Strategic Management and Planning Assignment

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Question Description

Purpose of Assignment

The purpose of this assignment is to help students understand strategic business terminology (vision, mission, goals, objectives, specific objectives, internal and external scanning), to recognize the components of a strategic plan and to be familiar with the core information and steps needed to create a strategic plan. Furthermore, this assignment allows students to recognize the difference between strategic planning and strategic management.

Assignment Steps

Write a 700-word analysis in which you complete the following:

  • Describe and define the primary components of the Strategic Management Process.
  • Describe and define internal and external analysis.
  • Describe and define the responsibilities and duties of the Strategic Manager.
  • Explain why companies need strategic management planning.

Cite 3 scholarly references, including at least two peer-reviewed references from the University Library.

Format your paper consistent with APA guidelines.

ANALYSIS OF THE EXTERNAL ENVIRONMENT: OPPORTUNITIES AND THREATS LEARNING OBJECTIVES Studying this chapter should provide you with the knowledge to: Explain the importance of correctly identifying and choosing a firm's industries and markets. Identify and measure the five major forces that shape average firm profitability within industries to evaluate the overall attractiveness of an industry. Discuss how understanding the five forces that shape industry competition is useful as a starting point for developing strategy. Identify the factors in the general environment that affect firm and industry profitability. 02 Nokia and the Smartphone Industry Nokia, a long-time leader in the telecommunications equipment and mobile phone industry, got its start in that industry in 1981 when it acquired a 51 percent stake in a Finnish telecommunication firm. Since that time, Nokia has sold more mobile phones than any other company. The firm has been the world leader in market share since the mid-1980s. By 2008, Nokia's worldwide market share had reached 40 percent, more than double the approximately 18 percent market share of Samsung, its nearest rival. The Nokia brand was a top seller everywhere, including the United States, China, Latin America, and Africa. Not only was Nokia the leader in handset manufacturing, offering value to its customers by manufacturing a full line of phones from the lowest end of the price range to the most expensive, the company also manufactured some of its own cell-phone components, such as cameras and accessories. In addition, Nokia designed and manufactured network infrastructure equipment, launched a gaming device (N-Gage) that tapped into the entertainment and media markets, and owned Symbian, the leading operating system for the new generation of multifunctional 3G phones. In all, Nokia had nine divisions producing products for a variety of industries, each with separate profit and loss accountability.1 As late as 2003, Nokia appeared to have a competitive advantage in cell phones in the same way that Microsoft had an advantage in PC operating system software and Intel in microprocessors. NOKIA FAILED, HOWEVER, TO LOOK MORE BROADLY AT WHAT THE CELL PHONE MARKET WAS BECOMING AND WHO MIGHT BECOME ITS NEW COMPETITORS IN THAT EMERGING MARKET. IT WASN'T PREPARED TO COMPETE WITH THEM AND COULDN'T SUSTAIN ITS COMPETITIVE ADVANTAGE. By 2010, however, Nokia had taken a nose dive. Although it still held a reasonable 32 percent of the worldwide market share of cell phones, the company commanded only 2 percent of the emerging smartphone market in North American. Nokia's profits had plunged 68 percent, from nearly €8 million in 2007 to only €3.3 million in 2009. Moreover, the firm's stock also tumbled, falling 86 percent from a high of $39.57 a share in October 2007 to $7.15 a share in April 2014. What happened? To a large extent, Nokia was caught off guard by fundamental changes in the mobile phone industry from 2003 to the present. Before the introduction of 3G (third generation) smart phones, the cell phone manufacturing industry had power over its suppliers, the makers of chips, and other parts for cell phones. Software wasn't a big part of the picture and most handset makers programmed their own software. The firm that could make the most attractive phone with the best hardware features at the lowest cost outperformed others in the industry. For years, Nokia had offered unique value to its customers by having the latest and best hardware. With the advent of 3G smart phones, however, software became the central differentiator. Today, most people buy a phone based on its operating system and the applications the operating system can run. Nokia did see the change coming and poured Research and Development (R&D) dollars into its own Symbian operating system, focusing on building the resources and capabilities necessary to compete in software. In 2003, 80 percent of all 3G phones—the first ones able to surf the Internet—were sold by companies that had licensed Nokia's Symbian operating system. In contrast, Microsoft, Nokia's major competitor at the time, had great difficulty with the early launch of Windows Mobile operating system for 3G smart phones. Several of Microsoft's partners abandoned Windows Mobile for Nokia's Symbian system.2 Nokia failed, however, to look more broadly at what the cell phone market was becoming and who might become its new competitors in that emerging market. It wasn't prepared to compete with them and couldn't sustain its competitive advantage. With the introduction of Apple's iPhone and Google's Android operating system, Nokia's share of operating systems plummeted so far that the company eventually teamed up with its old rival, Microsoft, to offer Windows Mobile 7 on Nokia phones.3 But this did little to stop the onslaught from Apple and Samsung, who sold phones using Google's Android system. In the first quarter of 2011, Nokia sold 108.5 million handsets for a total of $9.4 billion. Apple, in contrast, sold only 18.6 million iPhones but made $11.9 billion.4 Nokia had clearly lost the market for high-end phones to Apple and other phones running the Android operating system. In addition, Nokia's low-end handsets were under pressure from new Asian manufacturers. Indeed, thousands of new low-cost Shanzhai manufacturers, small Chinese firms focused on creating knockoff products, now make phones with names such as “Nckia.” The Shanzhai manufacturers flooded the markets in China, India, the Middle East, and Africa, threatening to erode Nokia's market share in the remaining markets where Nokia was still dominant.5 Indeed, Nokia's position in cell phones became so stark that in 2013 it sold its entire cell phone business, the cornerstone of its previous success, to Microsoft. Not only did Nokia have to sell, but it did so at a shockingly low price of only 5.5 billion euros, off from the highest market capitalization of 110 billion euros during its glory days.6 As described in Chapter 1, strategy involves crafting a plan to create competitive advantage—and superior profitability—in particular markets. This plan, however, is shaped by the landscape in which the firm competes. A firm's external environment provides both opportunities—ways of taking advantage of conditions in the environment to become more profitable—and threats—conditions in the competitive environment that endanger the profitability of the firm.7 Successful firms have a deep understanding of their environment and constantly scan the horizon to see opportunities and threats as they emerge.8 One of the key threats a strategist must understand and cope with is competition. Often, however, managers define competition too narrowly, as if it occurred only among today's direct competitors. Nokia was so focused on Microsoft as its key competitor in the 3G operating system industry, and Motorola and Ericsson as its cell phone competitors, that it failed to effectively prepare for Apple's entry into the industry. Competition for profits goes beyond established industry competitors to include four other forces that shape industry attractiveness and profitability: customers, suppliers, potential entrants, and substitute products. Together, all five forces define an industry's structure and shape the competitive interactions—and profitability—of companies within that industry. Even though industries might appear to differ significantly, the principles that determine the underlying drivers of profitability are often the same. The global cell phone industry, for instance, appears to have nothing in common with the highly profitable soft drink industry or the low-cost airline industry (i.e., Southwest and JetBlue). But to understand industry competition and profitability in these and other industries we must analyze the same five forces. This chapter will help you to recognize the major threats and opportunities that make up the competitive landscape, both the industry forces and general macroeconomic forces that drive industry attractiveness—and profitability. DETERMINING THE RIGHT LANDSCAPE: DEFINING A FIRM'S INDUSTRY The first strategic decision that most firms must make is to select the industry, and markets, in which it will compete. The Strategy in Practice feature discusses the U.S. government's classification of industries. A firm's industry also determines which customers and which competitors will be part of the firm's landscape. The landscape is typically defined by: (1) the industry (or industries) in which a firm competes, and (2) the product and geographic markets within that industry that the firm targets. For example, Nokia competes primarily in the cellular telephone manufacturing and operating system industries. Within the cellular telephone manufacturing industry, Nokia targets multiple product markets by selling a range of handsets, from high-end smart phones to inexpensive basic phones. The company also targets multiple geographic markets, focusing mainly on Europe and developing economies in the Middle East and Africa. STRATEGY IN PRACTICE HOW THE U.S. GOVERNMENT DEFINES INDUSTRIES One tool that helps to define industries is the NAICS (North American Industry Classification System), a series of codes generated by the U.S. government.9 These codes (formerly referred to as SIC codes, for Standard Industrial Classification) vary from two to seven digits, becoming more narrow with increasing numbers of digits. Table 2.1 provides the NAICS codes for the cell phone handset manufacturing and mobile operating system industries. In Nokia's early years, it competed primarily in category 334220, cell phones. As cell phones became more sophisticated, Nokia also began to compete in category 511210, operating systems. [TABLE 2.1] NAICS Codes for Nokia HANDSET HARDWARE BUSINESS HANDSET SOFTWARE BUSINESS Code Classification Code Classification 33 Manufacturing 51 Information 334 Computer and Electronic Product Manufacturing 511 Publishing Industries 3342 Communication Equipment Manufacturers 5112 Software Publishers 33422 Wireless Communication Equipment Manufacturers 51121 Software Publishers 334220 Cellular Telephone Manufacturers 511210 Operating Systems Software Publishers NAICS codes can be useful not just for helping to define an industry but also for determining who the primary competitors are, although in fast-changing industries, the NAICS can sometimes lag behind changing technologies or changing customer demands. As we've seen, Nokia failed to seriously update its definition of its industry to include all the companies competing under its new classification code. The choice of industries is important because not all industries are created equal. The profits of an average firm in some industries are substantially higher than profits of an average firm in other industries. Figure 2.1 shows the return on equity for a variety of industries over a ten-year period. As you can see, the industry in which a firm competes has a direct bearing on the profits earned by that firm. [Figure 2.1] Varying Attractiveness of U.S. Industries 2000–2010 Source: Troy's Almanac Be careful about assuming that it is obvious which industry a company competes in. For example, it seems obvious that Barnes & Noble competes in the book retailing industry and Microsoft competes in the computer software industry. However, it may be less obvious that those aren't their only industries. In addition to operating systems, Microsoft also makes the X-Box gaming system, so it competes in the gaming console industry as well as the PC operating system industry. Barnes & Noble sells an e-reader, the Nook that combines electronic books with computer hardware. Amazon.com, Barnes & Nobles' main book retailing competitor, not only sells books and the Kindle e-Reader, but also sells web services competing with Microsoft and a wide range of products online as a discount retailer competing with Walmart. Firms must choose which markets to compete in, with many large firms choosing to compete in several at the same time. If managers do not properly define and understand their industry, they may be vulnerable to unseen competitors. For example, Nokia defined itself primarily as a mobile handset manufacturer. As a result, managers failed to see computer hardware companies like Apple and web search companies like Google becoming potential competitors—or potential partners. Their focus on preventing Microsoft from creating a dominant position in the mobile operating system industry caused them to overlook Apple, a company that has consistently been the leader in innovative, user-friendly operating systems for a variety of platforms.10 Truly understanding an industry often begins by taking a customer-oriented view. Rather than identifying the industry based on the product or service they produce (such as cell phone handsets), firms should think carefully about the job that products do for customers. What need does a product fill? Understanding customer needs can be very helpful in defining the boundaries of an industry. If two firms have products that do the same job for customers—they meet similar customer needs—then those two firms can be considered part of the same industry. For instance, companies that meet the need for communication by manufacturing mobile handsets, as opposed to mobile ham radios (long-range walkie talkies), compete in the same industry.11 In the case of cell phones, changing customer needs broadened the boundaries of the industry, from primarily hardware manufacturing to include mobile operating systems and applications that allowed phones to do far more jobs for customers than just place a phone call. This led to new competitors for Nokia, including Apple and Google. FIVE FORCES THAT SHAPE AVERAGE PROFITABILITY WITHIN INDUSTRIES Michael Porter, a well-known strategy professor at Harvard, identified five forces that shape the profit-making potential of the average firm in an industry. As shown in Figure 2.2, those five forces are: (1) rivalry, (2) buyer power, (3) supplier power, (4) threat of new entrants, and (5) threat of substitute products. The strength of each of these five forces (known as Porter's Five Forces12) varies widely from industry to industry. For instance, in the semiconductor industry, the threat of substitutes is almost nonexistent, while in the carbonated soft drink industry it is a significant threat. A careful analysis of the five forces is a powerful way for firms to discover the threats and opportunities in their environments. We provide a tool at the end of this chapter to help you conduct a careful analysis of an industry's five forces. rivalry Competition among firms within an industry. Typically this involves firms putting pressure on each other and limiting each other's profit potential by attempting to steal profits and/or market share. substitute A product that is fundamentally different yet serves the same function or purpose as another product. threats Conditions in the competitive environment that endanger the profitability of a firm. opportunities Ways of taking advantage of conditions in the environment to become more profitable. [Figure 2.2] Analyzing Major Threats: The Five Forces Industry Analysis Tool Source: Adapted from Michael E. Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review 86, 1 (January 2008), pp. 80–86. There are three basic steps involved in using the five forces analysis tool: Step 1: Identify the specific factors relevant to each of the five major forces. We describe the factors that contribute to each of the five forces in the next five sections of this chapter. Step 2: Analyze the strength of each force. To what extent is it shaping the industry's attractiveness? The appendix at the end of the book lists several sources where you might find the data you need to analyze each of the five forces. Step 3: Estimate the overall strength of the combined five forces to determine the general attractiveness of the industry, the profit potential for an average firm in the industry. attractiveness of an industry The degree to which an average firm in the industry can earn good profits. Instructions for steps 2 and 3 are at the end of the chapter. Step 1, the factors relevant to each of the five forces, is discussed next. Rivalry: Competition among Established Companies Competition in an industry is sometimes referred to as war, with each company deploying as many weapons in its arsenal as possible to gain greater profits. Because there are typically a limited number of buyers, each firm's profits often come at the expense of other firms in the industry. Each move by a firm provokes countermoves among competitors, resulting in a constantly shifting competitive landscape populated by winners and losers. (Chapter 11 explores how successful firms manage that shifting landscape by planning for the countermoves of their rivals.) Firms' moves and countermoves can take many forms, including sales and promotions, better quality or service, a wider variety of products, or lower prices. Not surprisingly, these types of moves increase rivalry—the intensity with which companies compete with each other for customers—which tends to squeeze the profit margins of most firms in an industry. Rivalry among firms in an industry—for either rational or irrational reasons—is such an important driver of profitability that it is shown at the center of Figure 2.2. The following seven factors are critical to understanding the intensity of rivalry in an industry: The number and size of competitors Standardization of products Costs to buyers of switching to another product Growth in demand for products Levels of unused production capacity High fixed costs and highly perishable products The difficulty for firms of leaving the industry The Number and Relative Size of Competitors. The more competitors in an industry, the more likely that one or more of them will take action to gain profits at the expense of others. Economists call an industry with a lot of competitors a fragmented industry. In a fragmented industry, it is difficult to keep track of the pricing and competitive moves of multiple players. The large number of firms responding to one another tends to create intense rivalry. The same is true of the relative sizes of competitors. If firms are approximately the same size, they tend to be able to respond, or retaliate, strongly to moves by rival firms. Industries that are concentrated, as opposed to fragmented, have far fewer competitors and tend to be dominated by a few large firms. In these industries, rivalry is typically much less intense. Smaller competitors do not have the capability to respond to actions taken by large firms, and the few large competitors are more aware of each other and less likely to risk actions that may result in price wars. Relatively Standardized Products. Differentiated products, ones that boast different features or better quality, tend to engender loyalty in customers because they meet customer needs in unique ways. When products are standardized, or commodity-like, buyers are less loyal to a particular brand and it is easier to convince them to switch brands. A rider may be fiercely loyal to his or her HarleyDavidson motorcycle, for example, but willing to buy several different brands of gas for the Harley. Firms that sell standardized products—manufactured products or materials that are interchangeable regardless of who makes them like bolts and nuts, rubber, plastics or commodities such as coal, crude oil, salt, or sugar—often have to compete by offering sales, rebates, or lowering prices. Price wars increase rivalry and decrease profits. Low Switching Costs for Buyers. Switching costs include any cost to the customer for changing brands. Switching costs for buyers are related to the degree of product standardization. For a computer user, changing operating system or word processing software would entail considerable switching costs because the user would need to: (1) convert files to the new software, and (2) learn how to use the new software. Switching from an iPod to another MP3 player might require music lovers to move all of their music files from iTunes to a different music software. In contrast, most of us can change our brand of gum or candy bar without any switching costs. The lower the switching costs, the easier it is for competitors to poach customers, thereby increasing industry rivalry. switching costs Barriers that help keep buyers using the same supplier by imposing extra costs for switching suppliers. Switching costs are a fundamental part of not just rivalry but also the other four forces: Buyer power. If customers, or buyers, can easily switch firms, then buyers have increased power. Supplier power. If firms can't switch suppliers easily, then suppliers have increased power. New entrants. If buyers can easily switch to new companies attempting to enter the industry, there is a greater threat of new entrants. Substitutes. If buyers can switch to substitute products without much difficulty, firms face an increased threat from those substitutes. Slow Growth in Demand for Products or Services. When demand is increasing rapidly, most firms can grow without taking existing customers from competitors. When growth slows, however, firms can become desperate. They may try to increase their sales volume by attracting customers from their competitors through sales promotions, price discounts, or other tactics.13 Of course, competitors then respond with their own sales promotions and price cuts, thereby increasing industry rivalry. Consider the flat-screen television industry. When large, flat-panel displays were first introduced, prices were high. They remained that way for years while industry growth exploded. As flat-panel manufacturers anticipated slower growth, from 18 percent in 2010 to 4 percent in the first half of 2011, they dropped prices by more than 25 percent in the last quarter of 2010 in a bid to gain what market share they could from their competitors.14 High Levels of Unused Production Capacity. Unused production capacity is expensive. Firms typically try to produce at or near their full production capacity so that they can spread the fixed cost of factories, machinery, and other means of production across more units. In fact, they may try to produce more product than the market demands, in order to use their capacity completely. However, when more is produced than is demanded in the market, firms often have to drop their price or risk having unsold product. This has frequently been the case in the automobile industry. During an economic downturn, automakers offer price cuts, rebates, and special sales incentives to buyers so that they don't have significant unused production capacity. High Fixed Costs, Highly Perishable Products, High Storage Costs. Industries that produce or serve products in these three categories sometimes find themselves with a supply of products that they have to sell quickly or take large losses on. For example, airlines operate with high fixed costs. Most of the cost of a flight is in the airplane, the fuel, and the pilot and flight attendants. It is not in the cost of serving an additional passenger. The marginal cost of adding an additional passenger is truly only peanuts (and a drink). If it appears that a scheduled flight is going to have few passengers, an airline may be tempted to discount steeply in order to fill as many seats as possible. The variable cost of an additional passenger is very little, so selling a seat for less would not cost the airline money, but leaving it empty would mean the airline has fewer passengers over whom to spread its fixed costs. Firms that sell highly perishable products, such as fruits or vegetables, face similar problems. As food nears the date when produce will spoil, grocery chains often steeply discount it rather than lose the sale completely. Products with high storage costs exhibit the same characteristics. If firms have an oversupply and are forced to store the product, they may discount the price to avoid storage costs. In all three cases, steep discounting leads to increased rivalry as competitors are forced to respond with discounts of their own, or be left with losses while others recoup their production costs. High Exit Barriers. In some industries, companies don't exit even when they aren't making a lot of money. Most often, they stay because they have made investments in specialized equipment that can't be used in any other industry. For example, steel blast furnaces are very expensive and cannot be used in any industry other than steelmaking. If the firm exits the steel industry, its blast furnaces lose most of their value. Another barrier to exit is labor or government agreements that make it difficult to close a plant. Emotional ties to employees or a business can also lead to less than rational decisions by top management to stay in business. Buyer Power: Bargaining Power and Price Sensitivity When buyers have sufficient power, they can demand either lower prices or better products from their suppliers, thereby hurting average profitability of firms in the supplier industry. The two primary situations in which buyers have high power are when buyers hold a stronger bargaining position than sellers and when buyers are pricesensitive. The strength of a buyer's bargaining power or price sensitivity can be affected by a number of factors. When firms understand what causes buyers to have power over their industry, they have a better chance of countering that power. supplier A firm that provides products that are inputs to another firm's production process. Buyer Bargaining Power. Four key factors influence the degree to which buyers have bargaining power over their suppliers. We already discussed two of these factors—buyers' switching costs and demand—because they are also factors in rivalry among firms. The two remaining factors are the concentration and size of buyers and the threat that buyers can backward integrate: Number, or concentration, and size of buyers. Buyer concentration reflects the law of supply and demand. If there are few buyers but many sellers, then the sellers must compete more strongly for buyer business. Sellers in this situation are likely to give concessions to make the sale. Likewise, the larger the buyers, compared to sellers, the more likely sellers are to increase the level of competition in order to gain buyers' business. For example, farmers, as suppliers to the frozen-food industry, are not very concentrated. The three largest farmers account for only about 1 percent of all food produced and sold. Frozen food makers, however, are concentrated. The top four (Nestlé, Schwan, ConAgra, and HJ Heinz) accounted for nearly half (48.6 percent) of total market share in their industry in 2010.15 This means that frozen-food manufacturers, as buyers, have a great deal of power over farmers. A farmer who needs the business of the big four frozen-food makers in order to sell this year's crop may be willing to accept a lower price in order to secure their business. Credible threat of backward integration. In some cases, a buyer can exert pressure over suppliers by threatening them with backward integration, meaning they will make the product themselves. For example, one way Walmart keeps prices low for consumers is by threatening to expand its Sam's Choice store brand products into additional categories if manufacturers of other branded products don't meet Walmart's pricing demands. backward integration A firm purchases one or more of its suppliers in order to make a product itself rather than buying it from another firm. Buyer Price Sensitivity. In general, when buyers are more price-sensitive, they are more likely to exert pressure on suppliers to keep prices low. Buyers exert pressure not just through price negotiation but also through more comparison-shopping and a greater willingness to switch suppliers. Buyer price sensitivity tends to increase in the following situations: Buyers are struggling financially. When companies are struggling financially, they are more likely to be price-conscious and to look for ways to get less expensive sources of supply. If many of an industry's buyers are in the same situation, there is a cap on what suppliers can charge. Product is significant proportion of buyer's costs. Buyers tend to care more about getting a good price when the product they are buying creates a large part of the costs of their own production (or their budget, if the buyers are the end consumers). If the product is only a small part of their cost structure, buyers are less likely to bother negotiating or comparison-shopping. For instance, end consumers are less likely to do extensive comparison-shopping for a gallon of milk than they are for a home or car. Likewise, auto manufacturers are less likely to pressure suppliers of electrical wiring for price cuts than suppliers of steel or engine components. Buyers purchase in large volumes. When buyers purchase in large volumes, they typically expect to get breaks in price. In essence, the buyer is taking a risk by being willing to buy large amounts at once rather than smaller amounts over time. Product doesn't affect buyers' performance very much. If a product is very important to the quality of the buyers' end product, then buyers tend not to be very price conscious. For instance, when Nokia had the most innovative handsets on the market, many cellular phone carriers, like Verizon and T-Mobile, were willing to pay whatever Nokia charged in order to be able offer Nokia phones to their customers. However, if suppliers' products don't affect buyers' quality or performance very much, then buyers are much more likely to be price conscious. For instance, the plastic casing on tablet or laptop computers doesn't enhance the performance of the computers very much; it doesn't drive sales to the end consumer. As a consequence, PC manufacturers are likely to shop around for price discounts on plastic casings in ways that they might not for the microprocessors that run the computers. Product doesn't save buyers money. If a product saves buyers money, they tend not to be very price conscious when purchasing it. These types of products can be anything from machinery in manufacturing industries that replaces highly skilled, costly labor to inexpensive, overseas labor that replaces more expensive labor or machinery in countries such as the United States. If a product does not save buyers money, however, buyers are as likely to be price conscious as they are with other types of products they buy. Supplier Bargaining Power The factors that increase the bargaining power of suppliers are very similar to those that increase the bargaining power of buyers. In this case, however, the firms are not customers, but suppliers, those from whom your industry purchases inputs. When supplier industries have strong bargaining power, they can charge higher prices, which tend to decrease average profitability in an industry. As firms understand the factors that give suppliers power, they may be able to make decisions that decrease that power. Number, or Concentration, and Size of Suppliers. As with buyer concentration, supplier concentration follows the law of supply and demand. If there are few sellers, but lots of buyers in an industry, then the buyers have to compete to get the products that they want, often paying higher prices to get sufficient supply. Likewise, the larger the number of sellers compared to the buyers, the less likely buyers are to pay the price that sellers are demanding. For instance, ARM, a designer of semiconductor chips for smart phones, controls more than 95 percent of the market for its product,16 resulting in a highly concentrated supplier industry dominated by one large firm. As a consequence, Nokia, or any other smart phone handset manufacturer that wants a sufficient supply of chips, and wants the high-quality chips that won ARM its market share in the first place, has to buy from chip manufacturers who license from ARM. ARM has sufficient power that it can, to a large degree, set the price for its product. Suppliers who charge more often squeeze the profits of buyers, who may not be able to pass additional costs through to their customers. In fact, ARM's rise to power in the mobile semiconductor chip industry is a major contributor to Nokia's current difficulties. Nokia cannot charge enough for its low-cost handsets to make a good profit after paying for expensive ARM chips. Credible Threat of Forward Integration. In some cases, a supplier can exert pressure over its buyers by threatening them with forward integration, doing what its buyers do, if the buyers don't offer price concessions. A good example of this is Google and its decision to forward integrate in the smart phone handset industry by manufacturing its own phones.17 Google also licenses its Android operating system to other handset makers, such as HTC and Samsung. Google's ability to forward integrate gives Google power over those handset makers. When there is a credible threat of forward integration, buyers are often willing to take a cut in profit by paying higher prices, rather than risk losing the supply altogether and creating a new rival (if the supplier hasn't already forward integrated). forward integration A firm goes into the business of its former buyers, rather than continuing to sell to them. Threat of New Entrants As previously shown in Figure 2.1, not all industries are created equal. Industries in which the average firm is making good profits can often be targets, enticing firms from outside those industries to enter. Likewise, quickly growing industries are often attractive, which increases the incentive for outside firms to enter those industries. One of the important tasks for strategists is to identify firms that might enter their industries. New entrants pose a double hazard. First, they typically are anxious to gain market share.18 Unless the industry is growing quickly, that market share must come at the expense of existing firms. Second, new entrants bring new production capacity, which tends to drive prices down unless demand is growing faster than the increase in supply. New entrants mean greater rivalry, so existing firms often try to discourage new entrants by building barriers to entry. The higher the barriers to entry, the more difficult it is for potential entrants to get a foothold in the industry, and the more likely that they are to quit or choose to not enter in the first place. Likewise, incumbent firms, those already in the industry, often signal new entrants that they are likely to retaliate by slashing prices, increasing advertising, or other competitive moves that help the established firms hold on to their market share. If the threats of retaliation are perceived as credible, potential entrants might decide to stay away. barriers to entry The way organizations make it more difficult for potential entrants to get a foothold in the industry. It is essential for firms to understand the barriers to entry that already exist in their industry and to consider ways of increasing them. Existing firms may also want to build new barriers. Firms that are considering