Chapter 5: The Fundamentals of Strategic Management

The New Management Context

Strategic thinking is important since, first of all, it is related to competition and secondly, it deals with the longer term. One essential strategic feature of markets is competition. A company which can surpass its competitors or the industry average over an extended period has a sustainable competitive advantage .

Using accounting profitability is the most common practice to evaluate company performance and competitive advantage. Another practice to evaluate company performance and competitive advantage is assessing stock market performance, which reflects the perceptions of investors regarding an organization’s future performance. Total shareholder return (TSR) is the share price at the end of a period and at the beginning of a period plus dividends and it is the most common ratio to assess stock market performance in strategic management.

Strategy and Strategic Management

Strategy includes “the determination of the basic long- term goals of an enterprise, the adoption of courses of action and the allocation of resources necessary for carrying out these goals” for achieving sustainable competitive advantage. On the other hand, the Strategic management is the integrative management field that combines analysis of the firm’s external and internal environments, formulation of strategy resulting in the company’s corporate, business, and functional strategies, and implementation of a set of coherent actions in the quest for competitive advantage.

Stakeholder Approach to Strategic Management

The audiences who can affect or can be affected by the achievement of a company’s objectives are called stakeholders. Internal stakeholders are the stockholders, board of directors, executive officers, other managers, and employees. External stakeholders are the all other individuals and groups that have some claim on the company, including customers, suppliers, alliance partners, creditors, local and national governments, unions, local communities, media, and the public.

There are several benefits derived from having good stakeholder relationships.

• Building strong reputations that are rewarded in the marketplace by business partners, employees, and customers.
• Achieving greater organizational flexibility.
• Facilitating the formation of strategic alliances.
• Increasing trust lowers the costs for a firm’s business transactions.
• Revealing valuable information from stakeholders that can lead to greater efficiency and innovation.

Strategic Management Process: Analysis

The first step of a strategic management process is analysis. The managers start the analysis stage by evaluating the existing vision, mission, and values statements of companies.

A vision is a statement about where the company wants to be in the future. A vision communicates management’s aspirations to stakeholders about “where we are going” and helps channel the energies of company personnel in a common direction. The Mission is a statement about the reason for the existence of a company and describes what a company actually does. They differ in the strategy process. A vision defines what an organization wants to accomplish ultimately, a mission describes what an organization does actually. Values state what is desirable, proper, and appropriate in the organizational context. Values show what is right, what is wrong, what is fair, what is unfair, what is acceptable, what is unacceptable. They guide how managers and employees should conduct themselves, how they should do business, and what kind of organization they should build to help a company achieve its mission.

Business Management, External analysis

The external analysis comprises the analyses of the market structure and industry structure . In order to understand the markets and explain the firm behaviors in them, economists have developed four principal models of market structure which are based on four dimensions: (1) the number of producers in the market, (2) the companies’ degree of pricing power, (3) whether the products offered are undifferentiated or differentiated (products that are different but viewed substitutable by customers), and (4) the market is consolidated or fragmented (market share for the leading four firms is equal to or less than 40% of total industry sales).

• In a monopoly , a single producer sells an undifferentiated product with a large degree of pricing power in a consolidated market.
• In oligopoly , a few producers—more than one but not a large number—sell products which may be either undifferentiated or differentiated with some pricing power in a consolidated market.
• In monopolistic competition , many producers each sell a differentiated product with some pricing power in a consolidated or fragmented market. When a company can greatly differentiate its product, it creates a niche in the market in which it has some degree of temporary monopolistic power over pricing, thus the name “monopolistic competition”.
• In perfect competition many producers each sell an undifferentiated product and little or no ability for each individual company to raise its prices in a fragmented market.

Porter’s well-known analytical framework, the Five Forces model is essential in identifying opportunities and threats facing a specific company in an industrial context. His model: (1) rather than defining competition narrowly as rivalry to explain and predict a firm’s performance, competition must be viewed more broadly through considering the other forces in an industry, (2) the profit potential of an industry is a function of the five forces that shape competition.

These forces are;

1. Rivalry among existing competitors. Four factors have a major impact on the intensity of rivalry among established companies within an industry: market structure, demand conditions, cost conditions, and the height of exit barriers in the industry.
2. Threats of new entrants. The impact of new entrants depend on several factors such as economies of scale, network effects, customer switching costs, and government policy.
3. Bargaining power of buyers and bargaining power of suppliers.
4. Substitutes. These are products which can replace other products.

