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Unit 3

Strategy Formulation

3. 0.Introduction

Strategy formulation is often referred to as strategic planning or long run

planning and is concerned with developing a corporations mission,

objectives, strategies and policies. It begins with situation analysis: the

process of finding a strategic fit between external opportunities and internal

strengths while working around external threats and internal weaknesses.

3.1. Corporate level strategic alternatives

Corporate level strategies detail actions taken to gain a competitive

advantage through the selection and management of a mix of businesses

competing in several industries or product market. The primary concerns

of corporate level strategy are:

What businesses should the firm be in?

How the corporate office could manage its group of businesses?

How to make the corporation as a whole add up to more than the sum

of its business parts?

Corporate strategy is primarily about the choice of direction for the whole

firm. This is true whether the firm is small, one product company or a large

multinational corporation. In a large multi business company, how ever,

corporate strategy is also about managing various product lines and business

units for maximum value. In this instance, corporate head quarters must

play the role of the organizational parent, in that it must deal with various

product and business unit children.

A corporations direction strategy (also known as grand strategies) is

composed of three key alternatives.

growth strategies

Stability strategies

defensive strategies

Yoseph Yifru. AAU School of Commerce, Dec 2010


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A) Growth Strategies

The growth strategy seeks to significantly increase a firm's revenues orThe growth strategy seeks to significantly increase a firm's revenues or

market share. Many top executives believe that growth is the only strategymarket share. Many top executives believe that growth is the only strategy

for a healthy firm. However, a firm should adopt a growth strategy only iffor a healthy firm. However, a firm should adopt a growth strategy only if

that growth is expected to result in an increase in firm value. Growth may bethat growth is expected to result in an increase in firm value. Growth may be

attained in a variety of ways.attained in a variety of ways. Internal growthInternal growth is accomplished when a firmis accomplished when a firm

increases revenues, production capacity, and its workforce, whereasincreases revenues, production capacity, and its workforce, whereas

external growthexternal growth is accomplished when other firms are acquired pr merge oris accomplished when other firms are acquired pr merge or

through strategic alliance. Although internal growth enables the firm thethrough strategic alliance. Although internal growth enables the firm the

preserve its corporate culture and image while expanding at a morepreserve its corporate culture and image while expanding at a morecontrolled pace, external growth can enable the firm to grow morecontrolled pace, external growth can enable the firm to grow more

expediently. Internal growth can occur by expanding an existing business orexpediently. Internal growth can occur by expanding an existing business or

creating new ones.creating new ones.

The major types of growth strategies are discussed as follows.

1. Concentration

The most common grand strategy is concentration on the current business.

The firm directs its resource to the profitable growth of a single product, in a

single market, and with a single technology.

The reasons for selecting a concentration strategy are easy to understand.

Concentration is typically lowest in risk and in additional resources required.

It is also based on the known competencies of the firm. On the negative side

for most companies concentration tends to result in steady but slow

increases in growth and profitability and a narrow range of investment

options.

Firms use this strategy to gain competitive advantage in production skill,

marketing know how and reputation in the market place.



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Broadly speaking, the business can attempt to capture a large market share

by increasing present customer rate of usage, by attracting competitors

customer, or by interesting non users in the product or service.

2. Integration strategy

This focuses on moving to different industry level, different product and

technology but the basic market remain the same.

There are two major types of integrative growth strategies:

a. Horizontal integration

This long term strategy of a firm is based on growth through the acquisition

of one or more similar business operating at the same stage of theproduction marketing chain. Thus combination of two textile producers, two

shirt manufacturers or two closing stores chains would be classified as

horizontal integrations.

b. Vertical integration

Vertical integration allows the firm to enlarge its scope of operations within

the same overall industry. It is characterized by the firms expansion in to

other parts of the industry value chain directly related to the design,

production, distribution and / or marketing of the firms existing set of

products or services. Many companies practice vertical integration in some

way. Companies engage in vertical integration primarily to strengthen their

hold on resources deemed critical to their competitive advantage. It is also

an important strategy for firms that face great uncertainty, especially as it

concerns their sources of supply or future buyers of their products. Moreover,

it enables the firm to reduce the external transaction costs of working with

numerous suppliers and customers.

Full versus partial integration

Full integration occurs when the firm seeks to control all stages of the value

chain related to the final end products or services. On the other hand, firms

can also attempt a limited form of vertical integration known as partial



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integration. Partial integration refers to a selective choice of those value-

adding stages that are brought in house.

Backward versus for ward integration

The degree of vertical integration may be as important as its degree.

Backward integration an activity currently carried out by a supplier. It can

allow firms to convert moves the firms into a previously external supplier into

an internal profit.

Backward integration is particularly common in industries where low cost and

certainty of supply are vital to maintain the firms competitive advantage in

its end markets. For example, drug companies often exhibit high level of

backward integration to ensure supply of necessary chimerical ingredients

for their pharmaceuticals.

Forward integration moves the firm close to its customer. Forward

integration is designed to help the firm capture more of the value added in

the product or service offered to the customer.

3. Diversification growth strategy

This refers to an attempt to change the characteristic of the business through

either of new products, markets and technology or all the three.

Diversification growth strategy is classified into two categories:

A. Concentric (related) diversification

This involves the addition of a business related to the firm in terms of

technology, market, or products. With this type of growth strategy the new

business selected process a high degree of compatibility with the firms

current businesses.

Firms implement related diversification strategies to enable them to achieve

and exploit economies of scope and, by building on existing resources,

capabilities and core competencies, build a competitive advantage.



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Economies of scope represent cost saving attributed to entering an

additional business using capabilities and core competencies developed in

another business that can be transferred to a new business without

significant additional costs. In other words, firms that successfully transfer

core competencies from one business to another without incurring significant

additional costs will realize economies of scope.