going into an industry can use an analysis of the barriers to entry in the target industry to help them determine how likely they are to succeed. Economies of Scale, Experience, or Learning. These types of economies occur when the cost per unit of production (the cost for producing each individual product or service) decreases as a firm produces more. Typically, these economies come from mass manufacturing methods, discounts through purchasing in high volumes, employees becoming quicker and better at production, and being able to spread the fixed costs of production machinery, R&D, advertising, and marketing across more units.19 Chapter 4 will explore these three types of cost advantages in greater detail. In essence, lower costs allow the firm either to lower its price, perhaps in retaliation for a new firm entering the market, or to maintain its price while earning more profits than competitors. When economies of scale, experience, or learning exist in an industry, new firms will be at a cost disadvantage. New firms are not likely to have as much market share as existing firms, so they will not produce as much and can't achieve the same economies as existing firms. Some firms may not be able to lower their prices sufficiently to match incumbent firms' prices. Other new entrants may match incumbent prices, but earn smaller profit margins than the incumbents. The higher the economies of scale, the greater the barrier to entry and the easier it is for the larger incumbent to pose a credible threat of retaliation. If conditions change so that cost savings from these economies become smaller, the barrier diminishes. For example, from the late 1980s until the early 2000s, the cell phone handset manufacturing industry possessed high economies of scale. Nokia produced millions of handsets per year during this time and had the lowest costs of its competitors. Consequently, the number of firms in the industry was relatively stable during this period. However, the invention of flexible manufacturing processes, coupled with the rise of low-cost, highly-skilled labor in China in the mid-2000s, lowered the cost savings that could be achieved from high levels of production and allowed thousands of new Shanzhai manufacturers to successfully enter the industry. Other Cost Advantages Not Related to Scale. Incumbent firms might have cost advantages relative to new entrants for a variety of reasons besides economies of scale. These include the following: Patents or proprietary technology such as those that exist in the pharmaceutical industry Better locations (a deterrent to firms wishing to enter markets where Starbucks is dominant, for example) Economies of scope—less expensive costs per unit created by bundling different types of products. For example, Procter & Gamble has low-cost marketing and distribution costs, compared to firms that manufacture only one type of product, because P&G ships dozens of different types of products to the same retailers. (See Chapter 4 for a more detailed explanation of economies of scope.) Preferential access to critical resources, such as raw materials or access to distribution networks. For example, Chinese makers of lithium ion batteries have government-protected access to sources of rare earth elements, raw materials that are necessary for battery production. In many industries, new entrants face high barriers in the cost of building a dealer network or recruiting retailers to sell their products. With a limited number of potential dealers and retailers, new entrants often find themselves having to cut prices, and profit margins as well, to secure access to distribution. As with economies of scale, it is important for firms to track whether barriers are rising or falling. An expiring patent or the advent of an innovative distribution channel, such as the Internet, has the potential to radically change the strength of barriers related to cost advantages. Capital Requirements. It costs money to enter a new industry. Not only do potential entrants often need capital to build a factory or store, but they may also have to invest in R&D to generate viable products, build inventory, undertake sufficient advertising and marketing to take market share from incumbent firms, and have sufficient cash on hand to cover customer credit. Anything that increases the start-up costs will reduce the pool of possible entrants. For instance, the computer semiconductor chip industry, dominated by Intel, makes a very complex product. New entrants would need to spend years of R&D before they had a viable product and could make their first sale. The high capital requirements needed for long periods of R&D limit the number of entrants to those with enough financial or other resources to enter. However, firms that already have made R&D investments in similar products, such as semiconductor chips for mobile phones, could lower the capital costs associated with entering the computer semiconductor industry. It is likely no coincidence that ARM, the maker of mobile semiconductor chips, is one of only a few successful entrants into Intel's industry in the last 30 or more years. Network Effects. In some industries, network effects increase the switching costs for customers, making it more difficult for new entrants to steal business from incumbent firms. When network effects are in operation, the greater the number of people using products from a given firm, the greater the demand grows for that firm's product. For example, the more people who use a particular social networking site, the more customers want to continue to use the site, and the more new customers are likely to try it. A new entrant wanting to compete with Facebook is at a distinct disadvantage, because most of their potential customers' “friends” are likely to be on Facebook, making it less likely that they will be willing to switch to a new social media site. network effects Growth in demand for a firm's product that results from a growth in the number of existing customers. Government Policy Restrictions. Finally, government policies may make it more difficult to enter a market or even restrict a market completely to new entrants. For instance, governments often raise the costs of entry by requiring bonding, licenses, insurance, or environmental studies before a firm can enter an industry. New entrants will have to use capital that might have been used for R&D, production, or advertising to meet those requirements. When competing across international borders, additional regulations, such as trade restrictions and local content requirements, may be applied to try to limit foreign competition. In some industries, such as hairstyling, the requirements might be fairly minimal, but in others, such as oil refining, they can become so onerous that most new firms cannot overcome the barrier. Threat of Substitute Products A substitute is a product that is fundamentally different yet serves the same basic function or purpose as another product. One of the primary problems for the strategist in assessing substitutes is determining what is a substitute and what isn't. It involves determining the boundaries of an industry, as we addressed earlier in the chapter, and then scanning other industries to find products that might serve the same basic functions. For instance, email is a substitute for telephone messages, faxed documents, or documents delivered via the post office. All four are ways of delivering messages. Similarly, fruit juice is a substitute for any number of other drink products, including coffee, wine, and soda. Generally, something can be considered a substitute if it serves the same function, such as quenching thirst, but does so with a different set of characteristics. If the product has the same basic characteristics and is made using the same general set of inputs, it would be considered part of rivalry, rather than a substitute. For instance, competitor brands serving the same basic need, such as Apples iPhone and Samsung smart phones running Google's Android operating system, are rivals, not substitutes. In general, substitutes put downward pressure on the price that firms in an industry can charge. For instance, streaming video across the Internet is a substitute for watching movies in the theater. Even if you had the only movie theater in an area, you could not charge whatever price you wanted to. As your price rose, more customers would switch to streaming video. If the price difference is enough, customers will stream even though the quality is lower and they have to wait weeks or months before the movie leaves the theater and is available online. For some industries, such as newspapers, the low price of the substitute—in this case, free news on the Internet—can be disastrous, creating such a low cap on the prices they can charge that many firms go out of business. The factors that determine the intensity of a threat of substitutes include the awareness and availability of substitutes and their price and performance compared to an industry's products. Awareness and Availability. Sometimes customers aren't readily aware that substitutes exist. The threat increases when substitute products are well known. This is particularly true if there are strong brands among the substitute products. Likewise, if the substitute product is just as easy for customers to obtain as another industry's products are, it is more of a threat. If the substitute is difficult to find or acquire, the threat is diminished. Price and Performance. A significant part of the customer decision to switch to substitutes will concern the price and performance trade-offs. As we discussed earlier in the chapter, customers are more likely to switch to a substitute if the costs of switching are low. The price of the substitute, itself, also factors into customers' decisions. If substitutes are cheaper than products from another industry, the threat is higher. Likewise, if the performance of substitutes is similar or better, the threat is higher. The closer the substitute is in performance, the less flexible a seller can be with price. For instance, many newspapers have seen steep declines in circulation as Internet news has gained in quality. The Wall Street Journal, however, has not declined in circulation over the same time period because online substitutes for serious business news have not increased in quality nearly as fast as for other types of news. OVERALL INDUSTRY ATTRACTIVENESS Understanding the five forces that shape industry competition is useful as a starting point for developing strategy. Indeed, managers often define competition too narrowly, as if it occurred only among direct competitors. Yet competition for profits goes beyond direct rivals to include buyers, suppliers, potential entrants, and substitute products. The extended rivalry that results from all five forces defines an industry's structure and shapes the nature of competitive interaction within an industry. Every company should know what the average profitability of its industry is and how that has been changing over time. The five forces help explain why industry profitability is what it is—and why it might be changing. Attractive (profitable) industries are those where firms have created power over buyers and suppliers, created barriers to entry to reduce the threat of new entrants, and minimized the threat of substitutes while keeping rivalry to a minimum. Even inefficient, relatively poorly run companies can earn superior profits under such conditions. At the other extreme, are unattractive industries. Firms in these industries are consistently pressured by buyers and suppliers alike. They face high rivalry, easy entrance for new competitors, and many well-positioned substitute products. Under these conditions, only the most efficient, well-run companies are able to turn a profit. Each of the five forces can be analyzed to determine the degree to which, and how, it contributes to industry attractiveness. We provide a strategy tool at the end of this chapter for analyzing each force. After doing an analysis of each force, these can be combined to develop a detailed picture of what is driving the overall profitability—the attractiveness—of the industry. Few industries will rate high (attractive) or low (unattractive) on all forces. A significant threat from just one or two of the five forces is often sufficient to destroy the attractiveness of an industry. For example, many firms in the auto industry have struggled to be profitable over the last decade. This industry, however, has relatively low buyer and supplier power, no real threat of substitutes, and a moderate threat of new entrants. Rivalry, however, has been fierce, with constant excess production capacity and price discounting. Sometimes, it only takes one of the five forces to be unattractive to make an industry struggle. When many of the five forces are unattractive, firms face great challenges maintaining profitability. However, understanding each force and how it is influencing profitability helps managers know where to focus in dealing with those challenges. Moreover, a company strategist who understands that competition extends well beyond existing rivals will perceive wider competitive threats and be better prepared to address them. At the same time, thinking comprehensively about an industry's structure can uncover opportunities to improve performance on each of the five forces, thereby becoming the basis for distinct strategies that yield superior performance. One thing to keep in mind is that the five forces are subject to change. Each of the five forces can be altered by actions taken by firms within or without the industry. For instance, Google built the Android operating system, even though it gives it away for free, to increase the number of suppliers for its search engine, thus decreasing the supplier power that Apple might have had had it been able to dominate the smartphone industry. A good strategist always has her eye on actions and trends that might change any of the five forces in her industry. Not all of those trends come from actions taken by firms close to the industry. Some come from the general environment. These are discussed in the next section. HOW THE GENERAL ENVIRONMENT SHAPES FIRM AND INDUSTRY PROFITABILITY To determine the landscape that a firm competes in, it isn't enough to only understand the five forces that directly affect an industry. The general environment also needs to be understood. The general environment can affect firms in a variety of ways,20 including affecting the shape of each of the five industry forces. A simple way to think about the general environment is to break it down into eight categories. Strategic managers in the best companies are focused on each of these categories, looking for trends that might lead to new opportunities or threats. This is illustrated in Figure 2.3: Complementary products or services Technological change General economic conditions Population demographics Ecological/natural environment Global competitive forces Political, legal, and regulatory forces Social/cultural forces [Figure 2.3] Trends in Opportunities and Threats in the General Environment Developments in each of the eight categories shown in the outer ring have the potential to shape and change the general landscape for any specific industry. Each category can affect an industry's dynamics, which are shown by the area within the center circle, altering any or all of the five forces. You should always keep in mind that an industry's five forces are not static. The five forces are subject to change and may change, even radically, if elements of the general environment change. When you are examining the general environment, it is important, then, to not just get a picture of what things look like today but to analyze trends, the direction each category is headed toward tomorrow. Remember, as well, that this analysis is industry specific. You want to know how each of the eight categories is going to affect the industry you are studying. The relative importance of each of the general environmental factors differs from industry to industry. In the fast-food industry, social forces, such as a shift toward healthier eating, are likely to alter the threat of substitutes, but technological change doesn't play as a large a role. In the motorcycle manufacturing industry, demographics play a key role, as many industrialized nations experience an upward trend in the average age of the population, but changes in societal perceptions of motorcycles don't appear to be shifting quickly, resulting in fewer people riding motorcycles because they are perceived to be transportation for the young. Managers need to develop a deep sense of which environmental factors are strategically relevant to their own industries.21 Managers need to understand not only which factors have the largest impact on their industry right now, but also which factors are likely to change in the future, so that they can adapt their firms' strategies to changing conditions. Complementary Products or Services Complementary products or services are those that can be used in tandem with those in another industry. For example, video gaming hardware and software, or smartphone operating systems and apps, are complementary sets of products. When two complements are used together, they are worth more than when they are used apart. Complementary pairs or groups (also called ecosystems) of products can be found in many places, not just in the technology sector.22 Gas stations and roads are complements to automobiles, and piping is a complementary product to natural gas. Trends in complementary industries have the potential to radically alter—for better or worse—the landscape in which firms compete. complementary products or services Products or services that can be used in tandem with those from another industry. Take the rise of application software (apps), for instance. In the 1990s, Microsoft created tools for software designers. By doing so, Microsoft lowered the barriers to entry in the application software industry, a complementary industry to operating systems. Apple made