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

CHAPTER 1 What Is Strategy and Why Is It Important?

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Chapter 1 defines the concept of strategy and describes its many facets. The chapter explains what is meant by a competitive advantage, discusses the relationship between a company’s strategy and its business model, and introduces the student to the kinds of competitive strategies that can give a company an advantage over rivals in attracting customers and earning above-average profits. The chapter examines what sets a winning strategy apart from others and why the caliber of a company’s strategy determines whether it will enjoy a competitive advantage over other firms or be burdened by competitive disadvantage. By the end of this chapter the student 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.

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Learning Objectives

This chapter will help you understand:

What we mean by a company’s strategy and why it needs to differ from competitors' strategies.

The concept of a sustainable competitive advantage.

The five most basic strategic approaches for setting a company apart from its rivals.

That a company’s strategy tends to evolve.

What constitutes a viable business model.

The three tests of a winning strategy.

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In this opening chapter, we define the concept of strategy and describe its many facets. We 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 strategy apart from others and why that strategy should also pass the test of moral scrutiny.

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What Do We Mean By Strategy ?

A company’s strategy is the coordinated set of actions that its managers take in order to outperform the company’s competitors and achieve superior profitability.

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Understanding what is meant by strategy is essential to grasping the entirety of the strategy-making and implementation process. Managers must eventually achieve success to continue as managers. Success in strategic management requires a firm foundation of business knowledge, independent initiative, a broad-ranging intellect, strong intuitive and critical forward thinking, coordinated and sustained competitive effort (tasks are larger than individuals), and, most importantly, unimpeachable ethics and personal integrity.

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All Businesses Face Three Central Questions

What is our present situation?

Industry conditions and competitive pressures, market standing, competitive strengths and weaknesses, and future prospects in light of changes taking place in the business environment

What should the company’s future direction be and what performance targets should we set?

What buyer needs to try to satisfy

Which growth opportunities to emphasize?

Where to head and what outcomes to strive to achieve?

What’s our plan for running the company and achieving good results?

Challenges managers to craft a series of competitive moves and business approaches—henceforth called a strategy—for heading the firm in the intended direction, staking out a market position, attracting customers, and achieving the targeted outcomes

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Strategy Is about Making Choices

Strategy is all about choosing How:

How to position the firm in the marketplace

How to attract customers

How to compete against rivals

How to achieve the firm’s performance targets

How to capitalize on opportunities to grow the business

How to respond to changing economic and market conditions

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Normally, companies have a wide degree of strategic freedom in choosing the “hows” of strategy:

• How to position the company in the marketplace

• How to attract customers

• How to compete against rivals

• How to achieve the company’s performance targets

• How to capitalize on opportunities to grow the business

• How to respond to changing economic and market conditions

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Strategy Is about Competing Differently

Strategy as a choice:

Is deciding to compete differently from rivals—pressuring rivals by doing what they do not do or, even better, doing what they cannot do.

Guides the company in what it must do and also in knowing what it must not do.

Is successful when its actions, business approaches, and competitive moves appeal to buyers in ways that:

Set it apart from its rivals by either providing products with higher perceived values or efficiently producing at lower costs.

Stake out a market position that is not crowded with strong competitors.

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Strategy Is about Competing Differently—A strategy stands a better chance of succeeding when it is predicated on actions, business approaches, and competitive moves aimed at:

appealing to buyers in ways that set a company apart from its rivals.

staking out a market position that is not crowded with strong competitors.

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FIGURE 1.1 Identifying a Firm’s Strategy–What to Look for

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Figure 1.1—Identifying a Company’s Strategy—What to Look For shows what to look for in identifying the substance of a company’s overall strategy. These are the visible actions taken that signal what strategy the company is pursuing.

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Illustration Capsule 1.1 Apple Inc.: Exemplifying a Successful Strategy

Key elements of Apple’s successful strategy are:

Designing and developing its own operating systems, hardware, application software and services.

Continuously investing in R&D and frequently introducing products.

