A company's strategy stands a better chance of succeeding when

Chapter 1 What Is Strategy and Why Is It Important? 1

Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission

Strategy: Core Concepts and Analytical Approaches

An e-book published by McGraw-Hill Education

Arthur A. Thompson, The University of Alabama 6th Edition, 2020-2021

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chapter 1 What Is Strategy and Why Is It Important?

Strategy means making clear-cut choices about how to compete. —Jack Welch, former CEO, General Electric

Without a strategy the organization is like a ship without a rudder. —Joel Ross and Michael Kami

If your firm’s strategy can be applied to any other firm, you don’t have a very good one. —David J. Collis and Michael G. Rukstad

Managers of all types of businesses face three central questions: What’s our company’s present situation? What should the company’s future direction be and what performance targets should we set? What’s our plan for running the company and producing good results? Arriving at a thoughtful and probing answer to the question “What’s our company’s present situation?” prompts managers to evaluate industry conditions and competitive pressures, the company’s current market standing, its competitive strengths and weaknesses, and its future prospects in light of changes taking place in the business environment. The question “What should the company’s future direction be and what performance targets should we set?” pushes managers to consider what emerging buyer needs to try to satisfy, which growth opportunities to emphasize and which existing markets to de-emphasize or even abandon, where the company should be headed, and what outcomes the company should strive to achieve with respect to both its financial performance and its performance in the markets where it competes. The question “What’s our plan for running the company and producing good results?” challenges managers to craft a series of competitive moves and business approaches—what henceforth will be referred to as the company’s strategy—for heading the company in the intended direction, staking out a market position, attracting customers, and achieving the targeted financial and market performance.

The role of this chapter is to define the concept of strategy, identify the kinds of actions that determine what a company’s strategy is, introduce you to the concept of competitive advantage, and explore the tight linkage between a company’s strategy and its quest for competitive advantage. We will also explain why company strategies are partly proactive and partly reactive, why they evolve over time, and the relationship between a company’s strategy and its business model. We conclude the chapter with a discussion of what sets a winning

Chapter 1 • What Is Strategy and Why Is It Important? 2

strategy apart from a ho-hum or flawed strategy and why the caliber of a company’s strategy determines whether it will enjoy a competitive advantage or be burdened by competitive disadvantage. By the end of the chapter, you will have a clear idea of why the tasks of crafting and executing strategy are core management functions and why excellent execution of an excellent strategy is the most reliable recipe for turning a company into a standout performer over the long term.

What Do We Mean by “Strategy”?

A company’s strategy is defined by the specific market positioning, competitive moves, and business approaches that form management’s answer to “What’s our plan for running the company and producing good results?” A strategy represents managerial commitment to undertake one set of actions rather than another in an effort to compete successfully and achieve good performance outcomes. This commitment incorporates a coherent collection of choices and decisions about:

n How to attract and please customers.

n How to compete against rivals—and, ideally, gain a competitive advantage as opposed to being hamstrung by competitive disadvantage.

n How to position the company in the marketplace vis-à-vis rivals.

n How to capitalize on opportunities to grow the business.

n How best to respond to changing economic and market conditions.

n How to manage each functional piece of the business (e.g., R&D, supply chain activities, production, sales and marketing, distribution, finance, and human resources).

n How to achieve the company’s performance targets.

In effect, when managers craft a company’s strategy, they are saying, “Among the many different business approaches and ways of competing we could have chosen, we have decided to employ this particular combination of competitive and operating approaches in moving the company in the intended direction, strengthening its market position and competitiveness, and meeting or beating our performance objectives.” Choosing among the various alternative hows is often tough, involving difficult trade-offs and sometimes high risk. But that is no excuse for company managers failing to decide upon a concrete course of action that spells out “This is the strategic path we are going to take and here’s what we are going to do to pursue competitive success in the marketplace and achieve good business results.”2

In most industries, company managers have considerable leeway in choosing the hows of strategy. For example, managers may see a promising opportunity for the company to compete against rivals by striving to keep costs low and selling products/services at attractively low prices. Often, there is room for a company to pursue competitive success by offering buyers more features, better performance, longer durability, more personalized customer service, and/or quicker delivery. Many companies strive to gain a competitive edge over rivals via cutting-edge technological features, longer warranties, clever advertising, better brand-name recognition, or the development of competencies and capabilities rivals cannot match. But it is foolhardy to pursue all of these options simultaneously in an attempt to be all things to all buyers. Choices of how best to compete against rivals have to be made in light of the firm’s resources and capabilities and in light of the competitive approaches rival companies are employing.

