Strategic Formulation
HCAD 5390
Strategies
Strategies
Adaptive Strategies
4
Adaptive Strategies
Expansion Adaptive Strategy:
–
Orientation toward growth



5
Expand, cut back, status quo?
Concentrate within current industry, diversify into
other industries?
Growth and expansion through internal development
or acquisitions, mergers, or strategic alliances?
Adaptive Strategies
Basic Growth Strategies:
Concentration
–
Current product line in one industry
–
Vertical Integration
– Market Development
– Product Development
– Penetration
Diversification
–
6
Into other product lines in other industries
Adaptive Strategies
Expansion of Scope
Basic Concentration Strategies:
Vertical growth
Horizontal growth
7
Adaptive Strategies
Vertical growth
–
Vertical integration



8
Full integration
Taper integration
Quasi-integration
–
Backward integration
–
Forward integration
Adaptive Strategies
Adaptive Strategies
Horizontal Growth
–
10
Horizontal integration
Concentration on a Single Business
Advantages
–
–
–
Operational focus on a
single familiar industry or
market.
Current resources and
capabilities add value.
Growing with the market
brings competitive
advantage.
Disadvantages
–
–
–
No diversification of market
risks.
Vertical integration may be
required to create value
and establish competitive
advantage.
Opportunities to create
value and make a profit
may be missed.
Adaptive Strategies
Basic Diversification Strategies:
12
–
Concentric Diversification
–
Conglomerate Diversification
Adaptive Strategies
Concentric Diversification
–
–
13
Growth into related industry
Search for synergies
Adaptive Strategies
Adaptive Strategies
Unrelated (Conglomerate) Diversification
–
–
15
Growth into unrelated industry
Concern with financial considerations
Adaptive Strategies
Reasons for Diversification
Incentives
Reasons to Enhance Strategic
Competitiveness
Resources
Managerial
Motives
• Economies of scope/scale
• Market power
• Financial economics
Reasons for Diversification
Incentives
Resources
Managerial
Motives
Incentives with Neutral
Effects on Strategic
Competitiveness
•
•
•
•
•
Anti-trust regulation
Tax laws
Low performance
Uncertain future cash flows
Firm risk reduction
Incentives to Diversify
External Incentives:



Relaxation of anti-trust regulation allows more related
acquisitions than in the past
Before 1986, higher taxes on dividends favored spending
retained earnings on acquisitions
After 1986, firms made fewer acquisitions with retained
earnings, shifting to the use of debt to take advantage of tax
deductible interest payments
Incentives to Diversify
Internal Incentives:



Poor performance may lead some firms to diversify an
attempt to achieve better returns
Firms may diversify to balance uncertain future cash flows
Firms may diversify into different businesses in order to
reduce risk
Resources and Diversification


Besides strong incentives, firms are more likely to
diversify if they have the resources to do so
Value creation is determined more by appropriate
use of resources than incentives to diversify
Reasons for Diversification
Incentives
Resources
Managerial
Motives
Managerial Motives (Value
Reduction)
• Diversifying managerial
employment risk
• Increasing managerial
compensation
Managerial Motives to Diversify
Managers have motives to diversify
–
–
–
diversification increases size; size is associated with
executive compensation
diversification reduces employment risk
effective governance mechanisms may restrict such motives
Bureaucratic Costs and the Limits of
Diversification
Number
–
of businesses
Information overload can lead to poor resource allocation
decisions and create inefficiencies.
Coordination
–
–
As the scope of diversification widens, control and
bureaucratic costs increase.
Resource sharing and pooling arrangements that create
value also cause coordination problems.
Limits
–
among businesses
of diversification
The extent of diversification must be balanced with its
bureaucratic costs.
Performance
Relationship Between
Diversification and Performance
Dominant
Business
Related
Constrained
Level of Diversification
Unrelated
Business
Restructuring:
Contraction of Scope
Why
–
–
–
restructure?
Pull-back from overdiversification.
Attacks by competitors on core
businesses.
Diminished strategic advantages of
vertical integration and diversification.
Contraction
–
–
–
–
(Exit) strategies
Retrenchment
Divestment– spinoffs of profitable SBUs to investors;
management buy outs (MBOs).
Harvest– halting investment, maximizing cash flow.
Liquidation– Cease operations, write off assets.
Why Contraction of Scope?
The causes of corporate decline
– Poor management– incompetence, neglect
– Overexpansion– empire-building CEO’s
– Inadequate financial controls– no profit responsibility
– High costs– low labor productivity
– New competition– powerful emerging competitors
– Unforeseen demand shifts– major market changes
– Organizational inertia– slow to respond to new competitive
conditions
The Main Steps of Turnaround
Changing
–
the leadership
Replace entrenched management with new managers.
Redefining
–
Evaluate and reconstitute the organization’s strategy.
Asset
–
sales and closures
Divest unwanted assets for investment resources.
Improving
–
strategic focus
profitability
Reduce costs, tighten finance and performance controls.
Acquisitions
–
Make acquisitions of skills and competencies to strengthen
core businesses.
Adaptive Strategies
Maintenance of Scope
Enhancement
Status Quo
Market Entry Strategies