Strategically locating its stores and staffing them with knowledgeable personnel.

Maintaining a quality brand image, supported by premium pricing.

Committing to corporate social responsibility and sustainability through supplier relations.

Cultivating a diverse workforce rooted in transparency.

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Apple Inc. is one of the most profitable companies in the world, with revenues of more than $225 billion. For more than ten consecutive years, it has ranked number one on Fortune’s list of the “World’s Most Admired Companies.” Given the worldwide popularity of its products and services, along with its reputation for superior technological innovation and design capabilities, this is not surprising.

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Strategy and the Quest for Competitive Advantage

Competitive advantage:

Requires meeting customer needs either more effectively (with products or services that customers value more highly) or more efficiently (by providing products or services at a lower cost to customers.)

Sustainable competitive advantage requires:

Giving buyers lasting reasons to prefer a firm’s products or services over those of its competitors.

Developing expertise and long-term competitive capabilities that cannot be readily overcome.

Putting the constant quest for sustainable competitive advantage at center stage in crafting your strategy.

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The heart and soul of any strategy is the actions and moves in the marketplace that managers are taking to improve the company’s financial performance, strengthen its long-term competitive position, and gain a competitive edge over rivals. But sustainability is a relative term, with some advantages lasting longer than others. And regardless of how sustainable a competitive advantage may appear to be at a given point in time, conditions change. Even a substantial competitive advantage over rivals may crumble in the face of drastic shifts in market conditions or disruptive innovations.

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Basic Strategic Approaches (1 of 2)

Strategies for Building Competitive Advantage

Low-Cost Provider

Focused Low-Cost

Best-Cost Provider

Focused Differentiation

Broad Differentiation

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This figure shows five of the most frequently used strategic approaches to setting a firm apart from rivals and achieving a sustainable competitive advantage.

Low Cost Provider—Achieving a cost-based advantage over rivals

Broad Differentiation—Differentiating the firm’s product or service from rivals’ in ways that will appeal to a broad spectrum of buyers

Focused Low Cost—Concentrating on a narrow buyer segment (or market niche) and outcompeting rivals by having lower costs than rivals, and thus, being able to serve niche members at a lower price

Focused Differentiation—Concentrating on a narrow buyer segment (or market niche) and outcompeting rivals by offering niche members customized attributes that meet their tastes and requirements better than rivals’ products

Best Cost Provider—Giving customers more value for the money by satisfying buyers’ expectations on key quality/features/ performance/ service attributes, while beating their price expectations

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Basic Strategic Approaches (2 of 2)

Low-cost provider strategy—achieving a cost-based advantage over rivals

Broad differentiation strategy—differentiating the firm’s product or service from rivals in ways that appeal to a broad spectrum of buyers

A focused low-cost strategy—concentrating on a narrow buyer segment (or market niche) by having lower costs to serve niche members at a lower price

Focused differentiation strategy—concentrating on a narrow buyer segment (or market niche) by offering buyers customized attributes that meet their specialized needs and tastes better than rivals’ products

Best-cost provider strategy—giving customers more perceived value for their money by satisfying their expectations on key quality features, performance, and/or service attributes that match or exceed their price expectations

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Five of the most frequently used strategic approaches to setting a company apart from rivals and achieving a sustainable competitive advantage are:

Low-Cost Provider—Achieving a cost-based advantage over rivals.

Broad Differentiation—Seeking to differentiate the company’s product or service from those of rivals in ways that will appeal to a broad spectrum of buyers.

Focused Low Cost—Concentrating on a narrow buyer segment (or market niche) and outcompeting rivals by having lower costs than rivals, and thus, being able to serve niche members at a lower price.

Focused Differentiation—Concentrating on a narrow buyer segment (or market niche) and outcompeting rivals by offering niche members customized attributes that meet their tastes and requirements better than rivals’ products.

Best-Cost Provider—Giving customers more value for the money by satisfying buyers’ expectations on key quality/features/performance/service attributes, while beating their price expectations.

