Summary written in 2013-2014 (McGee, J., Thomas, H., Wilson, J. - 2010).
There are a lot of ways to define strategy. What they all have in common are the following seven concepts:
The future: this is the part about which there is uncertainty
Taking risk
Complex
Time to take the decisions, irreversible
Organisation and coordination of large numbers of people within organizations; there is a need to create a strategic fit between the resources and capabilities of the organization and the requirements asked of it
Implementations for change
Significant scale and importance
Strategy is a practice-driven subject, this means it is dependant of a lot of circumstances and is different in almost every organisation. Therefore there are a lot of strategic questions and problems which need to be solved to fit the environment. This is why strategy is more often emergent rather than planned.
Strategic problems are hard to solve because of:
Many stakeholders within the organization
Multiple objectives (because of the many stakeholders)
Importance of decisions: focus on the long duration
Uncertainties in the surroundings
Opportunity costs if no decision is made or the outcome is left to chance
Complexity: many variables and much internal coordination required
Intended strategy: strategy sets out a plan about how to get from here to there, while neglecting the concept of emerging strategy (Mintzberg).
Strategic intent (e.g. goal): strategy is being used to provide direction in the overall decision-making (Prahalad and Hamel).
Strategy can be used to ‘stretch and leverage’ to use the core competences of the organisation to innovate new products. This is also known as the concept of innovation. According to Porter, competitive strategy is mainly about being different, while the strategic position is not sustainable unless there are trade-offs with other positions. This strategic coherence among many activities is fundamental for the sustainability of that advantage.
There are many definitions of strategy, however, regardless of the definition, strategy should always be coherent and interlocked in the many activities a company holds. This coherence is needed to create and sustain a competitive advantage.
The five most important aspects of strategy, shown in figure 1.1 (page 6), are:
Purpose (for the organisation and stakeholder benefits)
External reference point (to the external context and the competitive domain)
Advantage (of being different and the competitive position)
Decisions (of investments and patterns)
Capability (of the managerial processes and the organisational design and structure)
Figure 1.2 on page 7 gives the main idea of strategy analysis. In the middle there are the plans, decisions and actions which influence the other three characteristics (external context, goals and resources and capabilities).
It is common to first determine a mission, followed by analysing the external environment, and finally an analysis of the internal environment.
Strategic planning is the process by which the firm organizes its resources and actions in relation to an external environment in order to achieve its goals or objectives. This is usually a formal and very hierarchical process.
Formal analysis would go through a number of stages in sequence. The first one is the mission statement: a detailed statement of strategic intent and major goals used to communicate goals. It is designed around what the business is and what it should be. This would then be followed by a review of the external environment and the internal environment. Based on this data, a SWOT-analysis can be made and used as a starting point for formulating the strategy. A business plan can be made, and is then submitted to an investment committee for resource allocation. After that, the budgets will be specified and agreed throughout the organization (see figure 1.3).
According to Mintzberg and Waters (1985), organizations make a plan, according to the mission, than set the objectives and allocate the resources. This pattern of actions sounds fine, but the environment changes, so most of the time things are not implemented as planned. The intended strategy is changed by the environmental determinism and becomes a new realized strategy (figure 1.4).
The external environment has three ranges of impact (see figure 1.5):
Market structure (competitive domain): customers and competitors, which forms the battleground for the competitive advantage.
Industry structure: technology, skills, location, allies, and suppliers.
Institutional and social context: political, legal, administrative, and regulatory influences, along with moral, ethical, social, and cultural influences.
Most of the influence on the company comes from within the market structure. But also the institutional and social context is becoming more and more important.
A PEST-analysis (figure 1.6) can be used to frame the political, economical, social, and technological forces that significantly influence the firm. Adding probabilities and possible outcomes to each event and multiplying the two calculate the expected value. However, this might be moderated by management action.
This is often done with the help of a SWOT-analysis (Strengths, Weaknesses, Opportunities, Threats), in which the SW is internal and the OT is external (at business level). The analysis is a tool of the ‘design school’ of Mintzberg. After all these elements are completed, a strategy can be determined. A strategy is always a continuum of intentions and emergence (learning by doing, environmental pressure), which leaves some parts of strategy unrealised, whereas other parts will be realised indeed.
Strengths and Weaknesses can be categorised in:
Management and organisation9
Operations: R&D, production.
Finance
Opportunities and Threats can be categorised in:
Societal changes: ageing population, immigration.
Governmental changes: deregulation, new laws.
Economic changes: recession, taxation policy.
Competitive changes: anti-trust laws.
Supplier changes: closure and opening of suppliers.
Market changes: new markets, market shocks.
The 5 forces of Porter can all be found in a SWOT analysis, but the SWOT is not static of nature and the SWOT can be used for a focal firm instead of a whole industry.
A cross-impact matrix gives much more dept and subtlety to a SWOT analysis (also called the TOWS analysis, see figure 1.8). This one gives the interaction of the dimensions. You can also label the variables of the SWOT to their importance or put them in order. To combine the four dimensions and read what they have to say with each other helps an organisation identify its strategy.
Strategy has the following seven concepts in common: the future, taking risk, complexity, irreversible decisions, need to create a strategic fit, implementations for change and significant scale and importance. Strategic problems are hard to solve because of many stakeholders within the organization, multiple objectives, importance of decisions, uncertainties in the surroundings, opportunity costs and complexity.
Intended strategy: strategy sets out a plan about how to get from here to there, while neglecting the concept of emerging strategy (Mintzberg).
Strategic intent (e.g. goal): strategy is being used to provide direction in the overall decision-making (Prahalad and Hamel).
Strategy can be used to ‘stretch and leverage’ to use the core competences of the organisation to innovate new products. This is also known as the concept of innovation. According to Porter, competitive strategy is mainly about being different, while the strategic position is not sustainable unless there are trade-offs with other positions. This strategic coherence among many activities is fundamental for the sustainability of that advantage.
The five most important aspects of strategy are purpose, external reference point, advantage, decisions and capability.
Strategic planning is the process by which the firm organizes its resources and actions in relation to an external environment in order to achieve its goals or objectives. This is usually a formal and very hierarchical process.
Formal analysis would go through a number of stages in sequence: a mission statement, a review of the external and internal environment, formulating the strategy, making a business plan and specify the budgets. The intended strategy is changed by the environmental determinism and becomes a new realized strategy.
The external environment has three ranges of impact: market structure, industry structure and institutional and social context.
A PEST-analysis (figure 1.6) can be used to frame the political, economical, social, and technological forces that significantly influence the firm.
The internal assessment is often done with the help of a SWOT-analysis (Strengths, Weaknesses, Opportunities, Threats), in which the SW is internal and the OT is external (at business level). Strengths and Weaknesses can be categorised in: management and organisation, operations and finance. Opportunities and Threats can be categorised in: societal changes, governmental changes, economic changes, competitive changes, supplier changes and market changes.
Strategy is dependent on management in a sense that they translate strategy so that it can be put into practice. Strategy can be divided into three parts, namely, strategy context (where), strategy content (what), and strategy process (how). Combined together they are called the strategic map.
It is useful to base strategy on models that are specifically designed for this purpose. What these models all have in common is that they need to be easy to read, quickly understood, and transparent. In conclusion, they should be simple enough for the entire organization to understand.
The classic or rational view: the original view of strategy of Chandler, as a strategic map, which is the basis of all the other views.
Evolutionary view: firms survive or don’t survive by means of natural selection and environmental determination (survival of the fittest). Strategy is irrelevant because nature will take its course anyway. Minimizing costs is the best.
Strategy processual or organizational process view: strategy emerges gradually and unclear from “sticky and messy” organizations and markets. Culture, routines, and standard operating procedures carry strategic behaviour.
Strategy as systems view: managers and organizations look into the future and plan effectively and with intentions. Social embeddedness is at the heart of this perspective, which implies that people’s economic behaviour is embedded in a network of social relations.
Resource-based view: this view revolves around resources and competences that are unique to the organization and shape the foundation of their position in the market. The competitive advantage in differentiating strategies from one another lies with management and resource availability. The way in which managers think and act strategically, and how they handle the available resources, distinguish one strategy from another.
This model (page 27) gives you the individual elements of strategy that are all connected throughout time and causality. The elements can change for themselves (feedback) or by causes within the organisation (managerial decisions). The organisational strategy needs to fit/align with the external context, and the internal organisations must have a fit with the overall strategy.
The elements of the systems framework are:
Environment: External and internal environment. External environment consists of customers, competitors, technology, regulation, the market en societal norms. Internal environments consists of the results, the culture, competences, new strategies, ideas and the resources.
A capability is the ability to perform a task or activity that involves complex patterns of coordination and cooperation between people and other resources. Skills are more specific, narrowly defined activities. The resources or competences that earn rent are the strategic assets or core competences and are the most important. Sharing can lead to economies of scale, economies of scope and experience effects.
Direction: This means the vision (where the organisation wants to be in the future), mission (company’s reason for being, where it is and its purpose) and values (of the organisational culture, shared beliefs among stakeholders).
Strategic options: the long-term strategic intent, created by the competences and resources of the organisation. It also contains the strategic stretch, the gap between the organisational ambition and resources.
Strategy: the strategic framework: follows the creative strategic thinking, containing the long-term goals (where are we going), the scope of the business, the competitive advantages and the business model. Step 1: Description of the vision, mission and values. Step 2: Description of the scope of the organisation, which product-markets do we compete in and is there relatedness or synergy in our product-markets. Step 3: The benefits (competitive advantages) of positioning in a chosen product-market. Step 4: Strategic logic, which means (A) positioning logic, (B) resource based logic and (C) business model.
Strategic decisions: there are three levels of strategic development: single business (cost based vs differentiation based, business strategy), multi-business (scale vs scope, corporate strategy) and multinational (global integrations vs national responsiveness). These trade-offs lead to four types of strategy (see figure 2.2, p. 32):
1. Improving and imitating: to the closest position on the frontier.
2. Innovating: move beyond the existing frontier, create a new one.
3. Migrating: shift on the frontier due to a new strategy.
4. Consolidating: shoring up and improving the position.
Operations: the business model: this contains the link between the intended strategy, the functional and operational requirements and the performance. This is business specific, but can also be used for the business portfolio.
Outcomes: a frequently used scoring system is the balanced scorecard.
This performance measurement examines the firm along the following perspectives:
Customer perspective: how do customers see the firm?
Internal perspective: what does the firm excel at?
Innovation and learning perspective: can the firm continue to improve and create value?
Financial perspective: how does the firm look at shareholders?
To ensure the position of an organisation they need to focus on strategic thinking and acting, related to the strategic content. The nature of the industry structure and the interrelationships amongst the forces and the firm are the most important. This is part of the Five Forces of Porter, with the most important assumptions:
Independence amongst all the factors
Organisations can formulate strategies close to their competitors
Structural advantage is the sole key to competitive success
Firms can exercise their power without constraints
The industry is the key unit of analysis
This model of Porter helps managers to put the strategy they developed in practice.
To view the system the best, managers make use of a micro-perspective view and a systems-based view. The micro-perspective focuses on more deeply rooted individual activity, while the systems-based reveals more about the interactions between context, organisation and individual action, to see the pattern. The structural coupling is the
interaction between the living system and its environment that triggers the living system in structures (see figure 2.3, p. 36).
Strategic planning is a mechanism that the company uses to organize its resources and actions to achieve objectives. This happens in a hierarchical way: the corporate level is the overall mission, with the internal resources and opportunities and threats. At business level (SBU) this mission is translated into markets and activities, combined with resource allocation. Market-segment level is based on the scope of activities assigned to the segment. This cycle of planning is iterative and repeated every year. The steps a company takes in this process are:
Executive briefing
General management meeting
Strategy assessment meeting
Plan overview
Strategy review meetings
Plan resubmission
Board presentation
External and internal events may cause changes to the plan, and the plan is in the first place restricted by the budget.
Business planning involves both the strategic and operational planning. It is complementary to strategic planning. Budgeting and control are derived from these plans and from the strategy. To asses whether the plan is performed correctly, organisation make use of performance measures, like matrices or the balanced scorecard. Data is gathered in the organisation to analyse the performance.
This section covers what the management has to think about when managing the company (figure 2.4, p. 40). This involves firstly strategic thinking, the intellectual, analytical activity that makes sense of the triad of forces to define the strategy at the heart of the company. Secondly, strategy making is how this thinking is put into practice. According to Mintzberg and Waters (1985) strategies are more of interplay between managerial agency and environmental determinism. They distinguish between intended and emergent strategies. Intended strategies are deliberate and planned as intended beforehand. Emergent strategies come into existence throughout the process and are without or against what was intentionally planned. What eventually comes out is the realized strategy, a combination of both.
Strategic decision making occurs when everything is analyzed and it is time for some action. These action may take long, but decisions sometimes have to be made quickly.
A distinction is being made between planning (i.e. coherence) vs. chaos (i.e. anarchy) with regard to strategic decision-making, where the former implies simplification and reducing risk, while the latter enhances creative, non-linear thinking. When placed against political process and problem solving, four types of decision process characteristics can be distinguished (figure 2.5, p. 43), namely:
Uncoupled (chaos/problem solving): strategic decision making, means unrelated to ends.
Uncontrolled (chaos/political process): random strategic decision making.
Intended (planning/problem solving): strategic decision making, means related to ends.
Incremental (planning/political process): strategic decision making, step by step and mutual adjustment to stakeholders.
Implementing is the practical heartland of delivering strategies that work. This is the actual phase in which the decisions are put into practice. Interpreting occurs when the managers of a company look at the environment and their internal organisation. They can translate this in their strategy. A cognitive community is a group of like-minded individuals.
An organisation always learns from their experience or learn new things. This can be adaptive learning (single loop) or generative learning (double loop).
Managerial agency: assumption that managers determine strategy by interpreting the environment and taking action to align their organizational practices with the requirements of the environment, to make effective decisions.
Nowadays, organizations face a “competitive landscape” which is driven by information technology and globalization. This landscape is characterized by hypercompetition, faded traditional boundaries, greater knowledge intensity, greater reliance on knowledge as a strategic asset, and discontinuous change. This lead to a new perspective on strategy, the competitive landscape perspective (figure 2.6, p. 46).
According to this perspective, strategy is deeply rooted in those processes where flexibility, knowledge creation and retention, and collaboration, are important. Furthermore, the ways in which strategy content, process, and context are combined, and how systems and practices are interlinked, create the competitive advantage.
Many strategies fall in between the polar extremes of planned vs emergent strategies. Figure 2.7 (p. 47) illustrates a range of planned vs externally determined strategies.
Michaud and Thoenig (2003) characterize four organizational types according to the degree of autonomy of managers, and the extent to which they try to formulate strategies for long-term effectiveness or for short-term gain. They are as follows:
Fragmented organization: external pressure perceived as weak, short-term focus, very good at what it currently does (learned organization), but difficulties in learning (changing and developing).
Self-sufficient organization: external pressure perceived as weak, long-term focus, strategic thinking is driven by improvisation and informal processes at the top of the organization.
