Tool Analysis Ford

I Academy of Management Executive, 1990 Vol. 4 No. 1

Concentrated growth strategies

John A. Pearce II, George Mason University James W. Harvey, George Mason University

Executive Overview 'Thi'his article offers a critical assessment of the merits of concentrated growth as the centerpiece of a business strategy. It includes an analysis of the environmental conditions that favor concentrated growth and why it often leads to superior performance. It also reviews methods by which innovation and expansion ccmjie managed at reasonable levels of risk to complement the iirm's basic focuSyThese guidelines make it possible to compare a firm's core characteristics with the knowledge and capabilities in technology and marketing that are necessary for profit and growth. The most important aspects of formulating and implementing concentrated growth strategies are analyzed and examples of current practice show specific instances when those aspects have resulted in success.

Article Many victims of merger mania were once mistakenly convinced that the best way to achieve company objectives was to pursue unrelated diversification in the search for financial opportunity and synergy, only to see corporate performance fall well below expectation. By rejecting that "conventional wisdom," Martin Marietta, Kentucky Fried Chicken, Compaq, Avon, Hyatt Legal Services, and Tenant have demonstrated the advantages of what is increasingly proving to be sound business strategy.

Pursuing a Concentrated Growth Strategy These companies are just a few of the majority of American business firms that compete by focusing on a specific product and market combination. Yet, little has been written about—and perhaps as little thought given to—the concentrated growth strategy.

Concentrated growth is the strategy of the firm that directs its resources to the profitable growth of a single product, in a single market, with a single dominant technology. The main rationale for this approach, sometimes called a market penetration or concentration strategy, is that the firm thoroughly develops and exploits its expertise in a delimited competitive arena.'

Despite the popularity and success of concentrated growth strategies, managers have been left without guidelines to help them determine when their firm should employ concentrated growth and how they should go about maximizing the advantages of the strategy. Furthermore, current adopters of the concentrated growth strategy are frequently tempted to expand into unrelated areas without fully understanding the consequences. The enticements to stray from this strategy include impatience to grow, pressure to use idle capacity, need to meet short-term goals, and underestimating current opportunities.^ Fascination with new product development and expansion into new markets should be tempered with the fact that new products fail at an average rate of 40% for consumer goods, 20% for industrial products, and 18% for services.^

A further enticement is to accelerate focused growth through horizontal

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integration. While such a strategy offers the advantage of enabling the firm to retain its basic product and market orientation, it exposes the company to a wide range of financially threatening complications. These potential problems include extended debt involvement; geographic variations in unions, worker contracts, and conditions of employment; added complexity in strategic planning and management coordination; and difficulties owing to multiple suppliers, local competitors, and governmental agencies. So numerous and great are these complications that their discussion is beyond the scope of this article. We restrict our attention to challenges confronted by managers who undertake a concentrated growth strategy through reliance on internal development.

Diversity and Perlormance "Stick to the knitting" is the phrase used by Peters and Waterman to describe one of several characteristics of successful corporations. "* Staying with what the firm does best and avoiding areas of operation of undeveloped skills are the bases for their endorsement of concentrated growth.

Systematic analysis of new product successes and failures further underscores the risk of deviating from company strengths. After examining 195 case histories, Calantone and Cooper identified nine new product introduction scenarios, based on resource compatibility and product superiority.^ The type of introduction that had the highest level of market success (72%) was described as a synergistic "close-to-home" product. These successful introductions had significant overlap with the firm's existing products, markets, technical expertise, and production proficiency. For example, "The Better Mousetrap with No Marketing" type of new product introduction had a success rate of 36%, while the "Me Too" product, with no technical or production synergy, averaged only 14%.

This study revealed that the pursuit of growth through expansion into previously unmastered technologies, or new markets, is done so at comparatively great risk. Other evidence adds support to the view that diversification, particularly unrelated diversification, is risky.

An analysis of the 250 largest firms in America's 25 largest industries revealed that firms that have higher measures of concentrated growth show greater financial performance.^

Another indictment of unrelated diversification was found in a study of America's best midsize businesses.^ Among the key findings was that "unrelated diversification is a mortal enemy of winning performance." In contrast, successes often resulted from "edging out." This term refers to strategies based on clear mission statements that are well-understood within the firm, predicated on offerings with value, and serve selected market segments while cautiously moving into related products, related markets, or both. Success with edging out strategies is derived from a commitment to innovation within well-known technology and well-defined market niches.

Rationale for Superior Performance Why do concentrated growth strategies lead to enhanced performance? An analysis of product successes and failures across multiple industries suggests several reasons. This study shows that the greatest influences on market success are those characteristic of firms that implement a concentrated growth strategy.^ These influences include the ability to assess market needs, knowledge of buyer behavior, customer price sensitivity, and effectiveness of promotion. Further underscoring the importance of concentrated growth-based company skills, the study also showed that these core capabilities are more of a determinant of

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The concentrating firm's ability to grow stems mainly from its development of one or more of three important strategic capabilities: marketing abilities, efficiencies of scale and other cost reductions, and product differentiation.

competitive market success than are the environmental forces faced by the firm. High success rates of new products are also tied to avoiding situations that require undeveloped skills, such as serving new customers and markets, acquiring new technology, building new channels, developing new promotional abilities, and facing new competition.^

A major misconception about the concentrated growth strategy is that the firm that practices it will settle for little or no growth. This is certainly not true for a firm that correctly utilizes the strategy. A firm employing concentrated growth grows by building on its competencies and achieving a competitive edge by concentrating in the product-market segment it knows best. The firm employing this strategy is aiming for the growth that results from increased productivity, better coverage of its actual product-market segment, and more efficient use of its technology.

The concentrating firm's ability to grow stems mainly from its development of one or more of three important strategic capabilities: marketing abilities, efficiencies of scale and other cost reductions, and product differentiation. Since the firm will try to develop a specific product-market it has two alternatives to no growth: (1) stimulate increased consumption of the product through marketing-related activities achieving efficiencies in production and distribution that allow the firm to cut its costs or to increase the value of the product in the consumer's mind, or (2) to develop special attributes that brands the product as different.

Taken together, these points provide insights into why concentrated growth strategies work. Managers should focus on well-understood markets, competitors, technology, manufacturing processes, promotion, and distribution. This approach significantly improves the likelihood of market success.

Conditions that Favor Concentrated Growth There are specific conditions in the firm's environment that are particularly conducive to the concentrated growth strategy. The first is when the firm's industry is resistant to major technological advancements. This is usually the case in the late growth and maturity stages of the product life cycle and in product-markets where product demand is stable and industry entry barriers, such as capitalization, are high. Machinery for the paper manufacturing industry, where the basic technology has not changed in more than a century is a good example.

A second especially favorable condition is when the firm's target markets are not product saturated. Markets with competitive gaps leave the firm with alternatives for growth in addition to taking market share away from competitors. The successful introduction of traveler services by Allstate and Amoco demonstrates that even an organization as entrenched and powerful as AAA could not build a defensible presence in all segments of the automobile club market.

A third condition that favors concentrated growth exists when the firm's product-markets are sufficiently distinctive to dissuade competitors in adjacent production markets from trying to invade the firm's segment. John Deere and Co. refrained from its planned growth in the construction machinery business when mighty Caterpillar threatened to enter Deere's mainstay, the farm machinery business, in retaliation. Rather than risk a costly price war on its own turf, Deere scrapped these plans for growth.

A fourth condition favorable to concentrated growth exists when the firm's inputs are reasonably stable in price and quantity and when they are available in the amounts and at the required times. Maryland-based Giant Foods is able to concentrate in the grocery business largely due to its long-term, stable arrangements with suppliers of its private label products. Most of these suppliers are the same makers of national brands that compete against the Giant labels.

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With a high market share and aggressive retail distribution. Giant controls the national brands' access to the consumer. Consequently, suppliers have considerable incentive to honor verbal agreements, called "bookings," in which they commit themselves to Giant for price, quality, quantity, and timing of shipments for a one year period.

The firm pursuing concentrated growth also benefits from being in a market with minimal seasonal or cyclical swings that would propel the firm to diversify. Night Owl Security, the Washington, D.C. market leader in home security services, commits customers to initial four-year contracts. In a town where affluent consumers tend to be quite transient, the length of this relationship is remarkable. Further reinforcement for Night Owl's concentrated growth strategy comes from the company's success in getting subsequent owners of its customers' homes to extend and renew the security service contract.

The firm can also grow while concentrating when it experiences competitive advantages based on efficient production or distribution channels. These advantages enable the firm to formulate advantageous pricing policies. More efficient production methods and better handling of distribution also allow the firm to achieve greater economies of scale or, in conjunction with marketing, result in a product that is differentiated in the mind of the consumer. Graniteville Company, the large South Carolina textile manufacturer, realized decades of growth and profitability by adopting a "follower" tact as part of its concentrated growth strategy. By producing fabrics only after market demand was well established, and by featuring products that could reflect its expertise in adopting manufacturing innovations and in highly efficient, long production runs, Graniteville prospered through concentrated growth.

Finally, the success of market generalists creates conditions for successful concentrated growth. °̂

When generalists succeed using universal appeals, they avoid making special appeals to different groups of customers. The net result is that markets dominated by generalists leave open many small pockets of markets where specialists can emerge and thrive.

For example, hardware store chains such as Stanbaugh-Thompsons and Hechinger, focus primarily on routine household repair problems and offer solutions that can be easily sold on a self-service, do-it-yourself basis. This approach leaves gaps at both the "semi-professional" and "neophyte" ends of the market—in terms of the purchaser's skill at household repairs and the extent to which available merchandise matches individual homeowner requirements.

Putting A New "Spin" on Concentrated Growth Firms that rely primarily on concentrated growth strategies may wish to modify their courses of action, yet retain their bases of strength. Managerial options represent varying degrees of concentrated growth. Managers can practice "Pure Concentrated Growth," edge out into related markets (let's call this "Market Extension"), or make minor modifications in products or develop closely related new ones that fit within existing lines ("Product Extension"). A final opportunity for growth is to combine market and product extensions to form a "Hybrid Extension" strategy.

Pure Concentrated Growth The pure concentrated growth strategy involves product improvement, intensifying promotion, expanding channels, and pricing for penetration, as exhibited by

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Kentucky Fried Chicken. Using the theme "We Do Chicken Right," KFC stresses product specialization, limited menu, expanded distribution, and aggressive advertising, sales promotion, and pricing.

Tenant Corporation, MasterCard and Visa pursued pure concentrated growth through product improvement. Tenant, a manufacturer of mechanized cleaning equipment for industrial markets, recently embarked on a major recommitment to product quality and performance. The results include a 60% share of the domestic market, a 40% share of the international market, and a rebuff to Toyota which had plans for increasing its share of the American market. MasterCard's and Visa's development of "affinity cards," which allows the holder to select an outside organization (usually nonprofit) for a contribution for each transaction, has succeeded in stimulating the use of its credit cards.

Market Extension Market extension allows companies to practice a different form of concentrated growth by identifying new uses for existing products and new demographically, psychographically, or geographically defined markets. Frequently, changes in media selection, promotional appeals, and distribution are used to initiate this approach. Market extension, by finding a new use for a product, was shown by Du Pont's Kevlar, an organic material used by police, security, and military personnel primarily for bullet-proofing. The product is now being used to refit and maintain wooden-hulled boats, since the material is both lighter and stronger than glass fibers and has eleven times the strength of steel.

News in the medical industry provides other examples of new markets for existing products. The National Institutes of Health's report of a study showing that aspirin may lower the incidence of heart attacks in healthy men is expected to boost sales in the $2.2 billion analgesic market. Due to the expansion of this market, it is also predicted that share values of non-aspirin brands, such as industry leaders Tylenol and Advil, will be hurt. Product extensions currently planned include "Bayer Calendar Pak," 28-day packaging to fit the once-a-day prescription for second heart attack prevention.

Product Extension The strategy of product extension is based on penetrating existing markets by incorporating product modifications in existing items, or developing new products with a clear connection to the existing line. The telecommunications industry provides an example of product extension based on product modification. To increase its estimated 8-10% share of the $5-6 billion corporate user market, MCI Communication Corp. augmented its product offering by extending its direct-dial service to 146 countries, the same as AT&T, at lower average rates. The recent addition of 79 countries to its network underscores management's belief in this market, estimated to grow 15-20% annually.

Other examples of expansions linked to existing lines include Gerber products decision to growth through general merchandise marketing to offset the flat baby food industry. Recent introductions include 52 items, ranging from feeding accessories to toys and children's wear.

The Hybrid Extension The hybrid extension is the search for new growth opportunities by simultaneously combining market and product modifications. This strategy is used by NAPA, a franchise organization of auto parts aftermarket distributors serving the repair industry and do-it-yourselfers. NAPA has expanded its operations to offer installation of its products. This new service is directed at the market of drivers

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who want complete services that NAPA has never served, and to those do-it-yourselfers who want to "trade up" to such services.

The greatest risk is that by concentrating in a single product- market the firm is particularly vulnerable to changes in that segment.

Overcommitment to a specific technology and product-market can hinder a firm's ability to enter a new or growing product market that offers more attractive cost-benefit tradeoffs for the firm.

Using a similar strategy, Dunkin' Donuts now offers a wider variety of breakfast items, such as eggs, breakfast meats, and croissants, targeted at the market segment not previously served by its donut and coffee offering, and at existing customers desiring diversity. Additionally, by packaging its coffee in cans for the first time, Dunkin Donuts is implementing a market extension strategy aimed at new customers who wish to serve its coffee at home or in the office.

Risks and Rewards of Concentrated Growth Under stable conditions, a concentrated growth strategy poses the lowest risk among grand strategies to a firm's economic stability. However, in a changing environment, a firm committed to concentrated growth faces high risks. The greatest risk is that by concentrating in a single product-market the firm is particularly vulnerable to changes in that segment. Slowed growth in the segment may jeopardize the company because its investment, competitive edge, and technology are deeply entrenched in a specific offering. Sudden changes by the firm are difficult when the product is threatened by near-term obsolescence, a faltering market, new substitutes, or changes in technology or customer needs. For example, the manufacturers of IBM-clones faced such a problem when IBM announced its adoption of the OS/2 operating system for its personal computer line. The change effectively made existing clones "out of date."

By entrenching in a specific industry, the concentrating firm is particularly susceptible to changes in the economic environment of its industry, since the firm does not have a cushion from involvement in other industries. For example. Mack Truck, the second largest truck maker in America, saw an 18 month slump in the truck industry result in a $20 million loss for the company.

Entrenchment in a specific product-market tends to make a concentrating firm more adept than competitors at detecting new trends. However, any failure to properly forecast major changes in the industry can result in extraordinary losses. Numerous makers of inexpensive digital watches declared bankruptcy when they failed to anticipate the competition posed by Swatch, Guess, qnd other trendy watches that emerged from the fashion industry.

A firm pursuing a concentrated growth strategy is also vulnerable to high opportunity costs by remaining in a specific product-market when other options are ignored that could employ the firm's resources more profitably. Overcommitment to a specific technology and product-market can hinder a firm's ability to enter a new or growing product market that offers more attractive cost-benefit tradeoffs for the firm. Had Apple computers maintained its policy of making equipment that did not interface with IBM equipment, it would have voluntarily ignored the strategic options that instead have proven to be its most profitable.

Rewards Examples abound of concentrating firms that report exceptional returns on its strategy. Companies like McDonald's, Goodyear, and Apple Computers have used first-hand knowledge and deep involvement with specific product segments to become powerful competitors in its markets. The strategy is even more often associated with successful smaller firms that have steadily and doggedly improved market position.

The limited additional resources necessary to implement concentrated growth, coupled with the limited risk involved, also make this strategy desirable for a firm

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with limited funds. For example, through a carefully devised concentrated growth strategy, medium-sized Deere and Company was able to become a major force in the agricultural machinery business even when competing with much bigger firms like Ford Motor Co. While other firms were trying to exit or diversify from the farm machinery business, Deere spent $2 billion in upgrading its machinery, boosting efficiency, and engaging in a program to strengthen its dealership system. This concentrated growth strategy enabled the company to become the leader in the farm machinery business, despite the fact that Ford was 10 times its size.

Firms that remain within a chosen product-market often extract the most from technology and market knowledge and minimize the risks associated with unrelated diversification. The reason for the success of a concentration strategy lies with the firm's superior insights into its technology, product, and customer, as a means of obtaining a sustainable competitive advantage. Superior performance on these aspects of corporate strategy has a significant positive effect on market success.

Conclusion Firms that are tempted to seek revenue streams through commitment to unrelated technology and markets or to lessen their dependence on mature products, must fully understand the risks of such actions. The enticement to develop new products and to expand into new markets must be tempered with the knowledge of high new product failure rates. When assessing strategic options, managers should consider the merits of concentrated growth. While building from a basis of stability and experience, concentrated growth strategies can also provide innovation and expansion at manageable levels of risk.

Endnotes ' For a more detailed and comprehensive description oi alternative business strategies, refer to John A. Pearce II. "Selecting Among Alternative Grand Strategies." CalUoinia Management Review, 30(2). Spring. 1982. 23-31.

^ A more complete list of nine reasons for abandoning a concentrated growth strategy is provided by M. Lauenstein and W. Skinner. "Formulating a Strategy of Superior Resources." Jouinal of Business Stiategy, Summer. 1980. 4-10.

' These results were reported in New Products Management for the 1980s, New York: Booz. Allen & Hamilton. 1982.

* The top selling book in which the term first appeared is T.J. Peters and R.H. Waterman. In Search of Excellence: Lessons From America's Best Run Companies, New York: Harper. 1982.

^ For details on this study, see Roger Calantone and Robert G. Cooper. "New Product Scenarios: Prospects for Success." Journal of Marketing, 45. Spring. 1981. 48-60.

° The complete findings of the study are reported in P. Varadarajan. "Product Diversity

and Firm Performance: An Empirical Investigation."/ournai o/Mariefing, 50. July. 1986. 43-57.

' A comprehensive and indepth presentation of the study appears a s Donald K. Clifford. Jr. and Richard E. Cavanagh. The Winning Performance: How America's High-Growth Midsize Companies Succeed, New York: Bantam Books. 1985.

° The original presentation of the study and its results appeared in Robert G. Cooper, "Identifying Industrial New Product Success: Project NewProd." Industrial Marketing Management, 8(2). April. 1979, 124-135.

^ For a complete description and analysis of the study, see Robert G. Cooper. "The Impact of New Product Strategies." Industrial Marketing Management, 12(4). October. 1983. 243-256.

'° For a provocative discussion of the corporate strengths of specialists and generalists. see Glenn R. Carroll. "The Specialist Strategy." California Management Review, 26(3). Spring. 1984. 126-137.

About the Author John A. Pearce II, Ph.D. is the holder of the Eakin Endowed Chair in Strategic Management in the School of Business Administration at George Mason University and chairman of the school's Management Department. Dr. Pearce is president of the Southern Management Association, and past chairman of the Academy's Entrepreneurship division. A State of Virginia Eminent Scholar, Dr.

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Pearce is a frequent leader of executive development programs and an active consultant to business and industry.

James W. Harvey is an associate professor of marketing at George Mason University in Fairfax, Virginia. His research interests include philanthropy, healthcare services, and strategic marketing. Dr. Harvey has served as consultant and executive development instructor for various organizations, including National Institutes of Health, Department of Health and Human Services, United Way of America, and National Academy for Voluntarism.

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Chapter 4

Managing Firm Resources

L E A R N I N G O B J E C T I V E S

After reading this chapter, you should be able to understand and articulate answers to the following

questions:

1. What is resource-based theory, and why is it important to organizations?

2. In what ways can intellectual property serve as a value-added resource for organizations?

3. How should executives use the value chain to maximize the performance of their organizations?

4. What is SWOT analysis and how can it help an organization?

Southwest Airlines: Let Your LUV Flow

Southwest Airlines’ acquisition of AirTran in 2011 may lead the firm into stormy skies.

Chapter 4 from Mastering Strategic Management was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 license without attribution as requested

by the work’s original creator or licensee. © 2014, The Saylor Foundation.

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Image courtesy of Stuart Seeger,http://en.wikipedia.org/wiki/File:Southwest_737_At_Burbank.jpg

In 1971, an upstart firm named Southwest Airlines opened for business by offering flights between

Houston, San Antonio, and its headquarters at Love Field in Dallas. From its initial fleet of three airplanes

and three destinations, Southwest has grown to operate hundreds of airplanes in scores of cities. Despite

competing in an industry that is infamous for bankruptcies and massive financial losses, Southwest

marked its thirty-eighth profitable year in a row in 2010.

Why has Southwest succeeded while many other airlines have failed? Historically, the firm has differed

from its competitors in a variety of important ways. Most large airlines use a “hub and spoke” system.

This type of system routes travelers through a large hub airport on their way from one city to another.

Many Delta passengers, for example, end a flight in Atlanta and then take a connecting flight to their

actual destination. The inability to travel directly between most pairs of cities adds hours to a traveler’s

itinerary and increases the chances of luggage being lost. In contrast, Southwest does not have a hub

airport; preferring instead to connect cities directly. This helps make flying on Southwest attractive to

many travelers.

Southwest has also been more efficient than its rivals. While most airlines use a variety of different

airplanes, Southwest operates only one type of jet: the Boeing 737. This means that Southwest can service

its fleet much more efficiently than can other airlines. Southwest mechanics need only the know-how to

fix one type of airplane, for example, while their counterparts with other firms need a working knowledge

of multiple planes. Southwest also gains efficiency by not offering seat assignments in advance, unlike its

competitors. This makes the boarding process move more quickly, meaning that Southwest’s jets spend

more time in the air transporting customers (and making money) and less time at the gate relative to its

rivals’ planes.

Organizational culture is the dimension along which Southwest perhaps has differed most from its rivals.

The airline industry as a whole suffers from a reputation for mediocre (or worse) service and indifferent

(sometimes even surly) employees. In contrast, Southwest enjoys strong loyalty and a sense of teamwork

among its employees.

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One tangible indicator of this culture is Southwest’s stock ticker symbol. Most companies choose stock

ticker symbols that evoke their names. Ford’s ticker symbol is F, for example, and Walmart’s symbol is

WMT. When Southwest became a publicly traded company in 1977, executives chose LUV as its ticker

symbol. LUV pays a bit of homage to the firm’s humble beginnings at Love Field. More important,

however, LUV represents the love that executives have created among employees, between employees and

the company, and between customers and the company. This “LUV affair” has long been and remains a

huge success. As recently as March 2011, for example, Southwest was ranked fourth

on Fortune magazine’s World’s Most Admired Company list.

In September 2010, Southwest surprised many observers when it announced that it was acquiring

AirTran Airways for $1.4 billion. Southwest and AirTran both emphasized low fares, but they differed in

many ways. AirTran routed most of its passengers through a hub-and-spoke system, and it relied on a

different plane than Southwest, the Boeing 717. The acquisition of AirTran thus raised important

questions about Southwest’s future. [1] How would AirTran’s hub-and-spoke system be integrated with

Southwest’s nonhub approach? Could the airlines’ respective fleets of 737s and 717s be joined without

losing efficiency? Perhaps most important, could Southwest maintain its legendary organizational culture

while taking over a sizable rival and integrating AirTran’s thousands of employees? When the acquisition

was finalized on May 2, 2011, it remained unclear whether Southwest was flying off course or whether

Southwest’s “LUV story” would continue for many years.

[1] Schlangenstein, M., & Hughes, J. 2010, September 28. Southwest risks keep-it-simple focus to spur growth.

Retrieved from http://www.washingtonpost.com/wp-dyn/content/article/2010/09/28/AR2010092801578.html

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4.1 Resource-Based Theory

L E A R N I N G O B J E C T I V E S

1. Define the four characteristics of resources that lead to sustained competitive advantage as articulated by

the resource-based theory of the firm.

2. Understand the difference between resources and capabilities.

3. Be able to explain the difference between tangible and intangible resources.

4. Know the elements of the marketing mix.

Four Characteristics of Strategic Resources

Southwest Airlines provides an illustration of resource-based theory in action. Resource-

based theory contends that the possession of strategic resources provides an organization with a golden

opportunity to develop competitive advantages over its rivals. These competitive advantages in turn

can help the organization enjoy strong profits.[1]

A strategic resource is an asset that is valuable, rare, difficult to imitate, and nonsubstitutable. [2] A

resource is valuable to the extent that it helps a firm create strategies that capitalize on opportunities and

ward off threats. Southwest Airlines’ culture fits this standard well. Most airlines struggle to be profitable,

but Southwest makes money virtually every year. One key reason is a legendary organizational culture

that inspires employees to do their very best. This culture is also rare in that strikes, layoffs, and poor

morale are common within the airline industry.

Competitors have a hard time duplicating resources that are difficult to imitate. Some difficult to imitate

resources are protected by various legal means, including trademarks, patents, and copyrights. Other

resources are hard to copy because they evolve over time and they reflect unique aspects of the firm.

Southwest’s culture arose from its very humble beginnings. The airline had so little money that at times it

had to temporarily “borrow” luggage carts from other airlines and put magnets with the Southwest logo

on top of the rivals’ logo. Southwest is a “rags to riches” story that has evolved across several decades.

Other airlines could not replicate Southwest’s culture, regardless of how hard they might try, because of

Southwest’s unusual history.

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A resource is nonsubstitutable when competitors cannot find alternative ways to gain the benefits that a

resource provides. A key benefit of Southwest’s culture is that it leads employees to treat customers well,

which in turn creates loyalty to Southwest among passengers. Executives at other airlines would love to

attract the customer loyalty that Southwest enjoys, but they have yet to find ways to inspire the kind of

customer service that the Southwest culture encourages.

Southwest Airlines’ unique culture is reflected in the customization of their aircraft over the years, such as the “Lone Star

One” design.

Image courtesy of planephotoman,http://en.wikipedia.org/wiki/File:Southwest_737_Lonestar_One.jpg.

Ideally, a firm will have a culture that embraces the four qualities. If so, these resources can provide

not only a competitive advantage but also a sustained competitive advantage—one that

will endure over time and help the firm stay successful far into the future. Resources that do not

have all four qualities can still be very useful, but they are unlikely to provide long-term advantages.

A resource that is valuable and rare but that can be imitated, for example, might provide an edge in the

short term, but competitors can overcome such an advantage eventually.

Resource-based theory also stresses the merit of an old saying: the whole is greater than the sum of its

parts. Specifically, it is also important to recognize that strategic resources can be created by taking

several strategies and resources that each could be copied and bundling them together in a way that

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cannot be copied. For example, Southwest’s culture is complemented by approaches that individually

could be copied—the airline’s emphasis on direct flights, its reliance on one type of plane, and its unique

system for passenger boarding—to create a unique business model whose performance is without peer in

the industry.

Resource-based theory can be confusing because the term resources is used in many different ways within

everyday common language. It is important to distinguish strategic resources from other resources. To

most individuals, cash is an important resource. Tangible goods such as one’s car and home are also vital

resources. When analyzing organizations, however, common resources such as cash and vehicles are not

considered to be strategic resources. Resources such as cash and vehicles are valuable, of course, but an

organization’s competitors can readily acquire them. Thus an organization cannot hope to create an

enduring competitive advantage around common resources.

On occasion, events in the environment can turn a common resource into a strategic resource. Consider,

for example, a very generic commodity: water. Humans simply cannot live without water, so water has

inherent value. Also, water cannot be imitated (at least not on a large scale), and no other substance can

substitute for the life-sustaining properties of water. Despite having three of the four properties of

strategic resources, water in the United States has remained cheap. Yet this may be changing. Major cities

in hot climates such as Las Vegas, Los Angeles, and Atlanta are confronted by dramatically shrinking

water supplies. As water becomes more and more rare, landowners in Maine stand to benefit. Maine has

been described as “the Saudi Arabia of water” because its borders contain so much drinkable water. It is

not hard to imagine a day when companies in Maine make huge profits by sending giant trucks filled with

water south and west or even by building water pipelines to service arid regions.

From Resources to Capabilities

The tangibility of a firm’s resources is an important consideration within resource-based

theory. Tangible resources are resources that can be readily seen, touched, and quantified. Physical assets

such as a firm’s property, plant, and equipment, as well as cash, are considered to be tangible resources.

In contrast, intangible resources are quite difficult to see, to touch, or to quantify. Intangible resources

include, for example, the knowledge and skills of employees, a firm’s reputation, and a firm’s culture. In

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comparing the two types of resources, intangible resources are more likely to meet the criteria for

strategic resources (i.e., valuable, rare, difficult to imitate, and nonsubstitutable) than are tangible

resources. Executives who wish to achieve long-term competitive advantages should therefore place a

premium on trying to nurture and develop their firms’ intangible resources.

Capabilities are another key concept within resource-based theory. A good and easy-to-remember way to

distinguish resources and capabilities is this: resources refer to what an organization owns, capabilities

refer to what the organization can do. Capabilities tend to arise over time as a firm takes actions that build on

its strategic resources. Southwest Airlines, for example, has developed the capability of providing excellent

customer service by building on its strong organizational culture. Capabilities are important in part because

they are how organizations capture the potential value that resources offer. Customers do not simply

send money to an organization because it owns strategic resources. Instead, capabilitiesare needed to bundle,

to manage, and otherwise to exploit resources in a manner that provides value added to customers

and creates advantages over competitors.

Some firms develop a dynamic capability. This means that a firm has a unique capability of creating new

capabilities. Said differently, a firm that enjoys a dynamic capability is skilled at continually updating its

array of capabilities to keep pace with changes in its environment. General Electric, for example, buys and

sells firms to maintain its market leadership over time, while Coca-Cola has an uncanny knack for

building new brands and products as the soft-drink market evolves. Not surprisingly, both of these firms

rank among the top thirteen among the “World’s Most Admired Companies” for 2011.

Strategy at the Movies

That Thing You Do!

How can the members of an organization reach success “doing that thing they do”? According to resource-

based theory, one possible road to riches is creating—on purpose or by accident—a unique combination of

resources. In the 1996 movie That Thing You Do!, unwittingly assembling a unique bundle of resources

leads a 1960s band called The Wonders to rise from small-town obscurity to the top of the music charts.

One resource is lead singer Jimmy Mattingly, who possesses immense musical talent. Another is guitarist

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Lenny Haise, whose fun attitude reigns in the enigmatic Mattingly. Although not a formal band member,

Mattingly’s girlfriend Faye provides emotional support to the group and even suggests the group’s name.

When the band’s usual drummer has to miss a gig due to injury, the door is opened for charismatic

drummer Guy Patterson, whose energy proves to be the final piece of the puzzle for The Wonders.

Despite Mattingly’s objections, Guy spontaneously adds an up-tempo beat to a sleepy ballad called “That

Thing You Do!” during a local talent contest. When the talent show audience goes crazy in response, it

marks the beginning of a meteoric rise for both the song and the band. Before long, The Wonders perform

on television and “That Thing You Do!” is a top-ten hit record. The band’s magic vanishes as quickly as it

appeared, however. After their bass player joins the Marines, Lenny elopes on a whim, and Jimmy’s diva

attitude runs amok, the band is finished and Guy is left to “wonder” what might have been. That Thing

You Do! illustrates that while bundling resources in a unique way can create immense success, preserving

and managing these resources over time can be very difficult.

Liv Tyler plays Faye Dolan, the love interest of drummer Guy Patterson, in That Thing You Do!

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Image courtesy of Daniel Dormann,http://en.wikipedia.org/wiki/File:LivTylerJune08.jpg.

Is Resource-Based Theory Old News?

Resource-based theory has evolved in recent years to provide a way to understand how strategic resources

and capabilities allow firms to enjoy excellent performance. But more than one wry observer has

wondered aloud, “Is resource-based theory just old wine in a new bottle?” This is a question worth

considering because the role of resources in shaping success and failure has been discussed for many

centuries.

Aesop was a Greek storyteller who lived approximately 2,500 years ago. Aesop is known in particular for

having created a series of fables—stories that appear on the surface to be simply children’s tales but that

offer deep lessons for everyone. One of Aesop’s fables focuses on an ass (donkey) and some grasshoppers.

When the ass tries to duplicate the sweet singing of the grasshoppers by copying their diet, he soon dies of

starvation. Attempting to replicate the grasshoppers’ unique singing capability proved to be a fatal

mistake. The fable illustrates a central point of resource-based theory: it is an array of resources and

capabilities that fuels enduring success, not any one resource alone.

In a far more recent example, sociologist Philip Selznick developed the concept

of distinctive competence through a series of books in the 1940s and 1950s.[3] A distinctive competence is

a set of activities that an organization performs especially well. Southwest Airlines, for example, appears

to have a distinctive competency in operations, as evidenced by how quickly it moves its flights in and out

of airports. Further, Selznick suggested that possessing a distinctive competency creates a competitive

advantage for a firm. Certainly, there is plenty of overlap between the concept of distinctive competency,

on the one hand, and capabilities, on the other.

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So is resource-based theory in fact old wine in a new bottle? Not really. Resource-based theory builds on

past ideas about resources, but it represents a big improvement on past ideas in at least two ways. First,

resource-based theory offers a complete framework for analyzing organizations, not just snippets of

valuable wisdom like Aesop and Selznick provided. Second, the ideas offered by resource-based theory

have been developed and refined through scores of research studies involving thousands of organizations.

In other words, there is solid evidence backing it up.

The Marketing Mix

Leveraging resources and capabilities to create desirable products and services is important, but

customers must still be convinced to purchase these goods and services. The marketing mix—also known

as the four Ps of marketing—provides important insights into how to make this happen. A master of the

marketing mix was circus impresario P. T. Barnum, who is famous in part for his claim that “there’s a

sucker born every minute.” The real purpose of the marketing mix is not to trick customers but rather to

provide a strong alignment among the four Ps (product, price, place, and promotion) to offer customers a

coherent and persuasive message.

A firm’s product is what it sells to customers. Southwest Airlines sells, of course, airplane flights. The

airline tries to set its flights apart from those of airlines by making flying fun. This can include, for

example, flight attendants offering preflight instructions as a rap. The price of a good or service should

provide a good match with the value offered. Throughout its history, Southwest has usually charged lower

airfares than its rivals. Place can refer to a physical purchase point as well as a distribution channel.

Southwest has generally operated in cities that are not served by many airlines and in secondary airports

in major cities. This has allowed the firm to get favorable lease rates at airports and has helped it create

customer loyalty among passengers who are thankful to have access to good air travel.

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Finally, promotion consists of the communications used to market a product, including advertising, public

relations, and other forms of direct and indirect selling. Southwest is known for its clever advertising. In a

recent television advertising campaign, for example, Southwest lampooned the baggage fees charged by

most other airlines while highlighting its more customer-friendly approach to checked luggage. Given the

consistent theme of providing a good value plus an element of fun to passengers that is developed across

the elements of the marketing mix, it is no surprise that Southwest has been so successful within a very

challenging industry.

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Few executives in history have had the marketing savvy of P. T. Barnum.

Image courtesy of The Strobridge Litho. Co., Cincinnati & New York,

http://en.wikipedia.org/wiki/File:Barnum_%26_Bailey_clowns_and_geese2.jpg.

K E Y T A K E A W A Y

Resource-based theory suggests that resources that are valuable, rare, difficult to imitate, and

nonsubstitutable best position a firm for long-term success. These strategic resources can provide the

foundation to develop firm capabilities that can lead to superior performance over time. Capabilities are

needed to bundle, to manage, and otherwise to exploit resources in a manner that provides value added

to customers and creates advantages over competitors.