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Why a Company’s Strategy Evolves over Time

Managers modify strategy in response to:

Changing market conditions.

Advancing technology.

Fresh moves of competitors.

Shifting buyer needs.

Emerging market opportunities.

New ideas for improving the strategy.

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Strategic Management Principle

Changing circumstances and ongoing management efforts to improve the strategy cause a firm’s strategy to evolve over time—a condition that makes the task of crafting strategy a work in progress, not a one-time event.

A firm’s strategy is shaped partly by management analysis and choice and partly by the necessity of adapting and of learning by doing.

Every company must be willing and ready to modify the strategy in response to changing market conditions, advancing technology, unexpected moves by competitors, shifting buyer needs, emerging market opportunities, and mounting evidence that the strategy is not working well.

Most of the time, a company’s strategy evolves incrementally from management’s ongoing efforts to fine-tune the strategy and to adjust certain strategy elements in response to new learning and unfolding events.

Industry environments characterized by high velocity change require companies to repeatedly adapt their strategies.

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

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Two elements combine to form the company’s Realized Strategy. Figure 1.2, A Company’s Strategy, is a Blend of Proactive Initiatives and Reactive Adjustments, and illustrates the elements of strategy that become the Realized Strategy. Strategy elements that prove unsuccessful are abandoned to be replaced by newly developed planned initiatives or reactive strategy elements in the current realized strategy.

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A Company’s Strategy Is Partly Proactive and Partly Reactive

Realized (current) strategy is a blend of:

Proactive (deliberate) strategy elements that include planned initiatives to improve the company’s financial performance and secure a competitive edge.

Reactive (emergent) strategy elements developed on the fly in response to unanticipated developments and fresh market conditions.

Abandoned and superseded strategy elements that no longer fit with the company’s ongoing strategy.

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A firm’s deliberate strategy consists of proactive strategy elements that are both planned and realized as planned. Its emergent strategy consists of reactive strategy elements that emerge as changing conditions warrant.

The evolving nature of a firm’s strategy means that its strategy is a blend of (1) proactive, planned initiatives to improve its financial performance and secure a competitive edge, and (2) reactive responses to unanticipated developments and fresh market conditions.

In total, these two elements combine to form the firm’s Realized Strategy.

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Just for Fun

Using the terms shown in Figure 1.2, explain why U.S. football teams get four downs to make a first down.

How does risk affect play selection (reactive strategy) as a team fails to advance on each of its four downs? What would be the risk effect of requiring more than a 10-yard gain for achieving a first down?

What rules of play in other sports (e.g., soccer) affect how the basic principles of strategy are applied to game play?

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Student insights into the application of strategy will likely vary, especially among veteran student athletes with on-field experience. Class discussions about preparation, play choice and implementation should foster increased recognition of the uncertainty of future conditions necessitating reactive strategizing.

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A Company’s Strategy and Its Business Model

How the firm will make money:

By providing customers with value

The firm’s customer value proposition

By generating revenues sufficient to cover costs and produce attractive profits

The firm’s profit formula

It takes a proven business model—one that yields appealing profitability—to demonstrate viability of a firm’s strategy.

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A firm’s business model sets forth the logic for how its strategy will create value for customers, while at the same time generate revenues sufficient to cover costs and realize a profit.

A business model is management’s plan 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.

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

REALIZED STRATEGY

Competitive Initiatives

Business Approaches

BUSINESS MODEL

Value Proposition

Profit Formula

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The two elements of a company’s business model are:

The customer value proposition lays out the company’s approach to satisfying buyer wants and needs at a price customers will consider a good value.

The profit formula describes the company’s approach to determining a cost structure that will allow for acceptable profits, given the pricing tied to its customer value proposition.

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Business Model Elements: The Customer Value Proposition

The customer value proposition is:

Satisfying buyer wants and needs at a price customers will consider a good value.

The greater the value provided (V) and the lower the price (P), the more attractive the value proposition is to customers

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Recall that any marketplace is simply a place to conduct an exchange of a perceived equality of values and prices for a good or service between a buyer and a seller.

