Strategy’s Role in Business
Vision and Mission Statements
Vision and Mission Statements
Throughout your competency-based program, you have gathered financial, leadership, and reflection skills. All of that information will come into play in this competency. What do you hope to become in the future? What is your purpose and role in society? As you read, distinguish between an organization’s vision and mission.
Vision, Mission, and Goals
The Importance of Vision
Good business leaders create a vision, articulate the vision, passionately own the vision, and relentlessly drive it to completion.
Many skills and abilities separate effective strategic leaders, like Howard Schultz of Starbucks, from poor strategic leaders. One of them is the ability to inspire employees to work hard to improve their organization’s performance. Effective strategic leaders are able to convince employees to embrace lofty ambitions and move the organization forward. In contrast, poor strategic leaders struggle to rally their people and channel their collective energy in a positive direction.
An organization’s vision describes what the organization hopes to become in the future. Well-constructed visions clearly articulate an organization’s aspirations. Avon’s vision is “to be the company that best understands and satisfies the product, service, and self-fulfillment needs of women—globally” (2014). This brief but powerful statement emphasizes several aims that are important to Avon, including excellence in customer service, empowering women, and the intent to be a worldwide player. Like all good visions, Avon sets a high standard for employees to work collectively toward. Perhaps no vision captures high standards better than that of aluminum maker Alcoa. This firm’s very ambitious vision is “to be the best company in the world—in the eyes of our customers, shareholders, communities, and people” (2014). By making clear their aspirations, Alcoa’s executives hope to inspire employees to act in ways that help the firm become the best in the world.
The results of a survey of 1,500 executives illustrate how the need to create an inspiring vision creates a tremendous challenge for executives. When asked to identify the most important characteristics of effective strategic leaders, 98% of the executives listed “a strong sense of vision” first. Meanwhile, 90% of the executives expressed serious doubts about their own ability to create a vision (Quigley, 1994). Not surprisingly, many organizations do not have formal visions. Many organizations that do have visions find that employees do not embrace and pursue the visions. Having a well-formulated vision employees embrace can therefore give an organization an edge over its rivals.
Figure 1.1 Examples of Vision Statements
Images from Herrera, D. (2008). Canadian Chevron. Retrieved from http://www.flickr.com/photos/dph1110/2672793430/; bfishadow. (2009). Google China office. Retrieved from http://www.flickr.com/photos/bfishadow/3458254707/; © Thinkstock; Like_the_Grand_Canyon. (2008). Kraft dinner. Retrieved from http://www.flickr.com/photos/like_the_grand_canyon/2406679678/; Like_the_Grand_Canyon. (2010). Kraft Philadelphia Balance mit Ziegenkase & Getrockneten Tomaten. Retrieved from http://www.flickr.com/photos/like_the_grand_canyon/4945749010/; Ehardt, S. (2005). Crest toothpaste. Retrieved from http://en.wikipedia.org/wiki/File:Crest_toothpaste.jpg.
In working to turn around Starbucks, Howard Schultz sought to renew Starbucks’s commitment to its mission statement: “to inspire and nurture the human spirit—one person, one cup, and one neighborhood at a time” (n.d.). A mission such as Starbucks’s states the reasons for an organization’s existence. Well-written mission statements effectively capture an organization’s identity and provide answers to the fundamental question, “Who are we?” While a vision looks to the future, a mission captures the key elements of the organization’s past and present (Figure 1.2 “Missions”).
Figure 1.2 Missions
Harley-Davidson (n.d.).; Internal Revenue Service (2014).; Starbucks (2014)., The Estée Lauder Company (2014).; L Brands (2014).; Fender Musical Instruments (2014). Images from Evb-wiki. (2007) My hog. Retrieved from http://en.wikipedia.org/wiki/File:Evb-my_hog.jpg; Internal Revenue Service. (2006). IRS. Retrieved from http://en.wikipedia.org/wiki/File:IRS.svg; Wilcox, J. (2005). Starbucks in Shanghai. Retrieved from http://www.flickr.com/photos/jeffwilcox/1882938710/; Burdette, D. (2010). Victoria’s Secret at Briarwood Mall. Retrieved from http://wikimediafoundation.org/wiki/File:Victoria’s_Secret_at_Briarwood_Mall.JPG; © Thinkstock
Organizations need support from their key stakeholders, such as employees, owners, suppliers, and customers, if they are to prosper. A mission statement should explain to stakeholders why they should support the organization by making clear what important role or purpose the organization plays in society. Google’s mission, for example, is “to organize the world’s information and make it universally accessible and useful” (n.d.). Google pursued this mission in its early days by developing a very popular Internet search engine. The firm continues to serve its mission through various strategic actions, including offering its Internet browser Google Chrome to the online community, providing free e-mail via its Gmail service, and making books available online for browsing.
Many consider Abraham Lincoln to have been one of the greatest strategic leaders in modern history.Image from Gardner, A. (n.d.). Retrieved from http://wikimediafoundation.org/wiki/File:Abraham_Lincoln_head_on_shoulders_photo_portrait.jpg
One of Abraham Lincoln’s best-known statements is that “a house divided against itself cannot stand.” This provides a helpful way of thinking about the relationship between vision and mission. Executives ask for trouble if their organization’s vision and mission are divided by emphasizing different domains. Some universities have fallen into this trap. Many large public universities were established in the late 1800s with missions that centered on educating citizens. As the 20th century unfolded, however, creating scientific knowledge through research became increasingly important to these universities. Many university presidents responded by creating visions centered on building the scientific prestige of their schools. This created a dilemma for professors: Should they devote most of their time and energy to teaching students (as the mission required) or on their research studies (as ambitious presidents demanded via their visions)? Some universities continue to struggle with this trade-off today and remain houses divided against themselves. In sum, an organization is more effective to the extent that its vision and its mission target employees’ effort in the same direction.
Note. Adapted from “Vision, Mission, and Goals,” by Ketchen, D. and Short, J., 2011, Mastering Strategic Management, Chapter 2, Section 1. Copyright 2011 Flat World Knowledge, Inc.
Pursuing the Vision and Mission Through SMART Goals
Pursuing the Vision and Mission Through SMART Goals
This section discusses the aim of goals and why the most effective goals are those that are SMART because they provide clarity, transparency, and accountability. As you read, think about writing a SMART goal for a new venture or privately owned business in your community. Record in your Learning Journal.
It is important that business students develop a working knowledge of SMART (specific, measurable, attainable, relevant, and time-bound) goals. Just like a SWOT (Strengths, Weaknesses, Opportunities, and Threats) Analysis, SMART goals need to be in the toolkit of every businessperson. Therefore, you will see SMART goals and SWOT analysis in several competencies as they apply in this program.
An organization’s vision and mission offer a broad, overall sense of the organization’s direction. To work toward achieving these overall aspirations, organizations also need to create goals—narrower aims that should provide clear and tangible guidance to employees as they perform their work on a daily basis. The most effective goals are those that are specific, measurable, aggressive, realistic, and time-bound. An easy way to remember these dimensions is to combine the first letter of each into one word: SMART (Figure 1.3 “Creating SMART Goals”). Employees are put in a good position to succeed to the extent that an organization’s goals are SMART.
Figure 1.3 Creating SMART Goals
Image from ©Thinkstock. (n.d.). Retrieved from http://www.thinkstock.com. Copyright by Thinkstock. Reproduced with permission.
A goal is specific if it is explicit rather than vague. In May 1961, President John F. Kennedy proposed a specific goal in a speech to the U.S. Congress: “I believe that this nation should commit itself to achieving the goal, before this decade is out, of landing a man on the moon and returning him safely to the earth” (National Aeronautics and Space Administration, n.d.). Explicitness such as was offered in this goal is helpful because it targets people’s energy. A few moments later, Kennedy made it clear that such targeting would be needed if this goal were to be reached. Going to the moon, he noted, would require “a major national commitment of scientific and technical manpower, material, and facilities, and the possibility of their diversion from other important activities where they are already thinly spread.” While specific goals make it clear how efforts should be directed, vague goals, such as “do your best,” leave individuals unsure of how to proceed.
A goal is measurable to the extent that whether the goal is achieved can be quantified. President Kennedy’s goal of reaching the moon by the end of the 1960s offered very simple and clear measurability: Either Americans would step on the moon by the end of 1969 or they would not. One of Coca-Cola’s recent goals was a 20% improvement to its water efficiency by 2012 relative to 2004 water usage. Because water efficiency is easily calculated, the company was able to chart its progress relative to the 20% target and devote more resources to reaching the goal if progress was slower than planned.
A goal is aggressive if achieving it presents a significant challenge to the organization. A series of research studies have demonstrated that performance is strongest when goals are challenging but attainable. Such goals force people to test and extend the limits of their abilities. This can result in reaching surprising heights. President Kennedy captured this theme in a speech in September 1962: “We choose to go to the moon. We choose to go to the moon in this decade…not because [it is] easy, but because [it is] hard, because that goal will serve to organize and measure the best of our energies and skills” (National Aeronautics and Space Administration, n.d.).
In the case of Coca-Cola, reaching a 20% improvement will require a concerted effort, but the goal can be achieved. Meanwhile, easily achievable goals tend to undermine motivation and effort. Consider a situation in which you have done so well in a course that you only need a score of 60% on the final exam to earn an A for the course. Understandably, few students would study hard enough to score 90% or 100% on the final exam under these circumstances. Similarly, setting organizational goals that are easy to reach encourages employees to work just hard enough to reach the goals.
It is tempting to extend this thinking to conclude that setting nearly impossible goals would encourage even stronger effort and performance than does setting aggressive goals. People tend to get discouraged and give up, however, when faced with goals that have little chance of being reached. If, for example, President Kennedy had set a time frame of one year to reach the moon, his goal would have attracted scorn. The country simply did not have the technology in place to reach such a goal. Indeed, Americans did not even orbit the moon until seven years after Kennedy’s 1962 speech. Similarly, if Coca-Cola’s water efficiency goal were 95% improvement, Coca-Cola’s employees would probably not embrace it. Thus goals must also be realistic, meaning that their achievement is feasible.
You have probably found that deadlines are motivating and that they help you structure your work time. The same is true for organizations, leading to the conclusion that goals should be time-bound through the creation of deadlines. Coca-Cola set a deadline of 2012 for its water efficiency goal, for example. The deadline for President Kennedy’s goal was the end of 1969. The goal was actually reached a few months early. On July 20, 1969, Neil Armstrong became the first human to step foot on the moon. Incredibly, the pursuit of a well-constructed goal had helped people reach the moon in just eight years.
Americans landed on the moon eight years after President Kennedy set a moon landing as a key goal for the United States.Image from NASA Apollo Archive. (n.d.). Retrieved from http://upload.wikimedia.org/wikipedia/commons/8/8b/5927_NASA.jpg
The period after an important goal is reached is often overlooked but is critical. Will an organization rest on its laurels or will it take on new challenges? The U.S. space program again provides an illustrative example. At the time of the first moon landing, Time magazine asked the leader of the team that built the moon rockets about the future of space exploration. “Given the same energy and dedication that took them to the moon,” said Wernher von Braun, “Americans could land on Mars as early as 1982” (“The Moon: Next, Mars and beyond,” 1969). No new goal involving human visits to Mars was embraced, however, and human exploration of space was de-emphasized in favor of robotic adventurers. Nearly three decades after von Braun’s proposed timeline for reaching Mars expired, President Barack Obama set in 2010 a goal of creating by 2025 a new space vehicle capable of taking humans beyond the moon and into deep space. This would be followed in the mid-2030s by a flight to orbit Mars as a prelude to landing on Mars (Amos, 2010). Time will tell whether these goals inspire the scientific community and the country in general.
Note. Adapted from “Vision, Mission, and Goals,” by Ketchen, D. and Short, J., 2011, Mastering Strategic Management, Chapter 2, Section 1. Copyright 2011 Flat World Knowledge, Inc.
What is an important goal for a new venture or privately owned business in your community? Use this questionnaire to create SMART (smart, measurable, aggressive, realistic, and time-bound) goals for the venture or business you identified.