it even easier to enter the app industry by releasing segments of its operating system code, creating even more new entrants and sparking the rise of single-purpose, inexpensive apps for mobile computing devices. Now, customers at Apple's app store can choose from hundreds of thousands of apps for their iPhones. The number of new entrants in the app industry is actually increasing the barriers to entry in the smartphone operating system industry. It would be difficult for a new mobile operating system to come on the scene and compete with Apple or Android. Even powerful Microsoft has experienced challenges entering the mobile operating system business.23 For many industries, changes in complementary products are one of the most important trends to keep an eye on. Some consider them significant enough that they even refer to them as a sixth force among the five industry forces.24 Technological Change Technological change within an industry has the potential to radically reshape a firm's landscape, and sometimes society with it. Technological changes can include new products, such as smart phones; new processes, such as hydraulic fracturing (fracking), which has dramatically increased the output of the natural gas industry; or new materials, such as lithium batteries, which make electric automobiles possible. In many industries, the pace of technological change has accelerated over the last couple of decades.25 Managers find it increasingly important to consistently scan the environment to locate potential new technologies that might affect their industries.26 Early adopters are often able to gain greater market share and earn higher profit margins than those who are late to adopt, suggesting the importance of incorporating new technologies early. Not only can technology change the nature of rivalry in an industry by giving some firms an upper hand in gaining market share, but it can sometimes lower barriers to entry. For instance, flexible manufacturing processes have allowed Shanzhai handset makers to nearly match Nokia's cost of manufacturing cell phones. Even in lowtechnology industries such as steel, new technology can sometimes pave the way for new entrants. In the 1970s, a new technology for smelting steel called the electric arc oven allowed new firms, such as Nucor, to enter the industry with only one-tenth the capital investment that would have been needed to start a traditional steel firm. Perhaps the technological change that has affected the threat of new entrants in the greatest number of industries in the last 20 years is the Internet. Some have suggested that the next giant wave of technology change, one we are in the middle of experiencing is wireless communication, like smart phones, which allow individuals to connect from and to anywhere and anyone at any time.27 General Economic Conditions Changing macroeconomic forces can also have a large impact on industries. The state of an economy can affect a region or nation and, subsequently, the ability of the average firm in an industry to be profitable. Analyzing the economic environment typically involves measuring the economic growth rate, interest rates, currency exchange rates, and the rate of inflation or deflation. The appendix provides a list of sources where you can find information on these economic indicators. Economic Growth. How quickly, or slowly, an economy is growing has a direct impact on most firms' bottom line. Economic expansion tends to improve customer balance sheets, lower price sensitivity, and increase the growth rate in an industry, as customers purchase more, easing rivalry. For example, a number of African nations, such as Nigeria and Kenya, have experienced solid levels of economic growth in the last few years.28 As a consequence, a growing percentage of the population has sufficient disposable income to afford products like automobiles and cell phones. Companies providing products like these in Africa have experienced a boom in customer demand.29 The reverse is also true. When an economy slows down, industry growth rates slow, customers are more price sensitive, and suppliers are also likely to be struggling and pursuing ways of increasing profits—at the expense of firms in your industry, if they have the power to do so. Interest Rates. Interest rates mostly can affect rivalry by increasing or decreasing the demand for an industry's products. This is true for expensive items like housing, cars, and even education, which often requires customers to take out loans to purchase. For example, the housing boom experienced in the United States and Europe in the early 2000s was fueled by low-interest-rate loans, sometimes below 4 percent, when the average mortgage interest rate in the previous decade had been above 6 percent. When interest rates are low, industry growth rates increase and rivalry decreases. When interest rates are high, the opposite can occur. In addition, interest rates affect the cost of capital. When interest rates are low, many firms can afford to invest in new assets. As interest rates increase, new investments become more difficult. As a result, firms sometimes engage in price wars as a strategy for gaining market share when rates are high, rather than investing in R&D and new product development. Currency Exchange Rates. Currency exchange rates reflect the value of one country's currency in relation to the currency from another country. Exchange rates can have a large impact on the prices that customers pay for products from firms in other countries, directly affecting profitability for those firms. For instance, from mid-2010 to mid-2011, the Swiss franc appreciated 65 percent against the U.S. dollar, making Swiss products 65 percent more costly in the United States, even though the cost of production hadn't changed at all. Nestlé, a Swiss firm, was particularly hard hit. It either had to decrease its profit margin to cover the extra cost or increase its prices substantially, risking fewer customers buying its products. Inflation. A significant, consistent rise in prices, known as inflation, can create many problems for firms. Inflation, or the opposite, deflation, means that the value of the dollar doesn't stay constant. Today, a product may cost $1. If inflation is at 2 percent a year, then next year that product will cost $1.02. Inflation or deflation, if they are high enough, can make it hard for firms to plan investments. Inflation tends to decrease overall economic growth, increasing rivalry and possibly buyer and supplier power and the threat of substitutes. When firms can't predict what price they will be able to get for a particular product, investments in new product development become riskier. When inflation is high, many industries experience increases in price competition, rather than development, as a means of gaining market share. Demographic Forces Demographic forces involve changes in the basic characteristics of a population, including changes in the overall number of people, the average age, the number of each gender or ethnicity, or the income distribution of the population.30 Because demographic changes involve basic shifts in the product and geographic markets that firm's target, demographic changes are always accompanied by opportunities and threats. Even though demographics often change slowly, they fundamentally reshape the landscape, so good strategic managers have a firm understanding of demographic trends. The appendix contains a list of readily available sources for demographic information. Some sources, such as the World Bank, contain hundreds of demographic indicators. Over the last 50 years, the size the world's population has more than doubled, from around 3 billion to more than 7 billion people. Projections suggest that the Earth's population could reach 9 billion by 2040.31 Each new individual is a potential new consumer, suggesting that growth rates of many industries will increase over time. However, increases in consumption resulting from population growth also mean that supplies of raw materials (such as the rare-earth metals terbium and europium currently used in flat-panel displays32) are likely to decrease. Furthermore, the world population isn't spread evenly over all nations. The enormous populations of China and India account, to a large degree, for the number of firms that have set up operations in those countries. The average age of the population within a nation can also have a tremendous effect on some industries. In Japan, for instance, more than 20 percent of the population is over age 65. In the United States, this won't occur until around 2040.33 The robotics industry has already felt this shift. Japanese companies like Honda have invested tens of millions of dollars in robots for home use, including walk-assist robots that help elderly people with weakened muscles remain ambulatory when they would otherwise need to use a wheelchair.34 Ecological/Natural Environment The natural environment can also be a source of change for many industries. In some cases, this involves changes to the physical environment such as increasing shortages of key inputs like rare earth metals or fluctuations in the amount and cost of energy (i.e., oil and gas). More often, though, current trends in the natural environment involve changes in the public's perception of how business affects the environment. From global warming to clean air and water, the public in many countries—including developing economies like China—are demanding that firms be more proactive in protecting the environment. Many firms have responded by implementing green initiatives. Although some of these may be for public relations purposes only many firms have established serious goals. For instance, Procter & Gamble has goals to use 30 percent renewable energy to power its plants by 2020. By 2014, 7.5 percent of its energy needs were already met by renewable energy. They have also promised to reduce their energy consumption, water usage, greenhouse gas emissions and waste by 20 percent by 2020. They have already reduced them by 8 percent by 2014.35 If consumers truly care about the environment, then actions like these increase rivalry as competitors are forced to respond in kind. Global Forces Global forces also play a large role in shaping many industries. Over the last 50 years, as communications and transportation technologies have undergone a revolution, trade barriers among nations have fallen dramatically. Many countries, from South Korea and Taiwan, to China and India, to Brazil and South Africa, have enjoyed remarkable economic growth and a rising standard of living. These changes have caused firms from many countries to expand operations and begin producing and selling across national borders. We will examine global forces and strategies for capitalizing on them in greater detail in Chapter 9. Political, Legal, and Regulatory Forces Political, legal, and regulatory forces are those that arise from the use of government. When new laws are passed, they may alter the shape of an industry and influence the strategic actions that firms might take.36 For example, the federal Affordable Health Care Act, enacted in 2009, mandates that health insurers cover everyone, including those with preexisting conditions. This may change the cost structure of the industry, potentially resulting in consolidation and less rivalry, as inefficient firms either go out of business or are acquired by more viable firms. In the United States following the Great Recession of 2008–2009, the Federal Reserve required banks to keep larger amounts of cash on hand to cover potential mortgage-related losses. One consequence of this regulation was less lending to small businesses, erecting entry barriers in many industries and changing the nature of rivalry in industries with many small firms. Because political processes, laws, and regulations have the potential to shape and constrain industries, managers should analyze and understand the impact of new laws and regulations and decide how to respond. The Affordable Health Care Act, for example, requires firms with over 50 employees to provide health insurance for their workers, or face fines. Because the law also provides for health insurance exchanges through which uninsured people can buy their own insurance, many firms are considering dropping employee health insurance as a benefit. Their managers have determined that the fines their companies face would be cheaper than the current premiums for health insurance. Of course, laws often provide opportunities, as well as threats. For instance, laws in many countries and states in the United States that require electricity providers to obtain a percentage of their electricity from renewable sources have resulted in a boom in demand for wind turbines and solar panels. Because of the potentially far-ranging effect of laws and regulations, many firms and industries strategically lobby government in an attempt to influence the lawmakers to enact legislations favorable to those industries. Social/Cultural Forces Social forces refer to society's cultural values and norms, or attitudes. Values and attitudes are so fundamental that they often affect the other six general environmental forces, shaping the overall landscape in which firms compete. For instance, changing cultural norms about health have resulted in laws against sodas being sold in schools and lawsuits against fast-food retailers such as McDonald's for marketing “unhealthy” food to children. Like the other environmental forces, however, social forces can create opportunities if a firm happens to be among the first to act on changes in values and attitudes. For instance, Facebook helped to change social norms about connecting to friends and family. It reaped enormous profits for being among the first to capitalize on the change in social networking. Social forces are different, sometimes radically so, in different countries. Firms that compete in a global industry must understand differences among consumers in each country they serve. For example, the collectivist orientation of many people in China results in a general belief that the well-being of the group is more important than that of the individual and a related norm of open information sharing.37 This open-sharing norm allows a greater acceptance of product knockoffs and software pirating than many people are comfortable with in countries that tend to have individualist orientations, such as the United States. SUMMARY One of the primary decisions that firms need to make is which industry, or environment, they are going to compete in. Defining a firm's industry correctly is important because it helps managers to identify their competition. One tool for helping to define an industry is the NAICS codes produced by the U.S. government. Not all industries are equally attractive. Five major forces determine the attractiveness of an industry, defined as the profitability of the average firm in the industry. These forces are: rivalry, buyer power, supplier power, threat of new entrants, and threat of substitute products. Good managers develop a deep understanding of the effect of each of the five forces on industry attractiveness. Such an understanding allows them to take strategic action to influence the five forces in a positive way for their firm and industry. Misunderstanding the nature of the five forces can lead to decisions that destroy industry profitability. Eight general environmental factors can affect the profit potential of a firm: complementary products or services; technological change; general economic conditions; demographic forces; the ecological/natural environment; global forces; political, legal, and regulatory forces; and social/cultural forces. Changes in any of these eight factors can create additional opportunities and threats and often shape the five industry-specific forces. KEY TERMS attractiveness of the industry backward integration barriers to entry complementary products or services forward integration network effects opportunities rivalry substitutes suppliers switching costs threat REVIEW QUESTIONS Why is it important for a firm to accurately determine what industry it is in? How should a firm decide what industry it is in? What are the five major industry forces? How do they shape average profitability in an industry? What factors determine the intensity of rivalry? Explain why increased buyer concentration would increase buyer power. Explain what it means for suppliers to have a credible threat of forward integration. What factors determine the intensity of the threat of new entrants? What are substitutes? What are the eight general environmental factors that affect industry profitability? How does each of the eight general environmental factors influence industry profitability? How do the eight general environmental factors affect the five industry forces? What are the elements of a complete external analysis? APPLICATION EXERCISES Exercise 1: Practice evaluating the industry five forces using the strategy tools presented in this chapter. Read the case, Coca-Cola, Pepsi, and the Shifting Landscape of the Carbonated Soft Drink Industry. Use the strategy tool presented in this chapter, along with data from the case, to evaluate: The intensity of rivalry within the cola manufacturing industry (where Coca-Cola and Pepsi are prominent firms). Is rivalry high, medium or low? The intensity of supplier power within the cola bottling industry (where Coca-Cola and Pepsi are prominent suppliers). Is supplier power high, medium, or low? Where sufficient data aren't available, use qualitative evidence to evaluate the strength of a particular factor. Fill in the explanation/data line of the strategy tool with page numbers and a summary of your logic. Which industry is likely to be more attractive: cola manufacturing or bottling? Why? Exercise 2: Analyze the effects of the general environment on an industry of your choice. Identify an industry you would like to learn more about. Ideally, you should be able to gather sufficient information on this industry to thoroughly analyze the impact of the general environment on industry