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Business Model Elements: The Profit Formula

The profit formula:

Creates a cost structure that allows for acceptable profits, given that pricing is tied to the customer value proposition.

V – the value provided to customers

P – the price charged to customers

C – the firm’s costs

The lower the costs (C) for a given customer value proposition (V–P), the greater the ability of the business model to be a moneymaker.

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The profit formula describes the company’s approach to determining a cost structure that will allow for acceptable profits, given the pricing tied to its customer value proposition..

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FIGURE 1.3 The Business Model and the Value-Price-Cost Framework

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Figure 1.3 illustrates the elements of the business model in terms of what is known as the Value-Price-Cost Framework highlighting the relationship between the Customer’s Value Proposition (V-P) and the Profit Formula (P-C).

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Is The Company’s Strategy A Winner?

THREE TESTS OF A WINNING STRATEGY

EXHIBITS GOOD FIT WITH SITUATION

RESULTS IN COMPETITIVE ADVANTAGE

PROMOTES SUPERIOR PERFORMANCE

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Three questions above can be asked to test the merits of one strategy versus another and distinguish a winning strategy from a losing or mediocre strategy.

Two kinds of performance improvements tell the most about the caliber of a company’s strategy: (1) gains in profitability and financial strength and (2) gains in the company’s competitive strength and market standing.

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What Makes a Strategy a Winner?

A winning strategy must pass three tests:

The fit test

Does it exhibit good fit with the external and internal aspects of the firm’s dynamic situation?

The competitive advantage test

Is it likely to result in a sustainable competitive advantage?

The performance test

Is it producing superior performance, as indicated by the firm’s profitability, financial and competitive strengths, and market standing?

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Three questions used to test the merits of one strategy versus another and to distinguish a winning strategy from a losing or mediocre strategy:

The Fit Test: How well does the strategy fit the company’s situation? To qualify as a winner, a strategy must be well matched to industry and competitive conditions, a company’s best market opportunities, and other aspects of the enterprise’s external environment.

The Competitive Advantage Test: Is the strategy helping the company achieve a sustainable competitive advantage? The bigger and more durable the competitive edge that a strategy helps build, the more powerful and appealing it is.

The Performance Test: Is the strategy producing good company performance? Which measures are reliable indicators of good strategic performance? Be careful of measures that can be influenced by external factors or manipulated by internal actions (high sales with low margins).

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Illustration Capsule 1.2 Pandora, Sirius XM, and Broadcast Radio: Three Contrasting Business Models

Who listens to the radio anymore?

How sustainable are the business models of Pandora, Sirius XM and over-the-air broadcasters over the long term?

Given the changes in user listening habits, which competitor’s present strategy best passes the three tests of a winning strategy?

What internal and external factors will create particular difficulties for each competitor in changing its strategy or business model?

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While all three provide the same type of entertainment service, the business models employed by Pandora, Sirius XM, and Over-The-Air Broadcast Radio are completely different. In the area of value proposition, Sirius XM provides commercial-free entertainment with some local content based upon a monthly fee, while Broadcast Radio provides entertainment with some local content, with interruptions for commercials, without a fee. Pandora bridges these two methods. In one mode it operates more like Over-the-Air Broadcast Radio, in that it provides entertainment without a fee that includes targeted advertisements, with the added benefit of allowing the listener to customize the music mix. In the other mode, listeners can elect to go ad-free for a fee, using Pandora One.

For profit, Sirius XM must attract a large enough customer base in order to cover costs and provide profit, while Broadcast Radio must attract a large enough advertiser base to cover costs and provide profit. Pandora, once again bridging the two, generates profit by either an advertiser base or through ad-free services.

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Why Crafting and Executing Strategy Are Important Tasks

Strategy provides:

A prescription for doing business.

A road map to competitive advantage.

A game plan for pleasing customers.

A formula for attaining long-term standout marketplace performance.