Think of a lifestyle change you want to make. Do you want to lose weight? Be more organized? Spend more time with family? Now use the Learning Journal to complete your own SMART goal analysis for your change; the outline below can help you organize your thoughts. After completing your SMART goal analysis, consider whether you believe this lifestyle goal is still realistic and attainable. If it is not, revise the goal by breaking it up into a smaller, more achievable goal and repeat the SMART analysis until you feel confident that you can achieve success.
Specific: What will you accomplish? How will you accomplish it?
Measurable: List at least two indicators that will measure whether or not your goal has reached fruition.
Aggressive: Is your goal challenging yet attainable? Have any others achieved success?
Realistic: Is your goal nearly impossible to attain or is achievement feasible?
Time-bound: Is your deadline motivating? Does it create a sense of urgency?
Assessing Organizational Performance
Assessing Organizational Performance
Organizational performance is a multidimensional concept, and wise managers rely on multiple measures of performance when gauging the success or failure of their organizations. As you read and gain an understanding of the complexities associated with assessing organizational performance, think of a real-world measurable example for each of the four dimensions of the balanced scorecard framework.
Share your example in the Discussion Board.
Organizational Performance: A Complex Concept
Organizational performance refers to how well an organization is doing to reach its vision, mission, and goals. Assessing organizational performance is a vital aspect of strategic management. Executives must know how well their organizations are performing to figure out what strategic changes, if any, to make. Performance is a very complex concept, however, and a lot of attention needs to be paid to how it is assessed.
Two important considerations are (1) performance measures, and (2) performance referents (Figure 1.4 “How Organizations and Individuals Can Use Financial Performance Measures and Referents”). A performance measure is a metric along which organizations can be gauged. Most executives examine measures such as profits, stock price, and sales in an attempt to better understand how well their organizations are competing in the market. But these measures provide just a glimpse of organizational performance. Performance referents are also needed to assess whether an organization is doing well. A performance referent is a benchmark used to make sense of an organization’s standing along a performance measure. Suppose, for example, that a firm has a profit margin of 20% in 2011. This sounds great on the surface. But suppose that the firm’s profit margin in 2010 was 35% and that the average profit margin across all firms in the industry for 2011 was 40%. Viewed relative to these two referents, the firm’s 2011 performance is cause for concern.
Using a variety of performance measures and referents is valuable because different measures and referents provide different information about an organization’s functioning. The parable of the blind men and the elephant—popularized in Western cultures through a poem by John Godfrey Saxe in the 19th century—is useful for understanding the complexity associated with measuring organizational performance. As the story goes, six blind men set out to “see” what an elephant was like. The first man touched the elephant’s side and believed the beast to be like a great wall. The second felt the tusks and thought elephants must be like spears. Feeling the trunk, the third man thought it was a type of snake. Feeling a limb, the fourth man thought it was like a tree trunk. The fifth, examining an ear, thought it was like a fan. The sixth, touching the tail, thought it was like a rope. If the men failed to communicate their different impressions they would have all been partially right but wrong about what ultimately mattered.
Figure 1.4 How Organizations and Individuals Can Use Financial Performance Measures and Referents
Image from Ketchen, D., & Short, J. (2011). Mastering strategic management. Irvington, NY: Flat World Knowledge.
This story parallels the challenge involved in understanding the multidimensional nature of organization performance because different measures and referents may tell a different story about the organization’s performance. For example, the Fortune 500 lists the largest U.S. firms in terms of sales. These firms are generally not the strongest performers in terms of growth in stock price, however, in part because they are so big that making major improvements is difficult. During the late 1990s, a number of Internet-centered businesses enjoyed exceptional growth in sales and stock price but reported losses rather than profits. Many investors in these firms who simply fixated on a single performance measure—sales growth—absorbed heavy losses when the stock market’s attention turned to profits and the stock prices of these firms plummeted.
The story of the blind men and the elephant provides a metaphor for understanding the complexities of measuring organizational performance.Image from Itcho, H. (1888). Blind monks examining an elephant. Retrieved from http://en.wikipedia.org/wiki/File:Blind_monks_examining_an_elephant.jpg
The number of performance measures and referents that are relevant for understanding an organization’s performance can be overwhelming, however. For example, a study of what performance metrics were used within restaurant organizations’ annual reports found that 788 different combinations of measures and referents were used within this one industry in a single year (Short & Palmer, 2003). Thus, executives need to choose a rich yet limited set of performance measures and referents to focus on.
The Balanced Scorecard
To organize an organization’s performance measures, Professor Robert Kaplan and Professor David Norton of Harvard University developed a tool called the balanced scorecard. The balanced scorecard is an approach to assessing performance that targets managers’ attention on four areas: (1) financial, (2) customer, (3) internal business process, and (4) learning and growth. Using the scorecard helps managers resist the temptation to fixate on financial measures and instead monitor a diverse set of important measures (Figure 1.5 “Beyond Profits: Measuring Performance Using the Balanced Scorecard”). Indeed, the idea behind the framework is to provide a “balance” between financial measures and other measures that are important for understanding organizational activities that lead to sustained, long-term performance. The balanced scorecard recommends that managers gain an overview of the organization’s performance by tracking a small number of key measures that collectively reflect four dimensions: (1) financial, (2) customer, (3) internal business process, and (4) learning and growth (Kaplan & Norton, 1992).
Figure 1.5 Beyond Profits: Measuring Performance Using the Balanced Scorecard
From Short, J. C., Bauer, T., Ketchen, D. J., & Simon, L. (2010). Atlas black: Managing to succeed. Irvington, NY: Flat World Knowledge. © Thinkstock
Financial measures of performance relate to organizational effectiveness and profits. Examples include financial ratios such as return on assets, return on equity, and return on investment. Other common financial measures include profits and stock price. Such measures help answer the key question, “How do we look to shareholders?”
Financial performance measures are commonly articulated and emphasized within an organization’s annual report to shareholders. To provide context, such measures should be objective and be coupled with meaningful referents, such as the firm’s past performance. For example, Starbucks’s 2009 annual report highlights the firm’s performance in terms of net revenue, operating income, and cash flow over a five-year period.
Customer measures of performance relate to customer attraction, satisfaction, and retention. These measures provide insight to the key question, “How do customers see us?” Examples might include the number of new customers and the percentage of repeat customers.
Starbucks realizes the importance of repeat customers and has taken a number of steps to satisfy and to attract regular visitors to their stores. For example, Starbucks rewards regular customers with free drinks and offers all customers free Wi-Fi access (Miller, 2010). Starbucks also encourages repeat visits by providing cards with codes for free iTunes downloads. The featured songs change regularly, encouraging frequent repeat visits.
Internal Business Process Measures
Internal business process measures of performance relate to organizational efficiency. These measures help answer the key question, “What must we excel at?” Examples include the time it takes to manufacture the organization’s good or deliver a service. The time it takes to create a new product and bring it to market is another example of this type of measure.
Organizations such as Starbucks realize the importance of such efficiency measures for the long-term success of its organization, and Starbucks carefully examines its processes with the goal of decreasing order fulfillment time. In one recent example, Starbucks efficiency experts challenged their employees to assemble a Mr. Potato Head to understand how work could be done more quickly (Jargon, 2009). The aim of this exercise was to help Starbucks employees in general match the speed of the firm’s high performers, who boast an average time per order of 25 seconds.
Learning and Growth Measures
Learning and growth measures of performance relate to the future. Such measures provide insight to tell the organization, “Can we continue to improve and create value?” Learning and growth measures focus on innovation and proceed with an understanding that strategies change over time. Consequently, developing new ways to add value will be needed as the organization continues to adapt to an evolving environment. An example of a learning and growth measure is the number of new skills learned by employees every year.
One way Starbucks encourages its employees to learn skills that may benefit both the firm and individuals in the future is through its tuition reimbursement program. Employees who have worked with Starbucks for more than one year are eligible. Starbucks hopes that the knowledge acquired while earning a college degree might provide employees with the skills needed to develop innovations that will benefit the company in the future. Another benefit of this program is that it helps Starbucks reward and retain high-achieving employees.
Measuring Performance Using the Triple Bottom Line
Ralph Waldo Emerson once noted, “Doing well is the result of doing good. That’s what capitalism is all about.” While the balanced scorecard provides a popular framework to help executives understand an organization’s performance, other frameworks highlight areas such as social responsibility. One such framework, the triple bottom line emphasizes the three Ps of people (making sure that the actions of the organization are socially responsible), the planet (making sure organizations act in a way that promotes environmental sustainability), and traditional organization profits. This notion was introduced in the early 1980s but did not attract much attention until the late 1990s.
In the case of Starbucks, the firm has made clear the importance it attaches to the planet by creating an environmental mission statement: “Starbucks is committed to a role of environmental leadership in all facets of our business,” in addition to its overall mission (Starbucks, n.d.). In terms of the “people” dimension of the triple bottom line, Starbucks strives to purchase coffee beans harvested by farmers who work under humane conditions and are paid reasonable wages. The firm works to be profitable as well, of course.
Note. Adapted from “Assessing Organizational Performance,” by Ketchen, D. and Short, J., 2011, Mastering Strategic Management, Chapter 2, Section 2. Copyright 2011 Flat World Knowledge, Inc.
This video uses science to explain the triple bottom line. It says that the long-term sustainability of an organization, includes not only the financial bottom line but a social and environmental one as well. As you watch this video, reflect on the importance of using the three Ps (people, planet, and profit) as a tool for measuring performance.
Techniques Used in Strategy Decisions
Generic Business-Level Strategies
Generic Business-Level Strategies
What strategy do you think a locally-owned business in your town or city uses to gain a competitive advantage? Read this section to explore how firms use generic business-level strategies to compete in a given industry.
As you read, note in your Learning Journal how such strategy is derived and why it is important to understand the differences and limitations of each generic strategy.
Understanding Business-Level Strategy through “Generic Strategies”
Why Examine Generic Strategies?
Business-level strategy addresses the question of how a firm will compete in a particular global industry (Figure 2.1 “Business-Level Strategies”). This seems to be a simple question on the surface, but it is actually quite complex because there are a great many possible answers to the question. Consider, for example, the restaurants in your town or city. Chances are that you live fairly close to some combination of McDonald’s, Subway, Chili’s, Applebee’s, Panera Bread Company, dozens of other national brands, and a variety of locally-based eateries that have just one location. Each of these restaurants competes using a business model that is at least somewhat unique. When an executive in the restaurant industry analyzes her company and her competitors, she needs to avoid getting distracted by all the nuances of different firms’ business-level strategies and losing sight of the big picture.
The solution is to think about business-level strategy in terms of generic strategies. A generic strategy is a general way of positioning a firm’s business-level strategy within an industry. Focusing on generic strategies allows executives to concentrate on the core elements of firms’ business-level strategies. The most popular set of generic strategies is based on the work of Professor Michael Porter (1980) of the Harvard Business School and subsequent researchers (Williamson & Zeng, 2009) who have built on Porter’s initial ideas.
Figure 2.1 Business-Level Strategies
Images from Debs. (2010). *clouds part* Anthropologie. Retrieved from http://www.flickr.com/photos/littledebbie11/4537337628/; GeneralCheese. (2010). Remodeled Walmart. Retrieved from http://en.wikipedia.org/wiki/File:Remodeld_walmart.jpg; n/a. (2006). Nordstrom. Retrieved from http://en.wikipedia.org/wiki/File:Nordstrom.JPG; NNECAPA. (2008). Dollar General sign, Port Henry, NY. Retrieved from http://www.flickr.com/photos/nnecapa/2794736274/
According to Porter, two competitive dimensions are the keys to business-level strategy. The first dimension is a firm’s source of competitive advantage. This dimension involves whether a firm tries to gain an edge on rivals by keeping costs down or by offering something unique in the market. The second dimension is firms’ scope of operations. This dimension involves whether a firm tries to target customers in general or whether it seeks to attract just a segment of customers. Four generic business-level strategies emerge from these decisions: (1) cost leadership, (2) differentiation, (3) focused cost leadership, and (4) focused differentiation. In rare cases, firms are able to offer both low prices and unique features that customers find desirable. These firms are following a best-cost strategy. Firms that are not able to offer low prices or appealing unique features are referred to as being “stuck in the middle.”
