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Reflection Paper 2

This assignment covers chapter one, Strategic Leadership: Managing the Strategy-Making Process for Competitive Advantage, and two, External analysis: The Identification of Opportunities and Threats. Write 3-4 pages in response to the questions below, including the questions that refer to Case # 14 in the back of your textbook. Please include the questions in your paper. Then

Chapter 1 Questions:
What is competitive advantage, and how does it relate to a company’s business model?
Describe the strategic planning model, and who is involved in the strategy-making process
Describe the SWOT analysis, its components, and how it aids a company in making strategic decisions. Provide examples of each component in the SWOT analysis.
What are the various levels of management, and how do they participate in the process of strategic decision making?
Chapter 2 Questions:
Define “Industry”, “Business” and “Sector”. How are these related?
How can Porter’s five-forces model aid in strategic decision making?
Describe how “Risk of Entry”, “Bargaining Power of Buyers”, “Bargaining Power of Suppliers”, and industry competition (“Threat of Substitutes”) affect the external threats a company faces. Provide examples of each.
Describe the industry life cycle, what strategic groups are, and what mobility barriers are.
Read Case # 14 Given

Discussion Questions for the Case “Given”

1. Analyze the gastrointestinal endoscopy industry and identify where the key opportunities and challenges are for Given.

2. What are some of Given’s advantages and weaknesses in this market?

Strategic Management Theory An Integrated Approach E I G H T H E D I T I O N

Charles W. L. Hill UNIVERSITY OF WASHINGTON

Gareth R. Jones TEXAS A&M UNIVERSITY

Houghton Mifflin Company Boston New York

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Executive Publisher: George Hoffman Executive Editor: Lisé Johnson Senior Marketing Manager: Nicole Hamm Development Editor: Suzanna Smith Senior Project Editor: Carol Merrigan Art and Design Manager: Jill Haber Cover Design Director: Tony Saizon Senior Photo Editor: Jennifer Meyer Dare Senior Composition Buyer: Chuck Dutton New Title Project Manager: James Lonergan Editorial Assistant: Kathryn White Marketing Assistant: Tom DiGiano

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Copyright © 2008 by Houghton Mifflin Company. All rights reserved.

No part of this work may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying and recording, or by any information storage or retrieval system without the prior written permission of Houghton Mifflin Company unless such copying is expressly permitted by federal copyright law. Address inquiries to College Permissions, Houghton Mifflin Company, 222 Berkeley Street, Boston, MA 02116-3764.

Printed in the U.S.A.

Library of Congress Control Number: 2007934815

Instructor’s examination copy: ISBN-10: 0-547-00490-7 ISBN-13: 978-0-547-00490-7

For orders, use student text ISBNs: ISBN-10: 0-618-89476-4 ISBN-13: 978-0-618-89476-5

1 2 3 4 5 6 7 8 9–DOW–11 10 09 08 07

For my children, Elizabeth, Charlotte, and Michelle Charles W. L. Hill

For Nicholas and Julia and Morgan and Nia Gareth R. Jones

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Contents

Preface xiii

Part 1 Introduction to Strategic Management

1 Strategic Leadership: Managing the Strategy-Making Process for Competitive Advantage 1 Opening Case: Dell Computer 1 Overview 3 Strategic Leadership, Competitive Advantage, and Superior Performance 4

Superior Performance 4 ● Competitive Advantage and a Company’s Business Model 5 ● Industry Differences in Performance 7 ● Performance in Nonprofit Enterprises 7

Strategic Managers 8 Corporate-Level Managers 8 ● Business-Level Managers 10 ● Functional-Level Managers 10

The Strategy-Making Process 10 A Model of the Strategic Planning Process 10 ● Mission Statement 11 ● External Analysis 16

Strategy in Action 1.1: Strategic Analysis at Time Inc. 17 Internal Analysis 18 ● SWOT Analysis and the Business Model 18 ● Strategy Implementation 19 ● The Feedback Loop 19

Strategy as an Emergent Process 20 Strategy Making in an Unpredictable World 20 ● Autonomous Action: Strategy Making by Lower-Level Managers 20

Strategy in Action 1.2: Starbucks’s Music Business 21 Serendipity and Strategy 21