Internal Analysis

Internal analysis gives managers the information they need to choose the strategy which will enable their company to achieve a sustainable competitive advantage. A company’s resources which enable the company to fully capitalize the other resources it controls are capabilities . Capabilities alone do not enable a company to formulate and implement its strategies, but they enable a company to use other resources to formulate and implement such strategies. Core competencies are unique strengths that are deeply embedded within a company. Core competencies are key for sustainable competitive advantage.

Value chain analysis. Value refers to the monetary amount that a customer is willing to pay for a product. If the price of the product is lower than the value of the product, the customer will definitely buy it. While this is the ideal case for the customer, the ideal case for the producer is determining the price that is equal to the value. Thus, the company’s profit will be as high as possible and it will be equal to the margin. Margin refers to the difference between value and total costs. Since the underlying intent of a company’s activities is to do things which will create the highest value (highest margin) for customers, all of the diverse but integrated activities that a company performs internally is called the value chain , which contains two categories of activities that create value: the primary activities that create value for customers directly, and the support activities that facilitate and increase the performance of the primary activities.

SWOT analysis

SWOT is an acronym for S trengths, W eaknesses, O pportunities, and T hreats of the company. While strengths and weaknesses are determined via internal analysis, opportunities and threats are obtained from external analysis. The steps are;

1. Focus on the strengths : Opportunities to infer “offensive” alternatives by using an internal strength in order to exploit an external opportunity. All managers would like their company to be in a position in which internal strengths can be used to take advantage of external opportunities.
2. Focus on the weaknesses : Threats to infer “defensive” alternatives by eliminating or minimizing an internal weakness in order to mitigate an external threat. A company confronted by numerous external threats and internal weaknesses may indeed be in a precarious position.
3. Focus on the strengths–threats: To use an internal strength to minimize the effect of an external threat.
4. Focus on the weaknesses–opportunities: To shore up an internal weakness to improve its ability to take advantage of an external opportunity.

Strategic Management Process: Formulation and Implementation

Formulation of strategies apply to different levels: Corporate, business, functional, and operational. Corporate-level strategy is about determining the operational fields, in other words which sectors to position in. It is important to remark that three strategy levels are hierarchical and the one above it restricts each level of strategy. Corporate-level strategy includes the determination of the long-term goals and objectives, the allocation of resources, and the adoption of courses of action in seeking competitive advantage when competing in more than one industry and market simultaneously. It concerns the broad question, where to compete and effects the entire business.

As a corporate-level strategy, diversification is the degree of doing business in different industries to offer new products and services. A strategic business unit (SBU) is an independent division of a larger Corporation with its own mission, vision, market features, customers, and profit-and-loss responsibilities. Dominant-business diversification happens as a company gains 70% to 94% of the revenue from one business, which shares its resources, capabilities, and core competencies with all the other SBUs. Related diversification forms when a company gains less than 70% of its revenue from one primary SBU. Unrelated diversification refers to getting less than 70% of its revenue from one primary SBU, and shares few if any of its resources, capabilities, and core competencies with the other SBUs.

Implementation of corporate-level strategy is supported by three major tools: mergers and acquisitions, outsourcing, and building strategic alliances. If two independent companies come together and become just one company, a merger occurs. Usually, companies which engage in mergers have similar sizes. However, one of the companies often becomes more dominant in the control after the merger. A company pursues an acquisition when it buys the second company. When the management of the target company does not want the company to be acquired, a hostile takeover occurs. Outsourcing refers to the contracting out of activities that otherwise would be conducted within a company.

Global Strategy

Global strategy refers to the determination of the long- term goals and objectives, the allocation of the resources, and the adoption of courses of action in seeking competitive advantage when competing around the world. A home replication strategy includes selling the same products in both domestic and foreign markets. It enables companies to leverage their home-based core competencies in foreign markets. Global strategy includes the determination of the long-term goals and objectives, the allocation of the resources, and the adoption of courses of action in seeking competitive advantage when competing around the world. A localization strategy requires maximizing local responsiveness hoping that local consumers will perceive the products as local ones. A global-standardization strategy is composed of achieving significant economies of scale and low cost inputs by pursuing a global division of labor based on wherever best-of-class capabilities reside at the lowest cost. A transnational strategy combines the benefits of a localization strategy (high local responsiveness) with those of a global-standardization strategy (lowest-cost position attainable).