Understanding the differences that underlie generic strategies is important because different generic strategies offer different value propositions to customers. A firm focusing on cost leadership will have a different value chain configuration than a firm whose strategy focuses on differentiation. For example, marketing and sales for a differentiation strategy often requires extensive effort while some firms that follow cost leadership, such as Waffle House, are successful with limited marketing efforts. This section presents each generic strategy and the “recipe” generally associated with success when using that strategy. When firms follow these recipes, the result can be a strategy that leads to superior performance. But when firms fail to follow logical actions associated with each strategy, the result may be a value proposition configuration that is expensive to implement and that does not satisfy enough customers to be viable.
Analyzing generic strategies enhances the understanding of how firms compete at the business level.Image from Ketchen, D. J., Short, J. C., Combs, J. G., & Terrell, W. (2011). Tales of Garcón: The franchise players. Irvington, NY: Flat World Knowledge.
Limitations of Generic Strategies
Examining business-level strategy in terms of generic strategies has limitations. Firms that follow a particular generic strategy tend to share certain features. For example, one way that cost leaders generally keep costs low is by not spending much on advertising. Not every cost leader, however, follows this path. While cost leaders such as Waffle House spend very little on advertising, Wal-Mart spends considerable money on print and television advertising despite following a cost leadership strategy. Thus, a firm may not match every characteristic that its generic strategy entails. Indeed, depending on the nature of a firm’s industry, tweaking the recipe of a generic strategy may be essential to cooking up success.
Note. Adapted from “Understanding Business-Level Strategy through ‘Generic Strategies’,” by Ketchen, D. and Short, J., 2011, Mastering Strategic Management, Chapter 5, Section 1. Copyright 2011 Flat World Knowledge, Inc.
Cost Leadership Strategy
Cost Leadership Strategy
Read this section to discover the advantages and disadvantages of a cost leadership strategy. Would this strategy benefit a new venture or existing privately-owned business in your community?
The Nature of the Cost Leadership Strategy
It is tempting to think of cost leaders as companies that sell inferior, poor-quality goods and services for rock-bottom prices. The Yugo, for example, was an extremely unreliable car that was made in Eastern Europe and sold in the United States for about $4,000. Despite its attractive price tag, the Yugo was a dismal failure because drivers simply could not depend on the car for transportation. Yugo exited the United States in the early 1990s and closed down entirely in 2008.
Figure 2.2 Cost Leadership Strategy: Examples
These are examples of cost leadership strategies.Images by Evan-Amos. (2011). LD-nutty-bar-split. Retrieved from http://en.wikipedia.org/wiki/File:LD-Nutty-Bar-Split.jpg; © Thinkstock
In contrast to firms such as Yugo whose failure is inevitable, cost leaders can be very successful. A firm following a cost leadership strategy offers products or services with acceptable quality and features to a broad set of customers at a low price. Payless ShoeSource, for example, sells name-brand shoes at inexpensive prices. Its low-price strategy is communicated to customers through advertising slogans such as “Why pay more when you can Payless?” and “You could pay more, but why?” Little Debbie snack cakes offer another example. The brand was started in the 1930s when O. D. McKee began selling sugary treats for five cents. Most consumers today would view the quality of Little Debbie cakes as a step below similar offerings from Entenmann’s, but enough people believe that they offer acceptable quality that the brand is still around eight decades after its creation.
Perhaps the most famous cost leader is Wal-Mart, which has used a cost leadership strategy to become the largest retailer in the world. The firm’s advertising slogans such as “Always Low Prices” and “Save Money. Live Better” communicate Wal-Mart’s emphasis on price slashing to potential customers. Meanwhile, Wal-Mart has the broadest customer base of any firm in the United States. Approximately 100 million Americans visit a Wal-Mart in a typical week (Hudson & Zimmerman, 2006). Incredibly, this means that roughly one-third of Americans are frequent Wal-Mart customers. This huge customer base includes people from all demographic and social groups within society. Although most are simply typical Americans, the popular website www.peopleofwalmart.com features photos of some of the more outrageous characters who have been spotted in Wal-Mart stores.
Cost leaders tend to share some important characteristics. The ability to charge low prices and still make a profit is challenging. Cost leaders manage to do so by emphasizing efficiency. At Waffle House restaurants, for example, customers are served cheap eats quickly to keep booths available for later customers. As part of the effort to be efficient, most cost leaders spend little on advertising, market research, or research and development. Waffle House, for example, limits its advertising to billboards along highways. Meanwhile, the simplicity of Waffle House’s menu requires little research and development.
Many cost leaders rely on economies of scale to achieve efficiency. Economies of scale are created when the costs of offering goods and services decreases as a firm is able to sell more items. This occurs because expenses are distributed across a greater number of items. Wal-Mart spent approximately $2 billion on advertising in 2008. This is a huge number, but Wal-Mart is so large that its advertising expenses equal just a tiny fraction of its sales. Also, cost leaders are often large companies, which allows them to demand price concessions from their suppliers. Wal-Mart is notorious for squeezing suppliers such as Procter & Gamble to sell goods to Wal-Mart for lower and lower prices over time. The firm passes some of these savings to customers in the form of reduced prices in its stores.
Advantages and Disadvantages of Cost Leadership
Each generic strategy offers advantages that firms can potentially leverage to enhance their success as well as disadvantages that may undermine their success. In the case of cost leadership, one advantage is that cost leaders’ emphasis on efficiency makes them well positioned to withstand price competition from rivals (Figure 2.3 “Executing a Low-Cost Strategy”). Kmart’s ill-fated attempt to engage Wal-Mart in a price war ended in disaster, in part because Wal-Mart was so efficient in its operations that it could live with smaller profit margins far more easily than Kmart could.
Figure 2.3 Executing a Low-Cost Strategy
Beyond existing competitors, a cost leadership strategy also creates benefits relative to potential new entrants. Specifically, the presence of a cost leader in an industry tends to discourage new firms from entering the business because a new firm would struggle to attract customers by undercutting the cost leaders’ prices. Thus a cost leadership strategy helps create barriers to entry that protect the firm—and its existing rivals—from new competition.
In many settings, cost leaders attract a large market share because a large portion of potential customers find paying low prices for goods and services of acceptable quality to be very appealing. This is certainly true for Wal-Mart, for example. The need for efficiency means that cost leaders’ profit margins are often slimmer than the margins enjoyed by other firms. However, cost leaders’ ability to make a little bit of profit from each of a large number of customers means that the total profits of cost leaders can be substantial.
In some settings, the need for high sales volume is a critical disadvantage of a cost leadership strategy. Highly fragmented markets and markets that involve a lot of brand loyalty may not offer much of an opportunity to attract a large segment of customers. In both the soft drink and cigarette industries, for example, customers appear to be willing to pay a little extra to enjoy the brand of their choice. Lower-end brands of soda and cigarettes appeal to a minority of consumers, but famous brands such as Coca-Cola, Pepsi, Marlboro, and Camel still dominate these markets. A related concern is that achieving a high sales volume usually requires significant upfront investments in production and/or distribution capacity. Not every firm is willing and able to make such investments.
Cost leaders tend to keep their costs low by minimizing advertising, market research, and research and development, but this approach can prove to be expensive in the long run. A relative lack of market research can lead cost leaders to be less skilled than other firms at detecting important environmental changes. Meanwhile, downplaying research and development can slow cost leaders’ ability to respond to changes once they are detected. Lagging rivals in terms of detecting and reacting to external shifts can prove to be a deadly combination that leaves cost leaders out of touch with the market and out of answers.
Note. Adapted from “Cost Leadership,” by Ketchen, D. and Short, J., 2011, Mastering Strategic Management, Chapter 5, Section 2. Copyright 2011 Flat World Knowledge, Inc.
Focused Cost Leadership Strategy
What type of market does a focused cost leadership strategy target? After reading, think of two different companies not mentioned in the text that target different demographics using this strategy. Share your examples in the Discussion Board.
Focused Cost Leadership and Focused Differentiation
Companies that use a cost leadership strategy and those that use a differentiation strategy share one important characteristic: Both groups try to be attractive to customers in general. These efforts to appeal to broad markets can be contrasted with strategies that involve targeting a relatively narrow niche of potential customers. These latter strategies are known as focus strategies (Porter, 1980).
The Nature of the Focus Cost Leadership Strategy
Focused cost leadership is one of two focus strategies. A focused cost leadership strategy requires competing based on price to target a narrow market (Figure 2.4 “Focused Cost Leadership”). A firm that follows this strategy does not necessarily charge the lowest prices in the industry. Instead, it charges low prices relative to other firms that compete within the target market. Redbox, for example, uses vending machines placed outside grocery stores and other retail outlets to rent DVDs of movies for $1. There are ways to view movies even cheaper, such as through the flat-fee streaming video subscriptions offered by Netflix. But among firms that rent actual DVDs, Redbox offers unparalleled levels of low price and high convenience.
Figure 2.4 Focused Cost Leadership
Images from Gaming4JC. (2009). Big Buford. Retrieved from http://commons.wikimedia.org/wiki/File:Big_Buford.jpg; © Thinkstock
Another important point is that the nature of the narrow target market varies across firms that use a focused cost leadership strategy. In some cases, the target market is defined by demographics. Claire’s, for example, seeks to appeal to young women by selling inexpensive jewelry, accessories, and ear piercings. Claire’s use of a focused cost leadership strategy has been very successful; the firm has more than 3,000 locations and has stores in 95% of U.S. shopping malls.
Redbox machines are available on university campuses nationwide.Image from Everett, V. (2007). A Big Mac and Saving Private Ryan please. Retrieved from http://www.flickr.com/photos/valeriebb/2224649723
In other cases, the target market is defined by the sales channel used to reach customers. Most pizza shops offer sit-down service, delivery, or both. In contrast, Papa Murphy’s sells pizzas that customers cook at home. Because these inexpensive pizzas are baked at home rather than in the store, the law allows Papa Murphy’s to accept food stamps as payment. This allows Papa Murphy’s to attract customers that might not otherwise be able to afford a prepared pizza. In contrast to most fast-food restaurants, Checkers Drive In is a drive-through-only operation. To serve customers quickly, each store has two drive-through lanes: one on either side of the building. Checkers saves money in a variety of ways by not offering indoor seating to its customers—Checkers’ buildings are cheaper to construct, its utility costs are lower, and fewer employees are needed. These savings allow the firm to offer large burgers at very low prices and still remain profitable.
Note. Adapted from “Focused Cost Leadership and Focused Differentiation,” by Ketchen, D. and Short, J., 2011, Mastering Strategic Management, Chapter 5, Section 4. Copyright 2011 Flat World Knowledge, Inc.
A famous cliché contends that “you get what you pay for.” This saying captures the essence of a differentiation strategy. What are two industries in which this strategy would be difficult to implement?
The Nature of the Differentiation Strategy
A firm following a differentiation strategy attempts to convince customers to pay a premium price for its goods or services by providing unique and desirable features (Figure 2.5 “Differentiation”). The message that such a firm conveys to customers is that you will pay a little bit more for our offerings, but you will receive a good value overall because our offerings provide something special.
Figure 2.5 Differentiation
Images from _nickd. (2008). Typographic tour of Chicago Part 2: Morton Salt factory 3/3. Retrieved from http://www.flickr.com/photos/_nickd/2313836162/; Vasquez, G. (2009). Chevelle SS ’69 Hot Wheels. Retrieved from http://www.flickr.com/photos/megavas/3302486505/; Hatfield, D. (2006). Day 4 – Magic Kingdom. Retrieved from http://www.flickr.com/photos/loimere/5068068920/; Pingstone, A. (2006). Fedex.A310-200.N420FE.ARP. Retrieved from http://en.wikipedia.org/wiki/File:Fedex.a310-200.n420fe.arp.jpg; ChunkySoup. (2007). Zoom Elite 2. Retrieved from http://en.wikipedia.org/wiki/File:Zoom_elite_2.png
In terms of the two competitive dimensions described by Michael Porter, using a differentiation strategy means that a firm is competing based on uniqueness rather than price and is seeking to attract a broad market (Porter, 1980). Coleman camping equipment offers a good example. If camping equipment such as sleeping bags, lanterns, and stoves fail during a camping trip, the result will be, well, unhappy campers. Coleman’s sleeping bags, lanterns, and stoves are renowned for their reliability and durability. Cheaper brands are much more likely to have problems. Lovers of the outdoors must pay more to purchase Coleman’s goods than they would to obtain lesser brands, but having equipment that you can count on to keep you warm and dry is worth a price premium in the minds of most campers.