E X E R C I S E S

1. Does your favorite restaurant have the four qualities of resources that lead to success as articulated by

resource-based theory?

2. If you were hired by your college or university to market your athletic department, what element of the

marketing mix would you focus on first and why?

3. What other classic stories or fables could be applied to discuss the importance of firm resources and

superior performance?

[1] Barney, J. B. 1991. Firm resources and sustained competitive advantage. Journal of Management, 17, 99–120;

Wernerfelt, B. 1984. A resource-based view of the firm. Strategic Management Journal, 5, 171–180.

[2] Barney, J. B. 1991. Firm resources and sustained competitive advantage. Journal of Management, 17, 99–120;

Chi, T. 1994. Trading in strategic resources: Necessary conditions, transaction cost problems, and choice of

exchange structure. Strategic Management Journal, 15(4), 271–290.

[3] Selznick, P. 1957. Leadership in administration. New York: Harper; Selznick, P. 1952. The organizational weapon.

New York, NY: McGraw-Hill; Selznick, P. 1949. TVA and the grass roots. Berkeley, CA: University of California Press.

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4.2 Intellectual Property

L E A R N I N G O B J E C T I V E S

1. Define the four major types of intellectual property.

2. Be able to provide examples of each intellectual property type.

3. Understand how intellectual property can be a valuable resource for firms.

Defining Intellectual Property

The inability of competitors to imitate a strategic resource is a key to leveraging the resource to achieve

long–term competitive advantages. Companies are clever, and effective imitation is often very possible.

But resources that involve intellectual property reduce or even eliminate this risk. As a result, developing

intellectual property is important to many organizations.

Intellectual property refers to creations of the mind, such as inventions, artistic products, and symbols.

The four main types of intellectual property are patents, trademarks, copyrights, and trade secrets.

If a piece of intellectual property is also valuable, rare, and nonsubstitutable, it constitutes

a strategic resource. Even if a piece of intellectual property does not meet all four criteria for serving as a

strategic resource, it can be bundled with other resources and activities to create a resource.

A variety of formal and informal methods are available to protect a firm’s intellectual property from

imitation by rivals. Some forms of intellectual property are best protected by legal means, while defending

others depends on surrounding them in secrecy. This can be contrasted with Southwest Airlines’ well-

known culture, which rivals are free to attempt to copy if they wish. Southwest’s culture thus is not

intellectual property, although some of its complements such as Southwest’s logo and unique color

schemes are.

Patents

Patents are legal decrees that protect inventions from direct imitation for a limited period of time.

Obtaining a patent involves navigating a challenging process. To earn a patent from the US

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Patent and Trademark Office, an inventor must demonstrate than an invention is new, nonobvious, and

useful. If the owner of a patent believes that a company or person has infringed on the patent, the owner

can sue for damages. In 2011, for example, a private company named EBSCO alleged that retailer Bass Pro

Shops sold a product that violated EBSCO’s patent on a deer-hunting stand that helps prevent hunters

from falling out of trees. Rather than endure a costly legal fight, the two sides agreed to settle EBSCO’s

complaint out of court.

Patenting an invention is important because patents can fuel enormous profits. Imagine, for example, the

potential for lost profits if the Slinky had not been patented. Shipyard engineer Richard James came up

with the idea for the Slinky by accident in 1943 while he was trying to create springs for use in ship

instruments. When James accidentally tipped over one of his springs, he noticed that it moved downhill in

a captivating way. James spent his free time perfecting the Slinky and then applied for a patent in 1946.

To date, more than three hundred million Slinkys have been sold by the company that Richard James and

his wife Betty created.

Patenting inventions such as the Slinky helps ensure that the invention is protected from imitation.

Image courtesy of Roger McLassus,http://upload.wikimedia.org/wikipedia/commons/f/f3/2006-

02-04_Metal_spiral.jpg.

Trademarks

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Trademarks are phrases, pictures, names, or symbols used to identify a particular organization.

Trademarks are important because they help an organization stand out and build an identity in the

marketplace. Some trademarks are so iconic that almost all consumers recognize them, including

McDonald’s golden arches, the Nike swoosh, and Apple’s outline of an apple.

Other trademarks help rising companies carve out a unique niche for themselves. For example, French

shoe designer Christian Louboutin has trademarked the signature red sole of his designer shoes. Because

these shoes sell for many hundreds of dollars via upscale retailers such as Neiman Marcus and Saks Fifth

Avenue, competitors would love to copy their look. Thus legally protecting the distinctive red sole from

imitation helps preserve Louboutin’s profits.

Fashionistas instantly recognize the trademark red sole of Christian Louboutin’s high-end shoes.

Image courtesy of

Arroser,http://wikimediafoundation.org/wiki/File:Louboutin_altadama140.jpg.

Trademarks are important to colleges and universities. Schools earn tremendous sums of money through

royalties on T-shirts, sweatshirts, hats, backpacks, and other consumer goods sporting their names and

logos. On any given day, there are probably several students in your class wearing one or more pieces of

clothing featuring your school’s insignia; your school benefits every time items like this are sold.

Schools’ trademarks are easy to counterfeit, however, and the sales of counterfeit goods take money away

from colleges and universities. Not surprisingly, many schools fight to protect their trademarks. In

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October 2009, for example, the University of Oklahoma announced that it was teaming with law

enforcement officials to combat the sale of counterfeit goods around its campus. [1] This initiative and

similar ones at other colleges and universities are designed to ensure that schools receive their fair share

of the sales that their names and logos generate.

Figure 4.7 Trademarks

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Images courtesy of unknown author, http://en.wikipedia.org/wiki/File:Aspirine-1923.jpg (bottom

left); Wilinckx, http://en.wikipedia.org/wiki/File:Trademark-symbool.png (top left); Hult Ketchen

International Group, LLC (top right); Helix84,

http://en.wikipedia.org/wiki/File:Burrbery_check.gif

Copyrights

Copyrights provide exclusive rights to the creators of original artistic works such as books, movies, songs,

and screenplays. Sometimes copyrights are sold and licensed. In the late 1960s,

Buick thought it had an agreement in place to license the number one hit “Light My Fire” for a television

advertisement from The Doors until the band’s volatile lead singer Jim Morrison loudly protested what he

saw as mistreating a work of art. Classic rock by The Beatles has been used in television ads in recent

years. After the late pop star Michael Jackson bought the rights to the band’s music catalog, he licensed

songs to Target and other companies. Some devoted music fans consider such ads to be abominations,

perhaps proving the merit of Morrison’s protest decades ago.

He looks calm here, but the licensing of a copyrighted song for a car commercial enraged rock legend Jim Morrison.

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Image courtesy of Polfoto/Jan Persson,

http://upload.wikimedia.org/wikipedia/commons/1/15/The_Doors_in_Copenhagen_1968.jpg.

Over time, piracy has become a huge issue for the owners of copyrighted works. In China, millions of

pirated DVDs are sold each year, and music piracy is estimated to account for at least 95 percent of music

sales. This piracy deprives movie studios, record labels, and artists of millions of dollars in royalties. In

response to the damage piracy has caused, the US government has pressed its Chinese counterpart and

other national governments to better enforce copyrights.

Trade Secrets

Trade secrets refer to formulas, practices, and designs that are central to a firm’s business and that remain

unknown to competitors. Trade secrets are protected by laws on theft, but once a secret is revealed,

it cannot be a secret any longer. This leads firms to rely mainly on silence and privacy rather than the

legal system to protect trade secrets.

Some trade secrets have become legendary, perhaps because a mystique arises around the unknown. One

famous example is the blend of eleven herbs and spices used in Kentucky Fried Chicken’s original recipe

chicken. KFC protects this secret by having multiple suppliers each produce a portion of the herb and

spice blend; no one supplier knows the full recipe. The formulation of Coca-Cola is also shrouded in

mystery. In 2006, Pepsi was approached by shady individuals who were offering a chance to buy a stolen

copy of Coca-Cola’s secret recipe. Pepsi wisely refused. An FBI sting was used to bring the thieves to

justice. The soft-drink industry has other secrets too. Dr Pepper’s recipe remains unknown outside the

company. Although Coke’s formula has been the subject of greater speculation, Dr Pepper is actually the

original secret soft drink; it was created a year before Coca-Cola.

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The recipe for Dr Pepper is a secret dating back to the 1880s.

Image courtesy of anyjazz65,

K E Y T A K E A W A Y

Intellectual property can serve as a strategic resource for organizations. While some sources of

intellectual property such as patents, trademarks, and copyrights can receive special legal protection,

trade secrets provide competitive advantages by simply staying hidden from competitors.

E X E R C I S E S

1. What designs for your college or university are protected by trademarks?

2. What type of intellectual property provides the most protection for firms?

3. Why would a firm protect a resource through trade secret rather than by a formal patent?

[1] Ward, C. 2009, October 8. OU works to prevent trademark infringement. The Oklahoma Daily. Retrieved

from http://www.oudaily.com/news/2009/oct/08/ou-works-prevent-trademark-infringement

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4.3 Value Chain

L E A R N I N G O B J E C T I V E S

1. Define the primary activities of the value chain.

2. Know the different support activities within the value chain.

3. Be able to apply the value chain to an organization of your choosing.

4. Understand the difference between a value chain and supply chain.

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Image courtesy of Carol M. Highsmith,

http://commons.wikimedia.org/wiki/File:Randy%27s_donuts1_edit1.jpg.

Elements of the Value Chain

When executives choose strategies, an organization’s resources and capabilities should be examined

alongside consideration of its value chain. A value chain charts the path by which products and services

are created and eventually sold to customers. [1] The term value chain reflects the fact that, as each step of

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this path is completed, the product becomes more valuable than it was at the previous step.

Within the lumber business, for example, value is added when a tree is transformed into usable

wooden boards; the boards created from a tree can be sold for more money than the price of the tree.

Adapted from Porter, M. (1985). Competitive Advantage. New York: Free Press. Exhibit is Creative Commons licensed at http://en.wikipedia.org/wiki/Image:ValueChain.PNG.”

Value chains include both primary and secondary activities. Primary activities are actions that are directly

involved in creating and distributing goods and services. Consider a simple illustrative example: doughnut

shops. Doughnut shops transform basic commodity products such as flour, sugar, butter, and grease into

delectable treats. Value is added through this process because consumers are willing to pay much more for

doughnuts than they would be willing to pay for the underlying ingredients.

There are five primary activities. Inbound logistics refers to the arrival of raw materials. Although

doughnuts are seen by most consumers as notoriously unhealthy, the Doughnut Plant in New York City

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has carved out a unique niche for itself by obtaining organic ingredients from a local farmer’s

market.Operations refers to the actual production process, while outbound logistics tracks the movement

of a finished product to customers. One of Southwest Airlines’ unique capabilities is moving passengers

more quickly than its rivals. This advantage in operations is based in part on Southwest’s reliance on one

type of airplane (which speeds maintenance) and its avoidance of advance seat assignments (which

accelerates the passenger boarding process).

Attracting potential customers and convincing them to make purchases is the domain

of marketing and sales. For example, people cannot help but notice Randy’s Donuts in Inglewood,

California, because the building has a giant doughnut on top of it. Finally, service refers to the extent to

which a firm provides assistance to their customers. Voodoo Donuts in Portland, Oregon, has developed a

clever website (voodoodoughnut.com) that helps customers understand their uniquely named products,

such as the Voodoo Doll, the Texas Challenge, the Memphis Mafia, and the Dirty Snowball.

Secondary activities are not directly involved in the evolution of a product but instead provide important

underlying support for primary activities. Firm infrastructure refers to how the firm is organized and led

by executives. The effects of this organizing and leadership can be profound. For example, Ron Joyce’s

leadership of Canadian doughnut shop chain Tim Hortons was so successful that Canadians consume

more doughnuts per person than all other countries. In terms of resource-based theory, Joyce’s leadership

was clearly a valuable and rare resource that helped his firm prosper.

Also important is human resource management, which involves the recruitment, training, and

compensation of employees. A recent research study used data from more than twelve thousand

organizations to demonstrate that the knowledge, skills, and abilities of a firm’s employees can act as a

strategic resource and strongly influence the firm’s performance. [2] Certainly, the unique level of

dedication demonstrated by employees at Southwest Airlines has contributed to that firm’s excellent

performance over several decades.

Technology refers to the use of computerization and telecommunications to support primary activities.

Although doughnut making is not a high-tech business, technology plays a variety of roles for doughnut

shops, such as allowing customers to use credit cards. Procurement is the process of negotiating for and

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purchasing raw materials. Large doughnut chains such as Dunkin’ Donuts and Krispy Kreme can gain cost

advantages over their smaller rivals by purchasing flour, sugar, and other ingredients in bulk. Meanwhile,

Southwest Airlines has gained an advantage over its rivals by using futures contracts within its

procurement process to minimize the effects of rising fuel prices.

From the Value Chain to Best Value Supply Chains

“Time is money!” warns a famous saying. This simple yet profound statement suggests that organizations

that quickly complete their work will enjoy greater profits, while slower-moving firms will suffer. The

belief that time is money has encouraged the modern emphasis on supply chain management. A

supply chain is a system of people, activities, information, and resources involved in creating a product

and moving it to the customer. A supply chain is a broader concept than a value chain; the latter refers to

activities within one firm, while the former captures the entire process of creating and distributing a

product, often across several firms.

Competition in the twenty-first century requires an approach that considers the supply chain concept in

tandem with the value-creation process within a firm: best value supply chains. These chains do not fixate

on speed or on any other single metric. Instead, relative to their peers, best value supply chains focus on

the total value added to the customer.

Creating best value supply chains requires four components. The first is

strategic supply chain management—the use of supply chains as a means to create competitive advantages

and enhance firm performance. Such an approach contradicts the popular wisdom centered on the need

to maximize speed. Instead, there is recognition that the fastest chain may not satisfy customers’ needs.

Best value supply chains strive to excel along four measures. Speed (or “cycle time”) is the time duration

from initiation to completion of the production and distribution process. Quality refers to the relative

reliability of supply chain activities. Supply chains’ efforts at managing cost involve enhancing value by

either reducing expenses or increasing customer benefits for the same cost level. Flexibility refers to a

supply chain’s responsiveness to changes in customers’ needs. Through balancing these four metrics, best

value supply chains attempt to provide the highest level of total value added.

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The value of strategic supply chain management is reflected in how firms such as Walmart have used their

supply chains as competitive weapons to gain advantages over peers. Walmart excels in terms of speed

and cost by locating all domestic stores within one day’s drive of a warehouse while owning a trucking

fleet. This creates distribution speed and economies of scale that competitors simply cannot match. When

Kmart’s executives decided in the late 1990s to compete head-to-head with Walmart on price, Walmart’s

sophisticated logistics system enabled it to easily withstand the price war. Unable to match its rival’s

speed and costs, Kmart soon plunged into bankruptcy. Walmart’s supply chains also possess strong

quality and flexibility. When Hurricane Katrina devastated the Gulf Coast in 2005, Walmart used not only

its warehouses and trucks but also its satellite technology, radio frequency identification (RFID), and

global positioning systems to quickly divert assets to affected areas. The result was that Walmart emerged

as the first responder in many towns and provided essentials such as drinking water faster than local and

federal governments could.

Meanwhile, failing to manage a supply chain effectively causes serious harm. For example, in 2003

Motorola was unable to meet demand for its new camera phones because it did not have enough lenses

available. Also, firms whose supply chains were centered in the Port of Los Angeles collectively lost more

than $2 billion a day during a 2002 workers’ strike. In terms of stock price, firms’ market value erodes by

an average of 10 percent following the announcement of a major supply chain problem.

The second component is agility, the supply chain’s relative capacity to act rapidly in response to dramatic

changes in supply and demand. [3] Agility can be achieved using buffers. Excess capacity, inventory, and

management information systems all provide buffers that better enable a best value supply chain to

service and to be more responsive to its customers. Rapid improvements and decreased costs in deploying

information systems have enabled supply chains in recent years to reduce inventory as a buffer. Much

popular thinking depicts inventory reduction as a goal in and of itself. However, this cannot occur without

corresponding increases in buffer capacity elsewhere in the chain, or performance will suffer. A best value

supply chain seeks to optimize the total costs of all buffers used. The costs of deploying each buffer differs

across industries; therefore, no solution that works for one company can be directly applied to another in

a different industry without adaptation.

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Agility in a supply chain can also be improved and achieved by colocating with the customer. This

arrangement creates an information flow that cannot be duplicated through other methods. Daily face-to-

face contact for supply chain personnel enables quicker response times to customer demands due to the

speed at which information can travel back and forth between the parties. Again, this buffer of increased

and improved information flows comes at an expense, so executives seeking to build a best value supply

chain will investigate the opportunity and determine whether this action optimizes total costs.

Adaptability refers to a willingness and capacity to reshape supply chains when necessary. Generally,

creating one supply chain for a customer is desired because this helps minimize costs. Adaptable firms

realize that this is not always a best value solution, however. For example, in the defense industry, the US

Army requires one class of weapon simulators to be repaired within eight hours, while another class of

items can be repaired and returned within one month. To service these varying requirements efficiently

and effectively, Computer Science Corporation (the firm whose supply chains maintain the equipment)

must devise adaptable supply chains. In this case, spare parts inventory is positioned in proximity to the

class of simulators requiring quick turnaround, while the less-time-sensitive devices are sent to a

centralized repair facility. This supply chain configuration allows Computer Science Corporation to satisfy

customer demands while avoiding the excess costs that would be involved in localizing all repair activities.

In situations in which the interests of one firm in the chain and the chain as a whole conflict, most

executives will choose an option that benefits their firm. This creates a need for alignment among chain

members. Alignment refers to creating consistency in the interests of all participants in a supply chain. In

many situations, this can be accomplished through carefully writing incentives into contracts.

Collaborative forecasting with suppliers and customers can also help build alignment. Taking the time to

sit together with participants in the supply chain to agree on anticipated business levels permits shared

understanding and rapid information transfers between parties. This is particularly valuable when

customer demand is uncertain, such as in the retail industry. [4]

K E Y T A K E A W A Y

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The value chain provides a useful tool for managers to examine systematically where value may be added

to their organizations. This tool is useful in that it examines key elements in the production of a good or

service, as well as areas in which value may be added in support of those primary activities.

E X E R C I S E S

1. If you were hired as a consultant for your university, what specific element of the value chain would you

seek to improve first?

2. What local business in your town could be improved most dramatically by applying the value chain?

Would improvements of primary or support activities help to improve this firm most? Could knowledge of

strategic supply chain management add further value to this firm?

[1] Porter, M. E. 1985. Competitive advantage: Creating and sustaining superior performance. New York, NY: Free

Press.

[2] Crook, T. R., Todd, S. Y., Combs, J. G., Woehr, D. J., & Ketchen, D. J. 2011. Does human capital matter? A meta-

analysis of the relationship between human capital and firm performance. Journal of Applied Psychology, 96(3),

443–456.

[3] Lee, H. L. 2004, October. The triple-A supply chain. Harvard Business Review, 83, 102–112.

[4] This section of the chapter is adapted from Ketchen, D. J., Rebarick, W., Hult, G. T., & Meyer, D. 2008. Best

value supply chains: A key competitive weapon for the 21st century. Business Horizons, 51, 235–243.

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4.4 Beyond Resource-Based Theory: Other Views on Firm Performance

L E A R N I N G O B J E C T I V E S

1. Be able to discuss other theories about firm success and failure beyond resource-based theory.

2. Be able to apply different theories to help explain competition in different industries.

Although resource-based theory stands as perhaps the most popular explanation of why some

organizations prosper while others do not, several other theories are popular. Enactment treats

executives as the masters of their domains. Enactment contends that an organization can, at least in

part, create an environment for itself that is beneficial to the organization. This is accomplished by

putting strategies in place that reshape competitive conditions in a favorable way.

By the 1990s, Microsoft had been so successful at reshaping the software industry to its benefit that

the firm was the subject of a lengthy antitrust investigation by the federal government. More

recently, Apple has been able to reshape its environment by introducing products such as the iPhone

and the iPad that transcend the traditional boundaries between the cell phone, digital camera, music

player, and computer businesses. No airline has ever been able to enact the environment, however,

perhaps because the airline industry is so fragmented.

Environmental determinism offers a completely opposite view from enactment on why some firms

succeed and others fail. Environmental determinism views organizations much like biological

theories view animals—organizations (and animals) are very limited in their ability to adapt to the

conditions around them. Thus just as harsh environmental changes are believed to have made

dinosaurs extinct, changes in the business environment can destroy organizations regardless of how

clever and insightful executives are.

Until 1978, the federal government regulated the airline industry by dictating what routes each

airline would fly and what prices it would charge. Once these controls were removed, airlines were

subjected to a series of negative environmental trends, including recession, overcapacity in the

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industry, new entrants, fierce price competition, and fuel shortages. Perhaps not surprisingly, dozens

of airlines have been crushed by these conditions.

An old saying notes that “imitation is the sincerest form of flattery.” This flattery is the focus

of institutional theory. In particular, institutional theory centers on the extent to which firms copy one

another’s strategies. Consider, for example, fast-food hamburger restaurants. Innovations such as

dollar menus and drive-through windows tend to be introduced by one firm and then duplicated by

the others.

Airlines also seem to follow a “monkey see, monkey do” mentality. To build passenger loyalty,

American Airlines introduced a frequent flyer program called AAdvantage in 1981. After flying a

certain number of miles on American flights, AAdvantage members were rewarded with a free flight.

The idea was to make passengers less likely to shop around for the cheapest ticket. Ironically,

AAdvantage turned out to be not much of an advantage at all. Many of American’s rivals quickly

developed their own frequent-flyer programs, and today most airlines reward frequent passengers.

In recent years, ideas such as charging passengers to check their luggage and eliminating free food

on flights have been copied by one airline after another.

Transaction cost economics is a theory that centers on just one element of business activity: whether it

is cheaper for a firm to make or to buy the products that it needs. This is an important element,

however, because choosing the more efficient option can enhance a firm’s profits. Automakers such

as Ford and General Motors face a wide variety of make-or-buy decisions because so many different

parts are needed to build cars and trucks. Sometimes Ford and GM make these products, and other

times they purchase them from outside suppliers. These firms’ financial situations are improved

when these decisions are made wisely and harmed when they are made poorly.

In contrast, airlines always buy (or rent) their airplanes. Large planes are generally bought from

Boeing or Airbus, while modest-sized airliners are purchased from companies such as Brazil’s

Embraer. It would be simply too costly for an airline to pursue a backward integration strategy and

enter the airplane manufacturing business. Insights such as these are powerful enough that the

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creator of transaction cost economics, Professor Oliver Williamson, was awarded a Nobel Prize in

Economic Sciences in 2009.

Each of these theories—enactment, environmental determinism, institutional theory, and

transaction cost economics—is useful for understanding some situations and some important

business decisions. Thus executives should keep these perspectives in mind as they attempt to lead

their firms to greater levels of success. However, one important advantage that resource-based

theory offers over the alternatives is that only resource-based theory does a good job of explaining

firm performance across a wide variety of contexts. Thus resource-based theory offers the point of

view of business that has the strongest value for most executives.

K E Y T A K E A W A Y

Although resource-based theory is the dominant perspective to predict performance in the strategic

management field, other theories exist to explain firm behavior. In some industries, explanations

provided by these theories can be very convincing.

E X E R C I S E S

1. What theory of the firm do you think best explains competition in the fast-food industry?

2. What is an example of an industry in which institutional theory seems to explain the behavior of firms?

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4.5 SWOT Analysis

L E A R N I N G O B J E C T I V E S

1. Understand what SWOT analysis is.

2. Learn how SWOT analysis can help organizations and individuals, and its limitations.

Five forces analysis examines the situation faced by the competitors in an industry. Strategic groups

analysis narrows the focus by centering on subsets of these competitors whose strategies are

similar. SWOT analysis takes an even narrower focus by centering on an individual firm. Specifically,

SWOT analysis is a tool that considers a firm’s strengths and weaknesses along with the

opportunities and threats that exist in the firm’s environment.

Executives using SWOT analysis compare these internal and external factors to generate ideas about

how their firm might become more successful. In general, it is wise to focus on ideas that allow a firm

to leverage its strengths, steer clear of or resolve its weaknesses, capitalize on opportunities, and

protect itself against threats. For example, untapped overseas markets have presented potentially

lucrative opportunities to Subway and other restaurant chains such as McDonald’s and Kentucky

Fried Chicken. Meanwhile, Subway’s strengths include a well-established brand name and a simple

business format that can easily be adapted to other cultures. In considering the opportunities offered

by overseas markets and Subway’s strengths, it is not surprising that entering and expanding in

different countries has been a key element of Subway’s strategy in recent years. Indeed, Subway

currently has operations in nearly 100 nations.

SWOT analysis is helpful to executives, and it is used within most organizations. Important cautions

need to be offered about SWOT analysis, however. First, in laying out each of the four elements of

SWOT, internal and external factors should not be confused with each other. It is important not to

list strengths as opportunities, for example, if executives are to succeed at matching internal and

external concerns during the idea generation process. Second, opportunities should not be confused

with strategic moves designed to capitalize on these opportunities. In the case of Subway, it would be

a mistake to list “entering new countries” as an opportunity. Instead, untapped markets are the

opportunity presented to Subway, and entering those markets is a way for Subway to exploit the

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opportunity. Finally, and perhaps most important, the results of SWOT analysis should not be

overemphasized. SWOT analysis is a relatively simple tool for understanding a firm’s situation. As a

result, SWOT is best viewed as a brainstorming technique for generating creative ideas, not as a

rigorous method for selecting strategies. Thus the ideas produced by SWOT analysis offer a starting

point for executives’ efforts to craft strategies for their organization, not an ending point.

In addition to organizations, individuals can benefit from applying SWOT analysis to their personal

situation. A college student who is approaching graduation, for example, could lay out her main

strengths and weaknesses and the opportunities and threats presented by the environment. Suppose,

for instance, that this person enjoys and is good at helping others (a strength) but also has a rather

short attention span (a weakness). Meanwhile, opportunities to work at a rehabilitation center or to

pursue an advanced degree are available. Our hypothetical student might be wise to pursue a job at

the rehabilitation center (where her strength at helping others would be a powerful asset) rather than

entering graduate school (where a lot of reading is required and her short attention span could

undermine her studies).

K E Y T A K E A W A Y

Executives using SWOT analysis compare internal strengths and weaknesses with external opportunities

and threats to generate ideas about how their firm might become more successful. Ideas that allow a firm

to leverage its strengths, steer clear of or resolve its weaknesses, capitalize on opportunities, and protect

itself against threats are particularly helpful.

E X E R C I S E S

1. What do each of the letters in SWOT represent?

2. What are your key strengths, and how might you build your own personal strategies for success around

them?

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4.6 Conclusion

This chapter explains key issues that executives face in managing resources to keep their firms

competitive. Resource-based theory argues that firms will perform better when they assemble

resources that are valuable, rare, difficult to imitate, and nonsubstitutable. When executives can

successfully bundle organizational resources into unique capabilities, the firm is more likely to enjoy

lasting success. Different forms of intellectual property—which include patents, trademarks,

copyrights, and trade secrets—may also serve as strategic resources for firms. Examining a firm’s

resources can be aided by the value chain, a tool that systematically examines primary and secondary

activities in the creation of a good or service and by a knowledge of supply chain management that

examines the value added of multiple firms working together. While resource-based theory provides

a dominant view for examining the determinants of firm success, other perspectives provide insight

for understanding specific behaviors of firms within an industry. Finally, SWOT analysis is a simple

but powerful technique for examining the interactions between factors internal and external to the

firm.

E X E R C I S E S

1. Divide your class into four or eight groups, depending on the size of the class. Each group should search

for a patent tied to a successful product, as well as a patent associated with a product that was not a

commercial hit. Were there resources tied to the successful organization that the poor performer did not

seem to attain?

2. This chapter discussed Southwest Airlines. Based on your reading of the chapter, how well has Southwest

done in bundling together the resources recommended by resource-based theory? What theoretical

perspective best explains the competitive actions of most firms in the airline industry?

3. Conduct a SWOT analysis of your college or university. Based on your analysis, what one strategic move

should your school make first, and why?

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Chapter 5

Selecting Business-Level Strategies L E A R N I N G O B J E C T I V E S

After reading this chapter, you should be able to understand and articulate answers to the following

questions:

1. Why is an examination of generic strategies valuable?

2. What are the four main generic strategies?

3. What is a best-cost strategy?

4. What does it mean to be “stuck in the middle”?

The Competition Takes Aim at Target

On January 13, 2011, Target Corporation announced its intentions to operate stores outside the United

States for the first time. The plan called for Target to enter Canada by purchasing existing leases from a

Canadian retailer and then opening 100 to 150 stores in 2013 and 2014. [1] The chain already included

more than 1,700 stores in forty-nine states. Given the close physical and cultural ties between the United

States and Canada, entering the Canadian market seemed to be a logical move for Target.

In addition to making its initial move beyond the United States, Target had several other sources of pride

in early 2011. The company claimed that 96 percent of American consumers recognized its signature logo,

surpassing the percentages enjoyed by famous brands such as Apple and Nike. In

March, Fortune magazine ranked Target twenty-second on its list of the “World’s Most Admired

Companies.” In May, Target reported that its sales and earnings for the first quarter of 2011 (sales: $15.6

billion; earnings: $689 million) were stronger than they had been in the first quarter of 2010 (sales: $15.2

billion; earnings: $671 million). Yet there were serious causes for concern, too. News stories in the second

half of 2010 about Target’s donations to political candidates had created controversy and unwanted

publicity. And despite increasing sales and profits, Target’s stock price fell about 20 percent during the

first quarter of 2011.

Chapter 5 from Mastering Strategic Management was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 license without attribution as requested

by the work’s original creator or licensee. © 2014, The Saylor Foundation.

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Concern also surrounded Target’s possible vulnerability to competition within the retail industry. Since its

creation in the early 1960s, Target executives had carved out a lucrative position for the firm. Target offers

relatively low prices on brand-name consumer staples such as cleaning supplies and paper products, but it

also offers chic clothing and household goods. This unique combination helps Target to appeal to fairly

affluent customers. Although Target counts many college students and senior citizens among its devotees,

the typical Target shopper is forty-one years old and has a household income of about $63,000 per year.

Approximately 45 percent of Target customers have children at home, and about 48 percent have a college

degree. [2] Perhaps the most tangible reflection of Target’s upscale position among large retailers is the

tendency of some customers to jokingly pronounce its name as if it were a French boutique: “Tar-zhay.”

Target’s lucrative position was far from guaranteed, however. Indeed, a variety of competitors seemed to

be taking aim at Target. Retail chains such as Kohl’s and Old Navy offered fashionable clothing at prices

similar to Target’s. Discounters like T.J. Maxx, Marshalls, and Ross offered designer clothing and chic

household goods for prices that often were lower than Target’s. Closeout stores such as Big Lots offered a

limited selection of electronics, apparel, and household goods but at deeply discounted prices. All these

stores threatened to steal business from Target.

Walmart was perhaps Target’s most worrisome competitor. After some struggles in the 2000s, the

mammoth retailer’s performance was strong enough that it ranked well above Target on Fortune’s list of

the “World’s Most Admired Companies” (eleventh vs. twenty-second). Walmart also was much bigger

than Target. The resulting economies of scale meant that Walmart could undercut Target’s prices anytime

it desired. Just such a scenario had unfolded before. A few years ago, Walmart’s victory in a price war over

Kmart led the latter into bankruptcy.

One important difference between Kmart and Target is that Target is viewed by consumers as offering

relatively high-quality goods. But this difference might not protect Target. Although Walmart’s products

tended to lack the chic appeal of Target’s, Walmart had begun offering better products during the

recession of the late 2000s in an effort to expand its customer base. If Walmart executives chose to match

Target’s quality while charging lower prices, Target could find itself without a unique appeal for

customers. As 2011 continued, a big question loomed: could Target maintain its unique appeal to

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customers or would the competitive arrows launched by Walmart and others force Target’s executives to

quiver?

[1] Target Corporation to acquire interest in Canadian real estate from Zellers Inc., a subsidiary of Hudson’s Bay

Company, for C$1.825 billion [Press release]. 2011, January 13. Target Stores. Retrieved from

http://pressroom.target.com/pr/news/target-corporation-to-acquire-real-estate.aspx

[2] Target fact card. 2007, January 2007. Retrieved from

http://sites.target.com/images/corporate/about/pdfs/corp_factcard_101107.pdf

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5.1 Understanding Business-Level Strategy through “Generic Strategies”

L E A R N I N G O B J E C T I V E S

1. Understand the four primary generic strategies.

2. Know the two dimensions that are critical to defining business-level strategy.

3. Know the limitations of generic strategies.

Why Examine Generic Strategies?

Business-level strategy addresses the question of how a firm will compete in a particular industry (Figure

5.1 "Business-Level Strategies"). This seems to be a simple question on the surface, but it is actually quite

complex. The reason is that there are a great many possible answers to the question. Consider, for

example, the restaurants in your town or city. Chances are that you live fairly close to some combination

of McDonald’s, Subway, Chili’s, Applebee’s, Panera Bread Company, dozens of other national brands, and

a variety of locally based eateries that have just one location. Each of these restaurants competes using a

business model that is at least somewhat unique. When an executive in the restaurant industry analyzes

her company and her rivals, she needs to avoid getting distracted by all the nuances of different firm’s

business-level strategies and losing sight of the big picture.

The solution is to think about business-level strategy in terms of generic strategies. A generic strategy is a

general way of positioning a firm within an industry. Focusing on generic strategies allows executives to

concentrate on the core elements of firms’ business-level strategies. The most popular set of generic

strategies is based on the work of Professor Michael Porter of the Harvard Business School and

subsequent researchers that have built on Porter’s initial ideas. [1]

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Figure 5.1 Business-Level Strategies

6

Images courtesy of GeneralCheese, http://en.wikipedia.org/wiki/File:Remodeld_walmart.jpg (top

left); unknown author, http://en.wikipedia.org/wiki/File:Nordstrom.JPG (top right);

NNECAPA, http://www.flickr.com/photos/nnecapa/2794736274/(bottom left); Debs,

http://www.flickr.com/photos/littledebbie11/4537337628/ (bottom right).

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According to Porter, two competitive dimensions are the keys to business-level strategy. The first

dimension is a firm’s source of competitive advantage. This dimension involves whether a firm tries to

gain an edge on rivals by keeping costs down or by offering something unique in the market. The second

dimension is firms’ scope of operations. This dimension involves whether a firm tries to target customers

in general or whether it seeks to attract just a segment of customers. Four generic business-level strategies

emerge from these decisions: (1) cost leadership, (2) differentiation, (3) focused cost leadership, and (4)

focused differentiation. In rare cases, firms are able to offer both low prices and unique features that

customers find desirable. These firms are following a best-cost strategy. Firms that are not able to offer

low prices or appealing unique features are referred to as “stuck in the middle.”

Understanding the differences that underlie generic strategies is important because different generic

strategies offer different value propositions to customers. A firm focusing on cost leadership will have a

different value chain configuration than a firm whose strategy focuses on differentiation. For example,

marketing and sales for a differentiation strategy often requires extensive effort while some firms that

follow cost leadership such as Waffle House are successful with limited marketing efforts. This chapter

presents each generic strategy and the “recipe” generally associated with success when using that strategy.

When firms follow these recipes, the result can be a strategy that leads to superior performance. But when

firms fail to follow logical actions associated with each strategy, the result may be a value proposition

configuration that is expensive to implement and that does not satisfy enough customers to be viable.