The two primary operations-related economies through which firms hope to

realize or create value from economies of scope are by sharing activates or

by sharing core competencies. Tangible resources such as factories and

equipment and an intangible resource, such as a sale force or know how, can

be shared to achieve scope economies.

Example of activity sharing possibilities

Inbound logistics: warehouse facilities

Operations : assembly facilities, maintenance operations

Outbound logistics: sales force, distribution

Support activities: procurement, technology development.

Firms also must recognize that, while activity sharing is attended to

reduce costs through relieving economies of scope, there are incremental

costs related to sharing activates (costs that are created by sharing)

2. Conglomerated (unrelated) diversification

This is a strategy of seeking growth by appealing to new markets with new

products that have no technology relationship to current product.

Firms implementing unrelated diversification strategies hope to create

value by realizing financial economies. Financial economies are cost

savings realized through improved allocation of financial resources based

on investments inside or outside the firm.

Major reasons for diversification1. low performance

When firms are able to earn above average or superior returns in a

single business, they have little incentive to diversify. On the other

hand, it has been shown that lower returns are related to greater

level of diversification.



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2. Uncertain future cash flows.

Firms also may implement diversification strategies when their

products reach majority (in the product life cycle) or are threatened

by external factors that the firm can not overcome.

3. firm risk reduction

4. Sufficient tangible and intangible resources.

Managerial motives to diversify include

Reduction of managerial risk.

Diversification may enable managers to reduce employment risk (the

risk related to the loss of their jobs or a reduction in compensation)

because by diversifying the firm managers may be able to diversify

their employment risk if profitability does not decline significantly as aresult of the diversification.

Desire for increased compensation

Diversification also may enable managers to increase their

compensation because of positive correlation between diversification,

firm size and executive compensation.

2. Stability strategy

A corporation may choose stability over growth by continuing its currentA corporation may choose stability over growth by continuing its current

activates without any significant change in direction. Although sometimesactivates without any significant change in direction. Although sometimes

viewed as a lack of strategy, the stability family of corporate strategies canviewed as a lack of strategy, the stability family of corporate strategies can

be appropriate for a successful corporation operating in a reasonablybe appropriate for a successful corporation operating in a reasonably

predictable environment. They are very popular with small business ownerspredictable environment. They are very popular with small business owners

who have found a niche and are happy with their success and thewho have found a niche and are happy with their success and the

manageable size of their firms. Stability strategies can be very useful in themanageable size of their firms. Stability strategies can be very useful in the

short run, but they can be dangerous if followed for too long.short run, but they can be dangerous if followed for too long.

Some of the more popular of these strategies are the pause/proceed withSome of the more popular of these strategies are the pause/proceed with

caution, no change, and profit strategiescaution, no change, and profit strategies

(1)(1) Pause/proceed with caution strategyPause/proceed with caution strategy

A pause/proceed with caution strategy is, in effect, a timeout- an opportunityA pause/proceed with caution strategy is, in effect, a timeout- an opportunity

to rest before continuing a growth or retrenchment strategy. It is a veryto rest before continuing a growth or retrenchment strategy. It is a very

deliberate attempt to make only incremental improvements until a particulardeliberate attempt to make only incremental improvements until a particular



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environmental situation changes. It is typically conceived as a temporaryenvironmental situation changes. It is typically conceived as a temporary

strategy to be used until the environment becomes more hospitable or tostrategy to be used until the environment becomes more hospitable or to

enable a company to consolidate its resources after prolonged rapid growth.enable a company to consolidate its resources after prolonged rapid growth.

(2) No change Strategy(2) No change Strategy

A no change strategy is a decision to do nothing new-a choice to continueA no change strategy is a decision to do nothing new-a choice to continue

current operations and policies for the foreseeable future. Rarely articulatedcurrent operations and policies for the foreseeable future. Rarely articulated

as a definite strategy, a no change strategys success depends on a lack ofas a definite strategy, a no change strategys success depends on a lack of

significant change in a corporations situation. The relative stability createdsignificant change in a corporations situation. The relative stability created

by the firms modest competitive position in an industry facing little or noby the firms modest competitive position in an industry facing little or no

growth encourages the company to continue on its current course, makinggrowth encourages the company to continue on its current course, making

only small adjustments for inflation in its sales and profit objectives. Thereonly small adjustments for inflation in its sales and profit objectives. There

are no obvious opportunities or threats nor much in the way of significantare no obvious opportunities or threats nor much in the way of significant

strengths or weaknesses.strengths or weaknesses.

(3) Profit Strategy(3) Profit Strategy

A profit strategy is a decision to do nothing new in a worsening situation butA profit strategy is a decision to do nothing new in a worsening situation but

instead to act as though the companys problems are only temporary. Theinstead to act as though the companys problems are only temporary. The

profit strategy is an attempt to artificially support profits when a companysprofit strategy is an attempt to artificially support profits when a companys

sales are declining by reducing investment and short-term discretionarysales are declining by reducing investment and short-term discretionary

expenditures. Rather than announcing the companys poor position toexpenditures. Rather than announcing the companys poor position to

shareholders and the investment community at large, top management mayshareholders and the investment community at large, top management may

be tempted to follow this very seductive strategy. Blaming the companysbe tempted to follow this very seductive strategy. Blaming the companys

problems on a hostile environment (such as ant business governmentproblems on a hostile environment (such as ant business government

policies).policies).