CORE CONCEPT A company’s strategy consists of the competitive moves and business approaches that managers employ to attract and please customers, compete successfully, pursue opportunities to grow the business, respond to changing market conditions, conduct operations, and achieve the targeted financial and market performance.

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Likewise, there are all kinds of market-positioning options.3 Some companies target the high end of the market, whereas others go after the middle or low end. Some position themselves to compete in many market segments, endeavoring to attract many types of buyers with a wide variety of models and styles; other companies focus on a single market segment, with product offerings specifically designed to meet the needs and preferences of a particular buyer type or buyer demographic. Some companies position themselves in only one part of the industry’s chain of production/distribution activities (preferring to be only in manufacturing or wholesale distribution or retailing), whereas others are partially or fully integrated, with operations ranging from components production to manufacturing and assembly to wholesale distribution to retailing. Some companies confine their operations to local or regional markets; others opt to compete nationally, internationally (in several countries), or globally (in all or most of the major country markets worldwide). Some companies decide to operate in only one industry, whereas others diversify broadly or narrowly into related or unrelated industries via acquisitions, joint ventures, strategic alliances, or starting up new businesses internally.

Strategy Is About Competing Differently Mimicking the strategies of successful industry rivals—with either copycat product offerings or maneuvers to stake out the same market position—rarely works. The best performing strategies are aimed at competing differently. This does not mean that the key elements of a company’s strategy have to be 100 percent different but rather that they must differ in at least some important respects that matter to buyers. A strategy stands a better chance of succeeding when it is predicated on actions, business approaches, and competitive moves aimed at (1) appealing to buyers in ways that set a company apart from its rivals—particularly when it comes to doing what rivals don’t do or, even better, doing what they can’t do and (2) staking out a market position that is not crowded with strong competitors. Really successful strategies often contain some distinctive “a-ha!” quality that goes beyond merely attracting buyer attention but that, more importantly, delivers what buyers perceive as superior value and converts them into loyal customers. Indeed, the more a strategy is aimed at competing differently in ways that deliver superior value to buyers, the more likely the strategy will produce a valuable competitive edge over rivals.4

Strategy and the Quest for Competitive Advantage

The heart and soul of any strategy are the actions and moves in the marketplace that managers are taking to gain a competitive advantage over rivals. A company achieves a competitive advantage whenever it has some type of edge over rivals in attracting buyers and coping with competitive forces. There are many routes to competitive advantage, but they all involve providing buyers with what they perceive as superior value compared to the offerings of rival sellers. Superior value can mean a good product at a lower price, a superior product that is worth paying more for, or a best-value offering that represents an appealing combination of features, quality, service, and other attributes at an attractively low price. Five of the most frequently used and dependable strategic approaches to setting a company apart from rivals, delivering superior value, achieving competitive advantage, and converting buyers into loyal customers are:

1. Striving to be the industry’s low-cost provider, thereby aiming for a cost-based competitive advantage over rivals that can then become the basis for charging lower prices and/or earning higher profits. Walmart and Southwest Airlines have earned strong market positions because of the low-cost advantages they have achieved over their rivals and their consequent ability to underprice competitors. Achieving lower costs than rivals can produce a durable competitive edge when rivals find it hard to match the low-cost leader’s approaches to driving costs out of the business.

There’s no one roadmap or prescription for running a business in a successful manner. Many different avenues exist for competing successfully, staking out a market position, and operating the different pieces of a business.

A creative, distinctive strategy that sets a company apart from rivals and delivers superior value to customers is a company’s most reliable ticket for winning a competitive advantage over rivals.

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2. Competing successfully and profitably against rivals based on differentiating features such as higher quality, wider product selection, added performance, value-added services, more attractive styling, technological superiority, or some other attributes that set a company’s product offering apart from those of rivals. Successful adopters of differentiation strategies include Apple (innovative products), Johnson & Johnson in baby products (product reliability), Chanel and Rolex (top-of-the-line prestige), and Mercedes and BMW (engineering design and performance). Differentiation strategies can be powerful as long as a company is sufficiently innovative to thwart the efforts of clever rivals to copy or closely imitate its product offering and means of delivering superior value.

3. Offering more value for the money. Giving customers more value for their money by meeting or beating buyers’ expectations regarding key quality/features/performance/service attributes while beating their price expectations is known as a best-cost provider strategy. This approach is a hybrid strategy that blends elements of the previous approaches. Toyota employs a best-cost provider strategy for its Lexus line of motor vehicles, as does Honda for its Acura line of cars and SUVs. Many consumers shop at L.L. Bean because of the good value it delivers: products with appealing quality/performance/features/ styling and attractively low prices. Likewise, Amazon.com has been highly successful in attracting customers with its more-value-for-the-money combination of appealing prices, wide selection, free shipping, extensive product information and reviews, and online shopping convenience.