Mercenary organization: external pressure perceived as strong, short-term focus, continuously changing organizational structure resulting in temporary clustering of skilled individuals (leads to weak loyalty).
Organic organization: external pressure perceived as strong, long-term focus, strong and cohesive organizational cultures (required skills and knowledge can be found inside the organizational boundaries).
Strategy can be divided into three parts, namely, strategy context (where), strategy content (what), and strategy process (how). Combined together they are called the strategic map. There are a lot of different ways to look at strategy: the classic or rational view, the evolutionary view, the strategy processual or organizational process view, the strategy as systems view and the resource-based view.
The strategy systems framework gives you the individual elements of strategy that are all connected throughout time and causality. The elements of the systems framework are the environment, the direction, the strategic options, strategy: the strategic framework, the strategic decisions, operations: the business model and the outcomes.
To view the system the best, managers make use of a micro-perspective view and a systems-based view. The micro-perspective focuses on more deeply rooted individual activity, while the systems-based reveals more about the interactions between context, organisation and individual action, to see the pattern. The structural coupling is the interaction between the living system and its environment that triggers the living system in structures (see figure 2.3, p. 36).
Strategic planning is a mechanism that the company uses to organize its resources and actions to achieve objectives. The steps a company takes in this process are executive briefing, general management meeting, strategy assessment meeting, plan overview, strategy review meetings, plan resubmission and board presentation.
Business planning involves both the strategic and operational planning. It is complementary to strategic planning. Budgeting and control are derived from these plans and from the strategy. To asses whether the plan is performed correctly, organisation make use of performance measures, like matrices or the balanced scorecard. Data is gathered in the organisation to analyse the performance.
Strategic thinking: the intellectual, analytical activity that makes sense of the triad of forces to define the strategy at the heart of the company. Strategy making is how this thinking is put into practice. Intended strategies are deliberate and planned as intended beforehand. Emergent strategies come into existence throughout the process and are without or against what was intentionally planned. What eventually comes out is the realized strategy, a combination of both. Strategic decision-making occurs when everything is analysed and it is time for some action.
A distinction is being made between planning (i.e. coherence) vs. chaos (i.e. anarchy) with regard to strategic decision-making, where the former implies simplification and reducing risk, while the latter enhances creative, non-linear thinking.
When placed against political process and problem solving, four types of decision process characteristics can be distinguished: uncoupled, uncontrolled, intended and incremental.
Implementing is the practical heartland of delivering strategies that work. This is the actual phase in which the decisions are put into practice.
Interpreting occurs when the managers of a company look at the environment and their internal organisation. They can translate this in their strategy. A cognitive community is a group of like-minded individuals.
An organisation always learns from their experience or learn new things. This can be adaptive learning (single loop) or generative learning (double loop).
Managerial agency: assumption that managers determine strategy by interpreting the environment and taking action to align their organizational practices with the requirements of the environment, to make effective decisions.
The competitive landscape perspective states that strategy is deeply rooted in those processes where flexibility, knowledge creation and retention and collaboration are important.
Michaud and Thoenig (2003) characterize four organizational types according to the degree of autonomy of managers, and the extent to which they try to formulate strategies for long-term effectiveness or for short-term gain. They are as follows: fragmented organization, self-sufficient organization, mercenary organization and organic organization.
Perfect competition implies price competition, easy entry and exit, and broad distribution of relevant knowledge. Firms, either individually or joint, attempt to create imperfections in the market to gain a competitive advantage over their competitors and in this way be able to charge a premium on their product. Competition takes place at market level and at the level where firms plan and invest for the future.
Competitive advantage is delivering superior value to customers and in doing so earning an above average return for the company and its stakeholders. Four key features of the market ‘context’ in which rivals sell their products are cost analysis, demand analysis, analysis of markets and competition and analysis of industry and competition.
Cost analysis is understanding the nature of costs that shape the foundation for the microeconomics of strategy. Costs can be fixed or variable. Opportunity costs are the sacrifice of the alternatives forgone in producing a product or service. How costs behave in the long run has strategic implications for firms and the structure of industries.
Economies of scale imply that the fixed costs go down when you produce more (see figure 3.1). The strategic significance of economies of scale depends on the minimum efficient plant size (MEPS). The higher the ratio of MEPS to market size, the larger the share of the market taken by one plant, and the more market power that can be exercised by the firm owning the plant. Indivisibility means that an input cannot be scaled down from a certain minimum size and can only be scaled up in further minimum size units. The cube-square rule: production capacity is usually determined by the volume of the processing unit (the cube of its linear dimensions), whereas cost more often arises from the surface area (the cost of the materials involved). As capacity increases, the average cost decreases, because the ratio of surface area to cube diminishes. The learning curve is an empirical estimate of the proportion by which unit costs fall as experience of production increases. Figure 3.2 shows the 80% experience curve (costs fall to 80% of previous level after production has doubled).
Economies of scope occur when the prices of the range of products go down due to joint production. Economies of scope refer to increased variety in operations.
The demand analysis provides a framework for analysing price and other influences on the sales of the firms’ products and it provides a baseline for pricing products and marketing in general for forecasting and manipulating demand. The following characteristics are important:
Price elasticity’s and their implications for revenues
Individual versus market demand
Final demand versus derived demand
Producer versus consumer goods
Durable versus perishable goods
For the analysis of markets and competition you can have a lot of options. The markets are viewed as follow (see also figure 3.4):
Perfect competition: intense rivalry, no one has more power
Monopoly: one has it all
Oligopoly: some have it all
Monopolistic competition: a lot of small players that differentiate from one another.
Outside the market there is the threat of new entrants, also known as the contestable markets.
Industry analysis: analysis of assets, resources and capabilities that create the economic foundation for firm operations (economic characteristics) and which determine individual capabilities that distinguish firms competing in the industry from one another (uniqueness). Porter’s five forces is the most well-known industry analysis.
According to Porter (1980), there are five forces that determine the “attractiveness” (e.g. industry profitability) of the firm, namely: rivalry, threat of entry, threat of substitutes, buyer power, and supplier power. The more “attractive” the industry is, the higher the profits.
The horizontal line (figure 3.5) represents the supply chain, which implies the build-up and flow of goods to the final customer. From left to right, at every step along the supply chain towards getting the product customer ready, value is added (labour costs, capital costs, and profits). Each added value brings along fixed and variable costs, therefore, the price of the product increases. How much profit is being made depends on competition. For example, under perfect competition prices tend to fall downward to a minimum rate of return on capital, just enough to remain in the industry.
Threat of entry is determined by the calculation of cost per unit of output to determine potential profit margins. There are three kinds of costs to be used in this calculation, namely:
Prices that can be charged and attainable volumes (depends on price elasticity of demand).
Unit costs of production and access to available economies of scale, scope and learning, and on the level of marketing and other costs of getting the product to markets.
Capital costs of investments.
These costs pose an entry barrier for a firm with the desire to enter, when they are higher than those of the firms already functioning in the industry combined with lower prices relative to the functioning firms (i.e. leads to lower profit margins, therefore, cost disadvantage or barrier). In case access is denied to important links of the model, such as technology or distribution systems, then a firm is blockaded from entry.
Suppliers will, if they can, raise the price (and with that their profit margins) at your expense. This is possible when the level of vertical integration is low, the product is not easily substituted, when the product being supplied is strongly needed for your own final product, and when there are only few suppliers in the industry. This is called supplier power.
Buyers want to pay as less as possible for the product, which is at the expense of firms and their suppliers. This is possible when the relative concentration of buyers is high, products are easily substituted, and demand is low. This is called buyer power.
In conclusion, location of power along the horizontal line of Porter’s model (i.e. supply chain) is essential in understanding how to make profits. Note the difference between threat of entry and threat of substitutes. The former implies exploiting the existing value proposition (i.e. industry attractiveness), whereas the latter implies changing this value proposition (i.e. changing dimensions of competition by displacing existing ways).
Competitive rivalry is the fifth force of Porter’s model (i.e. centre), which is where it all comes together and firms compete. The strength of competition and price level depends, among other things, on the amount of competitors, commodity-likeness of products, and the supply-demand balance.
Worldwide privatisation and deregulation has lead to an increase of competition and lower prices. Imperfections in the market create an opportunity to earn supernormal profits. Imperfections can be market-wide (could lead to monopoly), differences in information about product possibilities, consumer ignorance about benefits, or firm specific (see figure 3.6). Firm-specific imperfections are based on the creation of different assets (tangible or intangible) (i.e. resource-based view), and creation of distinctive, defensible positions (i.e. market-based view).
The essence of strategy implies creating space within which firms can improve their market position and performance by means of discrete and distinctive actions. This can be done on the basis of cost advantage or differentiation that are not easily imitated by other firms. Cost advantages are related to economies of scale (cost advantages due to expansion of a single product) and economies of scope (cost advantages due to joint production of different types of products). Economies of scope can be either broad or narrow.
Generic strategies (Porter, 1980) are typologies that offer type and range of strategic options based on pursuing either cost, differentiation, or scope advantages. They revolve around supply and demand in the market and strengths and weaknesses of the firm and its competitors. Figure 3.7, page 74 of the book demonstrates how these generic strategies are composed.
Figure 3.9 (p. 77) suggests the major possibilities of the systematically changes of Porter’s Five Forces. Three routes reconfigure the five forces: (1) redefining the market, (2) reconceiving the product and (3) redrawing the industry boundaries.
Cost leadership (broad target/lower cost):
Firm attempts to supply a product or service more cost-effectively than its competitors
Cost reduction should be continuous and should involve all stages of the value chain
Large market share is strongly desirable to attain and maintain cost advantage
More sustainable in the long-run
More appropriate in relatively stable environments
Most suitable in the case of commodity, no-frills products
Majority of the work is covered by unskilled personnel
Focus on cost control and developing formal systems
Differentiation (broad target/differentiation):
Firm attempts to add value to product through differentiation, to demand higher prices on the condition that the cost of adding value is lower than the envisaged extra revenue
Value is added by means of differentiating on product attributes, product innovation, or marketing.
Accurate picture of the market and willingness to pay for differentiation are essential
Product must be hard to imitate
Appropriate in dynamic industry environments, while at the same time differentiation increases environmental unpredictability
Employment of experts and focus on facilitating coordination between these experts
Focus (narrow target/lower cost or differentiation):
Defensible niche
Choice between low cost or differentiation focus in this niche
Stuck in the middle, according to Porter, implies that a firm pursues more than one strategy, which leaves the firm unsuccessful competitively speaking in the multiple strategies it is pursuing. This is due to all strategies being inconsistent in nature. However, many have already proven Porter wrong at this assumption regarding being stuck in the middle. Many companies have successfully used and benefited from combining strategies. Furthermore, low cost doesn’t necessarily imply low price, and differentiation doesn’t necessarily imply premium prices. Therefore, generic strategies should be used to capture and portray essential underlying economic forces that firms can interpret in the context of their own circumstances to formulate more suitable and complex strategies.
Another criticism is the lack of market orientation in the generic strategies matrix (fig. 3.8). Also missing is government and its frequently very significant role in the operation of markets. However, it is just a model and its not intended to be an accurate portrayal of the world.
This view is interrelated with Porters generic strategies. For a low-cost strategy, economies of scale and learning effects (learning by doing) are most valuable. They lower the costs; more is produced and this is therefore called the cost advantage. First-mover advantage includes having the first pick in resources and be the first to attract new customers.
Differentiation, making your product unique, consists of quality, reliability (durable product), performance or design, and the intangible assets of brand and reputation. Intangible assets are the ones that are hard for a competitor to imitate, so the ones that makes your product unique (see table 3.4). These require resources like time, capital costs and variable costs, which bring risk to the investment.
Figure 3.10 (p. 87) suggests a methodology by which you can begin an assessment of the market and the potential for differentiation.
Companies have to earn the competitive advantage by making customers buy their products. Positioning in the market in the right way contains the following elements:
Statement of competitive intent
Evidence of the advantage (shown to the customer)
Combination of:
1. Superior delivered cost position
2. Differentiated product
3. Protected niches
Evidence of direct benefits:
1. Perceived by customer group
2. That customers value and are willing to pay for
3. Cannot be obtained, now or in the relevant future
Sustainability of this competitive advantage persists of:
Power, compared to competitors
Catching-up, with changes in the industry
Keeping ahead
Changing game, of customer requirements
Virtuous circle, of incremental changes
Economists argue that competitive advantages are by their nature temporary in character and therefore decay quickly.
All of the information given in this chapter is summarized in figures 3.12 until 3.18. Figure 3.19 shows the size of the competitive advantage compared with the total number of competitive advantages.
For example, a Blockbuster is a firm that, in an industry with very few advantages, has them all and is the only big player. Like in the pharmaceutical markets they have a patent on a product. The Inch by Inch is an industry that has a lot of advantages, all in the hand of a lot of companies. They race like in Formula 1 racing, to keep up with each other. Performance differences here lie in the way they manage their resources and capabilities.
Perfect competition implies price competition, easy entry and exit, and broad distribution of relevant knowledge. Firms, either individually or joint, attempt to create imperfections in the market to gain a competitive advantage over their competitors and in this way be able to charge a premium on their product. Competitive advantage is delivering superior value to customers and in doing so earning an above average return for the company and its stakeholders. Four key features of the market ‘context’ in which rivals sell their products are cost analysis, demand analysis, analysis of markets and competition and analysis of industry and competition.
Cost analysis is understanding the nature of costs that shapes the foundation for the microeconomics of strategy. Costs can be fixed or variable. Opportunity costs are the sacrifice of the alternatives forgone in producing a product or service.
Economies of scale imply that the fixed costs go down when you produce more. The strategic significance of economies of scale depends on the minimum efficient plant size (MEPS). Indivisibility means that an input cannot be scaled down from a certain minimum size and can only be scaled up in further minimum size units. The cube-square rule: production capacity is usually determined by the volume of the processing unit (the cube of its linear dimensions), whereas cost more often arises from the surface area (the cost of the materials involved). As capacity increases, the average cost decreases, because the ratio of surface area to cube diminishes. The learning curve is an empirical estimate of the proportion by which unit costs fall as experience of production increases.
Economies of scope occur when the prices of the range of products go down due to joint production. Economies of scope refer to increased variety in operations.
The demand analysis provides a framework for analysing price and other influences on the sales of the firms’ products and it provides a baseline for pricing products and marketing in general for forecasting and manipulating demand.
For the analysis of markets and competition you can have a lot of options. The markets are viewed as follow: perfect competition, monopoly, oligopoly and monopolistic competition.
Industry analysis: analysis of assets, resources and capabilities that create the economic foundation for firm operations (economic characteristics) and which determine individual capabilities that distinguish firms competing in the industry from one another (uniqueness). Porter’s five forces is the most well-known industry analysis. The five forces are rivalry, threat of entry, threat of substitutes, buyer power and supplier power.