Coleman’s patented stove was originally developed for use by soldiers during World War II. Seven decades later, the Coleman Stove remains a must-have item for campers.Image from Tullis, B. W. (1942). Patent drawing for Coleman Model 520 Stove. Retrieved from http://en.wikipedia.org/wiki/File:Patent_Drawing_for_Coleman_Model_520_Stove.jpg
Successful use of a differentiation strategy depends on not only offering unique features but also communicating the value of these features to potential customers. As a result, advertising in general and brand building in particular are important to this strategy. Few goods are more basic and generic than table salt. This would seemingly make creating a differentiated brand in the salt business next to impossible. Through clever marketing, however, Morton Salt has done so. Morton has differentiated its salt by building a brand around its iconic umbrella girl and its trademark slogan of “When it rains, it pours.” Would the typical consumer be able to tell the difference between Morton Salt and cheaper generic salt in a blind taste test? Not a chance. Yet Morton succeeds in convincing customers to pay a little extra for its salt through its brand-building efforts.
FedEx and Nike are two other companies that have done well at communicating to customers that they provide differentiated offerings. FedEx’s former slogan, “When it absolutely, positively has to be there overnight,” highlights the commitment to speedy delivery that sets the firm apart from competitors such as UPS and the U.S. Postal Service. Nike differentiates its athletic shoes and apparel through its iconic “swoosh” logo as well as an intense emphasis on product innovation through research and development.
Developing a Differentiation Strategy at Express Oil Change
Express Oil Change and Service Centers is a chain of auto repair shops that stretches from Florida to Texas. Based in Birmingham, Alabama, the firm has more than 170 company-owned and franchised locations under its brand. Express Oil Change tries to provide a unique level of service, and the firm is content to let rivals offer cheaper prices. We asked an Express Oil Change executive about his firm (Ketchen & Short, 2010).
|Question:||The auto repair and maintenance business is a pretty competitive space. How is Express Oil Change being positioned relative to other firms, such as Super Lube, American LubeFast, and Jiffy Lube?|
|Don Larose, Senior Vice President of Franchise Development:||Every good business sector is competitive. The key to our success is to be more convenient and provide a better overall experience for the customer. Express Oil Change and Service Centers outperform the industry significantly in terms of customer transactions per day and store sales, for a host of reasons.|
|In terms of customer convenience, Express Oil Change is faster than most of our competitors—we do a 10-minute oil change while the customer stays in the car. Mothers with kids in car seats especially enjoy this feature. We also do mechanical work that other quick lube businesses don’t do. We change and rotate tires, do brake repairs, air conditioning, tune ups, and others. There is no appointment necessary for many mechanical services like tire rotation and balancing, and checking brakes. So, overall, we are more convenient than most of our competitors.|
|In terms of staffing our stores, full-time workers are all that we employ. Full-time workers are better trained and typically have less turnover. They therefore have more experience and do better quality work.|
|We think incentives are very important. We use a payroll system that provides incentives to the store staff on how many cars are serviced each day and on the total sales of the store, rather than on increasing the average transactions by selling the customer items they did not come in for, which is what most of the industry does. We don’t sell customers things they don’t yet need, like air filters and radiator flushes. We focus on building trust, by acting with integrity, to get the customer to come back and build the daily car count. This philosophy is not a slogan for us. It is how we operate with every customer, in every store, every day.|
|The placement of our outlets is another key factor. We place our stores in A-caliber retail locations. These are lots that may cost more than our competitors are willing or able to pay. We get what we pay for though; we have approximately 41% higher sales per store than the industry average.|
|Question:||What is the strangest interaction you’ve ever had with a potential franchisee?|
|Larose:||I once had a franchisee candidate in New Jersey respond to a request by us for proof of his liquid assets by bringing to the interview about $100,000 in cash. He had it in a bag, with bundles of it wrapped in blue tape. Usually, folks just bring in a copy of a bank or stock statement. Not sure why he had so much cash on hand, literally, and I didn’t want to know. He didn’t become a franchisee.|
Express Oil Change sets itself apart through superior service and great locations.Image from Express Oil Change (n.d.).
Advantages and Disadvantages of Differentiation
Each generic strategy offers advantages that firms can potentially leverage to enjoy strong performance, as well as disadvantages that may damage their performance. In the case of differentiation, a key advantage is that effective differentiation creates an ability to obtain premium prices from customers (Figure 2.6 “Executing a Differentiation Strategy”). This enables a firm to enjoy strong profit margins. Coca-Cola, for example, currently enjoys a profit margin of approximately 33%, meaning that about 33 cents of every dollar it collects from customers is profit. In comparison, Wal-Mart’s cost leadership strategy delivered a margin of under 4% in 2010.
Figure 2.6 Executing a Differentiation Strategy
This figure illustrates the advantages and disadvantages of differentiation in the women’s handbag market.
Images from Cooper, A. (2010). Alisha Cuthbert Chanel purple handbag. Retrieved from http://www.flickr.com/photos/classicchanelhandbags/4988644763/; EvelynGiggles. (2010). Fake purse. Retrieved from http://www.flickr.com/photos/evelynishere/5300824118/; slgckgc. (2011). Coach bag. Retrieved from http://www.flickr.com/photos/slgc/5379074286/; © Thinkstock
In turn, strong margins mean that the firm does not need to attract huge numbers of customers to have a good overall level of profit. Luckily for Coca-Cola, the firm does attract a great many buyers. Overall, the firm made a profit of just under $12 billion on sales of just over $35 billion in 2010. Interestingly, Wal-Mart’s profits were only 25% higher ($15 billion) than Coca-Cola’s while its sales volume ($421 billion) was 12 times as large as Coca-Cola’s. Profit statistics drawn from Standard & Poor’s stock reports on Coca-Cola and Walmart. This comparison of profit margins and overall profit levels illustrates why a differentiation strategy is so attractive to many firms.
To the extent that differentiation remains in place over time, buyer loyalty may be created. Loyal customers are very desirable because they are not price sensitive. In other words, buyer loyalty makes a customer unlikely to switch to another firm’s products if that firm tries to steal the customer away through lower prices. Many soda drinkers are fiercely loyal to Coca-Cola’s products. Coca-Cola’s headquarters are in Atlanta, and loyalty to the firm is especially strong in Georgia and surrounding states. Pepsi and other brands have a hard time convincing loyal Coca-Cola fans to buy their beverages, even when offering deep discounts. This helps keep Coca-Cola’s profits high because the firm does not have to match any promotions that its rivals launch to keep its customers.
Meanwhile, Pepsi also has attracted a large set of brand-loyal customers that Coca-Cola struggles to steal. This enhances Pepsi’s profits. In contrast, store-brand sodas such as Sam’s Choice (which is sold at Wal-Mart) seldom attract loyalty. As a result, they must be offered at very low prices to move from store shelves into shopping carts.
Beyond existing competitors, a differentiation strategy also creates benefits relative to potential new entrants. Specifically, the brand loyalty that customers feel to a differentiated product makes it difficult for a new entrant to lure these customers to adopt its product. A new soda brand, for example, would struggle to take customers away from Coca-Cola or Pepsi. Thus a differentiation strategy helps create barriers to entry that protect the firm and its industry from new competition.
The big risk when using a differentiation strategy is that customers will not be willing to pay extra to obtain the unique features that a firm is trying to build its strategy around. In 2007, department store Dillard’s stopped carrying men’s sportswear made by Nautica because the seafaring theme of Nautica’s brand had lost much of its cache among many men (Kapner, 2007). Because Nautica’s uniqueness had eroded, Dillard’s believed that space in its stores that Nautica had been occupying could be better allocated to other brands.
In some cases, customers may simply prefer a cheaper alternative. For example, products that imitate the look and feel of offerings from Ray-Ban, Tommy Bahama, and Coach are attractive to many value-conscious consumers. Firms such as these must work hard at product development and marketing to ensure that enough customers are willing to pay a premium for their goods rather than settling for knockoffs.
In other cases, customers desire the unique features that a firm offers, but competitors are able to imitate the features well enough that they are no longer unique. If this happens, customers have no reason to pay a premium for the firm’s offerings. IBM experienced the pain of this scenario when executives tried to follow a differentiation strategy in the personal computer market. The strategy had worked for IBM in other areas. Specifically, IBM had enjoyed a great deal of success in the mainframe computer market by providing superior service and charging customers a premium for their mainframes. A business owner who relied on a mainframe to run her company could not afford to have her mainframe out of operation for long. Meanwhile, few businesses had the skills to fix their own mainframes. IBM’s message to customers was that they would pay more for IBM’s products but that this was a good investment because when a mainframe needed repairs, IBM would provide faster and better service than its competitors could. The customer would thus be open for business again very quickly after a mainframe failure.
This positioning failed when IBM used it in the personal computer market. Rivals such as Dell were able to offer service that was just as good as IBM’s while also charging lower prices for personal computers than IBM charged. From a customer’s perspective, a person would be foolish to pay more for an IBM personal computer since IBM did not offer anything unique. IBM steadily lost market share as a result. By 2005, IBM’s struggles led it to sell its personal computer business to Lenovo. The firm is still successful, however, within the mainframe market where its offerings remain differentiated.
Note. Adapted from “Differentiation,” by Ketchen, D. and Short, J., 2011, Mastering Strategic Management, Chapter 5, Section 3. Copyright 2011 Flat World Knowledge, Inc.
Focused Differentiation Strategy
Focused Differentiation Strategy
A focused differentiation strategy requires offering unique features that fulfill the demands of a narrow market. After reading, think of two businesses that would benefit from using this strategy. Share in the Discussion Board and provide your rationale.
The Nature of the Focused Differentiation Strategy
Focused differentiation is one of two focus strategies. A focused differentiation strategy requires offering unique features that fulfill the demands of a narrow market (Figure 2.7 “Focused Differentiation”). As with a focused low-cost strategy, narrow markets are defined in different ways in different settings. Some firms using a focused differentiation strategy concentrate their efforts on a particular sales channel, such as selling over the Internet only. Others target particular demographic groups. One example is Breezes Resorts, a company that caters to couples without children. The firm operates seven tropical resorts where vacationers are guaranteed that they will not be annoyed by loud and disruptive children.
While a differentiation strategy involves offering unique features that appeal to a variety of customers, the need to satisfy the desires of a narrow market means that the pursuit of uniqueness is often taken to the proverbial “next level” by firms using a focused differentiation strategy. Thus, the unique features provided by firms following a focused differentiation strategy are often specialized.
Figure 2.7 Focused Differentiation
Images by rjp. (2004). Cinnabon. Retrieved from http://www.flickr.com/photos/zimpenfish/385384830/; Cars en travel. (2006). Mercedes-Benz SLR McLaren 2 cropped. Retrieved from http://commons.wikimedia.org/wiki/File:Mercedes-Benz_SLR_McLaren_2_cropped.jpg; © Thinkstock
When it comes to uniqueness, few offerings can top Kopi Luwak coffee beans. High-quality coffee beans often sell for $10 to $15 a pound. In contrast, Kopi Luwak coffee beans sell for hundreds of dollars per pound (Cat’s Ass Coffee, 2010). This price is driven by the rarity of the beans and their rather bizarre nature. As noted in a 2010 article in the New York Times, these beans “are found in the droppings of the civet, a nocturnal, furry, long-tailed catlike animal that prowls Southeast Asia’s coffee-growing lands for the tastiest, ripest coffee cherries. The civet eventually excretes the hard, indigestible innards of the fruit—essentially, incipient coffee beans—though only after they have been fermented in the animal’s stomach acids and enzymes to produce a brew described as smooth, chocolaty and devoid of any bitter aftertaste” (Onishi, 2010).
