands and products,
along with deep cereal and snacks category expertise. The joint venture has relied on
the Kellogg’s (cereal) and Pringles (chips) brands. Together, Kellogg and Wilmar
have been leveraging their complementary expertise to maximize marketing and
­manufacturing synergies.4
Alliances and joint ventures are not without risk, however. Conflicts occur over asymmetries in investments or profit splits. They can be difficult to manage and control. As
each firm has more “skin in the game,” there is more potential for financial and knowledge (IP and trade secret) losses. A partner, armed with insider information, can quickly
become a competitor. Safeguards must be built to minimize the potential for such losses.
An exit plan, which allows a JV partner to be bought out based on a prearranged valuation, is just one such safeguard.
A company achieves maximum control if it establishes its own greenfield operations
in the foreign country, as Cargill, international producer and marketer of food, agricultural,
financial, and industrial products and services, often does when it operates abroad. This
approach involves the company making direct foreign investments (DFI), which allow it to
control everything from production to marketing and distribution. It is better able to protect
its technology from appropriation by a foreign partner, and it is in a better position to
­engage in global strategic coordination and to achieve operational efficiencies.
However, greenfield operations are very challenging if the company does not have
prior foreign experience or experience in a particular country. The costs and risks are
great. Best Buy, for example, has estimated that its international retreat from its greenfield operations cost the company $245 million—and this is just one recent example of a
retailer finding that stores don’t always perform as well on foreign soil.5 Similarly,
­Target’s failure to expand in Canada was a major blow to the company.
Product-Market Approaches
Firms tend to position themselves according to one of three classic international strategies: multidomestic, global, or transnational (see Exhibit 6.4). Each of these strategies
reflects trade-offs that are made between responsiveness (to each local market) and
global production efficiency. Each is tied to business level decisions that accentuate a
firm’s basic low-cost, differentiated, or best-value position (as introduced in Chapter 4).
∙ A global strategy features a single dominant design or business model worldwide;
this approach takes advantage of economies of scale and is a highly efficient, lowcost way to expand internationally.
∙ A multidomestic strategy adapts and modifies a firm’s products and services to each
separate country or region and charges a premium price for customized goods that
meet the needs of individual markets. This differentiated approach is designed to extract high margins.
∙ A transnational strategy combines global efficiencies with local responsiveness. To
achieve the best value, it both exploits scale economies and adapts to local conditions.
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146 Part Two Making Moves
EXHIBIT 6.4
Global
Production Efficiency
Trade-Offs in
Global
Expansion
Transnational
Multidomestic
Local Market Responsiveness
When pressures to be cost efficient are high, and pressures for local responsiveness
are low, companies can use uniform global strategies. When cost pressures are low and
pressures for local responsiveness are high, multidomestic strategies can be followed to
adapt to the needs of each local market. The former is similar to a low-cost business
strategy, and the latter is similar to a differentiated strategy. If cost pressures are high and
the pressures for local responsiveness are also high, companies may be forced to move
toward the middle and carry out transnational strategies that have some elements of
global homogenization and some of local adaptation.
When entering global markets, a firm may have to meet the pressures for both low
cost and local responsiveness. Low cost may, for example, be best achieved by a single
brand produced in a uniform way for all markets everywhere, thus reducing design
costs, lowering manufacturing costs, and achieving greater efficiencies. However, given
the existence of different infrastructures, distribution patterns, and government demands, it may not be possible to achieve uniform policies throughout the world. Local
acceptance is likely only by accommodating local tastes and adapting to traditional
practices. Accommodating local needs, however, is costly and difficult, as the following
example indicates.
Local Adaptation
A U.S. firm entering another market must be sensitive to differences it will experience.
Its success often depends on its ability to adapt to these differences. The expansion of
fast-food companies into Japan provides a good example.6 At the start of the 1990s, the
fast-food business in Japan was rapidly expanding. People were spending a larger portion
of their incomes on eating out. Although Japan was the second-largest consumer market
in the world, it was an alien place to many U.S. franchises. The Japanese people were
friendly to the Americans, but many U.S. businesses that tried to move into Japan failed.
Kentucky Fried Chicken (KFC), on the other hand, found great success in adapting to the
market utilizing the tactics described in Exhibit 6.5.
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Chapter 6 Globalization 147
EXHIBIT 6.5
KFC in Japan
The key to KFC’s success in Japan was that it had a multi-point plan that married modern business practices with Japan’s century-old traditions:
•
•
•
•
•
•
•
•
•
•
•
•
•
Adapting to local customs. The head of KFC operations in Japan, an ex-IBM employee, was willing to adapt to local customs. At business gatherings, he would say a few words in Japanese no matter how difficult it was for him. He understood that he had to socialize,
network, and form personal bonds with KFC’s franchisees and other business partners. In Japan, business relations are built on trust, a
handshake, and a glass or two of sake. KFC’s head in Japan was an outgoing person, enjoyed the sake, was proud of his “fiberglass
liver,” and liked attending geisha parties.
Delegating authority. The KFC head in Japan also understood that he had to delegate real authority to his Japanese staff. His executive vice
president was a 27-year-old local man, whom he immediately hired to be his peer and with whom he shared an office and developed a friendship. He gave this man the opportunity to expand the business with him. Usually in Japan an employee cannot climb to the position of chief
operating officer until the age of 40, but KFC Japan’s second-in-command had a large say in decision-making from the outset.
Training for life. At KFC in Japan, employees did not “work” for the company, but “belonged” to it. Since employees were going to stay
with the company for their entire careers, the head of KFC Japan believed the company could invest heavily in training. The training
was not only in methods, but also in the spirit of the company. Employees started each day with a pledge to serve customers promptly,
be polite, maintain the stores in spotless condition, and pay attention to hygiene. They took these company slogans very seriously.
They were shown behind-the-counter techniques and drilled until they got it right. For instance, when an order was taken, they had to
remember that a packer was behind them and they had to repeat the order to the packer. They had to use both hands when giving the
product to the customer, and they had to say very politely, “Here you are.”
Locating stores effectively. The location of new stores was chosen carefully because overhead was high in comparison to that in the
United States. A new store could cost the equivalent of $400,000 to build and equip and $28,000 a month to maintain, so it had to
generate at least $85,000 a month in revenue. An algorithm was developed to predict business per month based on foot traffic, population density, and other factors.
Sizing stores appropriately. The first stores that KFC built in Japan were exact replicas of its U.S. stores. As KFC Japan’s chief operating
officer remarked, they were like “full-size Cadillacs.” In Japan’s crowded and narrow streets, they were not appropriate, so they had to
be redesigned. To suit local conditions, everything was reduced to one-third the size of a U.S. KFC store, but the smaller stores were
expected to do three times the business of their U.S. counterparts.
Changing the menu. The menu was adapted to Japanese tastes, with additional items such as smoked chicken, yogurt, and fish and
chips being available. French fries replaced mashed potatoes, and the coleslaw was less sweet than the U.S. version.
Having display samples. Japanese consumers demanded display samples that were exact replicas of the food they ate. These were
designed, built, and showcased in each store.
Displaying statues of the colonel. The head of KFC Japan found old life-size statues of the “Colonel” in a U.S. warehouse. He placed
them on the sidewalk in front of each store to show the authenticity of the product.
Advertising to Japanese customers. A Japanese agency developed the TV advertising campaign, which cost $5 million annually. The
advertisements stressed the product’s association with America and its “aristocratic elegance.” They also showed satisfied, smiling
faces the world over. The appeal was not the good basic food at a reasonable price, but the unusual, distinctive food from Kentucky
(the theme song was “My Old Kentucky Home”) that came from the Colonel’s home kitchen. The associations with the product’s noble
and fine features allowed KFC Japan to earn higher margins.
Having a committed partner. Mitsubishi, the trading company, was a half-owner of KFC Japan and was the main supplier of the meat. It
invested heavily in KFC Japan to expand the market for chicken, in which it had also invested. Mitsubishi was patient with KFC Japan,
allowing it to miss profit projections, while it built market share. Mitsubishi had a longer-term time horizon than the U.S.-based KFC and
less pressure from investors and financial analysts.
Co-opting local competitors. Usually, there were many Japanese competitors in the neighborhoods where KFC stores opened—sushi
and noodle shops and local butchers that sold smoked chicken on the side. KFC Japan mounted public relations efforts whenever it
opened a new store. Before opening the store, representatives from KFC Japan would tour the neighborhood, giving gifts and discount
coupons, introducing the store supervisor, and asking for support. All of this was done to prevent local opposition and to combat the
feeling that outsiders were not welcome.
Using local rituals. A centuries-old Shinto ritual with a Buddhist priest was performed at a store’s inauguration ceremonies. The prayers
were derived from seventh-century texts, and on an altar were items such as the branch of a tree, sake, rice cakes, and dried squid, all
of which were prescribed by Shinto law.
Fighting off U.S. competitors. All the care KFC Japan took did not prevent other U.S. firms from trying to follow in its footsteps. Church’s
Fried Chicken soon entered the Japanese market and claimed that its quality and service were better than those of KFC, its chickens
were larger and juicier, its slices were bigger, and its product’s taste was better because its chicken was marinated and fried, rather
than pressure-cooked, and therefore crispier.
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148 Part Two Making Moves
Deciding Where to Invest
In making choices about where to pursue global expansion, several specific questions arise:
∙ Which regions or countries are most ripe for global expansion?
∙ How similar are these regions to the home market?
∙ To what degree should the firm invest in different regions?
It is important to look beyond unilateral market factors such as size, growth and income level
per capita. Both the closeness and competitiveness of each nation must also be considered.
Pankaj Ghemewat, professor at the University of Navarra in Barcelona, developed the
CAGE framework to help business understand the multiple dimensions of “closeness” and
to balance these dimensions as they consider strategic moves abroad. Nations are considered
closest when they have multiple cultural, administrative, geographic, and economic similarities. According to CAGE, for example, Spain would be considered closer to Chile than to
the U.S. despite the fact that by geographic measures alone, the trip from Spain to Chile is
over twice as long. The cultural, administrative, and economic commonalities between Chile
and Spain help businesses in the two countries span their significant geographic separation.
Firms can use the CAGE framework to help them pinpoint where to move next. This
framework can also be used to identify key differences across countries that might handicap their efforts when competing with a specific country’s local firms. Walmart’s difficulties in Germany and Best Buy’s struggles in China can be clearly traced to
differences that the firms could not overcome. In both cases the companies have had to
withdraw after making efforts to expand in these countries. Walmart left Germany in
2006, abandoning that potentially lucrative market after nine years. Best Buy sold its
division in China to a real-estate group in 2014 after it failed to make positive returns on
its investment in that country. There are many reasons for Walmart’s failure. One reason
is that Walmart was not sustainable enough. Its environmental practices were not up to
German standards. Another reason is Walmart’s anti-union policies did not fit into
­German culture. Still another reason was anti-American attitudes on the part of German
consumers. Yet, there were fundamental cultural differences that also played a role, such
as Walmart requiring its employees to chant “WALMART! WALMART! WALMART!”
while carrying out group calisthenics that offended the post-war anti-authoritarian
­German psyche. Another example was Walmart making its employees smile at customers, which many German workers considered silly or embarrassing.
Exhibit 6.6 offers a summary of the distance factors that businesses should consider
when determining where to invest. Of course, some of these factors pose greater
EXHIBIT 6.6 Distance Factors
Cultural
Administrative
Geographic
Economic
Measures of Distance
Commonalities will reduce
the perceived distance
­between markets
Language
Ethnicity
Social Networks
Religion
Colonial Ties
Trading Blocs
Currency
Laws/Legal System
Physical Distance
Land Border
Weather/Climate
Time Zone
Differences will
­impede business
National Work Systems
Values, Norms &
­Dispositions
Level of Corruption
Political Stability
Hostilities/Unrest
Consumer Income
Resource Availability
• Human
• Organizational
• Financial
• Natural
• Infrastructure
• Distribution Networks
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Chapter 6 Globalization 149
c­ hallenges based on the product and industry. Food manufacturers, for example, must be
especially attuned to cultural norms and religious requirements of consumers across the
globe. Steel and textile manufacturers must often grapple with tariffs and other administrative hurdles created by protectionist governments. Providers of perishable, bulky, or
breakable goods are challenged most by geographic hurdles. Economic barriers have led
to innovations in agricultural equipment, and the lack of reliable infrastructure within
emerging markets has forced many firms to rethink product design and delivery practices.
Porter’s diamond framework, shown in Exhibit 6.7, helps businesses determine
where specific industries tend to thrive and why. Four national/regional characteristics
are key to a firm’s innovation, improved competitiveness, and the development of advantage that can be leveraged abroad:
∙ The first characteristic, factor conditions, describe the inputs provided by a nation or
region to a firm’s production. Any nation or region that can provide easier access—
whether from local or international sources—to high-quality and/or specialized ­inputs
provides a source of advantage to its firms. Such inputs include human resources,
administrative, technological and physical infrastructure, natural resources, etc.
∙ Demand conditions reflect the quality of customers available. A nation or region that
can offer its firms relatively sophisticated consumers and standards pressure its firms
to innovate faster and to create more advanced products than those of competitors
across the globe. The firm’s general context provides a picture of the national or regional environment within which the firm operates. A location where the rule of law
prevails, intellectual property protection exists, and capital is accessible provides fertile ground for the growth of its firms. Rigorous, open competition toughen the region/nation’s firms for battle on the international stage. This competitive element in
the diamond incorporates new entrants and substitutes as well as existing competitors, and it, too, is not confined to national borders.
∙ Lastly, any related and supporting industries within a region or nation can offer further
benefit. For example, the presence of research institutions or the proximity of other complementary businesses is certain to provide both innovation and marketing advantages.
This framework highlights the fact that the firm needs allies, especially when operating
internationally. Without allies, the firm cannot succeed globally; these allies are found
EXHIBIT 6.7
Where
Industries
Thrive and
Why: The
Diamond
Firm’s
General
Context
Factor
(Input)
Conditions
Demand
Conditions
Related &
Supporting
Industries
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150 Part Two Making Moves
EXHIBIT 6.8
Mexican
Manufacturing
Source: 2014 KPMG
Competitive
Alternatives Study.
Manufacturing in Mexico as a maquiladora offers significant benefits for foreign manufacturers—especially those
selling in the U.S. market. A number of the factors highlighted in both the CAGE framework and Porter’s “diamond”
clearly are promoted in this region. The Mexican government initially established the maquiladora program in the
1960s as a way to reduce unemployment along the borders, and in its early years the maquiladora industry mostly
attracted unsophisticated assembly (primarily in the textile, industrial, and simple electronics industries). Nonetheless, the program continued to gain momentum and by the 1980s was the largest source of foreign exchange in
Mexico. With the introduction of the North American Free Trade Agreement (NAFTA) in 1994, maquiladoras quickly
became the country’s second-largest industry. The Mexican government responded to the growth with both new
infrastructure and a strategic plan for better education and training for its citizens. By the turn of the 21st century,
the maquiladora industry was completely transformed into a highly supportive manufacturing ecosystem.
By 2015, the Mexican city of Tijuana, which borders the U.S. state of California, a hotbed of medical device
­innovation, had the largest concentration of medical device manufacturers in all of North America. The factors
­contributing to this regional success are clear:
•
•
•
•
•
•
•
•
•
The region provides a highly trained, quality-conscious workforce.
Its large manufacturing firms operate under FDA or European marking regulatory requirements.
There is a high concentration of English speakers, which facilitates communications and training.
The region offers abundant and flexible real estate.
It has a well-developed infrastructure with highways to support the mass transport of finished goods.
Its power and broadband connectivity are abundant.
It enjoys the support of strong Mexican government intellectual property rights protections.
Its unions are generally employer friendly.
It offers an 18.7% cost advantage relative to the U.S.
everywhere the firm competes. The attractiveness of an industry is determined by global
as well as domestic conditions. Mexico provides an example of a nation that has devel­
oped a clear advantage in manufacturing through both factor conditions and supporting
industries. The maquiladora model is outlined in Exhibit 6.8.
Global Success Factors
To what extent global expansion results in positive or negative net benefits for firms is
unclear. Firms face the greatest costs at globalization’s earliest stages. These costs may
be overcome with experience and learning, but they may grow again at globalization’s
later stages when conditions change again. Whether the net benefits are positive or nega­
tive depends on a number of factors:
∙ Does global expansion allow a firm to hedge economic risk?
∙ Can it benefit from differences in economic cycles? One country’s GDP may be on
the rise, while another’s is slowing.
∙ Does global expansion yield increased flexibility?
∙ Does it bestow useful managerial and technical knowledge and competence?
The positives must outweigh the negatives. The costs of coordinating and communicating
with foreign subsidiaries are likely to be high. As the locus of control diffuses among the
subsidiaries, the home office is required to exert great effort and expend resources to main­
tain control. Political and economic risks from operating in foreign countries are likely to be
greater than those encountered when operating domestically. An example is the risk of natio­
nalist expropriation. Most large oil company saw resources they ­controlled abroad expropri­
ated and nationalized. These factors lead to foreign subsidiary risk and underperformance.
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Chapter 6 Globalization 151
The Landscape of the Future
Pursuing global expansion depends on determining which regions in the world are most
attractive.7 By 2050, the distribution of the world’s people will be quite different than it
is today. In Europe, the population is expected to decline by about 9 percent, while in
Africa it is expected to grow by 120 percent. Within regions there is likely to be heterogeneity. Throughout the world, the movement from countryside to city is expected to
continue. By 2020, there are expected to be more than 30 mega-cities, many of them in
developing countries.
If the past provides a guide to the future, the pace of change will continue to be rapid.
By 2011, for example, there were more than one billion Internet users, but prosperity
spreads unevenly. It is accompanied by social and economic ills, population dislocations,
social upheavals, sickness, poverty, and debt. About a quarter of the world’s population
lives in poverty, and as many as one billion people are malnourished. In many parts of
the world, markets are underdeveloped, and it is not clear how to develop them, whether
through microfinancing loans tailored to help the poor, or outright aid.
The U.S. continues to be the world’s leading economic power, but will this trend continue? How quickly will lagging economies catch up and how? Who will set the standards for future economic growth? Will it be Asian countries or those in North America?
In 2007, five of the world’s 10 largest companies (Walmart, Exxon Mobil, General
­Motors, Chevron, and Conoco-Phillips) were headquartered in the United States. (The
other four were Shell, BP, Toyota, and Daimler.) In 2015, the world’s four largest companies were Chinese banks. The U.S. economy has weaknesses. It requires sufficient
early-stage ­venture capital to flourish. R&D has been moving outside the United States.
Technology alliances between foreign-owned firms and U.S.-owned companies have
mushroomed. Asian workers constitute a growing percentage of the world’s global R&D
workforce. Many factors have permitted nations throughout the world to begin catching
up with ­major industrial powers like the U.S.
Labor, Capital, and Technology
According to economists, labor, capital, and technology are the main factors that account
for differences in national economic growth rates. Labor consists of weekly working
hours, while capital is increments in investment minus depreciation. Labor can be augmented by improvements in educational quality and work intensity, by increased capital,
and by better technology.
The productivity of people in the world’s different countries is affected by differences
in education.
∙ Germany, for instance, is known for its high-quality scientific and technical education and specialized training. It has distinctive industrial apprenticeship systems
that few countries can match. Japanese workers are known for their skills in subjects such as mathematics and for their discipline, willingness to work hard, and
group orientation.
∙ Japan has a large pool of well-trained engineers and excellent in-house company
training programs. Japan’s strengths in elementary and secondary education and inhouse training compensate for weaknesses in its colleges and universities.
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152 Part Two Making Moves
∙ Great Britain has an outstanding tier of people noted for their creativity, inventiveness, and independent thinking and their capabilities in areas such as pure scientific
research, but its overall educational system lags behind that of other countries.
∙ Technical colleges have very low status in the U.S., and there are no well-developed
apprenticeship systems. The U.S. possesses very high-quality schools at the top, but
the percentage of students with science, technology, engineering, and math skills is
low. Public elementary and high schools in the United States have difficulty providing training in the sciences and mathematics as well as foreign languages. A major
U.S. strength is its openness to immigrants and its ability to attract talent from
throughout the world.
Investing in capital can partially make up for workforce quality. Economists have
found that the most significant predictor of economic growth is the accumulation of
capital, measured by investment in GDP. However, capital augmentation does not just
come from the replacement of old capital with new. It also results from the experience
and the knowledge that employees gain on the job and from the recombining and retrofitting of existing capital.
The Austrian economist Joseph Schumpeter argued that technical change plays a very
important role.8 New capital replaces old (“creative destruction”) in waves as particular
sectors (e.g., textiles, steel, railroads, automotive, and chemicals) dominate the world
economy at certain intervals, only to be replaced by other sectors (e.g., pharmaceuticals,
telecommunications, computers, and biotechnology).
Two kinds of technological change occur. Process technologies enable firms to improve
their ability to make goods and services, while product technologies are improvements in
the goods and services that are marketed to consumers. Historically, Japanese firms excelled at process technologies, and U.S. firms excelled at new-product innovations. Americans, for instance, invented the videocassette recorder, but the Japanese lowered the costs
of manufacturing—improved the process—so they could sell VCRs at low cost.
U.S. firms once managed the R&D process quite differently from Japanese firms, but
they have since copied much of what the Japanese do: deliberately creating excess information and sharing it among horizontally and vertically linked groups outside and inside
the firm, regularly consulting vendors and subcontractors during the development process, and overlapping development phases to speed up market entry and gain early consumer information.
Technological improvement does not just come about because of technological push.
It also arises out of market demand. Japanese demand for compact, portable, quiet, light,
multifunctional products comes from the crowded living conditions and small plants,
offices, and warehouses throughout the country. These conditions led to innovations in
the use of materials, energy, and logistics. Pioneering in space-saving and just-in-time
production was necessary to meet the demands of Japanese consumers. Japan’s consumers also are known to be sophisticated and quality-conscious.
Growth in the Japanese economy, however, has virtually stopped. Europe, too, is stagnant, and China is slowing down. Countries like Russia and Brazil, heavily dependent on
raw materials have not been sources of dynamic global growth. From where will future
growth come? Will it be India? Africa? The Middle East? Regardless, firms will have to
adjust the products they make, logistics, and manufacturing to new consumer demands.
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Chapter 6 Globalization 153
Open Economies
In some countries, the domestic markets are not large enough to support cost-efficient
firms, but this weakness does not matter when the trade sector grows and becomes part
of global commerce. Countries such as Singapore, Thailand, the Philippines, South
Korea, Taiwan, and Indonesia have large trade sectors and have benefited. Economists
consistently emphasize that open economies perform better than those sheltered from
global competition.
Economists argue that increased world trade has allowed nations to concentrate on the
things that they do best (their comparative advantage), while trading for those things
that they do less well. The gains from such specialization have been mutual; as each nation concentrates on what it does best, its trading partners consume a larger bundle of
goods than they could produce by themselves.
South Korea’s growth has also involved heavy exposure to international markets, but
the South Korean government assumed control over the private sector with the purpose
of creating significant export-led growth. Inflows of foreign credit came to South Korea
from financial institutions such as the World Bank and International Monetary Fund.
Few other countries have had such a high dependence on foreign trade as South Korea.
The only comparable nations are Hong Kong, Singapore, and Taiwan.
Both Taiwan and South Korea made enormous strides in the post–World War II
period, but they did so in quite different ways. Both had few resources, little arable
land, and high population densities. Both countries pursued export-led growth policies, but Taiwan was much less aggressive in protecting its domestic industries and
relied more on the free market. Similar to South Korea, Taiwan used a highly
­educated, technically trained (more than one-third of Taiwanese students in higher
education study engineering), and enterprising workforce to make its advances, but
unlike South Korea it mostly financed its companies through equity markets. These
companies were mostly lightly leveraged and small. In comparison, South Korea’s
large conglomerates, known as the chaebol, were highly concentrated and heavily
leveraged firms (e.g., Samsung, Hyundai, Lucky-Goldstar, Daewoo) that received
heavy government support.
Insecurity
Another important issue has been global security. Violent conflict has serious effects on
the global economy. It decimates populations, diminishes human and social capital, and
destroys physical infrastructure—roads, power and communication systems, transport
links, public and private buildings, and essential physical assets. Corporations must
spend heavily to protect both people and property. Violent conflict destabilizes governments, reducing their capacity to fight corruption and making them less able to guarantee contracts and more likely to impose exorbitant taxes. Because of violent conflict,
governments can be overthrown and replaced by regimes that can renegotiate the terms
under which companies operate. Though violent conflict adds to the dangers of doing
business and raises the likelihood that revenue streams will be curtailed or eliminated,
corporations have not stopped increasing their activities in many violent-prone nations
that have extractive natural resource-based industries, such as mining, oil and gas, and
forestry.
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154 Part Two Making Moves
Firms can take a number of steps to mitigate the dangers of operating in violenceprone nations. They can rely on the early warning systems that track structural conditions such as social solidarity (religious and ethnic heterogeneity), economic
development, and government capacity. A mechanism companies can use to mitigate the
dangers is to hedge their bets. Companies may decide to invest in a guarded or step-bystep fashion, diversify, and/or find partners before investing.
Youth
Since the role of young and educated people is an important factor in the development of
a country’s economy and society, their role must be better understood. Young and educated people can be divided into two main groups: The first group can be called “Gracious Living.” This group is optimistic and entrepreneurial. It favors the opening of
societies and the introduction of cosmopolitan ideas from throughout the world. Another
group may be referred to as “Disappointed and Disillusioned.” This group has a far different orientation. These young people also tend to be educated, compared to others in
their society, and relatively well off, but they also are resentful, and they tend to believe
that they have no future and that there is little hope that things can get better.
Because of these differences between groups of youth, it is in the interest of companies
to help spread a message of confidence and hope. The combined message of skills, opportunity, and hope are emphasized in the bottom of the pyramid advocacy of such
strategic thinkers as Prahalad and Hart.9 Money can be made by providing essential goods
and services that poor people need like cell phones, health care, better nutrition, and energy. While the opportunity is great, the challenges in reaching markets at the bottom of
the pyramid are also substantial. The market serving the poor is not homogenous, nor
does it have well-developed infrastructure. Those at the bottom of the pyramid are found
in many different circumstances. They live in both rural and urban settings. In India, most
are rural, and their access to markets and Western-style purchasing environments is very
limited. In Latin America, they are predominately urban. They are packed into dangerous
slums of large cities. Different types of technology are needed to serve the varied segments of the poor. The solutions to the problems of the poor must be delivered at an affordable price, but with so much variety, it is nearly impossible to reach the economies of
scale in terms of production and distribution that would enable reduced costs.
Nonetheless, the needs of the poor for the products and services (that people higher
up in the income pyramid take for granted) are great. These needs include communication, health, clean water, energy, food, hygiene, and jobs. To meet these needs, it is not
always possible to just copy or strip down the technologies used in developed nations or
wealthier markets; rather, adaptation is needed. To reduce costs and get these products
and services to the poor, significant innovation in product design, supply chain management, inventory control, delivery, and post-delivery maintenance is necessary. If mass
production is not possible when people are scattered and carrying out their crafts in
separate locations, then virtual, as opposed to actual production, scaling must be introduced to bring costs down and provide jobs. Information technology, if deployed in innovative ways, can be a useful way to bridge this gap.
For businesses, the benefits of moving in the direction of making cheap, high-quality
products and services available to the poor are not only to generate growth and profits, but
also to answer the critiques of stakeholders who question the purpose of businesses. Another
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Chapter 6 Globalization 155
side-benefit of serving the poor is the chance to experiment with new concepts for which they
may not otherwise be taken seriously. It may be possible to transfer the innovations that are
introduced to serve the poor to more mainstream markets. An example is a very small fuel
efficient “nano-car.” If it can be made very inexpensive and even less energy consuming, it
could eventually be adopted in cramped urban settings by drivers of all economic classes.
Serving the bottom of the pyramid can be an inspirational goal of business that can
inspire young people to have greater confidence in the business system. Such confidence
is critical; it is a stabilizing force. If instability overtakes the world, the benefits of globalization become more difficult to realize. Thus, corporations and governments of the
world must make the effort to educate the young and harness their drive, energy, creativity, and ambition. Many competing institutions are in conflict with today’s nation-state
and test its capacity to maintain people’s loyalty. Nonstate and superstate actors abound,
some of them threatening to the state and some supportive. They include terrorist organizations like ISIS and Hezbollah as well as NGOs such as Greenpeace and the World
Wildlife Fund and supra-government organizations like the United Nations, the World
Bank, and the World Trade Organization. Along with corporations and governments,
positive and constructive global institutions must be enlisted to create a better world.
Summary
Every aspect of strategic management has a global dimension: corporate performance,
the firm’s decisions about expansion and entering new markets, the external and internal
analyses managers carry out, the business-level moves they make relating to timing and
product positioning, and the corporate-level moves they make relating to mergers, acquisitions, and divestitures. This chapter has provided reasons firms globalize with emphasis on the life cycle factors that take place with product maturation. It has discussed the
options for globalization, the product-market approaches, and the need for local adaptation. It is critically important for a company to adapt to local customs when entering a
country. The nature of this adaptation has many dimensions, from delegating authority
to local managers to having local partners and following local customs. A company can
enter foreign markets in a variety of ways, including direct export, franchising, licensing, greenfield operations, or joint ventures.
This chapter has shown how the CAGE framework and Porter’s diamond can help
shape a firm’s international strategy and better enable it to answer the question of where
to invest. These frameworks were applied to Mexico’s U.S. border regions, where a renaissance in global manufacturing has taken place. Four global success factors have
been enumerated, including: does global expansion allow a firm to hedge economic risk,
can it benefit from differences in economic cycles, does global expansion yield increased
flexibility, and does it yield useful managerial and technical knowledge and competence? Various factors to consider in examining the global landscape of the future have
been discussed including the importance of labor, capital, and technology, open economies, global peace and violence, and youth.
Developed nations are mature markets. They may be saturated with the product a
company provides and thus be capable of less long-term growth. Will the future of the
global economy come from the pyramid’s bottom? This challenge is of utmost importance to anyone interested in global business.
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156 Part Two Making Moves
Exercises for the Student
Select a publicly held firm that has global exposure, markets, and operations. Examine
their most recent Annual Report and Investor Presentations.
∙ What appears to be the rationale behind their global efforts?
∙ Are specific modes of entry discussed such as exporting, alliances or greenfield investments?
∙ How would you classify their approach to the international scene: global, multidomestic, or transnational?
∙ What risks have they identified related to their current globalization strategies?
Exercises for the Practitioner
∙ Is your employer a global player?
∙ Does it compete with or partner in any way with global competitors?
∙ What are the benefits and the risks of your employer’s current global strategies
and tactics?
∙ What are the benefits and risks of your competition’s global approach?
∙ Fast-forward five years. Do you see your company gaining or losing ground in the
international marketplace? Why?
∙ What can be done now to improve long-term results?
Endnotes
1. M. Porter, The Competitive Advantage of Nations (New York: Free Press, 1990).
2. S. Zaheer, “Overcoming the Liability of Foreignness,” Academy of Management Journal 38,
no. 2 (1995), pp. 341–64.
3. M. Porter, Competitive Strategy (New York: Free Press, 1980).
4. “Kellogg Company and Wilmar International Limited Announce China Joint Venture,”
­September 24, 2012, http://newsroom.kelloggcompany.com/2012-09-24-Kellogg-CompanyAnd-Wilmar-International-Limited-Announce-China-Joint-Venture.
5. David Phelps, “Exporting Retail Brands Can Be Tough Sell,” StarTribune, February 26, 2011,
http://www.startribune.com/exporting-retail-brands-can-be-tough-sell/116947673/.
6. “The Colonel Comes to Japan,” Enterprise Series, Learning Corporation of America Video.
7. A. Marcus, Strategic Foresight: A New Look at Scenarios (New York: Palgrave MacMillan,
2009).
8. J. Schumpeter, Capitalism, Socialism and Democracy (New York: Harper, 1975) [orig.
pub.1942].
9. C. Prahalad, The Fortune at the Bottom of the Pyramid: Eradicating Poverty Through Profits
(Upper Saddle River, NJ: Wharton School Press, 2006); and S. Hart, Capitalism at the Crossroads. (Upper Saddle River, NJ: Wharton School Press, 2007).
