How can companies strategic-planning process take into account very rapid changes in its environment?
Discussion Questions
1. Discuss elements in your own life that have changed faster than you would have imagined. How did the changes happen?
2. What things can or do you buy now that did not exist five years ago? Three years ago?
3. What are some things that will become available in the next 3–5 years that are not now available? What do companies have to do to make them happen (besides, of course, having the necessary technology)?
4. How can a company’s strategic-planning process take into account very rapid changes in its environment?
5. In which areas do you think the most profound and rapid changes are occurring? Why?
CHAPTER 1Section 1.5 What Is “Success”?
discount rate. From that computed value is subtracted all current debt. If computed exactly the same way, even using different discount rates over time, one can keep track of shareholder value and use it as a criterion in decision making and investing (Rappaport, 1997).
Michael Raynor, who came to prominence for his con- tribution to the idea of disruptive innovation, believes that companies should adopt as their main purpose survival rather than shareholder value (Raynor, 2009). His thesis questions the choice of shareholder as the most important stakeholder because they are “own- ers” of the corporation and therefore deserve to have their investment maximized. Instead, as he says, “A stock certificate is a particular sort of claim on cor- porate wealth . . . not a deed of ownership” (Raynor, 2009, p. 5). More accurately, as suppliers of capital to the corporation, stockholders deserve to be paid enough to keep them investing, just as employees deserve enough payment to keep them motivated. Rather than maximizing stockholders’ returns at the expense of returns to other stakeholders, Raynor advocates being fair to all suppliers of inputs at a level that guarantees their continuation to ensure the corporation’s survival.
Net Worth Calculating the net worth or value of a privately held company is more difficult but becomes neces- sary if a company wants to be acquired or if it wants to issue shares to investors. What is typically done is that a valuation consultant is engaged and uses several (usually 3–5) valuation methods, eventually taking an average. Not until a company is actually bought is its true worth or market value established. Market value is distinct from book value, which is what is reflected on the company’s balance sheet and takes into account its depreciated and amortized assets, inventory, and goodwill. Market value represents the value an asset might fetch if sold on the open market. For example, a cus- tomer list (part of goodwill) has one value to an accountant and perhaps far more value to an acquirer.
Profit Profit is a popular reason why companies stay in business, but, as said in various ways in the finan- cial sector, “Cash is fact, profit is opinion.” Certainly, it’s complicated. In the sense used here, we mean net profit after taxes (NIAT) or “the bottom line.” It is what is left after all allowable expenses have been deducted over a specified period. There are other kinds of profit: gross profit; operating profit; earnings before interest, taxes, depreciation, and amortization (EBITDA); earnings before interest and taxes (EBIT); and net income before taxes (NIBT). Just look at any income statement.
NIAT is an accounting artifact, approved by the American Institute of Certified Public Accountants (AICPA) and conforming to widely accepted accounting rules called GAAP (Generally Accepted Accounting Principles). The final value depends on depreciation and amortization of assets on arti- ficial schedules created by accountants. Some equipment, for example, may be fully depreciated, having zero value, yet continue to be used for years.
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A company does not know its true worth or market value until it is bought.
CHAPTER 1Section 1.5 What Is “Success”?
As if to support the previous point, a company can spend cash but not profits. Nor can it spend retained earnings, which is a balance-sheet account that accumulates profits or losses from previ- ous years. It can spend only cash. At some point, profits show up as operating cash, loans are an influx of cash, investment gains result in cash, and even selling stock results in cash inflow. So it’s cash that is king, not profits. Having said that, NIAT is so pervasively used in business as an indica- tor of success that companies continue to use it widely.
Highly related to NIAT are several financial ratios that use NIAT, like net profit margin (NPM), which is NIAT divided by revenues, and return on equity (ROE), which is NIAT divided by total stockholders’ equity. NPM is a measure of a firm’s profitability relative to its revenues, and ROE is a proxy for the net profits that are, in a sense, generated by stockholders’ investment in the company.
Market Share Another measure of success is market share. Every company wants to be the market leader, but only one can be. What is not so obvious, especially to companies that publicly avow to increase market share, is that to do so, their revenues have to grow faster than total industry revenues. They will maintain their market share if they grow as fast as the industry, and actually lose market share if their growth lags behind the industry’s.
Some years ago, a graduate student prepared a report on the company he worked for, a defense- aerospace contractor in Los Angeles. He was tired of hearing the CEO constantly telling everyone he wanted the company to gain market share. His study revealed that the company would have had to invest about $1.5 billion over the next three years to do so, and simply did not have that amount of money, either in cash or borrowed funds, to invest. When he showed his results to the CEO, the CEO changed his tune about wanting to gain market share.