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Limitations of Generic Strategies

Examining business-level strategy in terms of generic strategies has limitations. Firms that follow a

particular generic strategy tend to share certain features. For example, one way that cost leaders generally

keep costs low is by not spending much on advertising. Not every cost leader, however, follows this path.

While cost leaders such as Waffle House spend very little on advertising, Walmart spends considerable

money on print and television advertising despite following a cost leadership strategy. Thus a firm may

not match every characteristic that its generic strategy entails. Indeed, depending on the nature of a firm’s

industry, tweaking the recipe of a generic strategy may be essential to cooking up success.

K E Y T A K E A W A Y

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Business-level strategies examine how firms compete in a given industry. Firms derive such strategies by

executives making decisions about whether their source of competitive advantage is based on price or

differentiation and whether their scope of operations targets a broad or narrow market. E X E R C I S E S

1. What are examples of each generic business-level strategy in the apparel industry?

2. What are the limitations of examining firms in terms of generic strategies?

3. Create a new framework to examine generic strategies using different dimensions than the two offered

by Porter’s framework. What does your approach offer that Porter’s does not?

[1] Porter, M. E. 1980. Competitive strategy: Techniques for analyzing industries and competitors. New York, NY:

Free Press; Williamson, P. J., & Zeng, M. 2009. Value-for-money strategies for recessionary times. Harvard Business

Review, 87(3), 66–74.

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5.2 Cost Leadership

L E A R N I N G O B J E C T I V E S

1. Describe the nature of cost leadership.

2. Understand how economies of scale help contribute to a cost leadership strategy.

3. Know the advantages and disadvantages of a cost leadership strategy.

The Nature of the Cost Leadership Strategy

It is tempting to think of cost leaders as companies that sell inferior, poor-quality goods and services for

rock-bottom prices. The Yugo, for example, was an extremely unreliable car that was made in Eastern

Europe and sold in the United States for about $4,000. Despite its attractive price tag, the Yugo was a

dismal failure because drivers simply could not depend on the car for transportation. Yugo exited the

United States in the early 1990s and closed down entirely in 2008.

In contrast to firms such as Yugo whose failure is inevitable, cost leaders can be very successful. A firm

following a cost leadership strategy offers products or services with acceptable quality and features to a

broad set of customers at a low price. Payless ShoeSource, for example, sells name-brand shoes

at inexpensive prices. Its low-price strategy is communicated to customers through advertising slogans

such as “Why pay more when you can Payless?” and “You could pay more, but why?”

Little Debbie snack cakes offer another example. The brand was started in the 1930s when O. D.

McKee began selling sugary treats for five cents. Most consumers today would view the quality of Little

Debbie cakes as a step below similar offerings from Entenmann’s, but enough people believe that they

offer acceptable quality that the brand is still around eight decades after its creation.

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Listeners of the popular radio show Car Talk voted the Yugo as the “worst car of the millennium.”

Image courtesy of Antp, http://upload.wikimedia.org/wikipedia/commons/e/e7/Yugo.jpg.

Perhaps the most famous cost leader is Walmart, which has used a cost leadership strategy to become the

largest company in the world. The firm’s advertising slogans such as “Always Low Prices” and “Save

Money. Live Better” communicate Walmart’s emphasis on price slashing to potential customers.

Meanwhile, Walmart has the broadest customer base of any firm in the United States. Approximately one

hundred million Americans visit a Walmart in a typical week. [1] Incredibly, this means that roughly one-

third of Americans are frequent Walmart customers. This huge customer base includes people from all

demographic and social groups within society. Although most are simply typical Americans, the popular

website http://www.peopleofwalmart.com features photos of some of the more outrageous characters that

have been spotted in Walmart stores.

Cost leaders tend to share some important characteristics. The ability to charge low prices and still make a

profit is challenging. Cost leaders manage to do so by emphasizing efficiency. At Waffle House

restaurants, for example, customers are served cheap eats quickly to keep booths available for later

customers. As part of the effort to be efficient, most cost leaders spend little on advertising, market

research, or research and development. Waffle House, for example, limits its advertising to billboards

along highways. Meanwhile, the simplicity of Waffle House’s menu requires little research and

development.

Many cost leaders rely on economies of scale to achieve efficiency. Economies of scale are created when

the costs of offering goods and services decreases as a firm is able to sell more items. This occurs because

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expenses are distributed across a greater number of items. Walmart spent approximately $2 billion on

advertising in 2008. This is a huge number, but Walmart is so large that its advertising expenses equal

just a tiny fraction of its sales. Also, cost leaders are often large companies, which allows them to demand

price concessions from their suppliers. Walmart is notorious for squeezing suppliers such as Procter &

Gamble to sell goods to Walmart for lower and lower prices over time. The firm passes some of these

savings to customers in the form of reduced prices in its stores.

Advantages and Disadvantages of Cost Leadership

Each generic strategy offers advantages that firms can potentially leverage to enhance their success as well

as disadvantages that may undermine their success. In the case of cost leadership, one advantage is that

cost leaders’ emphasis on efficiency makes them well positioned to withstand price competition from

rivals. Kmart’s ill-fated attempt to engage Walmart in a price war ended in disaster, in part

because Walmart was so efficient in its operations that it could live with smaller profit margins

far more easily than Kmart could.

Beyond existing competitors, a cost leadership strategy also creates benefits relative to potential new

entrants. Specifically, the presence of a cost leader in an industry tends to discourage new firms from

entering the business because a new firm would struggle to attract customers by undercutting the cost

leaders’ prices. Thus a cost leadership strategy helps create barriers to entry that protect the firm—and its

existing rivals—from new competition.

In many settings, cost leaders attract a large market share because a large portion of potential customers

find paying low prices for goods and services of acceptable quality to be very appealing. This is certainly

true for Walmart, for example. The need for efficiency means that cost leaders’ profit margins are often

slimmer than the margins enjoyed by other firms. However, cost leaders’ ability to make a little bit of

profit from each of a large number of customers means that the total profits of cost leaders can be

substantial.

In some settings, the need for high sales volume is a critical disadvantage of a cost leadership strategy.

Highly fragmented markets and markets that involve a lot of brand loyalty may not offer much of an

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opportunity to attract a large segment of customers. In both the soft drink and cigarette industries, for

example, customers appear to be willing to pay a little extra to enjoy the brand of their choice. Lower-end

brands of soda and cigarettes appeal to a minority of consumers, but famous brands such as Coca-Cola,

Pepsi, Marlboro, and Camel still dominate these markets. A related concern is that achieving a high sales

volume usually requires significant upfront investments in production and/or distribution capacity. Not

every firm is willing and able to make such investments.

Cost leaders tend to keep their costs low by minimizing advertising, market research, and research and

development, but this approach can prove to be expensive in the long run. A relative lack of market

research can lead cost leaders to be less skilled than other firms at detecting important environmental

changes. Meanwhile, downplaying research and development can slow cost leaders’ ability to respond to

changes once they are detected. Lagging rivals in terms of detecting and reacting to external shifts can

prove to be a deadly combination that leaves cost leaders out of touch with the market and out of answers.

K E Y T A K E A W A Y

Cost leadership is an effective business-level strategy to the extent that a firm offers low prices, provides

satisfactory quality, and attracts enough customers to be profitable. E X E R C I S E S

1. What are three industries in which a cost leadership strategy would be difficult to implement?

2. What is your favorite cost leadership restaurant?

3. Name three examples of firms conducting a cost leadership strategy that use no advertising. Should they

start advertising? Why or why not?

[1] Ann Zimmerman and Kris Hudson, “Managing Wal-Mart: How US-store chief hopes to fix Wal-Mart,” Wall

Street Journal, April 17, 2006.

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Images courtesy of _nickd, http://www.flickr.com/photos/_nickd/2313836162/ (top left);

Guillermo Vasquez, http://www.flickr.com/photos/megavas/3302486505/ (middle); Derek

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Hatfield, http://www.flickr.com/photos/loimere/5068068920/(bottom right); Adrian

Pingstone,http://en.wikipedia.org/wiki/File:Fedex.a310-200.n420fe.arp.jpg (top right);

ChunkySoup, http://en.wikipedia.org/wiki/File:Zoom_elite_2.png(bottom left).

L E A R N I N G O B J E C T I V E S

1. Describe the nature of differentiation.

2. Know the advantages and disadvantages of a differentiation strategy.

The Nature of the Differentiation Strategy

A famous cliché contends that “you get what you pay for.” This saying captures the essence of a

differentiation strategy. A firm following a differentiation strategy attempts to convince customers to pay

a premium price for its good or services by providing unique and desirable features (Figure 5.4

"Differentiation"). The message that such a firm conveys to customers is that you will pay a little bit more

for our offerings, but you will receive a good value overall because our offerings provide something

special.

In terms of the two competitive dimensions described by Michael Porter, using a differentiation strategy

means that a firm is competing based on uniqueness rather than price and is seeking to attract a broad

market. [1] Coleman camping equipment offers a good example. If camping equipment such as sleeping

bags, lanterns, and stoves fail during a camping trip, the result will be, well, unhappy campers. Coleman’s

sleeping bags, lanterns, and stoves are renowned for their reliability and durability. Cheaper brands are

much more likely to have problems. Lovers of the outdoors must pay more to purchase Coleman’s goods

than they would to obtain lesser brands, but having equipment that you can count on to keep you warm

and dry is worth a price premium in the minds of most campers.

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Coleman’s patented stove was

originally developed for use by

soldiers during World War II.

Seven decades later, the Coleman

Stove remains a must-have item for

campers.

Image courtesy of B. W. Tullis,

http://en.wikipedia.org/wiki/File:

Patent_Drawing_for_Coleman_M

odel_520_Stove.jpg.

Successful use of a differentiation strategy depends on not only offering unique features but also

communicating the value of these features to potential customers. As a result, advertising in general and

brand building in particular are important to this strategy. Few goods are more basic and generic than

table salt. This would seemingly make creating a differentiated brand in the salt business next to

impossible. Through clever marketing, however, Morton Salt has done so. Morton has differentiated its

salt by building a brand around its iconic umbrella girl and its trademark slogan of “When it rains, it

pours.” Would the typical consumer be able to tell the difference between Morton Salt and cheaper

generic salt in a blind taste test? Not a chance. Yet Morton succeeds in convincing customers to pay a little

extra for its salt through its brand-building efforts.

FedEx and Nike are two other companies that have done well at communicating to customers that they

provide differentiated offerings. FedEx’s former slogan “When it absolutely, positively has to be there

overnight” highlights the commitment to speedy delivery that sets the firm apart from competitors such as

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UPS and the US Postal Service. Nike differentiates its athletic shoes and apparel through its iconic

“swoosh” logo as well as an intense emphasis on product innovation through research and development.

Developing a Differentiation Strategy at Express Oil Change

Express Oil Change and Service Centers is a chain of auto repair shops that stretches from Florida to

Texas. Based in Birmingham, Alabama, the firm has more than 170 company-owned and franchised

locations under its brand. Express Oil Change tries to provide a unique level of service, and the firm is

content to let rivals offer cheaper prices. We asked an Express Oil Change executive about his firm. [2]

Question:

The auto repair and maintenance business is a pretty competitive space. How is Express Oil Change being positioned relative to other firms, such as Super Lube, American LubeFast, and Jiffy Lube?

Don Larose, Senior Vice President of Franchise Development:

Every good business sector is competitive. The key to our success is to be more convenient and provide a better overall experience for the customer. Express Oil Change and Service Centers outperform the industry significantly in terms of customer transactions per day and store sales, for a host of reasons.

In terms of customer convenience, Express Oil Change is faster than most of our competitors—we do a ten-minute oil change while the customer stays in the car. Mothers with kids in car seats especially enjoy this feature. We also do mechanical work that other quick lube businesses don’t do. We change and rotate tires, do brake repairs, air conditioning, tune ups, and others. There is no appointment necessary

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for many mechanical services like tire rotation and balancing, and checking brakes. So, overall, we are more convenient than most of our competitors.

In terms of staffing our stores, full-time workers are all that we employ. Full-time workers are better trained and typically have less turnover. They therefore have more experience and do better quality work.

We think incentives are very important. We use a payroll system that provides incentives to the store staff on how many cars are serviced each day and on the total sales of the store, rather than on increasing the average transactions by selling the customer items they did not come in for, which is what most of the industry does. We don’t sell customers things they don’t yet need, like air filters and radiator flushes. We focus on building trust, by acting with integrity, to get the customer to come back and build the daily car count. This philosophy is not a slogan for us. It is how we operate with every customer, in every store, every day.

The placement of our outlets is another key factor. We place our stores in A-caliber retail locations. These are lots that may cost more than our competitors are willing or able to pay. We get what we pay for though; we have approximately 41% higher sales per store than the industry average.

Question: What is the strangest interaction you’ve ever had with a potential franchisee?

Larose:

I once had a franchisee candidate in New Jersey respond to a request by us for proof of his liquid assets by bringing to the interview about $100,000 in cash to the meeting. He had it in a bag, with bundles of it wrapped in blue tape. Usually, folks just bring in a copy of a bank or stock statement. Not sure why he had so much cash on hand, literally, and I didn’t want to know. He didn’t become a franchisee.

Express Oil Change sets itself apart through superior service and great locations.

Images courtesy of Express Oil Change

Advantages and Disadvantages of Differentiation

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Each generic strategy offers advantages that firms can potentially leverage to enjoy strong performance, as

well as disadvantages that may damage their performance. In the case of differentiation, a key advantage

is that effective differentiation creates an ability to obtain premium prices from customers.

This enables a firm to enjoy strong profit margins. Coca-Cola, for example, currently enjoys a

profit margin of approximately 33 percent, meaning that about thirty-three cents of every dollar it

collects from customers is profit. In comparison, Walmart’s cost leadership strategy delivered a margin of

under 4 percent in 2010.

In turn, strong margins mean that the firm does not need to attract huge numbers of customers to have a

good overall level of profit. Luckily for Coca-Cola, the firm does attract a great many buyers. Overall, the

firm made a profit of just under $12 billion on sales of just over $35 billion in 2010. Interestingly,

Walmart’s profits were only 25 percent higher ($15 billion) than Coca-Cola’s while its sales volume ($421

billion) was twelve times as large as Coca-Cola’s. [3]This comparison of profit margins and overall profit

levels illustrates why a differentiation strategy is so attractive to many firms.

To the extent that differentiation remains in place over time, buyer loyalty may be created. Loyal

customers are very desirable because they are notprice sensitive. In other words, buyer loyalty makes a

customer unlikely to switch to another firm’s products if that firm tries to steal the customer away

through lower prices. Many soda drinkers are fiercely loyal to Coca-Cola’s products. Coca-Cola’s

headquarters are in Atlanta, and loyalty to the firm is especially strong in Georgia and surrounding states.

Pepsi and other brands have a hard time convincing loyal Coca-Cola fans to buy their beverages, even

when offering deep discounts. This helps keep Coca-Cola’s profits high because the firm does not have to

match any promotions that its rivals launch to keep its customers.

Meanwhile, Pepsi also has attracted a large set of brand-loyal customers that Coca-Cola struggles to steal.

This enhances Pepsi’s profits. In contrast, store-brand sodas such as Sam’s Choice (which is sold at

Walmart) seldom attract loyalty. As a result, they must be offered at very low prices to move from store

shelves into shopping carts.

Beyond existing competitors, a differentiation strategy also creates benefits relative to potential new

entrants. Specifically, the brand loyalty that customers feel to a differentiated product makes it difficult

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for a new entrant to lure these customers to adopt its product. A new soda brand, for example, would

struggle to take customers away from Coca-Cola or Pepsi. Thus a differentiation strategy helps create

barriers to entry that protect the firm and its industry from new competition.

The big risk when using a differentiation strategy is that customers will not be willing to pay extra to

obtain the unique features that a firm is trying to build its strategy around. In 2007, department store

Dillard’s stopped carrying men’s sportswear made by Nautica because the seafaring theme of Nautica’s

brand had lost much of its cache among many men. [4] Because Nautica’s uniqueness had eroded, Dillard’s

believed that space in its stores that Nautica had been occupying could be better allocated to other brands.

In some cases, customers may simply prefer a cheaper alternative. For example, products that imitate the

look and feel of offerings from Ray-Ban, Tommy Bahama, and Coach are attractive to many value-

conscious consumers. Firms such as these must work hard at product development and marketing to

ensure that enough customers are willing to pay a premium for their goods rather than settling for

knockoffs.

In other cases, customers desire the unique features that a firm offers, but competitors are able to imitate

the features well enough that they are no longer unique. If this happens, customers have no reason to pay

a premium for the firm’s offerings. IBM experienced the pain of this scenario when executives tried to

follow a differentiation strategy in the personal computer market. The strategy had worked for IBM in

other areas. Specifically, IBM had enjoyed a great deal of success in the mainframe computer market by

providing superior service and charging customers a premium for their mainframes. A business owner

who relied on a mainframe to run her company could not afford to have her mainframe out of operation

for long. Meanwhile, few businesses had the skills to fix their own mainframes. IBM’s message to

customers was that they would pay more for IBM’s products but that this was a good investment because

when a mainframe needed repairs, IBM would provide faster and better service than its competitors

could. The customer would thus be open for business again very quickly after a mainframe failure.

This positioning failed when IBM used it in the personal computer market. Rivals such as Dell were able

to offer service that was just as good as IBM’s while also charging lower prices for personal computers

than IBM charged. From a customer’s perspective, a person would be foolish to pay more for an IBM

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personal computer since IBM did not offer anything unique. IBM steadily lost market share as a result. By

2005, IBM’s struggles led it to sell its personal computer business to Lenovo. The firm is still successful,

however, within the mainframe market where its offerings remain differentiated.

Firms following a differentiation strategy must “watch” out for counterfeit goods such as the faux

Rolexes shown here.

Image courtesy of US Customs and Border Patrol,

http://en.wikipedia.org/wiki/File:Counterfeit_Rolex_Watch, _dsc4577_5f270.jpg.

K E Y T A K E A W A Y

Differentiation can be an effective business-level strategy to the extent that a firm offers unique features

that convince customers to pay a premium for their goods and services. E X E R C I S E S

1. What are two industries in which a differentiation strategy would be difficult to implement?

2. What is an example of a differentiated business near your college or university?

3. Name three ways businesses that provide entertainment that might better differentiate their services.

How might they do this?

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[1] Porter, M. E. 1980. Competitive strategy: Techniques for analyzing industries and competitors. New York, NY:

Free Press.

[2] Excerpted from Ketchen, D. J., & Short, J. C. 2010. The franchise player: An interview with Don Larose. Journal

of Applied Management and Entrepreneurship, 15(4), 94–101.

[3] Profit statistics drawn from Standard & Poor’s stock reports on Coca-Cola and Walmart.

[4] Kapner, S. 2007, November 1. Nautica brand losing ground. CNNMoney. Retrieved from

http://money.cnn.com/2007/10/31/news/companies/Kapner_Nautica.fortune/index.htm

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5.4 Focused Cost Leadership and Focused Differentiation

L E A R N I N G O B J E C T I V E S

1. Describe the nature of focused cost leadership and focused differentiation.

2. Know the advantages and disadvantages of focus strategies.

Companies that use a cost leadership strategy and those that use a differentiation strategy share one

important characteristic: both groups try to be attractive to customers in general. These efforts to

appeal to broad markets can be contrasted with strategies that involve targeting a relatively narrow

niche of potential customers. These latter strategies are known as focus strategies. [1]

The Nature of the Focus Cost Leadership Strategy

Focused cost leadership is the first of two focus strategies. A focused cost leadership strategy requires

competing based on price to target a narrow market. A firm that follows this strategy does not

necessarily charge the lowest prices in the industry. Instead, it charges low prices relative to other firms that

compete within the target market. Redbox, for example, uses vending machines placed outside grocery

stores and other retail outlets to rent DVDs of movies for $1. There are ways to view movies even cheaper,

such as through the flat-fee streaming video subscriptions offered by Netflix. But among firms that rent actual

DVDs, Redbox offers unparalleled levels of low price and high convenience.

Another important point is that the nature of the narrow target market varies across firms that use a

focused cost leadership strategy. In some cases, the target market is defined by demographics. Claire’s, for

example, seeks to appeal to young women by selling inexpensive jewelry, accessories, and ear piercings.

Claire’s use of a focused cost leadership strategy has been very successful; the firm has more than three

thousand locations and has stores in 95 percent of US shopping malls.

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Redbox machines are available on university campuses nationwide.

Image courtesy of Valerie Everett, http://www.flickr.com/photos/valeriebb/2224649723.

In other cases, the target market is defined by the sales channel used to reach customers. Most pizza

shops offer sit-down service, delivery, or both. In contrast, Papa Murphy’s sells pizzas that customers cook

at home. Because these inexpensive pizzas are baked at home rather than in the store, the law allows Papa

Murphy’s to accept food stamps as payment. This allows Papa Murphy’s to attract customers that might

not otherwise be able to afford a prepared pizza. In contrast to most fast-food restaurants, Checkers Drive

In is a drive-through-only operation. To serve customers quickly, each store has two drive-through lanes:

one on either side of the building. Checkers saves money in a variety of ways by not offering indoor

seating to its customers—Checkers’ buildings are cheaper to construct, its utility costs are lower, and

fewer employees are needed. These savings allow the firm to offer large burgers at very low prices and still

remain profitable.

The Nature of the Focused Differentiation Strategy

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Focused differentiation is the second of two focus strategies. A focused differentiation strategy requires

offering unique features that fulfill the demands of a narrow market. As with a focused low-cost

strategy, narrow markets are defined in different ways in different settings. Some firms using

a focused differentiation strategy concentrate their efforts on a particular sales channel, such as

selling over the Internet only. Others target particular demographic groups. One example is Breezes Resorts,

a company that caters to couples without children. The firm operates seven tropical resorts where

vacationers are guaranteed that they will not be annoyed by loud and disruptive children.

While a differentiation strategy involves offering unique features that appeal to a variety of customers, the

need to satisfy the desires of a narrow market means that the pursuit of uniqueness is often taken to the

proverbial “next level” by firms using a focused differentiation strategy. Thus the unique features provided

by firms following a focused differentiation strategy are often specialized.

When it comes to uniqueness, few offerings can top Kopi Luwak coffee beans. High-quality coffee beans

often sell for $10 to $15 a pound. In contrast, Kopi Luwak coffee beans sell for hundreds of dollars per

pound. [2] This price is driven by the rarity of the beans and their rather bizarre nature. As noted in a 2010

article in the New York Times, these beans

are found in the droppings of the civet, a nocturnal, furry, long-tailed catlike animal that prowls

Southeast Asia’s coffee-growing lands for the tastiest, ripest coffee cherries. The civet eventually

excretes the hard, indigestible innards of the fruit—essentially, incipient coffee beans—though

only after they have been fermented in the animal’s stomach acids and enzymes to produce a

brew described as smooth, chocolaty and devoid of any bitter aftertaste. [3]

Although many consumers consider Kopi Luwak to be disgusting, a relatively small group of coffee

enthusiasts has embraced the coffee and made it a profitable product. This illustrates the essence of a

focused differentiation strategy—effectively serving the specialized needs of a niche market can create

great riches.

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Larger niches are served by Whole Foods Market and Mercedes-Benz. Although most grocery stores

devote a section of their shelves to natural and organic products, Whole Foods Market works to sell such

products exclusively. For customers, the large selection of organic goods comes at a steep price. Indeed,

the supermarket’s reputation for high prices has led to a wry nickname—“Whole Paycheck”—but a sizable

number of consumers are willing to pay a premium to feel better about the food they buy.

The dedication of Mercedes-Benz to cutting-edge technology, styling, and safety innovations has made the

firm’s vehicles prized by those who are rich enough to afford them. This appeal has existing for many

decades. In 1970, acid-rocker Janis Joplin recorded a song called “Mercedes Benz” that highlighted the

automaker’s allure. Since then Mercedes-Benz has used the song in several television commercials,

including during the 2011 Super Bowl.

Janis Joplin’s musical tribute to Mercedes-Benz underscores the allure of the brand.

Image courtesy of de.wp, http://en.wikipedia.org/wiki/File:S-Klasse_W221.jpg.

Developing a Focused Differentiation Strategy at Augustino LoPrinzi Guitars and Ukuleles

Augustino LoPrinzi Guitars and Ukuleles in Clearwater, Florida, builds high-end custom instruments. The

founder of the company, Augustino LoPrinzi, has been a builder of custom guitars for five decades. While

a reasonably good mass-produced guitar can be purchased elsewhere for a few hundred dollars, LoPrinzi’s

handmade models start at $1,100, and some sell for more than $10,000. The firm’s customers have

included professional musicians such as Dan Fogelberg, Leo Kottke, Herb Ohta (Ohta-San), Lyle Ritz,

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Andrés Segovia, and B. J. Thomas. Their instruments can be found athttp://www.augustinoloprinzi.com.

We asked Augustino about his firm. [4]

Question: Were there other entrepreneurial opportunities you considered before you began making guitars?

Augustino Loprinzi:

I originally thought of pursuing a career in commercial art, but I found my true love was in classical guitar building. I was trained by my father to be a barber from a very young age, and after my term in the service, I opened a barbershop.

Question: What is the most expensive guitar you’ve ever sold?

Loprinzi: $17,500.

Question: How old were you when you started your first business in the guitar industry?

Loprinzi: I was in my early twenties.

Question: How did you get your break with more famous customers?

Loprinzi: I think word of mouth had a lot do with it.

Question: You have been active in Japan. Do the preferences of Japanese customers differ from those of Americans?

Loprinzi:

Yes. The Japanese want only high-end instruments. Aesthetics are very important to the Japanese along with high-quality materials and workmanship. The US market seems to care in general less about ornamentation and more about quality workmanship, tone, and playability.

Question: How do you stay ahead in your industry?

Loprinzi:

Always try to stay abreast on what the music industry is doing. We do this by reading several music industry publications, talking with suppliers, and keeping an eye on the trends going on in other countries because usually they come full circle. Also, for the past several years by following the Internet forums and such has been extremely beneficial.

Advantages and Disadvantages of the Focused Strategies

Each generic strategy offers advantages that firms can potentially leverage to enhance their success as well

as disadvantages that may undermine their success. In the case of focus differentiation, one advantage is

that very high prices can be charged. Indeed, these firms often price their wares far above what is charged

by firms following a differentiation strategy. REI (Recreational Equipment Inc.), for example,

commands a hefty premium for its outdoor sporting goods and clothes that feature name brands,

such as The North Face and Marmot. Nat Nast’s focus differentiation strategy

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centers on selling men’s silk camp shirts with a 1950s retro flair. These shirts retail for more than $100.

Focused cost leaders such as Checkers Drive In do not charge high prices like REI and Nat Nast do, but

their low cost structures enable them to enjoy healthy profit margins.

A second advantage of using a focus strategy is that firms often develop tremendous expertise about the

goods and services that they offer. In markets such as camping equipment where product knowledge is

important, rivals and new entrants may find it difficult to compete with firms following a focus strategy.

In terms of disadvantages, the limited demand available within a niche can cause problems. First, a firm

could find its growth ambitions stymied. Once its target market is being well served, expansion to other

markets might be the only way to expand, and this often requires developing a new set of skills. Also, the

niche could disappear or be taken over by larger competitors. Many gun stores have struggled and even

gone out of business since Walmart and sporting goods stores such as Academy Sports and Bass Pro

Shops have started carrying an impressive array of firearms.

In contrast to tacky Hawaiian

souvenirs, the quality of Kamaka

ukuleles makes them a favorite of

ukulele phenom Jake Shimabukuro

and others who are willing to pay

$1,000 or more for a high-end

instrument.

Image courtesy of

Wikimedia,http://en.wikipedia.org/

wiki/File:Jake_Shimabukuro.jpg.

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Finally, damaging attacks may come not only from larger firms but also from smaller ones that adopt an

even narrower focus. A sporting goods store that sells camping, hiking, kayaking, and skiing goods, for

example, might lose business to a store that focuses solely on ski apparel because the latter can provide

more guidance about how skiers can stay warm and avoid broken bones.

Strategy at the Movies

Zoolander

One man’s trash is another man’s fashion? That’s what fashion mogul Jacobim Mugatu was counting on

in the 2001 comedy Zoolander. In his continued effort to be the most cutting-edge designer in the fashion

industry, Mugatu developed a new line of clothing inspired “by the streetwalkers and hobos that surround

us.” His new product line, Derelicte, characterized by dresses made of burlap and parking cones and pants

made of garbage bags and tin cans, was developed for customers who valued the uniqueness of

his…eclectic design. Emphasizing unique products is typical of a company following a differentiation

strategy; however, Mugatu targeted a very specific set of customers. Few people would probably be

enticed to wear garbage for the sake of fashion. By catering to a niche target market, Mugatu went from a

simple differentiation strategy to a focused differentiation. Mugatu’s Derelicte campaign in Zoolander is

one illustration of how a particular firm might develop a focused differentiation strategy.

K E Y T A K E A W A Y

Focus strategies can be effective business-level strategies to the extent that a firm can match their goods

and services to specific niche markets. E X E R C I S E S

1. What are three different demographics that firms might target to establish a focus strategy?

2. What is an example of a business that you think is focused in too narrow a fashion to be successful? How

might it change to be more successful?

[1] Porter, M. E. 1980. Competitive strategy: Techniques for analyzing industries and competitors. New York, NY:

Free Press.

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[2] http://www.catsasscoffee.com/order3.html

[3] Onishi, N. 2010, April 17. From dung to coffee brew with no aftertaste. New York Times. Retrieved

from http://www.nytimes.com/2010/04/18/world/asia/18civetcoffee.html?pagewanted=all

[4] Excerpted from Short, J. C. 2007. A touch of the masters’ hands: An interview with Augustino and Donna

Loprinzi. Journal of Applied Management and Entrepreneurship, 12, 103–109.

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5.5 Best-Cost Strategy

L E A R N I N G O B J E C T I V E S

1. Describe the nature of a best-cost strategy.

2. Understand why executing a best-cost strategy is difficult.

The Challenge of Following a Best-Cost Strategy

Some executives are not content to have their firms compete based on offering low prices or unique

features. They want it all! Firms that charge relatively low prices and offer substantial differentiation are

following a best-cost strategy. This strategy is difficult to execute in part because creating unique

features and communicating to customers why these features are useful generally

raises a firm’s costs of doing business. Product development and advertising can both be quite expensive.

However, firms that manage to implement an effective best-cost strategy are often very successful.

Target appears to be following a best-cost strategy. The firm charges prices that are relatively low among

retailers while at the same time attracting trend-conscious consumers by carrying products from famous

designers, such as Michael Graves, Isaac Mizrahi, Fiorucci, Liz Lange, and others. This is a lucrative

position for Target, but the position is under attack from all sides. Cost leader Walmart charges lower

prices than Target. This makes Walmart a constant threat to steal the thriftiest of Target’s customers.

Focus differentiators such as Anthropologie that specialize in trendy clothing and home furnishings can

take business from Target in those areas. Deep discounters such as T.J. Maxx and Marshalls offer another

viable alternative to shoppers because they offer designer clothes and furnishings at closeout prices. A

firm such as Target that uses a best-cost strategy also opens itself up to a wider variety of potentially lethal

rivals.

Developing a Best-Cost Strategy at Plain Ivey Jane

According to government statistics, women are 60 percent less likely than men to become entrepreneurs.

Meanwhile, succeeding within the specialty fashion retailing market is notoriously difficult. These trends

do not worry Sarah Reeves, a young entrepreneur and 2007 graduate of Auburn University who is rapidly

becoming a key player within the Austin, Texas, retail scene by offering high-end fashion at low prices.

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On her website (http://www.plainiveyjane.com), Sarah describes Plain Ivey Jane as “the go-to place for

women who want to elevate their wardrobes. We offer high end designer names at a discount, and the new

overstocked apparel is handpicked from over 70 different brands to offer exactly what Austin needs at a

price every girl can afford. To pair with your fabulous new wardrobe, Plain Ivey Jane carries accessories

from undiscovered local artisans.” We asked Reeves to discuss her firm. [1]

Photo courtesy of Shanti Matulewski.

Question: Can you tell us a little about your Plain Ivey Jane concept?

Sarah Reeves, Owner:

Plain Ivey Jane sells overstock from Anthropologie, Urban Outfitters, Bloomingdales, and other high-end and small designers. Although I buy from the same designers as the big and famous retailers, our dresses and accessories are sold at a fraction of their prices.

Question: What differentiates your boutique from competitors?

Reeves:

I’m one of the lowest-priced retailers in the shopping district that people in Austin call the Second Street area. My niche in the fashion retailing business is that my merchandise is overstock from great brands. There’s maybe one other business in Austin that sells overstock. What makes my concept different is that it has the feel of a high-end retail store

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versus a basement feel of the typical discount retailer.

Question: Do have a lot of regular customers?

Reeves:

Yes. Once people find out what I offer, they’re in here all the time. I see the same group of people every few months, but getting in new faces is the challenge. I think a lot of people walk by and assume that our clothes are expensive, but nothing could be further from the truth.

Question: Were you fearful of starting your own business so young?

Reeves:

No, I figured this was a great time since I had nothing to lose. I thought getting it out of my system now was a good idea, and it was a good time since I was able to get a great deal on my lease. With the downturn in the economy, the time was right for my lower-priced strategy.

Question: What would you say is the biggest key to success for small business?

Reeves:

Flexibility. Rolling with the punches and definitely the ability to follow up with people. I thought that people who owned their own business must know what they are doing, but many people don’t. At this point, I prefer to do everything myself. At least I can blame myself when things go wrong.

Another key is networking with other small-business owners. A lot of the other boutique owners nearby have become close friends. I learn what works for them and what might possibly apply to my concept.

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The success that 2007 college graduate Sarah Reeves has enjoyed with Plain Ivey Jane may inspire

other young women to become entrepreneurs.

Photo courtesy of Shanti Matulewski.

Figure 5.10 Driving toward a Best-Cost Strategy by Reducing Overhead

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Images courtesy of Kari Sullivan,http://www.flickr.com/photos/ilovemypit/3726649397/ (top

left); Sarah B. Brooks, http://www.flickr.com/photos/foodclothingshelter/4753507671/(bottom

left); Samantha Marx,http://www.flickr.com/photos/spam/5166429482/

Pursuing the Best-Cost Strategy through a Low-Overhead Business Model

One route toward a best-cost strategy is for a firm to adopt a business model whose fixed costs and

overhead are very low relative to the costs that competitors are absorbing (Figure 5.10 "Driving toward a

Best-Cost Strategy by Reducing Overhead"). The Internet has helped make this possible for some firms.

Amazon, for example, can charge low prices in part because it does not have to endure the expenses that

firms such as Walmart and Target do in operating many hundreds of stores. Meanwhile, Amazon offers an

unmatched variety of goods. This combination has made Amazon the unquestioned leader in e-commerce.

Another example is Netflix. This firm is able to offer customers a far greater variety of movies and charge

lower prices than video rental stores by conducting all its business over the Internet and via mail. Netflix’s

best-cost strategy has been so successful that $10,000 invested in the firm’s stock in May 2006 was worth

more than $90,000 five years later. [2]

Hey Cupcake! in Austin, Texas, is a low-overhead bakery that has become a delicious success.

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Image courtesy of Evan Bench, http://www.flickr.com/photos/austinevan/3237785474.