4. Focusing on a narrow market niche and winning a competitive edge by doing a better job than rivals of serving the special needs and tastes of buyers that compose the niche. Prominent companies that enjoy competitive success in a specialized market niche include eBay in online auctions, Jiffy Lube International in quick oil changes, and The Weather Channel in cable TV.

5. Developing competitively valuable resources and capabilities that rivals can’t easily imitate or trump with resources or capabilities of their own. FedEx has superior capabilities in next-day delivery of small packages. Walt Disney has hard-to-beat capabilities in theme park management and family entertainment. Apple has formidable capabilities in innovative product design. Ritz-Carlton and Four Seasons have uniquely strong capabilities in providing their hotel guests with an array of personalized services. Hyundai has become the world’s fastest-growing automaker as a result of its advanced manufacturing processes and unparalleled quality control systems. Very often, winning a durable competitive edge over rivals hinges more on building competitively valuable resources and capabilities than it does on having a distinctive product. Clever rivals can nearly always copy the attributes of a popular or innovative product, but for rivals to match experience, know-how, and specialized competitive capabilities that a company has developed and perfected over a long period of time is substantially harder to duplicate and takes much longer.

Forging a strategy that produces a competitive advantage has great appeal because it enhances a company’s financial performance. A company is almost certain to earn significantly higher profits when it enjoys a competitive advantage as opposed to when it competes with no advantage or is hamstrung by competitive disadvantage. Competitive advantage is the key to above-average profitability and financial performance because strong buyer preferences for a company’s products or services translate into higher sales volumes (Walmart) and/or the ability to command a higher price (Häagen-Dazs), which in turn tend to improve earnings, return on investment, and other important financial outcomes. Furthermore, if a company’s competitive edge holds promise for being sustainable (as opposed to just temporary), then so much the better for both the strategy and the company’s future profitability. What makes a competitive advantage sustainable (or durable) as opposed to temporary are actions and elements in the strategy that cause an attractive number of buyers to have lasting reasons to purchase a company’s products or services, despite competitors’ best efforts to nullify or overcome those reasons.

CORE CONCEPT A company achieves competitive advantage when an attractive number of buyers are drawn to purchase its products or services rather than those of competitors. A company achieves sustainable competitive advantage when the basis for buyer preferences for its product offering relative to the offerings of its rivals is durable, despite competitors’ efforts to nullify or overcome the appeal of its product offering.

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The tight connection between competitive advantage and profitability means the quest for sustainable competitive advantage is typically the foremost consideration in choosing the central elements of a company’s strategy. Indeed, the competitive power of a company’s strategy is governed by one or more differentiating attributes or strategy elements that act as a magnet to draw customers and give them strong and often durable reasons to prefer its products or services. Thus, what separates a powerful strategy from a run-of-the-mill or ineffective one is management’s ability to forge a series of moves, both in the marketplace and internally, which tilts the playing field in the company’s favor and produces a sustainable competitive advantage over rivals. The bigger and more sustainable the competitive advantage, the better a company’s prospects for winning in the marketplace and earning superior long-term profits relative to its rivals. Without a strategy that leads to competitive advantage, a company risks being outcompeted by more strategically astute rivals and/or handcuffed by mediocre sales and uninspiring financial results.

Identifying a Company’s Strategy The best indicators of a company’s strategy are its actions in the marketplace and senior managers’ statements about the company’s current business approaches, future plans, and efforts to strengthen its competitiveness and performance. Figure 1.1 shows what to look for in identifying the key elements of a company’s strategy.

Once it is clear what to consider, the task of identifying a company’s strategy is mainly one of researching the company’s actions in the marketplace and its business approaches. In the case of publicly owned enterprises, senior executives often openly discuss the strategy in the company’s annual report and 10-K report, in press releases and company news (posted on the company’s website), and in the information provided to investors on the company’s website. To maintain the confidence of investors and Wall Street, most public companies are fairly open about their strategies. Company executives typically lay out key elements of their strategies in presentations to securities analysts (portions of which are usually posted in the investor relations section of the company’s website), and stories in the business media about the company often include aspects of the company’s strategy. Hence, except for some about-to-be-launched moves and changes that remain under wraps and in the planning stage, there’s usually nothing secret or undiscoverable about a company’s present strategy.