Worldwide privatisation and deregulation has lead to an increase of competition and lower prices. Imperfections in the market create an opportunity to earn supernormal profits. Firm-specific imperfections are based on the creation of different assets (tangible or intangible) (i.e. resource-based view), and creation of distinctive, defensible positions (i.e. market-based view).
The essence of strategy implies creating space within which firms can improve their market position and performance by means of discrete and distinctive actions. This can be done on the basis of cost advantage or differentiation that are not easily imitated by other firms. Cost advantages are related to economies of scale (cost advantages due to expansion of a single product) and economies of scope (cost advantages due to joint production of different types of products). Economies of scope can be either broad or narrow.
Generic strategies (Porter, 1980) are typologies that offer type and range of strategic options based on pursuing either cost, differentiation, or scope advantages. They revolve around supply and demand in the market and strengths and weaknesses of the firm and its competitors. Stuck in the middle, according to Porter, implies that a firm pursues more than one strategy, which leaves the firm unsuccessful competitively speaking in the multiple strategies it is pursuing. This is due to all strategies being inconsistent in nature. However, many have already proven Porter wrong at this assumption regarding being stuck in the middle.
First-mover advantage includes having the first pick in resources and be the first to attract new customers. Intangible assets are the ones that are hard for a competitor to imitate, so the ones that makes your product unique (see table 3.4).
Sustainability of competitive advantage persists of power, catching-up, keeping ahead, changing game and virtuous circle.
This chapter goes deeper into the concept of differentiation and strategy. The model of describing strategy and the differences between resources and capabilities are repeated in figures 5.1 until 5.4.
Describing strategy in four steps:
A clear set of long-term goals: ‘where are we going?’
The scope of the business: ‘what are we going to do?’
Competitive advantage: ‘how are we going to do it?’
The strategic logic: ‘how do we know it will work?’
To get to the right strategic position, you need to have a good idea of your surroundings. That is why the resources and capabilities of the company need to be examined. Two ways of doing that are the strategy cycle and the value chain model.
Strategic position means the impact of strategy on the external environment and assumes an interaction between the internal world of the firm (i.e. assets and organization) with its external environment (i.e. industry, non-market). Furthermore, each firm contains a real economy and a financial economy. The former refers to the creation of resources and capabilities and the positioning within product markets, whereas the latter refers to the firm’s profits and cash flows that result from this real economy. In case the firm successfully maintains superior profitability by competitive advantage and reinvesting in its assets and capabilities, one can speak of a virtuous cycle of competitive advantage and superior profitability. However, when the firm is unsuccessful by competitive disadvantage and poor profitability and isn’t able to reinvest and restore to competitive advantage and superior profitability, one can speak of a vicious spiral.
Resources are considered to be the tangible assets of a company (e.g. finance, skills of individual employees, purchased components and items of capital equipment), whereas capabilities are considered to be the intangible ones (e.g. knowledge, organization and management skills). See figure 5.5 and 5.6.
Another word used for capability is competence, which implies converting basic resources into customized assets. Therefore, resources and capabilities combined determine the core competence of the firm that implies an underlying capability of the firm by which it creates a distinctive characteristic in comparison to other firms. Additionally, this affects customer and corporate value.
According to Porter the supply chain is the spine of his five forces analysis. A subset of this supply chain is the value chain that consists out of primary activities (inbound logistics, operations, outbound logistics, marketing and sales, service) and support activities (firm infrastructure, HRM, technology development, procurement) as demonstrated by figure 5.7, page 143 of the book.
Within these activities a distinction is being made between three types of activities, namely: direct, indirect and quality assurance. Direct activities directly involve creating value for buyers (e.g. assembly, sales and advertising), indirect activities continuously facilitate performance of direct activities (e.g. maintenance, scheduling and administration), and quality assurance activities insure the quality of other activities (e.g. monitoring, inspecting, testing, checking).
The value chain framework is a useful tool for cost analysis because it can be used to identify those activities that are the source of competitive advantage and locate them within the value chain. When using the framework for cost analysis the following steps need to be taken:
Step 1 Define value chain in terms of elements that relate to sources of competitive advantage.
Step 2 Assign costs to each activity and determine the relative importance of those different activities.
Step 3 Compare costs by activity and benchmark against competitors in terms of efficiency and standards.
Step 4 Identify cost drivers (i.e. forces that move costs up and down).
Step 5 Identify linkages between activities.
Step 6 Identify opportunities for reducing costs.
Within this value chain the various activities are linked (i.e. ‘glued’ together) by means of tacit knowledge (i.e. something you know how to do but can’t explain it, such as riding a bike). This knowledge related to internal transactions is not visible and very specific to the organization. When costs of these internal transactions exceed the costs of buying outside, the organization should consider outsourcing these activities.
Markets can be divided into strategic segments (demand side) based on product range and associated price differentials.
Offer curves summarize the range of options open to customers in terms of price and product performance. The shape of this curve depends on customer price sensitivities and cost characteristics of the product. Furthermore, innovation can change the offer curve for example; by reducing costs in product development and manufacturing that will lead to lower prices being charged. See also figure 5.8, page 149.
Strategic segmentation can also be analysed by comparing price and differentiation patterns across a market as Figure 5.9, page 149 of the book, demonstrates. Offerings in point D in this figure can potentially destabilize the market.
Variables for segmentation of the market can be based on the buyers or on the characteristics of the product. The options are shown in figure 5.10, p. 150.
Consumer surplus means ‘profit’ that the consumer makes form a purchase and is calculated as follows: perceived gross benefit less user costs and transaction costs (=perceived net benefit) less price paid.
Consumer surplus is essential for a firm to compete successfully. Value maps show how these consumer surpluses work out competitively (figure 5.11, p. 152). Each point on the indifference curve (upward slope) relates to a specific price-quality combination and at each point on this curve consumer surplus is the same. The steeper the slope, the higher the price increases for increased quality. Above the curve means lower consumer surplus (higher price), whereas underneath the curve means higher consumer surplus (lower price).
Pricing below the indifference curve implies gaining volume at the expense of profit. However, genuine innovation can change the indifference curve, which will shift the original balance.
Economic value is created along the supply chain and into the value chain:
Consumer surplus equals benefit less price paid (B - P)
Firm profit (producer surplus) equals price paid by consumers less costs (P – C)
Total value equals consumer surplus and firm profit (B – C)
Value added equals firm profit less costs of raw materials (P – RM)
Price decisions are dependent on the price elasticity of demand and are essential in partitioning total value between consumers and firms.
Table 5.1, page 153 of the book, shows how price elasticity for the firm and type of advantage (cost or differentiation) are interrelated. The strategies are the share strategy and margin strategies. The borderline between a share strategy and a margin strategy is also known as the break-even price elasticity.
A strategic group is a firm within a group that makes strategic decisions that cannot readily be imitated by firms outside the group without substantial costs, significant elapsed time, or uncertainty about the outcome of those decisions. They are based on mobility barriers, which create limitations or replicability or imitation and can be considered as entry barriers for the strategic group (as opposed to for the entire industry).
Strategic groups have consequences along the following three dimensions:
Industry structure and its evolution
Nature of competition (i.e. oligopolistic interdependence)
Implications for relative performance of firms
Industry structure analysis aims to identify nature and range of profit-earning possibilities (i.e. benchmark).
Oligopolistic market structures imply different (strategic) groups of firms that behave in systematically different ways that are protected by mobility barriers.
Strategic group analysis provides a fundamental basis for the assessment of future strategic possibilities and emergence of new industry boundaries.
Mobility barriers (i.e. strategy differences), as opposed to industry structure characteristics, are useful in explaining persistent differences in profit rates between (strategic) groups in an industry where inter-group competition is taking place. According to Porter (1980), the intensity and pattern of this intergroup competition and consequences for profitability in the industry depend on the following factors:
Number and size distribution of groups (e.g. higher rivalry when strategic groups are numerous and more equal in size)
Strategic distance between groups (e.g. the greater the distance, the more rivalry)
Market interdependence between groups (e.g. high market interdependence leads to high rivalry where strategies are diverse)
Varying profits can be made across strategic groups affected by:
Differences in bargaining power towards customers/suppliers
Differences in degree of exposure to substitute products
Differences in degree to which firms within the group compete with each other
Differences in firms’ scale within the strategic group
Differences in cost of mobility into a strategic group (e.g. timing is essential)
Ability of the firm to execute or implement its strategy in operational sense
Strategic maps: two-dimensional replications of larger group structure within which important dimensions can be seen and through which key opportunities and threats can be depicted. The following aspects are essential:
Choice of strategy space (i.e. identification of the boundaries of the industry)
Choice of organizational levels to be incorporated (corporate, business or functional)
Identification of the variables which best capture firms’ strategies
Identification of stable time periods (i.e. in terms of punctuated equilibria)
Clustering of firms into strategic groups
Furthermore, these maps might be historical (i.e. backward-looking) or predictive (i.e. forward-looking). Historical maps are being used to develop an understanding of the nature of mobility barriers and time/cost involved in investing to overcome them.
Growth is often continuous and cumulative and implies change, whereas strategies are not readily/frequently changeable by nature. Innovation or new knowledge will most likely unsettle long-held beliefs and strategies.
Besides, it requires industry transformation, which can occur as follows:
Redefining the market (i.e. changing relationship with the customer)
Reconceiving the product (i.e. changes in psychology of consumers)
Redrawing the industry boundaries (i.e. general changes in underlying economics of production and supply chain)
Assessing strategy is about making the complexities simple. So this section provides some questions that make the process easier to understand. They concern judging the competitive strategy: how goes strategic thinking and ten questions for judging a strategic plan. All of these questions are in the book, pages 163-164.
To evaluate performance, a business applies the Balanced Scorecard. This broad-based performance measure revolves around the following main questions:
How do customers perceive us? (Customer Perspective)
What must we excel at? (Internal Perspective)
How can we continue to improve and create value? (Innovation and learning perspective)
How are we performing financially? (Financial perspective)
An example of the Balanced Scorecard is shown in figure 5.18, page 165 of the book.
Business model intends to provide a link between intended strategies, its functional and operational requirements, and the performance (i.e. cash flows and profits) that can be expected. In other words, it shows how a firm is making money by indicating where it is positioned along the value chain. Furthermore, it can be used for sensitivity testing and risk analysis. It has several functions, which are as follows:
Articulate value proposition
Identify market segment
Define structure of value chain
Estimate cost structure and profit potential
Describe position of firm within supply chain
Formulate strategy logic by which firm can gain and hold advantage
Figure 5.19, page 168 of the book shows the elements a typical business model contains.
The Du Pont accounting identities provides a starting point for identifying a business model as follows:
= (p – c)Q – F
NA = WC + FA
is profits
p is price
c is variable costs
Q is quantity sold
F is fixed costs
NA is net assets
WC is working capital
FA is fixed assets
Intended strategies should have specific effects on the variables in the previous equation. For example, with a differentiation strategy one can expect that both costs (i.e. variable costs such as quality and service levels plus fixed costs such as advertising and R&D) and prices will be raised.
Sustainability analysis is closely linked to the imitation of competitive advantage. It implies analysing potential responses by competitors and potential entrants and the impact of those actions on the degree of competition and on the cash flows that are generated by the competitive advantage of the incumbent firm.
Isolating mechanisms are economic forces that limit the extent to which a competitive advantage can be neutralized or copied.
Competitor analysis implies analysing these isolating mechanisms and is used to give insight into ways in which incumbents’ core competences can be imitated or outflanked. It contains the following elements:
Identifying which competitors to track (existing, new and potential)
Establishing competitor database
Analysing competitor strategies
There are many ‘fits’ required for an organisation. The strategic fit means that de businesses in an organisation have to be balances with the corporate strategy, or that the there has to be financial synergy if businesses are not related.
The market-related fit is the one that attracts customers for different products through the same channels. This way the costs for marketing can be lowered. It works well if an organisation has an economy of scope.
Operating fit is cost sharing by sharing knowledge and transferring skills throughout production and R&D, assembly and administration. This can lead to economies of scale.
Management fit occurs when different businesses share administrative or operating problems. This is useful because companies can compare the problems regarding their organisational culture.
Financial fit, the fit between success and costs, is the only one that is certain in a company.
Describing strategy in four steps:
A clear set of long-term goals: ‘where are we going?’
The scope of the business: ‘what are we going to do?’
Competitive advantage: ‘how are we going to do it?’
The strategic logic: ‘how do we know it will work?’
Strategic position means the impact of strategy on the external environment and assumes an interaction between the internal world of the firm (i.e. assets and organization) with its external environment (i.e. industry, non-market). Furthermore, each firm contains a real economy and a financial economy. The former refers to the creation of resources and capabilities and the positioning within product markets, whereas the latter refers to the firm’s profits and cash flows that result from this real economy.
Resources are considered to be the tangible assets of a company (e.g. finance, skills of individual employees, purchased components and items of capital equipment), whereas capabilities are considered to be the intangible ones (e.g. knowledge, organization and management skills). Resources and capabilities combined determine the core competence of the firm that implies an underlying capability of the firm by which it creates a distinctive characteristic in comparison to other firms.
According to Porter, the supply chain is the spine of his five forces analysis. A subset of this supply chain is the value chain that consists out of primary activities (inbound logistics, operations, outbound logistics, marketing and sales, service) and support activities (firm infrastructure, HRM, technology development, procurement). Within these activities a distinction is being made between three types of activities, namely: direct, indirect and quality assurance.
Within this value chain the various activities are linked (i.e. ‘glued’ together) by means of tacit knowledge (i.e. something you know how to do but can’t explain it, such as riding a bike). This knowledge related to internal transactions is not visible and very specific to the organization. When costs of these internal transactions exceed the costs of buying outside, the organization should consider outsourcing these activities.
Markets can be divided into strategic segments (demand side) based on product range and associated price differentials. Offer curves summarize the range of options open to customers in terms of price and product performance. The shape of this curve depends on customer price sensitivities and cost characteristics of the product. Furthermore, innovation can change the offer curve.
Consumer surplus means ‘profit’ that the consumer makes form a purchase and is calculated as follows: perceived gross benefit less user costs and transaction costs (=perceived net benefit) less price paid. Value maps show how these consumer surpluses work out competitively.
Economic value is created along the supply chain and into the value chain:
Consumer surplus equals benefit less price paid (B - P)
Firm profit (producer surplus) equals price paid by consumers less costs (P – C)
Total value equals consumer surplus and firm profit (B – C)
Value added equals firm profit less costs of raw materials (P – RM)
A strategic group is a firm within a group that makes strategic decisions that cannot readily be imitated by firms outside the group without substantial costs, significant elapsed time, or uncertainty about the outcome of those decisions. They are based on mobility barriers, which create limitations or replicability or imitation and can be considered as entry barriers for the strategic group (as opposed to for the entire industry).
Industry structure analysis aims to identify nature and range of profit-earning possibilities (i.e. benchmark). Oligopolistic market structures imply different (strategic) groups of firms that behave in systematically different ways that are protected by mobility barriers. Strategic group analysis provides a fundamental basis for the assessment of future strategic possibilities and emergence of new industry boundaries.