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C H A P T E R
S E V E N
Innovation and
Entrepreneurship
“What good will it do to follow the rules when some companies are
­re-writing them? … Shackled neither by convention nor by respect for
precedent … [the rule breakers] are intent on overturning the industrial
order. They are the malcontents, the radicals, the industrial revolutionaries.
Never has the world been more hospitable to industry revolutionaries
and more hostile to industry incumbents.”1
Gary Hamel, professor, Woodside Institute
Chapter Learning Objectives
• Exploring the rationale for innovation and entrepreneurship.
• Examining forms of innovation and entrepreneurship that allow organizations to thrive.
• Understanding the innovation process—from opportunity identification through value creation.
• Explaining the factors needed for successful innovation and entrepreneurship.
• Identifying barriers to innovation—including risk and uncertainty—and presenting processes designed
to overcome these barriers.
Introduction
Firms must be able to innovate and initiate change; however, they are generally conservative, and for good reason. Few new undertakings yield positive returns. Even fewer
become highly profitable. Honestly calculating the expected costs and benefits beforehand is almost certain to diminish the ardor for innovation and entrepreneurship. Yet, the
threat of disruption to any existing product offerings, consumer experiences, and business models is great. Without innovation and entrepreneurship, all of the moves discussed so far in this book (positioning; mergers, acquisitions, and divestitures; and
globalization) are likely to be undermined eventually.
157
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158 Part Two Making Moves
Though most firms go to great lengths to ballyhoo the importance of innovation and
entrepreneurship, few are really good at these activities. The number of failures they
experience is many times the number of successes. Only a minority of firms seems to
have truly mastered the innovation process. Many flounder. They initiate short-term initiatives that tap into their employees’ creativity but fail to do sufficient follow-up to ensure that these initiatives are successful. Rather than their breakthroughs being an
outcome of a reliable process, they are often attributed to the outstanding efforts of individuals, or to sheer luck. This is not a sustainable approach to innovation.
This chapter explores not only the deep-seated reasons firms must innovate in the
turbulent environments in which they operate, but also the processes for innovation and
entrepreneurship that make these activities more reliable. The risks and uncertainties
inherent in any effort to bring about change for the better are apparent. This chapter suggests what can be done to mitigate, contain, and control these hazards. It highlights the
barriers—internal and external—that stand in the way of commercializing ideas with
promise and suggests how they might be overcome.
Reasons for Innovation and Entrepreneurship
Confidence in a static world is misplaced. Customer loyalty cannot be guaranteed. Technological advancements offer an unending wave of better, faster, and cheaper products
and services. Rivals, substitute products, and new entrants rely on these continual
­advancements, using new and improved offerings to make inroads and steal away customers. Disruption is everywhere. Grappling with uncertainty is essential. As a result,
firms pursue innovations that range from minor, incremental improvements to significant, seismic shifts (see ­Exhibit 7.1).
EXHIBIT 7.1
Incremental
Improvements
and Seismic
Shifts
Minor Incremental Improvements
Focus on more efficient
processes or additional
features
• Same basic product and
service lineup
• Same customer base
Focus on market presence—awareness
and distribution capabilities of existing
value proposition
• Same basic product and service lineup
• New market channels, demography or
geography
Major Seismic Shifts
Focus on total reinvention
• Drastically modified lineup
of offerings and value capture
• Entirely different target market
• Must build/buy both
capabilities and customers
Focus on internal startups or M&A
• New product and service mix
• Existing target markets
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Chapter 7 Innovation and Entrepreneurship 159
EXHIBIT 7.2
Downsizing
Bubble Wrap
1 Load
iBubble
47 Loads
=
Original
Bubble
Wrap
Incremental Changes
Sealed Air Corporation provides an example of incremental change.2 The producer of the
iconic Bubble Wrap (see Exhibit 7.2) recently rolled out a revamped version of its signature
product dubbed iBubble, which it is selling in flattened sheets that shippers inflate when
needed. With the surge in online shopping and, consequently, shipping and the advent of
consciousness of space of online global retailers, the firm saw the opportunity of moving
away from giant air-filled rolls. The iBubble product occupies far less warehouse space
than Bubble Wrap, and it can be shipped economically outside of a 150-mile radius. By this
change, Sealed Air hopes to “re-inflate” its iconic brand, which had suffered share losses.
The recreational vehicle industry provides an example of a more significant change,
with Polaris moving beyond its heritage of making snowmobiles and expanding into a
broad range of utility vehicles. It now makes machines for use in factories and by the
military, going beyond its reliance on the consumer market. It also detected new global
trends in motorcycles and capitalized on the opportunity to serve motorcyclists around
the world. With these changes, it has broken sales records in contrast to its main rival
ArticCat whose pace with regard to new product introductions is more plodding. Polaris
is typically on the third or fourth iteration of a product by the time ArticCat can launch
its first iteration. Polaris’s returns to shareholders, as a result, have soared. ArticCat inventories have swelled, and it regularly sustains losses. To refresh the company’s product
pipeline, its management must remove excess inventories before it can innovate.
Seismic Shifts
The development of the iPhone and the iTunes/AppStore ecosystem signaled a seismic
shift for Apple. It cannibalized the firm’s prior iPod products and made accessible a person’s e-mail and the Internet in a single place and combines a camera, media player, and
the capacity for GPS navigation with the functionality of digital assistant, as well as an almost limitless number of downloadable applications that can personalize the experience
and further enhance the product’s usefulness. Throughout the world, this product has revolutionized p­ eople’s habits as the smartphone has become an extension of their everyday
decision making and has even begun to organize their lives.
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160 Part Two Making Moves
As a result, Apple’s smartphone innovation was quickly succeeded by similar offerings from other companies, such as HTC and Samsung. The introduction of the iPhone
vastly increased Apple’s revenue and the valuation of its stock. Not to be outdone,
Google quickly responded with its Android software, which competes with iOS in the
devices other smartphone makers produce.
That Apple, and not some other company, would achieve this breakthrough was not a
given. In 1999, the Japanese firm NTT DoCoMo released a smartphone that had 40 ­million
Japanese subscribers. However, NTT DoCoMo did not follow up, improve the product,
and introduce it globally. In fact, Apple had many worthy and capable competitors in the
PC, cellphone, wireless services, and software businesses. Companies like HP, Dell,
Lenovo, Toshiba, Sony, Intel, IBM, Acer, Samsung, Nokia, Motorola, E
­ ricsson,
­Blackberry, AT&T, Verizon, Sprint, T-Mobile, Google, and Microsoft could have gone
in this direction. Almost all of these firms were aware of the opportunity. Nokia,
­Motorola, and Blackberry to some extent had started to develop smartphones. Yet only
Apple, and to a lesser extent Google, with Samsung as its main partner, succeeded in
making smartphones a worldwide phenomenon.
These other firms did not act quickly enough. By selling smartphones, Dell and Acer
made feeble, but ultimately futile, attempts to challenge Apple’s dominance. They suffered setbacks, retreated, and became different companies than they were before. HP
­ultimately laid off more than 100,000 of its workers partly as a result of its inability to
enter the smartphone market, as did many other companies. Almost all these companies
also had to restructure. They were acquired (Motorola), went private (Dell), divested
critical units (Nokia and HP), or made other moves in an effort at revitalization.
Apple’s triumph left many victims in its wake. The survival of Blackberry and Acer
has been in jeopardy. To the extent that these companies continue to exist, they exist in a
significantly diminished way. These once-indomitable phone giants have become shells
of their old selves. Would anyone bet on their comeback? Microsoft and Intel tried, and
continue to try, to catch up with what Apple started, but so far they have not been successful. AT&T, Verizon, and Sprint get by because they are part of the smartphone
­ecosystem and deliver service plans and devices to customers.
The stakes are high. Races to make good on the next technological innovation put vast
pressure on firms. The winners may take nearly all the spoils. The failure to embrace innovation can be deadly for many companies. Remember Blockbuster stores and Kodak
films? Blockbuster, underestimating the potential impact of the Internet on the entertainment industry, declined the opportunity to purchase Netflix for a mere $50 million in 2000.
By 2014, Blockbuster had ceased all operations, while by 2015 Netflix was valued at over
$47 billion. Kodak, the inventor of digital technology, also lost out. It feared the cannibalization of its film business, giving up on the development of digital cameras after its first
offering was met with a lukewarm reception.
Both Incremental Changes and Seismic Shifts
Apple recognizes that seismic shifts alone are not sufficient. It needs to make some incremental shifts as well. It’s better to self-cannibalize than to have a rival do so. iPad
tablets impacted Mac laptop sales, and larger iPhones nibbled away at older and smaller
iPads, but Apple did not stop introducing products that replaced what it already sold.
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Chapter 7 Innovation and Entrepreneurship 161
Even a firm with as revolutionary a past as Apple must continue to regularly engage in
incremental innovation.
As Apple has pursued the growth of its iPhone line, it has made small adjustments to
the iPhones’ dimensions, displays, cameras, and processors. It has penetrated new geographic markets with this product, while the basic product and the competencies ­required
to build and market each subsequent version remain the same. For example, when selling
iPhones in China, Apple makes but small concessions and modifications for the Chinese
consumer. It designs, sells, and markets the same type of smartphone with the same type
functionality as it does in the U.S.
Today, Apple is on a continual search for the next seismic change. Its long-term
growth targets cannot be fully satisfied with small enhancements in its current product
lineup so it continues to launch products such as the iWatch and ApplePay. The performance gap between growth that can be attained with existing offerings and the expectations that investors have of Apple is too great.
Thus, all companies need to pursue incremental innovation and seismic shifts simultaneously. They should rely on familiar products and technologies for their growth while
at the same time placing bets on unfamiliar markets and unproven technologies. These
are hedges against an uncertain future. Regardless of how the future evolves, a company
must be ready for it. This approach to the uncertainty of what comes next is found in
­almost all business sectors and markets. Whether a company is in pharmaceuticals,
­entertainment, software, or bookselling, finding “big hits” is incredibly lucrative, yet the
search for them also leads to dead ends and the need to continuously exploit existing
“hits” for whatever remaining value they have. Pharmaceutical firms will capitalize on
the full lifespan of their patented formulations while spending millions in the lab to
achieve the next break-through. Hollywood studios will extract as much revenue as possible from replays of their old TV shows on cable TV while they pilot new offerings with
the hopes that one will become a blockbuster hit.
Will the Apple Watch gain sufficient traction to justify Apple’s development costs
and the marketing expenses, or will it be a bust and will Apple mainly be dependent on
modifications of the iPhone for its future revenue? The same question can be asked
about whether Apple Pay survives the battle for primacy in the point-of-sale payment
space. This question can be extended to Apple Music and how it fares versus Spotify and
Pandora. The jury is still out on all these questions, yet Apple still has the iPhone on
which to fall back. These innovations represent Apple’s attempt to keep demonstrating
that it is a leader. Companies must take advantage of what they have been good at in the
past by making incremental improvements but cannot rest on their laurels; rather, they
must show the potential for continued dynamism and growth.
The Process of Innovation
Races to make good on the next technological innovation are not just about technology.
Rather, and more importantly, they are about incorporating diverse technological possibilities into new business models. The iPhone was not a success simply because of its
touch navigation technology but because of the extensive eco-system of applications that
surrounded it that made this technology so useful. Thus, it is not technologies themselves
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162 Part Two Making Moves
that lead to the most seismic of shifts and wide-scale adoption but it is the business models behind them. Given the complexity involved in molding together new technologies
with new business models, only a few firms carry it out well.
Every successful innovator needs an innovation ecosystem that will promote and propel growth. Without such an ecosystem, it is highly improbably that ideas will gather
enough momentum to evolve through the stages of introduction/initiation, growth, and
product maturity. Some new businesses achieve sustained growth in just a few years,
while others may take half a century or more to take off.3 Yet, some new ventures never
get to the point of sustained growth, or the process unfolds over a very long time with
great frustration, companies exiting the scene, and turnover and loss of interest among
those who have been involved.
Therefore, an innovative eco-system wherein new business models can best develop
consists of at least four elements:
1. Passionate and determined innovators.
2. Organizations that can make their ideas a reality.
3. Financial backers—inside and outside these organizations—who recognize the idea’s
commercial potential and back new ventures through the setbacks and impediments
they inevitably experience.
4. Positive governmental support.
With these elements in place, a new idea has a greater chance of gaining widespread acceptance in the marketplace.
Passionate and Determined Innovators
Innovators must be persistent and have considerable commitment if they are to succeed. The difficulties they face are great. They include dealing with the competition,
accessing capital, and hiring and training a talented, dedicated cadre of workers to
whom they must provide sufficient rewards to assure ongoing commitment. Innovators
must also understand government regulation, taxes, and requirements that impinge on
their venture’s success. The numerous obstacles to success deter many from taking on
this role. As shown in Exhibit 7.3, the endpoint is not necessarily success, or failure.
Prolonged gestation—a state of neither complete take-off nor complete failure—also
is possible.
Persistence in an innovative endeavor is especially necessary between the time of an
idea’s take-off and its sustained growth. During this period, the founders or their successors have the challenge of sticking with it and maintaining their commitment even
though their business is not meeting expectations. Often innovators must be stubborn
dreamers who cling to their ideas despite the fact that the odds seem stacked against
them. They have to be risk takers who take on risk in anticipation of high rewards.
Those who start new businesses must try to minimize the risks. Thus, they often
­commence their businesses in niches they already know well from previous experience,
take on seasoned partners, obtain advice from well-regarded financial backers, or begin
as franchisees of larger firms that provide them with proven business models.
Innovators must carry out many tasks at once. They must establish record-keeping
systems to track revenues and expenses; set up contracts with suppliers; price, advertise,
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Chapter 7 Innovation and Entrepreneurship 163
EXHIBIT 7.3
Take-Off
Sales
Business
Evolution
Short of TakeOff
Prolonged Gestation
Time
Initiation
Start-Up
Shakeout
Maturity
Decline
and market the product or service; get feedback from early customers to improve quality;
acquire a physical location and needed furnishings, machinery, and equipment; hire,
manage, and staff the business’s employees; develop efficient operating processes; and
understand legal requirements.
They require a convincing business plan. To get funding they must have one, whether
they follow it precisely or not. The plan describes the business and has an external
analysis that covers such essentials as suppliers, customers, and competitors; an internal assessment of the business’s capabilities and its functional plans; an implementation schedule; an end-game strategy that indicates when the business will be profitable;
financial projections; and a risk analysis. Linear movement toward a well-defined goal
is rare. Innovation requires adaptation and learning. Simple planning is not likely to
work well.
Innovators also require creativity, intuition, and the ability to make on-the-spot
choices without too much formal analysis. However, it is possible to exaggerate the extent to which innovators are not deliberative and rational and to glorify and romanticize
their illogical, seat-of-pants decision making. To the extent that they apply and employ
known methods, these actually tend to be experimental ones. They use what amounts to
the scientific method to test hypotheses and learn from their experience. Innovators also
often rely on bootstrapping or bricolage; that is, they make do with the means or resources at hand, rather than having all the means and resources they need from the start.
Each endeavor an innovator begins is likely to be a bit idiosyncratic. Each differs somewhat and is likely to involve a degree of improvisation.
Many ideas show promise but fail to take off. Others take off but hardly expand.
Getting to sustained growth when a business can endure over the long haul requires
critical mass and momentum. Average time for a business moving from initiation to
sustained growth has been estimated to be 29 years, with a standard deviation of
15 years.4 Typically it takes many more years for a business to gain momentum than
the founders and initial innovators anticipate. This group does not always have the
skills, determination, or will to overcome the setbacks.
Inexperienced innovators lack requisite skills. New players must be found to take a
venture to the next stage. If they are not found, abandoning a business between initiation and take-off may happen even if an idea has intrinsic promise.
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164 Part Two Making Moves
New ventures fail for many reasons. Among the most common are inadequate customer development and lack of market knowledge and market planning.5 Reasons for
abandoning a venture include few customers, technological glitches, waning financial
support, and/or negative cash flow.
Many types of people have taken on the role of innovators. As opposed to working for
a large organization, there are personal reasons individuals have for pursuing this role.
They can range from a desire for more autonomy to the potential for great personal wealth.
Intrinsic rewards can drive the individual down an innovative path as well as extrinsic
ones. Some individuals find pleasure immersing themselves in new endeavors, solving
problems, building organizations, and providing opportunities within their communities.
They feel that as innovators, they have more freedom to engage in such pursuits. Some
innovators lack formal degrees or other credentials and find it difficult to thrive in large
organizations. This type of person can be a classic inventor/entrepreneur, one who is not
likely to be interested in managing a business if it becomes big.
Some people specialize in innovation, eventually becoming serial innovators who go
after one business opportunity after another and then sell ventures to other companies
and pursue new opportunities instead of managing existing ventures. Dean Kamen is an
example of this type. A college dropout, Kamen holds more than 150 U.S. and foreign
patents, many of them for innovative medical devices. While still a young man, he invented the first wearable medical infusion pump, which rapidly gained acceptance in
diverse medical applications. In 1976, he founded AutoSyringe, Inc., a medical device
company, to manufacture and market these pumps, but at age 30, tired of managing what
was becoming a big business, he sold AutoSyringe to Baxter. Since then, he has worked
on a number of business ideas for larger companies, a dialysis machine for Baxter, and a
patient mobility system for Johnson & Johnson. He is also the developer of the Segway,
the world’s first dynamically stabilized, self-balancing human transporter guided by the
rider’s natural motions.
Organizations That Transform Innovative Ideas into Reality
Organizations that transform innovative ideas into reality must be willing to support innovators—those individuals who identify valuable opportunities, understand how to assemble the resources and capabilities needed to derive benefit from them, and launch
new ventures despite the inherent uncertainty. Organizations of this nature do not wait
for change to happen to them. Rather, they act to initiate the process by encouraging this
type of individual. Yet, there is no simple formula for doing this. Different innovative
ventures combine different qualities in different ways. It is within organizations of some
kind that business plans and strategies are created and ideas are marketed, made into
­attractive business propositions, and brought to customers so they can be widely ­adopted.
Though small companies employing fewer than 500 people account for a large proportion of innovative activity, the role large corporations play is significant as well. Organizations use structural measures such as venture capital funds, spinouts, incubators, and
business development centers to enhance their entrepreneurship. These can lead to such
results as high R&D as percentage of sales, new product introductions, and basic innovations in business models. However, oftentimes, these measures do not fully capture
firms’ innovative activities.
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Chapter 7 Innovation and Entrepreneurship 165
Some organizations have more innovative corporate cultures than others. Their strategies incorporate innovation as a key theme. Examples of companies that tout their commitment and have been recognized for their contributions to innovation include Google,
Apple, Gilead Sciences, Virgin, Tesla, Cree, and Kickstarter.
Still, all companies must balance exploration (risk-embracing search and discovery of
future opportunities) with exploitation (a more risk-averse, approach which favors incremental change). As pointed out in earlier chapters, exploration and exploitation require
different organizational structures, systems, skills, styles, and processes. In many firms,
exploitation drives out exploration. For other organizations, it is hard to carry out the
two activities simultaneously.
Small firms or small units or groups within large firms, therefore, more often tend to
be the home for innovation than large firms or big units within large firms that already
have well-established business models, structures, and processes. Innovation within
large firms must overcome obstacles. Large firms have entrenched rules, routines, and a
dominant logic, as opposed to small ventures that can create new rules, new routines,
and a new dominant logic.
Nevertheless, as Gary Hamel argues, every company has “revolutionaries.”6 These
people are likely to be found among the young and among newcomers at the bottom of
the corporate pyramid, where there is more diversity. They are often to be found on the
margins, for instance, in foreign operations, where groupthink is less prevalent. Closedminded decision making at the top stifles those on the periphery. For managers who
wish to jump-start innovation at a firm, it may be necessary to remove people from their
usual setting. For instance, holding off-site meetings with a group of recognized creative, critical thinkers may fire employees up emotionally and make their innovative
initiatives contagious.
Internal cultures that support innovation tend to encourage personal growth and risk
taking. In such cultures, top management supports innovation, and there also are organizational champions below. Teamwork and collaboration are encouraged. For innovation
to succeed, hierarchies cannot be so overwhelmingly strong as to suppress it. The approval process for starting work on new ideas must be partially decentralized. The focus
should be on learning, and employees given time to pursue individual projects. Stress in
innovation pursuing organizations tends to be very high. Rigid bureaucracies, authoritarian leadership, and harsh penalties for failure tend to discourage innovation. An innovative company must tighten up its approach to market an innovation before competitors
do. Organizational characteristics needed to generate new ideas are not necessarily the
ones needed to implement them and make them successful business endeavors.
The Performance/Innovation Gap
Organizational dissatisfaction often motivates innovation within companies. It stems
from two sources: a company’s strategic goals and financial results. If a firm is lagging
behind its industry in market share, brand recognition, customer satisfaction, or profitability, it may become highly motivated to close the performance gap via innovation.
However, innovating is not the only choice open to such an organization. It must ­compare
the potential of further exploiting its current business undertakings with the potential
that might be achieved were it to innovate. If it can get by with its current offerings and
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166 Part Two Making Moves
EXHIBIT 7.4
Performance Goals
Innovation and
Performance
Gaps
In
Current
Year
va
no
n
Existing Potential
tio
Goal
Year
does not have to endure the uncertainty of innovation, where the returns might be higher
but are less sure, it may opt out of pursuing new directions.
Logic would dictate that the larger the performance gap, the greater the need for more
fundamental innovation—and the further innovation efforts will take an organization
from its core (see Exhibit 7.4). However, big gaps between a firm’s goals and its current
performance require giant leaps with unknown outcomes. Smaller gaps can be filled by
incremental innovations, whose results can be better anticipated. As pointed out, incremental innovations can utilize the firm’s existing resources and competencies and thus
are typically easier to carry out. Noncore efforts greatly increase the percentage of time,
effort, and resources needed to innovate.
Organizations with large performance gaps, moreover, often do not have the resources
to make the gigantic leaps they need to make to survive. AMD is an, example. In 2014
and 2015 it kept losing money, yet to end this downward spiral and make a leap forward,
it needed to garner enough resources, which it did not have. AMD has been stuck. It
needs the resources to make a large leap forward and yet its performance has been too
weak to assemble such resources. Thus, it has been in a downward spiral from which it
has been very hard for it to escape.
Thus, large leaps forward may be left to organizations with greater resources to pursue them. However, the organizations that have the resources to make seismic shifts
typically have not experienced sufficiently large performance gaps. Their motivation for
going beyond incremental change is not great. Inertia is greater in these organizations,
and therefore, innovation is stifled because organizations most able to make far-reaching
changes have little interest in taking on these ambitious tasks.
Patient Capital
The capital that supports new ideas must be patient. Short-termism can quickly derail
innovation-based strategies. As shown in Exhibit 7.5, short-termism has derailed
­innovation at Procter and Gamble (P&G), one of the world’s largest and most successful firms.7
Large corporations, like P&G, must invest in new ventures. They need to spend
­retained earnings on R&D and market research, and provide employees the opportunity
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Chapter 7 Innovation and Entrepreneurship 167
EXHIBIT 7.5
Short-Termism
at P&G
In 2000, P&G’s CEO Lafley sought to increase the rate of new product development by collaborating with outside
partners who could assist in areas like packaging and product design. These partnerships gave P&G access to
­important technologies, such as Sederma’s wrinkle-reducing formulations. Sederma became a key ingredient in
P&G’s best-selling and highly profitable Olay Regenerist line.
Lafley stumbled, however, when he assigned new product development efforts to business unit heads, each of
whom had immediate profit concerns. By 2008, sales of new P&G launches fell by half, fewer than six breakthroughs were made per year, and the innovation process had devolved into a series of incremental adjustments
to the current product line-up.
Bob McDonald, who replaced Lafley in 2009, recentralized R&D, but P&G still struggled to regain its innovation
momentum. Lafley came back, but revenues and profits continued to slide. P&G insider David Taylor then took
the helm.
The revolving door in the executive suite shined a spotlight on the key issue: the dearth of innovation, which hurt
the company’s premium pricing strategy. Customers only paid a premium for cutting-edge products.
Over the years, P&G had delivered a lineup of outstanding innovations. For example:
•
•
•
•
First synthetic detergent – Dreft (1933)
First fluoride toothpaste – Crest (1955)
First stackable chip – Pringles (1968)
Superior floor cleaning process – Swiffer (1999)
However, P&G had become conservative and was held back from introducing bold new concepts by the need to
satisfy investors’ quarterly profit expectations. The corporation no longer demonstrated strength in innovation
­because of its focus on meeting Wall Street goals.
Competitors advanced at its expense. Unilever, with R&D spending very close to P&G’s, greatly accelerated new
rollouts showing a clear innovation process advantage, while Henkel AG, a German-based multinational that
­competed in both consumer and industrial brands, surpassed P&G’s R&D spending.
As of June 2015, P&G’s revenues and profits continued to shrink, and many of its biggest hits were at least a
­decade old. Weak innovation left P&G with some the tough choices regarding cutting costs to free up funds for
­innovation and spinning off noncore businesses.
to develop new entrepreneurial ventures. Yet, the impact of leaders whose focus is solely
on maximizing share price in the short term all too often cripples innovation efforts.8
Innovation needs ongoing corporate support over the long term.
Other Funding Sources for New Ventures
In addition to corporate funding for innovation, new ventures can rely on four other
sources:
∙ Innovators use personal fortunes and contacts to get them started.
∙ Commercial banks provide loans. In developing countries, where stock markets are
weak, they tend to be a very important source of venture formation.
∙ Venture capitalists can take an equity position in a business.
∙ If an idea shows considerable promise, an initial public offering (IPO) of the stock
may be issued to raise additional funds. Working with an investment bank, a firm a
draws up a prospectus and presents it to potential shareholders.
Often more than one of these methods is used to propel an innovative idea from
startup to take-off. Personal funds, coupled with those of friends and family, are often
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168 Part Two Making Moves
required at the earliest stages. Banks and other sources will engage only when a concept
is proven. It’s also important to note that there are often multiple rounds of funding
throughout the life cycle of a firm. Therefore, continuously demonstrating progress to
the venture’s backers is a key to maintaining the flow of resources that startup enterprises need. The pressure is high because the proof is in their performance.
However they are funded, innovators need patient backers, but funding sources,
whether inside a corporation or outside it, tend to ebb and flow depending on many factors, including the overall state of the economy. The economic downturn at the end of
the first decade of the 21st century was not hospitable to new ideas. If backers are not
patient, they can kill ideas that are just starting to show promise.
Government Support
Governments play a large role in determining whether new endeavors succeed. They
may carry out the R&D on which an innovation is based, help fund the activity, or their
help can come in other ways, such as subsidies, standards, or a favorable infrastructure.
Conversely, haphazard and unpredictable government policies also can harm innovation’s progress. The rationale for the involvement of governments is that the payoff to
society—new jobs, and new industries—is greater than that to any individual investor or
company. Innovation, and entrepreneurship therefore would be underfunded without
government involvement. Rational individuals and firms would forgo the effort, because
they could not appropriate all the benefits on their own.
Virtually every country in the world has policies to encourage business startups.
Germany, Switzerland, and Japan once used mainly market-driven approaches, while
the United States, United Kingdom, and France relied more on top-down approaches
closely associated with the military. The U.S. government’s post–World War II technology policy nurtured more than 700 national labs that supported basic research for
both military and civilian purposes. The government also funded research in many
U.S. universities and private labs. The United States tended to be a leader in basic research, but it started to lag behind other countries in applications. Since the research
effort did not result in enough commercial products, Congress showed less willingness
to pay for it. Instead, it increased financing for the commercialization of technologies
that already showed promise.
As a result, the federal labs started to switch from basic to applied research. Many had
cooperative R&D arrangements with private companies. The National Institute of Standards and Technology’s (NIST) Advanced Technology Program (ATP) gave grants to
companies that developed promising but risky technologies. The amounts it gave were
relatively small. The companies had to be able to convince NIST that the ideas had technical merit and practicality and that they could be exploited commercially. The Commerce Department also had a strategic partnership initiative in which innovative
companies that produce new technologies had the opportunity to meet potential customers. The funding by the Defense Advanced Research Products Administration (DARPA)
served dual purposes, both military and commercial. The Pentagon, though, was the
largest funder of research in the U.S., the results of which have had a positive impact on
the civilian sector.
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Chapter 7 Innovation and Entrepreneurship 169
New products can be greatly helped by government support—and equally damaged
when support is uncertain. Technological innovations that have received highly beneficial support include:
∙ The Internet, GPS, and Siri were beneficiaries of the DARPA program.
∙ Various vaccines and the Human Genome Project obtained funding from the National
Institutes of Health.
∙ iRobot and Symantec received grants from the government’s Small Business Innovation Research Program (SBIR).
Financial assistance and regulatory policies, however, quickly change based on
changes in the political climate. Long-term government funding is in no way guaranteed.
Political interest can quickly wane. Lobbyists for special interest groups affect the distribution of government dollars. The government funding game is highly dynamic and
uncertain and the winners and losers are not clear. Funding is just part of the story, as
government also impacts innovation through myriads of regulations.
The Business Model
Many inventions are packaged into single products or services. A product or service
requires the assembling of diverse inventions into useable form. The assembling of
diverse inventions into useable form distinguishes mere invention from innovation.
Simply ­creating a new product or service out of a bundle of patents is not sufficient.
The new product or service must rest on an innovative business model designed to
bring the product or service to a broad consumer base; otherwise, the investment
costs of an organization do not justify the development costs of the new product
or service.
Inventions, innovations, and an organization’s business models are different.
A ­company’s patent portfolio is considered its inventions, which are not the same as a
full-scale innovation.
∙ Invention is the creation of a new idea or process, usually in a laboratory. It is a test
of the principle involved, an act of technical creativity in which a concept that may be
suitable for patenting is described. Many inventions, though, go nowhere. They are
patented and accumulate as intellectual property without much commercial benefit.
That is why innovation is so much more important than invention.
∙ Innovation is the process of trying to put inventions into widespread use. It is the effort to commercially exploit inventions for an organization’s benefit. Yet no matter
how promising new technologies may be, many fail to be adopted in a wide-scale
way because they do not have a full and well-developed business model for their
wide-scale use and rapid diffusion.
∙ The aim of the business model, therefore, is to stimulate the innovation’s rapid adoption. For a product such as the iPhone to gain mass appeal, it must be vigorously
promoted, advertised extensively, and reviewed in appropriate publications and media outlets. A way to shop for the product and buy it must be created.
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170 Part Two Making Moves
Inventing a product is just the first step—and a meaningless one if not followed by a
comprehensive process of advertising and physically getting the product to the customer.
In itself, business model innovation can be lucrative for a company. Consider Dell’s
initial business model, which eliminated the reseller. The company was not a technology
leader. It was an assembler of other companies’ technology and a broker between suppliers and customers. Its innovation lay in its business model. Similarly, Trader Joe’s has a
unique business model, which mixes a gourmet deli with a discount retailer. It is not a
technology leader. The success of Internet banks does not come from technology they
use, but rather from an innovative business model, which increases customer access and
volume because these banks are open around the clock and can be accessed from a personal computer or even a mobile phone.
Technology does not guarantee success. Success comes from a capacity to convert
technology into profitable business models. Profitable business models rely on determining the types of business opportunities to pursue, vetting the ideas that are generated,
forming a team to pursue prototypes and pilots that are selected, and scaling up and rolling out new business models to the broader world.
Determining the Opportunities to Pursue
Aspiring innovators at different levels within a firm (so-called intrapreneurs) and outside
of the firm (entrepreneurs) regularly generate new business ideas. They identify promising opportunities in the course of their everyday activities or by means of careful and
prolonged search processes. The number of new business ideas that such individuals
identify, though, always exceeds the number that can be competently carried out. Very
few of these ideas generate sustained revenue for organizations and become widely diffused in society.
The path to successful commercialization of new business ideas typically starts with
some type of dissatisfaction with the status quo, and, as indicated, the process does not
necessarily follow a logical path. It is filled with trials and errors, false hopes, and
dashed expectations. Different opportunities for commercialization constantly compete
with each other within organizations such that organizations do not know where to turn.
On which options should they focus? Where should they bet their talent, money, and
expertise? Innovation is an investment decision in which the choice of how to allocate
scarce resources is vital. To what extent should an organization hedge the risks by betting on many options? On the other hand, to what extent should it maintain an unwavering focus on a single or just a few options? Once there is a clear understanding of the
extent of resources available for innovation, the organization must decide which types of
the many opportunities that exist to pursue.