Moving toward a best-cost strategy by dramatically reducing expenses is also possible for firms that

cannot rely on the Internet as a sales channel. Owning a restaurant requires significant overhead costs,

such as rent and utilities. Some talented chefs are escaping these costs by taking their food to the streets.

Food trucks that serve high-end specialty dishes at very economical prices are becoming a popular trend

in cities around the country. In Portland, Oregon, a food truck called the Ninja Plate Lunch offers large

portions of delectable Hawaiian foods such as pulled pork for around $5. Another Portland food truck is

PBJ’s, whose unique and inexpensive sandwiches often center on organic peanut butter. Beyond keeping

costs low, the mobility of food trucks offers important advantages over a traditional restaurant. Some food

trucks set up outside big-city nightclubs, for example, to sell partygoers a late-night snack before they

head home.

K E Y T A K E A W A Y

A best-cost strategy can be an effective business-level strategy to the extent that a firm offers

differentiated goods and services at relatively low prices. E X E R C I S E S

1. What is an example of an industry that you think a best-cost strategy could be successful? How would you

differentiate a company to achieve success in this industry?

2. What is an example of a firm following a best-cost strategy near your college or university?

[1] Excerpted from Ketchen, D. J., & Short, J. C. Forthcoming. The discount diva: An interview with Sarah

Reeves. Journal of Applied Management and Entrepreneurship.

[2] Statistics drawn from Standard & Poor’s stock report on Netflix.

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5.6 Stuck in the Middle L E A R N I N G O B J E C T I V E S

1. Describe the problem of being stuck in the middle of different generic strategies.

2. Understand why trying to please everyone often creates problems when crafting a business-level

strategy.

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Images courtesy of F33, http://www.flickr.com/photos/f33/3204789700/(top right); Ethan

Prater,http://www.flickr.com/photos/eprater/4592959910/ (top left);

Caldorwards4,http://en.wikipedia.org/wiki/File:Big_Kmart,_Ontario,_Oregon_2006.jpeg(botto

m right); Rachel P. Maines, http://en.wikipedia.org/wiki/File:Sears_-

_Aids_That_Every_Woman_Appreciates.jpg (bottom left).

Stuck in the Middle: Neither Inexpensive nor Differentiated

Some firms fail to effectively pursue one of the generic strategies. A firm is said to be stuck in the middle if

it does not offer features that are unique enough to convince customers to buy its offerings, and its prices

are too high to compete effectively based on price. Arby’s appears to be a good example.

Arby’s signature roast beef sandwiches are neither cheaper than other fast-food

sandwiches nor standouts in taste. Firms that are stuck in the middle generally perform poorly because

they lack a clear market or competitive pricing. Perhaps not surprisingly, parent company Wendy’s has

been trying to sell Arby’s despite having recently acquired the company in 2008. Stockholders apparently

agreed with the plan to cut Arby’s loose—the price of Wendy’s stock rose 7 percent the day the plan was

announced. [1]

Doing Everything Means Doing Nothing Well

Michael Porter has noted that strategy is as much about executives deciding what a firm is not going to do

as it is about deciding what the firm is going to do.[2] In other words, a firm’s business-level strategy

should not involve trying to serve the varied needs of different segment of customers in an industry. No

firm could possibly pull this off.

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This illustration from 1887 captures the lesson of Aesop’s fable “The Miller, His Son, and Their Ass”—a lesson that

executives need to follow.

Image courtesy of Walter Crane,http://en.wikipedia.org/wiki/File:Can%27t_please_everyone2.jpg.

The fable “The Miller, His Son, and Their Ass” told by the ancient Greek storyteller Aesop helps illustrate

this idea. In this tale, a miller and his son were driving their ass (donkey) to market for sale. They soon

encountered a group of girls who mocked them for walking instead of riding. The father then told his son

to ride the animal. Not long after, father and son overheard a man claim that young people had no respect

for the elderly. On hearing this opinion, the father told the boy to dismount the animal and he began to

ride. They progressed a short distance farther and met a company of women and children. Several of the

women suggested that it was both ridiculous and lazy for the father to ride while the young son was forced

to walk alone; once again the two changed positions. Another bystander suggested that they could not

believe that the man was the owner of the beast, judging from the way it was weighted down. In fact, it

would make more sense for the man and his son to carry the ass. On hearing this, the father and his son

tied the animal’s legs together and carried it on a pole. As they crossed a bridge near town, the

townspeople began to gather and laugh at the unorthodox sight. The noise and the chaos frightened the

beast, leading it to thrash around until it tumbled into the river. With tongue in cheek, we note that the

moral of the story is that if you try to please everyone, you may lose your ass. [3]

Getting Outmaneuvered by Competitors

In many cases, firms become stuck in the middle not because executives fail to arrive at a well-defined

strategy but because firms are simply outmaneuvered by their rivals. After six decades as an electronics

retailer, Circuit City went out of business in 2009. The firm had simply lost its appeal to customers. Rival

electronics retailer Best Buy offered comparable prices to Circuit City’s prices, but the former offered

much better customer service. Meanwhile, the service offered by discount retailers such as Walmart and

Target on electronics were no better that Circuit City’s, but their prices were better.

The results were predictable—customers who made electronics purchases based on the service they

received went to Best Buy, and value-driven buyers patronized Walmart and Target. Circuit City’s demise

was probably inevitable because it lacked a competitive advantage within the electronics business.

Although Target was on the winning end of this battle, Target executives need to worry that their firm

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could become stuck in the middle between Walmart’s better prices on one side and the trendiness of

specialty shops on the other.

IBM’s personal computer business offers another example. IBM tried to position its personal computers

via a differentiation strategy. In particular, IBM’s personal computers were offered at high prices, and the

firm promised to offer excellent service to customers in return. Unfortunately for IBM, rivals such as Dell

were able to provide equal levels of service while selling computers at lower prices. Nothing made IBM’s

computers stand out from the crowd, and the firm eventually exited the business.

At its peak in the mid-2000s, Movie Gallery operated approximately 4,700 video rental stores. By 2010,

the firm was dead. This rapid demise can be traced to the firm becoming outmaneuvered by Netflix. When

Netflix began offering inexpensive DVD rentals through the mail, customers defected in droves from

Movie Gallery and other video rental stores such as Blockbuster. Netflix customers were delighted by the

firm’s low prices, vast selection, and the convenience of not having to visit a store to select and return

videos. Movie Gallery was stuck in the middle—its prices were higher than those of Netflix, and Netflix’s

service was superior. Once individuals lacked a compelling reason to be Movie Gallery customers, the

firm’s fate was sealed.

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Netflix and Redbox have left video rental stores such as Movie Gallery and Blockbuster stuck in the

middle. Blockbuster filed for bankruptcy in late 2010.

Image courtesy of Stu pendousmat,http://en.wikipedia.org/wiki/File:BlockbusterMoncton.JPG. K E Y T A K E A W A Y

When executing a business-level strategy, a firm must not become stuck in the middle between viable

generic business-level strategies by neither offering unique features nor competitive pricing. E X E R C I S E S

1. What is an example of a firm that you would consider to be “stuck in the middle”? What would your

advice be to the executives in charge of this firm?

2. Research a company that has gone bankrupt or otherwise stopped operations in the past decade because

their strategy was “stuck in the middle” of otherwise viable generic business-level strategies. Could its

demise have been prevented?

[1] McWilliams, J. 2011, January 21. Wendy’s/Arby’s to try to sell Arby’s. Atlantic Journal-Constitution. Retrieved

from http://www.ajc.com/business/wendys-arbys-to- try-810320.html

[2] Porter, M. E. 1996. What is strategy? Harvard Business Review, reprint 96608.

[3] Excerpted from Short, J. C., & Ketchen, D. J. 2005. Using classic literature to teach timeless truths: An

illustration using Aesop’s fables to teach strategic management.Journal of Management Education, 29(6), 816–

832.

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5.7 Conclusion

This chapter explains generic business-level strategies that executives select to keep their firms

competitive. Executives must select their firm’s source of competitive advantage by choosing to

compete based on low-cost versus more expensive features that differentiate their firm from

competitors. In addition, targeting either a narrow or broad market helps firms further understand

their customer base. Based on these choices, firms will follow cost leadership, differentiation,

focused cost leadership, or focused differentiation strategies. Another potentially viable business

strategy, best cost, exists when firms offer relatively low prices while still managing to differentiate

their goods or services on some important value-added aspects. All firms can fall victim to being

“stuck in the middle” by not offering unique features or competitive prices.

E X E R C I S E S

1. Divide your class into four or eight groups, depending on the size of the class. Each group should select a

different industry. Find examples of each generic business-level strategy for your industry. Discuss which

strategy seems to be the most successful in your selected industry.

2. This chapter discussed Target and other retailers. If you were assigned to turn around a struggling retailer

such as Kmart, what actions would you take to revive the company?

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Chapter 6

Supporting the Business-Level Strategy: Competitive and Cooperative Moves

L E A R N I N G O B J E C T I V E S

After reading this chapter, you should be able to understand and articulate answers to the following

questions:

1. What different competitive moves are commonly used by firms?

2. When and how do firms respond to the competitive actions taken by their rivals?

3. What moves can firms make to cooperate with other firms and create mutual benefits?

Can Merck Stay Healthy?

On June 7, 2011, pharmaceutical giant Merck & Company Inc. announced the formation of a strategic

alliance with Roche Holding AG, a smaller pharmaceutical firm that is known for excellence in medical

testing. The firms planned to work together to create tests that could identify cancer patients who might

benefit from cancer drugs that Merck had under development. [1]

This was the second alliance formed between the companies in less than a month. On May 16, 2011, the

US Food and Drug Administration approved a drug called Victrelis that Merck had developed to treat

hepatitis C. Merck and Roche agreed to promote Victrelis together. This surprised industry experts

because Merck and Roche had offered competing treatments for hepatitis C in the past. The Merck/Roche

alliance was expected to help Victrelis compete for market share with a new treatment called Incivek that

was developed by a team of two other pharmaceutical firms: Vertex and Johnson & Johnson.

Experts predicted that Victrelis’s wholesale price of $1,100 for a week’s supply could create $1 billion of

annual revenue. This could be an important financial boost to Merck, although the company was already

enormous. Merck’s total of $46 billion in sales in 2010 included approximately $5.0 billion in revenues

from asthma treatment Singulair, $3.3 billion for two closely related diabetes drugs, $2.1 billion for two

closely related blood pressure drugs, and $1.1 billion for an HIV/AIDS treatment.

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Despite these impressive numbers, concerns about Merck had reduced the price of the firm’s stock from

nearly $60 per share at the start of 2008 to about $36 per share by June 2011. A big challenge for Merck

is that once the patent on a drug expires, its profits related to that drug plummet because generic

drugmakers can start selling the drug. The patent on Singulair is set to expire in the summer of 2012, for

example, and a sharp decline in the massive revenues that Singulair brings into Merck seemed

inevitable. [2]

A major step in the growth of Merck was the 2009 acquisition of drugmaker Schering-Plough. By 2011,

Merck ranked fifty-third on the Fortune 500 list of America’s largest companies. Rivals Pfizer (thirty-first)

and Johnson & Johnson (fortieth) still remained much bigger than Merck, however. Important questions

also loomed large. Would the competitive and cooperative moves made by Merck’s executives keep the

firm healthy? Or would expiring patents, fearsome rivals, and other challenges undermine Merck’s

vitality?

Friedrich Jacob Merck had no idea that he was setting the stage for such immense stakes when he took

the first steps toward the creation of Merck. He purchased a humble pharmacy in Darmstadt, Germany, in

1688. In 1827, the venture moved into the creation of drugs when Heinrich Emanuel Merck, a descendant

of Friedrich, created a factory in Darmstadt in 1827. The modern version of Merck was incorporated in

1891. More than three hundred years after its beginnings, Merck now has approximately ninety-four

thousand employees.

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Merck’s origins can be traced back more than three centuries to Friedrich Jacob Merck’s purchase

of this pharmacy in 1688.

Image courtesy of

Wikimedia,http://upload.wikimedia.org/wikipedia/commons/e/eb/ENGEL_APHOTHEKE.png.

For executives leading firms such as Merck, selecting a generic strategy is a key aspect of business-level

strategy, but other choices are very important too. In their ongoing battle to make their firms more

successful, executives must make decisions about what competitive moves to make, how to respond to

rivals’ competitive moves, and what cooperative moves to make. This chapter discusses some of the more

powerful and interesting options. As our opening vignette on Merck illustrates, often another company,

such as Roche, will be a potential ally in some instances and a potential rival in others.

[1] Stynes, T. 2011, June 7. Merck, Roche focus on tests for cancer treatments. Wall Street Journal. Retrieved from

online.wsj.com/article/SB100014240527023044323045 76371491785709756.html?mod=googlenews_wsj

[2] Statistics drawn from Standard & Poor’s stock report on Merck.

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6.1 Making Competitive Moves

Figure 6.1 Making Competitive Moves

Image courtesy of 663highland, http://en.wikipedia.org/wiki/File:Enchoen27n3200.jpg

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L E A R N I N G O B J E C T I V E S

1. Understand the advantages and disadvantages of being a first mover.

2. Know how disruptive innovations can change industries.

3. Describe two ways that using foothold can benefit firms.

4. Explain how firms can win without fighting using a blue ocean strategy.

5. Describe the creative process of bricolage.

Being a First Mover: Advantages and Disadvantages

A famous cliché contends that “the early bird gets the worm.” Applied to the business world, the cliché

suggests that certain benefits are available to a first mover into a market that will not be available to later

entrants (Figure 6.1 "Making Competitive Moves"). A first-mover advantage exists when making the

initial move into a market allows a firm to establish a dominant position that other firms struggle to

overcome. For example, Apple’s creation of a user-friendly, small computer in the early 1980s helped

fuel a reputation for creativity and innovation that persists today. Kentucky Fried Chicken (KFC)

was able to develop a strong bond with Chinese officials by being the first Western restaurant chain

to enter China. Today, KFC is the leading Western fast-food chain in this rapidly growing market.

Genentech’s early development of biotechnology allowed it to overcome many of the

pharmaceutical industry’s traditional entry barriers (such as financial capital and distribution networks)

and become a profitable firm. Decisions to be first movers helped all three firms to be successful in their

respective industries. [1]

On the other hand, a first mover cannot be sure that customers will embrace its offering, making a first

move inherently risky. Apple’s attempt to pioneer the personal digital assistant market, through its

Newton, was a financial disaster. The first mover also bears the costs of developing the product and

educating customers. Others may learn from the first mover’s successes and failures, allowing them to

cheaply copy or improve the product. In creating the Palm Pilot, for example, 3Com was able to build on

Apple’s earlier mistakes. Matsushita often refines consumer electronic products, such as compact disc

players and projection televisions, after Sony or another first mover establishes demand. In many

industries, knowledge diffusion and public-information requirements make such imitation increasingly

easy.

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One caution is that first movers must be willing to commit sufficient resources to follow through on their

pioneering efforts. RCA and Westinghouse were the first firms to develop active-matrix LCD display

technology, but their executives did not provide the resources needed to sustain the products spawned by

this technology. Today, these firms are not even players in this important business segment that supplies

screens for notebook computers, camcorders, medical instruments, and many other products.

To date, the evidence is mixed regarding whether being a first mover leads to success. One research study

of 1,226 businesses over a fifty-five-year period found that first movers typically enjoy an advantage over

rivals for about a decade, but other studies have suggested that first moving offers little or no advantages.

Perhaps the best question that executives can ask themselves when deciding whether to be a first mover

is, how likely is this move to provide my firm with a sustainable competitive advantage? First moves that

build on strategic resources such as patented technology are difficult for rivals to imitate and thus are

likely to succeed. For example, Pfizer enjoyed a monopoly in the erectile dysfunction market for five years

with its patented drug Viagra before two rival products (Cialis and Levitra) were developed by other

pharmaceutical firms. Despite facing stiff competition, Viagra continues to raise about $1.9 billion in sales

for Pfizer annually. [2]

In contrast, E-Trade Group’s creation in 2003 of the portable mortgage seemed doomed to fail because it

did not leverage strategic resources. This innovation allowed customers to keep an existing mortgage

when they move to a new home. Bigger banks could easily copy the portable mortgage if it gained

customer acceptance, undermining E-Trade’s ability to profit from its first move.

Disruptive Innovation

Some firms have the opportunity to shake up their industry by introducing a disruptive innovation—an

innovation that conflicts with, and threatens to replace, traditional approaches to competing within an

industry. The iPad has proved to be a disruptive innovation since its introduction by Apple in 2010.

Many individuals quickly abandoned clunky laptop computers in favor of the sleek tablet format offered

by the iPad. And as a first mover, Apple was able to claim a large share of the market.

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The iPad story is unusual, however. Most disruptive innovations are not overnight sensations. Typically, a

small group of customers embrace a disruptive innovation as early adopters and then a critical mass of

customers builds over time. An example is digital cameras. Few photographers embraced digital cameras

initially because they took pictures slowly and offered poor picture quality relative to traditional film

cameras. As digital cameras have improved, however, they have gradually won over almost everyone that

takes pictures. Executives who are deciding whether to pursue a disruptive innovation must first make

sure that their firm can sustain itself during an initial period of slow growth.

Footholds

In warfare, many armies establish small positions in geographic territories that they have not occupied

previously. These footholds provide value in at least two ways. First, owning a

foothold can dissuade other armies from attacking in the region. Second, owning a foothold gives an army

a quick strike capability in a territory if the army needs to expand its reach.

Similarly, some organizations find it valuable to establish footholds in certain markets. Within the context

of business, a foothold is a small position that a firm intentionally establishes within a market in which it

does not yet compete.[3] Swedish furniture seller IKEA is a firm that relies on footholds. When IKEA enters

a new country, it opens just one store. This store is then used as a showcase to establish IKEA’s brand.

Once IKEA gains brand recognition in a country, more stores are established. [4]

Pharmaceutical giants such as Merck often obtain footholds in emerging areas of medicine. In December

2010, for example, Merck purchased SmartCells Inc., a company that was developing a possible new

treatment for diabetes. In May 2011, Merck acquired an equity stake in BeiGene Ltd., a Chinese firm that

was developing novel cancer treatments and detection methods. Competitive moves such as these offer

Merck relatively low-cost platforms from which it can expand if clinical studies reveal that the treatments

are effective.

Blue Ocean Strategy

It is best to win without fighting.

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Sun-Tzu, The Art of War

A blue ocean strategy involves creating a new, untapped market rather than competing with rivals in an

existing market. [5] This strategy follows the approach recommended by the ancient master of strategy

Sun-Tzu in the quote above. Instead of trying to outmaneuver its competition, a firm using a blue ocean

strategy tries to make the competition irrelevant. Baseball legend Wee Willie Keeler offered a similar idea

when asked how to become a better hitter: “Hit ’em where they ain’t.” In other words, hit the baseball where

there are no fielders rather than trying to overwhelm the fielders with a ball hit directly at them.

Nintendo openly acknowledges following a blue ocean strategy in its efforts to invent new markets. In

2006, Perrin Kaplan, Nintendo’s vice president of marketing and corporate affairs for Nintendo of

America noted in an interview, “We’re making games that are expanding our base of consumers in Japan

and America. Yes, those who’ve always played games are still playing, but we’ve got people who’ve never

played to start loving it with titles like Nintendogs, Animal Crossing and Brain Games. These games are

blue ocean in action.” [6] Other examples of companies creating new markets include FedEx’s invention of

the fast-shipping business and eBay’s invention of online auctions.

Bricolage

Bricolage is a concept that is borrowed from the arts and that, like blue ocean strategy, stresses moves that

create new markets. Bricolage means using whatever materials and resources happen to be available as

the inputs into a creative process. A good example is offered by one of the greatest inventions in the

history of civilization: the printing press. As noted in the Wall Street Journal, “The printing press is a

classic combinatorial innovation. Each of its key elements—the movable type, the ink, the paper and the

press itself—had been developed separately well before Johannes Gutenberg printed his first Bible in the

15th century. Movable type, for instance, had been independently conceived by a Chinese blacksmith

named Pi Sheng four centuries earlier. The press itself was adapted from a screw press that was being

used in Germany for the mass production of wine.” [7] Gutenberg took materials that others had created

and used them in a unique and productive way.

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Executives apply the concept of bricolage when they combine ideas from existing businesses to create a

new business. Think miniature golf is boring? Not when you play at one of Monster Mini Golf’s more than

twenty-five locations. This company couples a miniature golf course with the thrills of a haunted house. In

April 2011, Monster Mini Golf announced plans to partner with the rock band KISS to create a “custom-

designed, frightfully fun course [that] will feature animated KISS and monster props lurking in all 18

fairways” in Las Vegas. [8]

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Braveheart meets heavy metal when TURISAS takes the stage.

Image courtesy of Cecil, http://en.wikipedia.org/wiki/File:Turisas_-_Jalometalli_2008_-

_02.JPG.

Many an expectant mother has lamented the unflattering nature of maternity clothes and the boring

stores that sell them. Coming to the rescue is Belly Couture, a boutique in Lubbock, Texas, that combines

stylish fashion and maternity clothes. The store’s clever slogan—“Motherhood is haute”—reflects the

unique niche it fills through bricolage. A wilder example is TURISAS, a Finnish rock band that has created

a niche for itself by combining heavy metal music with the imagery and costumes of Vikings. The band’s

website describes their effort at bricolage as “inspirational cinematic battle metal brilliance.” [9]No one

ever claimed that rock musicians are humble.

Strategy at the Movies

Love and Other Drugs

Competitive moves are chosen within executive suites, but they are implemented by frontline employees.

Organizational success thus depends just as much on workers such as salespeople excelling in their roles

as it does on executives’ ability to master strategy. A good illustration is provided in the 2010 film Love

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and Other Drugs, which was based on the nonfiction book Hard Sell: The Evolution of a Viagra

Salesman.

As a new sales representative for drug giant Pfizer, Jamie Randall believed that the best way to increase

sales of Pfizer’s antidepressant Zoloft in his territory was to convince highly respected physician Dr.

Knight to prescribe Zoloft rather than the good doctor’s existing preference, Ely Lilly’s drug Prozac. Once

Dr. Knight began prescribing Zoloft, thought Randall, many other physicians in the area would follow

suit.

This straightforward plan proved more difficult to execute than Randall suspected. Sales reps from Ely

Lilly and other pharmaceutical firms aggressively pushed their firm’s products, such as by providing all-

expenses-paid trips to Hawaii for nurses in Dr. Knight’s office. Prozac salesman Trey Hannigan went so

far as to beat up Randall after finding out that Randall had stolen and destroyed Prozac samples. While

assault is an extreme measure to defend a sales territory, the actions of Hannigan and the other

salespeople depicted in Love and Other Drugs reflect the challenges that frontline employees face when

implementing executives’ strategic decisions about competitive moves.

Image courtesy of Marco, http://www.flickr.com/photos/zi1217/5528068221.

K E Y T A K E A W A Y

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Firms can take advantage of a number of competitive moves to shake up or otherwise get ahead in an

ever-changing business environment. E X E R C I S E S

1. Find a key trend from the general environment and develop a blue ocean strategy that might capitalize on

that trend.

2. Provide an example of a product that, if invented, would work as a disruptive innovation. How

widespread would be the appeal of this product?

3. How would you propose to develop a new foothold if your goal was to compete in the fashion industry?

4. Develop a new good or service applying the concept of bricolage. In other words, select two existing

businesses and describe the experience that would be created by combining those two businesses.

[1] This section draws from Ketchen, D. J., Snow, C., & Street, V. 2004. Improving firm performance by matching

strategic decision making processes to competitive dynamics.Academy of Management Executive, 19(4), 29–43.

[2] Figures from Standard & Poor’s stock report on Pfizer.

[3] Upson, J., Ketchen, D. J., Connelly, B., & Ranft, A. Forthcoming. Competitor analysis and foothold

moves. Academy of Management Journal.

[4] Hambrick, D. C., & Fredrickson, J. W. 2005. Are you sure you have a strategy? Academy of Management

Executive, 19, 51–62.

[5] Kim, W. C., & Mauborgne, R. 2004, October. Blue ocean strategy. Harvard Business Review, 76–85.

[6] Rosmarin, R. 2006, February 7. Nintendo’s new look. Forbes.com. Retrieved

fromhttp://www.forbes.com/2006/02/07/xbox-ps3-revolution-cx_rr_0207nintendo.html

[7] Johnson, S. The genius of the tinkerer. Wall Street Journal. Retrieved from

http://online.wsj.com/article/SB10001424052748703989304575503730101860838.html

[8] KISS Mini Golf to rock Las Vegas this fall [Press release]. 2011, April 28. Monster Mini Golf website. Retrieved

from http://www.monsterminigolf.com/mmgkiss.html

[9] http://www.turisas.com/site/biography/

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6.2 Responding to Competitors’ Moves

L E A R N I N G O B J E C T I V E S

1. Know the three factors that determine the likelihood of a competitor response.

2. Understand the importance of speed in competitive response.

3. Describe how mutual forbearance can be beneficial for firms engaged in multipoint competition.

4. Explain two ways firms can respond to disruptive innovations.

5. Understand the importance of fighting brands as a competitive response.

In addition to choosing what moves their firm will make, executives also have to decide whether to

respond to moves made by rivals. Figuring out how to react, if at all, to a competitor’s move

ranks among the most challenging decisions that executives must make. Research indicates

that three factors determine the likelihood that a firm will respond to a competitive move:

awareness, motivation, and capability. These three factors together determine

the level of competition tension that exists between rivals.

An analysis of the “razor wars” illustrates the roles that these factors play. [1]Consider Schick’s

attempt to grow in the razor-system market with its introduction of the Quattro. This move was

widely publicized and supported by a $120 million advertising budget. Therefore, its main

competitor, Gillette, was well aware of the move. Gillette’s motivation to respond was also high.

Shaving products are a vital market for Gillette, and Schick has become an increasingly formidable

competitor since its acquisition by Energizer. Finally, Gillette was very capable of responding, given

its vast resources and its dominant role in the industry. Because all three factors were high, a strong

response was likely. Indeed, Gillette made a preemptive strike with the introduction of the Sensor 3

and Venus Devine a month before the Schick Quattro’s projected introduction.

Although examining a firm’s awareness, motivation, and capability is important, the results of a

series of moves and countermoves are often difficult to predict and miscalculations can be costly. The

poor response by Kmart and other retailers to Walmart’s growth in the late 1970s illustrates this

point. In discussing Kmart’s parent corporation (Kresge), a stock analyst at that time wrote, “While

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we don’t expect Kresge to stage any massive invasion of Walmart’s existing territory, Kresge could

logically act to contain Walmart’s geographical expansion.…Assuming some containment policy on

Kresge’s part, Walmart could run into serious problems in the next few years.” Kmart executives also

received but ignored early internal warnings about Walmart. A former member of Kmart’s board of

directors lamented, “I tried to advise the company’s management of just what a serious threat I

thought [Sam Walton, founder of Walmart] was. But it wasn’t until fairly recently that they took him

seriously.” While the threat of Walmart growth was apparent to some observers, Kmart executives

failed to respond. Competition with Walmart later drove Kmart into bankruptcy.

Speed Kills

Executives in many markets must cope with a rapid-fire barrage of attacks from rivals, such as head-to-

head advertising campaigns, price cuts, and attempts to grab key customers. If a firm is going to respond

to a competitor’s move, doing so quickly is important. If there is a long delay between an attack and a

response, this generally provides the attacker with an edge. For example, PepsiCo made the mistake of

waiting fifteen months to copy Coca-Cola’s May 2002 introduction of Vanilla Coke. In the interim, Vanilla

Coke carved out a significant market niche; 29 percent of US households had purchased the beverage by

August 2003, and 90 million cases had been sold.

In contrast, fast responses tend to prevent such an edge. Pepsi’s spring 2004 announcement of a

midcalorie cola introduction was quickly followed by a similar announcement by Coke, signaling that

Coke would not allow this niche to be dominated by its longtime rival. Thus, as former General Electric

CEO Jack Welch noted in his autobiography, success in most competitive rivalries “is less a function of

grandiose predictions than it is a result of being able to respond rapidly to real changes as they occur.

That’s why strategy has to be dynamic and anticipatory.”

So…We Meet Again

Multipoint competition adds complexity to decisions about whether to respond to a rival’s moves.

With multipoint competition, a firm faces the same rival in more than one market. Cigarette makers R. J.

Reynolds (RJR) and Philip Morris, for example, square off not only in the United States but also in many

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countries around the world. When a firm has one or more multipoint competitors, executives must realize

that a competitive move in a market can have effects not only within that market but also within others. In

the early 1990s, RJR started using lower-priced cigarette brands in the United States to gain customers.

Philip Morris responded in two ways. The first response was cutting prices in the United States to protect

its market share. This started a price war that ultimately hurt both companies. Second, Philip Morris

started building market share in Eastern Europe where RJR had been establishing a strong position. This

combination of moves forced RJR to protect its market share in the United States and neglect Eastern

Europe.

If rivals are able to establish mutual forbearance, then multipoint competition can help them be

successful. Mutual forbearance occurs when rivals do not act aggressively because each recognizes that

the other can retaliate in multiple markets. In the late 1990s, Southwest Airlines and United Airlines

competed in some but not all markets. United announced plans to form a new division that would move

into some of Southwest’s other routes. Southwest CEO Herb Kelleher publicly threatened to retaliate in

several shared markets. United then backed down, and Southwest had no reason to attack. The result was

better performance for both firms. Similarly, in hindsight, both RJR and Philip Morris probably would

have been more profitable had RJR not tried to steal market share in the first place. Thus recognizing and

acting on potential forbearance can lead to better performance through firms not competing away their

profits, while failure to do so can be costly.

Responding to a Disruptive Innovation

When a rival introduces a disruptive innovation that conflicts with the industry’s current competitive

practices, such as the emergence of online stock trading in the late 1990s, executives choose from among

three main responses. First, executives may believe that the innovation will not replace established

offerings entirely and thus may choose to focus on their traditional modes of business while ignoring the

disruption. For example, many traditional bookstores such as Barnes & Noble did not consider book sales

on Amazon to be a competitive threat until Amazon began to take market share from them. Second, a firm

can counter the challenge by attacking along a different dimension. For example, Apple responded to the

direct sales of cheap computers by Dell and Gateway by adding power and versatility to its products. The

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third possible response is to simply match the competitor’s move. Merrill Lynch, for example, confronted

online trading by forming its own Internet-based unit. Here the firm risks cannibalizing its traditional

business, but executives may find that their response attracts an entirely new segment of customers.

Fighting Brands: Get Ready to Rumble

A firm’s success can be undermined when a competitor tries to lure away its customers by charging lower

prices for its goods or services. Such a scenario is especially scary if the quality of the competitor’s

offerings is reasonably comparable to the firm’s. One possible response would be for the firm to lower its

prices to prevent customers from abandoning it. This can be effective in the short term, but it creates a

long-term problem. Specifically, the firm will have trouble increasing its prices back to their original level

in the future because charging lower prices for a time will devalue the firm’s brand and make customers

question why they should accept price increases.

The creation of a fighting brand is a move that can prevent this problem. Afighting brand is a lower-end

brand that a firm introduces to try to protect the firm’s market share without damaging the firm’s existing

brands. In the late 1980s, General Motors (GM) was troubled by the extent to which the sales of small,

inexpensive Japanese cars were growing in the United States. GM wanted to recapture lost sales, but it did

not want to harm its existing brands, such as Chevrolet, Buick, and Cadillac, by putting their names on

low-end cars. GM’s solution was to sell small, inexpensive cars under a new brand: Geo.

Interestingly, several of Geo’s models were produced in joint ventures between GM and the same

Japanese automakers that the Geo brand was created to fight. A sedan called the Prizm was built side by

side with the Toyota Corolla by the New United Motor Manufacturing Incorporated (NUMMI), a factory

co-owned by GM and Toyota. The two cars were virtually identical except for minor cosmetic differences.

A smaller car (the Metro) and a compact sport utility vehicle (the Tracker) were produced by a joint

venture between GM and Suzuki. By 1998, the US car market revolved around higher-quality vehicles, and

the low-end Geo brand was discontinued.

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The Geo brand was known for its low price and good gas mileage, not for its styling.

Image courtesy of Bull-

Doser,http://upload.wikimedia.org/wikipedia/commons/6/6a/Geo_Metro_Convertible.JPG.

Some fighting brands are rather short lived. Merck’s failed attempt to protect market share in Germany by

creating a fighting brand is an example. Zocor, a treatment for high cholesterol, was set to lose its German

patent in 2003. Merck tried to keep its high profit margin for Zocor intact until the patent expired as well

as preparing for the inevitable competition with generic drugmakers by creating a lower-priced brand,

Zocor MSD. Once the patent expired, however, the new brand was not priced low enough to keep

customers from switching to generics. Merck soon abandoned the Zocor MSD brand. [2]

Two major airlines experienced similar futility. In response to the growing success of discount airlines

such as Southwest, AirTran, Jet Blue, and Frontier, both United Airlines and Delta Airlines created

fighting brands. United launched Ted in 2004 and discontinued it in 2009. Delta’s Song had an even

shorter existence. It was started in 2003 and was ended in 2006. Southwest’s acquisition of AirTran in

2011 created a large airline that may make United and Delta lament that they were not able to make their

own discount brands successful.

Despite these missteps, the use of fighting brands is a time-tested competitive move. For example, very

successful fighting brands were launched forty years apart by Anheuser-Busch and Intel. After Anheuser-

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Busch increased the prices charged by its existing brands in the mid-1950s (Budweiser and Michelob),

smaller brewers started gaining market share. In response, Anheuser-Busch created a lower-priced brand:

Busch. The new brand won back the market share that had been lost and remains an important part of

Anheuser-Busch’s brand portfolio today. In the late 1990s, silicon chipmaker Advanced Micro Devices

started undercutting the prices charged by industry leader Intel. Intel responded by creating the Celeron

brand of silicon chips, a brand that has preserved Intel’s market share without undermining profits. Wise

strategic moves such as the creation of the Celeron brand help explain why Intel ranks thirty-second

on Fortune magazine’s list of the “World’s Most Admired Corporations.” Meanwhile, Anheuser-Busch is

the second most admired beverage firm, ranking behind Coca-Cola.

K E Y T A K E A W A Y

When threatened by the competitive actions of rivals, firms possess numerous ways to respond,

depending on the severity of the threat.

E X E R C I S E S

1. Why might local restaurants not be in the position to respond to large franchises or chains? What can

local restaurants do to avoid being ruined by chain restaurants?

2. If a new alternative fuel was found in the auto industry, what are two ways existing car manufacturers

might respond to this disruptive innovation?

3. How might a firm such as Apple computers use a fighting brand?

[1] Portions of this section are adapted from Ketchen, D. J., Snow, C., & Street, V. 2004. Improving firm

performance by matching strategic decision making processes to competitive dynamics. Academy of Management

Executive, 19(4) 29-43. Ibid.

[2] Ritson, M. 2009, October. Should you launch a fighter brand? Harvard Business Review, 65–81.

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6.3 Making Cooperative Moves

L E A R N I N G O B J E C T I V E S

1. Know the four types of cooperative moves.

2. Understand the benefits of taking quick and decisive action.

In addition to competitive moves, firms can benefit from cooperating with one another. Cooperative

moves such as forming joint ventures and strategic alliances may allow firms to enjoy successes that

might not otherwise be reached. This is because cooperation enables firms to share (rather than duplicate)

resources and to learn from one another’s strengths. Firms that enter cooperative relationships

take on risks, however, including the loss of ontrol over operations, possible transfer of valuable secrets

to other firms, and possibly being taken advantage of by partners.[1]

Joint Ventures

A joint venture is a cooperative arrangement that involves two or more organizations each contributing to

the creation of a new entity. The partners in a joint venture share decision-making authority, control of

the operation, and any profits that the joint venture earns.