Often, market share cannot be measured, whether because there are simply too many competi- tors or because many competitors are privately held. In addition, it may not be possible to know how fast the industry’s total sales are growing against which a company could compare its own rate of revenue growth. In these circumstances, market share is not a good indicator of success. A closely related indicator is the company’s own revenue growth, which can be measured.
Another indicator of success is whether the company has a core competence, a capability that gives it a strategic or competitive advantage over its competitors. This will be discussed in more detail in Chapter 4.
Brand Equity Having a strong reputation, strong brand, or strong brand equity are also indicators of competitive success. These signify a successful differentiation strategy and, more than likely, a sizable market share, strong revenue growth, and healthy profits. A company is doing well on this criterion when customers buy its product because its brand is the primary reason for their purchase decision. Many people when they are thirsty go for a Coke, because Coca-Cola has such a strong brand and they have developed a habit of buying that brand. McDonald’s has a similar grip on many people wanting a quick hamburger. In the auto industry, Mercedes, BMW, Porsche, Lexus, Volvo, Toyota, and Honda all conjure up specific
CHAPTER 1Section 1.6 What Is Strategy?
brands—a unique set of promises— that attract loyal customers. They have strong brands and meet the needs of people who buy their cars.
Brand equity or brand strength refers to the power of a brand to influence purchases and loy- alty. Brands and reputations can increase, remain the same, or erode over time if efforts to main- tain them aren’t made. The main reasons for brand erosion are com- petitors duplicating the quality of a brand so that it is no longer unique or a company failing to perform in ways that the brand promises. Nor- dstrom’s department store offers an illustration of a successful differ-
entiation strategy. More than the strategy, Nordstrom’s legendary customer service has become its core competence and its brand. However, if other department stores provided similar out- standing service or Nordstrom’s own employees failed to live up to the company’s reputation, its brand equity could begin to decline. People would then stop shopping there because its brand had eroded, thereby adversely affecting its performance on other measures like revenues and profits.
1.6 What Is Strategy? Strategy is how a company actually competes (Abraham, 2006). This simple definition is not only true but also effective because it tacitly recognizes that companies could have a bad or ineffective strategy and hence not be able to compete well. Typical definitions of strategy are, in fact, defini- tions of a good or ideal strategy (see Appendix A for 77 such definitions). While these are commonly accepted terms, there is no agreement on a single definition of good or ideal strategy. In this section
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Nordstrom’s excellent customer service has become its core competence and its brand. If employees do not maintain a high level of customer service, the brand’s worth will decline.
Discussion Questions 1. Imagine you are a country’s minister for health. What measures of success might you adopt in
order to judge whether health expenditures are being made wisely? 2. What measures might you look at personally to assess how happy you are? 3. Imagine you have just graduated and are in the job market. What criteria might you use to help
you land the best job, assuming you got more than one offer? 4. It is widely held that it is enough for a firm to be profitable. Is it? What other measures might you
consider using to help ensure that the company would still be in business five years from now? 5. Imagine you are on the verge of retiring. Looking back on your career, how would you gauge how
successful it was? 6. Imagine you have only a few days to live. What criteria would you use to indicate to yourself how
good a life you have lived? 7. How might you tell that your company is the technological leader in its industry?
CHAPTER 1Section 1.6 What Is Strategy?
the most common strategies are introduced, grouped for convenience into seven categories: con- centration strategies, product-development strategies, market-development strategies, conglom- erate-diversification strategies, innovation strategies, technology strategies, and generic strategies.
Concentration Strategies A concentration strategy is some combination of producing an existing, improved, or new product or service for an existing, expanded, or new market. It’s useful to think of them as being one of the following types.
Product-Development Strategies Product-development strategies entail continuing to produce an existing product or service, improving them over time, and introducing new ones, all for the same market. The best examples are the auto companies that bring out improved versions of every model every year and, usually every four years, redesign every model. They periodically also introduce completely new models, like Honda’s Element, Toyota’s Scion line, and Nissan’s Leaf. Likewise, software companies bring out successively improved versions of their product by labeling them Version 2.0, 2.1, 2.2, 3.0, and so on. Microsoft has introduced successive versions of its ubiquitous Windows operating system, from 1.0 through the famous XP and the infamous Vista to the current Windows 7, a remarkable feat of constant improvement.
Market-Development Strategies Market-development strategies involve penetrating an existing market, expanding into related markets, or finding new markets for the existing products or services a company produces. A jeans manufacturer targeting young men could target older men or children. Banks expand their pres- ence by opening offices in supermarkets. If a company does business in only one state, expand-
ing to other states and eventually nationally is finding new markets, as is a domestic company expand- ing internationally.