Many firms struggle to identify these opportunities, or end up chasing after too many
options and not giving a single one the necessary amount of focus and attention. A
­disciplined approach may work best using the following lenses as a guide to decision
making as they can help organizations generate ideas that best align with their external
opportunities and internal capabilities.
External Sources of Opportunity
Can the organization capitalize on various macro-trends—demographic, regulatory,
­social, or other changes that are occurring?
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Chapter 7 Innovation and Entrepreneurship 171
∙ Every time a new regulation is introduced, a flood of firms offering administrative
services rushes in. When Sarbanes-Oxley (SOX) was introduced to protect investors
and improve the accuracy of public disclosures, SOX experts came out of the woodwork, and software developers raced to develop software-as-a-service (SaaS) solutions to facilitate compliance. The passage of the ACA (Affordable Care Act) had a
similar impact on the market for health care–related compliance specialists and software applications.
∙ Changing demographics also can create significant opportunities. For example, there
has been a recent rise in home health care options. Baby boomers are aging, while
costs of institutional care are skyrocketing. Successful home health services organizations tap into this problem. They allow the elderly to retain independence and remain
in the comfort of their homes for as long as possible. Firms that can capitalize on
macro trends have an advantage in generating revenue and profits from innovation.
Firms need to expand their horizons and embark on global learning about evolving customer perspectives in order to generate industry-leading ideas. Many firms have limited
human interaction across channels and borders. Broad, on-the-ground, and face-to-face
customer exposure is a significant source of ideas and inspiration. What are the plans
and unmet needs of key customers? The majority of new product and service ideas seem
to arise from consumers’ problems or “pain points.” Where the consumer suffers “pain,”
the innovator seeks a “solution” and begins vetting the opportunity. Exhibit 7.6 provides
some examples of consumer “pain” that have been resolved via innovation.
Market need must also be considered in tandem with the latest technological
­progress. Opportunities rest on market pull and technology push. Will the application of
new technologies allow organizations to alleviate customer problems in ways that are
better, faster, or cheaper than competitors?
An example of market demand and technological capability coming together may
be found in the widespread adoption of mobile devices coupled with the Internet of
Things. This confluence of technology and customers has the potential to make everyday life more and more convenient. Appliance makers tout functionality that allows a
EXHIBIT 7.6
Customer
“Pain” as
Innovation
Opportunity
Decade
Pain/Problem
Solution/Opportunity
1970s
Dragging heavy luggage through an airport
1970s
1980s
2000s
Appointments and long waits for basic/repetitive auto work
High-cost and time-consuming maintenance required of
permanent contact lens wearers
Phone access limited to home, business or coin-operated
phone booths
Difficulties sharing and updating research
Bulky, outdated paper-based map books
Limited consumer knowledge/power about retailers,
restaurants and other service providers
Health issues stemming from sedentary lifestyles
Wheeled bags of various
shapes, sizes and lightweight
materials
Fast tire/oil change facilities
Disposable, soft gas permeable
lenses
Mobile phones
2000s
Inconvenience of car ownership, especially in urban areas
1980s
1990s
1990s
2000s
The World Wide Web
Global positioning systems
Online product/business forums
and rating sites
Treadmill desks and wearable
fitness monitors
Sharable cars
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172 Part Two Making Moves
person to preheat the oven before arriving home. Light fixtures are being designed to
activate and illuminate a person’s path as he or she reaches the driveway. Locks can be
biometrically triggered, eliminating the need to fumble for keys. Whole-home automation has become the new thrust for firms that used to develop a limited lineup of
switches and dimmers.
Health care also has been greatly impacted by technological advancements that bring
together customer need with what technologies provide. The best hospitals can now provide better access to care, faster service, and more convenience for patients who must be
continually monitored. High-tech monitors are capable of transmitting data directly to
the doctor’s office, and videoconferencing technologies can provide patients and doctors
the opportunity to communicate face-to-face with housebound patients. Technology allows doctors to communicate with patients and enables digitized, consolidated medical
records, among other features.
The opportunities offered by technology are almost limitless, yet not all firms are in a
position to take advantage of them. The challenge innovators and entrepreneurs face is to
match technological opportunity with market need. Former 3M CEO James McNerney
once quipped in a speech: “At 3M, we are absolutely great at innovation . . . so great that
we have warehouses full of our (unsold) innovations!” The essence of successful innovation is that it fuses technological possibility with market demand. For managers at all
levels, it can be quite challenging to bring together different in-house functions (such as
marketing, R&D, and manufacturing) with knowledge of consumer needs and scientific
and technical developments.
Competitive pressure also can be a source of insights into where opportunities exist.
Are rivals pursuing technologies that will limit a firm’s options in the long term? Are
they introducing products or services that the firm should try to mimic or leapfrog?
­Innovation gaps are frequently filled when a firm is inspired by the offerings of a rival.
Rival success can be both a strong motivator and deep source of ideas for a firm’s innovation strategy. In the restaurant industry, fast casual models have been embraced by a
large number of consumers since Chipotle introduced the concept. In retail, the success
of online platforms has spurred traditional brick-and-mortar retailers to develop multichannel positions—and successful brick-and-click establishments have pushed Amazon
to build brick-and-mortar locations. Design cues taken from top luxury automakers are
frequently utilized by lower-cost rivals attempting to chip away at their lucrative profits.
Safety tools such as backup cameras have been copied so quickly over the years that today’s consumer would be hard-pressed to identify the original backup camera innovator
as Toyota. Google’s ongoing development of self-driving cars and Uber’s growing presence in ride-hailing has been the cause of both interest and great concern in the
­automobile industry.
Carmakers are determined to retain control of data generated by drivers worldwide—
and unwilling to cede control over value-added technological components. As a result,
they have actively moved to protect their turf and rectify an important knowledge resource gap. In August 2015, the top three German automakers purchased Nokia’s Here
navigation technology and mapping unit. Losing control over a mapping technology
present in over 80 percent of automobiles was not an option that Audi, Mercedes, and
BMW could tolerate. They had to prevail over Uber and Google in the bidding war for
this technology.
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Chapter 7 Innovation and Entrepreneurship 173
Internal Sources of Opportunity
Another source of insight into opportunities is a firm’s employees. To what extent have
an organization’s employees incubated new ideas and processes that can be scaled for the
benefit of the whole organization and its customers?
Any employee or team that has developed new offerings or improved processes within
a function or department can be a source of competitive advantage. Leaders should
­encourage innovative behavior, providing resources that will foster a culture of innovation, creating platforms for the best ideas to gain full acceptance and organization-wide
adoption, while also outlining for each employee the desired balance between current
(sustaining) operations and new frontiers.
Two firms that have implemented successful employee innovation programs are
AT&T and Whirlpool:
∙ With a $100 million dollar investment, AT&T created its “Foundry,” several centers
where employees have the opportunity to experiment. At the Foundry, employees
generate ideas and pitch them to teams of executives using VC-style presentations.
Products emerging from the Foundry have included a service that allows AT&T customers to send and receive text messages from any connected car, several home automation and security solutions, and even smart trashcans.
∙ Appliance maker Whirlpool also encourages innovation by opening up corporate ideation sessions to any employee who wants to contribute. Once an idea is generated,
employees then make a business case for their idea, compete for its development, and
participate in the concept’s testing and experimentation before full-scale commercialization takes place.
While generating innovative ideas clearly is useful, questions also must be raised
about the extent of fit of the new ideas with the organization’s resources and capabilities.
To what extent are a firm’s internal resources and capabilities aligned with the opportunity? A “sweet spot” rests at the intersection of three firm-based factors: (1) the firm’s
unique ability to understand customer perspectives and devise solutions for customer
problems, (2) a strategy that leverages such opportunities for a firm’s ongoing advantage, and (3) exclusive access to resources and capabilities required to deliver solutions
(see Exhibit 7.7).
Organizations must scan the external environment and then determines if they possess
special resources and capabilities and can marshal them in ways in introducing new
EXHIBIT 7.7
An Innovation
Sweet Spot
Customer
Perspectives
Relevant
Resources
Clear
Strategy
Innovation
Sweet
Spot
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174 Part Two Making Moves
EXHIBIT 7.8
MillerCoor’s
Tenth and
Blake Beer
Company
In 2010, brewing giant MillerCoors created a separate subsidiary company, Tenth & Blake Beer Company, to
­address new frontiers, namely the strategic opportunities present in the craft-brewing segment. Customers had
begun flocking to the segment as Fortune magazine soon reported:
Big, global breweries have taken notice of the craft beer movement—mostly because that’s where actual growth exists in
the otherwise stagnant beer industry. In 2011, craft brewing saw growth of 13% by volume, while overall U.S. beer sales
were down an estimated 1.3% by volume. And even though craft beer still accounts for less than 6% of all beer sales,
­anyone remotely connected to the business knows it will play a big part in the industry’s future. Craft beer delivers higher
profit margins, it attracts consumer spending, sought-after clientele for bars and restaurants, and many people are
­passionate about craft beer, similar to the same way people are passionate about wine.
For Tenth & Blake to succeed, there was a clear need for specialized capabilities and a degree of separation from
its corporate parent company. Many of the branding, sourcing, and manufacturing practices of craft brewers were
perceived as highly inconsistent with larger-scale brewing operations. A balance had to be struck in this situation.
Tenth & Blake customers can find a variety of unique, high-quality brews. It is committed to identifying and
­incubating the most promising new offerings from small brewers around the world, and preserving many of the
traditional practices, which lend craft brews their unique profiles, while providing financial support and other
­resources.
products and services that rivals cannot easily imitate. They also must deliberately prepare
for successive innovation frontiers, while simultaneously scanning for opportunities and
building the necessary resources, capabilities, and partnerships to support their ­existing
revenue sources. Brewing giant MillerCoors has seemingly addressed these s­ imultaneous
frontiers by creating an entirely separate division as illustrated in Exhibit 7.8.
Vetting Ideas
Most filters for thoroughly testing—or vetting—ideas aim to connect the dots between a
firm’s capabilities and available technologies, prospective customers, and the concept’s
profit potential. The vetting process assures that the organization is not wasting resources
on ideas that have little chance for success in the marketplace. Both AT&T and Whirlpool require employees to move beyond the process of idea generation and prove that
their ideas are worthy of attention and resources required for full commercialization.
Several screening devices have been developed to help determine whether to continue to
hone—or abandon—a new product or service concept. At Google, for example, they
subscribe to “share everything” and “fuel with data” philosophies that encourage teams
to aggressively test and iterate promising ideas.
An enduring model for vetting concepts is the Real-Win-Worth It screen.9 The idea
is to test each product or service concept to determine if the market and product are
“real,” if the potential offering and a company can be competitive and “win,” and
whether it’s “worth it” from both financial and strategic perspectives. The R-W-W is
meant to expose “faulty assumptions, gaps in knowledge, and potential sources of risk,
and (ensures) that every avenue for improvement has been explored.” 10 Most importantly, however, this screen helps innovation teams maintain momentum. Significant impediments on concept development projects are quickly identified and rectified, or they
are deemed impossible to rectify and the concept is abandoned without delay. Exhibit 7.9
provides an overview of this framework.
A recent Harvard Business Review article offers another more simplified
­approach, which encapsulates a number of points that have been discussed in this
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Chapter 7 Innovation and Entrepreneurship 175
EXHIBIT 7.9
The Real-WinWorth It
Screen
From a Market
Perspective...
A true customer need?
Affordability & willingness to
pay?
Market size sufficiency?
From a Product
Perspective...
Clear concept?
Manufacturable/deliverable?
Product satisfies customer?
From a Product
Perspective...
Does it have the potential for
SCA?
Expected rival responses?
From a Company
Perspective...
Clear concept?
Manufacturable/deliverable?
Product satisfies customer?
From a Product
Perspective...
Forecasted benefits > costs?
Is risk level acceptible?
From a Strategic
Perspective...
Does this fit our grand strategy?
Will corporate leaders get behind
it?
Is it Real?
Can We
Win?
Is it Worth
it?
c­ hapter. It recommends that innovators vet possibilities in their pipeline with simple
questions such as:11
∙ Is this idea consistent with an area of strategic opportunity in which the company has
a compelling competitive advantage?
∙ Does a company’s development team have an empathetic understanding of the customer? Can it clearly define the first customer and the path to reaching others?
∙ Can the team describe the business model in detail—from suppliers to channels to
money-making hypotheses?
The depth and intensity of the vetting process is a product of the firm’s industry and
competitive considerations. In hypercompetitive markets, concept life cycles are short.
Teams must be adept at quickly generating and filtering concepts lest they be left behind.
The bottom line is that no matter the industry or competitive conditions, and no matter which vetting process an organization selects—whether more intensive or more
­abbreviated—a disciplined approach to filtering ideas and focusing an organization’s
innovation efforts is a key to successful innovation.
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176 Part Two Making Moves
Creating Prototypes and Pilots Concepts
Designing new products or services that can delight customers and yield profits is both
challenging and risky. Often, the key to success is an organization’s ability to produce a
prototype or pilot offering—one that does not consume an excessive amount of resources prior to being presented to potential customers for hands-on testing. These prototypes or pilots are created solely for the purpose of gathering specific feedback.
∙ How does the product function outside of a controlled lab environment and in the
hands of customers?
∙ Does the service flow as efficiently as expected while meeting the customers’ expectations?
∙ Now that the customers have experienced the new offering, are they excited about its
utility and willing to pay?
If a pilot or prototype falls short in any way, it can travel quickly back to the drawing
board where the team working on it can discuss how adjustments should be made and
whether further adjustments are feasible.
∙ Is the technology robust enough to address the additional requirements that have been
uncovered via your testing?
∙ Will these extra features lead to higher levels of acceptance and profitability?
If the answer is “yes” to these internal screens, subsequent iterations of the product/
service can then follow the same cycle until the offering is ready for prime time.
­Exhibit 7.10 shows the cyclical nature of the product/service design process. When the
cycle begins again, choices must be made about whether to tweak the product/service or
look for an entirely different one.
In some industries with longer product development life cycles (such as pharmaceuticals and oil exploration), a rapid prototyping cycle is not possible. The key for the
EXHIBIT 7.10
The Iterative
Product/
Service Design
Process
2. Research
Options for
Satisfying
Requirements
1. Build an
Understanding
of Customer
Requirements
5. Deliver
Prototype to
Customer for
Testing
3. Select the
Most Viable
Options for
your Firm
4. Build
Prototype or
Pilot Program
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Chapter 7 Innovation and Entrepreneurship 177
o­ rganization is to dedicate resources that will help it chart a path to the future, no matter
how long the journey may be.
While the innovation team in charge of prototyping and piloting concepts can be very
lean, it is critical that it be allowed to pursue innovation projects full time. The team
must also be composed of individuals that have a deep understanding of and close proximity to the customer, and it must be given the resources and the latitude to craft multiple
iterations. A team of inexperienced part-timers not likely to have success in creating
­innovative solutions for customers when its competition is hungry, new, VC-backed
startups totally dedicated to success.12
Scaling Up and a Full Rollout
Once a concept has been proven, the organization’s efforts must turn to packaging, marketing, and delivering the product or service and offering it at scale. The resources and
capabilities required to execute on these activities are far different than those that an innovation team has, so a structured hand-off process from the innovation team to production and marketing teams should be seriously considered.
Innovation teams that fight to develop the concept and its full range of features are not
in the best position to make the trade-offs necessary to make the new offering profitable
at scale. Delivering consistent and profitable products at scale requires an entirely new
mindset, one that is dedicated to the replicable and reliable, rather than the unique and
exciting. The production team must be aware of the activities and investments required
to forge a support network of business-to-business partnerships and to build relationships with wider business-to-consumer markets. Forging this support network requires
adequate budgeting, planning, and incentives that are often at odds with the spirit of
new-product and service innovation processes.
Barriers to Innovation
The factors for innovation success are hard to assemble. Even one missing element can
undo a sound process (see Exhibit 7.11). Internal to an organization, there is need for a
clear leader vision and action plan, relevant skills, appropriate incentives, and supporting
resources. Innovators must pay close attention to the organizations needed to commercialize a new product or service, gather both financial and strategic resources, and build competencies. Firms need a supportive and permanent innovation/change structure. As shown
in Exhibit 7.11 any gaps in organizational preparation can quickly derail best intentions.
EXHIBIT 7.11
All the Pieces
That Must Be
in Place for
Successful
Innovation
Source: “Managing
Complex Change,”
2001, http://cydjournal.
org/Brandeis/
smith_0322.html.
Vision
X
X
X
X
X
Plan
Skills
Resources
Incentives
Degree of Success Realized
X
X
X
X
X
X
X
X
X
X
Mass confusion
False starts until plan solidifies
Anxiety over underperformance
Frustration at lack of support
Slow pace, little momentum
Change/progress made!
X
X
X
X
X
X
X
X
X
X
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178 Part Two Making Moves
EXHIBIT 7.12
Market Acceptance
The S-Curve
Time/Money Invested in New Concept
Long S-Shaped Diffusion Curves
Innovation rarely is instantaneous. Products, services, and technologies change as they
diffuse. They improve in reliability, quality, and flexibility. In a series of small steps and
refinements, they develop an evolving range of applications. Innovation usually starts as
a solution to a narrow problem, and innovators rarely know all the ramifications. IBM’s
Thomas Watson, for instance, thought the computer would be of limited use. He believed
the single computer his company made in 1947 would solve all the world’s scientific
problems, but had no commercial application.
Diffusion of new products, services, and technologies is very uneven. Diffusion follows the classic S-shape curve shown in Exhibit 7.12. The first adopters are daring.
Other people are slow to change, and only much later do they respond. Large firms in
rapidly growing industries are sometimes the first to innovate because they have the
necessary financial strength and access to information, but this innovation pattern is not
always the case. The early market for new products, services, and technologies is hard to
establish. Expectations that prices will fall retard adoption. People wait before they buy
because they believe that with further progress, prices will go down (think of the market
for personal computers). Meanwhile, inventors and developers, who endure most of the
risk, may not have the staying power, and second- and third-movers exploit their inventions. Imitators face lower costs, so the incentive to innovate is not large.
The entities that make discoveries are not always the ones that benefit the most from
them. The EMI scanner, for example, was an enormous scientific discovery, as important
as anything since X-rays, but EMI suffered great losses in developing it and sold the
rights to the technology at a cut-rate price. Relatively small engineering companies routinely produce innovations, such as the barcodes on retail products, that others use. Suppliers are the originators of many new ideas for their customers. Developers frequently
do not profit from the commercial application of their ideas. None of these organizations
benefit as much as society does from the innovations they introduce.
Many-Year Investments
After analyzing numerous innovations, Van de Ven and colleagues concluded that the
innovation process typically goes through stages across many years, as outlined in
­Exhibit 7.13. The gestation period can last for many years, after which seemingly coincidental events occur that set the stage for initiation. Often, internal or external shocks to
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Chapter 7 Innovation and Entrepreneurship 179
EXHIBIT 7.13
The Harrowing
Innovation
Journey
Coincidental events initiate the generation of new ideas
and the gestation of inventions. Without external
shocks or threats to the firm’s environment, however,
the level of organizational apathy can be great … Some
form of deep dissatisfaction is required in order to make
changes from status quo.
Well–intentioned “go–forward” plans might be presented
to resource controllers in form of sales pitches lacking
real analysis.
At formal project kick–off time, there may also be some
significant disagreements and lack of clarity about the
direction that should be taken with the invention … Ideas
proliferate, making managing difficult.
Over the many years–and many budget cycles–a lack
of continuity is found among personnel and other
resources.
Emotions run high, leading to frustration setbacks,
mistakes, and blame. Problems snowball and the
patience of resource providers weakens. A struggle for
power can ensue. Resources may run out before the
organization’s dreams are fulfilled.
an organization get things going. Dissatisfaction is needed to move people from the
­status quo.
The plans submitted by the developers of an innovation to the resource controllers are
too often in the form of sales pitches, not realistic assessments of the costs and the obstacles as the innovation unfolds. Once development begins, those involved usually discover there is disagreement and lack of clarity about what the innovation entails. Ideas
proliferate, making the challenge of managing the innovation very difficult. Continuity
among innovation personnel is broken as people come and go for many reasons, including frustration with the process as well as alternative career opportunities. Emotions run
high, and frustration levels build as normal setbacks are encountered, mistakes are made,
and blame is apportioned.
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180 Part Two Making Moves
At first, schedules are adjusted and additional resources are provided to compensate
for the unanticipated problems, but as the problems snowball, the patience of the
­resource providers weakens. The goals of the resource providers and innovation managers may begin to diverge and a struggle for power emerges about project goals and how
the project should be evaluated.
Resources tend to get tight and can run out before the dreams of the developers are
fulfilled. Innovations often are terminated because new resources are not forthcoming.
The ideas continue to show promise, but the resource providers lose patience. The ability
to see a project to the end is critical to the successful completion of an innovation, but it
is a very hard undertaking.
Flawed Processes
Flawed organizational processes spawn employee attitudes that inhibit innovation. Many
employees notice a significant disconnect between executive platitudes that tout the importance of innovation and the realities of their day-to-day efforts. Organizations treat
intellectual property (IP) as a valuable resource, but few seriously go about developing
all the IP they have to produce revenue and profits. Not many employees believe that
they will obtain the recognition they deserve for commercializing new ideas. As a result,
they often consider their efforts wasted. Ideas are poorly analyzed or reviewed, and firms
lack the resources needed to pursue the best ideas.
A survey of 150 innovation workers at American companies revealed many unproductive organizational processes around innovation:13
∙ Fewer than 30 percent of respondents’ organizations regularly measure and report on
innovation.
∙ Half of all organizations resort to either spreadsheets or e-mail to manage their innovation efforts; such methods are seen as insufficient to manage the full scope of required processes.
∙ Only 5 percent of American workers feel highly motivated to be innovative. They
tend to work at companies that do not have an effective process to encourage ideas,
strong management commitment and goals, prompt feedback, or performance-based
metrics, and they do not view IP as a strategic asset.
The CEO of the company that did the survey sums up these issues as companies’
“failure to have quantifiable, visible procedures” in place to translate intellectual property into bottom-line performance. He maintains that many employees believe “their
ideas will be ignored or simply don’t matter.”14
Risk and Uncertainty
When the odds of success are known with certainty (e.g., flipping a coin), it is called risk,
while conditions where the odds of success are not known with certainty are called
­uncertainty. This classification is a matter of degree. Uncertainty of varying levels can
quickly cloud a manager’s risk calculations. The art of assigning statistical probabilities is
just that—an art. When the odds are known with certainty, the situation is insurable; conversely, technical innovation is an uninsurable phenomenon. The odds of success cannot
be stated with precision. Even the best manager may not be able to manipulate a situation
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Chapter 7 Innovation and Entrepreneurship 181
to his or her liking in order to produce desired results. After the fact, it may be easy to say
why success or failure occurred, but before the fact, it is not easy to know what to do.
Most managers, therefore, have powerful reasons for keeping risk to a minimum. In
deliberating about whether to undertake an entrepreneurial project, they have to consider
both technical and commercial feasibility. They have to estimate:15
∙
∙
∙
∙
The probable development, production, and marketing costs.
The approximate timing of these costs.
The probable future income streams.
The time at which the income streams are likely to develop.
It’s obvious that these calculations are highly complex and many of the variables are
not completely known at project launch. There is a significant degree of uncertainty
buried in the risk calculation itself. Thus, businesses tend to concentrate on incremental
changes where success is easy and uncertainty is much lower.
In order to lower uncertainty, managers are naturally attracted to simple, well-trod
areas, such as new generations of existing products versus the creation of new product
lines (see Exhibit 7.14). Licensing others’ inventions, imitating others’ product introductions, modifying existing processes, and making minor technical improvements increase
odds of success. An automobile with a new type of engine, for instance, is less likely to
be introduced than an auto with simple modifications of existing engines. New models
and features are continually brought to market in the auto industry, but rarely do those
features require significant redesign efforts.
For a groundbreaking technological product to be launched, managers must have an
optimistic bias. There are just too many unknowns. “Glass half empty” leaders would
rather let their rivals explore the “bleeding edge.” Those that are willing to “start from a
blank sheet of paper” are rare, are often privately financed, and are exceedingly patient.
In 2015, Tesla Motors CEO Elon Musk told an auto industry gathering that the luxury
electric-car company would not be profitable until 2020. Will Toyota and GM decide to
shift gears and take aim at his company when it reaches critical mass and begins to show
a profit? Even after prototype testing, pilot plant work, trial production, and test
marketing, technical uncertainty is likely to exist in the early stages of technical product
EXHIBIT 7.14
Minimizing
Innovation
Risk
© Anne Cohen.
The Keys to Minimizing Innovation Risk
Focus on simple, well-trod areas
Establish new generations of existing products
Introduce new models
Differentiate product rather than create different product
License others’ inventions
Imitate others’ product introductions
Modify existing processes
Make minor technological improvements
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182 Part Two Making Moves
development. The question typically is not whether a product will or will not work;
rather, the issues at this stage are what standards of performance the product will achieve
under different operating conditions and what the costs will be of improving performance
under these conditions. Unexpected problems can arise before a product like Tesla’s
reaches the market, in the early stages of a promising commercial launch, and after
product introduction. A company like Tesla must be keenly aware of uncertainty that
emanates from technological change, business conditions, market disruptions, and
government policy that are hard to predict.
For example, unexpected problems affected the pharmaceutical company Syntex
even before its new product, Enprostil, reached the market. Syntex needed a new product because the patent on its major moneymaker, an anti-inflammatory drug called
Naprosyn, was about to expire. It thought it had come up with a new ulcer drug that
not only eased the pain of ulcers, but also lowered cholesterol. With millions of people
worldwide suffering from ulcers, drugs that treat the problem yield substantial profits.
However, the individual who pioneered Enprostil’s development spotted a dangerous
side effect of the drug: blood clots that could produce new ulcers. Test-tube clotting
suggested the drug could pose a risk of heart attack or stroke. Enprostil had trouble
winning FDA approval.
Serious setbacks can also occur in the early stages of a promising commercial
launch. For instance, Weyerhaeuser Company sought to become an important player in
the disposable diaper market with its Ultrasofts product. Ultrasofts had superior features—a cloth-like surface and superabsorbent pulp material woven into the pad to
keep babies dry. Consumer tests showed that parents favored it two-to-one over competing brands. The advertising and promotion campaign offered coupons that saved
parents $1 per package for trying the product. Procter and Gamble and KimberlyClark, which together had 85 percent of the disposable diaper market, responded with
aggressive cost-cutting and promotion campaigns to keep customers loyal. However,
early in production, manufacturing problems occurred in Weyerhaeuser’s Bowling
Green, Kentucky, plant. The system that sprayed the superabsorbent material into the
diapers malfunctioned and started a fire. Weyerhaeuser had to raise prices to retailers
by 22 percent to cover its unexpected expenses. The retailers responded by refusing to
give the product adequate shelf space. Weyerhaeuser then had no choice but to
­withdraw the product from the marketplace.
Summary
Achieving success in new business ventures is a long process that involves many
stages. Reasons exist for firms to undertake both incremental innovations and radical
innovations, both of which are necessary. For new products and services to be commercialized, entrepreneurs, innovative companies, investors, and government support
are needed. The process requires determined entrepreneurs, dynamic companies,
­willing and able financial backers, and government support that is long lasting
and ­predictable.
Commercialization means not only finding new opportunities for business innovation, but also exploiting these opportunities. Exploiting the opportunities rests on business models companies develop. They help companies determine which opportunities to
pursue and how to pursue them. In choosing these opportunities, companies must take
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Chapter 7 Innovation and Entrepreneurship 183
into account ­external and internal factors, which work together in the successful launching of new ventures. New opportunities can be discerned from observing macro-trends,
contact with customers, and exposure to technological progress and competitive pressures. Internal factors of importance are employee initiatives and alignment with resources and capabilities.
Evaluating the promise of a new venture requires careful assessment of both the
­maturity of the technologies on which it is based and their market potential. It is necessary to match market demand with technological capabilities. Companies must have
good systems in place for vetting ideas. They need teams that prototype and pilot
­concepts before they are ready for scaling up and fully rolling out.
Innovators and entrepreneurs must have the staying power and commitment needed
to see ideas through to realization. Many barriers have to be overcome. Long S-shaped
diffusion curves, multi-year investments, and flawed processes hinder innovation. Since
entities that make discoveries often are not the ones that profit from them, innovation is
rarely instantaneous, and because diffusion is uneven, the incentive to innovate is not
great. Often, innovation takes years, and resource providers may abandon projects ­before
they are successfully realized.
The obstacles to innovation and entrepreneurship start with uncertainty about the
­future. Because the uncertainty is great, managers, especially in existing firms, tend to
be very cautious. They typically innovate slowly, reluctantly, and only on the margin,
driven by personal circumstances or identification of a “pain,” to name a few motives.
Uncertainty prevents them from moving forward. There is considerable uncertainty
­before, during, and after a product reaches the market; and uncertainty about customers
as well as about government support.
For innovation to take place, both managers and entrepreneurs must have an optimistic bias, even if it is not always warranted. Because of the many disappointments that
exist in developing new business ideas, they must play hunches and work against odds.
If they are to calculate in a dispassionate and even-handed way the odds of success
against the risk of failure, they might not proceed. If they do not proceed, they, and their
companies, are not the only ones who suffer. Rather, everyone in society is likely to be
worse off. Persistence in pursuing innovative ideas provides social benefits above individual self-interest in change.
Exercises for the Practitioner
1. How motivated is your organization to innovate and why? Is its performance gap
significant?
2. Does your firm clearly support individual innovators in its ranks? If so, how does it
show its commitment to innovators?
3. Describe your organization’s innovation process in detail. Identify the strengths and
weaknesses of the process. How do you believe that the process has impacted the
long-term performance of your firm?
4. What types and degree of uncertainty does your firm face as it pursues innovation?
Which tactics does your organization use to reduce the uncertainties of innovation?
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184 Part Two Making Moves
Exercises for the Student
1. Examine the annual reports of the publicly held firm of your choice, and calculate the
ratio of dollars spent on R&D to revenues.
2. Look for new product and/or service announcements made by this firm. Is the firm an
innovation leader in its industry? Or does it tend to be a second/late mover instead?
Given what you know about the organization, does this posture make sense?
Endnotes
1. Gary Hamel, “Strategy as Revolution,” Harvard Business Review, July–August 1996, p. 69.
2. Loretta Chao, “Revamped Bubble Wrap Loses Its Pop, “The Wall Street Journal, July 1, 2015,
http://www.wsj.com/articles/revamped-bubble-wrap-loses-its-pop-1435689665.
3. H. Aldrich and C. Fiol, “Fools Rush In,” Academy of Management Review 19 (1994),
pp. 645–70.
4. Ibid.
5. J. Harrison, Strategic Management (New York: Wiley, 2003).
6. Hamel, “Strategy as Revolution.”
7. Lauren Coleman-Lochner and Carol Hymowitz, “At Procter & Gamble, the Innovation Well
Runs Dry,” BloombergBusiness, September 6, 2012, http://www.bloomberg.com/bw/­
articles/2012-09-06/at-procter-and-gamble-the-innovation-well-runs-dry.
8. Steve Denning, “Why U.S. Firms Are Dying: Failure to Innovate,” Forbes, February 27, 2015,
http://www.forbes.com/sites/stevedenning/2015/02/27/is-there-an-innovation-crisis-at-usfirms/.
9. It was initially developed by Dominick M. Schrello, principal of Schrello Marketing. Versions
of this model have been circulating since the 1980s and have been adopted by several leaders
in innovation including General Electric, Honeywell, and 3M.
10. George Day, “Is It Real? Can We Win? Is It Worth Doing? Managing Risk and Reward in an
Innovation Portfolio,” Harvard Business Review, December 2007, https://hbr.org/2007/12/isit-real-can-we-win-is-it-worth-doing-managing-risk-and-reward-in-an-innovation-portfolio.
11. Scott Anthony, David Duncan, and P. Siren, “Assessment: Should We Pursue This New
­Project?” Harvard Business Review, February 2015, https://hbr.org/2015/02/assessmentshould-we-pursue-this-new-project.