Sometimes two firms create a joint venture to deal with a shared opportunity. In April 2011, a joint

venture was created between Merck and Sun Pharmaceutical Industries Ltd., an Indian pharmaceutical

company. The purpose of the joint venture is to create and sell generic drugs in developing countries. In a

press release, a top executive at Sun stressed that each side has important strengths to contribute: “This

joint venture reinforces [Sun’s] strategy of partnering to launch products using our highly innovative

delivery technologies around the world. Merck has an unrivalled reputation as a world leading,

innovative, research-driven pharmaceutical company.” [2] Both firms contributed executives to the new

organization, reflecting the shared decision making and control involved in joint ventures.

In other cases, a joint venture is designed to counter a shared threat. In 2007, brewers SABMiller and

Molson Coors Brewing Company created a joint venture called MillerCoors that combines the firms’ beer

operations in the United States. Miller and Coors found it useful to join their US forces to better compete

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against their giant rival Anheuser-Busch, but the two parent companies remain separate. The joint

venture controls a wide array of brands, including Miller Lite, Coors Light, Blue Moon Belgian White,

Coors Banquet, Foster’s, Henry Weinhard’s, Icehouse, Keystone Premium, Leinenkugel’s, Killian’s Irish

Red, Miller Genuine Draft, Miller High Life, Milwaukee’s Best, Molson Canadian, Peroni Nastro Azzurro,

Pilsner Urquell, and Red Dog. This diverse portfolio makes MillerCoors a more potent adversary for

Anheuser-Busch than either Miller or Coors would be alone.

Strategic Alliances

A strategic alliance is a cooperative arrangement between two or more organizations that does not involve

the creation of a new entity. In June 2011, for example, Twitter announced the formation of a strategic

alliance with Yahoo! Japan. The alliance involves relevant Tweets appearing within various functions

offered by Yahoo! Japan. [3] The alliance simply involves the two firms collaborating as opposed to

creating a new entity together.

The pharmaceutical industry is the location of many strategic alliances. In January 2011, for example, a

strategic alliance between Merck and PAREXEL International Corporation was announced. Within this

alliance, the two companies collaborate on biotechnology efforts known as biosimilars. This alliance could

be quite important to Merck because the global market for biosimilars has been predicted to rise from

$235 million in 2010 to $4.8 billion by 2015. [4]

Colocation

Colocation occurs when goods and services offered under different brands are located close to one

another. In many cities, for examples, theaters and art galleries are clustered together in one

neighborhood. Auto malls that contain several different car dealerships are found in many areas.

Restaurants and hotels are often located near on another too. By providing customers with a variety of

choices, a set of colocated firms can attract a bigger set of customers collectively than the sum that could

be attracted to individual locations. If a desired play is sold out, a restaurant overcrowded, or a hotel

overbooked, many customers simply patronize another firm in the area.

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Because of these benefits, savvy executives in some firms colocate their own brands. The industry that

Brinker International competes within is revealed by its stock ticker symbol: EAT. This firm often sites

outlets of the multiple restaurant chains it owns on the same street. Marriott’s Courtyard and Fairfield Inn

often sit side by side. Yum! Brands takes this clustering strategy one step further by locating more than

one of its brands—A&W, Long John Silver’s, Taco Bell, Kentucky Fried Chicken, and Pizza Hut—within a

single store.

Co-opetition

Although competition and cooperation are usually viewed as separate processes, the concept of co-

opetition highlights a complex interaction that is becoming increasingly popular in many industries. Ray

Noorda, the founder of software firm Novell, coined the term to refer to a blending of competition and

cooperation between two firms. As explained in this chapter’s opening vignette, for example, Merck and

Roche are rivals in some markets, but the firms are working together to develop tests to detect cancer and

to promote a hepatitis treatment. NEC (a Japanese electronics company) has three different relationships

with Hewlett-Packard Co.: customer, supplier, and competitor. Some units of each company work

cooperatively with the other company, while other units are direct competitors. NEC and Hewlett-Packard

could be described as “frienemies”—part friends and part enemies.

Toyota and General Motors provide a well-known example of co-opetition. In terms of cooperation,

Toyota and GM vehicles were produced side by side for many years at the jointly owned New United

Motor Manufacturing Incorporated (NUMMI) in Fremont, California. While Honda and Nissan used

wholly owned plants to begin producing cars in the United States, NUMMI offered Toyota a lower-risk

means of entering the US market. This entry mode was desirable to Toyota because its top executives were

not confident that Japanese-style management would work in the United States. Meanwhile, the venture

offered GM the chance to learn Japanese management and production techniques—skills that were later

used in GM’s facilities. NUMMI offered both companies economies of scale in manufacturing and the

chance to collaborate on automobile designs. Meanwhile, Toyota and GM compete for market share

around the world. In recent years, the firms have been the world’s two largest automakers, and they have

traded the top spot over time.

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In their book titled, not surprisingly, Co-opetition, A. M. Brandenberger and B. J. Nalebuff suggest that

cooperation is generally best suited for “creating a pie,” while competition is best suited for “dividing it

up.” [5] In other words, firms tend to cooperate in activities located far in the value chain from customers,

while competition generally occurs close to customers. The NUMMI example illustrates this tendency—

GM and Toyota worked together on design and manufacturing but worked separately on distribution,

sales, and marketing. Similarly, a research study focused on Scandinavian firms found that, in the mining

equipment industry, firms cooperated in material development, but they competed in product

development and marketing. In the brewing industry, firms worked together on the return of used bottles

but not in distribution. [6]

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Joseph Addison, an eighteenth-century poet, is often credited with coining the phrase “He who hesitates

is lost.” This proverb is especially meaningful in today’s business world. It is easy for executives to become

paralyzed by the dizzying array of competitive and cooperative moves available to them. Given the fast-

paced nature of most industries today, hesitation can lead to disaster. Some observers have suggested that

competition in many settings has transformed into hypercompetition, which involves very rapid and

unpredictable moves and countermoves that can undermine competitive advantages. Under such

conditions, it is often better to make a reasonable move quickly rather than hoping to uncover the perfect

move through extensive and time-consuming analysis.

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The importance of learning also contributes to the value of adopting a “get moving” mentality. This is

illustrated in Miroslav Holub’s poem “Brief Thoughts on Maps.” The discovery that one soldier had a map

gave the soldiers the confidence to start moving rather than continuing to hesitate and remaining lost.

Once they started moving, the soldiers could rely on their skill and training to learn what would work and

what would not. Similarly, success in business often depends on executives learning from a series of

competitive and cooperative moves, not on selecting ideal moves.

K E Y T A K E A W A Y

Cooperating with other firms is sometimes a more lucrative and beneficial approach than directly

attacking competing firms.

E X E R C I S E S

1. How could a family jewelry store use one of the cooperative moves mentioned in this section?? What

type of organization might be a good cooperative partner for a family jewelry store?

2. Why is it that “any old map will do” sometimes in relation to strategic actions?

[1] Portions of this section are adapted from Ketchen, D. J., Snow, C., & Street, V. 2004. Improving firm

performance by matching strategic decision making processes to competitive dynamics. Academy of Management

Executive, 19(4), 29-43. Ibid.

[2] Merck & Co., Inc., and Sun Pharma establish joint venture to develop and commercialize novel formulations

and combinations of medicines in emerging markets [Press release]. 2011, April 11. Merck website. Retrieved

fromhttp://www.merck.com/licensing/our-partnership/sun-partnership.html

[3] Rao, L. 2011, June 14. Twitter announces “strategic alliance” with Yahoo Japan [Blog post]. Techcrunch website.

Retrieved fromhttp://www.techcrunch.com/2011/06/14/twitter-announces-firehose-partnership-with-yahoo-

japan

[4] Global biosimilars market to reach US$4.8 billion by 2015, according to a new report by Global Industry

Analysts, Inc. [Press release]. 2011, February 15. PRWeb website. Retrieved

from http://www.prweb.com/releases/biosimilars/human_growth _hormone/prweb8131268.htm

[5] Brandenberger, A. M., & Nalebuff, B. J. 1996. Co-opetition. New York, NY: Doubleday.

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[6] Bengtsson, M., & Kock, S. 2000. “Coopetition” in business networks—to cooperate and compete

simultaneously. Industrial Marketing Management, 29(5), 411–426.

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6.4 Conclusion

This chapter explains competitive and cooperative moves that executives may choose from when

challenged by competitors. Executives may choose to act swiftly by being a first mover in their

market, and their firms may benefit if they are offering disruptive innovations to an industry.

Executives may also choose a more conservative route by establishing a foothold within an area that

can serve as a launching point or by avoiding existing competitors overall by using a blue ocean

strategy. When firms are on the receiving end of a competitive attack, they are likely to retaliate to

the extent that they possess awareness, motivation, and capability. While responding quickly is often

beneficial, mutual forbearance can also be an effective approach. When firms encounter a potentially

disruptive innovation, they might ignore the threat, confront it head on, or attack along a different

dimension. Executives may also react to competitive attacks by using fighting brands. Rather than

engaging in a head-to-head battle with competitors, executives may also choose to engage in a

cooperative strategy such as a joint venture, strategic alliance, colocation, or co-opetition. Regardless

of the decision executives make, in many cases any attempt to act on a viable road map will result in

progress that will get the firm moving in the right direction.

E X E R C I S E S

1. Divide your class into four or eight groups, depending on the size of the class. Each group should select a

different industry. Find examples of competitive and cooperative moves that you would recommend if

hired as a consultant for a firm in that industry.

2. What types of cooperative moves could your college or university use to partner with local, national, and

international businesses? What benefits and risks would be created by making these moves?

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Chapter 1

Mastering Strategy: Art and Science

L E A R N I N G O B J E C T I V E S

After reading this chapter, you should be able to understand and articulate answers to the following

questions:

1. What are strategic management and strategy?

2. Why does strategic management matter?

3. What elements determine firm performance?

Strategic Management: A Core Concern for Apple

The Opening of the Apple Store

Image courtesy of Neil Bird, http://www.flickr.com/photos/nechbi/2058929337.

March 2, 2011, was a huge day for Apple. The firm released its much-anticipated iPad2, a thinner and

faster version of market-leading Apple’s iPad tablet device. Apple also announced that a leading publisher,

Random House, had made all seventeen thousand of its books available through Apple’s iBookstore.

Apple had enjoyed tremendous success for quite some time. Approximately fifteen million iPads were sold

in 2010, and the price of Apple’s stock had more than tripled from early 2009 to early 2011.

Chapter 1 from Mastering Strategic Management was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 license without attribution as requested

by the work’s original creator or licensee. © 2014, The Saylor Foundation.

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But future success was far from guaranteed. The firm’s visionary founder Steve Jobs was battling serious

health problems. Apple’s performance had suffered when an earlier health crisis had forced Jobs to step

away from the company. This raised serious questions. Would Jobs have to step away again? If so, how

might Apple maintain its excellent performance without its leader?

Meanwhile, the iPad2 faced daunting competition. Samsung, LG, Research in Motion, Dell, and other

manufacturers were trying to create tablets that were cheaper, faster, and more versatile than the iPad2.

These firms were eager to steal market share by selling their tablets to current and potential Apple

customers. Could Apple maintain leadership of the tablet market, or would one or more of its rivals

dominate the market in the years ahead? Even worse, might a company create a new type of device that

would make Apple’s tablets obsolete?

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1.1 Defining Strategic Management and Strategy

L E A R N I N G O B J E C T I V E S

1. Learn what strategic management is.

2. Understand the key question addressed by strategic management.

3. Understand why it is valuable to consider different definitions of strategy.

4. Learn what is meant by each of the 5 Ps of strategy.

What Is Strategic Management?

Issues such as those currently faced by Apple are the focus of strategic management because they help

answer the key question examined by strategic management—“Why do some firms outperform other

firms?” More specifically, strategic management examines how actions and events involving top

executives (such as Steve Jobs), firms (Apple), and industries (the tablet market) influence a firm’s

success or failure. Formal tools exist for understanding these relationships, and many of these tools are

explained and applied in this book. But formal tools are not enough; creativity is just as important to

strategic management. Mastering strategy is therefore part art and part science.

This introductory chapter is intended to enable you to understand what strategic management is and why

it is important. Because strategy is a complex concept, we begin by explaining five different ways to think

about what strategy involves. Next, we journey across many centuries to examine the evolution of

strategy from ancient times until today. We end this chapter by presenting a conceptual model that maps

out one way that executives can work toward mastering strategy. The model also provides an overall portrait

s of this book’s contents by organizing the remaining nine chapters into a coherent whole.

Defining Strategy: The Five Ps

Defining strategy is not simple. Strategy is a complex concept that involves many different processes and

activities within an organization. To capture this complexity, Professor Henry Mintzberg of McGill

University in Montreal, Canada, articulated what he labeled as “the 5 Ps of strategy.” According to

Mintzberg, understanding how strategy can be viewed as a plan, as a ploy, as a position, as a pattern, and

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as a perspective is important. Each of these five ways of thinking about strategy is necessary for

understanding what strategy is, but none of them alone is sufficient to master the concept. [1]

Figure 1.1 Defining Strategy: The Five Ps

Images courtesy of Thinkstock (first);Wikipedia (second); OldNavy (third); James Duncan

Davidson from Portland, USA (fourth)

Strategy as a Plan

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Strategic plans are the essence of strategy, according to one classic view of strategy. A strategic plan is a

carefully crafted set of steps that a firm intends to follow to be successful. Virtually every organization

creates a strategic plan to guide its future. In 1996, Apple’s performance was not strong, and Gilbert F.

Amelio was appointed as chief executive officer in the hope of reversing the company’s fortunes. In a

speech focused on strategy, Amelio described a plan that centered on leveraging the Internet (which at the

time was in its infancy) and developing multimedia products and services. Apple’s subsequent success

selling over the Internet via iTunes and with the iPad can be traced back to the plan articulated in 1996. [2]

A business model should be a central element of a firm’s strategic plan. Simply stated, a business model

describes the process through which a firm hopes to earn profits. It probably won’t surprise you to learn

that developing a viable business model requires that a firm sell goods or services for more than it costs

the firm to create and distribute those goods. A more subtle but equally important aspect of a business

model is providing customers with a good or service more cheaply than they can create it themselves.

Consider, for example, large chains of pizza restaurants such as Papa John’s and Domino’s.

Franchises such as Pizza Hut provide an example of a popular business model that has been successful worldwide.

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Image courtesy of Derek Jensen, http://wikimediafoundation.org/wiki/File:Bremen-indiana-pizza-hut.jpg.

Because these firms buy their ingredients in massive quantities, they pay far less for these items than any

family could (an advantage called economies of scale). Meanwhile, Papa John’s and Domino’s have

developed specialized kitchen equipment that allows them to produce better-tasting pizza than can be

created using the basic ovens that most families rely on for cooking. Pizza restaurants thus can make

better-tasting pizzas for far less cost than a family can make itself. This business model provides healthy

margins and has enabled Papa John’s and Domino’s to become massive firms.

Strategic plans are important to individuals too. Indeed, a well-known proverb states that “he who fails to

plan, plans to fail.” In other words, being successful requires a person to lay out a path for the future and

then follow that path. If you are reading this, earning a college degree is probably a key step in your

strategic plan for your career. Don’t be concerned if your plan is not fully developed, however. Life is full

of unexpected twists and turns, so maintaining flexibility is wise for individuals planning their career

strategies as well as for firms.

For firms, these unexpected twists and turns place limits on the value of strategic planning. Former

heavyweight boxing champion Mike Tyson captured the limitations of strategic plans when he noted,

“Everyone has a plan until I punch them in the face.” From that point forward, strategy is less about a

plan and more about adjusting to a shifting situation. For firms, changes in the behavior of competitors,

customers, suppliers, regulators, and other external groups can all be sources of a metaphorical punch in

the face. As events unfold around a firm, its strategic plan may reflect a competitive reality that no longer

exists. Because the landscape of business changes rapidly, other ways of thinking about strategy are

needed.

Strategy as a Ploy

A second way to view strategy is in terms of ploys. A strategic ploy is a specific move designed to outwit or

trick competitors. Ploys often involve using creativity to enhance success. One such case involves the

mighty Mississippi River, which is a main channel for shipping cargo to the central portion of the United

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States. Ships traveling the river enter it near New Orleans, Louisiana. The next major port upriver is

Louisiana’s capital, Baton Rouge. A variety of other important ports exist in states farther upriver.

Many decades ago, the governor of Louisiana was a clever and controversial man named Huey Long.

Legend has it that Long ordered that a bridge being constructed over the Mississippi River in Baton Rouge

be built intentionally low to the ground. This ploy created a captive market for cargo because very large

barges simply could not fit under the bridge. Large barges using the Mississippi River thus needed to

unload their cargo in either New Orleans or Baton Rouge. Either way, Louisiana would benefit. Of course,

owners of ports located farther up the river were not happy.

Ploys can be especially beneficial in the face of much stronger opponents. Military history offers quite a

few illustrative examples. Before the American Revolution, land battles were usually fought by two

opposing armies, each of which wore brightly colored clothing, marching toward each other across open

fields. George Washington and his officers knew that the United States could not possibly defeat better-

trained and better-equipped British forces in a traditional battle. To overcome its weaknesses, the

American military relied on ambushes, hit-and-run attacks, and other guerilla moves. It even broke an

unwritten rule of war by targeting British officers during skirmishes. This was an effort to reduce the

opponent’s effectiveness by removing its leadership.

Centuries earlier, the Carthaginian general Hannibal concocted perhaps the most famous ploy ever.

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Hannibal’s clever use of elephants to cross the Alps provides an example of a strategic ploy.

Image courtesy of Wikipedia, http://en.wikipedia.org/wiki/File:Hannibal3.jpg.

Carthage was at war with Rome, a scary circumstance for most Carthaginians given their far weaker

fighting force. The Alps had never been crossed by an army. In fact, the Alps were considered such a

treacherous mountain range that the Romans did not bother monitoring the part of their territory that

bordered the Alps. No horse was up to the challenge, but Hannibal cleverly put his soldiers on elephants,

and his army was able to make the mountain crossing. The Romans were caught completely unprepared

and most of them were frightened by the sight of charging elephants. By using the element of surprise,

Hannibal was able to lead his army to victory over a much more powerful enemy.

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Ploys continue to be important today. In 2011, a pizzeria owner in Pennsylvania was accused of making a

rather unique attempt to outmaneuver two rival pizza shops. According to police, the man tried to

sabotage his competitors by placing mice in their pizzerias. If the ploy had not been discovered, the two

shops could have suffered bad publicity or even been shut down by authorities because of health concerns.

Although most strategic ploys are legal, this one was not, and the perpetrator was arrested. [3]

Strategy as a Pattern

Strategy as pattern is a third way to view strategy. This view focuses on the extent to which a firm’s actions

over time are consistent. A lack of a strategic pattern helps explain why Kmart deteriorated into

bankruptcy in 2002. The company was started in the late nineteenth century as a discount department

store. By the middle of the twentieth century, consistently working to be good at discount retailing had led

Kmart to become a large and prominent chain.

By the 1980s, however, Kmart began straying from its established strategic pattern. Executives shifted the

firm’s focus away from discount retailing and toward diversification. Kmart acquired large stakes in

chains involved in sporting goods (Sports Authority), building supplies (Builders Square), office supplies

(OfficeMax), and books (Borders). In the 1990s, a new team of executives shifted Kmart’s strategy again.

Brands other than Kmart were sold off, and Kmart’s strategy was adjusted to emphasize information

technology and supply chain management. The next team of executives decided that Kmart’s strategy

would be to compete directly with its much-larger rival, Walmart. The resulting price war left Kmart

crippled. Indeed, this last shift in strategy was the fatal mistake that drove Kmart into bankruptcy. Today,

Kmart is part of Sears Holding Company, and its prospects remain uncertain.

In contrast, Apple is very consistent in its strategic pattern: It always responds to competitive challenges

by innovating. Some of these innovations are complete busts. Perhaps the best known was the Newton, a

tablet-like device that may have been ahead of its time. Another was the Pippin, a video game system

introduced in 1996 to near-universal derision. Apple TV, a 2007 offering intended to link televisions with

the Internet, also failed to attract customers. Such failures do not discourage Apple, however, and enough

of its innovations are successful that Apple’s overall performance is excellent. However, there are risks to

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following a pattern too closely. A consistent pattern can make a company predictable, a possibility that

Apple must guard against in the years ahead.

Strategy as a Position

Viewing strategy as a plan, a ploy, and a pattern involve only the actions of a single firm. In contrast, the

next P—strategy as position—considers a firm and its competitors. Specifically, strategy as position refers

to a firm’s place in the industry relative to its competitors. McDonald’s, for example, has long been and

remains the clear leader among fast-food chains. This position offers both good and bad aspects for

McDonald’s. One advantage of leading an industry is that many customers are familiar with and loyal to

leaders. Being the market leader, however, also makes McDonald’s a target for rivals such as Burger King

and Wendy’s. These firms create their strategies with McDonald’s as a primary concern. Old Navy offers

another example of strategy as position. Old Navy has been positioned to sell fashionable clothes at

competitive prices.

Old Navy occupies a unique position as the low-cost strategy within the Gap Inc.’s fleet of brands.

Image courtesy of Lindsey Turner, http://www.flickr.com/photos/theogeo/2148416495.

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Old Navy is owned by the same corporation (Gap Inc.) as the midlevel brand the Gap and upscale brand

Banana Republic. Each of these three brands is positioned at a different pricing level. The firm hopes that

as Old Navy’s customers grow older and more affluent, they will shop at the Gap and then eventually at

Banana Republic. A similar positioning of different brands is pursued by General Motors through its

Chevrolet (entry level), Buick (midlevel), and Cadillac (upscale) divisions.

Firms can carve out a position by performing certain activities in a different manner than their rivals. For

example, Southwest Airlines is able to position itself as a lower-cost and more efficient provider by not

offering meals that are common among other airlines. In addition, Southwest does not assign specific

seats. This allows for faster loading of passengers. Positioning a firm in this manner can only be

accomplished when managers make trade-offs that cut off certain possibilities (such as offering meals and

assigned seats) to place their firms in a unique strategic space. When firms position themselves through

unique goods and services customers value, business often thrives. But when firms try to please everyone,

they often find themselves without the competitive positioning needed for long-term success. Thus

deciding what a firm is not going to do is just as important to strategy as deciding what it is going to do. [4]

To gain competitive advantage and greater success, firms sometimes change positions. But this can be a

risky move. Winn-Dixie became a successful grocer by targeting moderate-income customers. When the

firm abandoned this established position to compete for wealthier customers and higher margins, the

results were disastrous. The firm was forced into bankruptcy and closed many stores. Winn-Dixie

eventually exited bankruptcy, but like Kmart, its future prospects are unclear. In contrast to firms such as

Winn-Dixie that change positions, Apple has long maintained a position as a leading innovator in various

industries. This positioning has served Apple well.

Strategy as a Perspective

The fifth and final P shifts the focus to inside the minds of the executives running a

firm. Strategy as perspective refers to how executives interpret the competitive landscape around them.

Because each person is unique, two different executives could look at the same event—such as a new

competitor emerging—and attach different meanings to it. One might just see a new threat to his or her

firm’s sales; the other might view the newcomer as a potential ally.

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An old cliché urges listeners to “make lemons into lemonade.” A good example of applying this idea

through strategy as perspective is provided by local government leaders in Sioux City, Iowa. Rather than

petition the federal government to change their airport’s unusual call sign—SUX—local leaders decided to

leverage the call sign to attract the attention of businesses and tourists to build their city’s economic base.

An array of clothing and other goods sporting the SUX name is available at http://www.flysux.com. Some

strategists such as these local leaders are willing to take a seemingly sour situation and see the potential

sweetness, while other executives remain fixated on the sourness.

Executives who adopt unique and positive perspectives can lead firms to find and exploit opportunities

that others simply miss. In the mid-1990s, the Internet was mainly a communication tool for academics

and government agencies. Jeff Bezos looked beyond these functions and viewed the Internet as a potential

sales channel. After examining a number of different markets that he might enter using the Internet,

Bezos saw strong profit potential in the bookselling business, and he began selling books online. Today,

the company he created—Amazon—has expanded far beyond its original focus on books to become a

dominant retailer in countless different markets. The late Steve Jobs at Apple appeared to take a similar

perspective; he saw opportunities where others could not, and his firm has reaped significant benefits as a

result.

K E Y T A K E A W A Y

Strategic management focuses on firms and the different strategies that they use to become and remain

successful. Multiple views of strategy exist, and the 5 Ps described by Henry Mintzberg enhance

understanding of the various ways in which firms conceptualize strategy.

E X E R C I S E S

1. Have you developed a strategy to manage your career? Should you make it more detailed? Why or why

not?

2. Identify an example of each of the 5 Ps of strategy other than the examples offered in this section.

3. What business that you visit regularly seems to have the most successful business model? What makes

the business model work?

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[1] Mintzberg, H. 1987. The strategy concept I: Five Ps for strategy. California Management Review, 30(1), 11–24.

[2] Markoff, J. 1996, May 14. Apple unveils strategic plan of small steps. New York Times. Retrieved

from http://www.nytimes.com/1996/05/14/business/apple-unveils-strategic -plan-of-small-steps.html

[3] Reuters. 2011, March 1. Philadelphia area pizza owner used mice vs. competition—police. Retrieved from

news.yahoo.com/s/nm/20110301/od_uk_nm/oukoe_uk_crime_pizza

[4] Porter, M. E. 1996, November–December. What is strategy? Harvard Business Review, 61–79.

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1.2 Intended, Emergent, and Realized Strategies

L E A R N I N G O B J E C T I V E S

1. Learn what is meant by intended and emergent strategies and the differences between them.

2. Understand realized strategies and how they are influenced by intended, deliberate, and emergent

strategies.

A few years ago, a consultant posed a question to thousands of executives: “Is your industry facing

overcapacity and fierce price competition?” All but one said “yes.” The only “no” came from the

manager of a unique operation—the Panama Canal! This manager was fortunate to be in charge of a

venture whose services are desperately needed by shipping companies and that offers the only simple

route linking the Atlantic and Pacific Oceans. The canal’s success could be threatened if transoceanic

shipping was to cease or if a new canal were built. Both of these possibilities are extremely remote,

however, so the Panama Canal appears to be guaranteed to have many customers for as long as

anyone can see into the future.

When an organization’s environment is stable and predictable, strategic planning can provide

enough of a strategy for the organization to gain and maintain success. The executives leading the

organization can simply create a plan and execute it, and they can be confident that their plan will

not be undermined by changes over time. But as the consultant’s experience shows, only a few

executives—such as the manager of the Panama Canal—enjoy a stable and predictable situation.

Because change affects the strategies of almost all organizations, understanding the concepts of

intended, emergent, and realized strategies is important. Also relevant are deliberate and

nonrealized strategies.

Intended and Emergent Strategies

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An intended strategy is the strategy that an organization hopes to execute. Intended strategies are usually

described in detail within an organization’s strategic plan. When a strategic plan is created for a new

venture, it is called a business plan. As an undergraduate student at Yale in 1965, Frederick Smith had to

complete a business plan for a proposed company as a class project. His plan described a delivery system

that would gain efficiency by routing packages through a central hub and then pass them to their

destinations. A few years later, Smith started Federal Express (FedEx), a company whose strategy closely

followed the plan laid out in his class project. Today, Frederick Smith’s personal wealth has surpassed $2

billion, and FedEx ranks eighth among the World’s Most Admired Companies according

to Fortune magazine. Certainly, Smith’s intended strategy has worked out far better than even he could

have dreamed.[2]

Emergent strategy has also played a role at Federal Express. An emergent strategy is an unplanned

strategy that arises in response to unexpected opportunities and challenges. Sometimes emergent

strategies result in disasters. In the mid-1980s, FedEx deviated from its intended strategy’s focus on

package delivery to capitalize on an emerging technology: facsimile (fax) machines. The firm developed a

service called ZapMail that involved documents being sent electronically via fax machines between FedEx

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offices and then being delivered to customers’ offices. FedEx executives hoped that ZapMail would be a

success because it reduced the delivery time of a document from overnight to just a couple of hours.

Unfortunately, however, the ZapMail system had many technical problems that frustrated customers.

Even worse, FedEx failed to anticipate that many businesses would simply purchase their own fax

machines. ZapMail was shut down before long, and FedEx lost hundreds of millions of dollars following

its failed emergent strategy. In retrospect, FedEx had made a costly mistake by venturing outside of the

domain that was central to its intended strategy: package delivery. [3]

Emergent strategies can also lead to tremendous success. Southern Bloomer Manufacturing Company was

founded to make underwear for use in prisons and mental hospitals. Many managers of such institutions

believe that the underwear made for retail markets by companies such as Calvin Klein and Hanes is

simply not suitable for the people under their care. Instead, underwear issued to prisoners needs to be

sturdy and durable to withstand the rigors of prison activities and laundering. To meet these needs,

Southern Bloomers began selling underwear made of heavy cotton fabric.

An unexpected opportunity led Southern Bloomer to go beyond its intended strategy of serving

institutional needs for durable underwear. Just a few years after opening, Southern Bloomer’s

performance was excellent. It was servicing the needs of about 125 facilities, but unfortunately, this was

creating a vast amount of scrap fabric. An attempt to use the scrap as stuffing for pillows had failed, so the

scrap was being sent to landfills. This was not only wasteful but also costly.

One day, cofounder Don Sonner visited a gun shop with his son. Sonner had no interest in guns, but he

quickly spotted a potential use for his scrap fabric during this visit. The patches that the gun shop sold to

clean the inside of gun barrels were of poor quality. According to Sonner, when he “saw one of those

flimsy woven patches they sold that unraveled when you touched them, I said, ‘Man, that’s what I can do’”

with the scrap fabric. Unlike other gun-cleaning patches, the patches that Southern Bloomer sold did not

give off threads or lint, two by-products that hurt guns’ accuracy and reliability. The patches quickly

became popular with the military, police departments, and individual gun enthusiasts. Before long,

Southern Bloomer was selling thousands of pounds of patches per month. A casual trip to a gun store

unexpectedly gave rise to a lucrative emergent strategy. [4]

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Realized Strategy

A realized strategy is the strategy that an organization actually follows. Realized strategies are a product of

a firm’s intended strategy (i.e., what the firm planned to do), the firm’s deliberate strategy (i.e., the parts

of the intended strategy that the firm continues to pursue over time), and its emergent strategy (i.e., what

the firm did in reaction to unexpected opportunities and challenges). In the case of FedEx, the intended

strategy devised by its founder many years ago—fast package delivery via a centralized hub—remains a

primary driver of the firm’s realized strategy. For Southern Bloomers Manufacturing Company, realized

strategy has been shaped greatly by both its intended and emergent strategies, which center on underwear

and gun-cleaning patches.

In other cases, firms’ original intended strategies are long forgotten. A nonrealized strategy refers to the

abandoned parts of the intended strategy. When aspiring author David McConnell was struggling to sell

his books, he decided to offer complimentary perfume as a sales gimmick. McConnell’s books never did

escape the stench of failure, but his perfumes soon took on the sweet smell of success. The California

Perfume Company was formed to market the perfumes; this firm evolved into the personal care products

juggernaut known today as Avon. For McConnell, his dream to be a successful writer was a nonrealized

strategy, but through Avon, a successful realized strategy was driven almost entirely by opportunistically

capitalizing on change through emergent strategy.

Strategy at the Movies

The Social Network

Did Harvard University student Mark Zuckerberg set out to build a billion-dollar company with more

than six hundred million active users? Not hardly. As shown in 2010’s The Social Network, Zuckerberg’s

original concept in 2003 had a dark nature. After being dumped by his girlfriend, a bitter Zuckerberg

created a website called “FaceMash” where the attractiveness of young women could be voted on. This

evolved first into an online social network called Thefacebook that was for Harvard students only. When

the network became surprisingly popular, it then morphed into Facebook, a website open to everyone.

Facebook is so pervasive today that it has changed the way we speak, such as the word friend being used

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as a verb. Ironically, Facebook’s emphasis on connecting with existing and new friends is about as

different as it could be from Zuckerberg’s original mean-spirited concept. Certainly, Zuckerberg’s

emergent and realized strategies turned out to be far nobler than the intended strategy that began his

adventure in entrepreneurship.

The Social Network demonstrates how founder Mark Zuckerberg’s intended strategy gave way to

an emergent strategy via the creation of Facebook.

Image courtesy of Robert Scoble, http://www.flickr.com/photos/scobleizer/5179377698.

K E Y T A K E A W A Y

Most organizations create intended strategies that they hope to follow to be successful. Over time,

however, changes in an organization’s situation give rise to new opportunities and challenges.

Organizations respond to these changes using emergent strategies. Realized strategies are a product of

both intended and realized strategies.

E X E R C I S E S

1. What is the difference between an intended and an emergent strategy?

2. Can you think of a company that seems to have abandoned its intended strategy? Why do you suspect it

was abandoned?

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3. Would you describe your career strategy in college to be more deliberate or emergent? Why?

[1] Mintzberg, H., & Waters, J. A. 1985. Of strategies, deliberate and emergent. Strategic Management Journal, 6,

257–272.

[2] Donahoe, J. A. 2011, March 10. Forbes: Fred Smith’s fortune grows to $.21B. Memphis Business Journal.

Retrieved fromhttp://www.bizjournals.com/memphis/news/2011/03/10/forbes-fred-smiths-fortune-grows-

to.html; Fortune: FedEx 8th “most admired” company in the world. Memphis Business Journal. Retrieved

from http://www.bizjournals .com/memphis/news/2011/03/03/fortune-fedex-8th-most- admired.html

[3] Funding Universe. FedEx Corporation. Retrieved fromhttp://www.fundinguniverse.com/company –

histories/FedEx-Corporation-Company-History.html

[4] Wells, K. 2002. Floating off the page: The best stories from the Wall Street Journal’s middle column. New York:

Simon & Shuster. Quote from page 97.

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1.3 The History of Strategic Management

L E A R N I N G O B J E C T I V E S

1. Consider how strategy in ancient times and military strategy can provide insights to businesses.

2. Describe how strategic management has evolved into a field of study.

Those who cannot remember the past are condemned to repeat it.

– George Santayana, The Life of Reason

Santayana’s quote has strong implications for strategic management. The history of strategic management

can be traced back several thousand years. Great wisdom about strategy can be acquired by

understanding the past, but ignoring the lessons of history can lead to costly strategic mistakes that could

have been avoided. Certainly, the present offers very important lessons; businesses can gain knowledge

about what strategies do and do not work by studying the current actions of other businesses. But this

section discusses two less obvious sources of wisdom: (1) strategy in ancient times and (2) military

strategy. This section also briefly traces the development of strategic management as a field of study.

Strategy in Ancient Times

Perhaps the earliest-known discussion of strategy is offered in the Old Testament of the

Bible. [1] Approximately 3,500 years ago, Moses faced quite a challenge after leading his fellow Hebrews

out of enslavement in Egypt. Moses was overwhelmed as the lone strategist at the helm of a nation that

may have exceeded one million people. Based on advice from his father-in-law, Moses began delegating

authority to other leaders, each of whom oversaw a group of people. This hierarchical delegation of

authority created a command structure that freed Moses to concentrate on the biggest decisions and

helped him implement his strategies. Similarly, the demands of strategic management today are simply

too much for a chief executive officer (the top leader of a company) to handle alone. Many important tasks

are thus entrusted to vice presidents and other executives.