3. Defensive strategy

This strategy is used to reverse a negative trend. There are three major

types of defensive strategies

A. Retrenchment / turnaround



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For any of a large number of reasons a business can find itself with declining

profits. Economic recessions, production inefficiencies, and innovative

breakthrough by competitors are only three causes. In many cases strategic

managers believe that firm can survive and eventually recovered if a

converted effort if made over a period of a few years to fortify basic

distinctive competencies. It is typically accomplished in one of two ways,

employed singly or in combination:

a. Cost reduction example include decreasing the workforce

through employee attrition, leasing rather than purchasing

equipment, and eliminating elaborate promotional activities.

b. Asset reduction: example include the sale of land, building

and equipment not essential to the basic activity of thebusiness, and eliminations of perks like the company

airplane and executive cars.

If these initial approached fail to achieve the required reductions, more

drastic action may be necessary. It is sometime essential to lay off

employees, drop items from a production line, and even low margin

customers. Since the underlying purpose of retrenchment is to reverse

current negative trends, the method is often refereed to as a turnaround

strategy.

B. Divestiture

A divestiture strategy involves the sale of a business or a major business

component. When retrenchment fails to accomplish the desired turnaround,

strategic managers often decide to sell the business. However, because the

intent is to find a buyer willing to pay a premium above the value of fixed

assets for on going concern, the term marketing for sale is more appropriate.

C.Liquidation / bankruptcy strategy

When a company finds itself in the worst possible situation with a poorWhen a company finds itself in the worst possible situation with a poor

competitive position in an industry with few prospects, management has onlycompetitive position in an industry with few prospects, management has only

a few alternatives all of them distasteful. Because no one is interested ina few alternatives all of them distasteful. Because no one is interested in

buying a weak company in an unattractive industry, the firm must pursue abuying a weak company in an unattractive industry, the firm must pursue a



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bankruptcy or liquidation strategy. Bankruptcy involves giving up managementbankruptcy or liquidation strategy. Bankruptcy involves giving up management

of the firm to the courts in return for some settlement of the corporationsof the firm to the courts in return for some settlement of the corporations

obligations. Top management hopes that once the court decides the claims onobligations. Top management hopes that once the court decides the claims on

the company, the company will be stronger and better able to compete in athe company, the company will be stronger and better able to compete in a

more attractive industry.more attractive industry.

In contrast to bankruptcy, which seeks to perpetuate the corporation,In contrast to bankruptcy, which seeks to perpetuate the corporation,

liquidation is the termination of the firm. Because the industry is unattractiveliquidation is the termination of the firm. Because the industry is unattractive

and the company too weak to be sold as a going concern, management mayand the company too weak to be sold as a going concern, management may

choose to convert as many saleable assts as possible to cash, which is thenchoose to convert as many saleable assts as possible to cash, which is then

distributed to the shareholders after all obligations are paid. The benefit ofdistributed to the shareholders after all obligations are paid. The benefit of

liquidation over bankruptcy is that the boards of directors, as representativesliquidation over bankruptcy is that the boards of directors, as representatives

of the shareholders, together with top management make the decisionsof the shareholders, together with top management make the decisions

instead of turning them over to the court, which may choose to ignoreinstead of turning them over to the court, which may choose to ignore

shareholders completelyshareholders completely.

3.1.1. Portfolio analysis

The business portfolio is the collection of businesses (SBUs) and products

that make up the company. There are different types of portfolio techniques

in use, the most well known of which are:

The Boston consulting Group BCG matrix

The general Electric screen GE- matrix

1. The BCG growth / share matrix

One of the most widely used portfolio approaches to corporate strategic

analysis has been the growth / share matrix pioneered by the Boston

consulting Group (BCG). This matrix facilities corporate strategic analysis of

likely generators and optimum users of corporate resources.

To use the BCG matrix, each of the companys business (SBUs) is plottedaccording to market growth rate and relative competitive position (relative

market share).Market growth is the projected rate of sales growth for the

market to be served by a particular business. It is usually measured as the

percentage increase in a markets sales or unit volume over the two most

recent years. Market growth rate provides an indicator of the relative



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attractiveness of the markets served by each of the businesses in the

corporations portfolio of businesses. Relative competitive position is

usually expressed as the ratio of a businesss market share divided by the

market share of the largest competitor in that market. The matrix has four

cells with differing implication for their in an overall corporate level

strategy.

1. Stars

The stars, as the BCG matrix labeled them, are businesses in a rapidly

growing market with large market shares. They represent the best

long- run opportunities (growth and profitability) in the firms portfolio.

These business require substantial investment to maintain (and

expand) their dominant position in a growing market. This investment

requirement is often in excess of what can be generated internally.

2. Cash Cows

These are high market share businesses in maturing, low-growth

markets or industries because of their strong position and minimal

reinvestment requirements for growth. These businesses often

generate cash in excess of their needs. Therefore, these businesses

are selectively milked as a source of corporate resources for

deployment elsewhere.



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3. Dogs

These are businesses that have low market share and low market

growth. They are in a saturated, mature market with intense

competition and low profit margins. Because of their weak position,

these businesses are managed for short term cash flow to supplement

corporate level resource needs. These businesses are eventually

divested or liquidated once the short-term harvesting is maximized.

4. Question marks

These businesses have considerable appeal because of their high

growth rate yet present questionable profit potential because of low

market share. They are known as cash guzzlers because their cash

needs are high as a result of rapid growth, while their cash generation

is low due to small market share. At the corporate level the concern is

identifying the question market that would most benefit from extra

corporate resources resulting in increased market share and

movement in to the star group.

Conventional strategic thinking suggests there are four possiblestrategies for each SBU:

(1) Build Share: here the company can invest to increase marketshare (for example turning a "question mark" into a star)

(2) Hold: here the company invests just enough to keep the SBU inits present position

(3) Harvest: here the company reduces the amount of investment inorder to maximize the short-term cash flows and profits from the SBU.This may have the effect of turning Stars into Cash Cows.