12. “Your organization also needs at least one individual, but preferably a small handful of individuals, who will get up every morning and go to sleep every night thinking about nothing but
innovation.” Scott Anthony, David Duncan, and P. Siren “Build an Innovation Engine in
90 Days,” Harvard Business Review, December 2014, https://hbr.org/2014/12/build-an-­
innovation-engine-in-90-days.
13. MindMatters Technologies, Inc., “Survey: American Corporations Suffer from an ‘Innovation
Crisis,’ with Insufficient Resources to Develop, Track New Ideas,” March 3, 2015, http://
www.mindmatters.net/News/MindMattersInnovationSurvey2015.aspx.
14. Ibid.
15. C. Freeman, The Economics of Industrial Innovation, 2nd ed. (Cambridge, MA: MIT Press,
1982); and F. Knight, Risk, Uncertainty, and Profit (New York: Houghton Mifflin, 1921).
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P A R T
T H R E E
Implementation and
Reinvention
EA
External Analysis
General Environment
Competitive Forces
1
IA
Internal Analysis
Resources, Capabilities
& Competencies
Selection of Options
Business, Global and Corporate Level
Strategies & Tactics
BS + GS + CS + IS
2
Implementation
Marshalling Resources & Making Moves
Evaluation of
Performance
&
Continuous
Reinvention
3
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C H A P T E R
E I G H T
Implementation
“The value of an idea lies in the using of it.”
Thomas A. Edison, American inventor
Chapter Learning Objectives
• Being aware that implementation is a highly dynamic process.
• Understanding that skillful implementation is required to drive results; it should be viewed as a core
competence.
• Revealing common obstacles to implementation and emphasizing the need for a more masterful
approach to the process.
• Discerning whether an organization is ready to embark on a strategic change initiative.
• Comprehending the activities required to fundamentally transform the firm into one that will always
stand ready for strategic challenges.
• Being conscious of the need to continuously monitor the competitive environment, nurture the
organization, and improve the implementation process itself.
Introduction
Implementation is the process of translating a strategy into action—bringing the ideas
and decisions covered in previous chapters to life. If an organization cannot effectively
manage the implementation process, it will lag behind its rivals in the marketplace.
Unfortunately, this process is often fraught with obstacles: Resources are scarce,
resistance to change is great, persistent yet agile leadership is rare, and consistent, transparent patterns of communications are atypical. As a result, numerous organizations
have struggled to ­realize the benefits of well-conceived strategic plans. This book’s
­analytical process for analyzing the external and internal environments and choosing the
optimal sequence and combination of moves will come to naught if implementation is
not effective.
The purpose of this chapter, therefore, is to examine successes and failures in strategy
execution while providing a framework to use in implementation—a dynamic framework
that is closely integrated and synchronized with the analysis and moves covered in previous chapters. The implementation component of the strategic management cycle never
stands alone (see Exhibit 8.1).1 Implementers must be willing to regularly rethink the
tactics necessary to achieve their objectives.
186
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Chapter 8 Implementation 187
EXHIBIT 8.1
Implementation
Must Be
Synchronized
With Strategy
Formulation &
Evaluation
Formulate
Implement
Evaluate
The Anatomy of Failure
Managers have grappled with the gap between organizational strategy and the attainment
of objectives for quite some time. A 2004 survey conducted by The Economist polled
both U.S. and Canadian senior operating executives across eight key industries and
found that 57 percent of companies did not successfully implement their strategic initiatives.2 The American Management Association and the Human Resources Institute
painted an even bleaker picture in 2006. Its survey of global executives and HR experts
revealed that just 3 percent of respondents rated their companies as very successful at
implementing strategies, while 62 percent described their organizations as mediocre or
worse.3 Success has not been the norm.
Mistakes in implementation result in an organization losing precious time, money, and
momentum versus its rivals. With this in mind, Exhibit 8.2 utilizes case study e­ xamples
to warn of obstacles that management could encounter along the way.
EXHIBIT 8.2
Significant
Implementation
Missteps—
Some Stories
and Important
Take-Aways
Home Depot: Performance-Enhancing Moves versus an Ingrained Culture
Home Depot’s overall performance had been lackluster when Robert Nardelli, a talented former executive at
­General Electric, was recruited for the company’s top spot. The organization recognized the need for change, but
Nardelli brought “the wrong toolbox to the job,” mistakenly believing that the strategies and tactics that had been
successful at GE could be readily transplanted to a big-box retail environment. In his efforts to streamline Home
Depot’s business processes and 2,000 stores, he overfocused on the processes and trampled on Home Depot’s
highly customer-focused and entrepreneurial culture. He angered the management ranks by firing long-time Home
Depot executives to bring in GE alumni, and then he enraged investors by losing out to rival Lowe’s when it began
to invest heavily in new and more attractive stores.
When competition heated up, Nardelli employed manufacturing-appropriate methods to shore up the bottom line,
but his tactics, which cut costs by increasing the number of less-knowledgeable part-time workers, left full-time
employees fuming and crippled customer service. Though cuts allowed Nardelli to reach earnings-per-share and
other growth targets—a “commendable job,” according to Barry Henderson, an equities analyst at T. Rowe Price—
investors questioned whether the company’s top-line growth was sustainable. After years of a declining stock
price, Home Depot announced Nardelli’s resignation. The moral of the story is that implementation efforts will fail
if leadership does not acknowledge that cultural norms can place boundaries on the pace and extent to which new
behaviors can be integrated into the existing organizational system—and if executive incentives are not carefully
aligned with a comprehensive organizational vision.
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188 Part Three Implementation and Reinvention
Circuit City: “Me Too” Moves versus Faster, More Savvy Foes
Circuit City’s Firedog offering was created to provide customers with an enhanced menu of services delivered at
cost levels comparable to the company’s low-cost and best-value rivals. Pulling a page from Best Buy’s playbook,
the Firedog team was to handle technical services for both computer equipment and home theater installations in
a way that closely mimicked the Geek Squad.
Unfortunately, this move was made well past the company’s prime. Complacence and inaction during prior industry
inflection points had created a significant long-term disadvantage. Starting in the 1880s, Circuit City failed to secure
prime real estate, while rivals were snapping up more convenient locales. The company reduced the breadth of its
product line when it stopped selling appliances, yet did not aggressively pursue the electronics niche with a strong
set of gaming offerings. It neglected to improve its Web presence, just as online retailers, such as Amazon.com
were hitting their stride. Then it lost to Best Buy in a contest to create an Apple presence in its stores.
Internally, old inventory levels began to swell, and soon Circuit City was unable to buy fresh products or pay off its
existing debts. Deep cuts at the front line (which were similar to Nardelli’s moves at Home Depot) eliminated over
8,000 of Circuit City’s most experienced employees, replacing them with cheaper workers. In the end, the organization only succeeded in mortally wounding customer service. Its descent was rapid, and by the end of 2008, it
announced its liquidation because it was not able to successfully implement its strategic initiatives. The moral of
the story is that poor timing coupled with inadequate management of market dynamics will sink any strategy.
United Airlines: A Low-Cost Segmentation Move versus Lack of Internal Commitment
United’s Ted concept was designed to give United a way to compete with low-cost airlines, such as Frontier, JetBlue,
and Southwest. Moves to standardize aircraft with no-frills configurations and maximize jet use through rapid turnarounds at airport gates were meant to reduce maintenance and operating costs significantly. With this plan in mind,
Ted began service February 12, 2004, in Denver, with 57 Airbus A320 aircraft, configured with 156 all-economy seats.
However, the airline’s overall cost structure lacked alignment with the new initiative, and the low-cost offering was
never certified as a separate operating entity. Ted was simply a brand name applied in an attempt to differentiate
the all-economy service from United’s mainline flights. As a result, all Ted flights actually were operated by United
Airlines crews flying under the United Airlines operating certificate—and those crews of pilots, flight attendants, and
mechanics were not always compensated per Ted’s low-cost design. United’s own operational needs also interfered
with the new brand implementation. Ted aircraft would be utilized as needed for mainline United flights, and mainline United aircraft were operated as Ted flights, which only confused the customer base and weakened the brand.
As a result of this lack of full commitment to the concept, costs at Ted were never as low as those of a genuine discount airline, and its operations led to significant losses. The fatal blow to the concept came when fuel prices spiked
and parent UAL dumped its gas-guzzling 737 models, reclaiming the A320s from the Ted operations and reconfiguring them to carry higher-margin first-class passengers. On January 6, 2008, operations were officially folded back
into the mainline brand and Ted was dead. The moral of the story is that implementation efforts will fail without a
lack of full commitment and alignment of structures, procedures, and resources with an organization’s strategy.
Swissair: Empire-Building Moves versus Resource Limitations and EU Law
The conventional wisdom of the airline industry, as in many other mature industries, has been that globalization
demands concentration into a small number of operators. Multiple carriers have formed alliances and merged to optimize aircraft utilization levels and build scale economies, but this conventional wisdom is too often oversimplified.
Swissair’s Hunter strategy was designed to set the airline on such a global path by focusing company resources on
markets with the largest growth potential—Belgium, Austria, Finland, Hungary, Portugal, and Ireland. Swissair
aimed to grow market share by acquiring small airlines instead of setting up alliance agreements. It acquired a significant stakes in Air Europe, Sabena, Air Liberté, AOM, Air Littoral, Volare, LOT, Turkish Airlines, South African
­Airways, Portugalia and LTU, and considered acquiring stakes in Aer Lingus, Finnair, Malév, TAM and Transbras.
With the exception of Polish carrier LOT, however, all the companies that Swissair acquired were in a desolate financial situation and required significant managerial intervention. EU law, which demanded majority citizen ownership
as a condition of retaining an EU operating permit, also complicated Swissair’s efforts. Swissair could own only
48.8 percent of each carrier on paper, yet it bore the full financial risk of ownership off balance sheet to obtain
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Chapter 8 Implementation 189
immediate and direct managerial control. Soon, the funds invested were significantly higher than initially approved
by the board, which lacked any solid experience in managing an international airline.
The culture of excellence, which defined the Swissair brand, was also not as easily transferable to non-Swiss cultures as initially estimated. Massive divestments were undertaken to reduce the steadily growing financing gap.
However, these divestments largely represented sale and leaseback transactions involving the group’s aircraft
fleet—transactions that yielded cash flow and improved the financial picture in the short run but resulted in lease
payments in subsequent years. Within two years, off-balance-sheet obligations increased by some CHF 5 billion,
and on October 1, 2001, Swissair’s liquidity requirements exploded. Regular flight operations could no longer be
maintained, so these were suspended on October 2, 2001, and at 3:35 p.m., the airline was grounded. The moral
of the story is that to successfully implement complex moves, an organization must employ skilled foresight—and
oversight—of both internal and external dynamics. Inflection points can occur throughout the process.
Sources: Home Depot: “Home Unimprovement: Was Nardelli’s Tenure at Home Depot a Blueprint for Failure?” http://
knowledge.wharton.upenn.edu/article.cfm?articleid=1636.
Circuit City: A. Hamilton, “Why Circuit City Busted, While Best Buy Boomed,” http://www.time.com/time/business/
article/0,8599,1858079,00.html; M. Raby, “Apple Expands Best Buy Relationship, Limits Deal with Circuit City,” http://www.
tgdaily.com/content/view/34543/113/.
United Airlines: S. Freeman, “United to Ground Its Ted Carrier “Washington Post, June 5, 2008, p. D01; http://www.
washingtonpost.com/wp-dyn/content/article/2008/06/04/AR2008060400945.html.
Swissair: Results of Ernst & Young’s Investigation Regarding Swissair, Zurich, January 24, 2003, http://www.liquidator-swissair.
ch/uploads/media/untersuchung1_e.PDF.
The Root Causes of Failure
Although the failures detailed in Exhibit 8.2 involve a variety of strategic moves in different industries on separate continents, the decisions and behaviors of those charged
with the implementation of these strategies suggest that the root causes of failure are
universal. A strategy-to-performance gap comes about because of “a combination of
­factors, such as poorly formulated plans, misapplied resources, breakdowns in communication, and limited accountability for results.”4 Exhibit 8.3 features a compilation of
EXHIBIT 8.3
Common
Obstacles to
Successful
Strategy
Execution
Home
Depot
Circuit
City
Inability to manage change effectively or
to overcome internal resistance to change
Poor or inadequate information sharing
between individuals or business units
responsible for strategy execution
x
x
Trying to execute a strategy that conflicts
with the existing power structure
x
Poor or vague strategy
x
Common Obstacles to Strategy Execution
Swissair
x
x
x
Unclear communication of responsibility
and/or accountability for execution
decisions or actions
x
Not having guidelines or a model to guide
strategy-execution efforts
Lack of feelings of “ownership” of a strategy
or execution plans among key employees
United
x
x
x
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190 Part Three Implementation and Reinvention
Lack of understanding of the role of
organizational structure and design in the
execution process
x
Inability to generate “buy-in” or agreement
on critical execution steps or actions
x
Lack of incentives or inappropriate
incentives to support execution objectives
x
Insufficient financial resources to
execute the strategy
x
x
Lack of upper-management support of
strategy execution
Ignoring customer perspectives and impacts
x
x
x
x
x
the most common obstacles that have challenged successful strategy implementation
(and includes some of the specific obstacles encountered by the organizations featured in
Exhibit 8.2.)5 It’s imperative for any manager to recognize and work to rectify these
obstacles as soon as they are encountered. A series of misstarts and hasty implementations attempted without sufficient commitment will eventually destroy the credibility of
the strategy an organization is trying to carry out.
A Comprehensive Implementation Framework
At the most basic level, implementation can be viewed as a structured process of
(1) creating a portfolio of change programs that will deliver the strategy, and
(2) attracting, allocating, and managing the necessary resources to deliver these change
programs.6 At first glance, the process may appear to be a straightforward task; however, genuine shifts in strategy imply a significant change in emphasis. Implementation
is felt throughout the organization. It typically involves changes in customers, suppliers, and markets; new technologies, or business processes; and unfamiliar leadership
styles or management techniques. Managers must prepare carefully for implementation
by assessing an organization’s change readiness.
Step 1: Assess Change Readiness
An organization’s readiness for change varies greatly based upon the extent of the change
anticipated and its past experience with change. A strategic initiative requiring deep,
fundamental transformations of both business model and process may be overwhelming
for the current organization. Employees find it difficult to envision their future roles
when the extent of change is so great. A track record of failed past initiatives will also
erode trust and increase the probability of subsequent failures. Employees that have
experienced such failures will be, understandably, hesitant to get behind any new ideas.
As Mankins and Steele comment:
Unrealistic plans create the expectation throughout the organization that plans simply will
not be fulfilled. Then, as the expectation becomes experience, it becomes the norm that
performance (goals) won’t be kept. . . . Commitments cease to be binding promises with
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Chapter 8 Implementation 191
EXHIBIT 8.4
A ChangeReadiness
Assessment
Exhibit created by
Anne Cohen based
upon forces identified
by IBM’s 2008
“Making Change
Work” survey.
Forces Against Change versus Forces That Support Change
No Higher Management
Commitment
Powerful Pioneers of Change &
Top Management Commitment
Negative Mindset
& Culture
Lack of Transparency &
Poor Quality Information
Change-Embracing
Culture
High Degree of Employee Involvement
and Honest/Timely Communication
Complexity Underestimated, Lack of Change
Know-How, Major Process Changes & Tech Barriers
Lack of Employee Motivation
& Resource Shortages
Efficient/Agile Organizational
Structure & Training Programs
Adjustment of Performance Measures with
Monetary & Non-monetary Incentives
real consequences. . . . Managers, expecting failure, seek to protect themselves from the
eventual fallout. They spend time covering their tracks rather than identifying actions to
enhance performance (or stretching to ensure that commitments are kept). . . . The organization becomes less self-critical and intellectually honest about its shortcomings. . . . It
loses the capacity to perform.7
Before launching any new initiatives, therefore, managers should assess their organization’s readiness. Has management shown an unflagging and highly visible commitment to past programs, or is it a fair-weather friend to change? Does information flow
freely, or do gatekeepers block and skew the process? The continua shown in Exhibit 8.4
help determine the level of resistance one can expect.
Once this initial assessment is complete, it is essential to develop strategies that leverage
the predominant forces for change in an organization and minimize the opposition. The
entire organization must be involved in adopting a state of change-readiness: The dynamic
environment within which today’s organizations operate demands nothing less and quickly
dispatches those lulled into a false sense of security. Today, perpetual readiness and e­ xpertise
in change management is a highly valued organizational competence. The change-ready
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192 Part Three Implementation and Reinvention
organization is prepared for the inevitable bumps in the road. It’s able to react more quickly
and pass more fluidly through all phases needed to implement new strategies.8
Step 2: Install Integrative Leadership
After the organization is readied for change, it must install decisive, yet integrative, leaders
to move the implementation process forward. Such integrative leaders are effective in
maneuvering organizations to resolve the strategy-to-performance gaps that exist in implementation. They are able learn new skills and master new approaches quickly. They have
the capacity to examine an initiative from multiple perspectives—from the strategic to the
organizational and operational—and to create action plans that both respect and stretch all
process and cultural boundaries. They consider both internal and external forces and,
unthreatened by weaknesses, deftly weave new resources into the organizational fold,
building competencies and competitive advantage. They are capable of overseeing a program of ever-improving, interdependent activities while building a culture of cooperation,
confidence, and performance. They never forget the balance that must be struck between
day-to-day oversight and propelling the organization forward (see Exhibit 8.5).
Not every leader, however, is courageous enough to embark upon new initiatives in an
integrative manner. New initiatives can undermine established organizational priorities,
resource allocations, and reporting relationships. Implementation can challenge leaders’
past decisions, their power, status, scope of responsibility, and business philosophies.
Some leaders will simply be incapable of grasping a new set of circumstances or learning new skills. These leaders will erect obstacles to change.
At the other end of the spectrum are leaders who lack discipline and throw caution to
the wind, making radical departures from the norm without considering current organizational realities. For example, when Procter and Gamble launched its Organization
2005 initiative, CEO Durk Jager set out to grow profits and enhance its competitive position with a series of highly aggressive moves: refocusing P&G on developing markets;
demanding a high rate of new global brand introductions; standardizing existing brands
across all geographic regions; redesigning the company’s structure, processes, and culture; and reducing time to market. It soon became obvious, however, that Jager’s program was too forceful, his confrontational style and unreasonable demands alienated his
management team, the accelerated product pipeline generated products that were only
moderately successful, and the organization lost ground in established markets. Jager
was soon replaced by A.G. Laffley who took a much more integrative approach, one that
EXHIBIT 8.5
Leaders Must
Manage Both
“Day-to-Day”
Management
and Forward
Movement
(Re-) Setting
Organizational
Direction
Propelling
Organization
Forward
Analysis of
Competitive Context,
Formulate Priorities
and Moves
Examination of
Organizational Context,
Interactions,
Maintain Momentum
Day-To-Day Management & Administration
Operational leadership–Working with people to ensure ST objectives are met
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Chapter 8 Implementation 193
balanced existing strengths with competitive realities.9 Laffley retained pipeline
improvements made under Jager, yet reined new developments back to a more measured
pace. He leveraged existing retailer relationships while developing extensions for existing powerhouse brands. He reappropriated underperforming assets, dropping brands that
did not fit with P&G’s focus. He addressed existing weaknesses in the IT infrastructure,
which increased efficiencies across the supply chain. P&G was then able to pursue
acquisitions and new market development from a greater position of strength.
When an organization is compelled by competitive forces to make a radical shift in
strategy, integrative leadership quickly becomes a critical resource. Organizations, therefore, must encourage, develop, reward, and retain leaders that incorporate integrative
behaviors into their everyday management. These leaders are among the most important
factors needed to maintain a change-ready organization.
Step 3: Create a Consistent Message
Strategic change is typically aborted whenever leadership does not act consistently, or
fails to demonstrate the same commitment to change that they expect from others. The
installed leadership team, therefore, must immediately come together to negotiate how
each leader will be held accountable for specific elements of the implementation, and to
build consensus around a common message for all stakeholders—one that will be shared
with both shareholders and operational employees.
Shareholders can exert relentless pressure on an organization to boost profits quarter
after quarter. This pressure, often foisted by the board onto senior executives, must be
well managed and not allowed to derail the implementation of long-term strategies. A
consistent message, a clear plan of action, and open lines of communication from leadership to the board and shareholders are vital to retaining support throughout the process.
Employees must also have a shared understanding of the desired end-state, yet most
companies do not communicate strategy broadly or effectively to their employees.
A 2005 study by Kaplan and Norton found that up to 85 percent of a company’s employees are unaware of, or do not understand, its strategy.10 If, for example, an organization’s
strategy is to become “best in class,” it must be made very clear to employees whether
that means to achieve top-quartile performance, to be the most profitable, to be the most
admired, or all of the above. The salesperson on the street, the call-center customer service representative, and the operations manager should be interpreting the organization’s
desired state in the same way.
To deliver such specific and targeted messages to employees, leaders need to have all
hands on deck, intermingling with groups and engaging employees across the organization in discussions about marketplace realities and the organization’s desired end-state.
Failing to create a common vision up front impedes future progress.
Step 4: Appoint Cross-Functional Program Teams
Strategic leadership teams alone are not in a position to identify and effectively define
the specific changes needed to successfully implement a strategy. Even if they are,
resentment is aroused when management simply announces a change and mandates the
specifics of implementation. The involvement and contributions of knowledgeable middle managers are necessary.
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194 Part Three Implementation and Reinvention
The placement of these middle managers on cross-functional program teams, which
are both highly visible and accessible, is strongly advised. Such accessible teams give
employees from each functional area an opportunity to engage in the implementation
process. They send a powerful message that the organization values its employee base. By
creating such program teams, leadership is saying, “Thank you for all of your efforts—the
competitive intelligence you provide from the front lines, the customer insights you’ve
shared . . . With your input, we’ve been able to determine what must happen, what moves
we need to make in order to secure advantage for our organization . . . With your continued engagement, we will also understand how we can best achieve our shared objectives.”
Ideally, the managers appointed to these program teams have been involved from the
earliest stages in the strategic leadership team’s diagnosis of the business environment;
they have helped build scenarios of change imagining how best the organization can
respond to various strategic contingencies.11 With these middle managers in place and
employees on board, the organization can quickly begin work to more clearly identify
gaps between the organization’s current and desired states. These gaps serve as the basis
for subsequent decisions and actions.
Step 5: Solicit Change Program Proposals
When cross-functional program teams effectively engage the employee base in discussions
about how to achieve strategic goals, the response is often significant. Employees are able to
inform management of additional resources they need, and functional groups can quickly
alert leadership if they will be significantly affected by the change. Ideas start to flow, specific
proposals begin to take shape, and the scope of the original strategic initiative tends to expand.
Unfortunately, financial and human resources are never unlimited, and are especially
stretched during times of transition. Even the process of reviewing proposals can become
overwhelming without a solid framework for submissions and selection. Each proposal that
gathers momentum, therefore, should be developed into a formal business case.12 The casewriting process requires sponsors to consider all facets of implementation and demonstrate
how their proposed change programs will contribute to the achievement of the organization’s strategic goals. Any acceptable submissions must include the following elements:
∙ An identification of the necessary changes from the status quo.
∙ An outline of new resource requirements, timelines, and costs (and how these will
compete with ongoing needs for continuity and cash flow).
∙ A clear definition of the expected benefits.
∙ A list of the individuals who, with the sponsor, will be responsible and accountable
for delivering the benefits.
This last element is crucial. Insisting on accountability at this stage eliminates a sponsor’s
tendencies to underestimate costs and overestimate benefits. Such accountability also
leads to more honesty downstream, when certain programs can become irrelevant due to
changing business conditions, and their adjustment (or abandonment) becomes necessary.
Step 6: Select and Prioritize Proposed Change Programs
To select and prioritize change programs, cross-functional teams and senior leadership must
utilize a prioritization plan—This plan must rely on objective and transparent ­criteria to
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Chapter 8 Implementation 195
EXHIBIT 8.6
Strategic
Program
Prioritization
Matrix
Source: An adaptation
of the Project
Prioritization Matrix
created by A. P.
Brache and S. BodleyScott—Harvard
Management Update
4/2009.
Balance
Short-Term Long-Term
x
x
x
x
x
x
x
Priority-Setting Criteria
Criteria Wt.
Builds our brand identity
Increases profitability
Minimizes risk
Provides positive ROI within 3 years
Benefits our broader community
Combined Weighted Scores =
10
10
6
3
1
Program 1
Program 2
Raw Wtd. Raw
9
7
8
2
5
90
70
48
6
5
219
Program 3
Wtd. Raw Wtd.
5
3
9
6
3
50
30
54
18
3
4
1
4
2
8
155
40
10
24
6
8
88
Resource Requirements
Marketing
Operations
Finance
HR
IT
x
x
x
x
x
x
Verdict →
Expedite
Program 1
x
Delay
Program 2
Drop
Program 3
blend current programs, products, and processes with the new strategy. These criteria may
include any number of factors, including expected ROI, risks, and so on. Such a prioritization
process helps functional areas, and the operational front lines balance the realities of a
dynamic competitive environment and the need for change with liquidity needs, cost control
programs, the sales of existing product lines, and the availability of new capital. The process
also helps the organization estimate how much time it will take to realize specific goals.
While an organization can transform its capabilities over time, there is a limit to how
far it can go and how fast. The decisions are never simple, and uncertainty always clouds
the decision-making process. However, without clearly defined priorities, employees are
only left to second-guess the intent of senior management as they attempt to resolve dayto-day conflicts between operational and change resource requirements. Without resolution, most employees will focus on earning revenue from a demanding customer, leaving
implementation of the strategic initiative hanging.
In “Which Initiatives Should You Implement,” Brache and Bodley-Scott provide a
methodology that management can use to examine the complete portfolio of projects,
and to determine which projects must be expedited, which can be combined, and which
should be delayed or canceled. An adaptation of their prioritization matrix appears in
Exhibit 8.6.13 “Raw” is the raw score of the priority, but Brache and Bodley-Scott suggest using a weighted score (Wtd).
Regardless of the selection criteria utilized, clear communications of which priorities are
to be pursued and funded, and why, illustrates clear leadership thinking and consistency. A
lack of priorities only leads to implementation overload, which wastes resources, distracts the
organization from its goals, and dulls its responsiveness to the competitive environment.14
Step 7: Assign Process Owners and Align Resources
Once program-specific priorities are set, the cross-functional teams must then select and
assign process owners to oversee the transition from the status quo. It is critical that the
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196 Part Three Implementation and Reinvention
selected process owners have adequate authority over all programs and areas involved in
the implementation of their processes, as they will also be held accountable for success
or failure. Mid- and top-level leaders are recommended.
Working in tandem with cross-functional teams and the sponsors of approved change
programs, the new process owners then begin to coordinate activities that span organizational functions. They define new process flows, audit policies, and determine whether
current resource levels are adequate to conduct the different phases of the transition.
Several questions designed to complete alignment of the new strategy with the existing
one must be answered as outlined in Exhibit 8.7.
Answers to these critical questions will help guide the organization as it shifts to its
desired state. Decision-making will be pushed to appropriate levels, preventing the formation of inefficient functional silos. In fact, as more efficient processes are designed, functional boundaries will begin to fade and will be replaced with more fluid and productive
lateral collaborations. For example, the marketing analyst who needs information from
­operations to determine the firm’s production capabilities will have a direct link to that unit.
The operations manager charged with boosting efficiencies at the plant level will have access
to finance department ­expertise. Even field and line employees will benefit from the collaborative environment and will gain a better grasp on the bottom-line impact of their decisions.
It is imperative, therefore, that these coordination activities not be short-circuited, and
that management resist the temptation to just strip costs indiscriminately. Modifying
­structures, eliminating resources, and removing layers of management can reduce costs drastically, but without fundamental changes that reduce process complexity and install strategysupportive incentives, an organization will eventually return to its original state. Structural
change must be the capstone—not the cornerstone—of any organizational transformation.15
EXHIBIT 8.7
Questions That
Must Be Asked
to Align the
Current
Organization
with a New
Strategy
Process Questions
•
•
•
•
How should work and process flows change to support new initiatives while improving efficiencies and reducing
redundancies across the organization?
Should specific decisions and activities be centralized or decentralized?
How should changes to supplier or customer interfaces be managed?
Which operating systems should be modified, and which information systems upgraded, to support new initiatives?
Structural Questions
•
•
•
•
•
•
Which employee groups and individuals will be most affected by the new priorities?
Must resource levels change on a permanent basis to address new workload levels per employee, or will
­temporary assistance suffice?
Can projects be combined in any way to share physical assets or human resources?
Can resources be reappropriated from lower-priority/cancelled initiatives?
Do employees need to be relocated and/or retrained, or will new hires be required?
What other changes should be made to ensure that the structure is conducive to rapid, strategy-supportive
­decision-making and knowledge transfer?
Policy and Culture Questions
•
•
•
Which policies create obstacles to the execution of new initiatives?
Do some incentives encourage the wrong behaviors?
What is the best way to maintain momentum and continue to nurture a strategy-supportive culture throughout
these changes?
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Chapter 8 Implementation 197
Step 8: Secure Funding, Formalize Operational Objectives,
and Design Incentives
To proceed with implementation, each transition initiative requires funding to cover its
entire timeline. Assuring adequate funding requires knowing whether internal cash flows
will be sufficient to support new initiatives. If they are not, external sources must be
tapped and the decision to utilize either stock and/or debt instruments must be made.
Too much debt in an organization’s capital structure can reduce the range of actions it
will be able to take in response to future threats that jeopardize its survival. On the other
hand, issuing an excessive amount of stock will dilute ownership control and affect stock
price overall. In the end, managers must determine the best mix of financing options for
their organization—stock, debt, or a combination of the two—that will provide maximum
earnings per share (which is assumed to be consistent with the maximization of share
price and immediate shareholder wealth) and will increase the odds that the organization
will continue to thrive. The tool of choice for such a decision is EPS/EBIT analysis,
which compares earnings per share (EPS) and earnings before interest and taxes (EBIT)
at various levels of sales—optimistic, pessimistic and most-likely scenarios.
Once funding is assured, all initiatives and their respective timelines must be divided
into annual budget cycles. These organizational time constraints force process owners to
parse multiyear transition initiatives into several phases. Specific goals must then be
defined for each phase, and the goals subdivided so that each phase goal can be linked to
each employee’s personal objectives and incentives. Employees must be provided with a
clear outline of the decisions and actions for which they will be held responsible and a
set of well-defined success criteria. These updated guidelines and criteria are the new
keys to their personal rewards and program success.
It is vital that employees not remain tied to reward schemes based upon objectives
that support the status quo. For example, if an organization has just set its sights on being
a service leader, managers should rethink any high-volume incentives that are in place to
reward customer service reps for keeping their calls short. Replacing such stopwatch
systems with customer satisfaction surveys and repeat-purchase data will motivate more
vision-supportive behaviors. If an organization is hoping to grow profits, it must reward
not only volume and market share, but also margin.
Additionally, managers must be sure to incorporate objectives and incentives that
reflect the fact that most employees are not operating in a vacuum, but rather are part of a
network. As a part of the network, they are responsible for delivering timely and highquality output to others (so that they can perform their own duties). Take, for instance, a
food-packaging manufacturer that hopes to increase profitability by 20 percent over the
next two years. At a basic level, this initiative places immediate pressure on the organization’s sales force, and the sales force will require an increased number of quotations from
the home office. Generating these quotations, however, requires the input of both package
design staff and plant operations. Any delays in their inputs impacts the timely delivery
of quotations, reduces the confidence of the food producer in the capabilities of the packaging manufacturer, and ultimately hurts the likelihood that the producer will enter into a
purchase agreement with the manufacturer.
In the end, there must be both vertical and horizontal consistency in the objectivessetting process (see Exhibit 8.8). Vertical consistency yields a strategy-transparent
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198 Part Three Implementation and Reinvention
EXHIBIT 8.8
Horizontal and
Vertical
Consistency in
Objectives
Support
Processes
Fair & Accurate
Transfer Pricing
Corporate
Level
Business
Level
Functional
Level
Operational
Level
Functional
Level
Operational
Level
Business
Level
Functional
Level
Timely Input To
Decision Support
Functional
Level
Business
Level
Functional
Level
Functional
Level
Operational
Level
Operational
Level
Operational
Level
Frontline Teamwork
s­ ubdivision of duties and responsibilities from the executive to the operating levels, while
horizontal consistency encourages collaboration and simultaneous progress across functions. Unfortunately, many organizations fail to persist in this comprehensive approach,
and as a result, their employees lack adequate direction and motivation, their budgets
swell, their timelines stretch, and they ultimately fail to reach their higher-level goals.