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In ancient China, strategist and philosopher Sun Tzu offered thoughts on strategy that continue to be

studied carefully by business and military leaders today. Sun Tzu’s best-known work is The Art of War. As

this title implies, Sun Tzu emphasized the creative and deceptive aspects of strategy.

One of Sun Tzu’s ideas that has numerous business applications is that winning a battle without fighting is

the best way to win. Apple’s behavior in the personal computer business offers a good example of this idea

in action. Many computer makers such as Toshiba, Acer, and Lenovo compete with one another based

primarily on price. This leads to price wars that undermine the computer makers’ profits. In contrast,

Apple prefers to develop unique features for its computers, features that have created a fiercely loyal set of

customers. Apple boldly charges far more for its computers than its rivals charge for theirs. Apple does

not even worry much about whether its computers’ software is compatible with the software used by most

other computers. Rather than fighting a battle with other firms, Apple wins within the computer business

by creating its own unique market and by attracting a set of loyal customers. Sun Tzu would probably

admire Apple’s approach.

Perhaps the most famous example of strategy in ancient times revolves around the Trojan horse.

According to legend, Greek soldiers wanted to find a way to enter the gates of Troy and attack the city

from the inside. They devised a ploy that involved creating a giant wooden horse, hiding soldiers inside

the horse, and offering the horse to the Trojans as a gift. The Trojans were fooled and brought the horse

inside their city. When night arrived, the hidden Greek soldiers opened the gates for their army, leading to

a Greek victory. In modern times, the term Trojan horse refers to gestures that appear on the surface to

be beneficial to the recipient but that mask a sinister intent. Computer viruses also are sometimes referred

to as Trojan horses.

A far more noble approach to strategy than the Greeks’ is attributed to King Arthur of Britain. Unlike the

hierarchical approach to organizing Moses used, Arthur allegedly considered himself and each of his

knights to have an equal say in plotting the group’s strategy. Indeed, the group is thought to have held its

meetings at a round table so that no voice, including Arthur’s, would be seen as more important than the

others. The choice of furniture in modern executive suites is perhaps revealing. Most feature rectangular

meeting tables, perhaps signaling that one person—the chief executive officer—is in charge.

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Another implication for strategic management offered by King Arthur and his Knights of the Round Table

involves the concept of mission. Their vigorous search to find the Holy Grail (the legendary cup used by

Jesus and his disciples at the Last Supper) serves as an exemplar for the importance of a central mission

to guide organizational strategy and actions.

Lessons Offered by Military Strategy

Key military conflicts and events have shaped the understanding of strategic management.

Indeed, the word strategy has its roots in warfare. The Greek verb strategosmeans “army leader” and the idea

of stratego (from which we get the word strategy) refers to defeating an enemy by effectively using resources.[2]

A book written nearly five hundred years ago is still regarded by many as an insightful guide for

conquering and ruling territories. Niccolò Machiavelli’s 1532 book The Prince offers clever recipes for

success to government leaders. Some of the book’s suggestions are quite devious, and the

word Machiavellianis used today to refer to acts of deceit and manipulation.

Two wars fought on American soil provide important lessons about strategic management. In the late

1700s, the American Revolution pitted the American colonies against mighty Great Britain. The

Americans relied on nontraditional tactics, such as guerilla warfare and the strategic targeting of British

officers. Although these tactics were considered by Great Britain to be barbaric, they later became widely

used approaches to warfare. The Americans owed their success in part to help from the French navy,

illustrating the potential value of strategic alliances.

Nearly a century later, Americans turned on one another during the Civil War. After four years of

hostilities, the Confederate states were forced to surrender. Historians consider the Confederacy to have

had better generals, but the Union possessed greater resources, such as factories and railroad lines. As

many modern companies have discovered, sometimes good strategies simply cannot overcome a stronger

adversary.

Two wars fought on Russian soil also offer insights. In the 1800s, a powerful French invasion force was

defeated in part by the brutal nature of Russian winters. In the 1940s, a similar fate befell German forces

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during World War II. Against the advice of some of his leading generals, Adolf Hitler ordered his army to

conquer Russia. Like the French before them, the Germans were able to penetrate deep into Russian

territory. As George Santayana had warned, however, the forgotten past was about to repeat itself.

Horrific cold stopped the German advance. Russian forces eventually took control of the combat, and

Hitler committed suicide as the Russians approached the German capital, Berlin.

Five years earlier, Germany ironically had benefited from an opponent ignoring the strategic management

lessons of the past. In ancient times, the Romans had assumed that no army could cross a mountain range

known as the Alps. An enemy general named Hannibal put his men on elephants, crossed the mountains,

and caught Roman forces unprepared. French commanders made a similar bad assumption in 1940.

When Germany invaded Belgium (and then France) in 1940, its strategy caught French forces by surprise.

The top French commanders assumed that German tanks simply could not make it through a thickly

wooded region known as the Ardennes Forest. As a result, French forces did not bother preparing a strong

defense in that area. Most of the French army and their British allies instead protected against a small,

diversionary force that the Germans had sent as a deception to the north of the forest. German forces

made it through the forest, encircled the allied forces, and started driving them toward the ocean. Many

thousands of French and British soldiers were killed or captured. In retrospect, the French generals had

ignored an important lesson of history: Do not make assumptions about what your adversary can and

cannot do. Executives who make similar assumptions about their competitors put their organizations’

performance in jeopardy.

Strategic Management as a Field of Study

Universities contain many different fields of study, including physics, literature, chemistry, computer

science, and engineering. Some fields of study date back many centuries (e.g., literature), while others

(such as computer science) have emerged only in recent years. Strategic management has been important

throughout history, but the evolution of strategic management into a field of study has mostly taken place

over the past century. A few of the key business and academic events that have helped the field develop

are discussed next.

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The ancient Chinese strategist Sun Tzu made it clear that strategic management is part art. But it is also

part science. Major steps toward developing the scientific aspect of strategic management were taken in

the early twentieth century by Frederick W. Taylor. In 1911, Taylor published The Principles of Scientific

Management. The book was a response to Taylor’s observation that most tasks within organizations were

organized haphazardly. Taylor believed that businesses would be much more efficient if management

principles were derived through scientific investigation. In The Principles of Scientific Management,

Taylor stressed how organizations could become more efficient through identifying the “one best way” of

performing important tasks. Implementing Taylor’s principles was thought to have saved railroad

companies hundreds of millions of dollars. [3] Although many later works disputed the merits of trying to

find the “one best way,” Taylor’s emphasis on maximizing organizational performance became the core

concern of strategic management as the field developed.

Also in the early twentieth century, automobile maker Henry Ford emerged as one of the pioneers of

strategic management among industrial leaders. At the time, cars seemed to be a luxury item for wealthy

people. Ford adopted a unique strategic perspective, however, and boldly offered the vision that he would

make cars the average family could afford. Building on ideas about efficiency from Taylor and others, Ford

organized assembly lines for creating automobiles that lowered costs dramatically. Despite his wisdom,

Ford also made mistakes. Regarding his company’s flagship product, the Model T, Ford famously stated,

“Any customer can have a car painted any color that he wants so long as it is black.” When rival

automakers provided customers with a variety of color choices, Ford had no choice but to do the same.

In 1912, Harvard University became the first higher education institution to offer a course focused on how

business executives could lead their organizations to greater success. The approach to maximizing

performance within this “business policy” course was consistent with Taylor’s ideas. Specifically, the goal

of the business policy course was to identify the one best response to any given problem that an

organization confronted. By finding and pursuing this ideal solution, the organization would have the best

chance of enjoying success.

In the 1920s, A&W Root Beer became the first franchised restaurant chain. Franchising involves an

organization (called a franchisor) granting the right to use its brand name, products, and processes to

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other organizations (known as franchisees) in exchange for an up-front payment (a franchise fee) and a

percentage of franchisees’ revenues (a royalty fee). This simple yet powerful business model allows

franchisors to grow their brands rapidly and provides franchisees with the safety of a proven business

format. Within a few decades, the franchising business model would fuel incredible successes for many

franchisors and franchisees across a variety of industries. Today, for example, both Subway and

McDonald’s have more than thirty thousand restaurants carrying their brand names.

The acceptance of strategic management as a necessary element of business school programs took a major

step forward in 1959. A widely circulated report created by the Ford Foundation recommended that all

business schools offer a “capstone” course. The goal of this course would be to integrate knowledge across

different business fields such as marketing, finance, and accounting to help students devise better ideas

for addressing complex business problems. Rather than seeking a “one best way” solution, as advocated

by Taylor and Harvard’s business policy course, this capstone course would emphasize students’ critical

thinking skills in general and the notion that multiple ways of addressing a problem could be equally

successful in particular. The Ford Foundation report was a key motivator that led US universities to create

strategic management courses in their undergraduate and master of business administration programs.

In 1962, business and academic events occurred that seemed minor at the time but that would later give

rise to huge changes. Building on the business savvy that he had gained as a franchisee, Sam Walton

opened the first Walmart in Rogers, Arkansas. Relying on a strategy that emphasized low prices and high

levels of customer service, Walmart grew to 882 stores with a combined $8.4 billion dollars in annual

sales by 1985. A decade later, sales reached $93.6 billion across nearly 3,000 stores. In 2010, Walmart

was the largest company in the world. In recent years, Walmart has arguably downplayed customer

service in favor of cutting costs. Time will tell whether deviating from Sam Walton’s original strategic

positioning will hurt the company.

Also in 1962, Harvard professor Alfred Chandler published Strategy and Structure: Chapters in the

History of the Industrial Enterprise. This book describes how strategy and organizational structure need

to be consistent with each other to ensure strong firm performance, a lesson that Moses seems to have

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mastered during the Hebrews’ exodus from Egypt. Many people working in the field of strategic

management consider Chandler’s book to be the first work of strategic management research.

Two pivotal events that firmly established strategic management as a field of study took place in 1980.

One was the creation of the Strategic Management Journal. The introduction of the journal offered a

forum for researchers interested in building knowledge about strategic management. Much like important

new medical findings appear in the Journal of the American Medical Association and the New England

Journal of Medicine, the Strategic Management Journal publishes pathbreaking insights about strategic

management.

The second pivotal event in 1980 was the publication of Competitive Strategy: Techniques for Analyzing

Industries and Competitors by Harvard professor Michael Porter. This book offers concepts such as five

forces analysis and generic strategies that continue to strongly influence how executives choose strategies

more than thirty years after the book’s publication. Given the importance of these concepts, both five

forces analysis and generic strategies are discussed in detail in Chapter 3, "Evaluating the External

Environment" and Chapter 5, "Selecting Business-Level Strategies", respectively.

Many consumers today take web-based shopping for granted, but this channel for commerce was created

less than two decades ago. The 1995 launch of Amazon by founder Jeff Bezos was perhaps the pivotal

event in creating Internet-based commerce. In pursuit of its vision “to be earth’s most customer-centric

company,” Amazon has diversified far beyond its original focus on selling books and has evolved into a

dominant retailer. Powerful giants have stumbled badly in Amazon’s wake. Sears had sold great varieties

of goods (even including entire houses) through catalogs for many decades, as had JCPenney. Neither

firm created a strong online sales presence to keep pace with Amazon, and both eventually dropped their

catalog businesses. As often happens with old and large firms, Sears and JCPenney were outmaneuvered

by a creative and versatile upstart.

Ethics have long been an important issue within the strategic management field. Attention to the need for

executives to act ethically when creating strategies increased dramatically in the early 2000s when a series

of companies such as Enron Corporation, WorldCom, Tyco, Qwest, and Global Crossing were found to

have grossly exaggerated the strength of their performance. After a series of revelations about fraud and

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corruption, investors in these firms and others lost billions of dollars, tens of thousands of jobs were lost,

and some executives were sent to prison.

Like ethics, the implications of international competition are of central interest to strategic management.

Provocative new thoughts on the nature of the international arena were offered in 2005 by Thomas L.

Friedman. In his book The World Is Flat: A Brief History of the Twenty-First Century, Friedman argues

that many of the advantages that firms in developed countries such as the United States, Japan, and Great

Britain take for granted are disappearing. One implication is that these firms will need to improve their

strategies if they are to remain successful.

Looking to the future, it appears likely that strategic management will prove to be more important than

ever. In response, researchers who are interested in strategic management will work to build additional

knowledge about how organizations can maximize their performance. Executives will need to keep track

of the latest scientific findings. Meanwhile, they also must leverage the insights that history offers on how

to be successful while trying to avoid history’s mistakes.

K E Y T A K E A W A Y

Although strategic management as a field of study has developed mostly over the last century, the

concept of strategy is much older. Understanding strategic management can benefit greatly by learning

the lessons that ancient history and military strategy provide.

E X E R C I S E S 1. What do you think was the most important event related to strategy in ancient times?

2. In what ways are the strategic management of business and military strategy alike? In what ways are they

different? 3. Do you think executives are more ethical today as a result of the scandals in the early 2000s? Why or why

not?

[1] Bracker, J. 1980. The historical development of the strategic management concept.Academy of Management

Review, 5(2), 219–224.

[2] Bracker, J. 1980. The historical development of the strategic management concept.Academy of Management

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1.4 Understanding the Strategic Management Process

L E A R N I N G O B J E C T I V E S

1. Learn the strategic management process.

2. Understand the four steps in the strategic management process.

Modeling the Strategy Process

Strategic management is a process that involves building a careful understanding of how the world is

changing, as well as a knowledge of how those changes might affect a particular firm. CEOs, such as late

Apple-founder Steve Jobs, must be able to carefully manage the possible actions that their firms might

take to deal with changes that occur in their environment. We present a model of the strategic

management process in Figure 1.7 "Overall Model of the Strategic Management Process". This model also

guides our presentation of the chapters contained in this book.

Figure 1.7 Overall Model of the Strategic Management Process

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The strategic management process begins with an understanding of strategy and performance. As we have

noted in this introductory chapter, strategic management is both an art and a science, and it involves

multiple conceptualizations of the notion of strategy drawn from recent and ancient history. In Chapter 2

"Leading Strategically", we focus on how leading strategically is needed if the firm is to achieve the long-

term strong performance companies such as Apple have attained. Consequently, how managers

understand and interpret the performance of their firms is often central to understanding strategy.

Environmental and internal scanning is the next stage in the process. Managers must constantly scan the

external environment for trends and events that affect the overall economy, and they must monitor

changes in the particular industry in which the firm operates. For example, Apple’s decision to create the

iPhone demonstrates its ability to interpret that traditional industry boundaries that distinguished the

cellular phone industry and the computer industry were beginning to blur. At the same time, firms must

evaluate their own resources to understand how they might react to changes in the environment. For

example, intellectual property is a vital resource for Apple. Between 2008 and 2010, Apple filed more

than 350 cases with the US Patent and Trademark Office to protect its use of such terms as apple, pod,

and safari. [1]

A classic management tool that incorporates the idea of scanning elements both external and internal to

the firm is SWOT (strengths, weaknesses, opportunities, and threats) analysis. Strengths and weaknesses

are assessed by examining the firm’s resources, while opportunities and threats refer to external events

and trends. The value of SWOT analysis parallels ideas from classic military strategists such as Sun Tzu,

who noted the value of knowing yourself as well as your opponent. Chapter 3 "Evaluating the External

Environment" examines the topic of evaluating the external environment in detail, and Chapter 4

"Managing Firm Resources" presents concepts and tools for managing firm resources.

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The importance of knowing yourself and your opponent is applicable to the knowledge of strategic

management for business, military strategy, and classic strategy games such as chess.

Strategy formulation is the next step in the strategic management process. This involves developing

specific strategies and actions. Certainly, part of Apple’s success is due to the unique products it offers the

market, as well as how these products complement one another. A customer can buy an iPod that plays

music from iTunes—all of which can be stored in Apple’s Mac computer. [2] In Chapter 5 "Selecting

Business-Level Strategies", we discuss how selecting business-level strategies helps to provide firms with

a recipe that can be followed that will increase the likelihood that their strategies will be successful.

In Chapter 6 "Supporting the Business-Level Strategy: Competitive and Cooperative Moves", we present

insights on how firms can support the business-level strategy through competitive and cooperative

moves. Chapter 7 "Competing in International Markets" presents possibilities for firms competing in

international markets, and Chapter 8 "Selecting Corporate-Level Strategies" focuses on selecting

corporate-level strategies.

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Strategy implementation is the final stage of the process. One important element of strategy

implementation entails crafting an effective organizational structure and corporate culture. For example,

part of Apple’s success is due to its consistent focus on innovation and creativity that Steve Jobs described

as similar to that of a start-up. Chapter 9 "Executing Strategy through Organizational Design" offers ideas

on how to manage these elements of implementation. The final chapter explores how to lead an ethical

organization through corporate governance, social responsibility, and sustainability.

K E Y T A K E A W A Y

Strategic management is a process that requires the ability to manage change. Consequently, executives

must be careful to monitor and to interpret the events in their environment, to take appropriate actions

when change is needed, and to monitor their performance to ensure that their firms are able to survive

and, it is hoped, thrive over time.

E X E R C I S E S

1. Who makes the strategic decisions for most organizations?

2. Why is it important to view strategic management as a process?

3. What are the four steps of the strategic management process?

4. How is chess relevant to the study of strategic management? What other games might help teach

strategic thinking?

[1] Apple Inc. litigation. Wikipedia. Retrieved from en.wikipedia.org/wiki/Apple_Inc._ litigation

[2] Inside CRM Editors. Effective strategies Apple uses to create loyal customers [Online article]. Retrieved

from http://www.insidecrm.com/features/strategies-apple-loyal -customers

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1.5 Conclusion

This chapter provides an overview of strategic management and strategy. Ideas about strategy span

many centuries, and modern understanding of strategy borrows from ancient strategies as well as

classic militaries strategies. You should now understand that there are numerous ways to

conceptualize the idea of strategy and that effective strategic management is needed to ensure the

long-term success of firms. The study of strategic management provides tools to effectively manage

organizations, but it also involves the art of knowing how and when to apply creative thinking.

Knowledge of both the art and the science of strategic management is needed to help guide

organizations as their strategies emerge and evolve over time. Such tools will also help you effectively

chart a course for your career as well as to understand the effective strategic management of the

organizations for which you will work.

E X E R C I S E S

1. Think about the best and worst companies you know. What is extraordinary (or extraordinarily bad) about

these firms? Are their strategies clear and focused or difficult to define?

2. If you were to write a “key takeaway” section for this chapter, what would you include as the material

you found most interesting?

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Chapter 2

Leading Strategically

L E A R N I N G O B J E C T I V E S

After reading this chapter, you should be able to understand and articulate answers to the following

questions:

1. What are vision, mission, and goals, and why are they important to organizations?

2. How should executives analyze the performance of their organizations?

3. In what ways can having a celebrity CEO and a strong entrepreneurial orientation help or harm an

organization?

Questions Are Brewing at Starbucks

Starbucks’s global empire includes this store in Seoul, South Korea.

Image courtesy of Wikimedia,http://commons.wikimedia.org/wiki/File:Starbucks-seoul.JPG.

Chapter 2 from Mastering Strategic Management was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 license without attribution as requested

by the work’s original creator or licensee. © 2014, The Saylor Foundation.

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March 30, 2011, marked the fortieth anniversary of Starbucks first store opening for business in Seattle,

Washington. From its humble beginnings, Starbucks grew to become the largest coffeehouse company in

the world while stressing the importance of both financial and social goals. As it created thousands of

stores across dozens of countries, the company navigated many interesting periods. The last few years

were a particularly fascinating era.

In early 2007, Starbucks appeared to be very successful, and its stock was worth more than $35 per share.

By 2008, however, the economy was slowing, competition in the coffee business was heating up, and

Starbucks’s performance had become disappointing. In a stunning reversal of fortune, the firm’s stock was

worth less than $10 per share by the end of the year. Anxious stockholders wondered whether Starbucks’s

decline would continue or whether the once high-flying company would return to its winning ways.

Riding to the rescue was Howard Schultz, the charismatic and visionary founder of Starbucks who had

stepped down as chief executive officer eight years earlier. Schultz again took the helm and worked to turn

the company around by emphasizing its mission statement: “to inspire and nurture the human spirit—one

person, one cup and one neighborhood at a time.” [1]About a thousand underperforming stores were shut

down permanently. Thousands of other stores closed for a few hours so that baristas could be retrained to

make inspiring drinks. Food offerings were revamped to ensure that coffee—not breakfast sandwiches—

were the primary aroma that tantalized customers within Starbucks’s outlets.

By the time Starbucks’s fortieth anniversary arrived, Schultz had led his company to regain excellence,

and its stock price was back above $35 per share. In March 2011, Schultz summarized the situation by

noting that “over the last three years, we’ve completely transformed the company, and the health of

Starbucks is quite good. But I don’t think this is a time to celebrate or run some victory lap. We’ve got a lot

of work to do.” [2] Indeed, important questions loomed. Could performance improve further? How long

would Schultz remain with the company? Could Schultz’s eventual successor maintain Schultz’s

entrepreneurial approach as well as keep Starbucks focused on its mission?

[1] Our Starbucks mission statement. Retrieved from http://www.starbucks.com/about-us/company-

information/mission-statement. Accessed March 31, 2011.

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[2] Starbucks CEO: Can you “get big and stay small” [Review of the book Onward: How Starbucks fought for its life

without losing its soul by Howard Schultz]. 2011, March 28. NPR Books. Retrieved

from http://www.npr.org/2011/03/28/134738487/starbucks-ceo-can-you-get-big-and-stay-small.

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2.1 Vision, Mission, and Goals

L E A R N I N G O B J E C T I V E S

1. Define vision and mission and distinguish between them.

2. Know what the acronym SMART represents.

3. Be able to write a SMART goal.

The Importance of Vision

Good business leaders create a vision, articulate the vision, passionately own the vision, and relentlessly

drive it to completion.

– Jack Welch, former CEO of General Electric

Many skills and abilities separate effective strategic leaders like Howard Schultz from poor strategic

leaders. One of them is the ability to inspire employees to work hard to improve their organization’s

performance. Effective strategic leaders are able to convince employees to embrace lofty ambitions and

move the organization forward. In contrast, poor strategic leaders struggle to rally their people and

channel their collective energy in a positive direction.

As the quote from Jack Welch suggests, a vision is one key tool available to executives to inspire the

people in an organization. An organization’s vision describes what the organization hopes to become

in the future. Well-constructed visions clearly articulate an organization’s aspirations. Avon’s vision is

“to be the company that best understands and satisfies the product, service, and self-fulfillment needs

of women—globally.” This brief but powerful statement emphasizes several aims that are important to Avon,

including excellence in customer service, empowering women, and the intent to be a worldwide player.

Like all good visions, Avon sets a high standard for employees to work collectively toward.

Perhaps no vision captures high standards better than that of aluminum maker Alcoa. This firm’s very ambitious

vision is “to be the best company in the world—in the eyes of our customers, shareholders, communities

and people.” By making clear their aspirations, Alcoa’s executives hope to inspire employees to act in ways that

help the firm become the best in the world.

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The results of a survey of one thousand five hundred executives illustrate how the need to create an

inspiring vision creates a tremendous challenge for executives. When asked to identify the most important

characteristics of effective strategic leaders, 98 percent of the executives listed “a strong sense of vision”

first. Meanwhile, 90 percent of the executives expressed serious doubts about their own ability to create a

vision. [1] Not surprisingly, many organizations do not have formal visions. Many organizations that do

have visions find that employees do not embrace and pursue the visions. Having a well-formulated vision

employees embrace can therefore give an organization an edge over its rivals.

Mission Statements

In working to turnaround Starbucks, Howard Schultz sought to renew Starbucks’s commitment to

its mission statement: “to inspire and nurture the human spirit—one person, one cup and one

neighborhood at a time.” A mission such as Starbucks’s states the reasons for an organization’s existence.

Well-written mission statements effectively capture an organization’s identity and provide answers to the

fundamental question “Who are we?” While a vision looks to the future, a mission captures the key

elements of the organization’s past and present.

Organizations need support from their key stakeholders, such as employees, owners, suppliers, and

customers, if they are to prosper. A mission statement should explain to stakeholders why they should

support the organization by making clear what important role or purpose the organization plays in

society. Google’s mission, for example, is “to organize the world’s information and make it universally

accessible and useful.” Google pursued this mission in its early days by developing a very popular Internet

search engine. The firm continues to serve its mission through various strategic actions, including offering

its Internet browser Google Chrome to the online community, providing free e-mail via its Gmail service,

and making books available online for browsing.

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Many consider Abraham Lincoln to have been one of the

greatest strategic leaders in modern history.

Image courtesy of Alexander Gardner,

http://wikimediafoundation.org/wiki/File:Abraham_Li

ncoln_head_on_shoulders_photo_portrait.jpg.

One of Abraham Lincoln’s best-known statements is that “a house divided against itself cannot stand.”

This provides a helpful way of thinking about the relationship between vision and mission. Executives ask

for trouble if their organization’s vision and mission are divided by emphasizing different domains. Some

universities have fallen into this trap. Many large public universities were established in the late 1800s

with missions that centered on educating citizens. As the twentieth century unfolded, however, creating

scientific knowledge through research became increasingly important to these universities. Many

university presidents responded by creating visions centered on building the scientific prestige of their

schools. This created a dilemma for professors: Should they devote most of their time and energy to

teaching students (as the mission required) or on their research studies (as ambitious presidents

demanded via their visions)? Some universities continue to struggle with this trade-off today and remain

houses divided against themselves. In sum, an organization is more effective to the extent that its vision

and its mission target employees’ effort in the same direction.

Pursuing the Vision and Mission through SMART Goals

An organization’s vision and mission offer a broad, overall sense of the organization’s direction. To work

toward achieving these overall aspirations, organizations also need to create goals—narrower aims that

should provide clear and tangible guidance to employees as they perform their work on a daily basis. The

most effective goals are those that are specific, measurable, aggressive, realistic, and time-bound. An easy

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way to remember these dimensions is to combine the first letter of each into one word: SMART.

Employees are put in a good position to succeed to the extent that an organization’s goals are SMART.

A goal is specific if it is explicit rather than vague. In May 1961, President John F. Kennedy proposed a

specific goal in a speech to the US Congress: “I believe that this nation should commit itself to achieving

the goal, before this decade is out, of landing a man on the moon and returning him safely to the

earth.” [2]Explicitness such as was offered in this goal is helpful because it targets people’s energy. A few

moments later, Kennedy made it clear that such targeting would be needed if this goal was to be reached.

Going to the moon, he noted, would require “a major national commitment of scientific and technical

manpower, materiel and facilities, and the possibility of their diversion from other important activities

where they are already thinly spread.” While specific goals make it clear how efforts should be directed,

vague goals such as “do your best” leave individuals unsure of how to proceed.

A goal is measurable to the extent that whether the goal is achieved can be quantified. President

Kennedy’s goal of reaching the moon by the end of the 1960s offered very simple and clear measurability:

Either Americans would step on the moon by the end of 1969 or they would not. One of Coca-Cola’s

current goals is a 20 percent improvement to its water efficiency by 2012 relative to 2004 water usage.

Because water efficiency is easily calculated, the company can chart its progress relative to the 20 percent

target and devote more resources to reaching the goal if progress is slower than planned.

A goal is aggressive if achieving it presents a significant challenge to the organization. A series of

research studies have demonstrated that performance is strongest when goals are challenging but

attainable. Such goals force people to test and extend the limits of their abilities. This can result in

reaching surprising heights. President Kennedy captured this theme in a speech in September 1962: “We

choose to go to the moon. We choose to go to the moon in this decade…not because [it is] easy, but

because [it is] hard, because that goal will serve to organize and measure the best of our energies and

skills.”

In the case of Coca-Cola, reaching a 20 percent improvement will require a concerted effort, but the goal

can be achieved. Meanwhile, easily achievable goals tend to undermine motivation and effort. Consider a

situation in which you have done so well in a course that you only need a score of 60 percent on the final

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exam to earn an A for the course. Understandably, few students would study hard enough to score 90

percent or 100 percent on the final exam under these circumstances. Similarly, setting organizational

goals that are easy to reach encourages employees to work just hard enough to reach the goals.

It is tempting to extend this thinking to conclude that setting nearly impossible goals would encourage

even stronger effort and performance than does setting aggressive goals. People tend to get discouraged

and give up, however, when faced with goals that have little chance of being reached. If, for example,

President Kennedy had set a time frame of one year to reach the moon, his goal would have attracted

scorn. The country simply did not have the technology in place to reach such a goal. Indeed, Americans

did not even orbit the moon until seven years after Kennedy’s 1961 speech. Similarly, if Coca-Cola’s water

efficiency goal was 95 percent improvement, Coca-Cola’s employees would probably not embrace it. Thus

goals must also be realistic, meaning that their achievement is feasible.

You have probably found that deadlines are motivating and that they help you structure your work time.

The same is true for organizations, leading to the conclusion that goals should be time-bound through

the creation of deadlines. Coca-Cola has set a deadline of 2012 for its water efficiency goal, for example.

The deadline for President Kennedy’s goal was the end of 1969. The goal was actually reached a few

months early. On July 20, 1969, Neil Armstrong became the first human to step foot on the moon.

Incredibly, the pursuit of a well-constructed goal had helped people reach the moon in just eight years.

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Americans landed on the moon eight years after President Kennedy set a moon landing as a key

goal for the United States.

Image courtesy of NASA Apollo Archive,

http://upload.wikimedia.org/wikipedia/commons/8/8b/5927_NASA.jpg.

The period after an important goal is reached is often overlooked but is critical. Will an organization rest

on its laurels or will it take on new challenges? The US space program again provides an illustrative

example. At the time of the first moon landing, Time magazine asked the leader of the team that built the

moon rockets about the future of space exploration. “Given the same energy and dedication that took

them to the moon,” said Wernher von Braun, “Americans could land on Mars as early as 1982.” [3] No new

goal involving human visits to Mars was embraced, however, and human exploration of space was de-

emphasized in favor of robotic adventurers. Nearly three decades after von Braun’s proposed timeline for

reaching Mars expired, President Barack Obama set in 2010 a goal of creating by 2025 a new space

vehicle capable of taking humans beyond the moon and into deep space. This would be followed in the

mid-2030s by a flight to orbit Mars as a prelude to landing on Mars. [4] Time will tell whether these goals

inspire the scientific community and the country in general.

K E Y T A K E A W A Y

Strategic leaders need to ensure that their organizations have three types of aims. A vision states what

the organization aspires to become in the future. A mission reflects the organization’s past and present by

stating why the organization exists and what role it plays in society. Goals are the more specific aims that

organizations pursue to reach their visions and missions. The best goals are SMART: specific, measurable,

aggressive, realistic, and time-bound.

E X E R C I S E S

1. Take a look at the website of your college or university. What is the organization’s vision and mission?

Were they easy or hard to find?

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2. As a member of the student body, do you find the vision and mission of your college or university to be

motivating and inspirational? Why or why not?

3. What is an important goal that you have established for your career? Could this goal be improved by

applying the SMART goal concept?

[1] Quigley, J. V. 1994. Vision: How leaders develop it, share it, and sustain it. Business Horizons, 37(5), 37–41.

[2] Key documents in the history of space policy: 1960s. National Aeronautics and Space Administration. Retrieved

from http://history.nasa.gov/spdocs.html#1960s

[3] The Moon: Next, Mars and beyond. 1969, July 15. Time. Retrieved

fromhttp://www.time.com/time/magazine/article/0,9171,901107,00.html

[4] Amos, J. 2010, April 15. Obama sets Mars goal for America. BBC News. Retrieved from

http://news.bbc.co.uk/2/hi/8623691.stm

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2.2 Assessing Organizational Performance

L E A R N I N G O B J E C T I V E S

1. Understand the complexities associated with assessing organizational performance.

2. Learn each of the dimensions of the balanced scorecard framework.

3. Learn what is meant by a “triple bottom line.”

Organizational Performance: A Complex Concept

Organizational performance refers to how well an organization is doing to reach its vision, mission, and

goals. Assessing organizational performance is a vital aspect of strategic management. Executives must

know how well their organizations are performing to figure out what strategic changes, if any, to make.

Performance is a very complex concept, however, and a lot of attention needs to be paid to how it is

assessed.

Two important considerations are (1) performance measures and (2) performance referents (Figure 2.5

"How Organizations and Individuals Can Use Financial Performance Measures and Referents").

A performance measure is a metric along which organizations can be gauged. Most executives examine

measures such as profits, stock price, and sales in an attempt to better understand how well their

organizations are competing in the market. But these measures provide just a glimpse of organizational

performance. Performance referents are also needed to assess whether an organization is doing well. A

performance referent is a benchmark used to make sense of an organization’s standing along a

performance measure. Suppose, for example, that a firm has a profit margin of 20 percent in 2011. This

sounds great on the surface. But suppose that the firm’s profit margin in 2010 was 35 percent and that the

average profit margin across all firms in the industry for 2011 was 40 percent. Viewed relative to these two

referents, the firm’s 2011 performance is cause for concern.

Using a variety of performance measures and referents is valuable because different measures and

referents provide different information about an organization’s functioning. The parable of the blind men

and the elephant—popularized in Western cultures through a poem by John Godfrey Saxe in the

nineteenth century—is useful for understanding the complexity associated with measuring organizational

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performance. As the story goes, six blind men set out to “see” what an elephant was like. The first man

touched the elephant’s side and believed the beast to be like a great wall. The second felt the tusks and

thought elephants must be like spears. Feeling the trunk, the third man thought it was a type of snake.

Feeling a limb, the fourth man thought it was like a tree trunk. The fifth, examining an ear, thought it was

like a fan. The sixth, touching the tail, thought it was like a rope. If the men failed to communicate their

different impressions they would have all been partially right but wrong about what ultimately mattered.

Figure 2.5 How Organizations and Individuals Can Use Financial Performance Measures and

Referents

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This story parallels the challenge involved in understanding the multidimensional nature of organization

performance because different measures and referents may tell a different story about the organization’s

performance. For example, the Fortune 500 lists the largest US firms in terms of sales. These firms are

generally not the strongest performers in terms of growth in stock price, however, in part because they are

so big that making major improvements is difficult. During the late 1990s, a number of Internet-centered

businesses enjoyed exceptional growth in sales and stock price but reported losses rather than profits.

Many investors in these firms who simply fixated on a single performance measure—sales growth—

absorbed heavy losses when the stock market’s attention turned to profits and the stock prices of these

firms plummeted.

The story of the blind men and the elephant provides a metaphor for understanding the

complexities of measuring organizational performance.

Image courtesy of Hanabusa Itcho,

http://en.wikipedia.org/wiki/File:Blind_monks_examining_an_elephant.jpg.

The number of performance measures and referents that are relevant for understanding an organization’s

performance can be overwhelming, however. For example, a study of what performance metrics were used

within restaurant organizations’ annual reports found that 788 different combinations of measures and

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referents were used within this one industry in a single year. [1]Thus executives need to choose a rich yet

limited set of performance measures and referents to focus on.

The Balanced Scorecard

To organize an organization’s performance measures, Professor Robert Kaplan and Professor David

Norton of Harvard University developed a tool called the balanced scorecard. Using the scorecard helps

managers resist the temptation to fixate on financial measures and instead monitor a diverse set of

important measures.