(4) Divest: the company can divest the SBU by phasing it out or

selling it - in order to use the resources elsewhere (e.g. investing inthe more promising "question marks").

Strategic implication of the BCG Matrix

The cash surplus from any cash cows should be used to support thedevelopment of selected question marks and nurture stars.



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The long term position is to consolidate the position of stars and turnfavored question marks in to stars, thus making the companysportfolio more attractive.

Question mark with the weakest or most uncertain long-term

prospects should be divested to reduce demands on a companys cash

resources. Dogs having reached the end of their useful life are generally best put

to sleep unless they are still performing a useful function not merelymaking a contribution to overheads.

The portfolio must be balanced when there are sufficient cash cows,stars and question marks.

2. The General Electric (GE)Approach

Another portfolio planning approach that helps a business determinewhether to invest in opportunities is the General Electric (GE)

approach. The GE approach examines a businesss strengths and theattractiveness of the industry in which it competes. As we have indicated,a business strengths are factors internal to the company, including stronghuman resources capabilities (talented personnel), strong technicalcapabilities, and the fact that the firm holds a large share of the market.The attractiveness of an industry can include aspects such as whether ornot there is a great deal of growth in the industry, whether the profitsearned by the firms competing within it are high or low, and whether ornot it is difficult to enter the market. For example, the automobileindustry is not attractive in times of economic downturn such as therecession in 2009, so many automobile manufacturers dont want to

invest more in production. They want to cut or stop spending as much aspossible to improve their profitability. Hotels and airlines face similarsituations.

Companies evaluate their strengths and the attractiveness of industries ashigh, medium, and low. The firms then determine their investmentstrategies based on how well the two correlate with one another. As figurebelow, The General Electric (GE) Approach shows, the investmentoptions outlined in the GE approach can be compared to a traffic light. Forexample, if a company feels that it does not have the business strengthsto compete in an industry and that the industry is not attractive; this willresult in a low rating, which is comparable to a red light. In that case, thecompany should harvest the business (slowly reduce the investmentsmade in it), divest the business (drop or sell it), or stop investing in it,which is what happened with many automotive manufacturers.



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The General Electric (GE) Approach

Although many people may think a yellow light means speed up, it actuallymeans caution. Companies with a medium rating on industry attractivenessand business strengths should be cautious when investing and attempt tohold the market share they have. If a company rates itself high on businessstrengths and the industry is very attractive (also rated high), this iscomparable to a green light. In this case, the firm should invest in thebusiness and build market share. During bad economic times, many

industries are not attractive. However, when the economy improvesbusinesses must reevaluate opportunities.

3.2 Business level strategies

Business level strategy focuses on improving the competitive position of aBusiness level strategy focuses on improving the competitive position of a

companys or business units products or services within the specific industrycompanys or business units products or services within the specific industry

or market segment that the company or business unit serves. Businessor market segment that the company or business unit serves. Business

strategy can be competitive (battling against all competitors for advantage)strategy can be competitive (battling against all competitors for advantage)

and /or cooperative (working with one or more competitors to gainand /or cooperative (working with one or more competitors to gain

advantage against other competitors). Just as corporate strategy asks whatadvantage against other competitors). Just as corporate strategy asks what

industry (ies) the company should be in, business strategy asks how theindustry (ies) the company should be in, business strategy asks how the

company or its units should compete or cooperate in each industry.company or its units should compete or cooperate in each industry.

Routes to building competitive advantage

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Competitive strategies must be based on some sources of competitive

advantage to be successful. Companies build competitive advantages when

they take steps that enable them to gain an edge over their rivals in

attracting buyers. These steps vary: for example, making the highest

quality , product, providing the best customer service, producing at eh lowest

cost, or focusing resources on a specific segment or niche of the industry

regardless of which avenue to building competitive advantage the firm

selects, customers should receive superior value than that offered by rival

firms. Recall that business level strategy focuses on how to compete in a

given business or industry with its different types of competitors aiming to

sell to the same or similar group of customer. In practice, competitors within

an industry may be companies with no other lines of business (single

business firms) or business units belonging to larger, diversified companies

that operate across many industries.

Competitive strategy may arise from the following questions:Competitive strategy may arise from the following questions:

Should we compete on the basis of low cost (and thus price), or shouldShould we compete on the basis of low cost (and thus price), or should

we differentiate our products or services on some basis other that cost,we differentiate our products or services on some basis other that cost,

such as quality or service?such as quality or service?

Should we compete head to head with our major competitors for theShould we compete head to head with our major competitors for the

biggest but most sought-after share of the market, or should we focusbiggest but most sought-after share of the market, or should we focus

on a niche in which we can satisfy a less sought-after but alsoon a niche in which we can satisfy a less sought-after but also

profitable segment of the market?profitable segment of the market?



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Although there are as many different competitive strategies as there are

firms competing, three underlying approaches to building competitive

advantage appear to exist at the broadest level. They are (1) low-cost

leaders hip strategies (2) differentiation. Strategies and (3) focus strategies.

These three broad types of competitive strategies have also been labeled

generic strategies. Let us now examine how each genetic type of competitive

strategy can build competitive advantage.