Strategy in Action 1.3: A Strategic Shift at Charles Schwab 22 Intended and Emergent Strategies 22

Strategic Planning in Practice 24 Scenario Planning 24 ● Decentralized Planning 25 ● Strategic Intent 26

Strategic Decision Making 27 Cognitive Biases and Strategic Decision Making 27 ● Groupthink and Strategic Decisions 29 ● Techniques for Improving Decision Making 29

Strategy in Action 1.4: Was Intelligence on Iraq Biased by Groupthink? 30 Strategic Leadership 31

Vision, Eloquence, and Consistency 31 ● Articulation of the Business Model 32 ● Commitment 32 ● Being Well Informed 32 ● Willingness to Delegate and Empower 33 ● The Astute Use of Power 33 ● Emotional Intelligence 33

Summary of Chapter 34 ● Discussion Questions 35 Practicing Strategic Management 35

Small-Group Exercise: Designing a Planning System ● Article File 1 ● Strategic Management Project: Module 1 ● Ethics Exercise

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Closing Case: The Best-Laid Plans—Chrysler Hits the Wall 37 Appendix to Chapter 1: Enterprise Valuation, ROIC, and Growth 39

2 External Analysis: The Identification of Opportunities and Threats 41 Opening Case: The United States Beer Industry 41 Overview 42 Defining an Industry 43

Industry and Sector 43 ● Industry and Market Segments 44 ● Changing Industry Boundaries 44

Porter’s Five Forces Model 45 Risk of Entry by Potential Competitors 46

Strategy in Action 2.1: Circumventing Entry Barriers into the Soft Drink Industry 47 Rivalry Among Established Companies 49

Strategy in Action 2.2: Price Wars in the Breakfast Cereal Industry 51 Industry Demand 51 ● Cost Conditions 52 ● Exit Barriers 52 ● The Bargaining Power of Buyers 53 ● The Bargaining Power of Suppliers 54

Strategy in Action 2.3: Wal-Mart’s Bargaining Power over Suppliers 55 Substitute Products 56 ● A Sixth Force: Complementors 56 ● Porter’s Model Summarized 57

Running Case: Dell Computer and the Personal Computer Industry 57 Strategic Groups Within Industries 58

Implications of Strategic Groups 59 ● The Role of Mobility Barriers 59 Industry Life Cycle Analysis 60

Embryonic Industries 61 ● Growth Industries 61 ● Industry Shakeout 61 ● Mature Industries 62 ● Declining Industries 63 ● Industry Life Cycle 63

Limitations of Models for Industry Analysis 63 Life Cycle Issues 63 ● Innovation and Change 64 ● Company Differences 66

The Macroenvironment 66 Macroeconomic Forces 66 ● Global Forces 68 ● Technological Forces 68 ● Demographic Forces 69 ● Social Forces 70 ● Political and Legal Forces 70

Summary of Chapter 71 ● Discussion Questions 71 Practicing Strategic Management 72

Small-Group Exercise: Competing with Microsoft ● Article File 2 ● Strategic Management Project: Module 2 ● Ethics Exercise

Closing Case: The Pharmaceutical Industry 73

Part 2 The Nature of Competitive Advantage

3 Internal Analysis: Distinctive Competencies, Competitive Advantage, and Profitability 75 Opening Case: Southwest Airlines 75 Overview 76

The Roots of Competitive Advantage 77 Distinctive Competencies 77 ● Competitive Advantage, Value Creation, and Profitability 80

The Value Chain 83 Primary Activities 83

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Strategy in Action 3.1: Value Creation at Burberry 85 Support Activities 85

Strategy in Action 3.2: Competitive Advantage at Zara 86 The Building Blocks of Competitive Advantage 87

Efficiency 87 ● Quality as Excellence and Reliability 88 ● Innovation 90 ● Customer Responsiveness 91 ● Business Models, the Value Chain, and Generic Distinctive Competencies 91

Analyzing Competitive Advantage and Profitability 93 Running Case: Comparing Dell to Hewlett-Packard 95 The Durability of Competitive Advantage 97

Barriers to Imitation 97 ● Capability of Competitors 99 ● Industry Dynamism 99 ● Summarizing Durability of Competitive Advantage 100