Acquisition: a strategy through which one organization buys a
controlling interest in another organization with the intent of
making the acquired firm a subsidiary business within its own
portfolio

Licensing: a strategy where the organization purchases the
right to use technology, process, etc.

Joint Venture: a strategy where an organization joins with
another organization(s) to form a new organization
Reasons for Making Acquisitions
Learn and develop
new capabilities
Increase
market power
Overcome
entry barriers
Cost of new
product development
Acquisitions
Increase speed
to market
Reshape firm’s
competitive scope
Increase
diversification
Lower risk compared
to developing new
products
Reasons for Making Acquisitions:
Increased Market Power

Factors increasing market power
–
–
–

when a firm is able to sell its goods or services above
competitive levels or
when the costs of its primary or support activities are below
those of its competitors
usually is derived from the size of the firm and its resources
and capabilities to compete
Market power is increased by
–
–
–
horizontal acquisitions
vertical acquisitions
related acquisitions
Reasons for Making Acquisitions:
Overcome Barriers to Entry

Barriers to entry include
–
–
–

acquisition of an established company
–

economies of scale in established competitors
differentiated products by competitors
enduring relationships with customers that create product
loyalties with competitors
may be more effective than entering the market as a
competitor offering an unfamiliar good or service that is
unfamiliar to current buyers
Cross-border acquisition
Reasons for Making Acquisitions:

Significant investments of a firm’s resources are
required to
–
–

develop new products internally
introduce new products into the marketplace
Acquisition of a competitor may result in
–
–
–
–
–
–
lower risk compared to developing new products
increased diversification
reshaping the firm’s competitive scope
learning and developing new capabilities
faster market entry
rapid access to new capabilities
Reasons for Making Acquisitions:
Lower Risk Compared to Developing
New Products


An acquisition’s outcomes can be estimated more
easily and accurately compared to the outcomes of an
internal product development process
Therefore managers may view acquisitions as lowering
risk
Reasons for Making Acquisitions:
Increased Diversification


It may be easier to develop and introduce new products
in markets currently served by the firm
It may be difficult to develop new products for markets
in which a firm lacks experience
–
–
it is uncommon for a firm to develop new products internally to
diversify its product lines
acquisitions are the quickest and easiest way to diversify a firm
and change its portfolio of businesses
Reasons for Making Acquisitions:
Reshaping the Firms’ Competitive Scope


Firms may use acquisitions to reduce their
dependence on one or more products or markets
Reducing a company’s dependence on specific
markets alters the firm’s competitive scope
Reasons for Making Acquisitions:
Learning and Developing New Capabilities


Acquisitions may gain capabilities that the firm does
not possess
Acquisitions may be used to
–
acquire a special technological capability
broaden a firm’s knowledge base
–
reduce inertia
–
Problems With Acquisitions
Integration
difficulties
Inadequate
evaluation of target
Resulting firm
is too large
Acquisitions
Large or
extraordinary debt
Managers overly
focused on acquisitions
Too much
diversification
Inability to
achieve synergy
Problems With Acquisitions
Integration Difficulties

Integration challenges include
–
–
–
–
–
melding two disparate corporate cultures
linking different financial and control systems
building effective working relationships (particularly when
management styles differ)
resolving problems regarding the status of the newly
acquired firm’s executives
loss of key personnel weakens the acquired firm’s
capabilities and reduces its value
Problems With Acquisitions
Inadequate Evaluation of Target