Although many consumers consider Kopi Luwak to be disgusting, a relatively small group of coffee enthusiasts has embraced the coffee and made it a profitable product. This illustrates the essence of a focused differentiation strategy—effectively serving the specialized needs of a niche market can create great riches.
Larger niches are served by Whole Foods Market and Mercedes-Benz. Although most grocery stores devote a section of their shelves to natural and organic products, Whole Foods Market works to sell such products exclusively. For customers, the large selection of organic goods comes at a steep price. Indeed, the supermarket’s reputation for high prices has led to a wry nickname—“Whole Paycheck”—but a sizable number of consumers are willing to pay a premium to feel better about the food they buy.
The dedication of Mercedes-Benz to cutting-edge technology, styling, and safety innovations has made the firm’s vehicles prized by those who are rich enough to afford them. This appeal has existing for many decades. In 1970, acid-rocker Janis Joplin recorded a song called “Mercedes Benz” that highlighted the automaker’s allure. Since then, Mercedes-Benz has used the song in several television commercials, including during the 2011 Super Bowl.
Developing a Focused Differentiation Strategy
Developing a Focused Differentiation Strategy at Augustino LoPrinzi Guitars and Ukuleles
Augustino LoPrinzi Guitars and Ukuleles in Clearwater, Florida, builds high-end custom instruments. The founder of the company, Augustino LoPrinzi, has been a builder of custom guitars for five decades. While a reasonably good mass-produced guitar can be purchased elsewhere for a few hundred dollars, LoPrinzi’s handmade models start at $1,100, and some sell for more than $10,000. The firm’s customers have included professional musicians such as Dan Fogelberg, Leo Kottke, Herb Ohta (Ohta-San), Lyle Ritz, Andrés Segovia, and B. J. Thomas. The following comments were excerpted from a 2007 interview with LoPrinzi (Short, 2007).
|Question:||Were there other entrepreneurial opportunities you considered before you began making guitars?|
|Augustino Loprinzi:||I originally thought of pursuing a career in commercial art, but I found my true love was in classical guitar building. I was trained by my father to be a barber from a very young age, and after my term in the service, I opened a barbershop.|
|Question:||What is the most expensive guitar you’ve ever sold?|
|Question:||How old were you when you started your first business in the guitar industry?|
|Loprinzi:||I was in my early 20s.|
|Question:||How did you get your break with more famous customers?|
|Loprinzi:||I think word of mouth had a lot do with it.|
|Question:||You have been active in Japan. Do the preferences of Japanese customers differ from those of Americans?|
|Loprinzi:||Yes. The Japanese want only high-end instruments. Aesthetics are very important to the Japanese along with high-quality materials and workmanship. The U.S. market seems to care in general less about ornamentation and more about quality workmanship, tone, and playability.|
|Question:||How do you stay ahead in your industry?|
|Loprinzi:||Always try to stay abreast on what the music industry is doing. We do this by reading several music industry publications, talking with suppliers, and keeping an eye on the trends going on in other countries because usually they come full circle. Also, for the past several years by following the Internet forums and such has been extremely beneficial.|
Note. Adapted from “Focused Cost Leadership and Focused Differentiation,” by Ketchen, D. and Short, J., 2011, Mastering Strategic Management, Chapter 5, Section 4. Copyright 2011 Flat World Knowledge, Inc.
Advantages and Disadvantages of the Focused Strategies
Advantages and Disadvantages of the Focused Strategies
After reading, identify an advantage and a disadvantage of focused strategies for an industry of your choosing. Record your thoughts in the Learning Journal.
Each generic strategy offers advantages that firms can potentially leverage to enhance their success as well as disadvantages that may undermine their success. In the case of focus differentiation, one advantage is that very high prices can be charged. Indeed, these firms often price their wares far above what is charged by firms following a differentiation strategy (Figure 2.8 “Executing a Focus Strategy”). REI (Recreational Equipment Inc.), for example, commands a hefty premium for its outdoor sporting goods and clothes that feature name brands, such as The North Face and Marmot. Nat Nast’s focus differentiation strategy centers on selling men’s silk camp shirts with a 1950s retro flair. These shirts retail for more than $100. Focused cost leaders such as Checkers Drive In do not charge high prices like REI and Nat Nast do, but their low cost structures enable them to enjoy healthy profit margins.
A second advantage of using a focus strategy is that firms often develop tremendous expertise about the goods and services that they offer. In markets such as camping equipment where product knowledge is important, rivals and new entrants may find it difficult to compete with firms following a focus strategy.
Figure 2.8 Executing a Focus Strategy: Advantages and Disadvantages
In terms of disadvantages, the limited demand available within a niche can cause problems. First, a firm could find its growth ambitions stymied. Once its target market is being well served, expansion to other markets might be the only way to expand, and this often requires developing a new set of skills. Also, the niche could disappear or be taken over by larger competitors. Many gun stores have struggled and even gone out of business since Wal-Mart and sporting goods stores such as Academy Sports and Bass Pro Shops have started carrying an impressive array of firearms.
In contrast to tacky Hawaiian souvenirs, the quality of Kamaka ukuleles makes them a favorite of ukulele phenom Jake Shimabukuro and others who are willing to pay $1,000 or more for a high-end instrument.Image from Surfsupusa. (2007). Jake Shimabukuro. Retrieved from http://en.wikipedia.org/wiki/File:Jake_Shimabukuro.jpg
Finally, damaging attacks may come not only from larger firms but also from smaller ones that adopt an even narrower focus. A sporting goods store that sells camping, hiking, kayaking, and skiing goods, for example, might lose business to a store that focuses solely on ski apparel because the latter can provide more guidance about how skiers can stay warm and avoid broken bones.
Organizations can create cost savings, time savings, and job satisfaction by careful thought. Organizations that take a new look and carefully choose proven strategies are the ones that create improvements. The type of strategy chosen depends on the organization you are at and where you want to go.
Strategy at the Movies
One man’s trash is another man’s fashion? That’s what fashion mogul Jacobim Mugatu was counting on in the 2001 comedy Zoolander. In his continued effort to be the most cutting-edge designer in the fashion industry, Mugatu developed a new line of clothing inspired “by the streetwalkers and hobos that surround us.” His new product line, Derelicte, characterized by dresses made of burlap and parking cones and pants made of garbage bags and tin cans, was developed for customers who valued the uniqueness of his…eclectic design. Emphasizing unique products is typical of a company following a differentiation strategy; however, Mugatu targeted a very specific set of customers. Few people would probably be enticed to wear garbage for the sake of fashion. By catering to a niche target market, Mugatu went from a simple differentiation strategy to a focused differentiation. Mugatu’s Derelicte campaign in Zoolander is one illustration of how a particular firm might develop a focused differentiation strategy.
Note. Adapted from “Focused Cost Leadership and Focused Differentiation,” by Ketchen, D. and Short, J., 2011, Mastering Strategic Management, Chapter 5, Section 4. Copyright 2011 Flat World Knowledge, Inc.
Some executives are not content to have their firms compete based on offering low prices or unique features. They want both!
As you read this section, consider when a best-cost strategy would be an effective business-level strategy. Why is executing it so difficult?
The Challenge of Following a Best-Cost Strategy
Figure 2.9 Best-Cost Strategy
Images from Roberts, C. (2010). Pabst Blue Ribbon neon sign. Retrieved from http://www.flickr.com/photos/ckroberts61/4399109703/; planephotoman. (2006). Southwest 737 SeaWorld. Retrieved from http://commons.wikimedia.org/wiki/File:Southwest_737_SeaWorld.jpg; © Thinkstock
Firms that charge relatively low prices and offer substantial differentiation are following a best-cost strategy (Figure 2.9 “Best-Cost Strategy”). This strategy is difficult to execute in part because creating unique features and communicating to customers why these features are useful generally raises a firm’s costs of doing business. Product development and advertising can both be quite expensive. However, firms that manage to implement an effective best-cost strategy are often very successful.
Target appears to be following a best-cost strategy. The firm charges prices that are relatively low among retailers while at the same time attracting trend-conscious consumers by carrying products from famous designers, such as Michael Graves, Isaac Mizrahi, Fiorucci, Liz Lange, and others. This is a lucrative position for Target, but the position is under attack from all sides. Cost leader Wal-Mart charges lower prices than Target. This makes Wal-Mart a constant threat to steal the thriftiest of Target’s customers. Focus differentiators such as Anthropologie that specialize in trendy clothing and home furnishings can take business from Target in those areas. Deep discounters such as T.J. Maxx and Marshalls offer another viable alternative to shoppers because they offer designer clothes and furnishings at closeout prices. A firm such as Target that uses a best-cost strategy also opens itself up to a wider variety of potentially lethal rivals.
Pursuing the Best-Cost Strategy through a Low-Overhead Business Model
Figure 2.10 Examples of Driving Toward a Best-Cost Strategy by Reducing Overhead
Images by Sullivan, K. (2004). Counter culture. Retrieved from http://www.flickr.com/photos/ilovemypit/3726649397/; Brooks, S. B. (2010). The best food cart ever. Retrieved from http://www.flickr.com/photos/foodclothingshelter/4753507671/; Marx, S. (2010). Ninja Plate Lunch. Retrieved from http://www.flickr.com/photos/spam/5166429482/; Dave, K., Short, J., Combs, J., & Terrell, W. (2011). Tales of Garcón: The franchise players. Irvington, NY: Flat World Knowledge.
One route toward a best-cost strategy is for a firm to adopt a business model whose fixed costs and overhead are very low relative to the costs that competitors are absorbing (Figure 2.10 “Driving Toward a Best-Cost Strategy by Reducing Overhead”). The Internet has helped make this possible for some firms. Amazon, for example, can charge low prices in part because it does not have to endure the expenses that firms such as Wal-Mart and Target do in operating many hundreds of stores. Meanwhile, Amazon offers an unmatched variety of goods. This combination has made Amazon the unquestioned leader in e-commerce.
Another example is Netflix. This firm is able to offer customers a far greater variety of movies and charge lower prices than video rental stores by conducting all its business over the Internet and via mail. Netflix’s best-cost strategy was so successful that $10,000 invested in the firm’s stock in May 2006 was worth more than $90,000 five years later. Statistics drawn from Standard & Poor’s stock report on Netflix.
Hey Cupcake! in Austin, Texas, is a low-overhead bakery that has become a delicious success.Image from Bench, E. (2008). Hey cupcake! Retrieved from http://www.flickr.com/photos/austinevan/3237785474
Moving toward a best-cost strategy by dramatically reducing expenses is also possible for firms that cannot rely on the Internet as a sales channel. Owning a restaurant requires significant overhead costs, such as rent and utilities. Some talented chefs are escaping these costs by taking their food to the streets. Food trucks that serve high-end specialty dishes at very economical prices are becoming a popular trend in cities around the country. In Portland, Oregon, a food truck called the Ninja Plate Lunch offers large portions of delectable Hawaiian foods such as pulled pork for around $5. Another Portland food truck is PBJ’s, whose unique and inexpensive sandwiches often center on organic peanut butter. Beyond keeping costs low, the mobility of food trucks offers important advantages over a traditional restaurant. Some food trucks set up outside big-city nightclubs, for example, to sell partygoers a late-night snack before they head home.
Note. Adapted from “Best-Cost Strategy,” by Ketchen, D. and Short, J., 2011, Mastering Strategic Management, Chapter 5, Section 5. Copyright 2011 Flat World Knowledge, Inc.
Ghemawat’s “AAA” Global Strategy Framework
Ghemawat’s “AAA” Global Strategy Framework
If you are going to compete on a global scale, you will need to decide on a strategy to gain a competitive advantage. Read this section to discover how positioning can create value in a global marketplace and whether to focus on one, two, or all three generic strategies—adaptation, aggregation, and arbitrage.
Generic Strategies for Global Value Creation
This section discusses generic strategies for creating value in a global context—adaptation, aggregation, and arbitrage—and a number of variants for each. This content draws substantially from Pankaj Ghemawat’s work (2007). Ghemawat first introduced this conceptualization in his important book Redefining Global Strategy and, as such, is not new.