Avoiding Failure and Sustaining Competitive Advantage 100 Why Companies Fail 100 ● Steps to Avoid Failure 102

Strategy in Action 3.3: The Road to Ruin at DEC 103 The Role of Luck 104

Strategy in Action 3.4: Bill Gates’s Lucky Break 105 Summary of Chapter 105 ● Discussion of Questions 106 Practicing Strategic Management 106

Small-Group Exercise: Analyzing Competitive Advantage ● Active File 3 ● Strategic Management Project: Module 3 ● Ethics Exercise

Closing Case: Starbucks 107

4 Building Competitive Advantage Through Functional-Level Strategy 109 Opening Case: Boosting Efficiency at Matsushita 109 Overview 110

Achieving Superior Efficiency 111 Efficiency and Economies of Scale 111 ● Efficiency and Learning Effects 113

Strategy in Action 4.1: Learning Effects in Cardiac Surgery 114 Efficiency and the Experience Curve 115 ● Efficiency, Flexible Production Systems, and Mass Customization 117

Strategy in Action 4.2: Mass Customization at Lands’ End 118 Marketing and Efficiency 119

Materials Management, Just-in-Time, and Efficiency 121 R&D Strategy and Efficiency 122 ● Human Resources Strategy and Efficiency 122 ● Information Systems and Efficiency 124 ● Infrastructure and Efficiency 124

Running Case: Dell’s Utilization of the Internet 125 Summary: Achieving Efficiency 125

Achieving Superior Quality 126 Attaining Superior Reliability 126

Strategy in Action 4.3: General Electric’s Six Sigma Quality Improvement Process 128 Implementing Reliability Improvement Methodologies 128 ● Improving Quality as Excellence 132

Strategy in Action 4.4: Six Sigma at Mount Carmel Health 132 Achieving Superior Innovation 134

The High Failure Rate of Innovation 134 ● Building Competencies in Innovation 136 Strategy in Action 4.5: Corning: Learning from Innovation Failures 141 Achieving Superior Responsiveness to Customers 142

Focusing on the Customer 142 ● Satisfying Customer Needs 143 Summary of Chapter 145 ● Discussion Questions 146

Contents v

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Practicing Strategic Management 146 Small-Group Exercise: Identifying Excellence ● Article File 4 ● Strategic Management Project: Module 4 ● Ethics Exercise

Closing Case: Verizon Wireless 147

Part 3 Strategies

5 Building Competitive Advantage Through Business-Level Strategy 149 Opening Case: E*Trade’s Changing Business Strategies 149 Overview 150 Competitive Positioning and the Business Model 151

Formulating the Business Model: Customer Needs and Product Differentiation 151 ● Formulating the Business Model: Customer Groups and Market Segmentation 153 ● Implementing the Business Model: Building Distinctive Competencies 156

Competitive Positioning and Business-Level Strategy 157 Competitive Positioning: Generic Business-Level Strategies 159

Cost Leadership 160 Strategy in Action 5.1: Ryanair Takes Control over the Sky in Europe 162

Focused Cost Leadership 163 ● Differentiation 166 ● Focused Differentiation 168 Strategy in Action 5.2: L. L. Bean’s New Business Model 169

The Dynamics of Competitive Positioning 170 Strategy in Action 5.3: Zara Uses IT to Change the World of Fashion 171

Competitive Positioning for Superior Performance: Broad Differentiation 172 Strategy in Action 5.4: Toyota’s Goal? A High-Value Vehicle to Match Every Customer Need 174

Competitive Positioning and Strategic Groups 177 ● Failures in Competitive Positioning 179 Strategy in Action 5.5: Holiday Inns on Six Continents 181 Summary of Chapter 182 ● Discussion Questions 183 Practicing Strategic Management 183

Small-Group Exercise: Finding a Strategy for a Restaurant ● Article File 5 ● Strategic Management Project: Module 5 ● Ethics Exercise

Closing Case: Samsung Changes Its Business Model Again and Again 184

6 Business-Level Strategy and the Industry Environment 186 Opening Case: Competition Gets Ugly in the Toy Business 186 Overview 187 Strategies in Fragmented Industries 188