Strategic maps: two-dimensional replications of larger group structure within which important dimensions can be seen and through which key opportunities and threats can be depicted. These maps might be historical (i.e. backward-looking) or predictive (i.e. forward-looking).
To evaluate performance, a business applies the Balanced Scorecard. This broad-based performance measure revolves around the following main questions:
How do customers perceive us? (Customer Perspective)
What must we excel at? (Internal Perspective)
How can we continue to improve and create value? (Innovation and learning perspective)
How are we performing financially? (Financial perspective)
Business model intends to provide a link between intended strategies, its functional and operational requirements, and the performance (i.e. cash flows and profits) that can be expected.
The Du Pont accounting identities provides a starting point for identifying a business model as follows:
= (p – c)Q – F
NA = WC + FA
Isolating mechanisms are economic forces that limit the extent to which a competitive advantage can be neutralized or copied. Competitor analysis implies analysing these isolating mechanisms and is used to give insight into ways in which incumbents’ core competences can be imitated or outflanked.
Resource-based view (RBV) and market-based view (MBV) complement each other and together they provide the basis for strategic theory. The way they complement each other is as follows:
Advantage requires some degree of difference between firms, which in itself requires construction of assets that are unique to the firm
Assets are unique to the firm in relation to the use for which they were designed
Creating a distinctive asset doesn’t necessarily imply that customers will like the resulting product offering
In conclusion, product positioning is equally important as the company’s resources and capabilities.
Strategists make a distinction between capabilities and resources. The former implies the ability to perform a task/activity that involves complex patterns of co-ordination/co-operation between people and other resources (e.g. R&D expertise, customer service and high-quality manufacturing), emerge and develop over time and are firm-specific. The latter are considered being the inputs into the firm’s operations as to produce goods and services (e.g. patents, capital equipment, and people).
Rents are surplus revenues over costs that are earned by resources and capabilities, otherwise called strategic assets or core competences.
Internal economy of the firm implies sets of discrete activities (e.g. product line) that lead to market positions and are supported by resources and capabilities. A distinction is being made between similar activities (i.e. common strategic and generic assets that can lead to economies of scale, scope and experience effects) and complementary activities (i.e. dissimilar sets of strategic assets that require co-ordination/co-operation).
There is no such thing as knowing exactly what is going to happen in the (near) future due to uncertainties and imperfect information. Managers, therefore, allocate resources based on past personal experience, firm’s experience, values, biases and personality.
Figure 6.1 (page 185 of the book) demonstrates how core competences and competitive advantages are construed. Fig. 6.2 compares typical resources and typical abilities. The distinctiveness of the firm’s specific set of resources and capabilities might lead to several issues, namely:
Configuration issue: which resources to acquire and what capabilities to develop
Firm-specificity issue: way in which resources and capabilities are developed
Co-ordination issue: way in which resources and capabilities are internally managed to create positional advantage
There are some different visions on how to manage the CCs. All based on the definition of capabilities and resources made by Grant (2002):
Vision 1: Prahalad and Hamel define core competence as collective learning in the organization, especially how to coordinate varying production skills and to integrate multiple streams of technologies (i.e. combination of individual technologies and production skills that underlie a company’s product lines).
Vision 2: core competence may also be defined as the set of firm-specific skills and cognitive processes that are directed towards achieving competitive advantage.
The Boston Consulting Group came up with capabilities-based competition, which contains four basic principles, namely:
Business processes are the building blocks of strategy (as opposed to products and markets)
Transforming these key processes into strategic capabilities that consistently provide superior value to the customer determines competitive success
These capabilities are created by making strategic investments in a support infrastructure that connects and transcends traditional strategic business units
Capabilities necessarily cross functions, therefore, the chief executive is the champion of a capability-based strategy
Furthermore, there are five dimensions on which a company’s strategic resources and capabilities should aim to outperform competition, which are:
Speed (i.e. the ability to respond quickly to customer or market demands and to incorporate new ideas and technologies quickly into products).
Consistency (i.e. the ability to produce a product that unfailingly satisfies customers’ expectations).
Acuity (i.e. ability to see the competitive environment clearly as to be able to anticipate and respond to customers’ evolving needs and wants).
Agility (i.e. ability to simultaneously to many different business environments).
Innovativeness (i.e. the ability to generate new ideas and to combine existing elements to create new sources of value).
Vision 3: Amit and Schoemaker (1993) talk about strategic assets, which they define as the set of resources and capabilities that are difficult to trade/imitate, scarce, appropriable, and specialized that are the foundation of the firm’s competitive advantage.
In conclusion: Assets = resources = capabilities. They can be divided into strategic assets (i.e. truly distinctive and unique to the firm that underpin positional advantage), complementary assets (i.e. jointly required with strategic assets for production/delivery of product/service), and make-or-buy assets (i.e. included based on financial calculations and will be excluded if the market can provide them at lower cost).
Figure 6.4 (page 188 of the book) shows how core competences link managerial cognition to the economics of the firm.
The essential characteristics of a CC are:
A CC is a bundle of skills and technologies, not one in particular
It is not an asset in the accounting way
Must have a disproportionate contribution to the customer-perceived value
Must be completely unique
Should provide an entrée into new markets (in a multi-business company)
The definition of a core competence is: the set of firm-specific and cognitive processes directed towards the attainment of competitive advantage.
The management of the organisation has to have knowledge of some issues in the environment of the organisation to interpret and use the CCs well. This is shown in figure 6.5, page 190 of the book.
There are some issues related to CCs, that enhance them.
Resource leverage: as already mentioned, the management has an influence on the CCs. There are five ways in which management can leverage (i.e. focus attention and effort on a specific object in the attempt to exclude rival objects) resources to create conditions under which core competence can emerge. They are as follows:
Concentrating resources: convergence and focus
Accumulating resources: extracting and borrowing
Complementing resources: blending and balancing
Conserving resources: co-opting and shielding
Recovering resources: expediting success
Identifying intangibles: intangible resources and capabilities are those that are not visible, however, they do have a significant impact on business success. In this book they are:
Intellectual property rights of patents, trademarks, copyright and registered designs
Trade secrets
Contracts and licences
Databases
Information in the public domain
Personal and organisational networks
The knowhow of employees, advisers, suppliers and distributors
The reputation of products and of the company
The culture of the company
The four most important ones are company reputation, product reputation, employee know-how and organization culture.
Furthermore, company reputation especially can give firms a significant advantage.
Value of a core competence: figure 6.6, page 194 of the book, captures the value of a core competence, where:
Path dependency refers to cumulative learning and experience over time that is difficult to duplicate on short term.
Causal ambiguity means not being able to identify the important element in a complex asset.
First-mover advantage implies the pre-emption of a market by being the first to create scale efficient assets
The basic foundations of value are imitability, durability, substitutability and appropriability.
Figure 6.7 and 6.8, page 196-197 of the book, show how strategic industry factors and core competences are interrelated. More specifically, it demonstrates that the RBV and MBV are complementary.
Strategic industry factors are sources of market imperfections that can be used by firms to create competitive advantage. According to Amit and Schoemaker:
They are determined through complex interaction between rivals, new entrants, customers, suppliers, regulators, innovators and other stakeholders.
They are strategic: basis for failure and competing with rivals.
They are ex post.
Development takes time, skills and capital.
Investments are largely irreversible.
Their pace of accumulation is determined by their own development and cannot be readily increased.
Their value in a firm will depend on its control on other factors (the complementary property).
The difference between core competences and strategic industry factors is that the former are intentions to create competitive advantage (ex ante), whereas the latter have already proven to actually work (ex post).
Strategic intent implies setting psychological targets, which provide a focus that all organizational members seek to adopt. Furthermore, it encourages people to stretch a little further to go beyond current resources, capabilities and means. When there is a gap between ambition (intent) and resources (reality) one can speak of strategic stretch. However, when it does work out there is strategic fit.
Strategic investments are risky due to uncertainty and require technological progress and substantial investments in R&D and new products (i.e. strategic innovation). Strategic innovation implies rewriting the rules of the game and leads to new ways of competitive advantage, different conception of the required core competences and different business models.
Since learning is also important in positioning in the right place, Prahalad and Hamel state that core competences have to support products that are current. But these products change, so the CCs have to change as well and learn from past experience. This is summarized in figure 6.9, page 201 of the book!
Strategic planning view implies deciding on long-term objectives and strategic direction, eliminating or minimizing weaknesses, avoiding threats, building and defending strengths, and taking advantage of opportunities. See also figure 6.10, p. 202.
Viable business opportunities rely on:
Existence of valuable market segments
Existence of a sustainable positional advantage
Creation of appropriate strategic assets
Key success factors (KFCs) are elements in the industry that are considered important for customers. In finding out what they are one should ask himself: “what do we have to do to succeed?” More specifically:
Is there a market?
Do we have some advantage?
Can we survive competition?
Furthermore, this analysis can be divided into customers and demand on the one hand and competition on the other hand. Additionally, creating value depends on positioning, customer persuasion, capability and efficiency. See figures 6.11 and 6.12.
In conclusion, a competitive strategy is influenced by a lot of elements. Keep in mind that:
Resources are limited, opportunities are infinite: trade-offs are essential
There can be opportunity costs
Always perform differently than rivals
You need to run faster than your competitors
Your competitive advantage is worth nothing if it is not sustainable
Lock out your imitators, have a stronger supply chain
What matters in the long run is return on investment, not market share or profit
Strategic positions have a time horizon of a decade, not just one cycle
Competitive advantage consists of two components: the value for the customers and the value for the firm.
Value for customers consist of:
The firm’s ability to make a better product than competitors
The firm’s ability to make customers recognize, purchase and value the difference
Value to the firm is:
The ability to create and sustain CC’s
The ability to run the business efficiently and at best practices.
These definitions can be operationalized according to the schema in figure 6.13 (p. 205). The four elements of value are coded as Positioning, Customer Persuasion, Capability and Efficiency. To score a firm on these aspects, the best practice is benchmarking. Data should be collected and compared with a benchmarking company.
A firm can forecast the lifecycle of a product they are currently in and another lifecycle, so they can predict almost seven years ahead. It is however important to broaden that strategic horizon, so firms need to analyse the enablers and blockers. On the long term these need to be managed. Enablers are easier to predict than blockers, because these often come from internally in the firm. See also figures 6.14 and 6.15 at p. 206.
Making this into a strategic analysis leads to a prediction of the firms growth, which can be four types of ‘confidence’, see figure 6.16, page 207 of the book.
Resource-based view (RBV) and market-based view (MBV) complement each other and together they provide the basis for strategic theory.
Rents are surplus revenues over costs that are earned by resources and capabilities, otherwise called strategic assets or core competences. Internal economy of the firm implies sets of discrete activities (e.g. product line) that lead to market positions and are supported by resources and capabilities. A distinction is being made between similar activities (i.e. common strategic and generic assets that can lead to economies of scale, scope and experience effects) and complementary activities (i.e. dissimilar sets of strategic assets that require co-ordination/co-operation).
The distinctiveness of the firm’s specific set of resources and capabilities might lead to several issues, namely:
Configuration issue: which resources to acquire and what capabilities to develop
Firm-specificity issue: way in which resources and capabilities are developed
Co-ordination issue: way in which resources and capabilities are internally managed to create positional advantage
There are some different visions on how to manage the CCs. There are five dimensions on which a company’s strategic resources and capabilities should aim to outperform competition, which are: speed, consistency, acuity, agility and innovativeness.
Assets = resources = capabilities. They can be divided into strategic assets (i.e. truly distinctive and unique to the firm that underpin positional advantage), complementary assets (i.e. jointly required with strategic assets for production/delivery of product/service), and make-or-buy assets (i.e. included based on financial calculations and will be excluded if the market can provide them at lower cost).
The definition of a core competence is: the set of firm-specific and cognitive processes directed towards the attainment of competitive advantage.
There are five ways in which management can leverage (i.e. focus attention and effort on a specific object in the attempt to exclude rival objects) resources to create conditions under which core competence can emerge. They are as follows: concentrating resources, accumulating resources, complementing resources, conserving resources and recovering resources.
Intangible resources and capabilities are those that are not visible, however, they do have a significant impact on business success.
Strategic industry factors are sources of market imperfections that can be used by firms to create competitive advantage.
Strategic intent implies setting psychological targets, which provide a focus that all organizational members seek to adopt. When there is a gap between ambition (intent) and resources (reality) one can speak of strategic stretch. However, when it does work out there is strategic fit.
Strategic investments are risky due to uncertainty and require technological progress and substantial investments in R&D and new products (i.e. strategic innovation). Strategic innovation implies rewriting the rules of the game and leads to new ways of competitive advantage, different conception of the required core competences and different business models.
Strategic planning view implies deciding on long-term objectives and strategic direction, eliminating or minimizing weaknesses, avoiding threats, building and defending strengths, and taking advantage of opportunities.
Key success factors (KFCs) are elements in the industry that are considered important for customers.
Competitive advantage consists of two components: the value for the customers and the value for the firm.
Value for customers consist of:
The firm’s ability to make a better product than competitors
The firm’s ability to make customers recognize, purchase and value the difference
Value to the firm is:
The ability to create and sustain CC’s
The ability to run the business efficiently and at best practices.
Over the years the old world of scale and scope economies have made room for (note: have not been replaced by) a new world of network externalities (i.e. network effects) due to the development of new information and communication technologies (i.e. ICT). As a result, operating methods for most manufacturing and service companies have transformed with regard to the importance of support functions. Overall, these changes have substantial effects on corporate strategies worldwide and have created a digital economy (i.e. multiple nodes, interconnectivity, cooperative) with increasing returns to scale characteristics, which is not moderated by the influence of diminishing returns. Note that 'node' is just another word for product or service.
Network effects imply that a good or a service has value to a potential consumer dependent on the number of other consumers who already own the particular good or are users of the particular service. Additionally, by purchasing this good or service, the new consumer indirectly influences the value of the consumers who already own the good or use the service. Positive feedback is essential in this process of network externalities. In these network industries, the value of almost all goods and services are influenced by aggregate consumption levels in the market and in markets for related goods. A distinction is being made between three types of networks, namely:
Virtual network (knowledge and information assets are intangible)
Pure network (an essential characteristic of the product or service is organized through complementary nodes and links)
Indirect or weak network (complementary nodes where links are created by the customer as opposed to for the customer)
Consumer externality implies that demand for a product or service is influenced by total demand for the product/service class or by total demand in a complementary one.
Market structure has shifted from natural monopoly to oligopoly, where issues of interconnectivity, compatibility, interoperability, and coordination of quality play an essential role.
A two-way network allows links to be operated in both directions; a one-way network has only one line of connection. If you have a star network, as shown in figure 7.1, page 219 of the book, there are 56 products in the connection (formula: n*(n-1)). So if there is a node added to the network, a disproportionate number of products are added to the network (=network economies of scale).
In a crystal network there are two main points, and these have some nodes of their own (figure 6.2, page 220 of the book). These main groups can use some of the technical experience of their network and combine this together.