Ghemawat’s “AAA” Global Strategy Framework
Ghemawat’s (2007) so-called AAA framework offers three generic approaches to global value creation. Adaptation strategies seek to increase revenues and market share by tailoring one or more components of a company’s business model to suit local requirements or preferences. Aggregation strategies focus on achieving economies of scale or scope by creating regional or global efficiencies; they typically involve standardizing a significant portion of the value proposition and grouping together development and production processes. Arbitrage is about exploiting economic or other differences between national or regional markets, usually by locating separate parts of the supply chain in different places.
Adaptation—creating global value by changing one or more elements of a company’s offer to meet local requirements or preferences—is probably the most widely used global strategy. The reason for this will be readily apparent: Some degree of adaptation is essential or unavoidable for virtually all products in all parts of the world. The taste of Coca-Cola in Europe is different from that in the United States, reflecting differences in water quality and the kind and amount of sugar added. The packaging of construction adhesive in the United States informs customers how many square feet it will cover; the same package in Europe must do so in square meters. Even commodities such as cement are not immune: its pricing in different geographies reflects local energy and transportation costs and what percentage is bought in bulk.
Ghemawat (2007) subdivides adaptation strategies into five categories: (1) variation, (2) focus, (3) externalization, (4) design, and (5) innovation (Figure 2.11 “AAA Strategies and Their Variants”).
Variation strategies not only involve making changes in products and services but also making adjustments to policies, business positioning, and even expectations for success. The product dimension will be obvious: Whirlpool, for example, offers smaller washers and dryers in Europe than in the United States, reflecting the space constraints prevalent in many European homes. The need to consider adapting policies is less obvious. An example is Google’s dilemma in China to conform to local censorship rules. Changing a company’s overall positioning in a country goes well beyond changing products or even policies. Initially, Coke did little more than “skim the cream” off big emerging markets such as India and China. To boost volume and market share, it had to reposition itself to a “lower margin–higher volume” strategy that involved lowering price points, reducing costs, and expanding distribution. Changing expectations for, say, the rate of return on investment in a country, while a company is trying to create a presence is also a prevalent form of variation.
Figure 2.11 AAA Strategies and Their Variants
de Kluyver, C. Fundamentals of Global Strategy. Irvington, NY: Flat World Knowledge.
A second type of adaptation strategy focuses on particular products, geographies, value chain stages, or market segments as a way of reducing differences across regions. A product focus takes advantage of the fact that wide differences can exist within broad product categories in the degree of variation required to compete effectively in local markets. Ghemawat (2007) cites the example of television programs: Action films need far less adaptation than local newscasts. Restriction of geographic scope can permit a focus on countries where relatively little adaptation of the domestic value proposition is required. A vertical focus strategy involves limiting a company’s direct involvement to specific steps in the supply chain while outsourcing others. Finally, a segment focus involves targeting a more limited customer base. Rather than adapting a product or service, a company using this strategy chooses to accept the reality that without modification, their products will appeal to a smaller market segment or different distributor network from those in the domestic market. Many luxury goods manufacturers use this approach.
Whereas focus strategies overcome regional differences by narrowing scope, externalization strategies transfer—through strategic alliances, franchising, user adaptation, or networking—responsibility for specific parts of a company’s business model to partner companies to accommodate local requirements, lower cost, or reduce risk. For example, Eli Lilly extensively uses strategic alliances abroad for drug development and testing. McDonald’s growth strategy abroad uses franchising as well as company-owned stores. And software companies heavily depend on both user adaptation and networking for the development of applications for their basic software platforms.
A fourth type of adaptation focuses on design to reduce the cost of, rather than the need for, variation. Manufacturing costs can often be achieved by introducing design flexibility so as to overcome supply differences. Introducing standard production platforms and modularity in components also helps to reduce cost. A good example of a company focused on design is Tata Motors, which has successfully introduced a car in India that is affordable to a significant number of citizens.
A fifth approach to adaptation is innovation, which, given its crosscutting effects, can be characterized as improving the effectiveness of adaptation efforts. For instance, IKEA’s flat-pack design, which has reduced the impact of geographic distance by cutting transportation costs, has helped that retailer expand into three dozen countries.
Aggregation is about creating economies of scale or scope as a way of dealing with differences. The objective is to exploit similarities among geographies rather than adapting to differences but stopping short of complete standardization, which would destroy concurrent adaptation approaches. The key is to identify ways of introducing economies of scale and scope into the global business model without compromising local responsiveness.
Adopting a regional approach to globalizing the business model—as Toyota has so effectively done—is probably the most widely used aggregation strategy. Regionalization or semiglobalization applies to many aspects of globalization, from investment and communication patterns to trade. And even when companies do have a significant presence in more than one region, competitive interactions are often regionally focused.
Examples of different geographic aggregation approaches are not hard to find. Xerox centralized its purchasing, first regionally, later globally, to create a substantial cost advantage. Dutch electronics giant Philips created a global competitive advantage for its Norelco shaver product line by centralizing global production in a few strategically located plants. And the increased use of global (corporate) branding over product branding is a powerful example of creating economies of scale and scope. As these examples show, geographic aggregation strategies have potential application to every major business model component.
Geographic aggregation is not the only avenue for generating economies of scale or scope. The other, nongeographic dimensions of the CAGE framework also lend themselves to aggregation strategies. Major book publishers, for example, publish their best sellers in but a few languages, counting on the fact that readers are willing to accept a book in their second language (cultural aggregation). Pharmaceutical companies seeking to market new drugs in Europe must satisfy the regulatory requirements of a few selected countries to qualify for a license to distribute throughout the EU (administrative aggregation). As for economic aggregation: The most obvious examples are provided by companies that distinguish between developed and emerging markets and, at the extreme, focus on just one or the other.
A third generic strategy for creating a global advantage is arbitrage. Arbitrage is a way of exploiting differences, rather than adapting to them or bridging them, and defines the original global strategy: Buy low in one market and sell high in another. Outsourcing and offshoring are modern-day equivalents. Wal-Mart saves billions of dollars a year by buying goods from China. Less visible but equally important absolute economies are created by greater differentiation with customers and partners, improved corporate bargaining power with suppliers or local authorities, reduced supply chain and other market and nonmarket risks, and through the local creation and sharing of knowledge.
Since arbitrage focuses on exploiting differences between regions, the CAGE framework is of particular relevance and helps define a set of substrategies for this generic approach to global value creation.
Favorable effects related to country or place of origin have long supplied a basis for cultural arbitrage. For example, an association with French culture has long been an international success factor for fashion items, perfumes, wines, and foods. Similarly, fast-food products and drive-through restaurants are mainly associated with U.S. culture. Benihana of Tokyo, the “Japanese steakhouse,” provides another example of cultural arbitrage—real or perceived. Although heavily American—the company has only one outlet in Japan out of more than 100 worldwide—it serves up a theatrical version of teppanyaki cooking that the company describes as “Japanese” and “eatertainment.”
Legal, institutional, and political differences between countries or regions create opportunities for administrative arbitrage. Ghemawat (2007) cites the actions taken by Rupert Murdoch’s News Corporation in the 1990s. By placing its U.S. acquisitions into holding companies in the Cayman Islands, the company could deduct interest payments on the debt used to finance the deals against the profits generated by its newspaper operations in Britain. Through this and other similar actions, it successfully lowered its tax liabilities to an average rate of less than 10%, rather than the statutory 30% to 36% of the three main countries in which it operated: Britain, the United States, and Australia. By comparison, major competitors such as Disney were paying close to the official rates.
With steep drops in transportation and communication costs in the last 25 years, the scope for geographic arbitrage—the leveraging of geographic differences—has been diminished but not fully eliminated. Consider what is happening in medicine, for example. It is quite common today for doctors in the United States to take X-rays during the day, send them electronically to radiologists in India for interpretation overnight, and for the report to be available the next morning in the United States. In fact, reduced transportation costs sometimes create new opportunities for geographic arbitrage. Every day, for instance, at the international flower market in Aalsmeer, the Netherlands, more than 20 million flowers and 2 million plants are auctioned off and flown to customers in the United States.
As Ghemawat (2007) notes, in a sense, all arbitrage strategies that add value are “economic.” Here, the term economic arbitrage is used to describe strategies that do not directly exploit cultural, administrative, or geographic differences. Rather, they are focused on leveraging differences in the costs of labor and capital, as well as variations in more industry-specific inputs (such as knowledge) or in the availability of complementary products.
Exploiting differences in labor costs—through outsourcing and offshoring—is probably the most common form of economic arbitrage. This strategy is widely used in labor-intensive (garments) as well as high-technology (flat-screen TV) industries. Economic arbitrage is not limited to leveraging differences in labor costs alone, however. Capital cost differentials can be an equally rich source of opportunity.
Note. Adapted from “Ghemawat’s ‘AAA’ Global Strategy Framework,” by de Kluyver, C., 2012, Fundamentals of Global Strategy, Chapter 3, Section 1. Copyright 2012 Flat World Knowledge, Inc.
Which “A” Strategy Should a Company Use?
Which “A” Strategy Should a Company Use?
In this section, you will explore what a company should look at when considering which “A” (of Pankaj Ghemawat’s AAA Framework of adaptation, aggregation, and arbitrage) to focus on for creating value in the global marketplace.
A company’s financial statements can be a useful guide for signaling which of the “A” strategies (of Pankaj Ghemawat’s AAA Framework of adaptation, aggregation, and arbitrage) will have the greatest potential to create global value. Firms that heavily rely on branding and that do a lot of advertising, such as food companies, often need to engage in considerable adaptation to local markets. Those that do a lot of research and development (R&D)—think pharmaceutical firms—may want to aggregate to improve economies of scale, since many R&D outlays are fixed costs. For firms whose operations are labor intensive, such as apparel manufacturers, arbitrage will be of particular concern because labor costs vary greatly from country to country.
Which “A” strategy a company emphasizes also depends on its globalization history. Companies that start on the path of globalization on the supply side of their business model, that is, that seek to lower cost or to access new knowledge, first typically focus on aggregation and arbitrage approaches to creating global value, whereas companies that start their globalization history by taking their value propositions to foreign markets are immediately faced with adaptation challenges. Regardless of their starting point, most companies will need to consider all “A” strategies at different points in their global evolution, sequentially or, sometimes, simultaneously.
Nestlé’s globalization path, for example, started with the company making small, related acquisitions outside its domestic market, and the company therefore had early exposure to adaptation challenges. For most of its history, IBM also pursued an adaptation strategy, serving overseas markets by setting up a mini-IBM in each target country. Every one of these companies operated a largely local business model that allowed it to adapt to local differences as necessary. Inevitably, in the 1980s and 1990s, dissatisfaction with the extent to which country-by-country adaptation curtailed opportunities to gain international scale economies led to the overlay of a regional structure on the mini-IBMs. IBM aggregated the countries into regions in order to improve coordination and thus generate more scale economies at the regional and global levels. More recently, however, IBM has also begun to exploit differences across countries (arbitrage). For example, it has increased its work force in India while reducing its headcount in the United States.
Procter & Gamble’s (P&G) early history parallels that of IBM, with the establishment of mini-P&Gs in local markets, but it has evolved differently. Today, the company’s global business units now sell through market development organizations that are aggregated up to the regional level. P&G has successfully evolved into a company that uses all three “A” strategies in a coordinated manner. It adapts its value proposition to important markets but ultimately competes—through global branding, R&D, and sourcing—on the basis of aggregation. Arbitrage, while important—mostly through outsourcing activities that are invisible to the final consumer—is less important to P&G’s global competitive advantage because of its relentless customer focus.
Note. Adapted from “Which ‘A’ Strategy Should a Company Use?,” by de Kluyver, C., 2012, Fundamentals of Global Strategy, Chapter 3, Section 2. Copyright 2012 Flat World Knowledge, Inc.
What are possible company constraints that prevent the use of simultaneously using all three As (of Pankaj Ghemawat’s AAA Framework of adaptation, aggregation, and arbitrage) with great effectiveness?