Chaining 189 ● Franchising 190 ● Horizontal Merger 190 ● Using Information Technology and the Internet 190

Strategy in Action 6.1: Clear Channel Creates a National Chain of Local Radio Stations 191 Strategies in Embryonic and Growth Industries 192

The Changing Nature of Market Demand 193 ● Strategic Implications: Crossing the Chasm 195 Strategy in Action 6.2: How Prodigy Fell into the Chasm Between Innovators and the Early

Majority 197 Strategic Implications of Market Growth Rates 198 ● Factors Affecting Market Growth Rates 198 ● Strategic Implications of Differences in Growth Rates 199

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Navigating Through the Life Cycle to Maturity 200 Embryonic Strategies 201 ● Growth Strategies 201 ● Shakeout Strategies 202 ● Maturity Strategies 203

Strategy in Mature Industries 203 Strategies to Deter Entry: Product Proliferation, Price Cutting, and Maintaining Excess Capacity 204 ● Strategies to Manage Rivalry 206

Strategy in Action 6.3: New Competitors for Toys “R” Us 207 Running Case: Dell Has to Rethink Its Business-Level Strategies 212

Game Theory 214 Strategy in Action 6.4: Coca-Cola and PepsiCo Go Head-to-Head 220 Strategies in Declining Industries 221

The Severity of Decline 221 ● Choosing a Strategy 222 Strategy in Action 6.5: How to Make Money in the Vacuum Tube Business 223 Summary of Chapter 224 ● Discussion Questions 225 Practicing Strategic Management 225

Small-Group Exercise: How to Keep the Salsa Hot ● Article File 6 ● Strategic Management Project: Module 6 ● Ethics Exercise

Closing Case: Nike’s Winning Ways 226

7 Strategy and Technology 228 Opening Case: Format War—Blu-Ray Versus HD-DVD 228 Overview 229

Technical Standards and Format Wars 230 Examples of Standards 230 ● Benefits of Standards 232 ● Establishment of Standards 233 ● Network Effects, Positive Feedback, and Lockout 233

Strategy in Action 7.1: How Dolby Became the Standard in Sound Technology 236 Strategies for Winning a Format War 237

Ensure a Supply of Complements 237 ● Leverage Killer Applications 237 ● Aggressively Price and Market 238 ● Cooperate with Competitors 238 ● License the Format 239

Costs in High-Technology Industries 240 Comparative Cost Economics 240 ● Strategic Significance 241

Strategy in Action 7.2: Lowering the Cost of Ultrasound Equipment Through Digitalization 242 Managing Intellectual Property Rights 242

Intellectual Property Rights 243 ● Digitalization and Piracy Rates 243 ● Strategies for Managing Digital Rights 244

Strategy in Action 7.3: Battling Piracy in the Videogame Industry 245 Capturing First-Mover Advantages 246

First-Mover Advantages 247 ● First-Mover Disadvantages 247 ● Strategies for Exploiting First-Mover Advantages 248

Technological Paradigm Shifts 251 Paradigm Shifts and the Decline of Established Companies 252

Strategy in Action 7.4: Disruptive Technology in Mechanical Excavators 255 Strategic Implications for Established Companies 256 ● Strategic Implications for New Entrants 258

Summary of Chapter 258 ● Discussion Questions 259 Practicing Strategic Management 259

Small-Group Exercise: Digital Books ● Article File 7 ● Strategic Management Project: Module 7 ● Ethics Exercise

Closing Case: The Failure of Friendster 260

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8 Strategy in the Global Environment 262 Opening Case: MTV—A Global Brand Goes Local 262 Overview 263 The Global and National Environments 264

The Globalization of Production and Markets 264 Strategy in Action 8.1: Finland’s Nokia 266

National Competitive Advantage 267 ● Using the Framework 269 Increasing Profitability and Profit Growth Through Global Expansion 269

Expanding the Market: Leveraging Products 270 ● Realizing Cost Economies from Global Volume 270 ● Realizing Location Economies 271 ● Leveraging the Skills of Global Subsidiaries 272

Cost Pressures and Pressures for Local Responsiveness 273 Pressures for Cost Reductions 274 ● Pressures for Local Responsiveness 275