The digital world, characterized by ICT, is governed by a different dynamic than the traditional economic model. Network externalities are the new drivers of the network economy.
Network externalities are defined as the increasing utility that a user derives from consumption of a product as the number of other users who consume the same product increases. The focus of interest in network economics has shifted from the analysis of natural monopoly towards issues of interconnection, compatibility, interoperability and coordination of quality.
Normally, the demand curve is downwards sloping, meaning that if price goes down, demand goes up, whereby 'demand shifters' push demand to a higher level. Furthermore, higher levels of consumption are either derived from higher incomes (positive income elasticity) or from lower prices (negative price elasticity).
Figure 7.3, page 223 of the book, shows how price is related to network size in the case of network economies (as opposed to quantity in traditional economies), where:
The intercept of the vertical axis of the previous figure represents the stand-alone value of a network good. Note that pure network goods are goods that have no stand-alone value, such as a telephone (you need other means to be able to use it, without them, it is useless and therefore has no value on its own).
Tipping point is where the installed base or size of the network tips expectations sharply towards one player or network and away from competition (figure 7.5).
Negative feedback systems, as used by traditional economics, implies that the strong get weaker at the margin and the weak get stronger, which eventually leads to a competitive equilibrium (i.e. diminishing marginal utility as consumption grows). Positive feedback systems, as used by the new (network) economies, imply that valuation of a product or service increases the more consumers consume due to interdependence of consumer decisions.
Figure 7.4, page 223 of the book, shows the “winner takes all” phenomenon. This describes an economic paradox: almost the first law of economics is that value comes from scarcity. However, in the digital economy value comes from plenty: the more something is demanded, and the more it is expected to be demanded then the more valuable it becomes.
Furthermore, the optimal size of a network is found where demand and cost interact in such a way that the joining of valuable consumers decreases to the point where the costs of acquiring and servicing new consumers exceed the price that these consumers are willing to pay (see fig. 7.6). This leads to three configurations, namely:
Pure network goods (as mentioned earlier)
Products with significant intrinsic value to attract a modest size group of users (e.g. enterprise solutions)
Products with high intrinsic demand but extensive consumer interactions providing a substantial total network value (e.g. processing software where the value from standardizing on MS Word is very high)
These configurations result in alternative network demand configurations, as figure 7.7, page 226 of the book, demonstrates.
In case of network externalities things work differently, where sales rise as accumulated sales (i.e. installed base) rise and equilibrium is to be found somewhere between actual demand and expectations of total demand. Therefore, the more a product or service is (expected to be) demanded, the more valuable it becomes. Furthermore, unless regulated network markets are strongly interconnected with regard to competing platforms, there is a high risk of 'the winner takes it all' phenomenon.
There are four settled levels of infrastructure within network industries (see figure 7.8), namely:
Technology and standards
Supply chain
Physical platforms
Consumer network
Two factors determine the significance of information economies, namely:
Continuous reduction in cost of information technology hardware products
Scale effect of global standards
Moore's law implies that every year and a half processing power doubles while costs hold constant.
Industry standard is achieved by three modes of selection process, namely:
Market-based selection (i.e. standards 'wars' where consumers decide on the dominant standard)
Negotiated standardization (i.e. organizations determine prevailing standards to reduce cost and uncertainty associated with new standards)
Hybrid standard setting (i.e. private firms adopt strategies to undercut collaborative decisions taken in negotiated standardization)
The interaction of the following three factors have led to an evolution within the structure of the information economy that have led to new ways of supply chain management, namely:
Increase in computational capacity for data mining
Growth of telecommunication networks (fixed and mobile)
Explosion of information sharing through the internet
Supply chains became more integrated and interconnected as well as deconstructed (i.e. outsourcing) to widen organizational boundaries and enhance business growth.
Organizations are becoming 'isomorphic' (i.e. similar in nature), which implies replaceable interrelationships. This has come about due to standardization of internal operations, materials resource planning (MRP), enterprise resource planning (ERP), and electronic customer relationship management (eCRM). As a result, entry barriers have lowered, however, the risk of not being able to retain business (fewer safety nets) has increased. See also figure 7.9, page 230 of the book.
Physical platforms are the tangible infrastructures that deliver service to a customer, such as computers, telephones and satellites, and are nowadays a complex structure of interconnected sub-platforms. Therefore, network architecture (i.e. standards that govern how a system and its modules interact) plays a crucial role. A distinction is being made between two kinds of dynamic processes with regard to network architecture, namely:
Modular innovation (i.e. retains architecture of the network, including joints, but modifies the modules)
Architectural innovation (i.e. modules are largely unchanged but architecture that connects them is changed)
Consumer network implies interdependencies between consumers. In the consumer market there are two types of values attached to a product, namely:
Autarky value (i.e. value associated with a product irrespective of the number of other users)
Synchronization value (i.e. value derived from interactions with other consumers)
Furthermore, consumers can be locked in when they invest in multiple complementary and durable assets of a physical platform where costs of switching to an alternative prevent them from doing so. This locking-in can occur on individual level, company level and societal level. When it occurs at societal level, it could have negative welfare effects when new superior technologies are being suppressed.
Companies have to make choices regarding technical standards; they have to make trade-offs. They can produce a unique product (network externalities), or one that is standard in the competition and a save but tough choice. The implications for the choice of market structure are:
The industry output will be higher if there are network externalities compared to standards.
Output inequity and price and profit inequality increase the extent of network externalities.
Is there are standards and strong network effects, there will be no equilibrium regarding network offerings.
Competition is seriously influenced by the size consequences of ‘the winner takes it all’.
Convergence of digital services means that different industries melt together to form one industry; they become linked by a powerful scope economy (i.e. a common technology).
To make extinctions between these industries, the government en EU has made some regulations. In the EU context this means:
Freedom of provisioning in EU countries: the EU has open borders; this makes trade in the EU cheap and fast.
Level playing field: this also leads to an open market for the ICT industry in the EU.
Country of origin: the development of e-commerce.
Broadcasting: new rules for television (on demand).
Access directive for pro-competitive obligations
Intellectual property rights
Media literacy efforts
Prudence in regulation: this helps small companies get bigger in the EU.
Distance selling is more complicated because of the borders
The cooling-off period creates complexity and uncertainty for EU online sellers.
There are still different regulations in the EU countries regarding e-commerce.
Because the digital environment develops so quickly, regulation becomes even more important. Some aspects are:
The ICT landscape and the EU’s regulatory role
- Increase in e-confidence
- Reflect the global context
- Adapt to new business models
- Focus on the next wave of innovation
- Adopt a technology-neutral approach
- Promote innovation
- Apply a ‘light touch’
- Encourage self-regulation
- React to market failure
- Harmonise the EU regulatory environment
- Regulate with clarity and coherence
Next-generation networks (NGNs): new ways of communicating with customers and building relationships with them.
Open standards
Digital Rights Management (DRM): licensing and copyrighting throughout technology
Intellectual property rights
Net neutrality: traffic shaping, the file transfer on the net should not be blocked
The regulations in the industry imply the complexity of the industry. The way to survive in these new markets are helped by the following:
Use expectation management
Open standards are the key to volume
There is a law of inversed pricing, give stuff away so later on people will find it valuable and buy from you
First: choose your network, second, find out how to compete within the network
Networks are replacing hierarchical business organisations
Use the brand to sell customers the new, uncertain products
The new landscape is based on continuous innovation that challenges you
Over the years the old world of scale and scope economies have made room for (note: have not been replaced by) a new world of network externalities (i.e. network effects) due to the development of new information and communication technologies (i.e. ICT). These changes have substantial effects on corporate strategies worldwide and have created a digital economy (i.e. multiple nodes, interconnectivity, cooperative) with increasing returns to scale characteristics, which is not moderated by the influence of diminishing returns.
A distinction is being made between three types of networks, namely:
Virtual network (knowledge and information assets are intangible)
Pure network (an essential characteristic of the product or service is organized through complementary nodes and links)
Indirect or weak network (complementary nodes where links are created by the customer as opposed to for the customer)
Consumer externality implies that demand for a product or service is influenced by total demand for the product/service class or by total demand in a complementary one. A two-way network allows links to be operated in both directions; a one-way network has only one line of connection. If you have a star network, there are 56 products in the connection (formula: n*(n-1)). In a crystal network there are two main points, and these have some nodes of their own.
Network externalities are defined as the increasing utility that a user derives from consumption of a product as the number of other users who consume the same product increases. The focus of interest in network economics has shifted from the analysis of natural monopoly towards issues of interconnection, compatibility, interoperability and coordination of quality.
Pure network goods are goods that have no stand-alone value, such as a telephone (you need other means to be able to use it, without them, it is useless and therefore has no value on its own). Tipping point is where the installed base or size of the network tips expectations sharply towards one player or network and away from competition. Negative feedback systems, as used by traditional economics, implies that the strong get weaker at the margin and the weak get stronger, which eventually leads to a competitive equilibrium (i.e. diminishing marginal utility as consumption grows). Positive feedback systems, as used by the new (network) economies, imply that valuation of a product or service increases the more consumers consume due to interdependence of consumer decisions. Figure 7.4, page 223 of the book, shows the “winner takes all” phenomenon.
The optimal size of a network is found where demand and cost interact in such a way that the joining of valuable consumers decreases to the point where the costs of acquiring and servicing new consumers exceed the price that these consumers are willing to pay.
There are four settled levels of infrastructure within network industries (see figure 7.8), namely: technology and standards, supply chain, physical platforms and consumer network.
Moore's law implies that every year and a half processing power doubles while costs hold constant. Industry standard is achieved by three modes of selection process, namely: market-based selection, negotiated standardization and hybrid standard setting.
Physical platforms are the tangible infrastructures that deliver service to a customer, such as computers, telephones and satellites, and are nowadays a complex structure of interconnected sub-platforms. Therefore, network architecture (i.e. standards that govern how a system and its modules interact) plays a crucial role. A distinction is being made between two kinds of dynamic processes with regard to network architecture, namely: modular innovation and architectural innovation.
Consumer network implies interdependencies between consumers. In the consumer market there are two types of values attached to a product, namely: autarky value and synchronization value. Furthermore, consumers can be locked in when they invest in multiple complementary and durable assets of a physical platform where costs of switching to an alternative prevent them from doing so.
Convergence of digital services means that different industries melt together to form one industry; they become linked by a powerful scope economy (i.e. a common technology).
Corporate strategy implies value gained from mixing businesses and the way in which to manage those to achieve optimum value. It can be separated into portfolio management, growth idea (i.e. profitable growth), and relatedness (i.e. synergies). It forms the overall plan for a diversified company and is concerned with choice of industry, setting organizational context for the strategic business units (SBUs), and managing relationships between these SBUs.
Over the years organizational structures have moved from the traditional U-form (i.e. centralized, functionally departmentalised operating firm, fig. 8.2) to the M-form (i.e. decentralised, multidivisional, semi-autonomous SBUs, fig. 8.3). The M-form relieved executives from operating duties and tactical decisions to free up space for broad strategic decisions such as resource allocation and acquisitions/divestments.
Organizations have become larger throughout time in attempting to achieve economies of scale (i.e. produce at lower costs) and scope (i.e. produce variety of products). A competitive strategy emerged, based on cost, differentiation and first-mover advantages, where the objective of corporate strategy was growth (i.e. scope driven) or moving abroad (i.e. scale effects). Furthermore, horizontal movements (i.e. acquisitions) and vertical integration (i.e. control material supplies and distribution) started to play a major role as well. Figures 8.4 and 8.5 illustrate the strategy-structure choices.
The M-form structure proved most suitable to handle these changes because it provides operational decentralization (i.e. business level) along with strategic direction (i.e. corporate level). However, there are some downsides to the M-form. Corporate managers are likely to get out of touch with what is really happening at the core of the organization and become reliant on middle management, accountability becomes ambiguous, and BUs have the natural tendency to compete, as opposed to cooperate, for the limited resources available. The biggest problem with the M-form is its tendency to impede the development of trans-firm competencies.
The economic logic behind the M-form is that here the whole had more value than the sum of its parts. In formula, this means:
Vc = As + Bs + Cs + Mc
Where:
Vc = value of the corporation
As,Bs,Cs = Value of stand alone businesses A, B and C
Mc = the total net value of corporate membership, the membership benefits
So: Vc > As+Bs+Cs by the value of Mc
Mc (which can also be negative) can have some different sources, organisational gain, benefits of scale and size, reorganisation, but the most potential one is the transaction cost Economics (TCE), where the transaction costs are shared within the whole corporation.
The M-form offers two major benefits according to the transaction cost theory, namely:
Governance
Corporate office takes on role of more informed/involved investor
Corporate office has a better overview, therefore, can closely monitor middle management
Corporate layer can look out for/prevent misuse of shareholder funds by middle management
Scope
Related business with similar markets/technologies/processes can share physical capital, knowledge and managerial expertise, whereby this shared process is overseen and controlled by corporate layer
Corporate synergies (i.e. total worth more than its parts) are best attainable by scope
Core competences (i.e. collective learning) can be achieved, especially on coordination of diverse production skills and integration of multiple streams of technology
These core competences support and enhance diversification by shaping trans-business capabilities
As illustrated before, business strategy has three key dimensions: competitive advantage, resource allocation decisions and the organization of the business. At the corporate level, these are structure and process, but also the portfolio question.
Within this portfolio, the characteristics are again portfolio management, relatedness and growth. For the corporate strategy to be consistent with the economics of strategy, there has to be:
Definition of divisions and business unit boundaries
Intended lateral integration and coordination between units
Vertical relationships between corporate tasks and roles and line operations (corporate business interface)
This Corporate Business interface sets out in accountability and authority in the in which there are three styles, namely:
Strategic planning (i.e. corporate executives define/monitor corporate and business strategies)
Strategic control (i.e. corporate executives influence business-level strategies and monitor financial results)
Financial control (i.e. control of business-level strategy is decentralized and relies solely on financial control at corporate level)
One way of pursuing corporate strategy implies adding value through buying and selling businesses. They can also invest in the bought company and sells it for more value. Lastly companies can buy conglomerates and sell the parts.