Figure 1.1 Identifying a Company’s Strategy—What to Look For

Actions to upgrade, build, or acquire competitively valuable resources and capabilities or to correct competitive weaknesses

Actions to diversify the company’s revenues and earnings by enter- ing new businesses

Actions to compete more successfully and profitably by reducing unit costs below those of rivals and very likely charging lower prices

Actions to compete more successfully and profitably by offering buyers more or better performance features, more appealing design, higher quality, better customer service, wider product selection, or other attributes that enhance buyer appeal

Actions and approaches used in managing R&D, production, sales and marketing, finance, and other key activities

Actions to enter new product segments or geographic markets or to exit existing ones

Actions to respond/adjust to changing market and competitive conditions or other external factors

Actions to capture emerging market opportunities and defend against external threats to the company’s business prospects

Actions to strengthen market standing or competitiveness via mergers, acquisitions, strategic alliances, and /or collaborative partnerships

The Pattern of Actions and

Business Approaches that Define a Company’s

Strategy

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Why a Company’s Strategy Evolves Over Time All companies, sooner or later, find it necessary to modify aspects of their strategy in response to changing market conditions, advancing technology, the fresh moves of competitors, shifting buyer needs and preferences, emerging market opportunities, new ideas for improving the strategy, and/or mounting evidence that certain aspects of the present strategy are no longer working well. Most of the time, a company’s strategy evolves incrementally from management’s ongoing efforts to fine-tune this or that piece of the strategy and to adjust certain strategy elements in response to new learning and unfolding events. However, on occasion, major strategy shifts are called for, such as when a strategy is clearly failing, market conditions or buyer preferences suddenly change dramatically, or important technological breakthroughs occur (as in medical devices and shale fracking). In some industries, conditions change at a fairly slow pace, making it feasible for the major components of a good strategy to remain in place for long periods. But in industries like smartphones, medical devices, computer chips, and genetic engineering where market conditions and technology change frequently and in sometimes dramatic ways, the life cycle of a given strategy is short. It is not uncommon for companies in high-velocity environments to overhaul key elements of their strategies several times a year or even to “reinvent” how they intend to compete differently from rivals and deliver superior value to customers.6

Regardless of whether a company’s strategy changes gradually or swiftly, the important point is that its present strategy is always temporary and on trial, pending management’s next round of strategy initiatives, the emergence of new industry and competitive conditions, and other unfolding developments that management believes warrant strategy adjustments. Thus, a company’s strategy at any given point is fluid, representing the temporary outcome of an ongoing process that, on the one hand, involves reasoned and creative management efforts to craft a competitively effective strategy and, on the other hand, involves ongoing responses to market change and constant experimentation and tinkering. Adapting to new conditions and constantly evaluating what is working well enough to continue and what needs to be improved are normal parts of the strategy-making process and result in an evolving strategy.7

A Company’s Strategy Is Partly Proactive and Partly Reactive The evolving nature of a company’s strategy means the typical company strategy is a blend of (1) proactive actions to secure a competitive edge and improve the company’s financial performance and (2) as-needed reactions to fresh market conditions and other unanticipated developments—see Figure 1.2. The biggest portion of a company’s current strategy usually consists of a combination of previously initiated actions and business approaches that are working well enough to merit continuation and newly launched initiatives aimed at boosting competitive success and financial performance. Typically, managers proactively modify this or that aspect of their strategy as new learning emerges about which pieces of the strategy are working well and which aren’t and as they explore and test new ways to improve the strategy. This part of management’s action plan for running the company is deliberate and constitute its proactive strategy elements.

Copyright © 2020 by Arthur A. Thompson. All rights reserved. Reproduction and distribution of the contents are expressly prohibited without the author’s written permission

CORE CONCEPT Changing circumstances and ongoing manage­ ment efforts to improve the strategy cause a company’s strategy to evolve over time— a condition that makes the task of crafting a strategy a work in progress, not a one­time or every­now­and­then event.

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Figure 1.2 A Company’s Strategy Is a Blend of Proactive Initiatives and Reactive Adjustments

Abandoned strategy elements

Prior Version

of Company Strategy

Latest Version

of Company Strategy

Proactive Strategy Elements

Newly-crafted strategic initiatives plus ongoing strategy elements

continued from prior periods

New strategy elements that emerge as managers react to changing

circumstances

Reactive Strategy Elements

But managers must always be willing to supplement or modify all the proactive strategy elements with as-needed reactions to unanticipated developments. Inevitably, there will be occasions when market and competitive conditions take an unexpected turn that call for some kind of strategic reaction or adjustment. Hence, a portion of a company’s strategy is always developed on the fly, coming as a response to fresh strategic maneuvers on the part of rival firms, unexpected shifts in customer requirements and expectations, important technological developments, newly appearing market opportunities, a changing political or economic climate, or other unanticipated happenings in the surrounding environment. These adaptive strategy adjustments form the reactive strategy elements.