Strategy in Action 8.2: Localization at IKEA 276 Choosing a Global Strategy 278

Global Standardization Strategy 279 Running Case: Dell’s Global Business Strategy 279

Localization Strategy 280 ● Transnational Strategy 280 ● International Strategy 282 ● Changes in Strategy over Time 282

Basic Entry Decisions 283 Which Overseas Markets to Enter 283 ● Timing of Entry 284 ● Scale of Entry and Strategic Commitments 285

The Choice of Entry Mode 286 Exporting 286 ● Licensing 287 ● Franchising 288 ● Joint Ventures 289 ● Wholly Owned Subsidiaries 290 ● Choosing an Entry Strategy 291

Global Strategic Alliances 293 Advantages of Strategic Alliances 293

Strategy in Action 8.3: Cisco and Fujitsu 294 Disadvantages of Strategic Alliances 294 ● Making Strategic Alliances Work 295

Summary of Chapter 298 ● Discussion Questions 299 Practicing Strategic Management 299

Small-Group Exercise: Developing a Global Strategy ● Article File 8 ● Strategic Management Project: Module 8 ● Ethics Exercise

Closing Case: The Evolution of Strategy at Procter & Gamble 300

9 Corporate-Level Strategy: Horizontal Integration, Vertical Integration, and Strategic Outsourcing 302 Opening Case: Oracle Strives to Become the Biggest and the Best 302 Overview 303 Corporate-Level Strategy and the Multibusiness Model 304 Horizontal Integration: Single-Industry Strategy 305

Benefits of Horizontal Integration 307 Running Case: Beating Dell: Why HP Acquired Compaq 308

Problems with Horizontal Integration 310 Strategy in Action 9.1: Horizontal Integration in Health Care 311 Vertical Integration: Entering New Industries to Strengthen the Core Business Model 312

Increasing Profitability Through Vertical Integration 314

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Strategy in Action 9.2: Specialized Assets and Vertical Integration in the Aluminum Industry 316

Problems with Vertical Integration 317 ● The Limits of Vertical Integration 318 Alternatives to Vertical Integration: Cooperative Relationships 319

Short-Term Contracts and Competitive Bidding 319 ● Strategic Alliances and Long-Term Contracting 320

Strategy in Action 9.3: DaimlerChrysler’s U.S. Keiretsu 321 Building Long-Term Cooperative Relationships 322

Strategic Outsourcing 323 Benefits of Outsourcing 325 ● Risks of Outsourcing 326

Summary of Chapter 327 ● Discussion Questions 328 Practicing Strategic Management 328

Small-Group Exercise: Comparing Vertical Integration Strategies ● Article File 9 ● Strategic Management Project: Module 9 ● Ethics Exercise

Closing Case: Read All About It News Corp. 329

10 Corporate-Level Strategy: Formulating and Implementing Related and Unrelated Diversification 331 Opening Case: Tyco’s Rough Ride 331 Overview 332

Expanding Beyond a Single Industry 333 A Company as a Portfolio of Distinctive Competencies 333

Increasing Profitability Through Diversification 335 Transferring Competencies Across Industries 336 ● Leveraging Competencies 337

Strategy in Action 10.1: Diversification at 3M: Leveraging Technology 338 Sharing Resources: Economies of Scope 339 ● Using Product Bundling 340 ● Managing Rivalry: Multipoint Competition 340 ● Utilizing General Organizational Competencies 341

Two Types of Diversification 343 Related Diversification 344 ● Unrelated Diversification 344

Strategy in Action 10.2: Related Diversification at Intel 345 Disadvantages and Limits of Diversification 346

Changing Industry- and Firm-Specific Conditions 346 ● Diversification for the Wrong Reasons 346 ● The Bureaucratic Costs of Diversification 347

Choosing a Strategy 349 Related Versus Unrelated Diversification 349 ● The Web of Corporate-Level Strategy 350

Entering New Industries: Internal New Ventures 351 The Attraction of Internal New Venturing 351 ● Pitfalls of New Ventures 352 ● Guidelines for Successful Internal New Venturing 353

Entering New Industries: Acquisitions 354 The Attractions of Acquisitions 355 ● Acquisition Pitfalls 355