Low Cost leadership Strategies

Low cost leadership strategies are based on a firms ability to provide a

product or service at a lower cost than its rivals. The basic operating

assumption behind a low-cost leadership strategy is to acquire a substantial

cost advantages over other competitors that can be passed in to the

consumers to gain a large market share. A low cost strategy then produces

a competitive advantage when the firm can earn a higher profit margin that

result from selling products at current market prices. In many cases, firms

attempting to execute low-cost strategies aim to sell a product that appeal to



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providing buyers with something that is different or unique, that makes the

companys product or service district from that of its rivals. The key

assumption behind a differentiation strategy is that customers willing to pay

a higher price for a product that is distinct (or at least perceived as such) in

some important way. Superior value is created because the product is of

higher quality, is technically superior in some way, comes with superior

service, or has a special appeal in some perceive way. In effect,

differentiation builds competitive advantage by making customers more

loyal- and less price- sensitive-to a given firms product.

Building a differentiation based advantage

Firms practicing differentiation seek to design and produce highly distinctive

or unique product or service attributes that create high value for their

customers. An important strategic consideration managers must recognize is

that differentiation does not mean the firm can neglect its cost structure

.While low unit cost is less important than distinctive product features to

firms practicing differentiations, the firms total cost structure is still

important.

In almost all differentiation strategies, attention to product quality and

services represents the dominant routes for firms to build competitive

advantage.

Advantage of differentiation

it allows firms to insulate themselves partially from competitive rivalry

in the industry.

Customers of differentiated products are less sensitive to price. In

practice, this attitude means that firms may be able to pass along

price increases to their customers.

Strategies based on high quality may, up to a point, actually increase

the potential market share that a firm can gain.

Differentiation poses substantial loyalty barriers that firms

contemplating entry must overcome.

Disadvantages of differentiation



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other firms may attempt to out differentiate firms that already have

distinctive products by providing similar or better product

Price premiums become difficult to justify as customers gain more

knowledge about the product.

Firms face a risk of over doing differentiation that may overtax or

overextend their resources.

3) Focus strategies

Focus strategies are designed to help a firm target a specific niche within

an industry. These niches could be a particular buyer group, a narrow

segment of a given product line, a geographic or regional market, or a niche

with distinctive, special taste and preference. The basic idea behind a focus

strategy is to specialize the firms activities in ways that other broader-linefirms cant perform as well.

Building a focus based advantage

Firms can build a focus in one of two ways. They can adopt a cost- based

focus in serving a particular niche or segment of the market, or they can

adopt a differentiation based focus. Within a particular targeted market or

niche, however, a focused firm can pursue many of the same characteristics

as the broader low-cost or differentiation approaches to building competitive

advantage. Thus many of the source of competitive advantage discussed

earlier for cost and differentiation also apply to focus strategies at the niche

or segment level.

3.3. Functional Level Strategy

Functional strategy is the approach taken in a functional area to achieve

corporate and business unit objectives and strategies by maximizing resource

productivity. It is concerned with developing and nurturing a distinctive

competence to provide a company or business unit with a competitive

advantage. For example, just as a multidivisional corporation has several

business units, each with its own business strategy, each business unit has

its own set of departments, each with its own functional strategy. The

orientation of the functional strategy is dictated by its parent business units



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strategy. For example, a business unit following a competitive strategy of

differentiation through high quality needs a manufacturing strategy that

emphasizes expensive, quality assurance processes over cheaper, high-

volume production; a human resource functional strategy that emphasizes

the hiring and training of a highly skilled, but costly, workforce; and a

marketing functional strategy that emphasizes distribution channel pull

using advertising to increase consumer demand over push using

promotional allowances to retailers. If a business unit were to follow a low-

cost competitive strategy, however, a different set of functional strategies

would be needed to support the business strategy.

3.3.1 Marketing strategy3.3.1 Marketing strategy

Marketing consists of those activities intended to move products or serviceMarketing consists of those activities intended to move products or service

form the producer to the consumer or market. Marketing strategy deals withform the producer to the consumer or market. Marketing strategy deals with

pricing, and distributing a product. Using a market development strategy, apricing, and distributing a product. Using a market development strategy, a

company or business unit can (1) capture a larger share of an existingcompany or business unit can (1) capture a larger share of an existing

market for current products through market saturation and marketmarket for current products through market saturation and market

penetration or (2) develop new markets for current products.penetration or (2) develop new markets for current products.

Using the product development strategy, a company or unit, can (1) developUsing the product development strategy, a company or unit, can (1) develop

new products for existing markets or (2) develop new products for newnew products for existing markets or (2) develop new products for new

markets.markets.

Using a successful brand name to market other products is called brandUsing a successful brand name to market other products is called brand

extension and is a good way to appeal to a company's current customers.extension and is a good way to appeal to a company's current customers.

There are numerous other marketing strategies. For advertising andThere are numerous other marketing strategies. For advertising and

promotion, for example, a company or business unit can choose between apromotion, for example, a company or business unit can choose between a

"push" and a "pull" marketing strategy."push" and a "pull" marketing strategy.

3.3.2. Financial strategy3.3.2. Financial strategy

Financial strategy examines the financial implications of corporate andFinancial strategy examines the financial implications of corporate and

business level strategic options and identifies the best financial course ofbusiness level strategic options and identifies the best financial course of

action. It can also competitive advantage through a lower cost of funds and aaction. It can also competitive advantage through a lower cost of funds and a

flexible ability to raise capital to support a business strategy.flexible ability to raise capital to support a business strategy.



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3.3.3. Research and development (R&D) strategy3.3.3. Research and development (R&D) strategy

R&D strategy deals with product and process innovation and improvement. ItR&D strategy deals with product and process innovation and improvement. It

also deals with the appropriate mix of different types of R&D (basic, product,also deals with the appropriate mix of different types of R&D (basic, product,

or process) and with the question of how new technology should be accessedor process) and with the question of how new technology should be accessed

internal development, external acquisition, or through strategic alliances.internal development, external acquisition, or through strategic alliances.