Indeed, the idea behind the framework is to provide a “balance” between financial measures

and other measures that are important for understanding organizational activities that lead to sustained,

long-term performance. The balanced scorecard recommends that managers gain an overview of the

organization’s performance by tracking a small number of key measures that collectively reflect four

dimensions: (1) financial, (2) customer, (3) internal business process, and (4) learning and growth. [2]

Financial Measures

Financial measures of performance relate to organizational effectiveness and profits. Examples include

financial ratios such as return on assets, return on equity, and return on investment. Other common

financial measures include profits and stock price. Such measures help answer the key question “How do

we look to shareholders?”

Financial performance measures are commonly articulated and emphasized within an organization’s

annual report to shareholders. To provide context, such measures should be objective and be coupled with

meaningful referents, such as the firm’s past performance. For example, Starbucks’s 2009 annual report

highlights the firm’s performance in terms of net revenue, operating income, and cash flow over a five-

year period.

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Customer Measures Customer measures of performance relate to customer attraction, satisfaction, and retention. These

measures provide insight to the key question “How do customers see us?” Examples might include the

number of new customers and the percentage of repeat customers.

Starbucks realizes the importance of repeat customers and has taken a number of steps to satisfy and to

attract regular visitors to their stores. For example, Starbucks rewards regular customers with free drinks

and offers all customers free Wi-Fi access. [3] Starbucks also encourages repeat visits by providing cards

with codes for free iTunes downloads. The featured songs change regularly, encouraging frequent repeat

visits.

Internal Business Process Measures

Internal business process measures of performance relate to organizational efficiency. These measures

help answer the key question “What must we excel at?” Examples include the time it takes to manufacture

the organization’s good or deliver a service. The time it takes to create a new product and bring it to

market is another example of this type of measure.

Organizations such as Starbucks realize the importance of such efficiency measures for the long-term

success of its organization, and Starbucks carefully examines its processes with the goal of decreasing

order fulfillment time. In one recent example, Starbucks efficiency experts challenged their employees to

assemble a Mr. Potato Head to understand how work could be done more quickly. [4] The aim of this

exercise was to help Starbucks employees in general match the speed of the firm’s high performers, who

boast an average time per order of twenty-five seconds.

Learning and Growth Measures

Learning and growth measures of performance relate to the future. Such measures provide insight to tell

the organization, “Can we continue to improve and create value?” Learning and growth measures focus on

innovation and proceed with an understanding that strategies change over time. Consequently,

developing new ways to add value will be needed as the organization continues to adapt to an evolving

environment. An example of a learning and growth measure is the number of new skills learned by

employees every year.

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One way Starbucks encourages its employees to learn skills that may benefit both the firm and individuals

in the future is through its tuition reimbursement program. Employees who have worked with Starbucks

for more than a year are eligible. Starbucks hopes that the knowledge acquired while earning a college

degree might provide employees with the skills needed to develop innovations that will benefit the

company in the future. Another benefit of this program is that it helps Starbucks reward and retain high-

achieving employees.

Measuring Performance Using the Triple Bottom Line

Ralph Waldo Emerson once noted, “Doing well is the result of doing good. That’s what capitalism is all

about.” While the balanced scorecard provides a popular framework to help executives understand an

organization’s performance, other frameworks highlight areas such as social responsibility. One such

framework, the triple bottom line, emphasizes the three Ps of people (making sure that the actions of the

organization are socially responsible), the planet (making sure organizations act in a way that promotes

environmental sustainability), and traditional organization profits. This notion was introduced in the

early 1980s but did not attract much attention until the late 1990s. The triple bottom line emphasizes the three Ps of people (social concerns), planet (environmental concerns), and profits (economic concerns). In the case of Starbucks, the firm has made clear the importance it attaches to the planet by creating an environmental mission statement (“Starbucks is committed to a role of environmental leadership in all facets of our business”) in addition to its overall mission.[5]In terms of the “people” dimension of the triple bottom line, Starbucks strives to purchase coffee beans harvested by farmers who work under humane conditions and are paid reasonable wages. The firm works to be profitable as well, of course.

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K E Y T A K E A W A Y

Organizational performance is a multidimensional concept, and wise managers rely on multiple measures

of performance when gauging the success or failure of their organizations. The balanced scorecard

provides a tool to help executives gain a general understanding of their organization’s current level of

achievement across a set of four important dimensions. The triple bottom line provides another tool to

help executives focus on performance targets beyond profits alone; this approach stresses the

importance of social and environmental outcomes.

E X E R C I S E S

1. How might you apply the balanced scorecard framework to measure performance of your college or

university?

2. Identify a measurable example of each of the balanced scorecard dimensions other than the examples

offered in this section.

3. Identify a mission statement from an organization that emphasizes each of the elements of the triple

bottom line.

[1] Short, J. C., & Palmer, T. B. 2003. Organizational performance referents: An empirical examination of their

content and influences. Organizational Behavior and Human Decision Processes, 90, 209–224.

[2] Kaplan, R. S., & Norton, D. 1992, February. The balanced scorecard: Measures that drive performance. Harvard

Business Review, 70–79.

[3] Miller, C. 2010, June 15. Aiming at rivals, Starbucks will offer free Wi-Fi. New York Times. Section B, p. 1.

[4] Jargon, J. 2009, August 4. Latest Starbucks buzzword: “Lean” Japanese techniques. Wall Street Journal, p. A1.

[5] Our Starbucks mission statement. Retrieved on March 31, 2011, fromhttp://www.starbucks.com/about-

us/company-information/mission-statement. Accessed March 31, 2011.

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2.3 The CEO as Celebrity

L E A R N I N G O B J E C T I V E S

1. Understand the benefits and costs of CEO celebrity status.

2. List and define the four types of CEOs based on differences in fame and reputation.

3. Be able to offer an example of each of the four types of CEOs

Benefits and Costs of CEO Celebrity

The nice thing about being a celebrity is that when you bore people, they think it’s their fault.

Henry Kissinger, former US Secretary of State

The word celebrity quickly brings to mind actors, sports stars, and musicians. Some CEOs, such as Bill

Gates, Oprah Winfrey, Martha Stewart, and Donald Trump, also achieve celebrity status. Celebrity CEOs

are not a new phenomenon. In the early twentieth century, industrial barons such as Henry Ford, John D.

Rockefeller, and Cornelius Vanderbilt were household names. However, in the current era of mass and

instant media, celebrity CEOs have become more prevalent and visible (Figure 2.7 "CEO"). [1]

Cornelius Vanderbilt was one of the earliest celebrity CEOs; Vanderbilt University serves as his

legacy.

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Image courtesy of Mathew Brady and Michel Vuijlsteke,

http://en.wikipedia.org/wiki/File:Cornelius_Vanderbilt_Daguerrotype2.jpg.

Both benefits and costs are associated with CEO celebrity. As the quote from Henry Kissinger suggests,

celebrity confers a mystique and reverence that can be leveraged in a variety of ways. CEO celebrity can

serve as an intangible asset for the CEO’s firm and may increase opportunities available to the firm.

Hiring or developing a celebrity CEO may increase stock price, enhance a firm’s image, and improve the

morale of employees and other stakeholders. However, employing a celebrity CEO also entails risks for an

organization. Increased attention to the firm via the celebrity CEO means any gaps between actual and

expected firm performance are magnified. Further, if a celebrity CEO acts in an unethical or illegal

manner, chances are that the CEO’s firm will receive much more media attention than will other firms

with similar problems. [2]

There are also personal benefits and risks associated with celebrity for the CEO. Celebrity CEOs tend to

receive higher compensation and job perks than their colleagues. Celebrity CEOs are likely to enjoy

increased prestige power, which facilitates invitations to serve on the boards of directors of other firms

and creates opportunities to network with other “managerial elites.” Celebrity also can provide CEOs with

a “benefit of the doubt” effect that protects against quick sanctions for downturns in firm performance

and stock price. However, celebrity also creates potential costs for individuals. Celebrity CEOs face larger

and more lasting reputation erosion if their job performance and behavior is inconsistent with their

celebrity image. Celebrity CEOs face increased personal media scrutiny, and their friends and family must

often endure increased attention into their personal and public lives. Accordingly, wise CEOs will attempt

to understand and manage their celebrity status. [3]

Types of CEOs

Icons are CEOs possessing both fame and strong reputations. The icon CEO combines style and substance

in the execution of his or her job responsibilities. Mary Kay Ash, Richard Branson, Bill Gates, and Warren

Buffett are good examples of icons. The late Mary Kay Ash founded Mary Kay Cosmetics Corporation. The

firm’s great success and Ash’s unconventional motivational methods, such as rewarding sales

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representatives with pink Cadillacs, made her famous. Partly because she emphasized helping other

women succeed and ethical business practices, Mary Kay Ash also had a very positive reputation. Richard

Branson has created an empire with more than four hundred companies, including Virgin Atlantic

Airways and Virgin Records. Branson’s celebrity status led him to star in his own reality-based show. He

has also appeared on television series such as Baywatch and Friends, in addition to several cameo

appearances in major motion pictures. Bill Gates, founder and former CEO of Microsoft, also has fame

and a largely positive reputation. Gates is a proverbial “household name” in the tradition of Ford,

Rockefeller, and Vanderbilt. He also is routinely listed among Time magazine’s “100 Most Influential

People” and has received “rock star” receptions in India and Vietnam in recent years.

Former Microsoft CEO Bill Gates exemplifies a CEO who has reached icon

status.

Image courtesy of World Economic Forum,

http://en.wikipedia.org/wiki/File:Bill_Gates_in_WEF_,2007.jpg.

Warren Buffett is perhaps the best-known executive in the United States. As CEO of Berkshire Hathaway,

he has accumulated wealth estimated at $62 billion and was the richest person in the world as of March

2008. Buffett’s business insights command a level of respect that is perhaps unrivaled. Many in the

investment and policymaking communities pay careful attention to his investment choices and his

commentary on economic conditions. Despite Buffett’s immense wealth and success, his reputation

centers on humility and generosity. Buffett avoids the glitz of Wall Street and has lived for fifty years in a

house he bought in Omaha, Nebraska, for $31,000. Meanwhile, his 2006 donation of approximately $30

billion to the Bill and Melinda Gates Foundation was the largest charitable gift in history.

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CEOs who display high levels of relative fame but low levels of reputation are in the group called

scoundrels. These CEOs are well known but vilified. The late Leona Helmsley was a prototypical

scoundrel. Leona Helmsley’s life was a classic rags-to-riches story. Born to immigrant parents, Helmsley

became a billionaire through her work as the head of an extensive hotel and real estate empire. While

certainly famous, her reputation was anything but positive, as reflected by her nickname: the Queen of

Mean. During Helmsley’s trial for tax fraud, her housekeeper quoted her as proclaiming, “We don’t pay

taxes. Only the little people pay taxes.” Following twenty-one months in jail, Helmsley was required to

perform 750 hours of community service. One hundred fifty hours were added to this sentence after it was

discovered that employees had performed some of her service hours. Helmsley’s apparent arrogance,

combined with her cruelty to employees and her reputation as the ultimate workplace bully, cemented her

position as a scoundrel.

The corporate governance scandals of the early 2000s revealed several CEOs as scoundrels. Perhaps the

best known were Kenneth Lay and Dennis Kozlowski. Both men rose to prominence as their firms’ success

and stock prices soared but were undone by dubious activities. Lay was once revered as the son of a poor

minister who founded Enron and built it into a giant in the energy business. In 2001, however, he became

the face of corporate abuses in the United States after Enron’s collapse led to scenes, captured on

television, of employees left jobless and with retirement accounts full of worthless Enron stock. Lay was

convicted of fraud in 2006 but died before sentencing.

Also born to a poor family, Kozlowski started at Tyco as an accountant and worked his way up to the

executive suite. In May 2001, a BusinessWeek cover story lauded Kozlowski as “the most aggressive CEO”

in the country and detailed his strategy for building Tyco into the next General Electric by using

acquisitions to gain the first or second position in all the industries in which it competed. By 2002,

Kozlowski’s reputation was in jeopardy. He was indicted for avoiding more than $1 million in sales taxes

on art purchases. Media stories described in detail a $2 million birthday party Kozlowski threw for his

wife (billing half of it to Tyco as a company function), a $19 million apartment Tyco purchased for him,

and $11 million worth of furnishings for the apartment (including an infamous $6,000 shower curtain).

Accusations that Kozlowski and another Tyco executive stole hundreds of millions of dollars from the firm

ultimately led to a prison sentence of eight to twenty-five years.

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Hidden gems are CEOs who lack fame but possess positive reputations. These CEOs toil in relative

obscurity while leading their firms to success. Their skill as executives is known mainly by those in their

own firm and by their competitors. In many cases, the firm has some renown due to its success, but the

CEO stays unknown. For example, consider the case of Anne Mulcahy. Mulcahy, CEO of Xerox, started

her career at Xerox as a copier salesperson. Despite building an excellent reputation by rescuing Xerox

from near bankruptcy, Mulcahy eschews fame and publicity. While being known for successfully leading

Xerox by example and being willing to fly anywhere to meet a customer, she avoids stock analysts and

reporters.

Silent killers are the fourth and final group of CEOs. These CEOs are overlooked and ignored sources of

harm to their firms. While scoundrels are closely monitored and scrutinized by the media, it may be too

late before the poor ethics or incompetence of the silent killers is detected. In this sense, silent killers are

sometimes worse than scoundrels. One example of a silent killer is Harding Lawrence, former CEO of

defunct Braniff International. Lawrence initiated a massive expansion of the airline following industry

deregulation in the late 1970s. The result was a bloated firm, ill-equipped to survive the extremely

competitive setting that evolved in the early 1980s. Howard Putnam, the CEO of a small regional carrier

named Southwest Airlines, was hired in a failed effort to save the company. By the time Braniff went

bankrupt, Putnam was left to explain its demise, and the name of the main culprit was all but forgotten.

Ironically, had Putnam declined the opportunity to try to save Braniff, perhaps he and not Herb Kelleher

would have become an icon at the helm of Southwest.

Strategy at the Movies

Iron Man

Has Tony Stark gone crazy? This was the question that many stakeholders of Stark Industries were asking

themselves in the 2008 blockbuster Iron Man. Tony Stark, CEO of Stark Industries, stunned his

shareholders, employees, and the world when he announced that he was changing Stark Industries’

mission from being one of the world’s leading weapons manufacturers to being a socially responsible,

clean energy producer. Following his announcement, Stark faced fierce opposition from his board of

directors, employees, the media, and clients such as the US military. The changes at Stark Industries

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attracted tremendous attention in part because of the glamorous Stark’s status as a celebrity CEO.

Initially, Stark is seen by the public as a scoundrel that pays little attention to the social impact his

company makes. After shifting the direction of Stark Industries, however, Stark is viewed as an icon that

is just as attentive to the social performance of the company as he is to its financial performance. Iron

Man illustrates that while changing elements such as firm mission and CEO status is difficult, it is not

impossible.

Iron Man: The Greatest Creation of Fictional Celebrity CEO Tony Stark

Image courtesy of Pop Culture Geek, http://www.flickr.com/photos/popculturegeek/4858995531.

Celebrity Rehabilitation

Anything I say or do is now at risk of showing up on the front page of a national daily newspaper and

therefore, I need to be much more conscious about the implications of everything that I say or do in all

situations.

John Mackey, CEO of Whole Foods Market

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Achieving the level of success that brings about celebrity is seldom a completely smooth process. Even

well-regarded celebrity CEOs seldom have totally untarnished reputations. Bill Gates has been portrayed

as a ruthless and devious genius, for example, while General Electric CEO Jack Welch was attacked in

media outlets for an extramarital affair.

One of the more interesting recent cases of a tarnished reputation centers on John Mackey, founder and

CEO of Whole Foods Market. His strategy of offering organic food and high levels of service allowed

Whole Foods to carve out a profitable and growing niche in an industry whose overall margins have been

squeezed as Walmart’s Supercenters have gained market share. Under Mackey’s leadership, Whole Food’s

stock price tripled from 2001 to 2006. Mackey’s efforts to make food supplies healthier and his teamwork-

centered management approach attracted publicity, and he appeared headed for icon status.

But in 2007 Mackey and Whole Foods were embarrassed by the revelation that Mackey had been

anonymously posting negative information about a rival, Wild Oats, online. Through his online persona

“rahodeb” (a scrambling of his wife’s name), Mackey asserted that Wild Oats’ stock was overpriced and

that the firm was headed toward bankruptcy. This was viewed by some observers as a possible effort to

manipulate Wild Oats’ stock price prior to a proposed acquisition by Whole Foods. Meanwhile, in e-mails

to other Whole Foods executives, Mackey noted that the acquisition of Wild Oats could allow them to

avoid “nasty price wars.” This caught the eye of Federal Trade Commission (FTC) regulators who were

concerned about the antitrust implications of the acquisition.

Whole Foods CEO John Mackey’s celebrity status was amplified when it was revealed that he had posted negative

information online about competitor Wild Oats.

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Image courtesy of Joe M500, http://en.wikipedia.org/wiki/File:John_Mackey,_of_Whole_Foods_in_2009.jpg.

What should a CEO do when his or her reputation takes a hit? As the old saying goes, honesty is the best

policy. An example is offered by David Neeleman, founder and CEO of JetBlue. The reputations of JetBlue

and Neeleman took a severe blow after a widely reported February 2007 debacle in which travelers were

stranded in airplanes for excessive periods of time during a busy holiday weekend. Neeleman took a giant

step toward restoring both his and JetBlue’s reputation by issuing a public, heartfelt apology. He not only

issued a written apology to customers but also bought full-page advertisements in newspapers, posted a

video apology online, and created a new “bill of rights” for JetBlue customers.

Mackey apologized for his actions via his blog in 2008. As part of this apology, Mackey acknowledged that

he had failed to recognize how expectations change when one becomes a celebrity. Mackey noted that

when Whole Foods was a smaller company, “I was seldom interviewed and few people knew or cared who

I was. I wasn’t a public figure and had no desire to become one.” As his company grew, however, Mackey

became subject to more scrutiny. As Mackey put it, “At some point in the past 10 years I went from being a

relatively unknown person to becoming a public figure. I regret not having the wisdom to recognize this

fact until very recently.”[4] A big part of managing celebrity status is realizing that one is in fact a celebrity.

K E Y T A K E A W A Y

The media exposure common to modern CEOs provides the opportunity for such top executives to reach

celebrity status. While this status can provide positive benefits to their firms such as increased

performance, CEOs should be aware of and manage the potential for increased scrutiny associated with

this status.

E X E R C I S E S

1. Can you identify another example of a celebrity CEO, such as Cornelius Vanderbilt, that existed prior to

the 1900s?

2. Identify examples of icons, scoundrels, hidden gems, and silent killers other than the examples offered in

this section.

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3. Would you enjoy the media attention associated with CEO celebrity, or would you prefer to hide from the

limelight? Does your answer have implications for your future career choices?

[1] This section of the chapter is adapted from Ketchen, D., Adams, G., & Shook, C. 2008. Understanding and

managing CEO celebrity. Business Horizons, 51(6), 529–534.

[2] Ranft, A. L., Zinko, R., Ferris, G. R., & Buckley, M. R. 2006. Marketing the image of management: The costs and

benefits of CEO reputation. Organizational Dynamics, 35(3), 279–290.

[3] Wade, J. B., Porac, J. F., Pollock, T. G., & Graffin, S. D. 2008. Star CEOs: Benefit or burden? Organizational

Dynamics, 37(2), 203–210.

[4] John Mackey’s blog. 2008, May 21. Re: Apology. Retrieved

fromhttp://www2.wholefoodsmarket.com/blogs/jmackey/2008/05/21/back-to-blogging/#more-26.

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2.4 Entrepreneurial Orientation L E A R N I N G O B J E C T I V E S

1. Understand how thinking and acting entrepreneurially can help organizations and individuals.

2. List and define the five dimensions of an entrepreneurial orientation.

The Value of Thinking and Acting Entrepreneurially

When asked to think of an entrepreneur, people typically offer examples such as Howard Schultz, Estée

Lauder, and Michael Dell—individuals who have started their own successful businesses from the bottom

up that generated a lasting impact on society. But entrepreneurial thinking and doing are not limited to

those who begin in their garage with a new idea, financed by family members or personal savings. Some

people in large organizations are filled with passion for a new idea, spend their time championing a new

product or service, work with key players in the organization to build a constituency, and then find ways

to acquire the needed resources to bring the idea to fruition. Thinking and behaving entrepreneurially can

help a person’s career too. Some enterprising individuals successfully navigate through the environments

of their respective organizations and maximize their own career prospects by identifying and seizing new

opportunities.[1]

As a college student, Michael Dell demonstrated an entrepreneurial

orientation by starting a computer-upgrading business in his dorm room.

He later founded Dell Inc.

Image courtesy of Ilan Costica,

http://en.wikipedia.org/wiki/File:Michael_Dell_at_Oracle_OpenWorld.J

PG.

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In the 1730s, Richard Cantillon used the French term entrepreneur, or literally “undertaker,” to refer to

those who undertake self-employment while also accepting an uncertain return. In subsequent years,

entrepreneurs have also been referred to as innovators of new ideas (Thomas Edison), individuals who

find and promote new combinations of factors of production (Bill Gates’ bundling of Microsoft’s

products), and those who exploit opportunistic ideas to expand small enterprises (Mark Zuckerberg at

Facebook). The common elements of these conceptions of entrepreneurs are that they do something new

and that some individuals can make something out of opportunities that others cannot.

Entrepreneurial orientation (EO) is a key concept when executives are crafting strategies in the hopes of

doing something new and exploiting opportunities that other organizations cannot exploit. EO refers to

the processes, practices, and decision-making styles of organizations that act entrepreneurially. [2] Any

organization’s level of EO can be understood by examining how it stacks up relative to five dimensions: (1)

autonomy, (2) competitive aggressiveness, (3) innovativeness, (4) proactiveness, (5) and risk taking.

These dimensions are also relevant to individuals.

Autonomy

Autonomy refers to whether an individual or team of individuals within an organization has the freedom

to develop an entrepreneurial idea and then see it through to completion. In an organization that offers

high autonomy, people are offered the independence required to bring a new idea to fruition, unfettered

by the shackles of corporate bureaucracy. When individuals and teams are unhindered by organizational

traditions and norms, they are able to more effectively investigate and champion new ideas.

Some large organizations promote autonomy by empowering a division to make its own decisions, set its

own objectives, and manage its own budgets. One example is Sony’s PlayStation group, which was created

by chief operating officer (COO) Ken Kutaragi, largely independent of the Sony bureaucracy. In time, the

PlayStation business was responsible for nearly all Sony’s net profit. Because of the success generated by

the autonomous PlayStation group, Kutaragi later was tapped to transform Sony’s core consumer

electronics business into a PlayStation clone. In some cases, an autonomous unit eventually becomes

completely distinct from the parent company, such as when Motorola spun off its successful

semiconductor business to create Freescale.

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Competitive Aggressiveness

Competitive aggressiveness is the tendency to intensely and directly challenge competitors rather than

trying to avoid them. Aggressive moves can include price-cutting and increasing spending on marketing,

quality, and production capacity. An example of competitive aggressiveness can be found in Ben & Jerry’s

marketing campaigns in the mid-1980s, when Pillsbury’s Häagen-Dazs attempted to limit distribution of

Ben & Jerry’s products. In response, Ben & Jerry’s launched their “What’s the Doughboy Afraid Of?”

advertising campaign to challenge Pillsbury’s actions. This marketing action was coupled with a series of

lawsuits—Ben & Jerry’s was competitively aggressive in both the marketplace and the courtroom.

Although aggressive moves helped Ben & Jerry’s, too much aggressiveness can undermine an

organization’s success. A small firm that attacks larger rivals, for example, may find itself on the losing

end of a price war. Establishing a reputation for competitive aggressiveness can damage a firm’s chances

of being invited to join collaborative efforts such as joint ventures and alliances. In some industries, such

as the biotech industry, collaboration is vital because no single firm has the knowledge and resources

needed to develop and deliver new products. Executives thus must be wary of taking competitive actions

that destroy opportunities for future collaborating.

Innovativeness

Innovativeness is the tendency to pursue creativity and experimentation. Some innovations build on

existing skills to create incremental improvements, while more radical innovations require brand-new

skills and may make existing skills obsolete. Either way, innovativeness is aimed at developing new

products, services, and processes. Those organizations that are successful in their innovation efforts tend

to enjoy stronger performance than those that do not.

Known for efficient service, FedEx has introduced its Smart Package, which allows both shippers and

recipients to monitor package location, temperature, and humidity. This type of innovation is a welcome

addition to FedEx’s lineup for those in the business of shipping delicate goods, such as human organs.

How do firms generate these types of new ideas that meet customers’ complex needs? Perennial

innovators 3M and Google have found a few possible answers. 3M sends nine thousand of its technical

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personnel in thirty-four countries into customers’ workplaces to experience firsthand the kinds of

problems customers encounter each day. Google’s two most popular features of its Gmail, thread sorting

and unlimited e-mail archiving, were first suggested by an engineer who was fed up with his own e-mail

woes. Both firms allow employees to use a portion of their work time on projects of their own choosing

with the goal of creating new innovations for the company. This latter example illustrates how multiple

EO dimensions—in this case, autonomy and innovativeness—can reinforce one another.

Ben & Jerry’s displays innovativeness by developing a series of offbeat and creative flavors over time.

Image courtesy of theimpulsivebuy,

Proactiveness

Proactiveness is the tendency to anticipate and act on future needs rather than reacting to events after

they unfold. A proactive organization is one that adopts an opportunity-seeking perspective. Such

organizations act in advance of shifting market demand and are often either the first to enter new markets

or “fast followers” that improve on the initial efforts of first movers.

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Consider Proactive Communications, an aptly named small firm in Killeen, Texas. From its beginnings in

2001, this firm has provided communications in hostile environments, such as Iraq and areas impacted by

Hurricane Katrina. Being proactive in this case means being willing to don a military helmet or sleep

outdoors—activities often avoided by other telecommunications firms. By embracing opportunities that

others fear, Proactive’s executives have carved out a lucrative niche in a world that is technologically,

environmentally, and politically turbulent. [3]

Risk Taking

Risk taking refers to the tendency to engage in bold rather than cautious actions. Starbucks, for example,

made a risky move in 2009 when it introduced a new instant coffee called VIA Ready Brew. Instant coffee

has long been viewed by many coffee drinkers as a bland drink, but Starbucks decided that the

opportunity to distribute its product in a different format was worth the risk of associating its brand name

with instant coffee.

Although a common belief about entrepreneurs is that they are chronic risk takers, research suggests that

entrepreneurs do not perceive their actions as risky, and most take action only after using planning and

forecasting to reduce uncertainty. [4] But uncertainty seldom can be fully eliminated. A few years ago,

Jeroen van der Veer, CEO of Royal Dutch Shell PLC, entered a risky energy deal in Russia’s Far East. At

the time, van der Veer conceded that it was too early to know whether the move would be

successful. [5] Just six months later, however, customers in Japan, Korea, and the United States had

purchased all the natural gas expected to be produced there for the next twenty years. If political

instabilities in Russia and challenges in pipeline construction do not dampen returns, Shell stands to post

a hefty profit from its 27.5 percent stake in the venture.

Building an Entrepreneurial Orientation

Steps can be taken by executives to develop a stronger entrepreneurial orientation throughout an

organization and by individuals to become more entrepreneurial themselves. For executives, it is

important to design organizational systems and policies to reflect the five dimensions of EO. As an

example, how an organization’s compensation systems encourage or discourage these dimensions should

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be considered. Is taking sensible risks rewarded through raises and bonuses, regardless of whether the

risks pay off, for example, or does the compensation system penalize risk taking? Other organizational

characteristics such as corporate debt level may influence EO. Do corporate debt levels help or impede

innovativeness? Is debt structured in such a way as to encourage risk taking? These are key questions for

executives to consider.

Examination of some performance measures can assist executives in assessing EO within their

organizations. To understand how the organization develops and reinforces autonomy, for example, top

executives can administer employee satisfaction surveys and monitor employee turnover rates.

Organizations that effectively develop autonomy should foster a work environment with high levels of

employee satisfaction and low levels of turnover. Innovativeness can be gauged by considering how many

new products or services the organization has developed in the last year and how many patents the firm

has obtained.

Similarly, individuals should consider whether their attitudes and behaviors are consistent with the five

dimensions of EO. Is an employee making decisions that focus on competitors? Does the employee

provide executives with new ideas for products or processes that might create value for the organization?

Is the employee making proactive as opposed to reactive decisions? Each of these questions will aid

employees in understanding how they can help to support EO within their organizations.

K E Y T A K E A W A Y

Building an entrepreneurial orientation can be valuable to organizations and individuals alike in

identifying and seizing new opportunities. Entrepreneurial orientation consists of five dimensions: (1)

autonomy, (2) competitive aggressiveness, (3) innovativeness, (4) proactiveness, and (5) risk taking.

E X E R C I S E S

1. Can you name three firms that have suffered because of lack of an entrepreneurial orientation?

2. Identify examples of each dimension of entrepreneurial orientation other than the examples offered in

this section.

3. How does developing an entrepreneurial orientation have implications for your future career choices?

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4. How could you apply the dimensions of entrepreneurial orientation to a job search?

[1] This section is adapted from Certo, S. T., Moss, T. W., & Short, J. C. 2009. Entrepreneurial orientation: An

applied perspective. Business Horizons, 52, 319–324.

[2] Lumpkin, G. T., & Dess, G. G. 1996. Clarifying the entrepreneurial orientation construct and linking it to

performance. Academy of Management Review, 21, 135–172.

[3] Choi, A. S. 2008, April 16. PCI builds telecommunications in Iraq. Bloomberg Businessweek. Retrieved

fromhttp://www.businessweek.com/magazine/content/08_64/s0804065916656.htm.

[4] Simon, M., Houghton, S. M., & Aquino, K. 2000. Cognitive biases, risk perception, and venture formation: How

individuals decide to start companies. Journal of Business Venturing, 14, 113–134.

[5] Certo, S. T., Connelly, B., & Tihanyi, L. 2008. Managers and their not-so-rational decisions. Business

Horizons, 51(2), 113–119.

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2.5 Conclusion

This chapter explains several challenges that executives face in attempting to lead their organizations

strategically. Executives must ensure that their organizations have visions, missions, and goals in

place that help move these organizations forward. Measures and referents for assessing performance

must be thoughtfully chosen. Some executives become celebrities, thereby creating certain

advantages and disadvantages for themselves and for their firms. Finally, executives must monitor

the degree of entrepreneurial orientation present within their organizations and make adjustments

when necessary. When executives succeed at leading strategically, an organization has an excellent

chance of success.

E X E R C I S E S

1. Divide your class into four or eight groups, depending on the size of the class. Assign each group to

develop arguments that one of the key issues discussed in this chapter (vision, mission, goals; assessing

organizational performance; CEO celebrity; entrepreneurial orientation) is the most important within

organizations. Have each group present their case, and then have the class vote individually for the

winner. Which issue won and why?

2. This chapter discussed Howard Schultz and Starbucks on several occasions. Based on your reading of the

chapter, how well has Schultz done in dealing with setting a vision, mission, and goals, assessing

organizational performance, CEO celebrity, and entrepreneurial orientation?

3. Write a vision and mission for an organization or firm that you are currently associated with. How could

you use the balanced scorecard to assess how well that organization is fulfilling the mission you wrote?

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Chapter 3

Evaluating the External Environment

L E A R N I N G O B J E C T I V E S

After reading this chapter, you should be able to understand and articulate answers to the following

questions:

1. What is the general environment and why is it important to organizations?

2. What are the features of Porter’s five forces industry analysis?

3. What are strategic groups and how are they useful to evaluating the environment?

Subway Is on a Roll

As shown in the highlighted countries, Subway is well on its way to building a worldwide sandwich

empire.

Image courtesy of Nomi887,http://en.wikipedia.org/wiki/File:Subway_world_map1edit.png.

Many observers were stunned in March 2011 when news broke that Subway had surpassed McDonald’s as

the biggest restaurant chain in the world. At the time of the announcement, Subway had 33,749 units

under its banner while McDonald’s had 32,737. [1] Despite its meteoric growth, many opportunities

remained. In China, for example, Subway had fewer than two hundred stores. In contrast, China hosts

Chapter 3 from Mastering Strategic Management was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 license without attribution as requested

by the work’s original creator or licensee. © 2014, The Saylor Foundation.

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more than 3,200 Kentucky Fried Chicken stores. Overall, Subway was on a roll, and this success seemed

likely to continue.

How had Subway surpassed a global icon like McDonald’s? One key factor was Subway’s efforts to provide

and promote healthy eating options. This emphasis took hold in the late 1990s when the American public

became captivated by college student Jared Fogle. As a freshman at Indiana University in 1998, the 425

pound Fogle decided to try to lose weight by walking regularly and eating a diet consisting of Subway

subs. Amazingly, Fogle dropped 245 pounds by February of 1999.

Subway executives knew that a great story had fallen into their laps. They decided to feature Fogle in

Subway’s advertising and soon he was a well-known celebrity. In 2007, Fogle met with President Bush

about nutrition and testified before the US Congress about the need for healthier snack options in schools.

Today, Fogle is the face of Subway and one of the few celebrities that are instantly recognizable based on

his first name alone. Much like Beyoncé and Oprah, you can mention “Jared” to almost anyone in America

and that person will know exactly of whom you are speaking. Subway’s line of Fresh Fit sandwiches is

targeted at prospective Jareds who want to improve their diets.

Because American diets contain too much salt, which can cause high blood pressure, salt levels in

restaurant food are attracting increased scrutiny. Subway responded to this issue in April 2011 when its

outlets in the United States reduced the amount of salt in all its sandwiches by at least 15 percent without

any alteration in taste. The Fresh Fit line of sandwiches received a more dramatic 28 percent reduction in

salt. These changes were enacted after customers of Subway’s outlets in New Zealand and Australia

embraced similar adjustments. Although the new sandwich recipes cost slightly more than the old ones,

Subway plans to absorb these costs rather than raising their prices. [2] This may be a wise strategy for

retaining customers, who have become very price sensitive because of the ongoing uncertainty

surrounding the American economy and the high unemployment.

[1] Kingsley, P. 2011, March 9. How a sandwich franchise ousted McDonald’s. The Guardian. Retrieved

from http://www.guardian.co.uk/lifeandstyle/2011/mar/09/subway-biggest -fast-food-chain

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[2] Riley, C. 2011, April. Subway lowers salt in its sandwiches. CNNMoney. Retrieved from

http://money.cnn.com/2011/04/18/news/companies/subway_salt/index.htm

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3.1 The Relationship between an Organization and Its Environment

L E A R N I N G O B J E C T I V E S

1. Define the environment in the context of business.

2. Understand how an organization and its environment affect each other.

3. Learn the difference between the general environment and the industry.

What Is the Environment?

For any organization, the environment consists of the set of external conditions and forces that have the

potential to influence the organization. In the case of Subway, for example, the environment contains its

customers, its rivals such as McDonald’s and Kentucky Fried Chicken, social trends such as the shift in

society toward healthier eating, political entities such as the US Congress, and many additional conditions

and forces.

It is useful to break the concept of the environment down into two components.

The general environment (or macroenvironment) includes overall trends and events in society such as

social trends, technological trends, demographics, and economic conditions. The

industry (or competitive environment) consists of multiple organizations that collectively compete with

one another by providing similar goods, services, or both.