Porter names this portfolio management and distinguishes between three organizational/process concepts, namely:
Restructuring (i.e. businesses are acquired with the intent of achieving value by active intervention/improvement)
Sharing activities (i.e. component businesses attempt to attain optimal utilization and learning/experience effects by sharing facilities, services, processes or systems)
Transferring skills (i.e. managing on going interrelatedness between businesses in your portfolio)
Parenting advantage (or corporate advantage, Goold (1994)) implies that parent companies can add value to its component businesses through orientation and management. In order to achieve this, the following requirements need to be met:
Corporate advantage must create extra value somewhere in the portfolio to reach competitive advantage
The value created must exceed cost of corporate overhead
The value added must be higher than any other possible parent could have created
Furthermore, Goold made a distinction between three classes of value-adding corporate strategy (see figure 8.7, p. 263), namely:
Stand-alone influence (i.e. value created by influence on individual business strategy and performance ‘10% versus 100%’ paradox)
Functional and services influence (i.e. adding value through the influence of a range of centrally controlled staff functions ‘beating the specialist’ paradox)
Linkage influence (i.e. increase value through relationships between businesses ‘enlightened self-interest’ paradox)
Style of the parent is determinant for the level of performance and can be divided into two dimensions (see figure 8.8, p. 265), namely:
Dimensions of planning influence (i.e. extent to which corporate level becomes involved in strategic/operational business planning)
Dimensions of control influence (i.e. extent to which business need to stick to budgets and operational targets)
Three styles emerge:
Financial control (i.e. tight financial control with low planning influence)
Strategic planning (i.e. high planning influence with flexible control influence)
Strategic control (i.e. moderate planning influence/control influence)
In conclusion, corporate strategy is contingent on organizational structure, systems and procedures. The role of the corporate layer is dependent on relatedness between SBUs and in order to achieve economies of scope cooperation between these SBUs is highly important. Furthermore, strategic orientations can be divided into cooperative (i.e. related diversification) and competitive (i.e. unrelated diversification) ones. With the former, SBUs cooperate to achieve economies of scope, whereas with the latter SBUs compete over resources that are attributed according to ‘best-use’. See also table 8.1, p. 266. In conclusion, competitive and cooperative organizations are dissimilar with regard to centralization, integration, control practices and incentive schemes, therefore, incompatible. By creating core business grouping or divisions this economic and organizational dilemma can be overcome.
Furthermore, several models were designed around portfolio management, such as the growth-share matrix created by the Boston Consulting Group (i.e. BCG matrix) and the GE model. The BCG matrix can be found in figure 8.9, page 267 of the book.
This model demonstrates that in a portfolio the different SBUs can have some function within the portfolio.
The boxes are:
Star: rising in the industry, most likely to become a cash cow
Question Mark: it is not certain, new markets
Dog: low-growth industries, most likely to be divested
Cash cow: large businesses in mature markets
Businesses can go from a star en go down to the dog position or can go the success route and become a cash cow in a mature market.
Another technique for portfolio management is the attractiveness/competitive position (GE). However, the GE model is not demonstrated in the book, but is to be found in the lecture slides of this course.
These portfolio techniques are no longer relevant, it became so easy to see which industries became stars and dogs that corporations tossed the bad ones en bought other ones. This led to major acquisition-driven conglomerates that eventually destroyed themselves because of too much debt.
The issue of having a balanced portfolio however remains.
The M-form does not get a lot of support from the academic background, even though it has been adopted in most large companies.
Academic research supports the fact that combining related businesses can add value to a corporation. In this relationship there have to be strong findings on both sides, similarities in the characteristics and a dynamic creation an accumulation of trans-business competences.
Some academic argue that the relatedness will eventually destroy value because shared competences do not have that much value anymore.
This value destruction was seen in the 1970s and 1980s, as mentioned above with the conglomerates. Because of globalisation companies can find related businesses in the same industry but in a different country. This will play a big role in the market in the nearby future.
As an example of all mentioned in this chapter, pages 271-275 illustrate the role of the headquarters of GE.
Mergers and acquisitions are used to change the portfolio quickly, but are not very popular or good for the moral of the acquired business. So now corporations form strategic alliances with partial ownership to grow.
Research has shown that acquisitions are not always the best way; they do not guarantee success. The acquired firm has to fit within the new organisational culture.
Acquisitions come in waves, when new opportunities open up, such as recently it has become easier to go global. Strategic and economic reasons drive corporations to acquire new companies. This can mean having market share, acquire new skills, diversify the portfolio or because of tax advantages and lower costs of capital (table 8.4, page 279 of the book).
When an acquisition has taken place, the corporation needs to integrate the new business, called post-acquisition integration. Ways of doing this are illustrated in figure 8.10, page 281 of the book. This can be an either/or decision or a company can go both ways in the integration. As mentioned before, the success-rate of this approach is very low.
Strategic alliances overcome these limitations and are therefore more common. A strategic alliance can be:
Between non-competitors (30%), figure 8.11:
a. International expansion: extend activities in new geographical markets;
b. Vertical integration: upstream or downstream;
c. Diversification: outside the industry origin.
The main forms in this kind of strategic alliances are:
Joint ventures: formed by companies that originate in different countries.
Vertical partnerships: formed by two companies that operate at two successive stages in the same production process.
Cross-industry agreements: collaborations formed by companies from total different industries, to leverage their complementary capabilities.
Amongst competitors (70%), figure 8.12:
a. Pre-competitive or shared supply alliance: cover only one stage in the production process, alliance is not apparent to the market the final product contains inputs from both companies.
b. Quasi-concentration alliance: covers the entire production process and results in a common product marketed by all allies. Assets and skills brought by each partner are similar and goal is to benefit from economies of scale eliminate competition between competitors.
c. Complementary alliance: when the assets contributed by the partner firms are different in nature.
All of this is summarized in tables 8.5 and 8.6, pages 286 and 287 of the book.
Corporate strategy implies value gained from mixing businesses and the way in which to manage those to achieve optimum value. It can be separated into portfolio management, growth idea (i.e. profitable growth), and relatedness (i.e. synergies). Over the years organizational structures have moved from the traditional U-form (i.e. centralized, functionally departmentalised operating firm, fig. 8.2) to the M-form (i.e. decentralised, multidivisional, semi-autonomous SBUs, fig. 8.3).
The economic logic behind the M-form is that here the whole had more value than the sum of its parts. In formula, this means:
Vc = As + Bs + Cs + Mc
Mc (which can also be negative) can have some different sources, organisational gain, benefits of scale and size, reorganisation, but the most potential one is the transaction cost Economics (TCE), where the transaction costs are shared within the whole corporation.
The M-form offers two major benefits according to the transaction cost theory, namely governance and scope.
The Corporate Business interface sets out in accountability and authority in the in which there are three styles, namely:
Strategic planning (i.e. corporate executives define/monitor corporate and business strategies)
Strategic control (i.e. corporate executives influence business-level strategies and monitor financial results)
Financial control (i.e. control of business-level strategy is decentralized and relies solely on financial control at corporate level)
One way of pursuing corporate strategy implies adding value through buying and selling businesses. They can also invest in the bought company and sells it for more value. Lastly companies can buy conglomerates and sell the parts. Porter names this portfolio management and distinguishes between three organizational/process concepts, namely restructuring, sharing activities and transferring skills.
Parenting advantage (or corporate advantage, Goold (1994)) implies that parent companies can add value to its component businesses through orientation and management. Furthermore, Goold made a distinction between three classes of value-adding corporate strategy (see figure 8.7, p. 263), namely stand-alone influence, functional and services influence and linkage influence.
Style of the parent is determinant for the level of performance and can be divided into two dimensions (see figure 8.8, p. 265), namely dimensions of planning influence and dimensions of control influence. Three styles emerge: financial control, strategic planning and strategic control.
The role of the corporate layer is dependent on relatedness between SBUs and in order to achieve economies of scope cooperation between these SBUs is highly important. Furthermore, strategic orientations can be divided into cooperative (i.e. related diversification) and competitive (i.e. unrelated diversification) ones. In conclusion, competitive and cooperative organizations are dissimilar with regard to centralization, integration, control practices and incentive schemes, therefore, incompatible. By creating core business grouping or divisions this economic and organizational dilemma can be overcome.
The boxes of the BCG matrix are star, question mark, dog and cash cow.
Academic research supports the fact that combining related businesses can add value to a corporation. In this relationship there have to be strong findings on both sides, similarities in the characteristics and a dynamic creation an accumulation of trans-business competences.
Mergers and acquisitions are used to change the portfolio quickly, but are not very popular or good for the moral of the acquired business. So now corporations form strategic alliances with partial ownership to grow. When an acquisition has taken place, the corporation needs to integrate the new business, called post-acquisition integration.
Strategic alliances overcome these limitations and are therefore more common. A strategic alliance can be between non-competitors (international expansion, vertical integration and diversification) and amongst competitors (pre-competitive or shared supply alliance, quasi-concentration alliance and complementary alliance).
There are many definitions for risk and uncertainty. However, regardless we all know what they mean. Translated into a business setting, risk and uncertainty are interrelated in such a way that taking risk provides that in order to make a profit one often needs to go for the unique, uncertain opportunities. Furthermore, research has shown that groups are more likely to take a risk than individuals. Since businesses contain many different groups of people (i.e. divisions/departments), risk will be more easily taken in this sense. However, when it comes to management, where individual decisions are taken, it depends on the personality and leadership style. Furthermore, factors such as (organizational) culture, age and experience can be determinant in risk taking.
However, the main distinctions that can be made within organizations are organizational risk and managerial risk, which are somehow interrelated and are useful in risk analysis and assessment (table 11.2, page 364 of the book provides an overview of these risks). Managerial risk taking is where managers make choices associated with uncertain outcomes. Organizational risk is where organizations face volatile income streams, which are associated with turbulent and unpredictable environments. Additionally, risk can be divided into categories, such as strategy, operations, economic and hazards and are often a combination of endogenous and exogenous origin.
Prospect theory implies that decision makers choose between risky alternatives influenced by both magnitude and probability of possible outcomes, in which a decision maker is assumed to prefer sure gain to probable gain of expected double value and to prefer a probable loss of expected double value to a sure loss. Furthermore, gains and losses are relative to a 'neutral' (relative) point, which can be individually or organizationally construed. Generally, it is the risk-averse managed organizations that reach above targeted returns, whereas risk-seeking managed organizations tend to end up below targeted levels. However, this is not necessarily always true because sometimes taking a risk can create super normal profits (think of factors such as first-mover advantage).
Uncertainty comes in many ways, shapes and sizes. In assessing risk and uncertainty, a PEST-analysis is a useful tool, which includes examining the following dimensions:
Political/legal
Economic
Socio-cultural
Technological
However, these macro-economic forces need to be held against micro-economic ones, such as industry structure, influence of suppliers, competitors and customers (table 11.4, page 368 of the book).
Risk analysis is used to assess the effects of uncertainty on decision-making, especially capital investment decisions, where one attempts to determine the 'worth' attached to the level(s) of risk. Worth can be measured in several ways, such as by calculating the net present value (NPV) or the internal rate of return (IRR).
The NPV risk analysis comprises the following actions (see also fig. 11.1):
Identify the main factors of uncertainty
Estimate the range of values within which each variable is expected to be found and assess the likelihood of occurrence
Select at random one particular value for each factor from the distribution of values
Conduct the previous step repeatedly to define and evaluate the odds of occurrence of each possible rate of return (NPV)
Derived from the outcomes NPV distributions can be created which help indicate the probability of making a loss, average NPV, probability of making a gain larger than a pre-specified level, and the level of risk. However, this is not sufficient in itself, therefore, risk analysis needs to be combined with other techniques, such as decision trees. Decision trees are designed to handle situations of sequential investment decision-making and assess risk across a series of related decisions (figure 11.2, page 371 of the book). Stochastic decision trees assume that:
All quantities and factors are empirical probability distributions
Information about results can be obtained in a probabilistic form
The probability distribution of possible results can be analysed using the concepts of utility and risk
Limitations to the risk analysis techniques are as follows:
Can be easily interpreted as falsely precise
Not always is the required sufficient thought and attention to detail being used
Models can be over-reliant on past relationships
'Soft' factors, such as cultural and social differences, are difficult to incorporate
Models rarely take into account the nature of the decision or characteristics of the firm making the decision
Risk can also be determined by means of indices, such as Business Environment Risk Indicators (BERI) and the Economic Intelligence Unit (EIU), which select a range of variables covering political, economic, and financial or operational aspects of the country in question. However, there are some limitations to this method of risk analysis, namely:
Indices cannot be easily tailored to inform specific decisions
Sometimes 'unattractive' outcomes related to risk might appear to be the best choice for the firm and vice versa
Indices assume that future performance can be predicted by the past, which is often not the case in these times of rapidly changing market conditions
For the purpose of understanding and trying to reduce risk and uncertainty more qualitative techniques such as scenario analysis can be used. Scenario analysis is about attempting to describe what is possible (i.e. visualizing the future) and designing flexible strategic options to cope with the diversity of possibilities by means of 'telling a story'. Furthermore, scenarios are useful in assessing long-term frameworks of a firm's overall strategy.
There are two key characteristics to a 'good story', namely:
It results from subjective assessments of a wide range of informed individuals/groups which are valid
It recognizes that decision makers have some influence on future development
A scenario is written as followed:
Identify focal issue(s)
Specify scope of planning and time frame
Establish a broad background that includes the organization's deep structure (e.g. PEST-analysis)
Identify the driving forces that link focal issues with long-term future
Identify critical environmental uncertainties
Create alternative futures by combining driving forces with uncertainties
Validate the alternative futures
Analyse scenario's for similarities, (sources of) difference(s), and mutual dependence
Quantify the effect of each scenario on the firm and select appropriate strategies
Develop strategic options and criteria for future choices and paths
In conclusion, scenarios consider a longer time horizon, and offers a more broad set of options, as opposed to other techniques. In this way they help to assess risk over longer-term and identify strategic options for the organization.
Scenarios do not offer whether the organization is capable of implementing future strategies. For this purpose decision makers should do as follows:
Explore the long-term beyond the planning horizon
Build on a wide set of assumptions
Explore a wide range of outcomes
Meld assumptions-outcome sets to derive ranges of possible futures
Explore paths required to move from the present to these futures
The question remains how effectively scenarios can be made and if they are useful to the organisation. That is why scenario planning also has some other functions:
Reflect the formulated strategy back against the organization
Identify what changes need to be made with regard to 'gap analysis'
Identify and select key indicators/signposts which will help monitor and assess implementation/performance of the chosen strategies
Gap analysis (table 11.5, p. 382) implies that core competences of the firm are assessed against future strategies. Furthermore, by defining an organization's core competences it can be determined to what extent they contribute/support towards the chosen strategy. This way a company can see what they need to fulfil their future scenario.
There are many definitions for risk and uncertainty. Translated into a business setting, risk and uncertainty are interrelated in such a way that taking risk provides that in order to make a profit one often needs to go. The main distinctions that can be made within organizations are organizational risk and managerial risk, which are somehow interrelated and are useful in risk analysis and assessment for the unique, uncertain opportunities. Managerial risk taking is where managers make choices associated with uncertain outcomes. Organizational risk is where organizations face volatile income streams, which are associated with turbulent and unpredictable environments. Additionally, risk can be divided into categories, such as strategy, operations, economic and hazards and are often a combination of endogenous and exogenous origin.
Prospect theory implies that decision makers choose between risky alternatives influenced by both magnitude and probability of possible outcomes, in which a decision maker is assumed to prefer sure gain to probable gain of expected double value and to prefer a probable loss of expected double value to a sure loss.
Uncertainty comes in many ways, shapes and sizes. In assessing risk and uncertainty, a PEST-analysis is a useful tool, which includes examining the following dimensions: political/legal, economic, socio-cultural and technological.