As shown in Figure 1.2, a company’s strategy evolves from one version to the next as managers abandon obsolete or ineffective strategy elements, settle upon a set of proactive strategy elements, and then—as new circumstances unfold—make adaptive strategic adjustments, which gives rise to reactive strategy elements. The latest version of a company’s strategy thus reflects the disappearance of obsolete or ineffective strategy elements and a modified combination of proactive and reactive elements.

Strategy and Ethics: Passing the Test of Moral Scrutiny

In choosing among strategic alternatives, company managers are well advised to embrace actions that can pass the test of moral scrutiny. Just keeping a company’s strategic actions within the bounds of what is legal does not mean the strategy is ethical. Ethical and moral standards are not governed by what is legal. Rather, they involve issues of “right” versus “wrong” and duty—what one should do. A strategy is ethical only if it does not entail actions and behaviors that cross the moral line from “can do” to “should not do.” For example, a company’s strategy definitely crosses into the should not do zone and cannot

CORE CONCEPT A strategy cannot be considered ethical just because it involves actions that are legal. To meet the standard of being ethical, a strategy must entail actions and behavior that can pass moral scrutiny in the sense of not being deceitful, unfair or harmful to others, disreputable, or unreasonably damaging to the environment.

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pass moral scrutiny if it entails actions and behaviors that are deceitful, unfair or harmful to others, disreputable, or unreasonably damaging to the environment. A company’s strategic actions or behavior cross over into the should not do zone and are likely to be deemed unethical when (1) they reflect badly on the company or (2) they adversely impact the legitimate interests and well-being of shareholders, customers, employees, suppliers, the communities where it operates, and society at large or (3) they provoke widespread public outcries about inappropriate or “irresponsible” actions/behavior/outcomes.

Admittedly, it is not always easy to categorize a given strategic behavior as ethical or unethical. Many strategic actions fall in a gray zone and can be deemed ethical or unethical depending on how high one sets the bar for what qualifies as ethical behavior. For example, is it ethical for advertisers of alcoholic products to place ads in media having an audience of as much as 50 percent underage viewers? Is it ethical for an apparel retailer attempting to keep prices attractively low to source clothing from manufacturers who pay substandard wages, use child labor, or subject workers to unsafe working conditions? Is it ethical for Nike, Under Armour, and other makers of athletic uniforms and other sports gear to pay a university athletic department large sums of money as an “inducement” for the university’s athletic teams to use their brand of products? Is it ethical for pharmaceutical manufacturers to charge higher prices for life-saving drugs in some countries than they charge in others? Is it ethical for a company to ignore the damage its operations do to the environment in a particular country, even though its operations are in compliance with current environmental regulations in that country?

Senior executives with strong ethical convictions are generally proactive in linking strategic action and ethics; they forbid the pursuit of ethically questionable business opportunities and insist that all aspects of company strategy are in accord with high ethical standards. They make it clear that all company personnel are expected to act with integrity, and they put organizational checks and balances into place to monitor behavior, enforce ethical codes of conduct, and provide guidance to employees regarding any gray areas. Their commitment to ethical business conduct is genuine, not hypocritical lip service.

The reputational and financial damage that unethical strategies and behavior can do is substantial. When a company is put in the public spotlight because certain personnel are alleged to have engaged in misdeeds, unethical behavior, fraudulent accounting, or criminal behavior, its revenues and stock price are usually hammered hard. Many customers and suppliers shy away from doing business with a company that engages in sleazy practices or turns a blind eye to its employees’ illegal or unethical behavior. They are turned off by unethical strategies or behavior and, rather than become victims or get burned themselves, wary customers take their business elsewhere and wary suppliers tread carefully. Moreover, employees with character and integrity do not want to work for a company whose strategies are shady or whose executives lack character and integrity. Besides, immoral or unethical actions are just plain wrong. Consequently, there are solid business reasons why companies should avoid employing unethical strategy elements.

The Relationship Between a Company’s Strategy and Its Business Model

Closely related to the concept of strategy is the concept of a company’s business model . A business model is manage- ment’s blueprint for delivering a valuable product or service to customers in a manner that will generate revenues sufficient to cover costs and yield an attractive profit.9 The two crucial elements of a company’s business model are (1) its customer value proposition and (2) its profit proposition (or “profit formula”).10 The customer value proposition lays out the company’s approach to satisfying buyer needs and requirements at a price they will consider a good value.11 Plainly, from a customer perspective, the greater the value delivered and the lower the price to get this value, the more

CORE CONCEPT A company’s business model sets forth how its strategy and operating approaches will create value for customers while at the same time generating ample revenues