One of the R&D choices is to be either a technological leader in which oneOne of the R&D choices is to be either a technological leader in which one

pioneers an innovation or a technological follower in which one imitates thepioneers an innovation or a technological follower in which one imitates the

products of competitors. Porter suggests that deciding to become aproducts of competitors. Porter suggests that deciding to become a

technological leader or follower can b e a way of achieving either overall lowtechnological leader or follower can b e a way of achieving either overall low

cost or differentiation.cost or differentiation.

3.3.4. Operations strategy3.3.4. Operations strategy

Operations strategy determines how and where a product or service is to beOperations strategy determines how and where a product or service is to be

manufactured, the level of vertical integration in the production process, andmanufactured, the level of vertical integration in the production process, and

the deployment of physical resources. It should also deal with the optimumthe deployment of physical resources. It should also deal with the optimum

level of technology the firm should use in its operations processes.level of technology the firm should use in its operations processes.

The concept of a product's life cycle eventually leading to one size fits allThe concept of a product's life cycle eventually leading to one size fits all

mass production is being increasingly challenged by the new concept of massmass production is being increasingly challenged by the new concept of mass

customization. A appropriate for an ever changing environment, masscustomization. A appropriate for an ever changing environment, mass

customization requires that people, processes, units and technologycustomization requires that people, processes, units and technology

reconfigure themselves to give customers exactly what they want, when theyreconfigure themselves to give customers exactly what they want, when they

want it. In contrast to continuous improvement, mass customization requireswant it. In contrast to continuous improvement, mass customization requires

flexibility and quick responsiveness. Managers coordinate independent,flexibility and quick responsiveness. Managers coordinate independent,

capable individuals. An efficient linkage system is crucial. The result is lowcapable individuals. An efficient linkage system is crucial. The result is low

cost, high quality, customized goods and services mass customization iscost, high quality, customized goods and services mass customization is

having a significant impact on product development. Under a true masshaving a significant impact on product development. Under a true mass

customization system, no one knows exactly what the next customer willcustomization system, no one knows exactly what the next customer will

wantwant

3.3.5. Purchasing strategy3.3.5. Purchasing strategy



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Purchasing strategy deals with obtaining the raw materials, parts, andPurchasing strategy deals with obtaining the raw materials, parts, and

supplies needed to perform the operations function. The basic purchasingsupplies needed to perform the operations function. The basic purchasing

choices are multiple, sole, and parallel sourcing. Under multiple sourcing, thechoices are multiple, sole, and parallel sourcing. Under multiple sourcing, the

purchasing company orders a particular part from several vendors. Multiplepurchasing company orders a particular part from several vendors. Multiple

sourcing has traditionally been considered superior to other purchasingsourcing has traditionally been considered superior to other purchasing

approaches because (1) it forces suppliers to compete for the business of anapproaches because (1) it forces suppliers to compete for the business of an

important buyer, thus reducing purchasing costs; and (2) if one supplierimportant buyer, thus reducing purchasing costs; and (2) if one supplier

could not deliver, another usually could, thus guaranteeing that parts andcould not deliver, another usually could, thus guaranteeing that parts and

supplies would always be on hand when needed.supplies would always be on hand when needed.

Multiple sourcing was one way a purchasing firm could control theMultiple sourcing was one way a purchasing firm could control the

relationship with its suppliers. So long as suppliers could provide evidencerelationship with its suppliers. So long as suppliers could provide evidence

that they could meet the product specifications, they were kept on thethat they could meet the product specifications, they were kept on the

purchaser's list of acceptable vendors for specific parts and supplies.purchaser's list of acceptable vendors for specific parts and supplies.

Unfortunately the common practice of accepting the lowest bid oftenUnfortunately the common practice of accepting the lowest bid often

compromised quality.compromised quality.

3.3.6. Logistics strategy3.3.6. Logistics strategy

Logistics strategy deals with the flow of products into and out of theLogistics strategy deals with the flow of products into and out of the

manufacturing process. Three trends are evident: centralization, outsourcing,manufacturing process. Three trends are evident: centralization, outsourcing,

and the use of the Internet. To gain logistical synergies across businessand the use of the Internet. To gain logistical synergies across business

units, corporations began centralizing logistics in the head quarter's group.units, corporations began centralizing logistics in the head quarter's group.

This centralized logistics group usually contains specialists with expertise inThis centralized logistics group usually contains specialists with expertise in

different transportation modes such as rail or trucking. They work todifferent transportation modes such as rail or trucking. They work to

aggregate shipping volumes across the entire corporation to gain betteraggregate shipping volumes across the entire corporation to gain better

contracts with shippers.contracts with shippers.

Many companies have found that outsourcing of logistics reduces costs andMany companies have found that outsourcing of logistics reduces costs and

improves delivery time. Many companies are using the Internet to simplifyimproves delivery time. Many companies are using the Internet to simplify

their logistical system.their logistical system.

3.3.7. Human resource management (HRM) strategy3.3.7. Human resource management (HRM) strategy



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HRM strategy, among other things, addresses the issue of whether aHRM strategy, among other things, addresses the issue of whether a

company or business unit should hire a large number of low skilledcompany or business unit should hire a large number of low skilled

employees who receive low pay, perform repetitive jobs, and most likely quitemployees who receive low pay, perform repetitive jobs, and most likely quit

after a short time (the McDonald's restaurant strategy) or hire skilledafter a short time (the McDonald's restaurant strategy) or hire skilled

employees who receive relatively high pay and are cress trained toemployees who receive relatively high pay and are cress trained to

participate in self managing work teams. As work increases in complexity,participate in self managing work teams. As work increases in complexity,

the more suited it is for teams, especially in the case of innovative productthe more suited it is for teams, especially in the case of innovative product

development efforts. Multinational corporations are increasingly using self-development efforts. Multinational corporations are increasingly using self-

managing work teams in their foreign affiliates as well as in home countrymanaging work teams in their foreign affiliates as well as in home country

operations. Researches indicate that the use of work teams leads tooperations. Researches indicate that the use of work teams leads to

increased quality and productivity as well as to higher employee satisfactionincreased quality and productivity as well as to higher employee satisfaction

and commitment.and commitment.