Step 9: Advance and Continually Monitor Initiatives
Armed with budget, clear objectives, and strategy-supportive incentives, programs are
now equipped to move forward. New processes are set into motion and monitoring
begins. Early wins should be celebrated, and any drift away from stated objectives should
be immediately corrected.
However, the monitoring process itself can be very challenging. The gathering of
accurate information can be both costly and time-consuming if systems designed to
improve processes have not been also designed to track the relevant activities of employees, the performance of vendors, the purchases and sentiments of customers, and the
countermoves of competitors.
When performance falls short, executives . . . often have no way of knowing whether ­critical
actions were carried out as expected, resources were deployed on schedule, ­competitors
­responded as anticipated, and so on. Unfortunately, without clear information on how and
why performance is falling short, it is virtually impossible for top management to take
­appropriate corrective action.16
Nevertheless, there are many tools that can help managers monitor both their progress
and their environment. Scorecards, such as Kaplan and Norton’s balanced scorecard,
can be used as they measure both leading and lagging factors of an organization’s overall
performance. Using such a scorecard, an organization’s financial results, employee turnover, and inventory changes may be tracked along with the leading indicators from this
week’s customer focus group or the results of the last month’s employee survey. Dashboards also can be fully integrated into the operating systems of organizations to provide
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Chapter 8 Implementation 199
relevant and timely performance data, aid in decision-making, and serve as a constant
reminder of the link between employee actions and results. When used properly, dashboards deliver a mix of operational, f­ inancial, and program-specific information that is
both timely and meaningful to stakeholders. A sales executive’s dashboard might extract
daily revenues from the accounting module of a firm’s ERP, unit sales from its CRM,
and market share against program objectives from industry research firms, while the
customer service center’s dashboard provides its representatives with real-time call statistics, wait times, and kudos or complaints that reflect customers’ changing needs and
priorities. An effective dashboard can help an organization synchronize its internal
beliefs with its external realities.
The broad appeal of monitoring tools is based on their applicability to almost any
organizational situation; they can take the form of either manual or highly automated
systems. However, such monitoring alone is insufficient. It’s imperative that leadership
is fully engaged in both measuring and adjusting to incoming competitive and operational signals. If leaders do not fully participate, the effectiveness of any system is
severely limited. Many complaints aimed at failed executives of the past have been traced
to such a laissez-faire approach to the monitoring and evaluation process.17
Whether manual or automated, the most effective monitoring systems are used to:
∙ Alert executives to the development of dangerous economic and competitive trends.
∙ Help managers identify and limit budget variances, which always spell trouble—use
too many resources one year and risk a poor evaluation or program cancellation;
use too few and risk future resource shortfalls and virtual program strangulation.
∙ Help justify the program variances that do occur—protecting program resources and
helping the organization maintain positive momentum.
∙ Provide an objective basis for the distribution of earned incentives across all levels of
the organization while helping an organization to identify and retain its best people
and practices, and pinpoint sources of underperformance for review and remediation.
∙ Continually reinforce the link between an organization’s strategy and the benefits
realized by both the organization and loyal employees.
Given ongoing financial and geopolitical uncertainties, organizations around the world
are forced to closely monitor events and quickly recognize and adapt to new realities.
Businesses must continually revisit priorities to get the most out of their existing resources.
Most must prune underutilized or nonperforming assets to survive. Though it’s painful,
the pinch yields both valuable lessons in financial discipline and investment opportunities
that set the stage for a period of growth once business conditions return to normal. Savvy
firms capitalize on the easy access to good talent and other valuable resources during any
downturns and expand when economies rebound. Those that invest during recessionary
times are positioned to leapfrog competitors who hesitate to make any such bold moves.18
Step 10: Fortify Gains and Refine the Implementation Process
Although this last step of the implementation framework seems to imply that this process is coming to a close, in practice, an implementation cycle is never complete. It
continually overlaps with the design of new strategies, the evaluation of existing initiatives, and the redirection of current processes.
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200 Part Three Implementation and Reinvention
The organization, its environment, and its processes require constant attention, oversight, and fortification. Managers must recognize that an organization’s internal culture
is under constant assault as it endures mergers and acquisitions, promotions and retirements, and basic turnover and hiring. It is highly susceptible to failure unless leadership
takes an active role in continuously fortifying and protecting it.
Accomplishments must be consistently communicated to all employees, supply partners, and key customers. This type of communication helps build a sense of pride and
loyalty in a brand. Successes must be promptly and generously rewarded. Such rewards
cement them into the psyche of the organization. Managers must encourage ongoing
strategic thinking and opportunity identification at all levels. This encouragement helps
the organization preserve its change-ready state and facilitates modifications as necessitated by both internal and external forces. Leaders must not hesitate to continually test
assumptions, revise strategies when necessary, revisit and learn from previous forecast
errors, fine-tune the program prioritization process, cut any programs that are not yielding expected benefits, reassign ineffective process owners, adjust policy, develop new
incentives, or replace monitoring systems that are no longer relevant to internal changes
or able to produce timely market and competitive intelligence.
Employees witnessing such a continuous improvement process will, in turn, become
more confident in leadership’s ability to deliver positive change and embrace future initiatives with greater trust and enthusiasm. Yet the mastering the implementation process
is much like learning to successfully land an aircraft on a carrier: It’s not simple and
never perfected the first time around. The seas are rough, and the runway target is constantly moving. Only the most skillful and practiced hands consistently hit the flight
deck’s sweet spot and emerge from the cockpit ready for the next sortie.
Summary
Failed initiatives leave in their wake suboptimal results—significant cost overruns,
­demoralized employees and, in the worst of cases, a downward spiral of disgruntled
customers and shrinking market shares. Management must learn to identify and rectify
the most destructive implementation behaviors, and must begin to consider the process
of implementation as a core competence to be continually honed and developed. Implementation tasks are summarized in Exhibit 8.9 on next page.
This chapter provided a comprehensive framework that:
∙
∙
∙
∙
∙
∙
∙
∙
Helps managers and executives determine whether their organizations are ready for change.
Emphasizes the importance of developing and retaining integrative leaders.
Helps those leaders manage stakeholder pressures.
Devises special organizational structures and positions to support the change
­process—from cross-functional program teams to process owners.
Assists in the diagnosis of misaligned processes, structures, policies, and culture.
Outlines key funding and budgeting decisions.
Explains how to create strategy-supportive objectives and incentives.
Scrutinizes and adjusts both the process and organization as required by internal and
external dynamics.
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Chapter 8 Implementation 201
EXHIBIT 8.9
Summary of
Key
Implementation
Activities
Task Name
1
Assess Change Readiness
2
Install Integrative Leadership
3
Create A Consistent Message
4
Appoint Cross-Functional Program Teams
5
Solicit Change Program Proposals
6
Select & Prioritize Proposed Change Programs
7
Assign Process Owners & Align Resources
8
Formalize Budgets, Operational Objectives & Incentives
9
Advance & Continually Monitor Initiatives
10
Fortify Gains & Refine The Implementation Process
The careful practice of this process delivers fundamental change and produces an
organization that is much more ready to adapt to the next, inevitable challenge—which
is strategy’s main point: the capacity to continuously adapt to the challenges an organization confronts.
Questions for the Practitioner
1. How well does your organization execute on its strategies? Has it experienced significant failures or successes in the past? What are the root causes of its successes
and/or failures from your role and your perspective within the organization?
2. Does your firm have a systematic approach to implementation? If so, what is it, and how
can it be improved? How does it compare to the framework provided in this chapter?
3. Given your firm’s external environment and the competitive dynamics of your industry, how is your firm doing? How do you believe that your firm’s approach to execution impacts the long-term performance of your firm?
Questions for the Student
1. Examine the annual reports of the publicly held firm of your choice, and assess strategic intent and implementation over time.
2. Look for strategies the firm has tried to carry out. Has the firm succeeded? Analyze
what happened and why? Make recommendations on how the firm could do better.
Endnotes
1. K. Nagendra, “The Recession Dilemma—To Save or to Invest,” ThoughtSpot, June 2, 2009,
https://thoughtspotblog.wordpress.com/2009/06/.
2. Key industries included manufacturing, oil, like, telecoms, health care, consumer goods and
retail. “Strategy Execution: Achieving Operational Excellence,” Economist Intelligence Unit,
http://graphics.eiu.com/files/ad_pdfs/Celeran_EIU_WP.pdf.
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202 Part Three Implementation and Reinvention
3. AMA/HRI survey included those in Europe and Asia. “Most Companies Are Only Moderately
Successful—Or Worse—When It Comes to Executing Strategy, Executives Say,” http://press.
amanet.org/press-releases/87/most-companies-are-only-moderately-successful%E2%80%84orworse%E2%80%84when-it-comes-to-executing-strategy-executives-say/.
4. Michael C. Mankins and Richard Steele, “Turning Great Strategy into Great Performance,”
­Harvard Business Review, July–August 2005.
5. The Wharton-Gartner Survey (2003) was a joint project between the Gartner Group, Inc., and
Lawrence G. Hrebiniak, professor at the Wharton School of the University of Pennsylvania
and teacher at the Wharton MBA and Executive Education programs. The short online survey
was sent to 1,000 individuals on the Gartner E-Panel database. The targeted respondents were
managers who were involved in strategy formulation and execution. The survey yielded
­responses from 243 individuals. Combined, the Wharton-Gartner Survey and the Wharton
Executive Education Survey provided responses on obstacles to strategy execution from more
than 400 managers. L. G. Hrebeniak, “Making Strategy Work: Overcoming the Obstacles to
Effective Execution,” Ivey Business Journal, March–April 2008.
6. G. Johnson, K. Scholes, and R. Whittington, Exploring Corporate Strategy, 7th ed. (Harlow,
England: Pearson Education Limited, 2005); W.D. Giles, “Making Strategy Work,” Long
Range Planning 24, no. 5 (1981), pp. 75–81.
7. Mankins and Steele, “Turning Great Strategy into Great Performance,” pp. 64–72.
8. From IBM’s 2008 study, “Making Change Work.” IBM Global Business Services researched
change management practices across the globe. The study quizzed over 1,500 project leaders,
sponsors, project managers, and change managers from many of the world’s leading organizations, ranging from small to very large.
9. R. Martin, The Opposable Mind: How Successful Leaders Win Through Integrative Thinking
(Boston: Harvard Business School Press, 2007).
10. R. S. Kaplan and D. P. Norton, “The Office of Strategy Management,” Harvard Business
­Review, October 2005, pp. 72–80.
11. A. Marcus, Strategic Foresight (New York: Palgrave MacMillan, 2008).
12. A. Franken, C. Edwards, and R. Lambert, “Executing Strategic Change—Understanding the
Critical Management Elements That Lead to Success” California Management Review 51,
no. 3 (Spring 2008), pp. 48–73.
13. A. P. Brache and S. Bodley-Scott, “Which Initiatives Should You Implement?” Harvard Management Update, April 2008.
14. See, for example, P. Rothschild, J. Duggal, and R. Balaban, “Strategic Planning Redux,”
­Mercer Management Journal 17 (2004), pp. 35–45.
15. G. L. Nielson, K. L. Martin, and E. Powers “The Secrets to Successful Strategy Execution,”
Harvard Business Review, June 2008.
16. Mankins and Steele, “Turning Great Strategy into Great Performance.”
17. P. Burrows, “Controlling the Damage at HP,” BusinessWeek, October 8, 2006, http://www.­
businessweek.com/magazine/content/06_41/b4004001.htm.
18. Nagendra, “The Recession Dilemma.”
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C H A P T E R
N I N E
Continuous
Reinvention
“Competitive advantage comes in the form of the progress a company
makes while its competitors, paralyzed by confusion, complexity, and
uncertainty, sit on the sidelines …”1
Lowell Bryan, Director, McKinsey & Co
Chapter Learning Objectives
• Being aware that a firm’s strategy must be regularly reinvented—that the quest for SCA is continual.
• Introducing alternative methods of selecting and valuing new initiatives.
• Discussing some of the latest models for reinvention—from open sourcing to reworking the business model.
• Providing examples of how firms have reinvented their strategies through such means as achieving
greater closeness to customers, bridging supplier/customer gaps, and putting in place smart
business designs.
• Understanding the role that both leading-edge industries and environmental challenges play in
innovation and entrepreneurship.
• Reviewing and summarizing the analytical approach to achieving sustained competitive advantage
(SCA) presented in this book.
Introduction
Firms cannot stand still; they must continually reinvent themselves. As argued in C
­ hapter 1,
they find themselves between two poles: their mission, which reflects where they were,
what they were good at in the past, and where they had achieved some type of comparative advantage, and their vision, where they would like to go and what they would like to
be good at in the future.
Attaining sustained competitive advantage (SCA) is rare. Many firms achieve temporary
advantage, but few make the advantage last. To succeed over the long term, businesses
must regularly remake themselves. In doing so, they confront two constants: first, the competition that never lets up, and second, the internal lethargy that stands in the way of change.
203
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204 Part Three Implementation and Reinvention
Building upon the best practices of implementation discussed in Chapter 8, this final
chapter delves into the process of reinvention and presents various ways to ­increase a
firm’s overall odds of long-term success. It also reviews key lessons from the book’s
overall framework: systematically examining external opportunities and threats; analyzing internal strengths and weaknesses; and implementing moves related to product
­positioning, corporate scope, globalization, and innovation and entrepreneurship. It
­concludes with a discussion of opportunities and business models that are emerging on
the frontiers of strategy.
Preparing for Inevitable Turmoil and Uncertainty
In the absence of a crystal ball, no one really knows what the future holds, how technology will evolve or how consumers, or governments and capital markets will react. Over
the long term, few assumptions can be made. So, how can a firm prepare for inevitable
turmoil and uncertainty and be prepared for an ever-increasing range of possibilities?
Some companies will choose to be followers, allowing other firms to experiment and
identify feasible and lucrative paths. They are adept market readers, who imitate their
competitors’ actions, market innovations, and what works for these firms. They copy the
innovations, make slight adjustments, and arrive at their own versions. The market reading and following strategy has worked extremely well for Samsung in its battles with
Apple.2 Samsung’s aggressive following of Apple has landed it in court—yet the total
impact of the court ruling against the firm has been minimal compared to the gain realized from an imitative strategy. K
­ orean carmaker Kia is another example of a market
reader that has taken its cues from firms that have already found success in the marketplace. The design of the 2015 Kia Sportspace concept was based on the Audi, modified
in a way that makes it appear like an Italian version of this car.3
Some firms will choose to be more proactive than the followers, and move down a
path of incremental improvements to their offerings. They adjust their approaches to
customer engagement and reinvigorate their brands across new channels. They make
improvements to their internal structures and processes, or they team with other organizations. These maneuvers are well within the capabilities of most customer-focused
organizations—and they can lead to some valuable, albeit temporary, advantages.
A Portfolio of Initiatives
The question remains, however, as to just how an organization can become a market
leader. How can it position itself to maximize gains before the followers and incremental
adjusters arrive? The answer to this question is rather complex, but it begins with having
a disciplined exploration/exploitation system. This system must strike a balance between
quick exploitative wins for temporary advantage and highly uncertain exploratory
maneuvers to create long-term advantages.
McKinsey’s portfolio of initiatives system is designed to help achieve this goal.4 This
system can be traced back to naval wartime strategy. Imagine that the objective is to
­deliver supplies to troops that are positioned across the sea. Sending one ship with all the
necessary provisions would be foolish. Both air and sea are filled with aggressors—­
submarines lurking below, enemy crafts cruising the sea’s surface, and bombers above.
Rivals have unknown capabilities and plans to thwart the ship. Enemy agents aim to
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Chapter 9 Continuous Reinvention 205
EXHIBIT 9.1
A Portfolio of
Initiatives
Source: Adapted from
McKinsey’s Enduring
Ideas Presentation
Series.
Initiatives
A
B
C
D
E
F
G
H
I
J
K
L
M
N
Time
×
×
×
×
×
×
×
×
×
×
×
Over time,
only a
portion
✓ of a firm’s
high-risk,
stretch
initiatives
will come
✓ to fruition
✓
i­ nfiltrate the boat’s crew and sabotage the voyage. Other external factors, such as storms,
can erupt and destroy the vessel.
The military’s answer has been to send battle groups, multiple supply and troop-­
carrying vessels accompanied by aircraft carriers, destroyers, and submarines. By
­moving in a pack, the ability of each ship to survive its cross of the ocean increases. The
strategy raises the chance that the supplies traverse the ocean even if individual ships fail
to achieve this task.
Businesses faced with high levels of uncertainty will likewise benefit when they
spread their risks across a portfolio of initiatives (see Exhibit 9.1). In the quest to develop
truly groundbreaking products, services, and delivery mechanisms; enter new industries;
and expand a firm’s global reach, convoy-like strategies will increase the likelihood that
at least some ambitious objectives are reached, even if others fail.
Banks and financial institutions have utilized this strategy for years. Mortgage portfolios
are filled with individual bets that customers will pay their debts. Lenders realize profits
when the majority of their bets are sound. Venture capital firms also manage portfolios of
deals, with the objective of scoring at least a handful of lucrative wins in the long term.
In fact, any organization facing an uncertain future can adopt a portfolio strategy. The
key is to pursue a carefully curated selection of short and long-range initiatives:
∙ Some of these efforts should be relatively safe bets to generate quick wins. These
moves will include extensions of current products, services, and customer markets.
These are first horizon bets.
∙ Other, frontiers hold significant promise but require that a firm acquire new capabilities, develop new businesses, and fundamentally alter its business models (see
­Figure 9.2). These are the firm’s second horizon bets. Their payoffs are not likely to
come until three to five years have passed.
∙ The last frontier is the least certain, but can also hold the greatest promise. As a
­result, firms will also make third horizon bets whose payoff comes in the more distant future, anywhere from five to 10 years forward.
In a dynamic and rapidly evolving business environment, where businesses must be prepared
for the unexpected, this type of hedging plays a role in strengthening an organization over
the long term. As circumstances change, organizations are ready for a range of outcomes.
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206 Part Three Implementation and Reinvention
EXHIBIT 9.2
New
Higher Risk Initiatives
Complex Organizational Transformations
Most Significant Potential for SCA
Products & Services
Existing
Novel
Initiatives,
Risk, and the
Capacity to
Sustain
Competitive
Advantage
(SCA)
Lower Risk Initiatives
Simpler Organizational Processes
Quicker, Incremental Wins
Existing
Customer Markets
New
The Alchemy of Growth, published in 1999, also recommends that firms pursue these
three horizons.5 The first horizon encompasses efforts to extend and defend the core
business that are currently providing the income necessary to stay afloat, the second
horizon is devoted to building emerging businesses to which can drive growth in revenues and profits in the near term, and the third horizon is meant to secure viable revenue
and profit options for the long term. Exhibit 9.3 offers a fascinating example of Disney’s
development along these horizons. The firm’s early moves from animation and character
licensing to a­ nimated feature films are an example of an organization’s ability to focus
on the first horizon while simultaneously developing second and third horizons of
related businesses. The creation of Disneyland was a significant leap into uncharted
waters, but as this ­horizon was transformed into a new reality, Disney did not stand still.
It pursued new horizons, acquiring ABC (and with it ESPN) an investment from which
it derived the majority of its profits and revenues in 2015.
Like the chess player mentioned in Chapter 1, companies must think more than one
step at a time into the future. At each stage, different initiatives are appropriate, and at
each stage, the company must consider not only the initiatives it is proposing, but also
how competitors will respond. Another key lesson is to pay attention to competitors’
responses. The success of a company’s initiatives is determined not by its initiatives
alone, but also by the initiatives of its competitors.
In fact, every employee of a company should embrace some form of horizon thinking.
Eric Schmidt, now executive chairman of Alphabet, one of Google’s two main divisions,
uses the 70:20:10 Model for Business Innovation. It dictates that in order to cultivate
­multiple-horizon thinking, employees should dedicate 70 percent of their time to core business tasks, 20 percent to projects related to the core, and 10 percent to projects that are
totally unrelated to the core. Other companies noted for innovation, such as 3M, have long
employed a similar approach.
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Chapter 9 Continuous Reinvention 207
EXHIBIT 9.3 Disney’s Ever-Expanding Horizon of Investments
Source: McKinsey’s Staircases to Growth.
1920’s
1930’s
1940’s
1950’s
1960’s
1970’s
1980’s
1990’s &
­Beyond
Current
Industry
­Involvement
Animation
Licensing
Music
Books
…..
…..
Disney Stores
Records,
S­ oftware
Publishing &
­Merchandising
Films
…..
TV
Motion
P­ ictures
…..
Touchstone,
Home Video
Mirimax
­Acquisition
Filmed
­Entertainment
Disney
­Channel
K-CAL TV,
­ABC-TV
Broadcasting
Live Theatre
Hockey,
­ aseball
B
Live
­Entertainment
Tokyo
­Disneyland
Euro Disney,
­Animal Kingdon
Theme Parks
Resorts
Disney
­Vacations,
Planned
­
Communities,
Cruises
Vacations,
­Resorts &
Property
­ evelopments
D
Disneyland
Walt Disney
World
EPCOT
Hotels
As uncertainty grows when the horizons are farther into the future, conservative
leaders too often err on the side of caution. They refuse to prepare, preferring instead to
simply wait things out. Yet there are significant advantages to be gained from preparation, even if many of the bets made on the future do not pan out and they amount to
nothing more than spaghetti thrown against the wall to see what sticks. Firms, like
­individuals, need to learn from experiments where failure is possible.
Rapid experimentation is the key to learning. The more spaghetti thrown against the
wall, the greater the chances that some of it will stick. The Wright Brothers, for example,
tested hundreds of wing and airfoil models, at great personal risk, before they achieved
successful flight. While experimenting they achieved a deeper understanding of what
works and what doesn’t. This type of trial-and-error learning process is useful in organizations. It provides them with knowledge they need for long term survival.6
Managing the Portfolio
An organization’s responsibility is to take prudent risks. It should not be immobilized by
uncertainty, nor should it embrace risk so wholeheartedly that the firm’s future survival
is jeopardized. Organizations must achieve an appropriate balance between sticking to
what is known to produce results in the here and now, and exploring bolder moves,
which can help the firm survive an uncertain future.
How is this balance to be achieved? As suggested in Chapter 8, internal project control
mechanisms can be put into place that set clear project milestones, utilize regular reviews,
and make continued investments contingent on a progress. Pilot programs and prototypes
(see Chapter 7) can build an understanding of what is possible and can fine-tune initial
efforts before costly expenditures are made to scale up investments. More significant
resources are secured only as product and market knowledge grows, and as time reveals
whether projects are economically and technically viable and politically feasible. With a
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208 Part Three Implementation and Reinvention
disciplined approach to learning, the range of possible outcomes may be reduced, and
some of the uncertainty eliminated.
Not every project that is subjected to this process is renewed. Not every project is
continued. Some are abandoned entirely. Others are put on hold and their pursuit is
­delayed. If postponed, they still may be held in reserve for revival later. The organization
must systematically create a memory bank of what it has learned from both successful
and unsuccessful experiments, for who knows for certain when such knowledge may be
useful? To start afresh without the knowledge once gained would be a waste and, under
some circumstances, it can put the organizations far behind its competitors.
The firm’s ability to not only approve project continuance, but to also delay or abandon projects within a firm’s portfolio of initiatives, should always be considered a real
option that offers significant strategic value over time for the following reasons:
∙ There is a strategic value in cementing an organization’s exclusive rights to future developments and in opening the door to related investments. Such moves block rivals as time
passes, forging a clearer path to profitability and competitive advantage.
∙ There is tactical value in maintaining flexibility and agility in the practice of making
a broad range of minimal upfront investments (and having the option to delay subsequent investments) over committing to just one long and costly path.
∙ There is residual value to be claimed when it becomes clear that an investment will
not meet full expectations, but that the physical or intellectual property that remains
can be redeployed or sold.
The real estate development process offers a clear example of the value that can be captured by creating a portfolio of options. This process is summarized in Exhibit 9.4.
In pharmaceuticals, what is ground-breaking and competitive at one ­moment can be
significantly reduced in value by a regulatory change or a faster rival. On the other hand,
a formulation initially designed for a limited purpose can increase in value as physicians
EXHIBIT 9.4
How Real
Estate
Developers
Build a
Portfolio of
Real Options
Real estate developers are speculators who secure a wide range of properties with the expectation that some
­locales in their portfolios are likely to gain significant value over time. Many of these properties are purchased at a
minimal upfront investment.
At the time of purchase outcomes are unknown. A property near a newly announced transit route may increase
tenfold in value very quickly, while another property that seemed more valuable when purchased, but remains
­isolated, may never appreciate as expected.
Thus, the real estate development process involves taking real options. Developers purchase of exclusive rights—
not obligations—to exercise the options to develop, delay, or abandon the land in their portfolios.
•
•
•
A decision to develop a parcel can be immediate if market conditions indicate that a quick ROI can be
achieved.
The decision can delayed until the developer is more certain that parcel development will be profitable (until
commercial businesses or homebuilders are clamoring for space).
The decision can be made to abandon a parcel if it fails to show promise and is not feasible to develop. In this
case, the developers will still be able to capture some residual value.
The bottom line is that a well-balanced portfolio of carefully selected parcels of land, even one containing many
question marks, provides developers with the flexibility and the agility to gain both financial and competitive
­advantage over time.
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Chapter 9 Continuous Reinvention 209
EXHIBIT 9.5
A Bad Investment…
Comparing
Project
Valuation
Techniques
Source: Adaptation
of example offered in
“Real Options Fact &
Fantasy,” Aswath
Damodaran, NYU
Stern.
Success
1/2
Becomes a Good One…
+100
2/3
Mid-course
correction
+20
1/3
Today
1/3
Now
1/2
Failure
+80
–10
2/3
–120
–20 Stop
experiment with off-label applications. Development project valuations frequently
change over time as new information comes to light.
As seen on the left in Exhibit 9.5, at the start of a lengthy project, the uncertainty is
great, and the odds of ultimate success may be like a coin toss. If there is a 50 percent probability that a firm will earn $100 million, and a 50 percent chance it will lose $120 million,
this equates to an expected value of minus $10 million: EV = (½)(100) + (½)(−120). Seeing only these odds leads to the conclusion not to pursue the idea further because the loss
is too great. On the right in Exhibit 9.5, however, mid-course correction is possible. The
odds are easier to determine. Potential downside risks are lower. The total expected value
of the proposed project is now calculated at a positive $10 million: EV = [(2/3) (−20) +
(1/3) (20)] + (1/3) [(2/3) (80) + (1/3) (−10)], which should trigger further investment.
There are many opportunities to capture additional value during the product development cycle. Drug companies, for example, rarely take a new formulation directly from
­compound invention to full commercialization without some form of delay. Projects are
abandoned at any point that they fail to meet safety and efficacy expectations and regulatory
approvals. This option to stop, instead of forging ahead, increases the ultimate project value,
a nuance not always captured when traditional discounted cash flow analysis is used to
determine if a project should be launched. Formerly abandoned projects are resurrected and
can provide residual value when existing formulations are repurposed. By using existing
formulations for new purposes, firms avoid early development stages—an approach, which
brings down failure rates and is on average 40 percent less expensive than investing in a new
drug from scratch.7 New drug development costs can reach $1 billion, so such savings are
significant. For example, a compound called sildenafil, which was originally to treat angina,
did not function for this purposes, and it could have been abandoned, but it became a highly
effective treatment for impotence and was rebranded as a very profitable drug, Viagra. This
example shows that the potential ­residual value of real options cannot be ignored.
Public-Private Partnership Models
Public-private partnerships (PPP) can also help organizations manage the uncertainty
surrounding massive, long-term initiatives that are designed to benefit society as a
whole. They combine resources, management skills, and technology of the private sector
with the resources, regulations, and other protections that governments may provide. 8
This approach is especially useful in the delivery of services that touch on basic needs.
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210 Part Three Implementation and Reinvention
EXHIBIT 9.6
Degrees of
Private Sector
Risk and
Involvement
per PPP Model
(Project Type)
Degrees of Risk & Involvement Required
Low
Medium
Design/Build
Lease/Dev/Operate
Operate/Maintain
Design/Build/Operate
Build/Finance
Design/Build/Finance/Maintain
Build/Finance/Maintain
Design/Build/Finance/Operate
High
Design/Build/Finance/
Operate/Maintain
Build/Own/Operate
Concession
Health care is a prime example.9 Given that populations have gotten older and more
urban in almost every country, care needs have skyrocketed. The challenges are significant, yet when PPPs are well designed and managed, they can begin to chip away at the
problem. The evolution of technology has presented a catch-22. Diseases and injuries that
once caused acute, fatal events, such as burns or cancer, have become more m
­ anageable.
New treatments have developed, often with the help of publicly funded research. They
save and extend lives, but also increase costs. PPPs can reduce reliance on bureaucratic
government structures while putting protective guidelines in place for the c­ onsumer and
mitigating private sector risks. They can be a powerful tool for reinvention of entire industries, such as medical devices, pharmaceuticals, and insurance. Ultimately they can lead
to significant ­improvements in health-care quality, efficiency, and access.
Transition economies greatly benefit from PPPs. Citizens in countries with transition
economies typically face infrastructure deficits, such as congested roads, poorly maintained transit systems and recreational facilities, and deteriorating schools, hospitals, and
water and water treatment systems. Poor infrastructure translates into less productivity
and competitiveness. It leads to more accidents, health problems and lower life expectancy. Governments with transition economies do not have the tax base needed to fund
improvements. PPPs, therefore, become valid methods to tackle the challenge. Business
leaders and public officials negotiate the best balance between fiscal responsibility, risk,
and control.10 There are a range of PPP models that allocate responsibilities and risks
between the public and private partners in different ways (see Exhibit 9.6).
Reinventing the Business Model
Business model innovation (see Chapter 7) focuses on improving how a company earns
revenues, incurs costs, and manages its risks; some initiatives can result in companies reinventing their business models, either in part or entirely. Business model reinvention takes a
company beyond just reimagining its products, technologies, and markets. A company
experiencing stagnating sales and declining profitability can search for new products and
services that it can offer to new customers in new ways. The business model encompasses
not only how products are created, but also how consumers interact and pay for them.
Several useful frameworks exist for business model reinvention. These frameworks
help firms analyze and make important trade-offs. As shown in Exhibit 9.7, even
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Chapter 9 Continuous Reinvention 211
EXHIBIT 9.7
Business Model
Reinvention—
Some
Considerations
Source: https://www.
capgemini-consulting.
com/resource-fileaccess/resource/pdf/
Business_Model_
Innovation.pdf.
Given our
customer
target...
Given our
interactions with
this customer...
Given the way
to we choose to
create value...
Can we
clearly state
an improved
value
proposition?
How can we
redefine our
revenue
model?
What will be
our revised
cost basis?
a ­simplified approach can help firms focus on what matters most: the value proposition,
revenues, and costs.
∙ The value proposition consists of products and services created to fulfill customer
­requirements. A deepened understanding of the market can reveal better targets—more
lucrative segments and geographies. Allstate, for example, drove new growth by understanding and accommodating the needs of four different customer segments, each with
distinct interaction preferences. Its high-touch response to customers compares favorably
to the low-cost approach of rivals, such as GEICO and Progressive (see Exhibit 9.8).
∙ The revenue model derives from the structure of customer interactions—their intensity, duration, channels, and payment methods. Shifts to decrease product touch times
or accelerate payments can provide significant top-line benefits. Subscription-based
­revenue models are on the rise, and are replacing less convenient single purchases
while increasing top-line revenues over the long term. Netflix has a subscription-based
model that has been copied by Amazon Prime. ­Amazon originally launched Prime to
provide the convenience of an unlimited two-day delivery service for a n­ umber of its
products, a move that has led to significantly higher loyalty and average sales. Then it
added an on-demand video and media streaming service like Netflix’s. Such subscription models whet consumers’ appetites for repositories of content a­ ccessible from
home for a flat monthly rate. Dollar Shave’s easy low-cost subscription model has
made inroads into a market P&G’s Gillette has long dominated. Gillette is now trying
to adjust its revenue model to incorporate elements of Dollar Shave’s model. It is
­trying to compete on value and pushing its own direct delivery service.