profitability. Although information is available for a wide variety of industries, this exercise will be easier if you choose an industry that has been written about consistently in the business press. In order to manage the volume of data required for a thorough analysis, your instructor might want you to focus solely on the home country of the largest firms in the industry (unless most firms earn a majority of their profits from abroad). Use data from a variety of sources, including those listed in the appendix, in your analysis. Try to identify the major effects of each of the eight factors (complementary products; technological change; general economic conditions; demographic forces; ecological/natural environment forces; global forces; political, legal, and regulatory forces; and social/cultural forces) on industry profitability. Identify and predict any short-term to medium-term changes in any of the eight factors that might alter average profitability in the industry. Address how those changes will affect industry profitability in the future. As part of the analysis, consider how the general environmental factors may affect each of the five industry forces (rivalry, buyer power, supplier power, threat of new entrants, and threat of substitutes). Strategy Tool Evaluating Industry Attractiveness Using Porter's Five Forces Model Understanding the five forces and their effect on the landscape that a firm competes in is a cornerstone of successful strategic analysis. Figures 2.4 through 2.9 are general analytical tools used by a number of Fortune 500 firms to evaluate the intensity of the five forces in an industry.38 These tools essentially help to quantify the ideas that we have already discussed in this chapter. In practice, top management often implicitly understands the dynamics of the five forces and might not personally use the tools presented here to map out the strength of each force and its overall effect on industry profitability. However, a number of Fortune 500 firms use these tools in their strategic planning departments to provide rigor to the strategic analyses and recommendations they present to top management. Although the tools might appear complicated, they distill the concepts from this chapter, allowing a relatively simple, yet comprehensive and detailed analysis of the five forces. [Figure 2.4] StrategyTool - Evaluating the Intensity of Rivalry (mark an × in the appropriate box for each factor) [Figure 2.5] StrategyTool Evaluating the Intensity of Buyer Power (mark an × in the appropriate box for each factor) [Figure 2.6] StrategyTool - Evaluating the Intensity of Supplier Power (mark an × in the appropriate box for each factor) [Figure 2.7] StrategyTool - Evaluating the Intensity Threat of New Entrants (mark an × in the appropriate box for each factor) [Figure 2.8] StrategyTool - Evaluating the Intensity of the Threat of Substitutes (mark an × in the appropriate box of each factor) [Figure 2.9] StrategyTool Evaluating the Overall Attractiveness of an Industry (highlight the appropriate box for each factor) You can look for the data to complete these analysis tools in the sources listed in the appendix at the end of the book. Many of the indicators in these analysis tools are objective numbers that you can obtain from various data sources. Others are more subjective; they require a logical argument for the level—low, medium, or high—that you choose. Even for more subjective indicators, however, data from various sources can take the guesswork out of doing a five-forces analysis. For each item, put an X in the box that most accurately reflects the data. For some boxes this is a range of data, for instance, 60 to 70 percent combined market share in the rivalry tool. If the correct number is anywhere within the range, put an X in the appropriate box. Cite your data source and/or explain your placement underneath each item. Your answer for some rows of boxes will be an average of more than one item. For instance, in the rivalry tool, the degree of industry standardization is the average of the four items below it. Each column is assigned a number, 1 through 6. To take the average, you add the value for each column (which, for each item, is determined by the set of numbers that most accurately reflects the data you have gathered) and divide by the number of items. For instance, to know where to place the X for degree of industry standardization in the rivalry tool, you will add the values from the four items below it, determined by which column they are located in, and divide by 4. To get the value for the overall intensity of each force you will add the values from the boxes with Xs in them and divide by the total possible for those rows. For rivalry, this means that you add the column values for each of the six rows of boxes, and then divide by 30. Round your answer to the nearest whole number, and place an X in the appropriate box in the “Overall Intensity of Rivalry” row. REFERENCES 1. Nokia SEC FORM 20-F, 2002, p. 27; Andy Reinhart, “Nokia's Next Act.” 2. “Special Report: The Fight for Digital Dominance—Nokia vs. Microsoft,” Economist (November 23, 2002). 3. S. Faris, “Is Windows Nokia's Lifeline?” Time (April 11, 2011). 4. “Nokia Market Share Falls but Microsoft Deal Confirmed,” BBC News (April 21, 2011). 5. B. Chiang, “China's ‘Bandit’ Cell Phones—The High-Tech Golden Egg with ‘Taiwan Inside,’” Commonwealth Magazine (December 3, 2008). 6. T. Kuittenen, “Nokia Sells Handset Business to Microsoft at a Shockingly Low Price,” Forbes (September 2, 2013). 7. D. A. Bosse, R. A. Philips, and J. S. Harrison, “Stakeholders, Reciprocity, and Firm Performance,” Strategic Management Journal, 30 (2009): 447–456. 8. P. Chattopadhyay, W. H. Glick, and G. P. Huber, “Organizational Actions in Response to Threats and Opportunities,” Academy of Management Journal, 44 (2001): 937–955. 9. These can be found at http://www.census.gov/eos/www/naics/index.html. 10. B. Hunt and P. Abrahams, “Microsoft's Battle with Symbian,” Financial Times (Feb. 25, 2003). 11. F. M. Scherer and D. Ross, Industrial Market Structure and Economic Performance (Boston: Houghton Mifflin, 1990). 12. M. E. Porter, “The Five Competitive Forces that Shape Strategy,” Harvard Business Review 86 (1) (2008): 78–93. 13. S. Nadkarni and V. K. Narayanan, “Strategic Schemas, Strategic Flexibility, and Firm Performance: The Moderating Role of Industry Clockspeed,” Strategic Management Journal 28 (2007): 243–270. 14. R. Tidwell, “2011 Flat Panel TV Growth Rate Projected to Fall Sharply,” News Junky Journal (May 2, 2011). 15. “Frozen Food Production in the U.S.” IBISWorld. Accessed September 2011. 16. A. Gonsalves, “ARM Introduces 2.5 GHz Cortex A-15 Processor,” InformationWeek (September 10, 2010). 17. A. Efrati and S. E. Ante, “Google's $12.5 Billion Gamble,” The Wall Street Journal (August 16, 2011), pp. A1 and A4. 18. K. E. Kushida and J. Zysman, “The Services Transformation and Network Policy: The New Logic of Value Creation,” Review of Policy Research 26 (2009):173–194. 19. R. Makadok, “Interfirm Differences in Scale Economies and the Evolution of Market Shares,” Strategic Management Journal 20 (1999): 935– 952. 20. L. Fahey, Competitors (New York: John Wiley and Sons, 1999). 21. J. A. Lamberg, H. Tikkanen, T. Nokelainen, and H. Suur-Inkeroinen, “Competitive Dynamics, Strategic Consistency, and Organizational Survival,” Strategic Management Journal 30 (2009): 45–60. 22. A. M. Brandenburger and B. J. Nalebuff, Co-opetition (New York: Currency Doubleday, 1996). 23. T. Virki and S. Mukherjee, “Windows Phone Struggles to Break Catch-22 as App Makers Hold Off,” Reuters (March 26, 2012). 24. A. S. Grove, Only the Paranoid Survive (New York: Doubleday, 1996). 25. R. K. Sinha and C. H. Noble, “The Adoption of Radical Manufacturing Technologies and Firm Survival,” Strategic Management Journal 29 (2008): 943–962. 26. D. Lavie, “Capability Reconfiguration: An Analysis of Incumbent Responses to Technological Change,” Academy of Management Review 31 (2006): 153–174. 27. S. A. Brown, “Household Technology Adoption, Use, and Impacts: Past, Present, and Future,” Information Systems Frontiers 10 (2008): 397–402. 28. The World Bank. http://data.worldbank.org/indicator/NY.GDP.MKTP.CD 29. “Nigeria Gives Huawei a Place to Prove Itself,” The Wall Street Journal (September 12, 2011), p. B2. 30. E. K. Foerdermayer and A. Diamantopoulos, “Market Segmentation in Practice: Review of Empirical Studies, Methodological Assessments, and Agenda for Future Research,” Journal of Strategic Marketing 16 (2008): 223–265. 31. U.S. Census Bureau, 2011, International database, http://www.census.gov/pic/www/idb/worldpopgraph.html. 32. D. Powell, “Sparing the Rare Earths: Potential Shortages of Useful Metals Inspire Scientists to Seek Alternatives for Magnet Technologies,” Science News (August 27, 2011), p. 20. 33. S. Moffett, “Fast-Aging Japan Keeps Its Elders on the Job Longer,” The Wall Street Journal (June 15, 2005), pp. A1 and A8. 34. http://corporate.honda.com/innovation/walk-assist/. 35. Procter and Gamble, Sustainability Report (2013), http://www.pg.com/en_US/downloads/sustainability/reports/PG_2013_Sustainability_Summary.pdf. 36. C. Oliver and I. Holzinger, “The Effectiveness of Strategic Political Management: A Dynamic Capabilities Framework,” Academy of Management Review 33 (2008): 496–520. 37. S. Michailova and K. Hutchings, “National Cultural Influences on Knowledge Sharing: A Comparison of China and Russia,” Journal of Management Studies 43 (2006): 384–405. 38. Roger McCarty is credited with the early versions of these tools. The five forces tools presented here are generalized forms of specific tools used in a number of Fortune 500 firms. While the tools presented here are a good starting point, in actual practice they may need to be altered to fit the circumstances of a particular industry. For instance, in the operating systems industry, network effects play a bigger role than the capital cost of plant and equipment.
LEARNING OBJECTIVES Studying this chapter should provide you with the knowledge to: Define business strategy, including the importance of competitive advantage, the four choices that are critical to strategy formulation, and the strategic management process. Summarize the information that the company's mission and thorough external and internal analysis provide to guide strategy. Discuss how strategies are formulated and implemented in order to achieve objectives. Explain who is responsible for, and who benefits from, good business strategy. 01 Strategy at Apple In 2000, Apple computer held a loyal customer base but was limping along as a relatively minor player in the personal computer market. Launched by Steve Jobs and Steve Wozniak, Apple was one of the pioneers in the industry. Unlike other PC makers that relied on Microsoft's operating system and application software, Apple wrote its own operating system software and much of its application software, which was known as being easy to use. In fact, Apple was the first to introduce software on a low cost personal computer with drop-down menus and a graphical user interface that allowed customers to easily complete a task—like drag a file to the trash to delete it. However, Apple's investment in unique software led to high-priced computers and created files that were originally incompatible with those of Microsoft's Windows operating system and Office software suite. As a result, Apple rarely achieved more than about a 5 percent share of the computer market.1 CUSTOMERS NOW COULD EASILY AND LEGALLY ACCESS SONGS SIMPLY BY CONNECTING THEIR iPODS TO THEIR COMPUTERS AND LETTING THE SOFTWARE DO TO THE REST. EVEN A TECHNOLOGY-CHALLENGED GRANDPARENT COULD DO IT. That all changed in 2001, however, when Apple entered an entirely new market with the launch of an MP3 portable music player called the iPod. Apple's MP3 player was not the first on the market. A company called Rio had offered an MP3 player for a couple of years before iPod's entry into the market. But iPod quickly took market share from the Rio, for three primary reasons: iPod had a mini hard drive that allowed it to hold 500 songs, as opposed to the roughly 15 songs the Rio could hold using flash memory. iPod was the first to introduce a “fly wheel” navigation button—the round button that was easy to use and allowed users to quickly scroll through menus and songs. iPod was backed with Apple's name and an innovative design.2 These advantages helped iPod quickly move to industry leadership, despite the fact that an iPod cost 15 to 25 percent more than a Rio.3 At the time the iPod was launched, it was difficult for most consumers to legally access digital downloads of songs. Initially, the iPod was only snapped up by a relatively small group of users, mostly teenagers and college students, who were illegally downloading songs through Napster and other free downloading sites. Apple recognized that in order to grow the market for iPods, it needed to help consumers legally access songs to play on their iPods. As a result, Apple developed software called iTunes, allowing customers to legally download songs. One main reason iTunes was able to provide legal downloads before its competitors was because Steve Jobs, as CEO of both Apple and Pixar (the animation movie production company), understood that music companies, like movie companies, were concerned about people pirating their products. So Apple worked with the music companies to sell songs that had been digitized using software that prevented customers from copying the songs to more than a few computers. iTunes was designed to be easy to use with the iPod. Customers now could easily and legally access songs simply by connecting their iPods to their computers and letting the software do to the rest. Even a technology-challenged grandparent could do it.4 But Apple wasn't done with its music player strategy. Apple's experience in the computer business was that other companies could make similar products, often at lower prices. Indeed, while Apple and IBM were the pioneers of the personal computer industry and dominated it during the early years, lower-priced competitors like Dell, Hewlett-Packard, Lenovo, and ASUS, eventually came to dominate the market. Apple realized it needed to prevent easy imitation of its music offering. So it created proprietary software called Fairplay that restricted the use of music downloaded from iTunes to iPods only. That meant consumers couldn't buy a lower-priced MP3 player and use it with iTunes because it was incompatible. If they wanted to use a different MP3 player, they would have to download and pay for music a second time.5 To top it off, Apple did something that no other maker of computers, music players, or any other electronic device company had done. It opened its own stores to sell Apple products. This required that Apple learn how to operate retail stores. The Apple Stores helped Apple create a direct link to its customers, making it easier for consumers to learn about and try out Apple products—and get their products serviced. As a result of Apple's strategic initiatives, it has built a very secure market position in music players, currently holding over 70 percent of that market.6 But the battle isn't over. Amazon has entered the industry, offering music buyers unrestricted use of its songs. Moreover, competitors e-Music, Rhapsody.com, and Spotify are offering music via subscription. Users can listen to any song they want for a monthly subscription fee. And Pandora, a free online radio service, offers similar unlimited access to songs. The $17 billion music industry is so large that it will continue to attract new competitors who want to dethrone Apple. How did Apple enter the music industry and within 10 years become the dominant seller of both songs and music players? Why is Pandora, a start-up, succeeding in the music industry while former giant Sony (maker of the Walkman and Discman) is struggling? For that matter, why is any company successful? Understanding the series of actions taken by Apple to achieve a dominant position in the online music business will go a long way toward understanding business strategy—a company's plan to gain, and sustain, competitive advantage in its markets. In this chapter, we'll help you get started by answering some basic questions. We begin with the most obvious: “What is a business strategy?” WHAT IS BUSINESS STRATEGY? The word strategy comes from the Greek word strategos, meaning, “the art of the general.” In other words, the origin of strategy comes from the art of war, and, specifically, the role of a general in a war. In fact, there is a famous treatise titled The Art of War that is said to have been authored by Sun Tzu, a legendary Chinese general. In the art of war, the goal is to win—but that is not the strategy. Can you imagine the great general Hannibal saying something like, “Our strategy is to beat Rome!” No, Hannibal's goal was to defeat Rome. His strategy was to bring hidden strengths against the weaknesses of his enemy at the point of attack—which he did when he crossed the Alps to attack in a way that his enemies did not believe he could. He achieved an advantage through his strategy. In similar fashion, a company's business strategy is defined as a company's plan to gain, and sustain competitive advantage in the marketplace. This plan is based on the theory its leaders have about how to succeed in a particular market. This theory involves predictions of which markets are attractive and how a company can offer unique value to customers in those markets in a way that won't be easily imitated by competitors. This theory then gets translated into a plan to gain competitive advantage. Apple's theory of how to gain a competitive advantage in music download business was to create cool and easy-to-use MP3 players that could easily—and legally—download digital songs from a computer through the iTunes store. Apple sought to sustain its advantage by making it impossible for competitor MP3 players to download songs from the iTunes store. The Apple Stores contributed to Apple's advantage by providing a direct physical link to customers