What Is Strategy?
imitating it. If all department stores improved their customer service to the level of Nordstrom’s, would customers still make a point of shopping there? Curiously, though it isn’t rocket science, no other department store has been able to match Nordstrom’s customer service for a long time and diminish its brand.
Low-Cost Leadership A low-cost leadership strategy is completely invisible; neither competitors nor customers know what a company’s costs are. Yet, if a price war were ever started, the company with the lowest costs in the industry would be the one standing at the end. This strategy isn’t about just reducing costs but rather reducing them to be the lowest in the industry. Thus, through subtle and not-so- subtle signals that are put out to other industry players, a company can tell its competitors, “Don’t mess with me, because I have the lowest costs.” This is one reason that makes Walmart the most formidable of competitors.
Focus A specialization or focus strategy targets a very small market (often called a niche) and, in so doing, reduces greatly the number of competitors in the arena. Big competitors won’t be interested in a niche market with a relatively few customers. For example, instead of being a publisher or even a textbook publisher, be a medical-textbook publisher with only medical students as customers. You will have a chance to dominate the niche as not many other publishers will want to specialize in that niche and even charge enough to cover higher unit costs because of the lower volume.
Strategic Alliances Strategic alliances are basically agreements between two companies, ranging from simple con- tracts (minimal integration and collaboration) to joint ventures and minority ownership (heavy integration and collaboration), but where each company remains separate. Figure 1.4 shows vari- ous kinds of strategic alliances and where along the spectrum they lie. The following discussion elaborates on the figure beginning at the left-hand end.
Outsourcing and Simple Contracts Into this category fall simple purchase agreements for products or services, like engaging consul- tants that often spell out terms such as deliverables and payments. Companies need protection in case products delivered are faulty, services are unsatisfactory, or even payment is late or not paid. Agreements take care of these eventualities.
Licensing Companies that own a patent or desirable trademark make extra money through licensing use of it to other companies. In this way, they control use of that asset, how much they are compensated, and the extent to which their brand is strengthened. Harley-Davidson, the global motorcycle man- ufacturer, licenses its name and logo on clothing, mugs, and telephones, while Disney makes a fortune licensing use of its proprietary characters such as Superman, Spiderman, and
CHAPTER 1Section 1.6 What Is Strategy?
Mickey Mouse on all kinds of products made by others. Have you ever wondered why clothing and caps from your alma mater are so expensive? About half the price goes toward the university itself as a licensing fee.
Licensing works both ways. Not only do owners of patents and trademarks benefit but companies on the other end are happy to pay the licensing fees and royalties for using someone else’s intel- lectual property since they are spared the years and expense of developing that product them- selves. For example, just about every company in the world making inkjet printers licenses the basic technology from Canon.
Shared Resources and Competences Companies may share the cost of R&D to develop technologies that require large amounts of capital and risk. A consortium of semiconductor manufacturers did this in the 1980s and ‘90s when they created Sematech. Companies may negotiate exclusive cross-distribution agreements whereby two companies in different countries agree to market each other’s products in their own country. Joint R&D projects between companies and universities for the benefit of both is becom- ing increasingly common. Sharing resources is common in the auto industry—Ford, for example, had Mazda develop a new transmission for the Ford Probe when the two companies decided that Mazda’s transmission was better than Ford’s.
Partial Acquisitions (50%) Sometimes small, high-tech startup companies come up with new technologies and products that revolutionize industries or take them by storm. They desperately need capital for additional R&D or to take the product to market. Some entrepreneurs feel that venture capitalists often take too large a chunk of equity for the capital they provide, earning the nickname “vulture capitalists.” An alternate source of capital can be large companies looking for new ideas and technologies that would benefit them. In fact, many have “venture divisions” for just that purpose—to find and invest in promising new companies and technologies. To be sure, they want an equity stake, but the equity demands are typically more reasonable since they are more interested in first rights to the technology when it is developed, giving them a competitive advantage. These investments typically result in 10–30% equity stakes in these companies in exchange for investments of $1–10 million. Such investor companies also may acquire a controlling interest in the small company later for an additional investment.
Joint Ventures Whereas two companies forming a strategic alliance still remain separate entities, forming a joint venture (JV) requires the formation of a new corporate entity jointly owned by the two compa- nies. An apt analogy often used in the literature is two parents giving birth to a child. The JV is governed by a detailed and encompassing agreement that specifies what each parent will con- tribute to the child, how much of the risk each parent incurs and the percentage of profit each is due, how long the agreement will endure, under what circumstances the agreement can be termi- nated, and how the remaining assets are distributed. Initial contributions take the form of capital, management, technology and patents, facilities, and so on. Research has shown that JVs tend to be more successful when the management team comes from one parent—usually the dominant one—rather than both parents, especially in international JVs (Killing, 1983).