EXHIBIT 9.8
Allstate’s Full
Set of Value
Propositions
Encompass
High Touch,
Generic
Answer
Self-Serve,
Generic
Allstate
High Touch,
Branded
Esurance
Self-Serve,
Branded
Source: http://
allstatenewsroom.com/
ar2012/segmentationstrategy/.
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212 Part Three Implementation and Reinvention
∙ The cost basis is determined by how a company creates its outputs and fulfills its
value proposition. The development of simplified designs and delivery channels can
significantly reduce a firm’s costs. It all depends on how unique assets and capabilities are deployed to generate superior customer value. The Trader Joe’s example,
featured in Chapter 3, illustrates the benefits of a simpler service design.
Open Source Options
In order to redefine their business models, some firms have been stretching beyond organizational boundaries to engage innovation partners across the value chain. This technique
has been coined Open Source Innovation (OSI). Crowds are the open-source partner of
choice because of their ability to add product insights, enhancements, and solutions.11
Firms call on customers, suppliers, distributors, external experts, and other partners to
assist them, instead of relying solely on their R&D departments as the source for their innovative ideas. This type of innovation offers scale, speed, and less failure. The problem is the
potential intellectual property risks and the administrative burdens. While the technique
produces solutions unattainable internally, it is loose, decentralized, and hard to control.
A number of crowdsourcing variations exist. Kickstarter and Indiegogo are two popular OSI
platforms. However, it’s important to select the right tool for an organization’s unique needs:
1. If the task is highly challenging, technical, analytical, scientific, creative or aesthetic
in nature, a contest might be the best approach. Sites, such as Tongal, provide readymade platforms for contests (see Exhibit 9.9).
EXHIBIT 9.9
Contests Can
Help Firms Tap
into Crowd
Wisdom
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Chapter 9 Continuous Reinvention 213
2. If the task involves customer support, a collaborative community may work best.
­Although it is impossible to control the actions of the community or the dissemination of
the IP the community creates (for example, if the purpose of the community is to develop
software), there are significant benefits in drawing on the skills of dispersed motivated
individuals who work either because of their altruism or the desire for recognition.
3. If the problem is to gain access to large pools of laborers—and it is possible to
clearly define and evaluate the tasks to be done—it is possible to create a crowdbased labor market that efficiently matches talent to the tasks that have been defined.
Firms, such as TaskRabbit, ClickWorker, and Upwork (the merger of Elance and
oDesk), have businesses based on this idea. Virtual workers from all over the world
participate, creating competition for workers in developed countries.
Minimally Viable Models
Still another reinvention tool is the minimally viable model (see Exhibit 9.10). This
iterative development methodology, fueled by an active customer feedback loop, yields
a series of minimum viable products (MVPs). This type of thinking started with the lean
movement of the 1970s. Variants of minimum viable processes are scrum and agile
methodologies, which dominate in software development.
Minimally viable thinking, however, is not limited to product or service development
activities. These concepts have been applied to many other innovative practices of organizations. Minimum viable teams skillfully perform the activities that the organization
needs to operate, nothing more. Nonproducers are not welcome. Cofounders of new initiatives have to grow or abandon them. A minimum viable organization is built to the
point where it can compete well and pivot quickly. It is designed to tie into flexible
resource global networks that span both spatial and geographic boundaries and are
reconfigured quickly, often by open source methods. These networks are made up of
autonomous teams, individuals, and assets.
Recent MVP successes, such as Dropbox and AirBnB, are mere connectors or repositories of externally sourced content. They own few assets themselves. Rather, they bring people
together and in contact with assets with whom they are in contact and with whom they work.
EXHIBIT 9.10
Minimally
Viable Models
Bare bones products
that appeal to only the
most budget conscious
consumer
Products that satisfy a
critical mass of the
buying public but are
costly to product
Source: Jon Radoff’s
blog.
Minimum
Viable
Best mode for startups–or any
smart innovators. Faster
development at lower risk
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214 Part Three Implementation and Reinvention
Eco-System Development
As “minimum viable” enterprises, Dropbox and AirBnB rely on robust eco-systems. In fact,
Robust eco-systems are now mandatory for business model reinvention. Organizations that
deliver these eco-systems to their customers have many advantages. The eco-systems offer
ease-of-use advantages that single-product innovation cannot match. Apple blazed this frontier,
tightly integrating its hardware and software platforms, while insisting that external software
developers adhere to rigorous human interface standards. Apple continues to reject new apps
that do not follow its design and functionality guidelines, which have yielded a library of apps
sold on iTunes that, besides somewhat standardized design, are forward-compatible and operate intuitively as well as communicating across multiple hardware formats (iPhone, iPad, and
iWatch). The apps have greatly increased the value of the devices Apple sells to users. With
cloud and streaming capabilities that adhere to iOS design standards continuing to evolve,
Apple’s robust and user-friendly eco-system has been a clear source of its ongoing advantage.
Nest Labs, a producer of programmable, self-learning, sensor-driven, Wi-Fi-enabled
home automation products, has also followed this model. Founded in 2010, this company has created a full eco-system for its users. It strives to generate a sprawling network
of devices and companies that complement what it does, and function in tandem with its
products. Its acquisition of Revolv, a flexible platform to Nest’s library of p­ roducts, furthers this goal. The company has started a program called “Works With Nest” for developers interested in linking to its products.
The efforts of Apple and Nest to create viable ecosystems to support their products stand
in contrast to those of ill-fated Google Glass.12 Google pursued the product as a technology
push initiative. It was a solution in search of a problem. Google Glass did not solve any existing consumer issue in an effective manner. Google was more interested in publicly
­demonstrating that it was a technology first mover than in carefully packaging the product to
demonstrate its utility. The rough edges of the pilot products, the beta versions, did not satisfy
user needs. The lack of an eco-system with complementary products and at least a few killer
apps made the product less than user friendly. Google has repeatedly made this mistake and
has been forced to shelve Google Glass and a number of other promising products.
Technology Push versus Market Pull
The technology-push model of innovation starts with discoveries in basic science and engineering. From these discoveries come new goods and services. Exceptionally creative entrepreneurs and people in the research labs of large corporations harness the ideas of science
and technology and find useful applications. However, numerous empirical studies and
descriptions of innovation demonstrate the importance of a clear perception of market
needs.13 Schmookler argued that market factors are more important than technology and that
market growth and potential are the main determinants of innovation.14 Researchers have
concluded that it is the linking of both components—technology-push factors and marketpull ­factors—over the product life cycle that is important.15 Studies show that the amount of
innovation coming from scientific and technical people is roughly equal to that from manufacturers and users. Frequent interactions between these groups are important. Users must be
sophisticated enough to make technically relevant recommendations and must be able to
purchase and use the products that incorporate their suggestions. Successful innovations need
both scientific/technical and market components.
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Chapter 9 Continuous Reinvention 215
The challenge innovators and entrepreneurs face is to match technological opportunity with market need. For companies, this means bringing together different in-house
functions (such as marketing, R&D, and manufacturing) with knowledge of consumer
needs and scientific and technical developments. The essence of successful innovation is
that it fuses technological possibility with market demand. Technology-push and marketpull models are atypical examples of a more general process in which constant interaction occurs between market requirements and scientific achievement.
Finding Technological Opportunities
Technological developments provide the new ideas for innovation and entrepreneurship,
but finding the right technological opportunities is not easy. To forecast technological
change, it is necessary to anticipate breakthroughs early. The means of doing so include
trend analysis, monitoring expert opinion, constructing alternative scenarios, and
­immersing oneself in leading- or cutting-edge technologies. The strengths and weaknesses of these approaches to technological forecasting are worth assessing.
Trends: Trends in one area often forecast trends in another (e.g., military jet speeds foretell commercial jet speeds). One can extrapolate, for instance, the number of components
needed to manufacture one product to estimate the number needed to manufacture a similar
product. But trends must be analyzed with caution. Simple extrapolation can be deceiving if
it does not account for the impact of one trend on another, fails to consider how the human
response to trends can change their direction, and has no room for surprises. Economic
forecasts are good at predicting the future on the basis of the past as long as the future
­resembles the past in important ways. However, radical breaks occur (e.g., the 1973 Arab oil
embargo, the fall of Communism, the 9/11 terrorist attacks, and the economic meltdown at
the end of the first decade of the 21st century), which few economists predicted.
Alternative Scenarios: Often, when the future is uncertain, the best coping method is to
construct alternative scenarios (see Chapter 2).16 Companies may create a series of possible
sequences of future events. Scenarios allow companies to think through what they would do if
unfavorable circumstances should arise and thus provide them with the opportunity to better
manage future contingencies when they come. Companies must monitor the environment for
signals that may be the forerunners of significant changes. To do so, they have to clarify which
indicators to follow. Then they have to understand how to interpret the information. A free
society produces an immense amount of information. Professional conferences, technical
papers, and the media all yield data that vie for a manager’s attention. What to focus on and
what to ignore—what is the “true” signal and what is the “noise”—is a perpetual problem.
Leading-Edge Industries
Leading-edge industries provide momentum for technological change. Companies monitor
them carefully. In these industries, they are likely to see the opportunities for profit. They can
then vigorously exploit the possibilities inherent in these sectors. The pioneers in a leadingedge sector typically are followed by a swarm of imitators. The combined activity of the
pioneers and their followers generates boom conditions. Soon, however, there are so many
imitators that prices fall and bust follows. Lagging sectors fall behind, their time passes, and
they wither and die or are kept afloat by government subsidy and bailout. New leading-edge
industries are needed to spur a revival, a process that has been called creative destruction.17
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216 Part Three Implementation and Reinvention
Technological progress occurs in waves. The first wave after the Industrial Revolution (1782–1845) saw major innovations in steam power and textiles; the second wave
(1845–1892) saw major innovations in railroads, iron, coal, and construction; and the
third wave (1892–1948) saw innovations in electrical power, automobiles, chemicals,
and steel. The prosperity of the post–World War II period was built on innovations in
semiconductors, consumer electronics, aerospace, pharmaceuticals, petrochemicals,
and synthetic and composite materials. Starting in 1993, the Internet and advances in
telecommunications started another wave of progress. Where future waves of innovation will come from remains uncertain.
The current era has been called one of post-industrialism.18 Post-industrial societies
differ from industrial societies in a number of ways. There is a move from goods to services and preeminence for professional and technical people. Control of technology and
technological assessment are primary activities. In post-industrial societies, physical
­resources are less significant. Intellectual resources are at the center of economic activity
rather than the manipulation and movement of products made from natural resources and
physical labor. The microchip symbolized this shift from the materials to ideas, as the
material costs of the product are but a small fraction of the total cost of manufacturing.
The information component is of greater value than the material component. The most
valuable part of the technology is the idea for its design. Here are a number of examples:
biotechnology, low-cost environmental solutions, and high-value environmental products.
Biotechnology
The movement from industrial to post-industrial society can bring into existence a more
sustainable society, one in which people’s basic needs for food and a healthy environment can be better met. For instance, instead of being sprayed with pesticides, plants can
be genetically coded to repel or destroy harmful insects. This is a much smarter way of
doing business because up to 90 percent of what is sprayed on crops is wasted. Biotechnology can create smarter products that reduce chemical use. A bioengineered potato
that defends itself against the potato beetle and does not have to be sprayed with pesticides is just one example. Bt cotton, which kills and repels budworms, is another.
By 2000 more than half of the U.S. soybean crop and more than one-third of the corn
crop involved bioengineered products. Scientists were able to protect crops, such as corn,
soybeans, cotton, potatoes, and tomatoes from pests. They were also working on taking
genes from fish that swim in icy water and injecting them into strawberries to enable the
strawberries to resist frost.
In addition to crop protection, biotechnology has promised advances in a number of
other fields:
∙ Nutrition. Scientists may be able to extract genes from one species (a Brazil nut) and
put them into another species (the soybean) to increase the protein level to make the
soybeans more nutritional. They are trying to make soybeans taste better and to
­remove some of the saturated fats to improve soybeans’ health benefits.
∙ Pharmaceuticals. Scientists may be able to introduce genes into rice that will enable
it to produce beta-carotene and thus combat the vitamin A deficiency common among
people who rely on rice for sustenance. They also have been developing vaccines for
hepatitis B, diarrhea, and other diseases that can be incorporated into the cells of a
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Chapter 9 Continuous Reinvention 217
banana or a sweet potato and thereby distributed to people in developing nations who
may not otherwise be protected against these diseases.
∙ Industrial. The aim is to make industrial materials, such as plastics, nylons, and other
petrochemical byproducts from genetically modified plants. These plants would replace world reliance on highly polluting hydrocarbons.
Some scientists and entrepreneurs hyped the chances of success, but there were difficulties deciding which products should come first. What deserves rapid commercialization?
Government has played a large role in the use of biotechnology for pharmaceuticals. Many federal agencies have some jurisdiction and guidelines are unclear.
While waiting for regulatory approval of a product, companies have to develop
manufacturing facilities that they cannot run at full capacity and sales forces that
cannot yet market the product. Many companies, therefore, have moved to nonpharmaceutical industries.
In addition, many environmentalists criticize genetically engineered food as
­being “Frankenstein” in quality. 19 They point to an incident in 1995 when a Brazil
nut gene had been spliced together with soybeans to increase the level of the amino
acids methionine and cysteine in the soybeans. The splicing together of the genes of
these plants produced nutritious animal feed; however, humans allergic to Brazil
nuts could die if they accidentally consumed a soybean or a soybean product with
the spliced gene. Environmentalists also publicized 1999 research by a Cornell University researcher showing that eggs of the monarch butterfly could perish if
exposed to Bt-modified corn pollen. The pollen destroyed three-day-old monarch
larvae 44 percent of the time in a laboratory study. When it comes to human consumption, environmentalists insist on a precautionary principle: so long as risks of
any kind exist, the burden is on the introducer of a new product to demonstrate
complete safety. They argue that genetically modified seeds were rushed to the market without adequate independent testing. Only minimal testing was done, or small
sample sizes were used, which did not pick up negative results. Though some of the
evidence has been speculative, environmentalists have warned against eating bioengineered foods, and European governments have imposed regulations calling for the
separation of approved and unapproved strains, requiring labeling, and preventing
the sale of some products.
Low-Cost Environmental Solutions
At one time, environmental issues were regarded primarily as threats to business.
However, if extracting more economic value from fewer natural resources and raw
materials can improve existing products and services and lead to the development of
new ones, these challenges can be the catalysts for business innovation. Environmental considerations have played a central role in many companies’ optimization of production processes not only in pollution-sensitive industries, such as petrochemicals
and electric power, and in basic manufacturing industries, such as auto, steel, paper,
and cement, but also in high-tech industries, such as semiconductors. While the
­conventional view is that environmental challenges impose costs on business, slow
productivity growth, and hinder global competitiveness, a revisionist view sees them
as the driving force for cost reduction.
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218 Part Three Implementation and Reinvention
Pollution can be seen as a form of inefficiency that demands of firms that they lower
their costs.20 It is an indication of unneeded scrap, harmful substances, and energy that
is not completely used and creates no value for customers. Competitive advantage,
therefore, can be reached by developing environmental competencies in areas, such as
pollution prevention, and in developing new energy-efficient products and services.
Companies have to add up total production inputs and try to minimize them, carefully
examining production processes to ensure that they are maximally efficient and do not
waste inputs. Many companies have inventoried their wastes, evaluated the impacts,
and implemented successful reduction programs. A successful program requires that
the company pay attention to product and process design, plant configuration, information and control systems, human resources, R&D, the suppliers’ role, and the corporate
organization. A team must be assembled, a method for measuring progress determined,
process flow diagrams prepared, and tracking systems for materials use set up. Operational and material changes have to be considered, including material use substitutions
and process and production changes. For such programs to succeed, employee involvement and recognition are needed.
High-Value Environmental Solutions
For many companies, excellence in protecting the environment has created opportunities
for competitive advantage. These companies not only have been lowering costs and
achieving cost leadership by pursuing environmental efficiency, but they also are pursuing a differentiation or focus strategy based on developing green products for niche markets. Win–win solutions mean that both the environment and society are better off.
A high-value environmental strategy does not just involve waste reduction; it also
entails developing new products and services. Consider the electric car as an example.
The 2009 Obama administration stimulus package included $2 billion in grants for electric car research and $25 billion in low-interest loans for green vehicle purchases. A way
to drive down electric car prices was to have customers lease the batteries from a third
party. Better Place, an Israeli startup, proposed to do this. Its business model was to own
and maintain the batteries and sell subscription plans for their use. It expected to operate
like a cell phone company that sold miles instead of minutes. Better Place, however,
overextended itself and went bankrupt.21
Other startups entered the electric car market, but the only one to survive and prosper
was Tesla. Its high-end Roadster sports car, priced at $109,000, accelerates from 0 to
60 miles per hour in less than four seconds and is faster than some Ferraris. Of great
importance is that the Roadster offered a solution to the range problem. Its lithium-ion
battery pack provided the car with a range of 245 miles. Compared to the Roadster, the
Leaf, Nissan’s mid-size all-electric vehicle, has a range of less than 100 miles.
Tesla overcame this longstanding barrier to the commercialization of an electric car by
designing a battery pack with 7,100 lithium-ion cells as opposed to the 192 cells in the
Leaf’s battery. Together with Panasonic, its battery supplier, Tesla created a sophisticated
computerized system for monitoring the batteries’ temperature and cooling them should
the batteries get too hot. Tesla also redesigned its car, placing the bulky battery packs
under the car, where they improved the car’s stability and handling. The battery packs
heightened the driving experience rather than acting as a deficit. Also, the R
­ oadster was
made from super-light high-tech materials in an extremely automated factory setting to
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Chapter 9 Continuous Reinvention 219
keep costs low, while the car’s shape was aerodynamically designed to minimize the drag.
These design improvements were essential if there was any hope that the electric car
could become commercially viable.
With the Roadster, Tesla entered the high-end automotive market. In this segment, a small slice of customers was prepared to pay a high premium to purchase an
innovative vehicle. At its sale price, more than $100,000, the Roadster clearly was
not for the masses, but Tesla’s plan from the beginning was to take on each of the
commercialization barriers it faced one by one. The next barrier was to move down
market and lower the price of the electric vehicle. Its business plan involved, after
building and selling the Roadster, using the money it made to build a more affordable car and, after building a more affordable car, using those profits to build an
even more affordable one. The second model Tesla produced was called the Model
S, and it sold for $69,000, competing in the same category as the Audi A6 and the
BMW 5 series. The car was 10 percent faster than said vehicles and offered other
attractive features that allowed it to win Consumer Report’s 2014 “car of the year”
award. The magazine gave it the highest rating it ever gave to a car, praising it for its
styling, handling, fuel efficiency, and safety.
However, Tesla would still have to create an even more affordable electric car, and
getting to the next level would not be easy. The batteries in a more affordable electric
vehicle, depending on how many there were in a pack, can cost anywhere between
$7,500 and $18,000. Can Tesla sell a mid-sized sedan for about $35,000 with batteries
this expensive? To lower costs, Tesla started to build a giant battery factory in the deserts
of Nevada with partner Panasonic. To ensure that there was sufficient demand for these
batteries, it opened up its electric vehicle patents to all comers, including conventional
automakers like GM in the hope they, too, would build this type of car in large numbers
and buy the batteries.
Wrapping Up: The Dilemma of Strategic Change
This book opened with a discussion of inflection points—momentous shifts in technologies, markets, laws and regulations, global conditions, and the economy that
create deep-seated departures from the past—and the significance of such points has
been emphasized throughout all nine chapters. When an inflection point occurs, the
pressure for change increases and firms have little choice but to try to remake themselves. Those that can better navigate such conditions are better able to thrive. They
struggle against vested interests that do not want to budge from the status quo. They
fight staff, for instance, that does not want to honestly confront the challenges that
lie ahead.
Yet firms often find that it is simpler to stick to the past than to move forward. Barriers to change abound, and resistance comes from many quarters. Mobilizing the forces
of change to overcome these barriers is not easy. Just determining where the firm wants
to be next is a difficult decision. Many corporations focus on what the firm has been
good at in the past. They do not want to give up what they are currently doing, nor do
they want to move to an unknown destination. Developing new capabilities and competencies is demanding, and they are reluctant to do so.
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220 Part Three Implementation and Reinvention
There are several approaches firms can take when dealing with the prospect of
­making changes:
∙ Some firms vigilantly guard the past. These are defenders.
∙ Other firms have no hesitation about taking the next steps and moving into the future.
They vigorously search for new opportunities. They are prospectors.
∙ Others try to simultaneously cultivate the past, while they journey into the future.
These are analyzers.
∙ Still others, overwhelmed by change, become confused and do not know what to do.
These firms are reactors.
When inflection points bear down on firms, the reactors may well be the poorest performers. They are adrift without direction. They may just be trying to keep their options open.
At some point, they will have to decide on a direction. Defenders, too, may be in a poor
position. However, if they can effectively mobilize resources, they may be able to protect
their current position. As survivors in unattractive industries, they can defend remaining
niches. As other firms leave the industry, they can pick up revenue streams and profits.
Prospectors, those who seize opportunities before others realize their value, face many
challenges. Key among them is the risk of being too far out in front of competitors. ­Pioneers
rarely realize the full gains of the quick and early thrusts they make into new territory.
Early movers face many problems. For instance, they must convince recalcitrant buyers to switch before a new product has been accepted and standards for its manufacture
and use have been established. The experiments in which they take part are costly. The
efforts they make are often premature; the mistakes are hard to undo. Aggressive second
movers learn from and capitalize on pioneers’ miscalculations; they take advantage of
the first movers’ misfortunes.
The managers of most firms tend to understand these risks. Seeing the failures of over
exuberance all around them, they do not have to be persuaded to be cautious. Many
choose to be conscious and deliberate analyzers. Perched between the past and the ­future,
they try to defend and exploit a successful niche and, at the same time, seek out new
­opportunities for growth and expansion.
This approach requires maintaining a delicate balance. Pulled in two directions at once,
the position the firm tries to straddle may not be tenable. The organizational requirements
for exploiting a past niche are not necessarily compatible with those for exploiting a future
one. The former calls for the utmost efficiency to fend off encroaching competitors,
whereas the latter requires maximum creativity to move into uncharted territory.
While efficiency depends on having strict command and control structures that may
stifle employees’ ability to innovate, creativity depends on loosening constraints that
stand in the way of new ways of thinking and behaving. Thus, the middle position may
not be viable. A firm may have to decide whether to continue as dominant in what it has
been doing well or try to become dominant—as soon as possible—in what it would like
to do well next. If it simultaneously tries to prospect and defend, it is likely to be mediocre at both and will fail because it has no comparative advantage.
Sustained Competitive Advantage
Sustained competitive advantage (SCA) is fleeting, and managers must be watchful of
major turning points in which the dilemma of where to go is most challenging. This
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Chapter 9 Continuous Reinvention 221
book has developed a sequence of steps that managers can take to deal with change. This
approach to strategy can be summarized as follows: SCA is equal to external analysis
(EA) plus internal analysis (IA) plus moves (M) that the strategist can take. That is,
SCA = EA + IA + M
The moves should be taken with as much knowledge as possible of the responses
opponents can make and the consequences of those responses.
External and Internal Analysis
External analysis (Chapter 2) and internal analysis (Chapter 3) both have a number of components. External analysis (EA) is an assessment of industry attractiveness. The industry is
defined as best as possible, although industry definition is often problematic because
industry boundaries are shifting. In analyzing the external environment, the organization:
∙ Examines the five forces (5F) in the industry—suppliers, customers, competitors,
new entrants, and substitutes. These determine the industry’s attractiveness.
∙ Assesses the macro-environmental forces (MF)—economics, politics, technology,
demography, social conditions, and the natural environment—that influence the five
industry forces.
∙ Conducts a stakeholder analysis (SA)—an assessment of such key constituencies as
shareholders, government, advocacy groups, and the media. This determines the network of ties between the firm and its constituencies.
Each of these assessments should be conducted to the extent possible. Thus,
EA = 5F + MF + SA
Internal analysis (IA) is an assessment of the firm’s strengths and weaknesses. In
analyzing the internal environment, the organization:
∙ Assesses the degrees to which it is mechanistic or organic and whether there is a good
fit with the environment.
∙ Examines the seven S’s (7S) in the firm—strategy, structure, systems, staffing, skills,
style, and shared values—to determine if there is balance among these factors.
∙ Assesses the firm’s value chain (VC)—its primary and support activities in areas,
such as inbound and outbound logistics. What are the linkages between the firm’s
value chain components and those of other firms?
∙ Examines the firm’s resources, capabilities, and competencies (RCC)—its strengths.
Are they combined in a way that provides something rare, hard to imitate, difficult to
substitute, and valuable?
Thus,
IA = 7S + VC + RCC
Each part of external and internal analyses provides a more complete picture, but time
constraints may preclude a thorough assessment of each element. Before choosing
moves, the analyst should ask:
∙ Given the firm’s unique configuration of resources, capabilities, and competencies,
how defensible is its position?
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222 Part Three Implementation and Reinvention
∙ Are the resources, capabilities, and competencies barriers to change, or can they be
the drivers of entrepreneurial activity and new business development?
Moves after External and Internal Analysis
External and internal analyses are only the start of the strategy process. They are
­preliminaries to making actual moves (M). The firm’s possible moves depend on the
­options available and on whether the firm should use or forgo them. Timing plays a role,
and competitors’ reactions must also be considered. The strategist needs to understand
the possible moves the organization can make. He or she must consider each move by
itself as well as combined with other moves in an ordered sequence. The strategist then
has to determine to what extent the moves have the potential to achieve the organization’s goals, given the fact that competitors are also choosing or forgoing moves at the
same time.
A rational process would be to list all the options available, consider all the consequences, and choose the best, but this degree of comprehensiveness may not be feasible.
Given the risks and uncertainties of each action and the limited time and calculating
ability of the analyst, precisely estimating results of following every potential course of
action is usually not possible. The analyst can, however, try to approximate this type of
estimation. A shortcut for generating a list of options is to think in terms of the moves
discussed in Chapters 4 through 7: positioning; mergers, acquisitions, and divestitures;
globalization; and innovation. Each of these chapters considered a type of generic move
that the analyst might think of pursuing.
Timing and Positioning
Chapter 4 dealt with the timing (T) of the moves a firm might make as well as the positioning (P). Should the moves be early or late, and what combination of low-cost and
high-quality attributes should be incorporated into a product or service to create a best
value proposition? These decisions are included in business strategy (BS):
BS = T + P
Mergers, Acquisitions, and Divestitures
Chapter 5 addressed mergers, acquisitions, and divestitures (MAD). At issue here are the
size and scope of the firm itself, the extent of its diversification, the degree to which it
should focus on one product or market or on many, and the degree to which it should be
integrated up or down the value chain. These decisions typically are included in the category of choices called corporate strategy (CS):
CS = MAD
Global Expansion
Chapter 6 dealt with the rationale for a firm’s global expansion (GE). Should such
­expansion be undertaken primarily for marketing, manufacturing, or other reasons?
Should it be carried out in a uniform way that promotes low cost or a customized way
that requires expensive adaptation? Another issue is the extent to which the firm should
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Chapter 9 Continuous Reinvention 223
outsource (OS) its global operations: Should it partner with local allies or internalize
them? These are some of the critical elements of global strategy (GS). Thus,
GS = GE + OS
Innovation, Entrepreneurship, and Implementation
Chapter 7 discussed innovation and entrepreneurship. The roles of entrepreneurs,
established firms, funding sources, and backers of the firm, including government,
have to be sorted out. The firm has to discover what opportunities (O) are available,
and it must analyze the obstacles to commercialization (C). It must achieve a match
between a technology’s development stage and the market’s readiness for that technology. This category of moves, which we refer to as innovation strategy (IS), can
be expressed as
IS = O + C
Finally, Chapters 8 and 9 dealt with implementation and reinvention. Without effective
implementation (I) all these moves are for naught. Without continual reinvention, the
firm stagnates and loses ground.
The Expanded Model
Together, the four categories of moves and the external and internal analyses create an
expanded model of SCA, as follows:
SCA
=
[EA + IA]
+
[BS + CS + GS + IS]
+
[I + R]
Analysis
Moves
Implementation &
Reinvention
If a firm continuously engages in this process, it will be better able to deal with inflection points, to redeploy assets, and to regularly reinvent itself. Two examples of reinvention are discussed in Exhibit 9.11: first, Microsoft’s reinvention in response to Netscape’s
emergence, and second, the reinvention of retail food companies in the face of Walmart’s
emergence.
Recognizing Customer Needs
The challenge the retail food industry faced was similar to the challenges many
industries have faced. They have had to reinvent themselves by giving more prominence to customer needs. This type of reinvention entails a view of the organization
as a feedback loop. It starts with recognition of customer needs and ends with an
attempt to satisfy these needs at a higher level. Companies must have aggressive
goals with respect to the speed and consistency with which they deliver goods and
services to their end-customers. It is essential to set up critical business processes,
as in the retail food industry, to accomplish these ends. Superior information is the
basis for meeting customer needs effectively. Companies have gone from products
to solutions (see Exhibit 9.11). Profits come not from a firm’s resource-intensive
assets, but from knowledge. To capture profitable niches in industries, companies
use their know-how.
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224 Part Three Implementation and Reinvention
EXHIBIT 9.11 Two Stories of Reinvention
Story 1 – Browser Wars. Microsoft reinvented itself in the face of a challenge presented by Netscape. For new entrants like Netscape,
staying under the radar is very important. The struggle between Netscape and Microsoft over Internet browsers involved a fast, flexible
­entrant, Netscape, which took on a dominant and powerful firm, Microsoft, in a judo-like struggle of a small flexible competitor against one
which was much larger and more powerful. Eventually, however, Microsoft’s Sumo-like tactics prevailed.
In 1997, at the height of the browser wars, Netscape had 700 employees and $80 million in sales, while Microsoft had 17,000 employees
and $6 billion in sales. In 1996, Netscape peaked with close to 90 percent of the browser market. One year later, its market share was
down to less than 50 percent. Ultimately, it was Microsoft, not Netscape that controlled this market.
Netscape achieved its initial dominance of the browser market in a number of ways. By releasing a beta version of Navigator in 1994, Netscape
­received free assistance in developing the product from early users who acted as a quality-assurance team. It then separated the browser from
other Internet options sold by vendors (such as dial-up access and e-mail accounts) and virtually gave the browser away for free. The official price
was $39, but academics and nonprofit organizations did not have to pay, and anyone could download the browser for a free 90-day trial.
At first, Microsoft more or less ignored Netscape—it was preoccupied with bringing another Windows version to the market. But in December
1995, Bill Gates proclaimed that Microsoft was going to be “hard core” about the Internet. Netscape’s aim was to build market share and set
the industry standard, and then make money through licensing fees for Navigator code used in browsers, intranet and extranet software,
­e-commerce solutions, Web servers priced in the thousands of dollars, and a portal that competed with Yahoo!, AOL, and InfoSeek.
Microsoft matched these moves. Not only did it give away its Internet Explorer to all users, including corporate clients, but it also bundled it
with Windows 95. Internet Explorer popped up on the desktop of every Windows user. Microsoft also outbid Netscape for contracts with
­Internet service providers, including giant AOL with its millions of customers. In putting AOL’s icon on the Windows desktop, however,
­Microsoft ceded ground to AOL and undercut its own online network, MSN.
Microsoft was determined to break Netscape, particularly because Netscape’s managers claimed that their system would make the
­Windows operating system unnecessary. By threatening the existence of Windows, Netscape’s executives spurred Microsoft to retaliate.
­Unlike in judo, Netscape’s managers were not sufficiently prepared for Microsoft’s inevitable response and retaliation.
By means of its struggle with Netscape, Microsoft reinvented itself. Still, it was hurt by this battle. The Department of Justice challenged its tactics
as violating the Sherman Antitrust Act: As a company with a dominant position—more than 90 percent of the operating-system market—Microsoft
could not use its Windows monopoly to defeat a competitor in another market it wished to enter. Microsoft’s exclusive bundling deals and the
threat it made to cut customers off from Windows if they used Netscape went too far. Microsoft defeated Netscape, but its long clash with the
­Justice Department seriously damaged the software maker. That clash made Microsoft a much less aggressive company.