that competitors couldn't match. In this particular instance, Apple's plan to gain, and sustain, competitive advantage worked. But there have been other times, such as with the Apple Newton Message Pad (the first handheld computer that Apple sold as a personal digital assistant) that Apple's theory about how to gain and sustain competitive advantage did not work. Sometimes strategies are successful and sometimes they are not. business strategy A plan to achieve competitive advantage that involves making four strategic choices: (1) markets to compete in; (2) unique value the firm will offer in those markets; (3) the resources and capabilities required to offer that unique value better than competitors; and (4) ways to sustain the advantage by preventing imitation. competitive advantage When a firm generates higher profits compared to its competitors. market The industry and geographic area that a company competes in. unique value The reason a firm wins with customers or the value proposition it offers to customers, such as a low cost advantage or differentiation advantage. Strategies are more likely to be successful when the plan explicitly takes into account four factors: the attractiveness of a market how to offer unique value relative to the competition what resources or capabilities are necessary to deliver that unique value how to sustain a competitive advantage once it has been achieved. The goal of the strategic plan is to create competitive advantage. First, let's examine the goal. Competitive Advantage What exactly do we mean when we use the term competitive advantage?7 In the sports world, it is usually obvious when a team has a competitive advantage over another team: The better team wins the game by having a higher score. The ability to consistently win is based on attracting and developing better players and coaches, and by employing strategies to exploit the weaknesses of opponents. In the business world, the scoring is measured by looking at the profits (as a percentage of invested capital) generated by each firm. We describe the most common ways of measuring profits in Strategy in Practice: Measuring American Home Products' Competitive Advantage. STRATEGY IN PRACTICE MEASURING AMERICAN HOME PRODUCTS' COMPETITIVE ADVANTAGE To see which firms in an industry are most successful, we typically compare their return on assets (ROA), a calculation of operating profits divided by total assets, or their return on equity (ROE), which is operating profits divided by total stockholders' equity. The company that consistently generates the highest returns for its investors, in terms of ROA or ROE, wins the game. For example, from 1971 to 2000, the pharmaceutical company American Home Products averaged 19 percent ROA, compared to competitor American Cyanamid's 7 percent. American Home Products' ROA was higher than American Cyanamid's every year for 30 years. This is evidence that during this time period, American Home Products had a competitive advantage over American Cyanamid.8 American Home Products' advantage over American Cyanamid frequently has been attributed to its ability to develop more blockbuster drugs (through more effective research and development) and to quickly get those drugs to market through a larger and more effective sales force. Profitability of Different Firms in the Pharmaceutical Industry Source: Annual reports; 1973– 1992 Just as in sports, where an inferior team may outscore a superior team on a given day, it may be possible for an inferior company to outscore a superior company in a particular quarter, or perhaps even a year. Competitive advantage requires that a firm consistently outperform its rivals in generating above-average profits. A firm has a competitive advantage when it can consistently generate above-average profits through a strategy that competitors are unable to imitate or find too costly to imitate. Above-average profits are profit returns in excess of what an investor expects from other investments with a similar amount of risk. Risk is an investor's uncertainty about the profits or losses that will result from a particular investment. For example, investors suffer a lot of uncertainty (and, hence, risk) when they put their money into a start-up company that is trying to launch products based on a new technology, such as a solar power company. There is much less risk in investing in a stable firm with a long history of profitability, such as a utility company that supplies power to customers who have few, if any, alternative sources of power.9 above-average profits Returns in excess of what an investor expects from other investments with a similar amount of risk. Many organizations work to achieve objectives other than profit. For example, universities, many hospitals, government agencies, not-for-profit organizations, and social entrepreneurs play important roles in making our economy work and our society a better place to live. These organizations do not measure their success in terms of profit rates, but they still use many of the tools of strategic management to help them succeed (see Chapter 14). For these organizations, success might be measured using tangible outcomes such as the number of degrees granted, patient health and satisfaction measures, people served, or some other measure of an improved society. The primary source of a company's competitive advantage can come from several areas of its operations. For example, the diamond company De Beers has an advantage that comes from paying lower costs for its diamonds than other companies do, because De Beers owns its own diamond mines. Competitive advantage can also come from different functional areas within the company. Biotechnology pioneer Genentech's advantage comes primarily from research and development that has produced several blockbuster drugs; Toyota's advantage in automobiles comes primarily from its operations (known as the Toyota Production System); Procter & Gamble's advantage in household products comes largely from its sales and marketing, and Nordstrom's advantage as a retailer comes largely from its merchandising and service. The Strategic Management Process The processes that firms use to develop a strategy can differ dramatically across firms. In some cases, executives do not spend significant time on strategy formulation and strategies are often based only on recent experience and limited information. However, we propose that a better approach to the formulation of strategy is the strategic management process outlined in Figure 1.1. The strategic management process for formulating and implementing strategy involves thorough external analysis and internal analysis. Only after conducting an analysis of the company's external environment and its internal resources and capabilities are a firm's executives and managers able to identify the most attractive business opportunities and to formulate a strategy for achieving competitive advantage. [Figure 1.1] The Strategic Management Process strategic management process The process by which organizations formulate a plan and allocate resources to achieve competitive advantage that involves making four strategic choices: (1) markets to compete in; (2) unique value the firm will offer in those markets; (3) the resources and capabilities required to offer that unique value better than competitors; and (4) ways to sustain the advantage by preventing imitation. external analysis Examining the forces that influence industry attractiveness, including opportunities and threats that exist in the environment. internal analysis The analysis of a firm's resources and capabilities to assess how effectively the firm is able to deliver the unique value (value proposition) that it hopes to provide to customers. The central task of the strategy formulation process is specifying the high-level plan and set of actions the company will take in its quest to achieve competitive advantage. Once the plan for creating competitive advantage is created, the final step is to develop a detailed plan to effectively implement, or put into action, the firm's strategy through specific activities. The focus of the strategic management process should be to make four key strategic choices, as shown in Figure 1.2 Which markets the company will pursue. A company's markets include both the industries in which it competes and its geographic markets. What unique value to offer the customer in those markets. This is the firm's value proposition, the reason the company wins with a set of customers.10 What resources and capabilities are required? What does the company need to have and know how to do so that it can deliver its unique value better than competitors, and exactly how will the company deliver its unique value?11 How the company will capture value and sustain a competitive advantage over time. Firms need to create barriers to imitation to keep other companies from delivering the same value. [Figure 1.2] Four Key Strategic Choices in Strategic Management Markets. One of the first decisions a company must make is which markets it will serve. Leaders must choose the industries a company competes in and the product and service markets within those industries. For example, before iPod, Apple only competed in the computer industry. Its product markets included desktop and laptop computers. Launching iPod and iTunes took Apple into the music industry. Later, when Apple launched the iPhone, it entered the cell phone business. It is also important to select geographic markets to serve. Apple competes on a worldwide basis, which allows it to spread heavy research and development costs across its many geographic markets. By contrast, Walmart started by focusing on rural markets, which allowed it to offer lower prices than the “mom and pop” retail stores in small towns.12 Unique Value. After a company chooses the markets in which to compete, it then attempts to offer unique value in those markets. This is often referred to as a company's value proposition, or the value that it proposes to offer to customers. Companies typically try to achieve a competitive advantage by choosing between one of two generic strategies for offering unique value: low cost or differentiation. Companies such as Walmart, Ryanair, Taco Bell, and Kia attract customers by being cost leaders, offering products or services that are priced lower than competitor offerings. A firm that chooses a low-cost strategy (the focus of Chapter 4) focuses on reducing its costs below those of its competitors. Key sources of cost advantage include economies of scale, lower-cost inputs, or proprietary production know-how. cost advantage An advantage that a firm has over its competitors in the activities associated with producing a product or service, thereby allowing it to produce the same product at lower cost. A firm that chooses a differentiation strategy (the focus of Chapter 5) focuses on offering features, quality, convenience, or image that customers cannot get from competitors. Apple's unique value is offering iPods (music players), iPhones (smart phones), and iPads (tablets) that are well designed, innovative, easy to use, and have features that competing products don't have (“there's an App for that”). In similar fashion, Starbucks wins through differentiation by offering multiple blends of high-quality coffee in convenient locations. differentiation advantage An advantage a firm has over its competitors by making a product more attractive by offering unique qualities in the form of features, reliability, and convenience that distinguishes it from competing products. Resources and Capabilities. Delivering unique value requires developing resources and capabilities that will allow the company to perform activities better than competitors. Indeed, perhaps the most critical role of the strategist is to figure out how to build or acquire the resources and capabilities necessary to deliver unique value. Resources refer to assets that the firm accumulates over time, such as plants, equipment, land, brands, patents, cash, and people. Steve Jobs was a key resource for Apple because he had the uncanny ability to figure out what customers wanted before even they knew. Capabilities refers to processes (or recipes) the firm develops to coordinate human activity to achieve specific goals. To illustrate, Starbucks has key resources that allow it to succeed through differentiation, include its Starbucks brand, its retail store locations, its recipes to produce different coffee blends, and even some patents to protect those recipes. Its capabilities include its processes to roast coffee beans for the best flavor, create new coffee blends, design stores with great atmosphere, and find optimal store locations. These resources and capabilities have allowed Starbucks to deliver unique value to customers, thereby helping the company outperform other coffee shops within the coffee retailing industry. Sustaining Advantage. By being the first to offer music downloads through its easy-to-use iTunes software, Apple encouraged its customers to store their entire music libraries on iTunes. Designing iTunes so that it wouldn't download songs to other music players helped Apple to prevent competing MP3 players from taking market share from iPod. Of course, Apple's brand image and its Apple Stores also prevent competitors from easily imitating its products and services. These actions helped Apple capture the value it created. WHAT INFORMATION AND ANALYSIS GUIDES STRATEGY FORMULATION? As Figure 1.1 shows, the earliest steps in the strategic management process involve analyses and choices that later result in the formulation and implementation of a company's strategy. These choices are made within the context of the company's mission and only after an analysis of the external environment and internal organization. Mission A company's mission outlines the company's primary purpose and often specifies the business or businesses in which the firm intends to compete—or the customers it intends to serve. People in business often use the terms mission, vision, or purpose somewhat interchangeably. For our purposes in this book, we will use the term mission to refer to the primary purpose of the organization. mission A company's primary purpose that often specifies the business or businesses in which the firm intends to compete—or the customers it intends to serve. Most business firms start with a mission, even if it isn't formally stated. For example, Starbucks founder Howard Schultz got the idea to introduce coffee bars to America when he visited Italy and experienced the great coffee and convenience of Italian espresso bars. His external analysis of the coffee shop industry in the United States led him to believe that there was an opportunity to bring an exceptional coffee experience to America. Schultz once said American coffee was so bad it tasted like “swill.” He discovered café latte when visiting an espresso bar in Verona, Italy, and thought, “I have to take this to America.”13 So he launched Starbucks, a company that offered higher-quality coffee than traditional coffee shops, and included many varieties at a premium price. In essence, Starbucks started with a mission to bring high-quality coffee to the masses in the United States. As companies grow and develop formal mission statements, these statements often define the core values that a firm espouses, and are often written to inspire employees to behave in particular ways. Starbucks formalized its mission as follows: Our mission: to nurture and inspire the human spirit—one person, one cup, and one neighborhood at a time.14 It then proceeds with the statement: Here are the principles of how we live that every day—which is followed by a set of principles or values designed to guide employee behaviors. Even after it has been formalized, however, a company's mission is still open to interpretation, as Strategy in Practice: Apple's Evolving Mission shows. External Analysis External analysis is critical for addressing the first strategic choice: Where should we compete? External analysis involves: (1) an examination of the competition and the forces that shape industry competition and profitability; and (2) customer analysis to understand what customers really want. The combined results of external analysis with internal analysis of the firm are often summarized as a SWOT analysis. SWOT is an acronym for Strengths, Weaknesses, Opportunities, and Threats.15 External analysis is particularly useful for shedding light on the latter two: opportunities and threats. SWOT analysis Strategic planning method used to evaluate the strengths, weaknesses, opportunities, and threats involved in a business. Industry Analysis. One of the central questions for the strategist is to determine which markets or industries to compete in. The fact of the matter is that all industries are not created equal. To illustrate, between 1992 and 2006, the average return on invested capital in U.S. industries ranged from as low as zero to more than 50 percent.16 The most profitable industries include prepackaged software, soft drinks, and pharmaceuticals. These industries are more than five times as profitable as the least profitable industries, which include airlines, hotels, and steel. This does not mean that a steel or airline company cannot be successful or profitable (Southwest Airlines has been quite profitable17), but it does mean that the average profitability of all firms in these industries is low compared to other industries. This makes the challenge of making money in these low-profit industries even greater. STRATEGY IN PRACTICE APPLE'S EVOLVING MISSION When Steve Jobs and Steve Wozniak launched Apple in 1976, their primary purpose was to make great computers that people loved to use. Twenty-four years later, Apple was still essentially a computer company when it launched the iPod, a device that took the company into the music industry. But did you know that Apple was not the first computer company to make a small, handheld MP3 player with a mini-hard drive that could store your entire music library? That honor goes to Compaq (later acquired by