Strategy in Action 10.3: Postacquisition Problems at Mellon Bank 357 Guidelines for Successful Acquisition 358

Entering New Industries: Joint Ventures 360 Restructuring 361

Why Restructure? 361 Summary of Chapter 362 ● Discussion Questions 362

Contents ix

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Practicing Strategic Management 363 Small-Group Exercise: Dun & Bradstreet ● Article File 10 ● Strategic Management Project: Module 10 ● Ethics Exercise

Closing Case: United Technologies Has an “ACE in Its Pocket” 364

Part 4 Implementing Strategy

11 Corporate Performance, Governance, and Business Ethics 366 Opening Case: The Rise and Fall of Dennis Kozlowski 366 Overview 367

Stakeholders and Corporate Performance 367 Stakeholder Impact Analysis 368 ● The Unique Role of Stockholders 368 ● Profitability, Profit Growth, and Stakeholder Claims 369

Strategy in Action 11.1: Price Fixing at Sotheby’s and Christie’s 371 Agency Theory 372

Principal-Agent Relationships 372 ● The Agency Problem 372 Strategy in Action 11.2: Self-Dealing at Computer Associates 376 Governance Mechanisms 377

The Board of Directors 377 ● Stock-Based Compensation 379 ● Financial Statements and Auditors 380 ● The Takeover Constraint 380 ● Governance Mechanisms Inside a Company 381

Ethics and Strategy 384 Ethical Issues in Strategy 384

Strategy in Action 11.3: Nike and the Sweatshop Debate 385 The Roots of Unethical Behavior 388 ● The Philosophical Approaches to Ethics 389 ● Behaving Ethically 392

Running Case: Dell’s Code of Ethics 394 Summary of Chapter 396 ● Discussion Questions 397 Practicing Strategic Management 397

Small-Group Exercise: Evaluating Stakeholder Claims ● Article File 11 ● Strategic Management Project: Module 11 ● Ethics Exercise

Closing Case: Working Conditions at Wal-Mart 399

12 Implementing Strategy in Companies That Compete in a Single Industry 401 Opening Case: Strategy Implementation at Dell Computer 401 Overview 402 Implementing Strategy Through Organizational Design 403 Building Blocks of Organizational Structure 404

Grouping Tasks, Functions, and Divisions 404 ● Allocating Authority and Responsibility 405 Strategy in Action 12.1: Union Pacific Decentralizes to Increase Customer Responsiveness 408

Integration and Integrating Mechanisms 409 Strategic Control Systems 409

Levels of Strategic Control 411 ● Types of Strategic Control Systems 411 ● Using Information Technology 414

Strategy in Action 12.2: Control at Cypress Semiconductor 415 Strategic Reward Systems 415

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Organizational Culture 416 Culture and Strategic Leadership 417 ● Traits of Strong and Adaptive Corporate Cultures 417

Strategy in Action 12.3: How Ray Kroc Established McDonald’s Culture 418 Building Distinctive Competencies at the Functional Level 419

Functional Structure: Grouping by Function 419 ● The Role of Strategic Control 420 ● Developing Culture at the Functional Level 421 ● Functional Structure and Bureaucratic Costs 423 ● The Outsourcing Option 424

Implementing Strategy in a Single Industry 425 Implementing Cost Leadership 426 ● Implementing Differentiation 427 ● Product Structure: Implementing a Wide Product Line 428 ● Market Structure: Increasing Responsiveness to Customer Groups 429 ● Geographic Structure: Expanding Nationally 429 ● Matrix and Product-Team Structures: Competing in Fast-Changing, High-Tech Environments 431 ● Focusing on a Narrow Product Line 433

Strategy in Action 12.4: Restructuring at Lexmark 434 Restructuring and Reengineering 435 Summary of Chapter 437 ● Discussion Questions 438 Practicing Strategic Management 438

Small-Group Exercise: Deciding on an Organizational Structure ● Article File 12 ● Strategic Management Project: Module 12 ● Ethics Exercise

Closing Case: Nokia’s New Product Structure 440

13 Implementing Strategy in Companies That Compete Across Industries and Countries 442 Opening Case: Ford Has a New CEO and a New Global Structure 442 Overview 443 Managing Corporate Strategy Through the Multidivisional Structure 444