Good Strategy + Good Strategy Execution = Good Management

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How well a company performs is directly attributable to the caliber of its strategy and the proficiency with which the strategy is executed by its managers.

1. Crafting and executing strategy are top priority managerial tasks for two big reasons:

High-performing enterprises are nearly always the product of astute, creative, and proactive strategy making.

Even the best-conceived strategies will result in performance shortfalls if they are not executed proficiently.

2. Good Strategy + Good Strategy Execution = Good Management.

Crafting and executing strategy are core management functions.

Among all the things managers do, nothing affects a company’s ultimate success or failure more fundamentally than how well its management team charts the company’s direction, develops competitively effective strategic moves and business approaches, and pursues what needs to be done internally to produce good day-to-day strategy execution and operating excellence.

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Applying What You Learned in This Chapter

Google’s browser-based Chrome operating system and its online applications suite are challenging Microsoft’s long-term dominance of the office productivity application marketplace sectors.

What should be Microsoft’s near-term response to this competitive challenge?

How will Microsoft’s long-term response to this competitor’s actions affect its business model?

Which competitor’s strategy will likely be the eventual winner in the marketplace? Why?

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Discussions of how strongly Microsoft will to respond to Google’s growth as a competitor in the maturing office productivity applications marketplace is likely to be influenced by the choice of application suites that a respondent uses. Emphasizing how rapidly technology changes occur in the electronic communications industry should bring an eventual recognition that, no matter how well a strategy performs in the market in its beginning, the changes in the market will eventually overwhelm its success.

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The Road Ahead

Strategy is about asking the right questions.

What must managers do, and do well, to make a firm successful in the marketplace?

Strategy requires getting the right answers

Good strategic thinking and good management of the strategy-making, strategy-executing process are important.

First-rate capabilities and skills in crafting and executing strategy are essential to managing successfully.

Welcome and best wishes for your success!

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Throughout the remaining chapters and the accompanying case collection, the spotlight is trained on the foremost question in running a business enterprise: What must managers do, and do well, to make a company a winner in the marketplace?

The mission of this book is to provide a solid overview of what every business student and aspiring manager needs to know about crafting and executing strategy.

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APPENDIX: IMAGE DESCRIPTIONS FOR UNSIGHTED STUDENTS

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Appendix 1: Figure 1.1 Identifying a Firm’s Strategy–What to Look for, Text Alternative

The actions to look for are:

Strengthening of its bargaining position with suppliers, distributors, and others.

Gaining sales and market share via more performance features, more appealing design, better quality or customer service, wider product selection, or other such actions.

Gains in sales and market share with lower prices based on lower costs.

Entering into or exiting from new or existing product lines or geographic markets.

Using new approaches in managing R&D, production, sales and marketing, finance, and other key activities.

Upgrading, building, or acquiring competitively important resources and capabilities.

Capturing emerging market opportunities and defending against external threats to the firm’s business prospects.

Strengthening market standing and competitiveness by acquiring or merging with other firms.

Strengthening competitiveness via strategic alliances and collaborative partnerships.

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Appendix 2: Figure 1.2 A Firm’s Strategy Is a Blend of Proactive Initiatives and Reactive Adjustments, Text Alternative

Deliberative strategy (or proactive strategy elements) includes new planned initiatives plus ongoing strategy elements continued from prior periods.

Emergent strategy (or reactive strategy elements) includes new strategy elements that emerge as managers react adaptively to changing circumstances.

Both of these result in a firm's current (or realized) strategy.

Prior strategy elements may also be abandoned.

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Appendix 3: Figure 1.3 The Business Model and the Value-Price-Cost Framework, Text Alternative

Customer value (V) is the customer's share (customer value proposition). This value may affect or be affected by product price (P) which is the firm's share (profit formula). These values in turn affect and are affected by the per-unit cost (C).

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Concepts and Cases

22e

Thompson

Peteraf

Gamble

Strickland

The Quest for Competit ive Advantage

STRATEGY Crafting & Executing