HP). Compaq developed an MP3 player before Apple, but the company decided this was not an industry and product market that it wanted to enter. Compaq decided not to pursue the MP3 business because it saw its mission as being a computer maker, and music players fell outside of that mission. Instead of refining the design and launching its MP3 player on the market, Compaq sold the technology to a Korean company. In contrast, Apple decided that this product market was not outside its mission. Apple's decision was influenced by its external analysis. Apple looked at the multibillion-dollar music business and quickly realized that no company was offering legal digital downloads—so the market was wide open because of the challenges of protecting the files from easily being copied. Apple's leaders also considered its internal capabilities. Unlike Compaq—which only made computer hardware but not software—Apple had vast experience at writing software for Apple computers. It also had far greater design expertise than Compaq. In fact, the company had long been hailed for the cutting-edge designs of the iMac and some of its other computers. Apple decided to channel its internal capabilities at writing software to navigate an MP3 player. Apple's software engineers came up with the innovative “flywheel” design for navigating the iPod. Likewise, it channeled its design capabilities toward designing a product that was elegant and small enough to fit in your pocket. As a result of formulating a strategy to enter the MP3 player market—and subsequently the iPhone and iPad markets—Apple's mission has broadened. The company no longer focuses on just being a computer maker. In fact, in 2007 it changed its name from Apple Computer Inc. to Apple Inc. to reflect this change in its mission. Why are some industries more profitable than others? Strategy professor Michael Porter developed a model for conducting industry analysis called the Five Forces that Shape Industry Competition.18 Understanding the five forces that shape industry competition is one of the starting points for developing strategy, and will be discussed in detail in Chapter 2. This framework helps managers think about what the company can do to increase its power over suppliers and buyers, create barriers to other firms looking to enter the market, reduce the threat of substitute products or services, and reduce rivalry with competitors. Customer Analysis. External analysis also involves an analysis of customers or potential customers, notably an analysis of their needs and price sensitivity. In particular, the strategist can make better decisions about how to offer unique value by considering groups of customers who all have similar needs. This is called customer segmentation analysis.19 For example, in the automobile industry, some customers want cars that are very stylish, powerful, luxurious, and packed with technology and gadgets. These customers are the focus of companies such as Porsche, Mercedes Benz, BMW, and Lexus. Others want trucks with the capacity to haul heavy items and move easily over rough terrain. These customers are the focus of the truck divisions of Chevy and Ford. Still others want economy cars for basic transportation—the focus of Hyundai and Kia. price sensitivity The degree to which the price of a product or service affects consumers' willingness to purchase the product or service. segmentation analysis Dividing up customers into groups or segments based on similar needs or wants. External analysis should enlighten managers about the competitive forces that influence the profitability of particular markets and industries, as well as opportunities and threats. In addition, it should shed light on what customers want and what they are willing to pay to have their needs met. Internal Analysis Whereas external analysis focuses on a company's industry, customers, and competitors, internal analysis focuses on the company itself. Internal analysis completes the SWOT by focusing on strengths and weaknesses. More formally, internal analysis involves an analysis of the company's set of resources and capabilities that can be deployed—or should be developed—to deliver unique value to customers. We discuss internal analysis in greater detail in Chapter 3. In the 1980s, the resourcebased view of the firm, also known as the resource-based model, was developed to explain why some firms outperform other firms within the same industry.20 Why does Nucor make money in the steel business when most of its U.S. competitors do not? Why does Southwest fly high in the air travel business while most of its competitors are (financially) grounded? The resource-based model assumes that each company is a collection of resources and capabilities (also referred to as competencies) that are deployed to deliver unique value.21 resource-based view of the firm Determining the strategic resources available to a company. Firms that don't have the resources and capabilities that are necessary to implement the strategies they are contemplating, may need to improve, change, or possibly create them in order to offer unique value to their customers. This is where resource allocation becomes an important dimension of strategy. Once a company decides how it hopes to offer unique value, it must allocate the resources necessary to build those resources or capabilities. For example, once Target realized that it could not compete directly on prices with Walmart, it allocated additional resources to move “upmarket.” This involved investing heavily in a trends department, a new mix of higher-quality products, relationships with designers, more expensive suburban retail locations, and significant TV advertising to get the message out to customers. HOW ARE STRATEGIES FORMULATED? Formulating a strategy involves selecting which actions the company will take to gain and sustain competitive advantage. Remember, competitive advantage requires that the company do all of the following: Provide unique value to a set of customers in the appropriate markets. Develop a set of resources and capabilities that allow the company to deliver that unique value to customers better than competitors. Sustain the competitive advantage by figuring out how to prevent imitation of the chosen strategy. A company will also need to formulate, and then implement, strategy at three different levels of the organization: corporate, business unit (product), and functional. Corporate strategy refers to decisions that are made by senior corporate executives about where to compete in terms of industries and markets. For example, Amazon's corporate executives made the decision to enter the electronic reader/tablet business with the Kindle where it would face new competitors like Apple. Similarly, Amazon's launch of Amazon Web Services—a business that provides web hosting, cloud storage, and marketplace software—was made at corporate headquarters by the corporate management team. Business unit strategy is made at the level of the strategic business unit—standalone business units in a company that typically have their own profit and loss responsibility. Amazon's online discount business would be considered one business unit, whereas Kindle and Amazon Web Services would be different business units. The general manager of each business unit addresses the questions we've identified regarding how to gain and sustain advantage in that particular market. Finally, within each business unit are different functions such as finance, product development, operations, information technology, sales and marketing, and customer service. A functional strategy should align with the overall business unit strategies to effectively implement the business unit strategy (see Figure 1.3). corporate strategy Decisions about what markets to compete in, made by executives at the corporate level of an organization. business unit strategy Decisions about how to gain and sustain advantage, made at the manager level for each standalone business unit within a company. functional strategy Decisions about how to effectively implement the business unit strategy within functional areas like finance, product development, operations, information technology, sales and marketing, and customer service. [Figure 1.3] Multiple Levels of Strategic Analysis Strategy Vehicles for Achieving Strategic Objectives In many instances, firms rely on a few key strategy vehicles to help them enter attractive markets and build the resources and capabilities necessary to deliver unique value. These strategy vehicles include such things as diversification, acquisitions, alliances, vertical integration, and international expansion. In some cases, a firm may choose to grow by diversifying, adding to its products or opening a new line of business. Acquisition is a strategy vehicle used for growth and diversification or to acquire key resources. strategy vehicles Activities and strategic choices—such as make versus buy, acquisitions, and strategic alliances—that influence a firm's ability to enter particular markets, deliver unique value to customers, or create barriers to imitating its product. For example, when Apple acquired NeXT Computing, the late Steve Jobs's start-up, Apple acquired the operating system that became OSX—and the acquisition brought Steve Jobs back to Apple.22 More recently, Apple acquired SIRI, a company that made voice recognition and search software that was the technology behind SIRI (pronounced sir'-ee), Apple's personal assistant on the iPhone. Sometimes companies decide to access new resources and capabilities through a strategic alliance—an exclusive relationship with another firm—rather than through acquisition. For example, Apple teamed up with AT&T in an alliance to launch the iPhone in the United States. AT&T put huge promotional dollars behind the iPhone—and paid Apple 10 percent of their revenues from each iPhone subscriber—in order to be the exclusive distributor of iPhones for the first five years. Vertical integration, or the make-buy decision, is also a vehicle for achieving objectives.23 For example, when Apple decided to move into retailing by establishing Apple Stores, the company made a decision to “make” stores that sold their own products, rather than simply “buy” the retailing services of stores run by other companies, like Best Buy or Walmart. Finally, companies may use international expansion as a vehicle to achieve economies of scale, access key resources, or learn new skills. Indeed, some companies use international expansion as a primary source of competitive advantage. These strategy vehicles—discussed in detail in Chapters 6 to 9—are important tools that strategists use to achieve key strategic objectives. Strategy Implementation The final step in the strategic management process is to implement the strategy that was chosen during the strategy formulation phase. Strategy implementation occurs when a company adopts a set of organizational processes that enable it to effectively carry out its strategy. Effective implementation typically requires the following: strategy implementation The translation of a chosen strategy into organizational action so as to effectively implement the activities required to achieve strategic goals and objectives. The functional strategies within the company—research and development, operations, sales and marketing, human resource management—are well aligned with delivering the unique value identified in the overall strategy. Implementation is generally more successful when a company can measure how effectively functional activities are being performed to support the overall strategy. The organization's structure, systems, staff, skills, style (culture), and shared values are designed to facilitate the execution of the strategy. This is the McKinsey 7-S framework, which is useful for creating the alignment necessary to ensure effective implementation. STRATEGY IN PRACTICE WALMART FUNCTIONAL STRATEGIES IMPLEMENT THE OVERALL STRATEGY When a company has a clear strategy regarding how it plans to offer unique value, or “win” with customers, this helps guide the implementation of the overall strategy within each of the different business functions. As we've discussed, Walmart's strategy is to win by being a cost leader in its markets. Walmart's functional areas support that strategy in a number of ways:24 Walmart's human resource management strategy focuses on keeping labor costs as low as possible. Walmart pays relatively low wages and has few layers of management, which minimizes labor costs. Walmart also has a nonunion stance and once even closed a store in Canada when the workers tried to unionize.25 Managers have small offices with inexpensive furniture, and when they travel, they stay at inexpensive hotels and frequently share a room. Walmart's information technology and operations areas also focus attention on cost reduction. Walmart has invested in information technology to lower the costs of communicating with thousands of suppliers and to provide suppliers with real-time data on what products are selling, at what price, in what store. Walmart purchasing department negotiates aggressively with suppliers. Walmart uses its tremendous buying power to get the lowest prices on products from its suppliers. It also offers a product mix that appeals to price-sensitive customers. Marketing does price checks at competitors. The goal of the marketing staff is to ensure that Walmart's prices are always as low, if not lower, than competitors. We discuss how companies can effectively create alignment with their strategy—or change the organization to align with a new strategy—in Chapter 12. The Strategy in Practice: Walmart Functional Strategies Implement the Overall Strategy feature describes some of the actions that Walmart has taken to ensure that its functional activities align with and implement the overall business unit strategy. To ensure successful implementation, the organization should have clear metrics, or ways to measure whether or not the plan is being implemented. In Chapter 12, we provide a strategy tool, our version of the balanced scorecard, which suggests some useful metrics that functional area leaders, and the CEO and top management team, can use to determine how effectively strategies are being implemented.26 WHO IS RESPONSIBLE FOR BUSINESS STRATEGY? Strategic leaders are typically the leaders of an organization who develop strategy through the strategic management process. These leaders are responsible for not only formulating strategy, but also for explaining the strategy in a way that employees will understand—and in a way that will motivate employees to execute it. Chapter 13 explains the role the board of directors and the top management team play in formulating and implementing strategy. Theorist Henry Mintzberg refers to strategies that are developed by management, using the strategic management process shown in Figure 1.1, as “intended” or “deliberate” strategies.27 Deliberate strategies are implemented as a result of careful analysis of markets, customers, competitors, and a firm's resources and capabilities. Target's move to upscale discount retailing came after it concluded that it could not compete with Walmart on costs and prices. So it created a trends department, created partnerships with high-end fashion designers (e.g., Oscar de la Renta) and stores (Neiman Marcus), offered a higher-end mix of products, and built stores in more affluent suburban areas as opposed to rural towns. Target's strategy to become Tarzhay was the result of a deliberate strategic plan. strategic leaders Organizational leaders charged with formulating and implementing a strategy with the objective of ensuring the survival and success of an organization. deliberate strategy A plan or pattern of action that is formulated through a deliberate planning process that is then carried out to achieve the mission or goals of an organization. ETHICS AND STRATEGY THE PRICE COMPANIES PAY TO STAY COMPETITIVE One of the central ethical challenges facing the strategist is making decisions designed to deliver unique value to customers. A decision could, for example, focus on low cost and how it might result in reduced value for specific stakeholder groups. Over the past few years, an increasing number of US companies have shut down US facilities and fired American workers as they have shifted their activities overseas to save money. For example, IBM laid off over 1,200 employees in New York and Vermont because their jobs could be done more cost effectively in “Brazil, India, and now China.”31 In similar fashion, HP announced layoffs of 500 customer service workers in Arkansas due to global restructuring, the term often used to describe a company's plan to fire workers and move activities from one location to another.32 And Eaton, a 101-year-old Cleveland-based manufacturer of electronic components, moved its corporate address to Ireland, where the top corporate tax rate is 12.5 percent versus 35 percent in the United States. These are only a few of the many examples of organizations making difficult decisions in order to stay competitive. But at what price? In each of these instances, the company's leaders are responding to customer demands (lower prices) and shareholder demands (higher profit returns). But in doing so, they are neglecting employee demands (job retention) and community demands (taxes provide community benefits). Some may question whether it is ethical to fire employees and avoid US taxes in order to better meet the desires of customers and shareholders. Others will argue that if the company does not keep its customers and shareholders happy, employees will eventually lose their jobs anyway because the company will not be cost competitive, and companies that go bankrupt cannot pay taxes. The challenge of meeting the sometimes-competing needs of various stakeholder groups is one that is constantly faced by a company's leaders. A typical response is to prioritize stakeholders' needs—with customers and shareholders needs coming first—and take strategic actions that best meet their needs. But actions that take unduly from employees and communities