A combination of product- and market-development strategies is employed when expanding a mar- ket or finding a new market requires modifying the product. Examples of this are jeans for men having to be redesigned for women, or cars having to be modified for countries where drivers drive on the other side of the road. Sometimes modi- fying a product is the only way of expanding the market. Increasing a car’s performance to appeal to younger male buyers, adjusting its size and flexibility to
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Innovation strategy is a product-development strategy that requires research and development to focus on introducing technologically advanced processes or products.
CHAPTER 1Section 1.6 What Is Strategy?
appeal to families, expanding its range of colors to appeal to women buyers, or adding luxury features and status to attract higher-income and older people all illustrate this approach. Most concentration strategies fall into this category.
Conglomerate-Diversification Strategy A conglomerate-diversification strategy is one in which a company introduces a brand new prod- uct or service for a new market. In business, this is rare because of the high risk, and few if any companies use it. If a company really wants to do this, it would instead purchase another company in the industry it wants to enter, which would drastically reduces its risk.
Innovation and Technology Strategies Innovation strategy is a product-development strategy that deserves discussion on its own. Inno- vation strategy requires research and development (R&D) and focuses on introducing technologi- cally advanced products or processes. The “R” of R&D involves both basic and applied research. Basic research focuses on discovering new things and processes unimagined before and is very costly with uncertain outcomes. Applied research takes existing knowledge and concentrates on commercializing it. The “D” of R&D is highly applied and focuses on improving existing products.
Figure 1.3 shows the basic types of innovation strategy, varying from short-term, relatively inex- pensive, and low-risk in the bottom-right corner of the figure to long-term, requiring considerable
Tuning and
incremental
New core
process
Unique radical
Research and
Advanced Development
New core
product
Add-ons and enhancements
Addition to product family
Next generation of core product Platform or next generation
Enhancements, hybrids, and derivatives
Sustaining
Next generation
process
Single dept.
upgrade
Process Changes
P ro
d u
c t
C h
a n
g e s
Figure 1.3: Degrees of innovation strategy
CHAPTER 1Section 1.6 What Is Strategy?
investment, and high-risk in the top left. As the degree of change increases along either dimen- sion, the likelihood that the project will require more time and resources also increases. The ideal situation for a company pursuing an innovation strategy is to have a balanced portfolio including projects ready without much investment in the near term, some requiring more investment and time ready in the medium term, and some more risky, long-term projects requiring more research and advanced development.
Technology strategy, another facet of an innovation strategy, instead focuses on developing new or improving existing technologies and becomes the domain of companies whose products or whose very existence depends on winning the technological race. Technology refers to abstract and concrete tools—such as knowledge, skills, and artifacts—that can be used to create, produce, and deliver products.
Generic Strategies Michael Porter (1985) discovered in his research that a lack of a competitive advantage was the reason companies generated below-industry-average profits. He proposed that the way to obtain- ing a competitive advantage was through one of three generic strategies, so called because they applied to any industry. Those generic strategies are differentiation, low-cost leadership, and focus.
Differentiation A differentiation strategy involves developing a product that is unique from or superior to the product offered by the competition. There are myriad ways of doing this as was discussed when differentiation was introduced (Section 1.2). The difficulty of competing in this way is that custom- ers must perceive the product as being differentiated. It does not matter how differentiated you think your product is, if customers don’t perceive it, they won’t buy your product. An attraction of this strategy is that if your product is differentiated, you can charge more for it because custom- ers will be willing to pay more. When companies “play a different game” and leave competitors behind, they take differentiation to a new level.
One special case of differentiation is a blue-ocean strategy, which is a way of competing that requires finding a market that is not being served at all. In other words, identifying a market where you are the only provider and have no competitors. Such a market space is called a blue ocean. The name comes from an analogy where a “red ocean” represents a bloody shark-feeding frenzy all going after some prey, meaning there is too much competition. A blue ocean, on the other hand, is free of any predator except you—no competition, no blood.
Having a strong brand is another form of differentiation but is singled out because the basis of the differentiation is reputation. Companies with strong brands have strong reputations and are highly differentiated from each other. The reputation is built over time and represents the degree to which a company has met or exceeded its promises to customers. The more a company delivers on or exceeds its promises, the stronger will be its reputation. In turn, more people will have con- fidence buying from the company. For example, if a company promises great customer service and consistently treats every customer like a VIP, it will become known for customer service—just as with Nordstrom’s department stores—and people will shop there because of that great customer service. Reputations and brands can, if a company is not careful, erode with time, either because a company is not so assiduous doing what it promised or because competitors are successfully