Every action that an organization takes, such as raising its prices or launching an advertising campaign,

creates some degree of changes in the world around it. Most organizations are limited to influencing their

industry. Subway’s move to cut salt in its sandwiches, for example, may lead other fast-food firms to

revisit the amount of salt contained in their products. A few organizations wield such power and influence

that they can shape some elements of the general environment. While most organizations simply react to

major technological trends, for example, the actions of firms such as Intel, Microsoft, and Apple help

create these trends. Some aspects of the general environment, such as demographics, simply must be

taken as a given by all organizations. Overall, the environment has a far greater influence on most

organizations than most organizations have on the environment.

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Why Does the Environment Matter?

Understanding the environment that surrounds an organization is important to the executives in charge

of the organizations. There are several reasons for this. First, the environment provides resources that an

organization needs in order to create goods and services. In the seventeenth century, British poet John

Donne famously noted that “no man is an island.” Similarly, it is accurate to say that no organization is

self-sufficient. As the human body must consume oxygen, food, and water, an organization needs to take

in resources such as labor, money, and raw materials from outside its boundaries. Subway, for example,

simply would cease to exist without the contributions of the franchisees that operate its stores, the

suppliers that provide food and other necessary inputs, and the customers who provide Subway with

money through purchasing its products. An organization cannot survive without the support of its

environment.

Second, the environment is a source of opportunities and threats for an organization. Opportunities are

events and trends that create chances to improve an organization’s performance level. In the late 1990s,

for example, Jared Fogle’s growing fame created an opportunity for Subway to position itself as a healthy

alternative to traditional fast-food restaurants. Threats are events and trends that may undermine an

organization’s performance. Subway faces a threat from some upstart restaurant chains. Saladworks, for

example, offers a variety of salads that contain fewer than five hundred calories. Noodles and Company

offers a variety of sandwiches, pasta dishes, and salads that contain fewer than four hundred calories.

These two firms are much smaller than Subway, but they could grow to become substantial threats to

Subway’s positioning as a healthy eatery.

Executives must also realize that virtually any environmental trend or event is likely to create

opportunities for some organizations and threats for others. This is true even in extreme cases. In

addition to horrible human death and suffering, the March 2011 earthquake and tsunami in Japan

devastated many organizations, ranging from small businesses that were simply wiped out to corporate

giants such as Toyota whose manufacturing capabilities were undermined. As odd as it may seem,

however, these tragic events also opened up significant opportunities for other organizations. The

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rebuilding of infrastructure and dwellings requires concrete, steel, and other materials. Japanese concrete

manufacturers, steelmakers, and construction companies are likely to be very busy in the years ahead.

Third, the environment shapes the various strategic decisions that executives make as they attempt to lead

their organizations to success. The environment often places important constraints on an organization’s

goals, for example. A firm that sets a goal of increasing annual sales by 50 percent might struggle to

achieve this goal during an economic recession or if several new competitors enter its business.

Environmental conditions also need to be taken into account when examining whether to start doing

business in a new country, whether to acquire another company, and whether to launch an innovative

product, to name just a few.

K E Y T A K E A W A Y

An organization’s environment is a major consideration. The environment is the source of resources that

the organizations needs. It provides opportunities and threats, and it influences the various strategic

decisions that executives must make.

E X E R C I S E S

1. What are the three reasons that the environment matters?

2. Which of these three reasons is most important? Why?

3. Can you identify an environmental trend that no organizations can influence?

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3.2 Evaluating the General Environment

L E A R N I N G O B J E C T I V E S

1. Explain how PESTEL analysis is useful to organizations.

2. Be able to offer an example of each of the elements of the general environment.

The Elements of the General Environment: PESTEL Analysis

An organization’s environment includes factors that it can readily affect as well as factors that largely lay

beyond its influence. The latter set of factors are said to exist within the general environment. Because the

general environment often has a substantial influence on an organization’s level of success, executives

must track trends and events as they evolve and try to anticipate the implications of these trends and

events.

PESTEL analysis is one important tool that executives can rely on to organize factors within the general

environment and to identify how these factors influence industries and the firms within them. PESTEL is

an anagram, meaning it is a word that created by using parts of other words. In particular, PESTEL

reflects the names of the six segments of the general environment: (1) political, (2) economic, (3) social,

(4) technological, (5) environmental, and (6) legal. Wise executives carefully examine each of these six

segments to identify major opportunities and threats and then adjust their firms’ strategies accordingly.

P Is for “Political”

The political segment centers on the role of governments in shaping business. This segment includes

elements such as tax policies, changes in trade restrictions and tariffs, and the stability of governments.

Immigration policy is an aspect of the political segment of the general environment that offers important

implications for many different organizations. What approach to take to illegal immigration into the United

States from Mexico has been a hotly debated dilemma. Some hospital executives have noted that illegal

immigrants put a strain on the health care system because immigrants seldom can pay for medical

services and hospitals cannot by law turn them away from emergency rooms.

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Meanwhile, farmers argue that a tightening of immigration policy would be harmful because farmers rely

heavily on cheap labor provided by illegal immigrants. In particular, if farmers were forced to employ only

legal workers, this would substantially increase the cost of vegetables. Restaurant chains such as Subway

would then pay higher prices for lettuce, tomatoes, and other perishables. Subway would then have to

decide whether to absorb these costs or pass them along to customers by charging more for subs. Overall,

any changes in immigration policy will have implications for hospitals, farmers, restaurants, and many

other organizations.

E Is for “Economic”

The economic segment centers on the economic conditions within which organizations operate. It

includes elements such as interest rates, inflation rates, gross domestic product, unemployment rates,

levels of disposable income, and the general growth or decline of the economy.

The economic crisis of the late 2000s has had a tremendous negative effect on a vast array of

organizations. Rising unemployment discouraged consumers from purchasing expensive, nonessential

goods such as automobiles and television sets. Bank failures during the economic crisis led to a dramatic

tightening of credit markets. This dealt a huge blow to home builders, for example, who saw demand for

new houses plummet because mortgages were extremely difficult to obtain.

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Some businesses, however, actually prospered during the crisis. Retailers that offer deep discounts, such

as Dollar General and Walmart, enjoyed an increase in their customer base as consumers sought to find

ways to economize. Similarly, restaurants such as Subway that charge relatively low prices gained

customers, while high-end restaurants such as Ruth’s Chris Steak House worked hard to retain their

clientele.

S Is for “Social”

A generation ago, ketchup was an essential element of every American pantry and salsa was a relatively

unknown product. Today, however, food manufacturers sell more salsa than ketchup in the United States.

This change reflects the social segment of the general environment. Social factors include trends in

demographics such as population size, age, and ethnic mix, as well as cultural trends such as attitudes

toward obesity and consumer activism. The exploding popularity of salsa reflects the increasing number

of Latinos in the United States over time, as well as the growing acceptance of Latino food by other

ethnic groups.

Sometimes changes in the social segment arise from unexpected sources. Before World War II, the

American workforce was overwhelmingly male. When millions of men were sent to Europe and Asia to

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fight in the war, however, organizations had no choice but to rely heavily on female employees. At the

time, the attitudes of many executives toward women were appalling. Consider, for example, some of the

advice provided to male supervisors of female workers in the July 1943 issue of Transportation

Magazine: [1]

Older women who have never contacted the public have a hard time adapting themselves and are

inclined to be cantankerous and fussy. It’s always well to impress upon older women the importance

of friendliness and courtesy.

General experience indicates that “husky” girls—those who are just a little on the heavy side—are

more even tempered and efficient than their underweight sisters.

Give every girl an adequate number of rest periods during the day. You have to make some allowances

for feminine psychology. A girl has more confidence and is more efficient if she can keep her hair

tidied, apply fresh lipstick and wash her hands several times a day.

The tremendous contributions of female workers during the war contradicted these awful stereotypes. The

main role of women who assembled airplanes, ships, and other war materials was to support the military,

of course, but their efforts also changed a lot of male executives’ minds about what females could

accomplish within organizations if provided with opportunities. Inequities in the workplace still exist

today, but modern attitudes among men toward women in the workplace are much more enlightened than

they were in 1943.

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Women’s immense contributions to the war effort during World War II helped create positive

social changes in the ensuing decades.

Image courtesy of J. Howard Miller, http://en.wikipedia.org/wiki/File:We_Can_Do_It!.jpg.

Beyond being a positive social change, the widespread acceptance of women into the workforce has

created important opportunities for certain organizations. Retailers such as Talbot’s and Dillard’s sell

business attire to women. Subway and other restaurants benefit when the scarceness of time lead dual

income families to purchase take-out meals rather than cook at home.

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T Is for “Technological”

The technological segment centers on improvements in products and services that are provided by

science. Relevant factors include, for example, changes in the rate of new product development, increases

in automation, and advancements in service industry delivery. One key feature of the modern era

is the ever-increasing pace of technological innovation. In 1965, Intel cofounder Gordon E. Moore

offered an idea that has come to be known as Moore’s law. Moore’s law suggests that the performance

of microcircuit technology roughly doubles every two years. This law has been very accurate in the

decades since it was offered.

One implication of Moore’s law is that over time electronic devices can become smaller but also more

powerful. This creates important opportunities and threats in a variety of settings. Consider, for example,

photography. Just a decade ago, digital cameras were relatively large and they produced mediocre images.

With each passing year, however, digital cameras have become smaller, lighter, and better. Today, digital

cameras are, in essence, minicomputers, and electronics firms such as Panasonic have been able to

establish strong positions in the market. Meanwhile, film photography icon Kodak has been forced to

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abandon products that had been successful for decades. In 2005, the firm announced that it would stop

producing black-and-white photographic paper. Four years later, Kodachrome color film was phased out.

Successful technologies are also being embraced at a much faster rate than in earlier generations. The

Internet reached fifty million users in only four years. In contrast, television reached the same number of

users in thirteen years while it took radio thirty-eight years. This trend creates great opportunities for

organizations that depend on emerging technologies. Writers of applications for Apple’s iPad and other

tablet devices, for example, are able to target a fast-growing population of users. At the same time,

organizations that depend on technologies that are being displaced must be aware that consumers could

abandon them at a very rapid pace. As more and more Internet users rely on Wi-Fi service, for example,

demand for cable modems may plummet.

Although the influence of the technological segment on technology-based companies such as Panasonic

and Apple is readily apparent, technological trends and events help to shape low-tech businesses too. In

2009, Subway started a service called Subway Now. This service allows customers to place their orders in

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advance using text messages and avoid standing in line at the store. By offering customers this service,

Subway is also responding to a trend in the general environment’s social segment: the need to save time in

today’s fast-paced society.

E Is for “Environmental”

The environmental segment involves the physical conditions within which organizations operate. It

includes factors such as natural disasters, pollution levels, and weather patterns. The threat of

pollution, for example, has forced municipalities to treat water supplies with chemicals. These chemicals

increase the safety of the water but detract from its taste. This has created opportunities for businesses that

provide better-tasting water. Rather than consume cheap but bad-tasting tap water, many consumers

purchase bottled water. Indeed, according to the Beverage Marketing Corporation, the amount of bottled water

consumed by the average American increased from 1.6 gallons in 1976 to 28.3 gallons in 2006.[2]

At present, roughly one-third of Americans drink bottled water regularly.

As is the case for many companies, bottled water producers not only have benefited from the general

environment but also have been threatened by it. Some estimates are that 80 percent of plastic bottles end

up in landfills. This has led some socially conscious consumers to become hostile to bottled water.

Meanwhile, water filtration systems offered by Brita and other companies are a cheaper way to obtain

clean and tasty water. Such systems also hold considerable appeal for individuals who feel the need to cut

personal expenses due to economic conditions. In sum, bottled water producers have been provided

opportunities by the environmental segment of the general environment (specifically, the spread of poor-

tasting water to combat pollution) but are faced with threats from the social segment (the social

conscience of some consumers) and the economic segment (the financial concerns of other consumers).

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L Is for “Legal”

The legal segment centers on how the courts influence business activity. Examples of important legal

factors include employment laws, health and safety regulations, discrimination laws, and antitrust laws.

Intellectual property rights are a particularly daunting aspect of the legal segment for many organizations.

When a studio such as Pixar produces a movie, a software firm such as Adobe revises a program, or a

video game company such as Activision devises a new game, these firms are creating intellectual property.

Such firms attempt to make profits by selling copies of their movies, programs, and games to individuals.

Piracy of intellectual property—a process wherein illegal copies are made and sold by others—poses a

serious threat to such profits. Law enforcement agencies and courts in many countries, including the

United States, provide organizations with the necessary legal mechanisms to protect their intellectual

property from piracy.

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In other countries, such as China, piracy of intellectual property is quite common. Three other general

environment segments play a role in making piracy a major concern. First, in terms of the social segment,

China is the most populous country in the world. Second, in terms of the economic segment, China’s

affluence is growing rapidly. Third, in terms of the technological segment, rapid advances in computers

and communication have made piracy easier over time. Taken together, these various general

environment trends lead piracy to be a major source of angst for firms that rely on intellectual property to

deliver profits.

K E Y T A K E A W A Y

To transform an avocado into guacamole, a chef may choose to use a mortar and pestle. A mortar is a

mashing device that is shaped liked a baseball bat, while a pestle is a sturdy bowl within which the

mashing takes place. Similarly, PESTEL reflects the general environment factors—political, economic,

social, technological, environmental, and legal—that can crush an organization. In many cases, executives

can prevent such outcomes by performing a PESTEL analysis to diagnose where in the general

environment important opportunities and threats arise.

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E X E R C I S E S

1. What does each letter of PESTEL mean?

2. Using a recent news article, identify a trend that has a positive and negative implication for a particular

industry.

3. Can you identify a general environment trend that has positive implications for nursing homes but

negative implications for diaper makers?

4. Are all six elements of PESTEL important to every organization? Why or why not?

5. What is a key trend for each letter of PESTEL and one industry or firm that would be affected by that

trend?

[1] 1943 guide to hiring women. 2007, September–October. Savvy & Sage, p. 16.

[2] Plastic recycling facts. earth911.com. Retrieved from http://earth911.com/recycling/plastic/plastic-bottle-

recycling-facts

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3.3 Evaluating the Industry

L E A R N I N G O B J E C T I V E S

1. Explain how five forces analysis is useful to organizations.

2. Be able to offer an example of each of the five forces.

The Purpose of Five Forces Analysis

Visit the executive suite of any company and the chances are very high that the chief executive officer and

her vice presidents are relying on five forces analysis to understand their industry. Introduced more than

thirty years ago by Professor Michael Porter of the Harvard Business School, five forces analysis has long

been and remains perhaps the most popular analytical tool in the business world.

Adapted from Porter, M. (1980). Competitive strategy. New York: Free Press.

The purpose of five forces analysis is to identify how much profit potential exists in an industry. To do so,

five forces analysis considers the interactions among the competitors in an industry, potential new

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entrants to the industry, substitutes for the industry’s offerings, suppliers to the industry, and the

industry’s buyers. [1] If none of these five forces works to undermine profits in the industry, then the profit

potential is very strong. If all the forces work to undermine profits, then the profit potential is very weak.

Most industries lie somewhere in between these extremes. This could involve, for example, all five forces

providing firms with modest help or two forces encouraging profits while the other three undermine

profits. Once executives determine how much profit potential exists in an industry, they can then decide

what strategic moves to make to be successful. If the situation looks bleak, for example, one possible move

is to exit the industry.

The Rivalry among Competitors in an Industry

The competitors in an industry are firms that produce similar products or services. Competitors use a

variety of moves such as advertising, new offerings, and price cuts to try to outmaneuver one another to

retain existing buyers and to attract new ones. Because competitors seek to serve the same general set of

buyers, rivalry can become intense. Subway faces fierce competition within the restaurant business,

for example. This is illustrated by a quote from the man who built McDonald’s into a worldwide icon.

Former CEO Ray Kroc allegedly once claimed that “if any of my competitors were

drowning, I’d stick a hose in their mouth.” While this sentiment was (hopefully) just a figure of speech,

the announcement in March 2011 that Subway had surpassed McDonald’s in terms of numbers of stores

might lead the hostility of McDonald’s toward its rival to rise.

Understanding the intensity of rivalry among an industry’s competitors is important because the degree of

intensity helps shape the industry’s profit potential. Of particular concern is whether firms in an industry

compete based on price. When competition is bitter and cutthroat, the prices competitors charge—and

their profit margins—tend to go down. If, on the other hand, competitors avoid bitter rivalry, then price

wars can be avoided and profit potential increases.

Every industry is unique to some degree, but there are some general characteristics that help to predict

the likelihood that fierce rivalry will erupt. Rivalry tends to be fierce, for example, to the extent that the

growth rate of demand for the industry’s offerings is low (because a lack of new customers forces firms to

compete more for existing customers), fixed costs in the industry are high (because firms will fight to have

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enough customers to cover these costs), competitors are not differentiated from one another (because this

forces firms to compete based on price rather than based on the uniqueness of their offerings),

and exit barriers in the industry are high (because firms do not have the option of leaving the industry

gracefully). Exit barriers can include emotional barriers, such as the bad publicity associated with massive

layoffs, or more objective reasons to stay in an industry, such as a desire to recoup considerable costs that

might have been previously spent to enter and compete.

Industry concentration is an important aspect of competition in many industries. Industry concentration

is the extent to which a small number of firms dominate an industry. Among circuses, for example,

the four largest companies collectively own 89 percent of the market. Meanwhile, these companies tend

to keep their competition rather polite. Their advertising does not lampoon one another, and they do not

put on shows in the same city at the same time. This does not guarantee that the circus industry will be

profitable; there are four other forces to consider as well as the quality of each firm’s strategy.

But low levels of rivalry certainly help build the profit potential of the industry.

In contrast, the restaurant industry is fragmented, meaning that the largest rivals control just a small

fraction of the business and that a large number of firms are important participants. Rivalry in

fragmented industries tends to become bitter and fierce. Quiznos, a chain of sub shops that is roughly 15

percent the size of Subway, has directed some of its advertising campaigns directly at Subway, including

one depicting a fictional sub shop called “Wrong Way” that bore a strong resemblance to Subway.

Within fragmented industries, it is almost inevitable that over time some firms will try to steal customers

from other firms, such as by lowering prices, and that any competitive move by one firm will be matched

by others. In the wake of Subway’s success in offering foot-long subs for $5, for example, Quiznos has

matched Subway’s price. Such price jockeying is delightful to customers, of course, but it tends to reduce

prices (and profit margins) within an industry. Indeed, Quiznos later escalated its attempt to attract

budget-minded consumers by introducing a flatbread sandwich that cost only $2. Overall, when choosing

strategic moves, Subway’s presence in a fragmented industry forces the firm to try to anticipate not only

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how fellow restaurant giants such as McDonald’s and Burger King will react but also how smaller sub

shop chains like Quiznos and various regional and local players will respond.

The Threat of Potential New Entrants to an Industry

Competing within a highly profitable industry is desirable, but it can also attract unwanted attention from

outside the industry. Potential new entrants to an industry are firms that do not currently compete in the

industry but may in the future. New entrants tend to reduce the profit potential of an industry by increasing

its competitiveness. If, for example, an industry consisting of five firms is entered by two new firms, this means

that seven rather than five firms are now trying to attract the same general pool of customers. Thus executives

need to analyze how likely it is that one or more new entrants will enter their industry as part of their effort

to understand the profit potential that their industry offers.

New entrants can join the fray within an industry in several different ways. New entrants can be start-up

companies created by entrepreneurs, foreign firms that decide to enter a new geographic area, supplier

firms that choose to enter their customers’ business, or buyer firms that choose to enter their suppliers’

business. The likelihood of these four paths being taken varies across industries. Restaurant firms such as

Subway, for example, do not need to worry about their buyers entering the industry because they sell

directly to individuals, not to firms. It is also unlikely that Subway’s suppliers, such as farmers, will make

a big splash in the restaurant industry.

On the other hand, entrepreneurs launch new restaurant concepts every year, and one or more of these

concepts may evolve into a fearsome competitor. Also, competitors based overseas sometimes enter

Subway’s core US market. In February 2011, Australia-based Oporto opened its first US store in

California. [2] Oporto operates more than 130 chicken burger restaurants in its home country. Time will

tell whether this new entrant has a significant effect on Subway and other restaurant firms. Because a

chicken burger closely resembles a hamburger, McDonald’s and Burger King may have more to fear from

Oporto than does Subway.

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Every industry is unique to some degree, but some general characteristics help to predict the likelihood

that new entrants will join an industry. New entry is less likely, for example, to the extent that existing

competitors enjoy economies of scale (because new entrants struggle to match incumbents’ prices),

capital requirements to enter the industry are high (because new entrants struggle to gather enough cash

to get started), access to distribution channels is limited (because new entrants struggle to get their

offerings to customers), governmental policy discourages new entry, differentiation among existing

competitors is high (because each incumbent has a group of loyal customers that enjoy its unique

features), switching costs are high (because this discourages customers from buying a new entrant’s

offerings), expected retaliation from existing competitors is high, and cost advantages independent of size

exist.

The Threat of Substitutes for an Industry’s Offerings

Executives need to take stock not only of their direct competition but also of players in other industries

that can steal their customers. Substitutes are offerings that differ from the goods and services provided

by the competitors in an industry but that fill similar needs to what the industry offers.How strong of a

threat substitutes are depends on how effective substitutes are in serving an industry’s customers.

At first glance, it could appear that the satellite television business is a tranquil one because there are only

two significant competitors—DIRECTV and DISH Network. These two industry giants, however, face a

daunting challenge from substitutes. The closest substitute for satellite television is provided by cable

television firms, such as Comcast and Charter Communications. DIRECTV and DISH Network also need

to be wary of streaming video services, such as Netflix, and video rental services, such as Redbox. The

availability of viable substitutes places stringent limits on what DIRECTV and DISH Network can charge

for their services. If the satellite television firms raise their prices, customers will be tempted to obtain

video programs from alternative sources. This limits the profit potential of the satellite television

business.

In other settings, viable substitutes are not available, and this helps an industry’s competitors enjoy

profits. Like lightbulbs, candles can provide lighting within a home. Few consumers, however, would be

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willing to use candles instead of lightbulbs. Candles simply do not provide as much light as lightbulbs.

Also, the risk of starting a fire when using candles is far greater than the fire risk of using lightbulbs.

Because candles are a poor substitute, lightbulb makers such as General Electric and Siemens do not need

to fear candle makers stealing their customers and undermining their profits.

The dividing line between which firms are competitors and which firms offer substitutes is a challenging

issue for executives. Most observers would agree that, from Subway’s perspective, sandwich maker

Quiznos should be considered a competitor and that grocery stores such as Kroger offer a substitute for

Subway’s offerings. But what about full-service restaurants, such as Ruth’s Chris Steak House, and “fast

causal” outlets, such as Panera Bread? Whether firms such as these are considered competitors or

substitutes depends on how the industry is defined. Under a broad definition—Subway competes in the

restaurant business—Ruth’s Chris and Panera should be considered competitors. Under a narrower

definition—Subway competes in the sandwich business—Panera is a competitor and Ruth’s Chris is a

substitute. Under a very narrow definition—Subway competes in the sub sandwich business—both Ruth’s

Chris and Panera provide substitute offerings. Thus clearly defining a firm’s industry is an important step

for executives who are performing a five forces analysis.

The Power of Suppliers to an Industry

Suppliers provide inputs that the firms in an industry need to create the goods and services that they in

turn sell to their buyers. A variety of supplies are important to companies, including raw materials,

financial resources, and labor. For restaurant firms such as Subway, key suppliers include such firms as Sysco

that bring various foods to their doors, restaurant supply stores that sell kitchen equipment, and

employees that provide labor.

The relative bargaining power between an industry’s competitors and its suppliers helps shape the profit

potential of the industry. If suppliers have greater leverage over the competitors than the competitors

have over the suppliers, then suppliers can increase their prices over time. This cuts into competitors’

profit margins and makes them less likely to be prosperous. On the other hand, if suppliers have less

leverage over the competitors than the competitors have over the suppliers, then suppliers may be forced

to lower their prices over time. This strengthens competitors’ profit margins and makes them more likely

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to be prosperous. Thus when analyzing the profit potential of their industry, executives must carefully

consider whether suppliers have the ability to demand higher prices.

Every industry is unique to some degree, but some general characteristics help to predict the likelihood

that suppliers will be powerful relative to the firms to which they sell their goods and services. Suppliers

tend to be powerful, for example, to the extent that the suppliers’ industry is dominated by a few

companies, if it is more concentrated than the industry that it supplies and/or if there is no effective

substitute for what the supplier group provides. These circumstances restrict industry competitors’ ability

to shop around for better prices and put suppliers in a position of strength.

Supplier power is also stronger to the extent that industry members rely heavily on suppliers to be

profitable, industry members face high costs when changing suppliers, and suppliers’ products are

differentiated. Finally, suppliers possess power to the extent that they have the ability to become a new

entrant to the industry if they wish. This is a strategy calledforward vertical integration. Ford, for

example, used a forward vertical integration strategy when it purchased rental car company (and Ford

customer) Hertz. A difficult financial situation forced Ford to sell Hertz for $5.6 billion in 2005. But

before rental car companies such as Avis and Thrifty drive too hard of a bargain when buying cars from an

automaker, their executives should remember that automakers are much bigger firms than are rental car

companies. The executives running the automaker might simply decide that they want to enjoy the rental

car company’s profits themselves and acquire the firm.

Strategy at the Movies

Flash of Genius

When dealing with a large company, a small supplier can get squashed like a bug on a windshield. That is

what college professor and inventor Dr. Robert Kearns found out when he invented intermittent

windshield wipers in the 1960s and attempted to supply them to Ford Motor Company. As depicted in the

2008 movie Flash of Genius, Kearns dreamed of manufacturing the wipers and selling them to Detroit

automakers. Rather than buy the wipers from Kearns, Ford replicated the design. An angry Kearns then

spent many years trying to hold the firm accountable for infringing on his patent. Kearns eventually won

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in court, but he paid a terrible personal price along the way, including a nervous breakdown and

estrangement from his family. Kearns’s lengthy battle with Ford illustrates the concept of bargaining

power that is central to Porter’s five forces model. Even though Kearns created an exceptional new

product, he had little leverage when dealing with a massive, well-financed automobile manufacturer.

The Power of an Industry’s Buyers

Buyers purchase the goods and services that the firms in an industry produce. For Subway and other

restaurants, buyers are individual people. In contrast, the buyers for some firms are other firms rather than

end users. For Procter & Gamble, for example, buyers are retailers such as Walmart and Target who

stock Procter & Gamble’s pharmaceuticals, hair care products, pet supplies, cleaning products, and other

household goods on their shelves.

The relative bargaining power between an industry’s competitors and its buyers helps shape the profit

potential of the industry. If buyers have greater leverage over the competitors than the competitors have

over the buyers, then the competitors may be forced to lower their prices over time. This weakens

competitors’ profit margins and makes them less likely to be prosperous. Walmart furnishes a good

example. The mammoth retailer is notorious among manufacturers of goods for demanding lower and

lower prices over time. [3] In 2008, for example, the firm threatened to stop selling compact discs if record

companies did not lower their prices. Walmart has the power to insist on price concessions because its

sales volume is huge. Compact discs make up a small portion of Walmart’s overall sales, so exiting the

market would not hurt Walmart. From the perspective of record companies, however, Walmart is their

biggest buyer. If the record companies were to refuse to do business with Walmart, they would miss out

on access to a large portion of consumers.

On the other hand, if buyers have less leverage over the competitors than the competitors have over the

buyers, then competitors can raise their prices and enjoy greater profits. This description fits the textbook

industry quite well. College students are often dismayed to learn that an assigned textbook costs $150 or

more. Historically, textbook publishers have been able to charge high prices because buyers had no

leverage. A student enrolled in a class must purchase the specific book that the professor has selected.

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Used copies are sometimes a lower-cost option, but textbook publishers have cleverly worked to

undermine the used textbook market by releasing new editions after very short periods of time.

Of course, the presence of a very high profit industry is attractive to potential new entrants. Firms such as

the publisher of this book, have entered the textbook market with lower-priced offerings. Time will tell

whether such offerings bring down textbook prices. Like any new entrant, upstarts in the textbook

business must prove that they can execute their strategies before they can gain widespread acceptance.

Overall, when analyzing the profit potential of their industry, executives must carefully consider whether

buyers have the ability to demand lower prices. In the textbook market, buyers do not.

Every industry is unique to some degree, but some general characteristics help to predict the likelihood

that buyers will be powerful relative to the firms from which they purchases goods and services. Buyers

tend to be powerful, for example, to the extent that there are relatively few buyers compared with the

number of firms that supply the industry, the industry’s goods or services are standardized or

undifferentiated, buyers face little or no switching costs in changing vendors, the good or service

purchased by the buyers represents a high percentage of the buyer’s costs, and the good or service is of

limited importance to the quality or price of the buyer’s offerings.

Finally, buyers possess power to the extent that they have the ability to become a new entrant to the

industry if they wish. This strategy is called backward vertical integration. DIRECTV used to be an

important customer of TiVo, the pioneer of digital video recorders. This situation changed, however, when

executives at DIRECTV grew weary of their relationship with TiVo. DIRECTV then used a backward

vertical integration strategy and started offering DIRECTV-branded digital video recorders. Profits that

used to be enjoyed by TiVo were transferred at that point to DIRECTV.

The Limitations of Five Forces Analysis

Five forces analysis is useful, but it has some limitations too. The description of five forces analysis

provided by its creator, Michael Porter, seems to assume that competition is a zero-sum game, meaning

that the amount of profit potential in an industry is fixed. One implication is that, if a firm is to make

more profit, it must take that profit from a rival, a supplier, or a buyer. In some settings, however,

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collaboration can create a larger pool of profit that benefits everyone involved in the collaboration. In

general, collaboration is a possibility that five forces analysis tends to downplay. The relationships among

the rivals in an industry, for example, are depicted as adversarial. In reality, these relationships are

sometimes adversarial and sometimes collaborative. General Motors and Toyota compete fiercely all

around the world, for example, but they also have worked together in joint ventures. Similarly, five forces

analysis tends to portray a firm’s relationships with its suppliers and buyers as adversarial, but many

firms find ways to collaborate with these parties for mutual benefit. Indeed, concepts such as just-in-time

inventory systems depend heavily on a firm working as a partner with its suppliers and buyers.

K E Y T A K E A W A Y

“How much profit potential exists in our industry?” is a key question for executives. Five forces analysis

provides an answer to this question. It does this by considering the interactions among the competitors in

an industry, potential new entrants to the industry, substitutes for the industry’s offerings, suppliers to

the industry, and the industry’s buyers.

E X E R C I S E S

1. What are the five forces?

2. Is there an aspect of industry activity that the five forces seems to leave out?

3. Imagine you are the president of your college or university. Which of the five forces would be most

important to you? Why?

[1] Porter, M. E. 1979, March–April. How competitive forces shape strategy. Harvard Business Review, 137–156.

[2] Odell, K. 2011, February 22. Portuguese-influenced Australian chicken burger chain, Oporto, comes to

SoCal. Eater LA. Retrieved from

http://la.eater.com/archives/2011/02/22/portugueseinfluenced_australian_chicken_burger_chain_oporto_comes

_to_socal.php

[3] Bianco, B., & Zellner, W. 2003, October 6. Is Wal-Mart too powerful? Bloomberg Businessweek. Retrieved

fromhttp://www.businessweek.com/magazine/content/03_40/b3852001_mz001.htm

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3.4 Mapping Strategic Groups

L E A R N I N G O B J E C T I V E S

1. Understand what strategic groups are.

2. Learn three ways that analyzing strategic groups is useful to organizations.

The analysis of the strategic groups in an industry can offer important insights to executives. Strategic

groups are sets of firms that follow similar strategies to one another. [1] More specifically, a strategic

group consists of a set of industry competitors that have similar characteristics to one another but

differ in important ways from the members of other groups.

Understanding the nature of strategic groups within an industry is important for at least three

reasons. First, emphasizing the members of a firm’s group is helpful because these firms are usually

its closest rivals. When assessing their firm’s performance and considering strategic moves, the other

members of a group are often the best referents for executives to consider. In some cases, one or

more strategic groups in the industry are irrelevant. Subway, for example, does not need to worry

about competing for customers with the likes of Ruth’s Chris Steak House and P. F. Chang’s. This is

partly because firms confront mobility barriers that make it difficult or illogical for a particular firm to

change groups over time. Because Subway is unlikely to offer a gourmet steak as well as the

experience offered by fine-dining outlets, they can largely ignore the actions taken by firms in that

restaurant industry strategic group.

Second, the strategies pursued by firms within other strategic groups highlight alternative paths to

success. A firm may be able to borrow an idea from another strategic group and use this idea to

improve its situation. During the recession of the late 2000s, midquality restaurant chains such as

Applebee’s and Chili’s used a variety of promotions such as coupons and meal combinations to try to

attract budget-conscious consumers. Firms such as Subway and Quiznos that already offered low-

priced meals still had an inherent price advantage over Applebee’s and Chili’s, however: There is no

tipping expected at the former restaurants, but there is at the latter. It must have been tempting to

executives at Applebee’s and Chili’s to try to expand their appeal to budget-conscious consumers by

experimenting with operating formats that do not involve tipping.

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Third, the analysis of strategic groups can reveal gaps in the industry that represent untapped

opportunities. Within the restaurant business, for example, it appears that no national chain offers

both very high-quality meals and a very diverse menu. Perhaps the firm that comes the closest to

filling this niche is the Cheesecake Factory, a chain of approximately 150 outlets whose menu

includes more than 200 lunch, dinner, and dessert items. Ruth’s Chris Steak House already offers

very high quality food; its executives could consider moving the firm toward offering a very diverse

menu as well. This would involve considerable risk, however. Perhaps no national chain offers both

very high quality meals and a very diverse menu because doing so is extremely difficult.

Nevertheless, examining the strategic groups in an industry with an eye toward untapped

opportunities offers executives a chance to consider novel ideas.

K E Y T A K E A W A Y

Examination of the strategic groups in an industry provides a firm’s executives with a better

understanding of their closest rivals, reveals alternative paths to success, and highlights untapped

opportunities.

E X E R C I S E S

1. What other colleges and universities are probably in your school’s strategic group?

2. From what other groups of colleges and universities could your school learn? What specific ideas could be

borrowed from these groups?

[1] Hunt, M. S. 1972. Competition in the major home appliance industry 1960–1970. (Unpublished doctoral dissertation). Harvard University, Cambridge, MA; Short, J. C., Ketchen, D. J., Palmer, T., & Hult, G. T. 2007. Firm, strategic group, and industry influences on performance. Strategic Management Journal, 28, 147–167.

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3.5 Conclusion

This chapter explains several considerations for examining the external environment that executives

must monitor to lead their organizations strategically. Executives must be aware of trends and

changes in the general environment, as well as the condition of their specific industry, as elements of

both have the potential to change considerably over time. While PESTEL analysis provides a useful

framework to understand the general environment, Porter’s five forces is helpful to make sense of an

industry’s profit potential. Strategic groups are valuable for understanding close competitors that

affect a firm more than other industry members. When executives carefully monitor their

organization’s environment using these tools, they greatly increase the chances of their organization

being successful.

E X E R C I S E S

1. In groups of four or five, use the PESTEL framework to identify elements from each factor of the general

environment that could have a large effect on your future career.

2. Use Porter’s five forces analysis to analyze an industry in which you might like to work in the future.

Discuss the implications your results may have on the salary potential of jobs in that industry and how

that could impact your career plans.