Story 2 – Retail Food. The retail food industry has experienced deep-seated transformation. Changing consumer demographics and
­lifestyles, alternative whole-meal replacement chains, specialty stores, hypermarkets, cooperatives, deep discounters, and, most
­significantly, general merchandisers, such as Walmart have eroded market positions among traditional grocery stores and supermarkets.
By 2000, Walmart had become the largest grocer in the United States.
Walmart’s strategies posed basic challenges to the grocery industry. The company’s distribution costs were about 3 percent of sales,
roughly half the cost of the typical supermarket chain. The grocery industry’s response to these changes was a gargantuan campaign to
acquire new competencies in supplier and customer relations. The actions it took were meant to improve the efficiency of the supply chain,
a complicated undertaking involving both people’s skill levels and technology. With competition in the food industry rising and a rapidly
changing retail environment, acquiring capabilities in supplier and customer relations was a key to grocers’ survival. Firms in the industry
had to acquire new information systems that linked customers, wholesalers, and manufacturers; achieved enhanced food chain integration; and provided for stronger alliances between retailers and vendors, leaner inventories, lower inventory costs, and better logistics.
Thus, the industry’s goal was an entire reinvention of all its business practices; it tried to reengineer the supply chain with new alliances
and incentives that would do away with waste. Stronger alliances between retailers and suppliers were expected to yield leaner inventories,
lower inventory costs, better logistics, and improved exchange of information. The goal was to get higher product turnover and greater
sales per square foot. The supermarket industry recognized the importance of supply chain management in achieving this goal.
Supermarkets are at the end point in a long chain of food distribution that starts with the grower and processor and manufacturer and
moves through an assortment of wholesalers, distributors, and warehouses before final purchase and consumption by consumers. The
­average supermarket deals with many suppliers, and the industry understood that supply chain improvement was vital. The entire industry
effort was designed to have the right goods available to consumers at the right times and in the right proportions. The Walmart challenge
unleashed reinvention in the industry.
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Chapter 9 Continuous Reinvention 225
Precision merchandising eliminates mismatches between what is on the shelf and
what a firm’s customers want. Walmart, for instance, uses the data it collects on customers’ purchasing habits to create predictive algorithms for nearly every inch of shelf space
in its stores. If it can eliminate discrepancies between what customers want and what is
available, it not only reduces shortages, but also minimizes closeouts and losses on
­excess inventory.
Many companies use their knowledge to micro-segment their customers (see C
­ hapter 4).
There are significant differences in customer wants and needs based on age, income, gender,
and so on. Because one size does not fit all, some managers ­divide customers into finer and
finer segments, trying to serve a category of one, or nearly one, customer. M
­ icro-segmenting
yields a market in which customers are willing to pay more for products because the products
are better suited to their needs, more ­personalized, and more functional.
A firm must use its data to figure out which groups of customers are profitable and
which are not. Managers must ask if there is any value to serving some customers at a loss.
Do the money-losing customers help to cover fixed costs? Can they be converted to profitable customers? If they have no value, why is the firm serving them? The firm must a­ nalyze
and reanalyze its customers to know which result in the most profit and how to manage
those that are not so good. It has to understand how the brands, styles, design, functions,
performances, and prices that it offers fit together to serve different customer classes.
Customer analysis (as illustrated in Exhibit 9.12) leads managers to examine the value
chain and think of ways of bringing customers and suppliers closer together. Since a
company cannot be good at everything, it should divide the value chain into separate elements and determine where it can derive the most value, concentrating on areas in which
it can establish leadership and outsource the rest.
To create smart business designs, companies must think in terms of customers, suppliers, distribution channels, and competing value chains. These are the main building blocks.
The firm’s goal should be to establish a continuous flow of goods, services, and ­information
from suppliers to customers. The firm engages in numerous transactions and communications with customers, so it should try to move from ad hoc, episodic interactions to continuous, accurate interactions. The types of interactions analyzed should reduce guesswork,
increase efficiency, and enhance the flexibility and fast response the firm needs.
EXHIBIT 9.12
Creating
Solutions for
Customers
Customer Process–BEFORE
Customer Process–AFTER
• Inefficiency and confusion
• Supplier simplifies process
• Components bought separately,
integration incomplete or totally
dysfunctional
• Provides entire system and/or
complete package of maintenance,
service and financing
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226 Part Three Implementation and Reinvention
Summary
Firms must prepare for inevitable turmoil and uncertainty. To do so, they require a portfolio of strategic initiatives that they must manage. The major challenges in managing
this portfolio are identifying the types of initiatives to be pursued, allocating limited
management resources across the portfolio, and appropriately managing the risk inherent in each project. Firms that are successful on these fronts greatly improve their odds
of achieving sustained competitive advantage.
Firms rely on many methods for reducing the risks and uncertainties inherent across
their portfolios of initiatives. Public-private partnerships offer one way of containing the
uncertainty. Pared-down approaches to business model reinvention can also limit the
downside of venturing into unfamiliar territory. Methods that assist in reinvention
­include open source innovation, minimally viable business models, and the development
of robust and vibrant eco-systems. To reinvent the business model, firms must search for
and find technological opportunities. Often these can be found among leading-edge
­industries, which have shifted from a reliance on materials and physical capital to a reliance on ideas and intellectual capital. Some examples of these are biotechnology and
low-cost and high-value environmental solutions, such as, in the case of the latter, the
electric car and Tesla’s efforts to remake the auto industry.
This chapter has also emphasized the main themes of this book. The purpose of strategy is to achieve sustained competitive advantage. Doing so requires a good knowledge
of external opportunities and threats and internal strengths and weaknesses. Based on
this knowledge, a company is ready to recommend a series of moves it can make. These
moves can address the cost and quality of the products and services that the firm offers.
They can involve expanding or subtracting from the scope of the firm’s businesses via
mergers, acquisitions, and divestitures; globalizing the firm’s offerings; or engaging in
innovation and entrepreneurship with entirely new products, services, or lines of business. Success of the moves depends on effective implementation.
The activity of gaining knowledge about the external and internal environment and
considering the moves that the firm can make is not a one-time event. Rather, the firm
must engage in it continuously and must be constantly alert to changes in its external and
internal environment and ready to make moves that reinvent its strategy. Two examples
of the need for reinvention come from Microsoft in its battle with Netscape and the retail
food industry in its battle with Walmart.
Lastly, this final chapter has shown how creative business redesigns can bring firms
into closer contact with their customers. Enhanced customer intimacy comes from business designs that systematically collect detailed information about customers, break up
customers into smaller and smaller segments, and provide them with integrated packages
of solutions rather than separate products and services. Smart ­business designs break down
the barriers that stand between firms and their customers and then multiply the points of
access or contact points between the two parties. Firms move into uncontested spaces that
can be protected through smart business designs that bring closeness to customers.
Questions for the Practitioner
1. Does your firm adhere to Eric Schmidt’s 70:20:10 rule? If so, what types of “third horizon” projects has it undertaken? If not, where should it begin expanding its ­horizons?
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Chapter 9 Continuous Reinvention 227
2. Is your firm organized to fully capitalize on a sufficient portfolio of longer-range opportunities? Explain.
3. Has your firm explored open source or public-private initiatives?
4. Does your firm (or any of its competitors) offer an eco-system of products and services? If so, describe the eco-system and whether it provides a competitive advantage.
5. To what extent is your firm utilizing the range of strategic options presented in this
book’s SCA model? If minimal, why do you believe this is so? Propose two or three
alternatives to your firm’s current approach. Discuss the trade-offs that would be involved in changing the types of maneuvers that are typically made.
Questions for the Student
1. Spend some time identifying some of the most groundbreaking innovations made
over the past two years.
2. Research the processes that were followed to arrive at these innovations. Were
they the result of MVP processes, public-private partnerships? Business model
­innovations?
3. Given the direction of the latest innovations, what seems to be the best “next horizon”? What types of resources and structures would be required of a firm undertaking
such “next horizon” development?
4. How can you personally utilize the concepts of external analysis, internal analysis,
strategies/tactics, and implementation to forge a personal competitive advantage as
you begin your career?
Endnotes
1. Lowell Bryan, “Just-In-Time Strategy for a Turbulent World,” McKinsey & Company,
June 2002, http://www.mckinsey.com/insights/strategy/just-in-time_strategy_for_a_turbulent_world.
2. Max Nissen, “Samsung Has a Totally Different Strategy from Apple, and It’s Working Great,”
Business Insider, March 15, 2013, http://www.businessinsider.com/samsung-corporate-­
strategy-2013-3#ixzz3jpw1sQ74.
3. Andreie Nedelea, “Kia Details the Design of Its Sportspace Concept,” CARSCOOPS, February 27, 2015, http://www.carscoops.com/2015/02/kia-details-design-of-its-sportspace.html.
4. Bryan, “Just-In-Time Strategy for a Turbulent World.”
5. Mehrdad Baghai, The Alchemy of Growth: Practical Insights for Building the Enduring Enterprise (Basic Books: New York, 1999).
6. Tom Stafford, “Fundamentals of Learning: The Exploration-Exploitation Trade-Off,” June 6,
2012, http://www.tomstafford.staff.shef.ac.uk/?p=48.
7. A. R. Oxford, “Drug Development Teaching Old Pills New Tricks,” The Economist, February
13, 2013, http://www.economist.com/blogs/schumpeter/2013/02/drug-development.
8. Patrick Sabol and Robert Puentes, “Private Capital, Public Good,” The Brookings Institution,
2013, http://www.brookings.edu/research/reports2/2014/12/17-infrastructure-public-privatepartnerships-sabol-puentes.
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228 Part Three Implementation and Reinvention
9. Marc Mitchell, “An Overview of Public Private Partnerships in Health,” Harvard School of Public
Health, undated, https://www.hsph.harvard.edu/ihsg/publications/pdf/PPP-final-MDM.pdf.
10. United Nations Economic Commission for Europe, “Guidebook on Promoting Good Governance in Public-Private Partnerships,” United Nations, New York and Geneva, 2008, http://
www.unece.org/fileadmin/DAM/ceci/publications/ppp.pdf.
11. Kevin J. Boudreau and Karim R. Lakhani, “Using the Crowd as an Innovation Partner,” Harvard
Business Review, April 2013, https://hbr.org/2013/04/using-the-crowd-as-an-innovation-partner.
12. Elaine Chen, “How a Technology-Push Process Led to the Reboot of Google Glass,” Wired
Innovation Insight, March 27, 2015, http://insights.wired.com/profiles/blogs/how-a-technologypush-process-led-google-glass-to-its-reboot#axzz3k3sCcMAl.
13. R. Rothwell and W. Zegveld, Reindustrialization and Technology (Armonk, NY: M. E.
Sharpe, 1985).
14. J. Schmookler, Invention and Economic Growth (Cambridge, MA: Harvard University
Press, 1966).
15. E. Von Hippel, “Appropriability of Innovation Benefit as a Predictor of the Functional Locus
of Innovation,” Sloan School of Management MIT working paper 1084–79, 1979.
16. A. Marcus, Strategic Forecasting: A New Look at Scenarios (New York: Palgrave McMillan, 2009).
17. J. Schumpeter, Business Cycles (New York: McGraw-Hill, 1939); N. Kondratiev, “The Major
Economic Cycles,” Voprosy Konjunktury 1 (1925), pp. 28–79, English translation reprinted in
Lloyd’s Bank Review, no. 129 (1978); I. Kirzner, Perception, Opportunity, and Profit
(­Chicago: The University of Chicago Press, 1979).
18. D. Bell, The Coming of Post-Industrial Society (New York: Basic Books, 1973).
19. A. Marcus, Innovations in Sustainability: Fuel and Food (Cambridge, UK: Cambridge
­University Press, 2015); also see A. Marcus The Future of Technology Management and the
Business Environment: Lessons on Innovation, Disruption, and Strategy (New York: ­Financial
Times Pearson, 2015).
20. M. Porter and C. van der Linde, “Green and Competitive,” Harvard Business Review 73
(1995), pp. 120–34.
21. Marcus, Innovations in Sustainability: Fuel and Food; and Marcus, The Future of Technology
Management.
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G L O S S A R Y
A
action-response cycles The strategic interactions
within an industry—moves and countermoves—that
continually shape competitive decisions and ultimately
determine the outcome of competitive battles.
accounting data Financial performance data based
on past company actions.
agency A theory holding that the obligation of the
company is to put shareholders first as they are the ones
risking the most.
agile giants Companies that possess both the ability
to move quickly to new competitive ground (their
­vision), and to assert their strength to hold/defend that
ground (vision becomes mission).
B
balanced scorecard Multidimensional approach of
measuring corporate performance through the sum of
quantitative, qualitative, leading and lagging factors.
barriers to entry Barriers within an attractive
­industry that deter new companies from entering. They
­secure the place of existing companies.
best-value strategy How some companies combine
elements of low cost and differentiation positions to
create a competitive product and/or service that can
­attract a swath of both premium- and price-conscious
buyers.
blocking Defensive tactic as it prevents a rival from
moving in the first place.
bootstrapping or bricolage Making do with the
means or resources at hand, rather than having all the
means and resources needed from the start.
bottom of the pyramid A focus on the world’s poor
as the major market of the future where the opportunity
is great, but the challenges in reaching this market are
also substantial.
business plan A plan consisting of a description of
the business, an external analysis, an internal analysis,
an implementation schedule, an end-game strategy,
which indicates when the business will be viable,
­financial projections, and an analysis of risk.
business strategy A firm’s deliberate decisions
­regarding how it can best position and present itself
(vs. its rivals) in order to win customers and realize
profits—low-cost, differentiated, or some combination
of the two, such as best value.
bypass Also called the end-run or blue ocean
­strategy, it is designed to minimize direct conflict by
setting new standards that create a unique and
­uncontested space.
C
CAGE framework An analytical outline that helps
firms identify and understand multiple dimensions of
global distance—­cultural, administrative, geographic,
and economic.
capabilities The sets of skills and routines that allow
the company to exploit its resources in ways that are
valuable and difficult for other firms to imitate. These
may include a firm’s coordination and control systems,
the company’s culture, its production knowledge, its
experience and long-standing relations with a variety of
stakeholders, such as government, and knowledge of
customers; may be compared to software, while the
­resources are the company’s hardware.
chaebol A term that refers to Korean global multinationals that own multiple international enterprises.
classic approach to management theory A topdown approach, which relies on accountability and
­control starting with the board and top management and
extending to all employees, who are divided according
into specialties and issued commands they are expected
to follow.
community model (of capitalism) Common in Japan
and some European countries, this form of capitalism
managers considers senior members in the company
and shareholders as just one of many stakeholder
groups that have to be satisfied; managers are freer
from short-term pressures imposed by stock market
prices and quarterly profits.
229
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230 Glossary
comparative advantage What a company does best
relative to all other firms.
competencies Firm-based talents used to combine,
transform, and channel key resources and capabilities in
strategically-supportive ways to satisfy customer needs;
they provide access to new markets, give customers
benefits, and are very hard for competitors to imitate.
contingency theory States that a firm should select
its management style—mechanistic or organic—based
on its situation. There is not just one “best way.”
co-opetition Ways in which companies are able to
compete and cooperate at the same time in order to
broaden markets and create new value—and thereby
­escape zero-sum games where one company benefits at
another’s expense.
corporate strategy Focuses on the scope of the
­company; what businesses and industries it should
­participate in.
cost basis How a company creates its outputs and
­fulfills its value proposition.
cross-impact matrix Used in the creation of scenarios
to illustrate how one trend may intersect with ­another.
culture The key values, beliefs, and assumptions
about how an organization should conduct its business;
treat its employees, customers, suppliers, and others;
and foster innovativeness and flexibility.
D
decline Stage within industry life cycle that sees falling customer bases, prices, and margins; companies exit
or are squeezed out during this stage.
defenders Companies that cling to their niche and try
to defend their turf.
defensive maneuvers Responses to rivals’ offensive
maneuvers and a reaction to threatening situations.
Delphi method Developed by Rand Corporation as
way to elicit expert opinion about important trends in
society, technology, and government, it combines the
beliefs of different experts to sharpen the predictions
made about developments in these areas.
diamond framework Porter’s explanation of why
certain nations possess unique competitive advantages.
National advantages can be attributed to factor
­conditions (production inputs), demand conditions,
competitive conditions (firm, strategy, structure, and
­rivalry), and related and supporting industries.
differentiated position A way a firm can distinguish
itself by adding distinct and valuable features to its
product/service lineup. Differentiators aim to capture
higher margins as they appeal to smaller (low volume)
segments of the market.
distinctive competence Unique accumulation of
­capabilities that lead to advantages that your rivals do
not share. Managers must be careful that these do not
evolve into rigidities.
E
eco-efficiency The process of reducing the ecological
impact that a company has while maintaining the delivery of competitively priced goods and services.
economies of scope The cost savings realized by
­reducing redundancies and sharing management structure,
administration systems, marketing departments, R&D, and
other functions across the business units of a corporation.
economic growth A positive change in the level of
production of goods and services by a country over a
certain period of time.
economic value added (EVA) Arguably, the most
important way to judge over time whether a company is
winning competitive battles since it compares what the
company is earning for shareholders in relation to the
cost of capital.
effect uncertainty The inability to predict the impact
of environmental factors on the firm—what will
changes in conditions mean for a particular firm?
embryonic stage The beginning stage in the industry
life cycle when prices are high, margins low, and profits still not certain; products are of lesser reliability;
competition has yet to take hold, and there is not much
export activity.
entrepreneur An individual, group, or organization
that discovers and starts to exploit new business or
other opportunities while assuming the risks.
EPS/EBIT analysis Compares earnings per share
(EPS) and earnings before interest and taxes (EBIT) at
various levels of sales—optimistic, pessimistic and
most-likely scenarios.
exporting production Outsourcing or setting up
­production and distribution in a foreign company.
external analysis Determination of the opportunities
and threats facing an industry via an assessment of its
environment and stakeholder groups.
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Glossary 231
F
first horizon bets Relatively safe bets designed to
generate some quick wins with time frames that are
short and continuing to tap and extend the firm’s current products, services, and customer markets.
first movers Aggressive newcomers that take risks in
anticipation of high returns.
flanking attack A company capitalizes on the weakness of its rival by attacking from the rival’s edges.
formulation Strategy design and creation as opposed
to implementation.
franchising A company disseminates its business
methods and models, provides franchisers with a brand
identity and a business image, and gains a percentage of
that franchised company’s profit.
frontal assaults Best carried out if a firm matches or
exceeds the strengths of a rival.
G
GDP per capita Gross domestic product per capita is
the total output of goods and services for final use
­produced by an economy per person; it indicates how
wealthy the individuals in a country are at a given
­moment in comparison to individuals in other countries.
global product-market strategy An approach to
­international competition that promotes the same product/
service configuration worldwide. It takes advantage of
economies of scale and scope and is a highly ­efficient,
low-cost way to expand internationally.
global strategy What will be the scope of the company’s global activities, where it will sell its products,
source its raw materials, design and make its products,
and do research and development.
greenfield operations When a company starts up its
own manufacturing, production, marketing, or other
sets of activities in a foreign country rather then relying
on joint ventures, alliances, or acquisition to access
­already existing sources of that activity.
Gross Domestic Product (GDP) The total value of
goods and services produced by a nation over a given
period, usually one year, GDP consists of four components: personal consumption, private investment,
­government spending, and exports.
growth stage Industry life cycle stage where sales
steadily increase, prices go down, and profits rise;
p­ roduct reliability increases as does the competition and
exports also begin to rise.
guerilla moves Tactics often deployed by only the
smallest and weakest of competitors and designed for
maximum impact at low cost.
H
hedging Having a backup plan to deal with risk and
uncertain external conditions.
horizontal integration A company increases market
share by purchasing companies that share the same
business line.
human relations approach to management
­theory Rather than being hierarchical and based on
command and control structures, this approach emphasizes employee development, motivation, and learning
company values, informal coordination, two-way communication, performance, and not following orders.
I
implementation The alignment of a strategy with
the management systems and tools to carry it out
­successfully.
industry Organizations offering similar products or
services that satisfy similar customer need that share
similar characteristics and are subject to similar market
forces.
industry analysis An assessment of the environment
and conditions surrounding a business—including the
impacts of its competitors, customers and suppliers.
industry environment The context in which a
­company operates.
industrial organization (IO) economics An
­externally-biased branch within the field of economics
that focuses on the formation of monopolies and near-­
monopolies.
inflection points Extraordinary shifts in the
­competitive landscape that change the basis for
­sustained competitive advantage.
innovation The process of putting an invention or
other important discoveries into widespread use.
intangible benefits Valued product or service
­features whose impacts are felt rather than seen—such
as exclusivity, brand mystique, and high-sheen, highservice selling environments.
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232 Glossary
intangible resources Assets that are not physical in
nature, such as a reputation for toughness or quality or
loyalty of dealers and trust of customers, which have
been nurtured through history. They cannot be easily
traded, and are dependent on particular organizational
processes.
internal analysis The processes that a company uses
to examine its strengths and weaknesses in order to better compete with other companies.
introductory stage Stage favoring offensive moves
that capitalize on the weaknesses of the status quo,
while their new concept is being proven.
invention Creation of a new idea and/or its demonstration in prototype form.
inversion Takes place when a firm reincorporates
outside of its current national jurisdiction in order to
­reduce its tax burden.
J
just-in-time (JIT) An approach to inventory management where a company produces only what the customer wants, in the quantities the customer actually
requires, and when the customer needs it.
L
leading-edge industries Industries that depend upon
newly emerging technologies that provide the impetus
for economic growth.
learn This ability allows a company to achieve scale
quickly, survive and thrive.
legalistic model (of capitalism) Model of capitalism
that emphasizes the obligations that managers as employees of the owners (the shareholders) owe their employers.
liability of foreignness Means that because of the difficulties of operating globally some firms decide to remain
domestic players and respond to international threats as
they occur from a more focused domestic stance.
licensing Rather than directly produce and sell its
products abroad, a company can establish a legal
­arrangement with a foreign firm that can produce and
sell the company’s products for a fee.
life cycle Implies that products evolve through stages
of introduction, growth, maturity, and decline.
low-cost position Distinguishing oneself through the
high-volume sale of low-margin items.
M
M-form A corporate strategy where high-level executives make strategic choices, interact with shareholders and
allocate resources to separate, independent business units.
macro-environment Broad overarching forces that
impact the industry environment, including law, politics, technology, demography, society, economic climates, and the physical environment.
management theory Various approaches to scrutinizing, investigating, and breaking down an organization’s
strengths and weaknesses, including the classic ­approach,
the human relations approach, and contingency theory.
material-balance models Models for analyzing an
organization’s production processes based on an analysis of inputs and outputs, whose goal is to increase
­usable products and decrease waste.
maturity Stage within the industry life cycle where
sales volumes level out, and profits are lower as more
companies are competing for market share; innovation
is rare and overcapacity begins; and exports blossom
since there are few new consumers at home.
matrix structure A structure within a company’s internal environment where an employee may have multiple
reporting arrangements based on the clients they serve, the
geography covered, and/or their functional expertise.
micro-segmenting Dividing customers into finer and
finer segments in order to serve smaller and smaller categories of customers and to provide them with more
precisely what they need.
minimally viable models Lean business designs that
are crafted in a highly iterative fashion—an approach
that accelerates the product development and customer
feedback loop.
mission Typically represents what the company has
been good at in the past, what it has accomplished,
where its employees take pride in their achievements.
multidomestic product-market strategy Adapts and
modifies a product or service to each separate country
or region; extracts high margins and charges a premium
price for delivering customized products and services
that meet the needs of individual markets.
N
natural parity A state of equilibrium to which
­competitive firms frequently return—one of equality
(vs. one of competitive advantage).
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Glossary 233
O
R
open source innovation (OSI) An approach to
­product/service development that engages external
­partnerships across a firm’s value chain.
outliers Companies that are able to break the natural
parity that prevails in their industries and sustain competitive advantage (or on the other side companies that
realize competitive disadvantage) for long periods, such
as a decade or more.
readiness An unflagging and highly visible commitment to execute an initiative.
realized strategies Actual outcomes that are not
­determined by what any single company intends, but by
the moves and countermoves of competitors responding
to changing conditions over time.
Real-Win-Worth It screen Test of each product or
service concept to determine if the market and product
are “real,” if the potential offering and a company can
be competitive and “win,” and whether it’s “worth it”
from both financial and strategic perspectives.
repositioning Constant adjustment and revisiting of
strategy.
resources An organization’s basic financial, physical,
and human capital.
resource-based view (RBV) An internally-biased
perspective that helps to explain why some firms within
industries consistently outperform others; rather than
market power (the industrial organization view) it emphasizes the ability of firms to reap higher returns from
resources through the way they configure their capabilities and competencies.
response uncertainty Uncertainty about what a firm
should do based on its knowledge of conditions in the
macro-environment.
retrenchment A move to reduce and refocus a firm—
to trim it back to a more defensible position. It is
­primarily a move of “last resort” pursued when a firm is
in distress and must shift to survival mode.
revenue model How a firm intends to generate
­receipts. It is based on the structure of customer
­interactions—their intensity, duration, channels, and
payment methods.
risk Odds of success are known with certainty; to be
contrasted with uncertainty.
P
Porter’s five forces An industry assessment framework that determines industry attractiveness based upon:
(1) competition among existing rivals, (2) new entrants,
(3) substitutes, (4) customers, and (5) suppliers.
portfolio planning Corporate strategy that helps large,
complex organizations manage their separate business
units by focusing on the direction, coordination, control,
and profitability of the different business units.
positioning A way to gain distinction in an industry
by occupying a unique market niche that other companies cannot easily imitate.
post-industrialism An era following industrialism,
which is characterized by a move from goods to services;
the prominence of theoretical knowledge; and the preeminence of technology and technological assessment.
pre-emptive strike An offensive maneuver that aims
to seize an opportunity before a rival can act upon it.
prototype (pilot offering) Does not consume an
­excessive amount of resources prior to being presented
to potential customers for hands-on testing.
prisoner’s dilemma Situation in game theory where
it is rational for each player, not knowing how the other
player will act, to act in a way that will make both
­players worse off.
process technologies Enable firms to improve their
ability to make goods and services.
prospectors Companies that aggressively pursue new
growth opportunities.
product technologies Improvements in the goods and
services themselves.
public-private partnerships (PPP) A way to ­manage
new initiative uncertainty by combining resources,
management skills, and technology of the private sector
with the resources, regulations, and other protections
that governments may provide.
S
S-shape curve A pattern of industry growth which
­reflects that first adopters are daring; other people are
slow to change, and only much later do they ­respond;
meanwhile, inventors and developers, who endure most
of the risk, may not have the staying power.
scenario A depiction of a possible future based on the
intersection of various trends over time.
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234 Glossary
second horizon bets More aggressive pursuits that
drive a firm into new and unfamiliar territory, and require
a higher risk tolerance that hold significant promise, but
require that the firm acquire new capabilities, develop new
businesses, and even fundamentally alter its strategy. Payoffs may not come until three to five years have passed.
sensitivity analysis A study of various assumptions,
the odds of outcomes based upon each assumption, and
the payoffs that can be expected for each distinct
­outcome.
sequential game A competitive contest where one
player goes first and the other player gets to observe the
results before making their move.
serial entrepreneurs Go after one business opportunity after another and then sell these ventures to larger
companies to pursue new opportunities instead of
­managing existing ventures.
seven S analysis The seven characteristics that Peters
and Waterman used to describe excellent firms:
(1) Strategy (2) Structure (3) Systems (4) Style
(5) Staffing (6) Skill (7) Shared values.
shared values Unity of purpose—a part of management that Peters and Waterman found was often
slighted by U.S. managers in comparison to their
­Japanese counterparts.
simultaneous game A competitive contest where two
or more players act at the same time.
skill The capability to compete and generate new
business—a part of management that Peters and Waterman found was often slighted by U.S. managers in
comparison to their Japanese counterparts.
smart (business) designs Better ways of meeting
customer needs through the use of detailed and systematic information about customers; this information
­allows firms to satisfy customer needs for integrated
­solutions rather than for separate products and services;
better designs often break down barriers between a
business and its customers by eliminating redundant
supply channels; they take advantage of special niches
firms occupy in the value chain, and they tend to provide small segments of customers with customized
products and services that meet their unique needs.
staffing Matching jobs with the people available to
hold them in an organization—a part of management that
Peters and Waterman found was often slighted by U.S.
managers in comparison to their Japanese counterparts.
stakeholders Those who affect and are directly
­affected by a company’s actions and results.
stakeholder theory As opposed to agency, it holds
that managers are accountable to an array of outside and
internal stakeholders to whom managers must provide
­incentives (wages to workers, taxes to government, products to customers, etc.) to induce their involvement.
state uncertainty Uncertainty about conditions in the
macro-environment of the firm, for instance where the
economy is headed, what the next government will be,
how will technology change, and so on.
stock market data Based on investors’ perceptions
of future company returns.
strategic business units (SBUs) Operating divisions
containing closely related businesses within a larger
parent company.
strategic groups Sets of industry competitors that are
utilizing similar approaches in an attempt to satisfy very
similar groups of customers. These companies must
find finer and finer points of distinction between them
in ­order to stand out.
strategic inflection point A major point of departure,
a point of no return, where a company’s competitive
­environment is radically altered due to new technologies, different regulatory conditions, or changing
­customer preferences; in response to these changes, the
company is forced to alter its strategies.
strategy An organization’s game plan for achieving
sustainable competitive advantage over the competition,
improving its position in relation to customers, and
­allocating resources to high-return activities.
structure A coherent form dividing labor, allocating
responsibilities, coordinating tasks, and assuring
­accountability—an aspect of management that Peters and
Waterman found was often overemphasized by U.S.
managers in comparison to their Japanese counterparts.
style Extent of actual alignment between management
and employees and the organization’s real strategic
needs as opposed to lip service—an aspect of management that Peters and Waterman found was often
slighted by U.S. managers in comparison to their
­Japanese counterparts.
sustainable society A society based on three principles: protection of the environment, economic equity,
and economic growth; in such a society the needs of
­future generations are not sacrificed for the consumption of the current generation.
sustained competitive advantage (SCA) The goal of
strategic management, which is to consistently
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Glossary 235
o­ utperform relevant competitors for long periods of
time, such as a decade or more; the aim of strategy, in
other words, is to be a dynasty, not a one-time winner.
One-time winners can succeed by luck. Being a dynasty
requires skill.
sweet spot In a competitive context, this is the
­optimal state that a firm can achieve. It is found at
the intersection of 1) a firm’s unique ability to
­understand customer perspectives and devise solutions for customer problems, 2) a clear strategy that
leverages such opportunities for a firm’s ongoing
advantage, and 3) the firm’s exclusive access to the
resources and capabilities required to deliver such
solutions.
SWOT analysis As assessment of the strengths,
weaknesses, opportunities and threats that helps a firm
select appropriate strategies.
systems Description of how critical processes are carried out in an organization—an aspect of management
that Peters and Waterman found was often overemphasized by U.S. managers in comparison to their Japanese
counterparts.
T
tangible benefits Created by melding superior
­engineering, top-quality materials, and exacting manufacturing into high-performance equipment.
technology Knowledge of how to convert the factors
of production into goods and services.
technology-push model Innovation starts with
­discoveries in basic science and engineering, and from
these discoveries come new goods and services to the
marketplace.
third horizon bets Firms willing to take on an indefinite unknown future; bets whose payoff may come in
the distant future, anywhere from five to ten years
­forward.
timing dilemmas The dilemmas that a company faces
about whether to go first and be a pioneer with a new
strategy or to be a fast follower and allow another firm
to take these risks; often the issue is deciding whether
to continue with an old product or utilize a new ­product,
business model, or practice.
total quality management (TQM) Management
method established by such gurus as Edwards Deming,
TQM is designed to achieve enhanced productivity and
greater quality at the same time; it, therefore, breaks
with Porter’s generic strategies, which assume that a
firm has to choose between low cost or high quality.
Under TQM, a firm has a few trusted suppliers rather
than having power over many suppliers in accord with
­Porter’s framework.
transnational product-market strategy Combines
global design and local responsiveness; to achieve best
value, it both exploits scale economies and adapts to
­local conditions.