3.3.8. Strategies to avoid3.3.8. Strategies to avoid

Several strategies, which could be considered corporate, business, orSeveral strategies, which could be considered corporate, business, or

functional, are very dangerous. Managers who have made a poor analysis orfunctional, are very dangerous. Managers who have made a poor analysis or

lack creativity may be trapped into considering some of the followinglack creativity may be trapped into considering some of the following

strategies to avoid:strategies to avoid:

Follow the leader: Imitating a leading competitor's strategy mightFollow the leader: Imitating a leading competitor's strategy might

seem to be a good idea, but it ignores a firm's particular strengths andseem to be a good idea, but it ignores a firm's particular strengths and

the possibility that the leader may be wrong.the possibility that the leader may be wrong.

Hit another home run: If a company is successful because it pioneeredHit another home run: If a company is successful because it pioneered

an extremely successful product, it tends to search for another superan extremely successful product, it tends to search for another super

product that will ensure growth and prosperity. Like betting on longproduct that will ensure growth and prosperity. Like betting on long

shots at the horse races, the horse races, the probability of finding ashots at the horse races, the horse races, the probability of finding a

second winner is slight.second winner is slight.

Arms Race: entering into a spirited battle with another firm forArms Race: entering into a spirited battle with another firm for

increased market share might increase sales revenue, but thatincreased market share might increase sales revenue, but that

increase will probably be more than offset by increases in advertising,increase will probably be more than offset by increases in advertising,

promotion, R&D, and manufacturing costs.promotion, R&D, and manufacturing costs.

Do Everything: When faced with several interesting opportunities,Do Everything: When faced with several interesting opportunities,

management might tend to leap at all of them,. At first, a corporationmanagement might tend to leap at all of them,. At first, a corporation



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might have enough resources to develop each idea into a project, butmight have enough resources to develop each idea into a project, but

money, time, and energy are soon exhausted as the many projectsmoney, time, and energy are soon exhausted as the many projects

demand large infusions of resources.demand large infusions of resources.

Losing Hand: A corporation might have invested so much in aLosing Hand: A corporation might have invested so much in a

particular strategy that top management is unwilling to accept itsparticular strategy that top management is unwilling to accept its

failure. Believing that it has too much invested to quit, the corporationfailure. Believing that it has too much invested to quit, the corporation

continues to throw "good money after bad."continues to throw "good money after bad."

3 .4. STRATEGIC CHOICE: SELECTION OF THE BEST STRATEGY

After the pros and cons of the potential strategic alternatives have been

identified and evaluated, one must be selected for implementation. By now,

many feasible alternatives probably will have emerged. How is the beststrategy determined?

Perhaps the most important criterion is the ability of the proposed

strategy to deal with the specific strategic factors developed earlier in

the SWOT analysis. If the alternative doesnt take advantage of

environmental opportunities and corporate strengths and lead away

from environmental threats and corporate weaknesses, it will probably

fail.

Another important consideration in the selection of a strategy is the

ability of each alternative to satisfy agreed-on objectives with the least

use of resources and with the fewest negative side effects.

It is therefore important to develop a tentative implementation plan that

addresses managements likely difficulties. This should be done in light of

societal trends, the industry, and the companys situation based on the

construction of scenarios.

APPLYING EVALUATION CRITERIA

When considering which course of action to pursue, it is normally the cause

that a number of options present themselves to an organizations top



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management. In order to ensure that each option is fairly and equally

assessed, a number of criteria are applied.

For each option, four criteria are applied questions to ask of each option. In

order to pass, the option must usually receive an affirmative answer to each

one. The four criteria are:

1. Is the strategic option suitable?

2. Is the strategic option feasible?

3. Is the strategic option acceptable?

4. Will the strategic option enable the organization to achieve competitive

advantage?

Suitability criterionA strategic option is suitable if it will enable the organization to actually

achieve its strategic objectives. If it will in any way fall short of achieving

these objectives, then there is no point in pursuing it and the option should

be discarded.

Similarly, if an organizations objective is to spread market portfolio by

gaining a presence in foreign markets, then the option of increasing the

companys investment in its domestic home would clearly be unsuitable.

Feasibility criterion

A strategic option is feasible if it is possible. When evaluating options using

these criteria, it is likely that the options will be feasible to varying degrees.

Some will be completely unfeasible, others might be, whilst yet others are

definitely feasible.

The extent to which an option is suitable will depend in large part upon the

resource base that the organization has. A deficit in any of the key resource

areas (physical resources, financial, human and intellectual) will present a

problem at this stage of evaluation. If an option requires capital that is

unavailable, human skills that are difficult to buy in, land or equipment that

is equally difficult to obtain or a scarce intellectual resource, then it is likely

to fail the feasibility criterion.

Acceptability criterion



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A strategic option is acceptable if those who must agree to the strategy

accept the option. This raises an obvious question who are those who agree

that the option is acceptable?

We encountered the concept of stakeholders in chapter one. The extent that

stakeholders can exert influence upon an organizations strategic decision-

making rests upon the two variable, power and interest. Stakeholders that

have the highest combination of both the ability to influence (power) and the

willingness to influence (interest) will have the most effective influence.