Although most companies will focus on just one “A” at any given time, leading-edge companies—such as General Electric (GE), P&G, IBM, and Nestlé, to name a few—have embarked on implementing two, or even all three of the As (of Pankaj Ghemawat’s AAA Framework of adaptation, aggregation, and arbitrage). Doing so presents special challenges because there are inherent tensions between all three foci. As a result, the pursuit of “AA” strategies, or even an “AAA” approach, requires considerable organizational and managerial flexibility (Ghemawat, 2007).
Pursuing Adaptation and Aggregation
P&G started out with a focus on adaptation. Attempts to superimpose aggregation across Europe first proved difficult and, in particular, led to the installation of a matrix structure throughout the 1980s, but the matrix proved unwieldy. So, in 1999, the then CEO, Durk Jager, announced another reorganization whereby global business units (GBUs) retained ultimate profit responsibility but were complemented by geographic market development organizations (MDOs) that actually managed the sales force as a shared resource across GBUs. The result was disastrous. Conflicts arose everywhere, especially at the key GBU-MDO interfaces. The upshot: Jager departed after less than one year in office.
Under his successor, A. G. Lafley, P&G has enjoyed much more success, with an approach that strikes a better balance between adaptation and aggregation and that makes allowances for differences across general business units and markets. For example, the pharmaceuticals division, with distinct distribution channels, has been left out of the MDO structure. Another example: In emerging markets, where market development challenges are huge, profit responsibility continues to rest with country managers.
Aggregation and Arbitrage
VIZIO, founded in 2002 with only $600,000 in capital by entrepreneur William Wang to create high quality, flat-panel televisions at affordable prices, has surpassed established industry giants Sony Corporation and Samsung Electronics Company to become the top flat-panel high-definition television (HDTV) brand sold in North America. To get there, VIZIO developed a business model that effectively combines elements of aggregation and arbitrage strategies. VIZIO’s contract manufacturing model is based on aggressive procurement sourcing, supply-chain management, economies of scale in distribution.
While a typical flat-screen television includes thousands of parts, the bulk of the costs and ultimate performance are a function of two key components: the panel and the chipset. Together, these two main parts account for about 94% of the costs. VIZIO’s business model therefore focuses on optimizing the cost structure for these component parts. The vast majority of VIZIO’s panels and chipsets are supplied by a handful of partners. Amtran provides about 80% of VIZIO’s procurement and assembly work, with the remaining 20% performed by other ODMs, including Foxconn and TPV Technology.
One of the cornerstones of VIZIO’s strategy is the decision to sell through wholesale clubs and discount retailers. Initially, William Wang was able to leverage his relationships at Costco from his years of selling computer monitors. VIZIO’s early focus on wholesale stores also fit with the company’s value position and pricing strategy. By selling through wholesale clubs and discount stores, VIZIO was able to keeps its prices low. For VIZIO, there is a two-way benefit: The prices of its TVs are comparatively lower than those from major manufacturers at electronics stores, and major manufacturers cannot participate as fully as they would like to at places like Costco.
VIZIO has strong relationships with its retail partners and is honored to offer them only the most compelling and competitively priced consumer electronics products. VIZIO products are available at valued partners including Wal-Mart, Costco, Sam’s Club, BJ’s Wholesale Club, Sears, Dell, and Target stores nationwide along with authorized online partners. VIZIO has won numerous awards including a number-one ranking in the Inc. 500 for “Top Companies in Computers and Electronics,” Good Housekeeping’s “Best Big-Screens,” CNET’s “Top 10 Holiday Gifts,” and PC World’s “Best Buy,” among others (Vizio, n.d.).
Arbitrage and Adaptation
An example of a strategy that simultaneously emphasizes arbitrage and adaptation is investing heavily in a local presence in a key market to the point where a company can pass itself off as a “local” firm or “insider.” Citibank in China provides a good example. The company, part of Citigroup, has had an intermittent presence in China since the beginning of the 20th century. A little more than 100 years later, in 2007, it was one of the first foreign banks to incorporate locally in China. The decision to incorporate locally was motivated by the desire to increase Citibank’s status as an “insider;” with local incorporation, the Chinese government allowed it to extend its reach, expand its product offerings, and become more closely engaged with its local customers in the country.
China’s decision in 2001 to become a member of the World Trade Organization (WTO) was a major factor in Citibank’s decision to make a greater commitment to the Chinese market. Before China joined the WTO, the banking environment in China was fairly restrictive. Banks such as Citibank could only give loans to foreign multinationals and their joint-venture partners in local currency, and money for domestic Chinese companies could only be raised in offshore markets. These restrictions made it difficult for foreign banks to gain a foothold in the Chinese business community.
Once China agreed to abide by WTO trading rules, however, banks such as Citibank had significantly greater opportunities: They would be able to provide local currency loans to blue-chip Chinese companies and would be free to raise funds for them in debt and equity markets within China. Other segments targeted by Citibank included retail credit cards and home mortgages. These were Citibank’s traditional areas of expertise globally, and a huge potential demand for these products was apparent.
Significant challenges remained, however. Competing through organic growth with China’s vast network of low-cost domestic banks would be slow and difficult. Instead, in the next few years, it forged a number of strategic alliances designed to give it critical mass in key segments. The first consisted of taking a 5% stake in China’s ninth-largest bank, SPDB, a move that allowed Citibank to launch a dual-currency credit card that could be used to pay in renminbi in China and in foreign currencies abroad. In the following years, Citibank steadily increased its stake to the maximum 20% allowed under Chinese law and significantly expanded its product portfolio.
In June 2007, Citibank joined forces with Sino-U.S. MetLife Insurance Company, Ltd., to launch an investment unit-linked insurance product. In July 2008, the company announced the launch of its first debit card. Simultaneously, it signed a deal with China’s only national bankcard association, which allowed Citibank’s debit cardholders to enjoy access to the association’s vast network in China. The card would provide Chinese customers with access to over 140,000 ATMs within China and 380,000 ATMs in 45 countries overseas. Customers could also use their debit cards with over 1 million merchants within China and in 27 other countries. In 2009, Citibank was one of the top foreign banks operating in China, with a diverse range of products, eight corporate and investment bank branches, and 25 consumer bank outlets (Ko & Joshi, 2009).
Developing an AAA Strategy
There are serious constraints on the ability of any one company to use all three “A”s simultaneously with great effectiveness. Such attempts stretch a firm’s managerial bandwidth, force a company to operate with multiple corporate cultures, and can present competitors with opportunities to undercut a company’s overall competitiveness. Thus, to even contemplate an “AAA” strategy, a company must be operating in an environment in which the tensions among adaptation, aggregation, and arbitrage are weak or can be overridden by large-scale economies or structural advantages, or in which competitors are otherwise constrained. Ghemawat (2007) cites the case of GE Healthcare (GEH). The diagnostic imaging industry has been growing rapidly and has concentrated globally in the hands of three large firms, which together command an estimated 75% of revenues in the business worldwide: GEH, with 30%; Siemens Medical Solutions (SMS), with 25%; and Philips Medical Systems (PMS), with 20%. This high degree of concentration is probably related to the fact that the industry ranks in the 90th percentile in terms of R&D intensity.
These statistics suggest that the aggregation-related challenge of building global scale has proven particularly important in the industry in recent years. GEH, the largest of the three firms, has consistently been the most profitable, reflecting its success at aggregation through (a) economies of scale (e.g., GEH has higher total R&D spending than its competitors, but its R&D-to-sales ratio is lower), (b) acquisition prowess (GEH has made nearly 100 acquisitions under Jeffrey Immelt before he became GE’s CEO), and (c) economies of scope the company strives to integrate its biochemistry skills with its traditional base of physics and engineering skills; it finances equipment purchases through GE Capital).
GEH has even more clearly outpaced its competitors through arbitrage. It has recently become a global product company by rapidly migrating to low-cost production bases. By 2005, GEH was reportedly more than halfway to its goals of purchasing 50% of its materials directly from low-cost countries and locating 60% of its manufacturing in such countries.
In terms of adaptation, GEH has invested heavily in country-focused marketing organizations. It also has increased customer appeal with its emphasis on providing services as well as equipment—for example, by training radiologists and providing consulting advice on postimage processing. Such customer intimacy obviously has to be tailored by country. And, recently, GEH has cautiously engaged in some “in China, for China” manufacture of stripped-down, cheaper equipment, aimed at increasing penetration there.
Note. Adapted from “From A to AA to AAA,” by de Kluyver, C., 2012, Fundamentals of Global Strategy, Chapter 3, Section 3. Copyright 2012 Flat World Knowledge, Inc.
T here are several factors that companies should consider in applying the AAA framework. Most companies would be wise to focus on one or two of the “A”s—while it is possible to make progress on all three “A”s, especially for a firm that is coming from behind, companies (or, more often to the point, businesses or divisions) usually have to focus on one or, at most, two “A”s in trying to build competitive advantage. Companies should also make sure the new elements of a strategy are a good fit organizationally. If a strategy does embody substantially new elements, companies should pay particular attention to how well they work with other things the organization is doing. IBM has grown its staff in India much faster than other international competitors (such as Accenture) that have begun to emphasize India-based arbitrage. But quickly molding this workforce into an efficient organization with high delivery standards and a sense of connection to the parent company is a critical challenge; failure in this regard might even be fatal to the arbitrage initiative.
Companies should also employ multiple integration mechanisms. Pursuit of more than one of the “A”s requires creativity and breadth in thinking about integration mechanisms. Companies should also think about externalizing integration. Not all the integration that is required to add value across borders needs to occur within a single organization. IBM and other firms have shown that some externalization can be achieved in a number of ways: joint ventures in advanced semiconductor research, development, and manufacturing; links to, and support of, Linux and other efforts at open innovation; (some) outsourcing of hardware to contract manufacturers and services to business partners; IBM’s relationship with Lenovo in personal computers; and customer relationships governed by memoranda of understanding rather than detailed contracts. Finally, companies should know when not to integrate. Some integration is always a good idea, but that is not to say that more integration is always better.
Note. Adapted from “Pitfalls and Lessons in Applying the AAA Framework,” by de Kluyver, C., 2012, Fundamentals of Global Strategy, Chapter 3, Section 4. Copyright 2012 Flat World Knowledge, Inc.
Three Planning Steps
Mission, Vision, and Core Values
How do you make your entrepreneurial dreams come to fruition? The first step to building the groundwork for strategic planning and moving a business forward is to determine your mission, vision, and values.
As you read this section, think about a new venture or repositioning an existing business to increase value. This will help with your Final Assessment.
Mission and Vision
The mission statement describes the purpose of your organization—the reason for its existence. It tells the reader what the organization is committed to doing. It can be very concise, like the mission statement from Mary Kay Inc. (the cosmetics company): “To enrich the lives of women around the world” (Mary Kay Inc., n.d.). Or it can be as detailed as the one from Harley-Davidson: “We fulfill dreams through the experience of motorcycling, by providing to motorcyclists and to the general public an expanding line of motorcycles and branded products and services in selected market segments” (Harley-Davidson, n.d.).
The vision describes where the organization would like the business to be in the future.
It is important that the mission and vision of the company are aligned with any new initiative or strategy. Sometimes a strategy is developed for a new initiative within an existing organization and sometimes a strategy can be developed between two organizations. As an example, the mission and vision for Flat World Knowledge is to offer affordability, accessibility, and student success. The mission for our institution is to become the foremost leader in adult education.
Thus, when Flat World Knowledge and our institution first decided to become partners to build the competency-based program of which you are a part, success was more likely because of each organization’s similar goals. When organizations share the same core values, it is more likely that partnerships and alliances will be more successful.
Figure 3.1 What Do Your Core Values Influence?
Your core values influence your beliefs, attitudes, behaviors, and skills.Eckmann, H. June 13, 2014
Having defined your mission, your next step is to ask what the organization stands for. What values will define it? What principles should guide our actions as we build and operate the business? The small set of guiding principles that you identify as crucial to your company are known as core values—fundamental beliefs about what’s important and what is and isn’t appropriate in conducting company activities. Core values affect the overall planning processes and operations. At Volvo, for example, three core values—safety, quality, and environmental care—define the firm’s “approach to product development, design and production” (Volvo Group Global, n.d.). Core values should also guide the behavior of every individual in the organization. Coca-Cola, for instance, reports that its stated core values—honesty, integrity, diversity, quality, respect, responsibility, and accountability—tell employees exactly what behaviors are acceptable. How do companies communicate core values to employees and hold them accountable for putting those values into practice? They link core values to performance evaluations and compensation (The Coca-Cola Company, n.d.).