CHAPTER 1Section 1.6 What Is Strategy?
In the 1950s, Fujitsu and TRW formed a JV called TRW-Fujitsu, based in Los Angeles, for the express purpose of marketing Fujitsu products in the United States. Fujitsu contributed technology, prod- ucts, and capital, while TRW contributed management and staff, facilities, and capital. Ultimately, it was terminated a few years later because sales did not meet expectations.
Acquisitions and Mergers An acquisition strategy is one in which a company buys another to take full control of it. It may purchase anywhere from a majority 51% stake to an outright 100% ownership. “Full control” means that the acquirer makes all subsequent decisions, and its board of directors and manage- ment survive intact; the acquired companies do not. However, if it is doing well, it may make sense to retain the full management of the acquired company and simply invest in it so that it can grow and do even better. Acquisitions are paid for with cash, a combination of cash and debt and stock, or entirely with stock. In an all-stock acquisition, shares of stock in the acquired company would be exchanged for a negotiated number in the combined company. In any acquisition the final price and method of payment is, of course, negotiated by both boards of directors.
The principal reason to acquire another company is because it fits with the overall strategy, but other reasons are also common, such as for financial gain or appreciation, to prevent a competitor from doing so, or simply because the CEO gets a kick out of “wheeling and dealing.” Acquisitions are often risky, because the value it was expected to add is seldom realized. In many cases this happens because the acquirer over- paid. Additionally, problems can arise if the cultures of the acquired company and the acquirer clash and key personnel in the acquired com- pany leave (Ackatcherian, 2001).
Associated Press/Ian Nicholson/PA Wire
When British Airways merged with Spanish air carrier Iberia, they were adopting a strategy that would make them more competitive in the marketplace.
Figure 1.4: Continuum of strategic alliances
Outsourcing
Contract Services
Traditional M&A
Partial Acquisitions (Controlling
>50%)
100% Acquisitions
Corporate Alliances Increasing Partner Commitment
Licensing (nonequity)
Joint Ventures
Shared Resources
and Competences
(Nonequity)
Partial Acquisitions
(Noncontrolling <50%)
Increasing Integration and Collaboration Contractual Collaborative
CHAPTER 1Section 1.6 What Is Strategy?
A merger strategy also combines two companies, but the combined entity makes joint deci- sions and literally merges its operations carefully—some members of the board, senior manage- ment, and operational management stay on in the combined company. Often the CEO is from one company and the president from the other. Mergers succeed only when the cultures of the two entities are similar and both parties feel that merging would be in their mutual interest. In common usage the term merger is loosely used to refer to an acquisition, which is a very differ- ent arrangement.
Diversification A diversification strategy signals a move to enter another industry, which could be related to the industry it’s in or unrelated. It is often misused when companies call the broadening or extending of their product line “diversification.” There are two principal ways to enter another industry or segment. The first approach is through internal R&D, as when, for example, a new technology or product has application in another industry. A company that invented a flow meter to measure more accurately gas flow in an automobile was able to implement this strategy when it learned that this same flow meter could, in a much smaller design, be used to measure blood flow in a human being.
The second route to diversification is through acquisition, particularly in an industry in which no one in the company has any experience. The idea is to not only become an instant player in that industry but also minimize the risk by having managers and employees already experienced in that industry. The strategy works particularly well when a growth industry is targeted and all the com- pany needs to grow and succeed is capital. Mattel, Inc., the toy company, sought to diversify into the electronic segment of children’s games and acquired The Learning Company for $3.6 billion, badly overpaying for it (Mattel, Inc., 2000).
Retrenchment and Divestiture A retrenchment strategy is a conscious decision to become smaller. This could be a response to a declining industry or declining level of funding such as some defense companies had to do when military budgets were slashed. In other situations a company will divest itself of some assets by selling off a division or closing poorly performing stores. When revenues suddenly decline, com- panies have to trim expenses and payroll accordingly to fit their new reality. Selling off a division or major assets is also called a divestiture strategy.
Continuing the Mattel story, after paying too much for The Learning Company, it ran into financial trouble. Instead of increasing profits by $50 million the next year, it subsequently incurred $300 million in losses and resulted in $7 billion lopped off the company’s valuation—a 61% plunge in its stock price, costing CEO Jill Barad her job. The new CEO immediately divested The Learning Company for a fraction of its purchase price (many said “given away”) in October 2000 (Mattel, Inc., 2000).
Being acquired, or selling the company, is a special case of a divestiture strategy where the whole company is divested, that is, sold to another company or person. It is the opposite of an acquisition strategy. Are there circumstances when any company would actually want to do this? The answer is Yes. Selling a company represents a change in ownership, but in most