to compensate customers and shareholders are viewed by many as unethical. Emergent strategy is a strategy that was not expressly intended in the original planning of strategy. Strategies that emerge when leaders recognize and act on unexpected opportunities that occur through serendipity, such as ideas from people within the organization, are called emergent strategies.28 Apple's transformation from a computer company to a company known mostly for its music players and cell phones was the result of a strategy that emerged after the introduction of the iPod. The iPod opened up opportunities—such as the iPhone and iPad—that the company's senior executives did not necessarily foresee. emergent strategy A plan or pattern of action that develops and emerges over time in an organization despite a mission or goals. Successful companies typically have strategies that are partly deliberate, due to effective strategic planning processes, and partly emergent, due to a willingness to respond to ideas that come from within the organization. In a successful company, everyone in the organization has some responsibility for understanding the company's strategy and for offering ideas to improve the company's strategic position. Who Benefits from a Good Business Strategy? Every organization has a set of stakeholders to whom it is accountable—and who therefore can influence business strategy. Organizations have four primary stakeholder groups: stakeholders Those who have a share or an interest in the activities and performance of an organization. Capital market stakeholders (shareholders, banks, etc.) Product market stakeholders (customers, suppliers) Organizational stakeholders (employees) Community stakeholders (communities, government bodies, community activists).29 There is a lively debate that will be discussed in Chapter 13 about which of these four stakeholder groups is the most important and should be the primary beneficiaries of successful business strategies. Some people believe that shareholders (owners of the company) are the most important. Others make the case that customers, employees, governments, or communities should be the primary beneficiaries of business activity. In the United States, shareholders typically receive highest priority, but each stakeholder group can influence the strategic decisions that are made by a company. shareholders Owners of a company. Sometimes, different stakeholder groups have conflicting views as to the appropriateness of different strategic decisions. Imagine that your company can lower its product costs by closing down your plants in the United States and moving production to China, where labor is cheaper. This will require firing many of your U.S. employees. Both the employee stakeholder group and community stakeholder groups in the cities where your plants are located will perceive this move as negative, and they will try to stop the company from making this decision. However, shareholders and customer stakeholder groups may applaud this decision. It could increase profits for shareholders and lower prices for customers, or both. Because of conflicts like this, companies need to make sure their strategic actions follow accepted ethical standards for business activity. In the ideal situation, a firm has such an effective business strategy that it generates above-average profit returns. Above-average returns allow companies to not only meet the expectations of shareholders, but also satisfy the expectations of other suppliers of capital, product-market, organizational, and community stakeholders. Since stakeholders influence, and are influenced by, strategic decisions made by a company's management team, it is important to understand and consider the needs of different stakeholder groups when making strategic decisions.30 Why You Need to Know Business Strategy Understanding business strategy and the strategic management process is important for at least two reasons: When you start your own company or are the president or general manager of a department or division within a company, your primary job will be to formulate and implement an effective business strategy. Even as a junior person in your company, by understanding basic strategy principles you will be more effective at developing and implementing ideas that are consistent with, and support, your business unit's overall strategy. Being able to understand and contribute to your firm's strategy may lead to earlier promotions as you stand out from your peers. Understanding strategy will help you evaluate the strategy of companies you choose to work for. Effective strategy can give a company competitive advantage over its rivals. Companies with competitive advantage typically provide superior advancement opportunities, higher pay, and greater job security than companies without any competitive advantage. In summary, understanding the strategic management process—as well as the concepts that are fundamental to the formulation, and implementation, of strategy—will likely be very helpful as you pursue a successful career in business. SUMMARY A company's business strategy is defined as a plan to achieve competitive advantage. Formulating a strategy involves making four key choices: (1) what markets or industries the company will pursue; (2) what unique value to offer the customer in those markets; (3) what resources and capabilities will allow the firm to deliver that unique value better than competitors; and (4) how the company will sustain its advantage and prevent imitation of its strategy by competitors. The strategic management process involves the selection of a company mission as well as external and internal analyses that contribute to the formulation of a company's strategy. A company's mission outlines the company's primary purpose and scope of activity. External analysis involves an analysis of the company's current (or potential) markets or industries to understand the environmental factors that influence a firm's profitability. Internal analysis involves an analysis of the company's set of resources and capabilities (or new ones that need to be developed) that can be deployed to create competitive advantages. These analyses contribute to the formulation of a company's strategy. Once the plan for creating competitive advantage is created, the final step is to develop a plan to effectively implement the firm's strategy. Every organization has a set of stakeholders to whom it is accountable—and who therefore can influence business strategy. The four primary stakeholder groups are capital market stakeholders (shareholders, other suppliers of capital like banks), product market stakeholders (customers, suppliers), organizational stakeholders (employees), and community stakeholders (communities, government bodies). The chief executive officer and vice presidents of the different business functions are ultimately responsible for a company's strategy. They are often assisted by a VP of strategic planning (chief strategy officer), who may lead a planning staff or in some cases by a management-consulting firm. Good strategic leaders, however, will seek information and ideas from anyone in the company. You need to understand business strategy because: (1) it will give you the tools to more effectively evaluate, and contribute, to the strategy of the company that employs you; and (2) it will give you the knowledge you need to evaluate the strategy of organizations you may want to join. KEY TERMS above-average profits business strategy business unit strategy competitive advantage corporate strategy cost advantage deliberate strategies differentiation strategy emergent strategy external analysis functional strategy internal analysis market mission price sensitivity resource-based view of the firm segmentation analysis shareholders stakeholders strategic leaders strategic management process strategy implementation strategy vehicles SWOT analysis unique value REVIEW QUESTIONS Why is it important for you to understand business strategy? How would you describe/define strategy? What are the four choices that are part of strategy formulation? What are the two generic strategies, or primary ways, in which companies attempt to offer unique value relative to competitors? Who is ultimately responsible for a company's strategy? Who does this individual (or individuals) call on for help in formulating strategy for the firm? According to Michael Porter's “five forces” model, why do some firms earn higher profits than other firms? What are resources and capabilities, what is the difference between them, and why do firms need to assess them? What are three keys to the successful implementation of a company strategy? Who are the four primary stakeholder groups that influence strategic decisions in a company? APPLICATION EXERCISES Exercise 1: Read the Walmart case and answer the following questions. Consider the markets Walmart chose to focus on, relative to other discount retailers, such Target, Sears Holding, and Dollar Tree. How are Walmart's markets different from those of its competitors? Does Walmart's choice of market focus contribute to its competitive advantage? If so, how? What is Walmart's unique value or value proposition? Why do customers choose Walmart? Does Walmart really deliver lower prices? How does Walmart deliver its unique value better than competitors? What resources does it have, and what capabilities has it developed that help it deliver its unique value? Are the functional strategies of areas such as human resource management, information technology, sales and marketing, store operations, procurement and logistics, information technology, aligned to support Walmart's overall strategy for delivering unique value? Do any of the functions contribute more to Walmart's success than others? Why don't other discount retailing competitors seem to be able to imitate Walmart's strategy? What, if anything, prevents imitation? How is Target's strategy different from Walmart's in terms of the markets it focuses on, unique value it tries to offer, resources, and capabilities it has developed, and the ways it has tried to prevent imitation? Has Target's strategy also been successful? What factors might make it difficult to maintain a competitive edge? What has made it difficult for Walmart to compete with Target and in international markets? Exercise 2: Examine the Business Strategy of a Company Identify a company you would like to learn more about that seems to have a competitive advantage (earns aboveaverage profit returns). Gather data about the strategy of that company, using public sources such as the company website or its annual reports, public articles, and your own experience. Identify the mission statement of the company, if it has one. How does this mission statement guide the behavior and actions of people in the company? What markets or industries does the company focus on? Does this differ from competitors in any particular way? What unique value does it try to offer to customers? Why do most of its customers pick its products over those of competitors? Try to identify any resources or capabilities this company has that help it offer unique value. This is the most difficult step in the assignment, because companies often try to hide their sources of competitive advantage. REFERENCES 1. S. Levy, Insanely Great: The Life and Times of Macintosh, the Computer that Changed Everything (New York: Penguin Books, 1994). 2. S. Levy, The Perfect Thing: How the iPod Shuffles Commerce, Culture, and Coolness. (New York: Simon and Schuster, 2006). 3. D. Yoffie, Apple Computer 2005 (Cambridge, MA: Harvard Business School Press, 2005). 4. E. Smith, “Can Anybody Catch iTunes?” The Wall Street Journal (Nov. 27, 2006), pp. 41 +. 5. P. Kafka, “How Are Those DRM-free MP3s Selling?” Silicon Alley Insider (2008), www.alleyinsider.com/2008/3. 6. http://www.afterdawn.com/news/article.cfm/2009/09/09/ipod_market_share_at_738_percent_225_mi llion_ipods_sold_more_games_for_touch_than_psp_nds_apple. 7. For more discussion about competitive advantage see: J. Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Management 17(1) (1991): 99–120; R. Reed, “Causal Ambiguity, Barriers to Imitation, and Sustained Competitive Advantage,” Academy of Management Review, 15 (1) (1990): 88–102. M. E. Porter, Competitive Advantage, 2nd ed. (New York: The Free Press, 1998). 8. T. C. Powell, N. Rahman, and W. H. Starbuck, “European and American Origins of Competitive Advantage,” Advances in Strategic Management, 27 (2010): 313–351. 9. For a discussion of risk versus uncertainty see F. Knight, F. Risk, Uncertainty, and Profit (Chicago: Houghton Mifflin Co., 1921). According to Knight, though the distribution of outcomes may be very wide, risk is possible to measure, whereas uncertainty is immeasurable; even the possible distribution of outcomes is unknown. 10. See M. Porter, “What Is Strategy,” Harvard Business Review (Nov.–Dec.1996): 61–78. 11. See B. Wernerfelt, “A Resource-Based View of the Firm,” Strategic Management Journal 5(2) (1984): 171–180. Also see Barney, 99–120. 12. See: http://www.dailymail.co.uk/news/article1394087/Is-end-Mom-Pop-stores-Mini-Wal-Mart-express-stores-coming- town-near-you.html. 13. H. Shultz, Pour Your Heart Into It: How Starbucks Built a Company One Cup at a Time (New York: Hyperion, 1997). 14. See: http://www.starbucks.com/about-us/company-information/missionstatement. 15. The technique of SWOT analysis is credited to Albert Humphrey. For more information see T. Hill & R. Westbrook, “SWOT Analysis: It's Time for a Product Recall,” Long Range Planning 30 (1) (1997): 46–52. doi:10.1016/S0024-6301(96)00095-7. J. Scott Armstrong, “The Value of Formal Planning for Strategic Decisions,” Strategic Management Journal 3 (3) (1982): 197–211. 16. Harvard Business Review, HBR's 10 Must-Reads on Strategy (2011), http://books.google.com/books?id=aIUUMi7jpsC&pg=PA48&lpg=PA48&dq=1992+to+2006+average+return+on+invested+capital&source =bl&ots=Od-2BgCcJe&sig=c9BVKyhhl8tvBJDGPwOwbK9IAM&hl=en&sa=X&ei=B5SeUYGFOaPiiAL5h4HQDw&ved=0CDEQ6AEwAQ#v=onepage&q=199 2%20to%202006%20average%20return%20on%20invested%20capital&f=false 17. J. Mouawad, “Pushing 40, Southwest Is Still Playing the Rebel,” New York Times (Nov. 20, 2010), “http://www.nytimes.com/2010/11/21/business/21south.html?pagewanted=all&_r=0 18. M. Porter, “The Five Competitive Forces That Shape Strategy,” Harvard Business Review (Jan. 2008): 79–93. 19. For an overview of customer segmentation see D. Goldstein, “What Is Customer Segmentation?” Mind of Marketing (May 2007), http://www.mindofmarketing.net/2007/05/customer-segmentationwhy-exactly-does.html. Also, see C. Christensen and M. Raynor, The Innovator's Dilemma, Chapter 3 for a discussion of segmenting customers based on product attributes, demographics, or “job-tobe-done.” Also see: C. Christensen 2010. Integrating around the job to be done.” Harvard Business School Press, Module note. N9-611-004. 20. This is often called the resource-based view of the firm within the field of strategic management. See Wernerfelt, 171–180, and Barney, 99–120. 21. See G. Hamel and C. K. Prahalad, “The Core Competence of the Corporation,” Harvard Business Review (May–June, 1990). 22. See: D. E. Dilger, “Apple's 15 Years of NeXT,” Apple Insider (Dec. 21, 2011), http://appleinsider.com/articles/11/12/21/apples_15_years_of_next 23. See: http://www.businessdictionary.com/definition/make-or-buy-decision.html. 24. P. Ghemewat, S. Bradley, K. Mark, “Wal-Mart Stores in 2003,” Harvard Business Review (Sep. 2003). 25. S. Berfield, “Walmart vs. Union-Backed OUR Walmart,” BloombergBusinessweek (December 13, 2012). http://www.businessweek.com/articles/2012-12-13/walmart-vs-dot-union-backed-our-walmart. 26. R. S. Kaplan and David P. Norton, “The Balanced Scorecard—Measures that Drive Performance,” Harvard Business Review (Feb. 1992). 27. H. Mintzberg, The Rise and Fall of Strategic Planning (New York: The Free Press, 1994). 28. K. Moore, “Porter or Mintzberg: Whose View of Strategy Is the Most Relevant Today?” Forbes (March 28, 2011), http://www.forbes.com/sites/karlmoore/2011/03/28/porter-or-mintzberg-whose-view-of-strategy-isthe-most-relevant-today/ 29. R. E. Freeman, Strategic Management: A Stakeholder Approach (Boston: Pitman, 1984). 30. J. Harrison and R. E. Freeman, “Stakeholders, Social Responsibility, and Performance: Empirical Evidence and Theoretical Perspectives,” Academy of Management Journal 42 (5) (1999): 479–485. 31. A. Kelly. “IBM layoffs: Computer Company Cuts Thousands of Jobs as Part of Restructuring Plan.” International Business Times (June 12, 2013), http://www.ibtimes.com/ibm-layoffs-computer-company-cuts-thousands-jobs-worldwide-partrestructuring-plan-1304949 32. L. Jones and L. Turner. “Update: HP to Lay Off 500 in Conway,” Arkansas Business (July 8, 2013), http://www.arkansasbusiness.com/article/93433/reports-hewlettpackard-to-lay-off-500-in-conway?page=all

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Components of the Strategic Management Process
Strategic planning is an organizational management activity that helps the business is
focusing its energy and resources, setting priorities and strengthening the operations to ensure
that the workers and the stakeholders aim at achieving the common goals. Strategic planning
provides that the company assesses the adjustment within it and works towards the intended
outcomes (Stevenson, 2007). An effective vital plan checks on where the company is headed
to and the actions that it needs to ensure the success as well as the effects it requires to
maintain that it progresses. The five elements of a strategic plan include vision, mission and
aspirations, core values, strengths weaknesses and opportunities, objectives, strategies and
operational tactics, and measurement and funding streams.
Mission, Vision, and Aspirations
A Mission Statement is the company’s overall lasting formulation of why it exists and
what it believes it will become. The mission statement includes the goals the company
intends to accomplish and how it plans to ensure that they are achieved. An exce...

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