Note. Adapted from “Business Ethics and Social Responsibility,” by Collins, K., 2014, Exploring Business, Chapter 2. Copyright 2014 Flat World Knowledge, Inc.
Prepare a mission statement that describes the purpose of your business and tells customers, employees, and others what the business is committed to doing. Share your mission statement in the Discussion Board.
Where do you want to be and how do you get there? Read this section to discover how to formulate a strategic plan, different types of planning, and how to implement strategy. Take notes in the Learning Journal; this information will be useful for your Final Assessment.
Once an organization’s purpose and intended strategy align, the organization needs to develop a plan. This plan needs to be well thought out and approved for the financial, political, and hierarchical ramifications. Without a plan, it’s difficult to succeed at anything. The reason is simple: If you don’t know where you’re going, you can’t really move forward. The formulation needs to utilize analysis from both the financial and leadership strategies. Look at your community. What could you offer that would add value? Look at a problem that needs solving. Now, think about what you have to offer. Ask others for their opinion. In the formulating stage, you first want to ask lots of people a series of questions, and then begin research. Your strategy will only be successful if other key people who are affected by this proposed change see that their lives will improve. Find out what stakeholders would want to see happen, and try to determine with them what the strategy could be to improve the community. Use data for your community and on research.gov websites to identify demographic and financial trends. Find a need and figure out a way to try to solve it.
Successful managers decide where they want to be and figure out how to get there. In planning, managers set goals and determine the best way to achieve them. As a result of the planning process, everyone in the organization knows what should be done, who should do it, and how it should be done.
Developing a Strategic Plan
Coming up with an idea—say, starting a note-taking business—is a good start, but it’s only a start. Planning for it is a step forward. Planning begins at the highest level and works its way down through the organization. The first step is strategic planning, during which a company’s leadership establishes an overall course of action. To begin this process, ask yourself a couple of very basic questions: Why does the organization exist? What value does it create? Sam Walton posed these questions in the process of founding Wal-Mart, which allowed him to determine that his new chain of stores would exist to offer customers the lowest prices with the best possible service (Scott, n.d.).
After you’ve identified the purpose of your company, you’re ready to take the remaining steps in the strategic-planning process:
There are different types of planning necessary in developing strategy, such as tactical, operational, contingency, and crisis planning.
The overall plan is broken down into more manageable, shorter-term components called tactical plans. These plans specify the activities and allocation of resources (people, equipment, money) needed to implement the overall strategic plan over a given period. Often, a long-range strategic plan is divided into several tactical plans; a five-year strategic plan, for instance, might be implemented as five one-year tactical plans.
The tactical plan is then broken down into various operational plans that provide detailed action steps to be taken by individuals or groups to implement the tactical plan and, consequently, the strategic plan. Operational plans cover only a brief period—say, a week or a month. At Notes-4-You, for example, note takers might be instructed to turn in typed class notes five hours earlier than normal on the last day of the semester (an operational guideline). The goal is to improve the customer-satisfaction score on dependability (a tactical goal) and, as a result, to earn the loyalty of students through attention to customer service (a strategic goal).
Plan for Contingencies and Crises
Even with great planning, things don’t always turn out the way they’re supposed to. Perhaps your plans were flawed, or maybe you had great plans but something in the environment shifted unexpectedly. Successful managers anticipate and plan for the unexpected. Dealing with uncertainty requires contingency planning and crisis management.
With contingency planning, managers identify aspects of the business that are most likely to be adversely affected by change and develop alternative courses of action in case an anticipated change does occur. You probably do your own contingency planning; for example, if you’re planning to take in a sure-fire hit movie on its release date, you may decide on an alternative movie in the event you can’t get tickets to your first choice.
This is where you will put your project management skills to work. Look over the material from your Project Management competency and use those specific skills to implement your strategy. Review the 32 steps below to be sure that you have thought about and plan to create strategies for each of these steps:
Keep in mind that organizations also face the risk of encountering crises that require immediate attention. Rather than waiting until such a crisis occurs and scrambling to figure out what to do, many firms practice crisis management. Some, for instance, set up teams trained to deal with emergencies. Members gather information quickly and respond to the crisis while everyone else carries out his or her normal duties. The team also keeps the public, employees, press, and government officials informed about the situation and the company’s response to it (Perkins, 2000).
Note. Adapted from “Planning,” by Collins, K., 2014, Exploring Business, Chapter 6, Section 2. Copyright 2014 Flat World Knowledge, Inc.
Using SWOT Analysis
Using SWOT Analysis
As you read, think about how executives use SWOT analysis and how ideas generated from it can allow a firm to leverage its strengths, steer clear of or resolve its weaknesses, capitalize on opportunities, and protect itself against threats. Create a SWOT analysis for an organization of which you are familiar. Share your example in the Discussion Board.
Five forces analysis examines the situation faced by the competitors in an industry. Strategic groups analysis narrows the focus by centering on subsets of these competitors whose strategies are similar. SWOT analysis takes an even narrower focus by centering on an individual firm. Specifically, SWOT analysis is a tool that considers a firm’s strengths and weaknesses along with the opportunities and threats that exist in the firm’s environment (Figure 4.1 “SWOT”).
Figure 4.1 SWOT Analysis
Image from Ketchen, D., & Short, J. (2011). Mastering strategic management. Irvington, NY: Flat World Knowledge.
SWOT analysis is an assessment of strengths, weaknesses, opportunities, and threats. It is a tool to help organizations understand internal strengths and weaknesses and external opportunities of the environment. Ken Andrews (1971) of Harvard Business School developed SWOT in the early 1970s. It is an audit of a company’s internal workings, which are relatively easier to control than outside factors. Examining opportunities and threats is a part of environmental analysis; a company must look outside of the organization to assess opportunities and threats over which it has lesser control. Andrews’s original conception of the strategy model that preceded the SWOT asked four basic questions about a company and its environment: (1) What can we do? (2) What do we want to do? (3) What might we do? and (4) What do others expect us to do?
Executives using SWOT analysis compare these internal and external factors to generate ideas about how their firm might become more successful. In general, it is wise to focus on ideas that allow a firm to leverage its strengths, steer clear of or resolve its weaknesses, capitalize on opportunities, and protect itself against threats. For example, untapped overseas markets have presented potentially lucrative opportunities to Subway and other restaurant chains such as McDonald’s and KFC. Meanwhile, Subway’s strengths include a well-established brand name and a simple business format that can easily be adapted to other cultures. In considering the opportunities offered by overseas markets and Subway’s strengths, it is not surprising that entering and expanding in different countries has been a key element of Subway’s strategy in recent years. Indeed, Subway currently has operations in nearly 100 nations.
China’s huge population and growing wealth makes it an attractive opportunity for Subway and other American restaurant chains.© Thinkstock
In laying out each of the four elements of SWOT, internal and external factors should not be confused with each other. It is important not to list strengths as opportunities, for example, if executives are to succeed at matching internal and external concerns during the idea generation process. Second, opportunities should not be confused with strategic moves designed to capitalize on these opportunities. In the case of Subway, it would be a mistake to list “entering new countries” as an opportunity. Instead, untapped markets are the opportunity presented to Subway, and entering those markets is a way for Subway to exploit the opportunity. Finally, and perhaps most important, the results of SWOT analysis should not be overemphasized. SWOT analysis is a relatively simple tool for understanding a firm’s situation. As a result, SWOT is best viewed as a brainstorming technique for generating creative ideas, not as a rigorous method for selecting strategies. Thus the ideas produced by SWOT analysis offer a starting point for executives’ efforts to craft strategies for their organization, not an ending point.
In addition to organizations, individuals can benefit from applying SWOT analysis to their personal situation. A college student who is approaching graduation, for example, could lay out her main strengths and weaknesses and the opportunities and threats presented by the environment. Suppose, for instance, that this person enjoys and is good at helping others (a strength) but also has a rather short attention span (a weakness). Meanwhile, opportunities to work at a rehabilitation center or to pursue an advanced degree are available. Our hypothetical student might be wise to pursue a job at the rehabilitation center (where her strength at helping others would be a powerful asset) rather than entering graduate school (where a lot of reading is required and her short attention span could undermine her studies).
Strengths and Weaknesses
A good starting point for strategizing is an assessment of what an organization does well and what it does less well. In general, good strategies take advantage of strengths and minimize the disadvantages posed by any weaknesses. TOMS Shoes, for example, is known for its trendy footwear that helps others by donating a pair of shoes to a person in need for every pair of shoes sold. A weakness of TOMS Shoes is that its strategy can be easily duplicated. For example, Sketchers has launched BOBS Shoes with a similar style and mission to that of TOMS. As is evidenced by the competitive dynamics of these two shoemakers, the hardest thing for an organization to do is to develop its competitive advantage into a sustainable competitive advantage. What makes a competitive advantage sustainable? A competitive advantage is sustainable if it will exist after all attempts at strategic imitation have ceased. The organization’s strengths cannot be easily duplicated or imitated by other firms, nor made redundant or less valuable by changes in the external environment.
Opportunities and Threats
Understanding the external environment is also critical to understanding strategic management. Opportunities assess factors external to the business that could enable a business to exist and/or prosper. For example, an aging population could lead to opportunities in numerous industries that cater to that demographic. Threats include factors beyond the firm’s control that could place the strategy, or the business, at risk. Like opportunities, these are considered external because managers typically have no control over them, but may benefit from having plans to respond to these opportunities or threats. For example, the struggling world economy has posed challenges for countless firms within multiple industries.
Note. Adapted from “SWOT Analysis,” by Ketchen, D. and Short, J., 2011, Mastering Strategic Management, Chapter 4, Section 5. Copyright 2011 Flat World Knowledge, Inc.
Internal and External Analysis Tools
Internal and External Analysis Tools
Read this section to discover some of the tools you might use to understand the internal (strengths and weaknesses) and external environments (opportunities and threats).
Internal Analysis Tools
Internal analysis tools help identify an organization’s strengths and weaknesses. Two tools for internal analysis are the value chain and VRIO tools. The value chain dissects the organization and then identifies areas of unique strength or weakness. Sometimes these parts take the form of functions, like marketing or manufacturing. For instance, Disney excels at developing and profiting from its branded products, such as Cinderella or Pirates of the Caribbean. This is a marketing function, as well as a design function, another Disney strength.
Value chain functions are also called capabilities. VRIO—which stands for Value, Rarity, Imitability, and Organization—is a framework that suggests that a capability, or a resource, such as a patent or a desirable location, is likely to yield a competitive advantage to an organization when it can be shown that it is valuable, rare, difficult to imitate, and supported by the organization. Where the value chain might suggest internal areas of strength, VRIO helps predict whether those strengths will give it a competitive advantage. For example, while other movie studios can copy Disney’s strategy by marketing their films, they are unlikely to successfully imitate the iconic status Disney has developed over years of marketing commitment and through association with their well-known theme parks.
External Analysis Tools
Two primary tools to examine the external environment are PESTEL and industry analysis. PESTEL is an acronym that stands for Political, Economic, Sociocultural, Technological, Environmental, and Legal environments. The PESTEL framework directs managers to collect information about and analyze each environmental dimension to identify the broad range of threats and opportunities facing the organization. Industry analysis, in contrast, maps out the different relationships that the organization might have with suppliers, customers, and competitors. Whereas PESTEL provides you with a good sense of the broader macro-environment, industry analysis informs you about the organization’s competitive environment and the key industry-level factors that seem to influence performance.
Figure 4.2 PESTEL Analysis
From Ketchen, D., & Short, J. (2011). Mastering strategic management. Irvington, NY: Flat World Knowledge.
Note. Adapted from “Strategic Management in the P-O-L-C Framework,” by Carpenter, M., Bauer, T., Erdogan, B., and Short, J., 2013, Principles of Management, Chapter 5, Section 1. Copyright 2013 Flat World Knowledge, Inc.
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