U
uncertainty Odds of success are unknown; to be contrasted with risk.
V
value chain The primary and support activities,
which a firm undertakes to deliver products and services to customers; each can be broken down to determine how profitable it is (what are its margins).
value net A tool that emphasizes opportunities for the
mutual advancement of competitors, customers, and
suppliers within an industry. This approach stands in
stark contrast to the concept of “zero-sum game.”
value proposition Products and services created to
fulfill customer requirements.
vertical integration A company combines
production, distribution, and/or sales within its own
structure.
vetting ideas Filters that aim to connect the dots
between a firm’s capabilities and available technologies, prospective customers, and the concept’s profit
potential.
vision Typically based on an understanding that the
senior leaders of a company have of a company’s future
possibilities and where it should be moving next. What
should the company be aiming for so that it can excel in
the future? A vision typically provides employees with
a sense of direction. It tells them where the company
should be heading. All companies are caught between
what they have been good at in the past (their mission)
and what they would like to be good at in the future
(their vision).
VRIO analysis Asks the question is a resource valuable, rare, costly to imitate, and is a firm organized to
capture the value of the resource.
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Index
A
ABB Group, 132
ABC, 115, 133, 207
Accountability, 71–77
contingency theory, 73–74
seven S’s, 75–76
SWOT analysis, 76–77
task- team-oriented organization, 72–73
Accounting data, 19
Acer, 160
Acquisitions. see Mergers and acquisition (M&A)
Action-response cycles, 12
Adelphia, 6, 7
Administration, 65
Agency theorists, 40–41
Agile giants, 9
Ahlstrand, B., 12, 13
Airbus, 39, 99, 110
Airline industry, 24, 36, 49
five forces example, 38–40
Albert, S., 83, 101
Albertsons, 117–118
The Alchemy of Growth, 206
Aldrich, H., 162
Alexander, R., 100
Alexander McQueen, 63
Allergan Generics, 111
Alliances, 114
Alliant Tech, 117
Allied Signal, 117
Almor, T., 73
Alternative scenarios, 215
Amazon, 16, 28, 74, 130, 172, 188, 211
AMD, 7–8, 123, 166
American Airlines, 118
Amit, R., 53, 64
Amoco, 111
Amphenol, 120
Analyzers, 8
Angwin, J., 133
Anheuser-Busch, 95–96
Ansoff, H., 71
Antony, J., 115
AOL, 117
Apple, 26–27, 28, 43, 44, 45, 67, 95, 96, 99,
100, 113, 114, 159, 160–161, 165, 188,
204, 214
ARM, 35
Arthur Andersen, 6, 7
ArticCat, 159
Art of War (Sun-Tzu), 12, 82
Assets, redeploying, 14–15
AstraZeneca, 123
Atari, 99
AT&T, 94, 99, 116, 117, 118, 160, 173, 174
Audi, 172, 204, 219
B
BAE Systems, 110
Balaban, R., 195
Balanced scorecard, 198
Barnes & Noble, 6, 28, 114
Barney, J., 53, 55, 58
Barriers to entry, 37
Barriers to innovation, 177–182
flawed organizational processes, 180
many-year investments, 178–180
S-shape curve, 178
Battaglio, S., 133
Baxter, 164
Bayer, 123
BCG matrix, 129–130
Bear Stearns, 120
Bell, D., 216
Best Buy, 6, 26, 90, 91–92, 98, 102, 106, 145,
148, 188, 189
Best value, 89–90
Better Place, 218
Bic, 99
Biotechnology, 216–217
industrial material, 217
237
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238 Index
Biotechnology—(Cont.)
nutrition, 216
pharmaceuticals, 216–217
Biovail, 93
Blackberry, 43, 44, 160
Blocking, 96
Blue ocean strategy, 95
BMW, 172, 219
BNSF, 119
Bodley-Scott, S., 195
Boeing, 16, 84, 99, 110
Bombardier, 110
Bootstrapping, 163
Borders, 6
Boston Consulting Group, 129
Boston Dynamics, 112
Bottom of the pyramid, 154
Boyd, A., 53
BP, 111, 151
Brache, A. P., 195
Brache/Bodley-Scott prioritization matrix, 195
Brandenburger, A., 105
Bricolage, 163
Bristol-Myers Squibb, 123
Brito, D., 109
Brown and Brown, 122
Brumagin, A., 53
Bryan, L., 203, 204
BS. see Business-level strategy (BS)
Burger King, 115
Burrows, P., 199
Business-level strategy (BS), 4, 109
multidomestic approach, 140, 145
transnational approach, 140, 145–146
Business model, 169–177
external sources of opportunity, 170–172
internal sources of opportunity, 173–174
opportunities to pursue, determination of, 170
prototypes/pilot offering, 176–177
reinventing, 210–215
scaling up/full rollout, 177
vetting ideas, 174–175
Bypass, offensive tactics, 95
C
Cable industry, 27
CAGE framework, 148–149
Canadian National, 119
Canon, 62–63, 99
Capabilities, 60–62
culture and, 61–62
replenishing, 64
resources/competencies vs., 55–58
significance of, 58–60
Capacity utilization, 31–32
Capital, 151–152
Catalao-Lopes, M., 109
Caterpillar, 46
CBS, 27, 124, 134–135
CEMEX, 46
Cendant, 19
Chaebols, 112
Change management
change program proposals, 194
consistent message, 193
cross-functional program teams, 193–194
prioritization plan, 194–195
process owners/align resources, 195–196
readiness for change, 190–191
Change program proposals, 194
Charkravarthy, B., 90
Charles Schwab & Co., 119
Chess analogy, 6–11
changing rules, 8
envisioning where to go next, 8–10
making moves that matter, 11
operating by rules, 7–8
reversals of fortune, 10–11
Chevron, 111, 151
Chipotle, 32, 43, 44, 45, 172
Chrysler, 116
Churchill, Winston, 12
Circuit City, 6, 92, 98, 102, 106, 188, 189
Cirque du Soleil, 95
Cisco Systems, 120
Citicorp, 119, 120
Citigroup, 99
ClickWorker, 212
Coca-Cola, 10, 35, 99, 105, 106, 141, 142
Comcast, 27, 99
Commit with fallbacks, 16
Company analysis. see Internal analysis (IA)
Compaq, 55, 116
Comparative advantage, 9, 29, 203
Competencies, 60–62
organization’s distinctive, 62–64
replenishing, 64
resources/capabilities vs., 55–58
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Index 239
Competition
commercial/investment banking, 99–100
domestic, 139
Competitive advantage. see Sustained competitive
advantage (SCA)
Competitive intelligence, 94
Competitive position. see Positioning; Repositioning
Competitive pressure, 172
Comprehensive implementation framework,
190–200
change program proposals, 194
consistent message, 193
cross-functional program teams, 193–194
design incentives/operational objectives/secure
funding, 197–198
initiatives, advance and continually monitor,
198–199
integrative leadership, 192–193
prioritize change programs, 194–195
process owners and align resources, 195–196
readiness for change, 190–191
refining process, 199–200
Con Edison, 28
Conoco, 111
Conoco-Phillips, 151
Consistent message, 193
Contraction, 128–129
Control Data, 117
Cool, K., 53
Core competences, 52
Corning, 99
Corporate hierarchy, 131–133
Corporate-level strategy (CS), 4, 109–110
contraction, 128–129
corporate hierarchy and, 131–133
expansion, 128
franchising, 114–115
licensing, 114–115
M-form, 128
portfolio management, 128
vertical integration, 113, 133–136
Cost base, 211
Courtney, H., 15
Covidien, 27, 28, 133
Cree, 165
Cross-functional program teams, 193–194
Cross-impact matrix, 48
CS. see Corporate-level strategy (CS)
CSX, 119
Culture, 33, 74
and capabilities, 61–62
Customers, 35–36
Customer service, 65
D
Daewoo, 153
Daimler-Benz, 116, 151
Darden Restaurants, 113
D’Aveni, R., 83, 105
Davis, M., 104
Deals, track records in making, 120–122
Decision making, as organization’s capability, 74
Decline stage, 97, 143
DeepMind Technologies, 112
Defenders, 8
Defensive maneuvers, 96
DeFillippi, R., 53
deHavilland, 99
Dell, 26, 36, 55, 66, 67, 100, 123, 160, 170
value chain linkages example, 66–67
Delta Airlines, 24, 36, 118
Demographics, 33
Deregulation, 118–119
in banking industry, 119
role of, 118
Design incentives, 197–198
Determined innovators, 162–164
Dial, 92
Diamond framework, 149
Dickson, W., 72
Dierickx, I., 53
Differentiation positions, 86–88
low-cost and, 88–90
Digital Equipment, 76
Disappointed and disillusioned, youth group, 154
Disney, 117, 133, 206–207
Distinctive competence, 62–64
Diversification
reasons for, 110–112
types of, 112–114
Divestitures, 115–117
Division of labor, as organization’s capability, 74
Dollar Shave, 211
Domestic competition, 139
DoubleClick, 112
Dove, 92
Dow Chemical, 111, 122
Drake, E., 32
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240 Index
Dreyfus Corp, 119
Duggal, J., 195
DuPont, 111
Dutch company, 106
Dynegy, 19
F
E
EA. see External analysis (EA)
Earnings per share (EPS), 197
eBay, 16, 28, 117
Ecolab, 47
Economic value added (EVA), 19–20
Economies of scope, 126
Eco-system, development of, 214
Edwards, C., 194
Effect uncertainty, 47
Eisenhardt, K., 99
Eli Lilly, 123, 133
Ellis, S., 73
Embraer, 110
Embryonic stage, 141
EMI, 99
End-run strategy, 95
Enron, 6, 7, 11, 19, 41
Entrants, 34–35
Entrepreneurs, 164
Entrepreneurship, 157–158
importance of, 158
EPS/EBIT analysis, 197
Ericsson, 160
Euromonitor, 26
European Aeronautic Defense and Space Company, 39, 41
European Union (EU), 7
EVA. see Economic value added (EVA)
Expansion, 128
Export products, 144
External analysis (EA), 3, 24, 53, 221–222
five forces framework, 33–36
framework for, 29–30
industrial organization economics, 31–32
industry, defined, 25–27
industry dynamics, 36–41
moves after, 222–223
scenarios, 45–49
strategic group analysis, 42–44
trade-offs, 28–29
External pressures and industry movement, 27–28
Exxon Mobil, 111, 151
Failure
anatomy of, 187–190
root causes of, 189–190
Fallbacks, 16
FedEx, 16, 35
Ferdman, R., 43
Ferraris, 218
Financial considerations, levels of, 68–71
Financial Modernization Act, 1999, 119–120
Fingerhut, 117
Fiol, C., 162
First horizon bets, 205
First movers vs. late starters, 97–99
Fisher, A., 115
Five forces framework, 33–36
airlines industry example, 38–40
new entrants, 34–35
pharmaceuticals industry example, 37–38
rivals, 34
substitutes, 35
suppliers and customers, 35–36
sustained competitive advantage, 36
Flanking attack, 95
Food and Drug Administration (FDA),
37, 38
Ford, 114
Formulating, strategy, 13
Fox, 115, 133
Franchise, 144
Franchising agreements, 114–115
Franken, A., 194
Freeman, C., 181
Freeman, R., 41
Friedman, M., 4, 7
Frito-Lay, 117
Frontal assaults, 95
Frontier, 188
Fumbling the Future (Smith and Alexander), 100
Funding, 197–198
G
Game theory, 100–106
expanding assumptions of, 103–104
learning from, 104–106
prisoner’s dilemma, 101
sensitivity analysis and, 102
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Index 241
sequential game, 100, 102–103
simultaneous game, 100–102
Gap, performance/innovation, 165–166
Gartner Group, 2
Gatorade, 10
The Government Employees Insurance Company
GEICO, 211
Genentech, 123
General Dynamics, 110
General Electric (GE), 10, 26, 27, 99, 113, 115, 129,
130, 131–132, 187
General Mills, 104
General Motors (GM), 117, 124, 130, 151,
182, 219
General Signal, 122
Generic strategic positions, 83, 84
Geographic scope, 31
Gilead Sciences, 165
Gillette, 211
Glass-Steagall Act, 1933, 119
GlaxoSmithKline, 93
Global Crossing, 19
Global economic meltdown, M&A and, 122–123
Globalization, 139–155
CAGE framework, 148–149
insecurity, 153–154
labor, capital, and technology, 151–152
local adaptation, 146
mergers and acquisitions, 122–123
open economies, 153
product-market approaches, 145–146
reasons for, 140–143
success factors, 150
youth and, 154–155
Global strategy (GS), 4, 145
exporting production, 144
franchising, 144
greenfield operations, 145
licensing, 144
Goldman Sachs, 99, 120
Google, 7, 26, 28, 61, 95, 111, 113, 160, 165, 172, 174,
207, 214
Government, entrepreneurial endeavors and, 168–169
Government policies, 32–33
Gracious Living, 154
Grand Metropolitan Ltd., 117
Grant, R., 87, 88, 99
Grove, A., 1, 9, 14
Growth stage, 97, 141
GS. see Global strategy (GS)
GSK, 123
Guerilla moves, 95–96
Gunther, M., 133
H
Hall, R., 53
Hamel, G., 16, 52, 53, 63, 64, 157, 165
Hansen, 35
Hanson PLC, 117
Harley-Davidson, 88
Harrison, J., 164
Hart, S., 154
Hawawini, G., 3, 29
Hayek, F., 71
Hedging against uncertainty, 15–16
Herzberg, F., 72
Hesterly, W., 58
Hewlett-Packard (HP), 55, 67, 116, 123, 160, 199
Hoffman-LaRoche, 104
Holland Sweetener, 105–106
Home Depot, 15
Honeywell, 117, 132
Hormel, 31
HTC, 160
HULU, 115
Human resource management, 65
Hyundai, 153
I
IA. see Internal analysis (IA)
IBIS, 26
IBM, 11, 26, 55, 66, 114, 123, 160, 178
Icarus paradox, 100
IMC Global, 118
Implementation, 4, 186–201
anatomy of failure, 187–190
comprehensive framework (see Comprehensive
implementation framework)
cycle of, 187
mistakes in, 187
readiness for change, 190–191
refining process, 199–200
Improvising, 12–13, 18
Inbound logistics, 65
Incremental changes, 159, 160–161
Indiegogo, 212
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242 Index
Industrial organization (IO) economics, 31–32
resource-based view vs., 53–55
Industry
defined, 25–27
dynamics, 36–41
external pressures and movement, 27–28
life cycle, 30
moves, 28–29
transient attractiveness, 40
Industry analysis
pharmaceuticals example, 37–38
Industry evolution, 141–143
decline stage, 143
embryonic stage, 141
growth stage, 141
maturity stage, 141
Inevitable turmoil, preparation for, 204–210
Innovation, 157–158, 169
barriers to, 177–182
importance of, 158
passionate and determined innovators, 162–164
process of, 161–169
reasons for, 158–161
Innovation strategy (IS), 4
Innovators
passionate/determined, 162–164
as risk takers, 162–163
In Search of Excellence (Peters and Waterman), 75
Insecurity, globalization and, 153–154
Intangible resources, 59
Integrating mechanisms, as organization’s capability, 74
Integrative leaders, 192–193
Intel Corporation, 1, 6, 7–8, 9, 14, 31, 100, 105, 123, 160
Intended strategies, 13
InterMune, 123
Internal analysis (IA), 3, 52–77, 221–222
accountability, assuring, 71–77
defined, 53
levels of financial considerations, 68–71
moves after, 222–223
resource-based view, 53–64
value chain analysis, 64–67
Internal startups, 115
International Standard Industrial Classification
(ISIC), 26
Introductory stage, life cycle, 97
Invention, 169
Inversions, 33
Investor’s Business Daily (IBD) ratings, 20
IS. see Innovation strategy (IS)
ISIC. see International Standard Industrial
Classification (ISIC)
ITT, 117
Ivory, 91, 92
J
Japanese manufacturers, 14
JCPenney, 89
Jensen, M., 40
JetBlue, 188
Johnson, G., 190
Johnson & Johnson, 27, 123, 164
Joint ventures (JVs), 115
JPMorgan Chase, 119, 120
JVs. see Joint ventures (JVs)
K
Kaplan, R. S., 193, 198–199
Kasturi, V., 90
Kellogg, 104
Kentucky, 182
Kentucky Fried Chicken, 146, 147
KFC, 115
Kickstarter, 165, 212
Kirzner, I., 215
Kmart, 53, 76, 88, 93
Knight, F., 15, 181
Kodak, 16, 76
Kohlberg Kravis Roberts & Co., 120
Kondratiev, N., 215
L
Labor, 151–152
Lado, A., 53
Lambert, R., 194
Lampel, J., 12, 13
Late starters, first movers vs., 97–99
Leadership, 73, 192–193
Leading-edge industries, 215–216
Learning curve effects, 32
Lehman Brothers, 120
Lenovo, 160
Lewis, M., 53
Liability of foreignness, 140
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Index 243
License, 144
Life cycle, 96–97. see also specific stages
industry, 30
Lipman, J., 133
Lockheed Martin, 110
Logistics, 65
Low-cost positions, 84–86
advantage of, 85–86
differentiation and, 88–90
Lucent, 19, 118
Lucky-Goldstar, 153
Luttwak, E., 12
M
M&A. see Mergers and acquisition (M&A)
MacMillan, R., 53
Makani Power, 112
Makridakis, S., 102
Management strategy
action-response cycles, 12
asset redeployment, 14–15
changing rules, 8
chess analogy, 6–11
commit with fallbacks, 16
concentrating forces, 13–14
delay until clarity emerges, 16
envisioning where to go next, 8–10
gambling on most probable outcome, 15
hedging against uncertainty, 15–16
know your enemy/yourself, 12
making moves that matter, 11
mergers and acquisition (M&A) and, 127–129
operating by rules, 7–8
planning and improvising, 12–13, 18
reversals of fortune, 10–11
robust route, 15–16
sports analogy, 16–19
understanding of, 6–19
war analogy, 11–16
Mankins, M. C., 189, 190, 191, 198
Many-year investments, 178–180
Marcus, A., 2, 15, 30, 151, 194, 215, 217, 218
Margin, impact of position on, 90
Market exchange, 59
Marketing and sales, 65
MarketLine Reports, 26
Market readers, 204
Market segmentation, 87–88
Martin, J., 99
Martin, K. L., 196
Martin, R., 192
MasterCard, 115
Maturity stage, life cycle, 97
McCoy, C., 7
McDonald, 15, 32, 43, 115
McGrath, G., 53
McKinsey & Co., 75, 129, 130, 131, 203, 204
Measurement. see Performance measurement
Mechanistic model, contingency theory, 73
Meckling, W., 40
Medicare, 10
Medtronic, 9, 10, 27, 28, 68, 117, 133
Mercedes, 172
Merck, 93, 123, 133
Mergers and acquisition (M&A)
broadening scope, 122
buying competitors, 122
for consolidation, 120–121
and divestiture results, 115–117
effective management of, 127–129
failures of, 123–126
full-scale, tactics short of, 114–115
global economic meltdown, 122–123
merger of equals, 127
move to new industries, 122
purchasing talent, 122
shifting landscape, 117–120
success of, 126–129
Merrill Lynch, 120, 122
M-form, 128
Michels, A., 115
Microsoft, 6, 7, 8, 9, 18, 99, 100, 105, 113, 117,
160, 223, 224
Miller, D., 53, 99, 100
MillerCoors, 174
Milliken, F., 47
Minimally viable models, 213
Mintzberg, H., 12, 13
Mission, of company, 8, 9
Missoni, 63
Mitsubishi, 147
Mobil, 111
Mobile phone industry, strategic group map of, 42–43
Modularizaton, 97
Moneyball (book/movie), 53, 54
Monopoly, 31
Monsanto, 105–106, 111
Monster Beverage, 35
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244 Index
Morgan Stanley, 91, 92, 120
“Most probable” outcome, 15
Motorola, 160
Moves. see also Positioning
after external/internal analysis, 222–223
first movers, 97–99
guerilla, 95–96
industry, 28–29
winning, 4–6
Multidomestic approach, 140, 145
Mylan, 111
MySpace, 117
N
Nagendra, K., 186, 199
NAICS. see North American Industry Classification
System (NAICS)
Nalebuff, B., 105
Napoleon, 12, 13
Natural parity, 3
Natural resources technology, 33
NBC, 27, 114, 115
NEC, 14
Neiman Marcus, 89
Nelson, R., 53, 63
Nest Labs, 112
Netflix, 160, 211
NetJets, 95
Netscape, 7, 99, 223, 224
New businesses
funding sources for, 167–168
government support and, 168–169
innovative companies and, 164–165
innovators, passionate/determined, 162–164
patient capital, 166–167
prolonged gestation for, 162
New entrants, 34–35
New opportunities
determination of, 170
external sources of, 170–172
internal sources of, 173–174
News Corp, 117, 133, 134
NGC, 10
Nielson, G. L., 196
Nike, 10
Nintendo, 99
Nokia, 43, 44, 160, 172
Norfolk Southern, 119
North American Industry Classification System
(NAICS), 25–26
Northern States Power, 117
Northrop Grumman, 110
Norton, D. P., 193, 198–199
Novartis, 123
NTT DoCoMo, 160
Nutrition, 216
O
Organisation for Economic Co-operation and
Development OECD, 32
Offensive tactics, 95–96
bypass, 95
flanking attack, 95
frontal assaults, 95
guerilla moves, 95–96
pre-emptive strike, 95
Oil and Gas industry, 46
Only the Paranoid Survive (Grove), 14
On War (von Clausewitz), 12
Open economies, 153
Open source innovation (OSI), 212–213
Operational objectives, 197–198
Operations, 65
Oracle, 113, 123
Organic model, contingency theory, 73
OSI. see Open source innovation (OSI)
Oster, S., 100
Outbound logistics, 65
Overall dominance, 19–20
Oxford, A. R., 209
P
Panasonic, 218
Panera, 43, 44, 45
Paramount, 28
Passionate innovators, 162–164
Peers, M., 133
Penrose, E., 53
PepsiCo, 10, 26, 35, 105, 117, 142
Performance/innovation gap, 165–166
Performance measurement, 18–19
economic value added, 19–20
Investor’s Business Daily (IBD) ratings, 20
overall dominance measurement, 19–20
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Index 245
Performance mechanisms, as organization’s
capability, 74
Perrigo, 111
Persistence, 162
Peters, T., 75, 76, 77
Petrofina, 111
Pfizer, 93, 116, 123
Pharmaceutical, 33, 36, 37, 38, 40,
46, 49, 96
Pharmaceutical industry, 46, 216–217
five forces example, 37–38
mergers and acquisitions in, 123
Pharmacia, 116, 123
Phillips, 111
Pilkington, 99
Pilot offering, 176–177
Pisano, G., 99
Pizza Hut, 115
Planning, 12–13, 18
Polaris Industries, 111
Polaroid, 76
Porter, M., 2, 24, 29, 33, 83, 88, 92, 139, 141, 149,
150, 155, 218
Porter’s diamond framework, 149
Portfolio management, 128, 207–209
Portfolio models, 129–133
BCG matrix, 129–130
GE/McKinsey model, 130–131
Portfolios
of initiatives, 204–207
managing (see Portfolio management)
Positioning, 83–94, 222. see also Moves;
Repositioning
differentiation positions, 86–88
impact on margin, 90
low-cost positions, 84–86
Post, 104
Post-industrialism, 216
Powell, T., 3
Powers, E., 196
PPP. see Public-private partnerships (PPP)
Prahalad, C., 16, 52, 53, 63, 64, 154
Pre-emptive strike, 95
Prioritization plan, 194–195
Prisoner’s dilemma, 101
Procter & Gamble (P&G), 33, 92, 95, 166–167,
182, 192–193, 211
Progressive, 211
Prolonged gestation, for new businesses, 162
Prospectors, 8
Prototypes, 176–177
Prudent risks, 207
Public-private partnerships (PPP), 209–210
Q
Quinn, J., 12, 13
R
Ralcorp, 104
Ravenscraft, D., 115
Raynor, M., 15
Raytheon, 110
RBV. see Resource-based view (RBV)
Reactors, 8
Readiness for change, 190–191
Realized strategies, 13
Real-Win-Worth It screen, 174
Redeploying assets, 14–15
Reebok, 10
Reed, R., 53
Reinvention, 203–225
business model, 210–215
inevitable turmoil/uncertainty, preparation for,
204–210
Repositioning, 4, 90–92. see also Positioning
Best Buy example, 90–92
Ivory example, 90–92
Resource-based view (RBV), 53–64
capabilities, 55–58, 60–62
competencies, 55–58, 60–62
industrial organization economics vs., 53–55
organization’s distinctive competence, 62–64
resources, 55–58
VRIO analysis, 58–60
Resource procurement, 65
Resources
capabilities and, 55–58
competencies and, 55–58
intangible, 59
replenishing, 64
significance of, 58–60
tangible, 59
Response uncertainty, 47
Restaurant industry, strategic group map of, 43–44
Retaliation, defensive maneuver, 96
Retrenchment, 96
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246 Index
Revenue model, 211
Reversals of fortune, 10–11
Reynolds, 99, 122
Rheingold, 99
Risks
prudent, 207
and uncertainty, 180–182
Rivals, 31, 34
RJR Nabisco, 120
Robinson, D., 100
Roche, 123
Roethlisberger, F., 72
Rohm & Haas, 122
Rose, F., 133
Rothschild, P., 195
Rothwell, R., 214
Ruefli, T., 3
Rumelt, R., 112
S
Samsung, 42, 43, 44, 112, 113, 153, 160, 204
Sanofi-Aventis, 123
Sarbanes-Oxley (SOX) Act, 171
SCA. see Sustained competitive advantage (SCA)
Scale economies, 31, 32
Scenarios, 45–49
defining bookends, 46
leading indicators, 46–47
simple extrapolation, 45
systems analysis, 47–49
Scherer, F., 115
Schering-Plough, 123
Schmookler, J., 214
Schoemaker, P., 53, 64
Scholes, K., 190
Schrello, M., 174
Schumpeter, J., 152, 215
Schwab, 91, 92
Schwartz, P., 30
Scorecard, 18–19
Sealed Air Corporation, 159
Sears, 89, 117
Second horizon bets, 205
Segmentation, market, 87–88
Seismic shifts, 159–161
Sensitivity analysis, 102
Sequential game, 100, 102–103
Serial innovators, 164
Seven-S framework, 75–76
shared values, 76
skills, 76
staffing, 75–76
strategy, 75
structure, 75
style, 75
systems, 75
Shake Shack, 44
Shamsie, J., 53
Shared values, 76
Shell, 151
Shenkar, O., 73
Sheun, A., 99
Simple extrapolation, 45
Simultaneous game, 100–102
Skills, 76
Smith, D., 100
Soft drink market
international market shares, 141
product maturity of, 141
Sony, 27, 160
Southwest Airlines, 16, 188
Sports analogy, 16–19
getting it early, 17–18
relying on teamwork, 18
scorecard, 18–19
Sprint, 94–95, 116, 117, 160
Spulber, D., 104
SPX, 122
S-shape curve, 178
St. Paul, 117–118
Staffing, 75–76
Stakeholders, 40–41
Stakeholder theorists, 41
Starbucks, 88, 114
State uncertainty, 47
Steele, R., 189, 190, 191, 198
Stewart, T., 32
Stock market data, 19
Strategic change, 219–225
Strategic group analysis, 42–44
mobile phone industry, 42–43
restaurant industry, 43–44
Strategic inflection points, 1–2
Strategic management, tools of, 6–19
Strategies for Change (Quinn), 13
Strategy, 75
blue ocean/end-run, 95
business-level (see Business-level strategy (BS))
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Index 247
as design, 13
implementing/formulating, 13
intended, 13
realized, 13
Strengths, weaknesses, opportunities, and threats
(SWOT) analysis, 76–77
Structure, 75
Style, 75
Subramanian, V., 3, 29
Substitutes, 35
Subway, 43, 115
Sun, H., 113, 118, 123
Sunbeam, 19
Sun Microsystems, 113, 123
Sun-Tzu, 12
SuperValue, 117
Suppliers, 35–36
Supply chain traceability, 71
Sustained competitive advantage (SCA), 2–4, 36, 203,
220–222
resource-based view and, 54
three-step model for, 5–6
Syngenta, 111
Syntex, 182
Systems, 75
Systems analysis, and scenarios, 47–49
cross-impact matrix, 48
T
Tactics, 94–96
defensive, 96
offensive, 95–96
Tangible resources, 59
Target, 93, 145
Target Corporation, 53, 62
Tata Group, 112
Taylor, F., 72
Teams, cross-functional program, 193–194
Teamwork, 18
Technological opportunities, 215–219
alternative scenarios, 215
biotechnology, 216–217
high-value environmental solutions, 218–219
leading-edge industries, 215–216
low-cost environmental solutions, 217–218
trends, 215
Technological progress, 171
Technology, 151–152
Technology development, 65
Technology-push model, 214–215
Teece, D., 99
Tenneco, 117
Tenth & Blake Beer Company, 174
Tesla & Tesla Motors, 35, 165, 181, 182, 218, 219
Teva, 111
Texaco, 111
Third horizon bets, 205
Time Warner, 28, 99, 117
Timing, 96–106, 222
Best Buy example, 98–99
early movers vs. late starters, 97–99
game theory (see Game theory)
life cycle, 96–97
value of rapid adjustment, 99–100
Titan Aerospace, 112
T-Mobile, 160
Tongal, 212
Toshiba, 160
Toth, J., 12
Toyota, 114, 151, 172, 182
Trade-offs, 28
Trader Joe’s, 89, 170, 212
Transaction costs, 135–136
Transient industry attractiveness, 40
Transnational approach, 140, 145–146
Trends, 215
Tyco, 41, 112
U
Uber, 113, 172
Uncertainty
effect, 47
hedging against, 15–16
levels of, 15
preparation for, 204–210
response, 47
risk and, 180–182
state, 47
Unilever, 33
Union Pacific, 119
United Airlines, 188, 189
United Dominion, 122
United Health, 117
United Technologies, 10, 132
Upwork, 212
US Airways, 118
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248 Index
V
Valuable, rare, inimitable, and organized (VRIO)
analysis, 58–60
Value chain analysis, 64–67
administration, 65
customer service, 65
Dell example, 66–67
human resource management, 65
inbound logistics, 65
linkages, 66
marketing and sales, 65
operations, 65
outbound logistics, 65
resource procurement, 65
technology development, 65
Value proposition, 211
van der Linde, C., 218
Venkatraman, S., 53
Verdin, P., 3, 29
Verizon, 94, 116, 160
Vertical integration, 113, 133–136
Vetting ideas, 174–175
Viacom, 134–135
Virgin & Virgin Group, 112, 165
Vision, of company, 8, 9
von Clausewitz, Carl, 12, 13
Von Hippel, E., 214
VRIO analysis. see Valuable, rare, inimitable, and
organized (VRIO) analysis
W
W. R. Grace, 117
wall, B., 133
Walmart, 28, 53, 73, 84, 88, 93, 94, 142, 148,
151, 223, 225
Wang Laboratories, 76
War analogy, 11–16
commit with fallbacks, 16
concentrating forces, 13–14
delay until clarity emerges, 16
hedging against uncertainty, 15–16
intended strategies, 13
know your enemy/yourself, 12
most probable outcome, 15
planning and improvising, 12–13, 18
realized strategies, 13
redeploying assets, 14–15
robust route, 15–16
Warner-Lambert, 123, 134
Waste Management, 19
Waterman, R., 75, 76, 77
Watson Pharmaceuticals, 93
Wells Fargo, 117
Wendy, 43
Wernerfelt, B., 53
Westinghouse, 27, 76, 124
Weyerhaeuser Company, 182
Wheelwright, S., 102
Whirlpool, 173, 174
Whittington, R., 190
Wiggins, R., 3
Williamson, O., 135
Wilmar, 145
Winter, S., 53, 63
Woodward, J., 73
WorldCom, 6, 7, 19, 41, 118
Wright, P., 53
Wyeth, 123
X
Xerox, 16, 76, 99, 100, 102
Xiaomi, 43
XM and Sirius, 95
Y
Yahoo, 26
Youth, and globalization, 154–155
Z
Zaheer, S., 140
Zegveld, W., 214