Risk analysis is used to assess the effects of uncertainty on decision-making, especially capital investment decisions, where one attempts to determine the 'worth' attached to the level(s) of risk. Worth can be measured in several ways, such as by calculating the net present value (NPV) or the internal rate of return (IRR).
Decision trees are designed to handle situations of sequential investment decision-making and assess risk across a series of related decisions (figure 11.2, page 371 of the book). Stochastic decision trees assume that:
All quantities and factors are empirical probability distributions
Information about results can be obtained in a probabilistic form
The probability distribution of possible results can be analysed using the concepts of utility and risk
Risk can also be determined by means of indices, such as Business Environment Risk Indicators (BERI) and the Economic Intelligence Unit (EIU), which select a range of variables covering political, economic, and financial or operational aspects of the country in question.
For the purpose of understanding and trying to reduce risk and uncertainty more qualitative techniques such as scenario analysis can be used. Scenario analysis is about attempting to describe what is possible (i.e. visualizing the future) and designing flexible strategic options to cope with the diversity of possibilities by means of 'telling a story'. There are two key characteristics to a 'good story', namely:
It results from subjective assessments of a wide range of informed individuals/groups which are valid
It recognizes that decision makers have some influence on future development
In conclusion, scenarios consider a longer time horizon, and offers a more broad set of options, as opposed to other techniques. In this way they help to assess risk over longer-term and identify strategic options for the organization.
The question remains how effectively scenarios can be made and if they are useful to the organisation. That is why scenario planning also has some other functions:
Reflect the formulated strategy back against the organization
Identify what changes need to be made with regard to 'gap analysis'
Identify and select key indicators/signposts which will help monitor and assess implementation/performance of the chosen strategies
Gap analysis (table 11.5, p. 382) implies that core competences of the firm are assessed against future strategies.
Strategic decisions are the decisions that drive or shape most of the organization's actions, are not easily modified once implemented and greatly impact organizational performance. Furthermore, these decisions are framed and shaped against a wider context, such as government intervention policies (e.g. privatisation and deregulation), and are made by choice of management. In the decision making process managers rely, among other things, on previous experience and feelings/intuition. Finally, strategy nowadays implies positioning the firm throughout competition, internationalisation, and changing markets/technologies.
The strategic decision making process consists of four aspects (see fig. 12.1, p. 392):
Decision action (individuals and groups)
Organisational action (choices and outcomes)
Interpretations and responses to the environment
Knowledge, interests, preferences and world views
Decision-making is mostly about making a choice between two alternatives. This choice is dependant of the context it is in.
Decision-making can be viewed by different perspectives, such as the five mentioned by Mintzberg, which are:
Decision-making as a plan (i.e. intentional course of action)
Decision-making as a ploy (i.e. designed to outsmart competition)
Decision-making as a pattern (i.e. emergent behaviour)
Decision-making as a position (i.e. achieving a match between organization and environment)
Decision-making as a perspective (i.e. reflect strategist's view on the world/organization)
Strategic programming is based on planning and evaluation based on standardisation of procedures and activities around managerial decision-making.
Game theory was designed to help make sense of and react to actions of competitors by examining what is likely to happen when two players make choices and figuring out the best outcomes/pay-offs of these choices. Game theory is based on several assumptions, namely:
Players are perfectly rational in their behaviour/choices
Players have perfect knowledge of the rules
Players always want to maximize returns
An example of game theory is shown in figure 12.2, page 397 of the book.
Sensitivity analysis is used to investigate what happens if the underlying assumptions of a strategic decision are questioned and modified. This creates essential awareness with management about the consequences of even the slightest modification.
Options help management make key decisions about future activities when current strategies are letting them down (i.e. strategic decay). Organizational decline can be evident or sometimes less evident, such as when organizations are profitable, however, share price collapses due to erosion of confidence in future profitability. Furthermore, option techniques rely on two dimensions, namely:
Identification of additional or alternative organizational capabilities that might be needed to satisfy future product/service needs
Identification of potential future markets and/or new consumer behaviours
Additionally, based on degrees of capabilities and knowledge of new markets, four strategic options can be distinguished (see fig. 12.3, p. 398), namely:
No options (low capabilities/low knowledge): decision making is limited to being reactive and becoming part of others' strategies
Bounded options (high capabilities/low knowledge): capable but little awareness of new markets
Trading options (low capabilities/high knowledge): aware, but unable to do anything whereby the best option is to trade information
Full set of options (high capabilities/high knowledge): high ability to identify and follow strategic options
Strategic decision-making can be classified in three distinct types:
Sporadic: it is a subject to delays and recycles.
Fluid: smooth flow and shorter duration.
Constricted: a small number of seniors makes the decision (in between)
The determinants of these three are mainly the political nature of the decision and the complexity of the problems involved. Table 12.2, page 401 of the book gives an overview of these variables.
More in depth there are three characteristics that influence the decision-making.
The first are the decision-specific characteristics. Decision-specific characteristics can be divided into (1) interpretation of a problem(s) by decision makers and (2) characteristics of the decision or problem(s) to be solved.
Strategic decisions have the following characteristics:
They are difficult to define precisely
Understanding the problem is part of the solution
There are a series of possible best solutions
Each solution represents a trade off
They are difficult to assess in terms of performance
They are connected with other problems in the organisation
There are high levels of uncertainty involved
They require high degrees of risk
They are difficult to reverse
They are likely to be discontinuous and political
The second variable is the organizational context. Organizational context mainly covers systems, structure, ownership and control, and organization culture.
The last determinant is the relationship between decision-making and performance. It is very difficult for managers to connect their decisions to outcomes of performance, especially when it goes the right way.
Decisions might fail where typical mistakes are as follows:
Failure to address the real problem
Decision made the problem worse as opposed to better
Wrongly made decisions become irreversible and pull the organization even further into crisis
Research points out that it mainly goes wrong within the implementation phase of the decision, so from the point of authorization to when the decision is put into practice.
It remains very difficult to pinpoint where things have gone wrong. However, some key factors exist with regard to higher-achieving decisions, namely:
Structure and receptiveness of organizational culture to the decision
Features of what actions managers take during the process
Features of the decision-process itself
Finally, achieving successful decisions relies on
Knowledge base of managers: how familiar managers are with the problem to be addressed.
Receptivity of organizational context to the strategic decision being implemented: how ready the organization is to adopt the changes required by the strategic decision.
(See figure 12.4, page 409 of the book).
Research on this topic has also shown that:
No single organisation has all the strategic decision in one cell (of fig. 12.4)
There is considerable variation in value in the decision
Getting the decisions in the top will likely increase the overall performance
There are no differences in the types of organisation in this matrix
To make a decision successful, the formulation and the implementation have to be consistent and right. There has to be an anticipation in both of the processes. Even though this may take some more time, it is essential for the success of a decision.
There also has to be a political connection. If the stakeholders do not agree in the formulation phase, this is likely to cause problems for the implementation.
Lastly it is important to know who are involved in both the processes. The four greatest players are: Production and Service Delivery, Finance, Suppliers and Marketing (with Sales). The influence of the four players is in the formulation phase almost the same, but in the implementation the Suppliers are not that much involved anymore.
Strategic decisions are the decisions that drive or shape most of the organization's actions, are not easily modified once implemented and greatly impact organizational performance. The strategic decision making process consists of four aspects:
Decision action (individuals and groups)
Organisational action (choices and outcomes)
Interpretations and responses to the environment
Knowledge, interests, preferences and world views
Decision-making can be viewed by different perspectives, such as the five mentioned by Mintzberg, which are:
Decision-making as a plan (i.e. intentional course of action)
Decision-making as a ploy (i.e. designed to outsmart competition)
Decision-making as a pattern (i.e. emergent behaviour)
Decision-making as a position (i.e. achieving a match between organization and environment)
Decision-making as a perspective (i.e. reflect strategist's view on the world/organization)
Strategic programming is based on planning and evaluation based on standardisation of procedures and activities around managerial decision-making. Game theory was designed to help make sense of and react to actions of competitors by examining what is likely to happen when two players make choices and figuring out the best outcomes/pay-offs of these choices.
Sensitivity analysis is used to investigate what happens if the underlying assumptions of a strategic decision are questioned and modified.
Options help management make key decisions about future activities when current strategies are letting them down (i.e. strategic decay).
Additionally, based on degrees of capabilities and knowledge of new markets, four strategic options can be distinguished (see fig. 12.3, p. 398), namely no options, bounded options, trading options and a full set of options.
Strategic decision-making can be classified in three distinct types:
Sporadic: it is a subject to delays and recycles.
Fluid: smooth flow and shorter duration.
Constricted: a small number of seniors makes the decision (in between)
More in depth there are three characteristics that influence the decision-making. The first are the decision-specific characteristics. Decision-specific characteristics can be divided into (1) interpretation of a problem(s) by decision makers and (2) characteristics of the decision or problem(s) to be solved. The second variable is the organizational context. Organizational context mainly covers systems, structure, ownership and control, and organization culture. The last determinant is the relationship between decision-making and performance.
It is very difficult for managers to connect their decisions to outcomes of performance, especially when it goes the right way.
Decisions might fail where typical mistakes are as follows:
Failure to address the real problem
Decision made the problem worse as opposed to better
Wrongly made decisions become irreversible and pull the organization even further into crisis
It remains very difficult to pinpoint where things have gone wrong. However, some key factors exist with regard to higher-achieving decisions, namely:
Structure and receptiveness of organizational culture to the decision
Features of what actions managers take during the process
Features of the decision-process itself
Finally, achieving successful decisions relies on
Knowledge base of managers: how familiar managers are with the problem to be addressed.
Receptivity of organizational context to the strategic decision being implemented: how ready the organization is to adopt the changes required by the strategic decision.
Learning is considered the key internal resource to the firm and is meant to create value. A learning organization is one that is able to create, acquire, and transfer knowledge and to change its behaviour to reflect new knowledge. Systemic knowledge is the knowledge that is already inside the organisation. Knowledge management is the process of identifying, extracting and managing the information, intellectual property and accumulated knowledge that exists within a company and the minds of its employees. Dussage et al. point out clearly the distinction between ‘incremental’ innovations (refining and improving existing products or processes) and ‘radical’ innovations (introducing totally new concepts).
The learning process has to involve incremental learning that stimulates to follow up with the technology. Technologies can be:
Sustaining: improve product performance among existing firms
Disruptive: worse short-term product performance, followed by a new product, so failure of the current product.
To win over the competition with your innovation, the company has to have a value innovation. The innovation has to have radically superior value to customers and has to be available to the mass of buyers in the target market.
Revolutionary innovators are the ones that do not come up with an imitation for a lower price, but really make something new. Being efficient is no longer enough to be called innovative. Knowledge can influence these decisions because of the economic concepts, the alternative definitions of innovation and the organizational approaches.
Knowledge has already been integrated in some of the models in this book. Par example in the resource-based view: knowledge as an asset. Or in the Schumpeterian origin, knowledge was an innovation. Lastly, in the evolutionary economics knowledge was represented as part of the internal organisation and its routines.
These views will be covered in the remainder of this chapter.
This assumption is based on the market-based view (see figure 14.1, p. 457). Learning is involved in developing the core competences of a company, mostly through objectified knowledge. This way they can create a framework (figure 14.2, p. 458) to view the competition. Part of this knowledge is ‘in the organization’, but not written down. These are the intangibles (intangible assets). Those can be divided in:
The relational assets
The knowledge assets
The competences (or capabilities)
In the Schumpeterian theory it is stated that because of the dynamic environment, innovation is a medium through which creative destruction of existing technologies and knowledge take place. Schumpeter suggested there were patterns of change and ferment (radical innovation) interspersed with stability (incremental innovation).
Hyper competition argues that competitive advantage is created and destroyed at a rapid rate.
Companies survive in these markets because it is hard for new entrants to compete. One of the explanations for that is the sunk cost effect: existing companies have already invested in the technology so their contribution margin is lower to produce the products. Another explanation is the replacement effect: the monopolist in the market is a hard one to replace, so if someone enters the market, they cannot replace this monopoly that easily. Also, because of a new entrant, the monopolist has to invest as well, keeping their position in the market. It might be that the monopolist is challenged and has to lower their prices to keep the market share: this is called the efficiency effect. If this last effect is high, the other ones are low and in reverse.
The technology races to get to the dominant design: the design to which all of the competition has to adapt to stay in the market. Most of the times, the innovator of a technology is not the winner in the market.
This is a more micro-analytic approach, which aims to go where the competitive advantage is created in the resources. This approach want to analyse everything in the organisation, to open up the black box. Some of these routines are written down, but the value is in the tacit knowledge applied in them.
Knowledge-based view implies that knowledge can be viewed as an organizational asset that is created and enhanced by learning and is part of strategic management. Instead of firms out-doing each other, nowadays firms are trying to out-know each other by excelling at innovation, creativity and foresight.
Knowledge can be divided into stocks (underpins outputs and inputs of the learning process) and flows (where knowledge passes from one to another). Knowledge can be transferred as follows, according to the model of knowledge, created by Nonaka:
Internalization (i.e. process by which individuals adopt external information and build it into their existing values and assumptions)
Socialization (i.e. learning through participation in small group interactions)
Combination (i.e. learning through the exchange of explicit forms of knowledge that may be articulated in conversation, or in written form)
Externalization (i.e. conversion of tacit knowledge to explicit knowledge, which then may be available for others in the organization to access)
This results in the learning spiral, shown in figure 14.4, page 466 of the book.
The value chain was already introduced in this book. Nowadays, this chain becomes tighter and with the corporate glue and collective knowledge corporations, it can create knowledge architecture in the form of a value web (see figure 14.5, p. 468). This web has linkages between knowledge as assets, knowledge embedded in processes and the pathways to competitive advantage. Teece (1997) argues there are four knowledge processes in this web:
Entrepreneurial (creative)
Coordinative and integrative (static)
Learning (dynamic)
Reconfigurational (transformational)
In relation with strategy, there are three categories in knowledge important, also considered as the elements of the KBV. Specific knowledge is the knowledge production in functions and draws links between the elements of knowledge and knowledge renewal (fig. 14.7, p. 470). The aspects are: production, access, diffusion, connection and renewal. Organizational knowledge is the process in which the elements are taken into the organisation (fig. 14.8). Together, these create the knowledge web of the organisation.
Learning can be viewed from different levels of analysis, ranging from individual learning to organizational learning, and organizations appear rather less adaptive at learning than individuals. Learning can be separated into:
Adaptive learning (i.e. single-loop)
Organization can adapt to its environment and environmental rates of change
Simple
Involving existing models: it is used for improving efficiency and effectiveness in existing strategic practices
Poses a barrier to developing new ways of learning
Generative learning (i.e. double-loop)
Generate increased or new capabilities
Complex
May occur when a change in strategy is so difficult to implement that it exposes the problems in existing practices, causing fundamental changes in the way the organization approaches strategic problems
Encourages exploration of new opportunities
Learning can be divided into learning organization, group learning, one-to-one learning and individual learning. However, it is hard to pinpoint where learning is taking or has taken place. To achieve this, learning must be made tacit, which can be done by reflection processes.