Evaluation requires that hundreds of issues be
closely examined, including
–
–
–
–

financing for the intended transaction
differences in cultures between the acquiring and target firm
tax consequences of the transaction
actions that would be necessary to successfully meld the two
workforces
Ineffective due-diligence process may
–
result in paying excessive premium for the target company
Problems With Acquisitions
Large or Extraordinary Debt


Firm may take on significant debt to acquire a
company
High debt can
–
–
–
increase the likelihood of bankruptcy
lead to a downgrade in the firm’s credit rating
preclude needed investment in activities that contribute to
the firm’s long-term success
Problems With Acquisitions
Inability to Achieve Synergy



Synergy exists when assets are worth more when
used in conjunction with each other than when they
are used separately
Firms experience transaction costs (e.g., legal fees)
when they use acquisition strategies to create
synergy
Firms tend to underestimate indirect costs of
integration when evaluating a potential acquisition
Problems With Acquisitions
Too Much Diversification



Diversified firms must process more information of
greater diversity
Scope created by diversification may cause
managers to rely too much on financial rather than
strategic controls to evaluate business units’
performances
Acquisitions may become substitutes for innovation
Problems With Acquisitions
Managers Overly Focused on Acquisitions



Managers in target firms may operate in a state of
virtual suspended animation during an acquisition
Executives may become hesitant to make decisions
with long-term consequences until negotiations have
been completed
Acquisition process can create a short-term
perspective and a greater aversion to risk among
top-level executives in a target firm
Problems With Acquisitions
Too Large




Additional costs may exceed the benefits of the
economies of scale and additional market power
Larger size may lead to more bureaucratic controls
Formalized controls often lead to relatively rigid and
standardized managerial behavior
Firm may produce less innovation
Strategic Alliance

A strategic alliance is a cooperative strategy in which
–
–
firms combine some of their resources and capabilities
to create a competitive advantage
 A strategic alliance involves
– exchange and sharing of resources and capabilities
– co-development or distribution of goods or services
Strategic Alliance
Firm A
Resources
Capabilities
Core Competencies
Firm B
Resources
Capabilities
Core Competencies
Combined
Resources
Capabilities
Core Competencies
Mutual interests in designing, manufacturing,
or distributing goods or services
Types of Cooperative Strategies



Joint venture: two or more firms create an
independent company by combining parts of their
assets
Equity strategic alliance: partners who own different
percentages of equity in a new venture
Nonequity strategic alliances: contractual
agreements given to a company to supply, produce,
or distribute a firm’s goods or services without equity
sharing
Marketing & Sales
Procurement
Technological Development
Human Resource Mgmt.
Firm Infrastructure
Support Activities
Service
Outbound Logistics
Operations
Inbound Logistics
Primary Activities
Service
Marketing & Sales
Procurement
Technological Development
Human Resource Mgmt.
Firm Infrastructure
Supplier
Support Activities
Vertical Alliance
Strategic Alliances
Outbound Logistics
Operations
Inbound Logistics
Primary Activities
• vertical complementary strategic
alliance is formed between firms
that agree to use their skills and
capabilities in different stages of
the value chain to create value
for both firms
• outsourcing is one example of
this type of alliance
Strategic Alliances
Buyer
Buyer
Primary Activities
Service
Marketing & Sales
Procurement
Inbound Logistics
Technological Development
Operations
Human Resource Mgmt.
Outbound Logistics
Firm Infrastructure
Marketing & Sales
Support Activities
Service
Procurement
Technological Development
Human Resource Mgmt.
Firm Infrastructure
Support Activities
Potential Competitors
Outbound Logistics
Operations
Inbound Logistics
Primary Activities
• horizontal complementary strategic alliance is formed
between partners who agree to combine their resources and
skills to create value in the same stage of the value chain
• focus on long-term product development and distribution
opportunities
• the partners may become competitors
• requires a great deal of trust between the partners
Types of Business-Level Strategies