Where two or more stakeholder groups have comparable influence, the

possibility of conflict over acceptability will be heightened. In most cases, the

board of directors will be the most influential stakeholder.

Competitive advantage criterion

We learned in Chapter two that one of the key objectives in strategy is to

create competitive advantage. This criterion asks a simple question of any

strategic option: what is the point of pursuing an option if it isnt going to

result in superior performance (compared with competitors) or higher than

average profitability? In other words, a strategic option would fail this test if

it was likely to result in the business being only ordinary or average with

regard to the industry norm.

This is particularly important when considering product options. For example,

if a new product option is forecast to receive an uncertain reception from the

market, we might well ask what the point of the launch is at all. It would be

unlikely to result in competitive advantage for the business.

FINANCIAL TOOLSF FOR EVALUATION

In the evaluation and selection stage, a number of tools are available to

managers that may assist in deciding upon the most appropriate option. Not

all of them will be appropriate in every circumstance and some are more

widely used than others. They are used to explore the implications of the

options so that the decisions that are made are based upon the best possible

information.



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Accountants are usually very involved in strategic evaluation and selection

because of their expertise in understanding the financial implications of the

possible courses of action. There are two major areas of financial analysis:

cash-flow forecasting and investment appraisal.

Cash flow forecasting

One of the most straightforward financial tools is cash-flow analysis some-

times called funds-flow analysis. Essentially, it involves a forecast of the

expected income from an option, of the costs that will be incurred and, from

this, the forecast net cash inflows or outflows. For most options, the forecast

will be broken down into monthly chunks and a profit and loss statement

will be constructed for each month. If the same procedure is carried out for

each option, the most favorable can be identifies.

Investment appraisal

An investment, at its simplest, is some money put up for a project in the

expectation that it will enable more money to be made in the future. The

questions surrounding investment appraisal concern how much will the

organization make against each investment option.

There is a strong time elementto investment appraisal techniques because

the returns on the investment may remain for several years or even decades.

It is for this reason that a factor is often built in to the calculation to account

for inflation.

The first and most obvious thing that accountants want to know about any

investment is the payback period. This is the time taken to repay the

investment the shorter the better. If, for example, an investment of $1000

is expected to increase profits by $100 a month, then the payback period will

be 10 months.

In practice, payback periods are rarely this short and it is this fact that

makes investment appraisal calculations a bit more complicated. When the

effects of inflation are taken into account, the returns on an investment can

be eroded over time. Consequently, accountants include a factor to account

for the effects of inflation, usually on a best-guess basis.



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Other tools for evaluation

Financial evaluation of strategic options is very important, but for most

organizations other tools can also provide useful information. These may

require financial information as an input and so they should be seen not as

instead of financial analyses, but as well as. They enrich the information,

enabling management to select the best strategic option.

Cost benefit analysis

Cost-benefit analysis applies to almost every area of life, not just strategic

evaluation and selection. Each option will have a cost associated with it and

will be expected to return certain benefits. If both of these can be quantified

in financial terms, then the cost-benefit calculation will be relatively

straightforward. The problem is that this is rarely the case.

The costs of pursuing one particular option will have a number of elements.

Any financial investment costs will be easily quantifiable. Against this, the

cost of not pursuing the next best option needs to be taken into account

the opportunity cost. There may also be a number of social and

environmental costs which are much harder to attach a value to.

The same problems apply to the benefits. In addition to financial benefits, an

organization may also take into account social benefits and others such as

improved reputation or improved service. Intangible benefits are very

difficult to attach a value to for a cost-benefit analysis as they can take a

long time to work through in increased financial performance.

Social costs and benefits

All organizations have an impact upon the societies that are in their locality

or that are affected by their products or activities. Although the term social

is a bit nebulous, it is generally taken to mean the effect on the condition of

employment, social well-being, health, chemical emissions, pollution,

aesthetic appearance (e.g. eyesores), charitable societies, etc.

A strategic option will have an element of social cost and social benefit. We

would describe a social cost as a deterioration in any of the above an

increase in unemployment, higher levels of emissions, pollution, declining

salaries, etc. Conversely, a social benefit will result in an improvement in the



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condition of society increasing employment, cleaner industry, better

working conditions, etc.

Impact analysis

When a strategic option may be reasonably expected to have far-reaching

consequences in either social or financial terms, an impact study may be

appropriate. Essentially, this involves asking the question, If this option goes

ahead, what will its impact be upon . . .

The thing that might be impacted upon will depend upon the particular

circumstances of the option. For a proposed development of a new nuclear

power station, for example, the impact study would typically take into

account the developments implications for local employment, local tourism,

health risk to employees and local residents, the reputation and appearance

of the town or region, local flora and fauna, among other things.

In many cases, an impact study will be an intrinsic part of the cost-benefit

calculation, and it suffers from the same limitations that of evaluating the

true value of each thing that may be impacted.

WHAT IF? AND SENSITIVITY ANALYSIS

The uncertainties of the future, as we have seen, make any prediction

inexact. Whilst an organization can never be certain of any sequence of

future events, what if? analysis, and its variant, sensitivity analysis, can

give an idea of how the outcome would be affected by a number of possible

disruptions.

The development of computerized applications such as spreadsheets have

made this activity easier than it used to be. A financial model on a

spreadsheet that makes a number of assumptions such as revenue

projections, cost forecasts, inflation rate, etc., can be modified to show

instantly the effect of, say, a 10 per cent increase in costs or a higher-than-

expected rate of inflation. This is designed to show how sensitive the cash

flow is to its assumptions hence the name.

Qualitative variables can also be analyzed. If an option has a high

dependency upon the availability of a key raw material or the oversight of a



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key manager, a what if? Study will show the effect that the loss or reduction

in the key input would have.

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