Communities of practice, as opposed to dominant logic, occurs when members of a community learn through participation in tasks together, and transfers practices, ideas and concepts about the work processes. These communities can become one of the organization's core competences. Therefore, it is important that they are identified and encouraged by management and given legitimacy in order to get them into the mainstream of organizational information flows. An organisation needs to:
Identify the communities
Provide infrastructure
Use non-traditional methods to assess the value of a community of practice
A learning organization is one that is able to create, acquire, and transfer knowledge and to change its behaviour to reflect new knowledge. Systemic knowledge is the knowledge that is already inside the organisation. Knowledge management is the process of identifying, extracting and managing the information, intellectual property and accumulated knowledge that exists within a company and the minds of its employees. Dussage et al. point out clearly the distinction between ‘incremental’ innovations (refining and improving existing products or processes) and ‘radical’ innovations (introducing totally new concepts).
The learning process has to involve incremental learning that stimulates to follow up with the technology. Technologies can be sustaining and disruptive. To win over the competition with your innovation, the company has to have a value innovation.
Revolutionary innovators are the ones that do not come up with an imitation for a lower price, but really make something new. Being efficient is no longer enough to be called innovative. Knowledge can influence these decisions because of the economic concepts, the alternative definitions of innovation and the organizational approaches.
Learning is involved in developing the core competences of a company, mostly through objectified knowledge. This way they can create a framework (figure 14.2, p. 458) to view the competition. Part of this knowledge is ‘in the organization’, but not written down. These are the intangibles (intangible assets). Those can be divided in relational assets, knowledge assets and the competences.
In the Schumpeterian theory it is stated that because of the dynamic environment, innovation is a medium through which creative destruction of existing technologies and knowledge take place. Schumpeter suggested there were patterns of change and ferment (radical innovation) interspersed with stability (incremental innovation).
Companies survive in these markets because it is hard for new entrants to compete. Explanations are the sunk cost effect and the replacement effect. It might be that the monopolist is challenged and has to lower their prices to keep the market share: this is called the efficiency effect. The technology races to get to the dominant design: the design to which all of the competition has to adapt to stay in the market.
Knowledge-based view implies that knowledge can be viewed as an organizational asset that is created and enhanced by learning and is part of strategic management.
Knowledge can be divided into stocks (underpins outputs and inputs of the learning process) and flows (where knowledge passes from one to another). Knowledge can be transferred as follows, according to the model of knowledge, created by Nonaka: internalization, socialization, combination and externalization. This results in the learning spiral.
The value chain becomes tighter and with the corporate glue and collective knowledge corporations, it can create knowledge architecture in the form of a value web. This web has linkages between knowledge as assets, knowledge embedded in processes and the pathways to competitive advantage.
Teece (1997) argues there are four knowledge processes in this web: entrepreneurial, coordinative and integrative, learning and reconfigurational.
In relation with strategy, there are three categories in knowledge important, also considered as the elements of the KBV. Specific knowledge is the knowledge production in functions and draws links between the elements of knowledge and knowledge renewal (fig. 14.7, p. 470). The aspects are: production, access, diffusion, connection and renewal. Organizational knowledge is the process in which the elements are taken into the organisation (fig. 14.8). Together, these create the knowledge web of the organisation.
Learning can be viewed from different levels of analysis, ranging from individual learning to organizational learning, and organizations appear rather less adaptive at learning than individuals. Learning can be separated into adaptive learning and generative learning. Learning can be divided into learning organization, group learning, one-to-one learning and individual learning.
Communities of practice, as opposed to dominant logic, occurs when members of a community learn through participation in tasks together, and transfers practices, ideas and concepts about the work processes.
Due to exogenous forces, such as a global economy, government liberalization, and an increasing influence of foreign institutional investors, corporate governance has become more important. Furthermore, there are endogenous pressures related to purpose, responsibility, control, leadership, and power of boards.
Despite the lacking of a single model about effective governance, the OECD has pointed out corporate governance as essential to improving economic efficiency/growth, and enhancing investor confidence. Moreover, some events have taken place that argue for stronger governance, which are:
Succession of corporate scandals
Performance weaknesses at least partially related to poor governance and leadership
Disjuncture between CEO compensation and that of executive directors, and the financial performance of organizations they are managing
Furthermore, codes of governance have been created that are produced under different legal systems and have been customized to particular national settings. As a result, many differences exist with regard to governance.
Over time, power has separated between executive management of major public companies and their increasingly diverse/remote shareholders, which has lead to a problem of control.
Agency theory implies that effective boards will take the shareholders' (i.e. principals) interest into consideration, use their experience in decision making, and use their power to prohibit self-interest tendencies of corporate management (i.e. agents). To do so, boards need to be able to exercise substantial power over corporate management.
Multiple and double agency implies that the agent has more relationships than just with the shareholders. The second relationship is with the organisation itself. This one has to ensure the alignment between the objectives and successful implementation. Multiple agents occur if a company starts an alliance with another organisation, like a joint venture. Here the managers are agents for the owners of the joint venture.
The stakeholder theory is the opposite of the agency theory. The agents strive for profit maximization, while this one want to stress the importance of all the stakeholders.
(The next section is on the corporate governance in the UK and not relevant in this summary so left out.)
O’Neal and Thomas outline the three basic functions of the board:
Advising and counselling top management
Monitoring and controlling top management
Developing corporate strategy
A board of directors oversees the senior executives. The head of the board is a chairman, who has the following duties:
Oversee board members' selection and succession
Review organization's performance and allocate funds
Oversee corporate social responsibility (CSR)
Adhere to the law
Furthermore, boards should be able to rule independently of other influences, especially that of management (see table 15.2, p. 500). Additionally, it is important that boards have access to and be provided with accurate, timely, and relevant information in order to do their job efficiently. In their practice, boards should act as follows (see table 15.3, p. 501):
Ensure they focus on correct issues during meetings and avoid side-tracking
Size is important
All members should feel they can contribute freely and effectively and arrive well-prepared at meetings
Regular meeting should be held with high levels of attendance
Build in maintenance and learning functions into operations and processes
High level of commitment
Training and development
Assessment of performance, as a team and individually
Boards must ensure that strategic decisions incorporate ethical, socially responsible and sustainable factors. An organization that fails to operate in a corporate social responsible way faces the risk of poor market ratings and adverse publicity. Table 15.4 summarizes the nine principles on human rights, labour and the environment that an organization needs to address.
The board has two major strategic purposes:
To exercise control (by overseeing the performance of the organization and those who lead it);
To provide strategic leadership (by shaping the values, identity and strategic decisions of the organization).
Additionally, it is crucial that boards generally agree on what the key drivers of performance are, which can be measured by, for example, financial results, corporate reputation or customer satisfaction.
An example of performance measurement is using the balanced scorecard approach as was explained earlier. Furthermore, any broad-based performance measure revolves around the following main questions:
How do customers perceive us?
What must we excel at?
How can we continue to improve and create value?
How are we performing financially?
This measurement process can be divided into outcomes (i.e. measures) that measure results of past actions, and performance drivers (i.e. goals) that aim to predict future success.
In addition to prioritising strategic decisions, boards are also required to assess risk (e.g. strategic, financial, compliance and operational risk). This demands clear communication and understanding between the board and management of the organization, in a sense that management implements what the board decides.
It is easier to measure board’s ineffectiveness (i.e. minimalist) as opposed to effectiveness (i.e. maximalist). Indicators of ineffectiveness can be as follows:
Poor chairing of the board
Cliques and politicking between and inside board meetings
Failure to encourage open discussion and allow issue spotting
Board is focused on narrow sets of issues and fixated by historical reporting and operational matters
Closed process of recruitment to the board
Effectiveness is related to board purposes and design choices, local responsiveness, and dynamism of boardroom activities. However, no matter how effective a board may function, tensions will always exist around power. An effective board must have:
Non-executives allowed into strategic decision-making processes
Non-executives allowed to roam outside the board
Possibility to remove old power systems in the board
High levels of trust and openness
Ensure that the balance of power between the chair and the CEO is clear
Through globalization there had been a pressure of developing an international corporate governance code. A multinational corporation corporate governance has to have a strong independent board to oversee all the operations and there needs to be good communication. This can increase the stock prices and allow the corporation to grow effectively.
There are a lot of differences in countries regarding corporate governance, mostly concerned with the ownership structure, the state of the economy, the legal system, politics, culture and history. The world can be separated in two most commonly approaches:
Outsider/market exit approach: the shareholders are the most important and so is maximize shareholder profit: this is the western approach.
Insider/voice approach: all the firms’ stakeholders control the decisions the managers make. This is more common in Asian countries.
The remainder of this section explores the differences between the UK, Germany and Japan in their corporate governance. The examples are useful if the theory of this chapter does not speak enough on its own.
Due to exogenous forces, such as a global economy, government liberalization, and an increasing influence of foreign institutional investors, corporate governance has become more important. Furthermore, there are endogenous pressures related to purpose, responsibility, control, leadership, and power of boards.
Agency theory implies that effective boards will take the shareholders' (i.e. principals) interest into consideration, use their experience in decision making, and use their power to prohibit self-interest tendencies of corporate management (i.e. agents).
Multiple and double agency implies that the agent has more relationships than just with the shareholders. The second relationship is with the organisation itself. This one has to ensure the alignment between the objectives and successful implementation. Multiple agents occur if a company starts an alliance with another organisation, like a joint venture. Here the managers are agents for the owners of the joint venture.
The stakeholder theory is the opposite of the agency theory. The agents strive for profit maximization, while this one want to stress the importance of all the stakeholders.
O’Neal and Thomas outline the three basic functions of the board:
Advising and counselling top management
Monitoring and controlling top management
Developing corporate strategy
In their practice, boards should act as follows: ensure they focus on correct issues during meetings and avoid side-tracking and build in maintenance and learning functions into operations and processes. Boards must ensure that strategic decisions incorporate ethical, socially responsible and sustainable factors. An organization that fails to operate in a corporate social responsible way faces the risk of poor market ratings and adverse publicity.
The board has two major strategic purposes: to exercise control and to provide strategic leadership.
It is easier to measure board’s ineffectiveness (i.e. minimalist) as opposed to effectiveness (i.e. maximalist).
There are a lot of differences in countries regarding corporate governance, mostly concerned with the ownership structure, the state of the economy, the legal system, politics, culture and history. The world can be separated in two most commonly approaches: the outsider/market exit approach and the insider/voice approach.
A company wants to measure its performance to evaluate if their strategy is the right one. Managers must link their critical success factors to the performance of the company to fine tune in the right direction.
This domain can be used to measure organisational effectiveness and exists of three rings, from the inside out (see fig. 16.1, p. 521):
The financial performance: accounting principles are used.
Business performance (financial + operational performance): performance indicators are used to identify the operational success.
Organisational effectiveness: benchmarking the strategic goals to examine performance. This includes the shareholders and stakeholders of the company.
Accounting-based performance measurements are related to the efficiency of the company. Examples are:
ROI (return on investment): net income/capital investment
ROE (return on equity): net income/shareholders equity
ROS (return on sales): net income/sales revenue
ROA (return on assets): net income/assets
EPS (earnings per share): net income/number of shares outstanding
P/E (price/earnings ratio): ratio of stock price/net income
These measurements can also be used to indicate the growth of the company.
The Economic Value Added (EVA) is the net operating profit after tax (as a percentage) – weighted average cost of capital. The result is an indicator of the strategic value of the company. This is also called the economic profit and can be used to evaluate performance of businesses to see if they are adding value to the corporation.
The Shareholder Value Approach (SVA) is all about maximizing shareholder value. This means calculating the Net Present Value of the firm.
To do this, the managers have to develop their business model first. This lays out the processes and structures of the organisation and the links in between. A business model must have the following elements (fig. 16.2, p. 525):
Value proposition
Nature of inputs
How to transform inputs (including technology)
Nature of outputs
Vertical scope
Horizontal scope
Geographical scope
Nature of customers
How to organize
This business model explains the logic of the intended strategy in terms of the key strategic choices and the specific operations that have to take place. With this detailed plan, the consequences for cash flows can be determined and the link between (intended) strategy and (expected) performance can be established.
If a business model is developed, the steps of the SVA are as follows:
Clear identification of the business model with the strategic, operational and financial drivers.
Derivation of the model of the set of viable strategic options.
Evaluation and estimation of the cash flow profiles with each option.
Estimation of the company’s cost of capital
Discounting the cash flow profile for each strategic option
Choosing the strategic option with the highest NPV
The Balanced Scorecard is a broader approach of evaluating performance with more perspectives. It identifies four groups with Key Performance Indicators. These are all shown on pages 530-531 of the book. The four main groups are:
Financial lens measures
Consumer lens measures
Internal lens measures
Innovation and learning lens measures
Drivers for these KPI’s are the critical success factors: the Balanced Scorecard measures them well because of the variety of aspects and the way they are linked together in a single map which gives an easy overview.
To make the Balance Scorecard work, managers have to make the linkage between the short-term and long-term goals. This goes by four processes (see fig. 16.4, p. 532):
Translation of the vision and strategy statements
Communicating and linking
Business planning
Feedback and learning
In practice, most of these analyses are done by the CFO and are communicated throughout the organisation.
Figure 16.5 (p. 534) shows a strategy map. This strategy map unfolds the four lenses of the balanced scorecard (the core process) and builds them systematically from workforce and operational issues to a customer value proposition that leads to improved shareholder value.
The domain of business performance can be used to measure organisational effectiveness and exists of three rings, from the inside out (see fig. 16.1, p. 521):
The financial performance: accounting principles are used.
Business performance (financial + operational performance): performance indicators are used to identify the operational success.
Organisational effectiveness: benchmarking the strategic goals to examine performance. This includes the shareholders and stakeholders of the company.
Accounting-based performance measurements are related to the efficiency of the company. Examples are: ROI, ROE, ROS, ROA, EPS en P/E. The Economic Value Added (EVA) is the net operating profit after tax (as a percentage) – weighted average cost of capital. The Shareholder Value Approach (SVA) is all about maximizing shareholder value. This means calculating the Net Present Value of the firm. If a business model is developed, the steps of the SVA are as follows:
Clear identification of the business model with the strategic, operational and financial drivers.
Derivation of the model of the set of viable strategic options.
Evaluation and estimation of the cash flow profiles with each option.
Estimation of the company’s cost of capital
Discounting the cash flow profile for each strategic option
Choosing the strategic option with the highest NPV
The Balanced Scorecard is a broader approach of evaluating performance with more perspectives. It identifies four groups with Key Performance Indicators. The four main groups are:
Financial lens measures
Consumer lens measures
Internal lens measures
Innovation and learning lens measures
To make the Balance Scorecard work, managers have to make the linkage between the short-term and long-term goals. This goes by four processes (see fig. 16.4, p. 532):
Translation of the vision and strategy statements
Communicating and linking
Business planning
Feedback and learning
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