Business-level strategies are intended to create
differences between the firm’s position relative to
those of its rivals
To position itself, the firm must decide whether it
intends to perform activities differently or to perform
different activities as compared to its rivals
Five Generic Strategies
Broad
target
Cost
Uniqueness
Cost
Leadership
Differentiation
Integrated Cost
Leadership/
Differentiation
Narrow
target
Competitive Scope
Competitive Advantage
Focused Cost
Leadership
Focused
Differentiation
Cost Leadership Strategy
An integrated set of actions designed to produce or
deliver goods or services at the lowest cost, relative to
competitors with features that are acceptable to
customers
– relatively standardized products
– features acceptable to many customers
– lowest competitive price
Cost Leadership Strategy
Cost saving actions required by this strategy:
– building efficient scale facilities
– tightly controlling production costs and overhead
– minimizing costs of sales, R&D and service
– building efficient manufacturing facilities
– monitoring costs of activities provided by outsiders
– simplifying production processes
How to Obtain a Cost Advantage
Determine and
control
Cost Drivers
•
•
•
•
•
Alter production process
Change in automation
New distribution channel
New advertising media
Direct sales in place
of indirect sales
Reconfigure, if
needed
Value Chain
•
•
•
•
New raw material
Forward integration
Backward integration
Change location
relative to suppliers
or buyers
Factors That Drive Costs



Economies of scale
Asset utilization
Capacity utilization
pattern
• Seasonal, cyclical
 Interrelationships
 Order processing
and distribution
 Value chain linkages
• Advertising & sales
• Logistics &
operations



Product features
Performance
Mix & variety of
products
 Service levels
 Small vs. large buyers
 Process technology
 Wage levels
 Product features
 Hiring, training,
motivation
Cost Leadership Strategy and the
Five Forces of Competition
Five Forces of
Competition
Bargaining Power
of Suppliers
Rivalry Among
Competing Firms
Can use cost leadership
strategy to advantage since:
 competitors avoid price
wars with cost leaders,
creating higher profits
for the entire industry
Cost Leadership Strategy and the
Five Forces of Competition
Five Forces of
Competition
Bargaining Power
of Suppliers
Bargaining Power of
Buyers
Can mitigate buyers’ power
by:
 driving prices far below
competitors, causing
them to exit and shifting
power with buyers back
to the firm
Cost Leadership Strategy and the
Five Forces of Competition
Bargaining Power of
Suppliers
Five Forces of
Competition
Bargaining Power
of Suppliers
Can mitigate suppliers’
power by:
 being able to absorb cost
increases due to low cost
position
 being able to make very
large purchases, reducing
chance of supplier using
power
Cost Leadership Strategy and the
Five Forces of Competition
Threat of New Entrants
Five Forces of
Competition
Bargaining Power
of Suppliers
Can frighten off new
entrants due to:
 their need to enter on a
large scale in order to be
cost competitive
 the time it takes to move
down the learning curve
Cost Leadership Strategy and the
Five Forces of Competition
Threat of Substitute
Products
Five Forces of
Competition
Bargaining Power
of Suppliers
Cost leader is well
positioned to:
 make investments to be
first to create
substitutes
 buy patents developed
by potential substitutes
 lower prices in order to
maintain value position
Major Risks of Cost Leadership
Strategy



Dramatic technological change could take away your
cost advantage
Competitors may learn how to imitate value chain
Focus on efficiency could cause cost leader to
overlook changes in customer preferences
Differentiation Strategy
An integrated set of actions designed by a firm to
produce or deliver goods or services (at an acceptable
cost) that customers perceive as being different in ways
that are important to them
–
–
–
price for product can exceed what the firm’s target
customers are willing to pay
nonstandardized products
customers value differentiated features more than they
value low cost
Differentiation Strategy






Value provided by unique features and value
characteristics
Command premium price
High customer service
Superior quality
Prestige or exclusivity
Rapid innovation
Differentiation Strategy
Differentiation actions required by this strategy:
– developing new systems and processes
– shaping perceptions through advertising
– quality focus
– capability in R&D
– maximize human resource contributions through
low turnover and high motivation
How to Obtain a Differentiation
Advantage
Control if
needed
Reconfigure to
maximize
Cost Drivers
Value Chain
• Lower buyers’ costs
• Raise performance of product or service
• Create sustainability through:
customer perceptions of uniqueness
customer reluctance to switch to non-unique product
Factors That Drive Differentiation







Unique product features
Unique product performance
Exceptional services
New technologies
Quality of inputs
Exceptional skill or experience
Detailed information
Achieving Superior Customer
Responsiveness
Developing
–
–
–
Top leadership commitment to customers.
Employee attitudes toward customers.
Bringing customers into the company.
Satisfying
–
–
a customer focus:
customer needs:
Customization of the features of products and services to meet
the unique need of groups and individual customers.
Reducing customer response times:



Marketing that communicates with production.
Flexible production and materials management.
Information systems that support the process.
Differentiation Strategy and the Five
Forces of Competition
Rivalry Among
Competing Firms
Five Forces of
Competition
Bargaining Power
of Suppliers
Can defend against
competition because:
 brand loyalty to
differentiated product
offsets price competition
Differentiation Strategy and the
Five Forces of Competition
Bargaining Power of
Buyers
Five Forces of
Competition
Bargaining Power
of Suppliers
Can mitigate buyer power
because:
 well differentiated
products reduce customer
sensitivity to price
increases
Differentiation Strategy and the Five
Forces of Competition
Bargaining Power of
Suppliers
Five Forces of
Competition
Bargaining Power
of Suppliers
Can mitigate suppliers’
power by:
 absorbing price
increases due to higher
margins
 passing along higher
supplier prices because
buyers are loyal to
differentiated brand
Differentiation Strategy and the
Five Forces of Competition
Threat of New Entrants
Five Forces of
Competition
Bargaining Power
of Suppliers
Can defend against new
entrants because:
 new products must
surpass proven
products or,
 new products must be at
least equal to
performance of proven
products, but offered at
lower prices
Differentiation Strategy and the
Five Forces of Competition
Threat of Substitute
Products
Five Forces of
Competition
Bargaining Power
of Suppliers
Well positioned relative to
substitutes because:
 brand loyalty to a
differentiated product
tends to reduce
customers’ testing of
new products or
switching brands
Major Risks of Differentiation
Strategy


Customers may decide that the price differential
between the differentiated product and the cost
leader’s product is too large
Means of differentiation may cease to provide value
for which customers are willing to pay
Major Risks of Differentiation
Strategy


Experience may narrow customer’s perceptions of
the value of differentiated features of the firm’s
products
Makers of counterfeit goods may attempt to replicate
differentiated features of the firm’s products
Focused Business-Level Strategies
A focus strategy must exploit a narrow target’s
differences from the balance of the industry by:
– isolating a particular buyer group
– isolating a unique segment of a product line
– concentrating on a particular geographic market
– finding their “niche”
Factors That May Drive Focused
Strategies




Large firms may overlook small niches
Firm may lack resources to compete in the broader
market
May be able to serve a narrow market segment more
effectively than can larger industry-wide competitors
Focus may allow the firm to direct resources to
certain value chain activities to build competitive
advantage
Major Risks of Focused Strategies



Firm may be “outfocused” by competitors
Large competitor may set its sights on your niche
market
Preferences of niche market may change to match
those of broad market
Choosing a Business-Level
Strategy

Focus strategy success is affected by:
–
–
–
–
–
Competitor entry into focuser’s market segment.
Suppliers capable of increasing costs affecting only the
focuser.
Buyers defecting from market segment.
Substitute products attracting customers away from
focuser’s segment.
New entrants overcoming entry barriers that are the source
of the focuser’s competitive advantage.
Choosing a Generic Business-Level
Strategy
MY FIRM HAS
A COMPETITIVE
ADVANTAGE
MY FIRM HAS
A COMPETITIVE
ADVANTAGE
STUCK
IN THE
MIDDLE
Choosing a Generic Business-Level
Strategy

Cost Leadership and Differentiation
Cost
Leadership
Benefits
Differentiation
Benefits
Choosing a Generic Business-Level
Strategy

Cost Leadership and Differentiation
Flexible
Manufacturing
Technologies
Cost
Leadership
Benefits
Combined
Benefits
Differentiation
Benefits
Advantages of Integrated Strategy
A firm that successfully uses an integrated cost
leadership/differentiation strategy should be in a
better position to:
– adapt quickly to environmental changes
– learn new skills and technologies more quickly
– effectively leverage its core competencies while
competing against its rivals
Benefits of Integrated Strategy


Successful firms using this strategy have aboveaverage returns
Firm offers two types of values to customers
– some differentiated features (but less than a true
differentiated firm)
– relatively low cost (but now as low as the cost
leader’s price)
Major Risks of Integrated Strategy


An integrated cost/differentiation business level
strategy often involves compromises (neither the
lowest cost nor the most differentiated firm)
The firm may become “stuck in the middle” lacking
the strong commitment and expertise that
accompanies firms following either a cost leadership
or a differentiated strategy