Advantages of a Multidivisional Structure 447 ● Problems in Implementing a Multidivisional Structure 448 ● Structure, Control, Culture, and Corporate-Level Strategy 450 ● The Role of Information Technology 453

Strategy in Acton 13.1: SAP’s ERP Systems 454 Implementing Strategy Across Countries 455

Implementing a Localization Strategy 456 ● Implementing an International Strategy 457 ● Implementing a Global Standardization Strategy 458 ● Implementing a Transnational Strategy 459

Strategy in Action 13.2: Using IT to Make Nestlé’s Global Structure Work 460 Entry Mode and Implementation 462

Internal New Venturing 462 ● Joint Venturing 465 ● Mergers and Acquisitions 466 Information Technology, the Internet, and Outsourcing 467

Information Technology and Strategy Implementation 468 Strategy in Action 13.3: Oracle’s New Approach to Control 469

Strategic Outsourcing and Network Structure 470 Strategy in Action 13.4: Li & Fung’s Global Supply-Chain Management 471 Summary of Chapter 472 ● Discussion Questions 473 Practicing Strategic Management 473

Small-Group Exercise: Deciding on an Organizational Structure ● Article File 13 ● Strategic Management Project: Module 13 ● Ethics Exercise

Closing Case: GM Searches for the Right Global Structure 474

Endnotes 477 Box Source Notes 493

Contents xi

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Appendix: Analyzing a Case Study and Writing a Case Study Analysis C1

What Is a Case Study Analysis? C1 Analyzing a Case Study C2 Writing a Case Study Analysis C6 The Role of Financial Analysis in Case Study Analysis C8

Profit Ratios C8 ● Liquidity Ratios C9 ● Activity Ratios C10 ● Leverage Ratios C10 ● Shareholder-Return Ratios C11 ● Cash Flow C12

Conclusion C12

Index I1

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Preface

Since the seventh edition was published, this book has strengthened its position as the most widely used strategic management textbook on the market. This tells us that we continue to meet the expectations of existing users and attract many new users to our book. It is clear that most strategy instructors share with us a concern for cur- rency in the text and its examples to ensure that cutting-edge issues and new devel- opments in strategic management are continually addressed.

Just as in the last edition, our objective in writing the eighth edition has been to maintain all that was good about prior editions, while refining our approach to dis- cussing established strategic management issues and adding new material to the text to present a more complete, clear, and current account of strategic management as we move steadily into the twenty-first century. We believe that the result is a book that is more closely aligned with the needs of today’s professors and students and with the realities of competition in the new global environment.

We have updated many of the features running throughout the chapters, including all new Opening Cases and Running Cases. For the Running Cases, Dell has replaced Wal-Mart as the focus company. In this edition, we have made no changes to the number or sequencing of our chapters. However, we have made many significant changes inside each chapter to refine and update our presentation of strategic man- agement. Continuing real-world changes in strategic management practices such as the increased use of cost reduction strategies like global outsourcing, ethical issues, and lean production, and a continued emphasis on the business model as the driver of differentiation and competitive advantage, have led to many changes in our ap- proach. To emphasize the importance of ethical decision making in strategic man- agement, we have included a new feature in the end matter of every chapter that in- troduces concept-specific ethical dilemmas that could develop in a real-world business setting.

Throughout the revision process, we have been careful to preserve the balanced and integrated nature of our account of strategic management. As we have continued to add new material, we have also shortened or deleted coverage of out-of-date or less important models and concepts to help students identify and focus on the core concepts and issues in the field. We have also paid close attention to retaining the book’s readability.

We have received a lot of positive feedback about the usefulness of the end-of-chap- ter exercises and assignments in the Practicing Strategic Management sections in our book. They offer a wide range of hands-on learning experiences for students. Follow- ing the Chapter Summary and Discussion Questions, each chapter contains the fol- lowing exercises and assignments:

xiii

Comprehensive and Up-to-Date Coverage

Practicing Strategic Management: An

Interactive Approach

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● Small Group Exercise. This short (20-minute) experiential exercise asks students to divide into groups and discuss a scenario concerning some aspect of strategic management. For example, the scenario in Chapter 11 asks students to identify the stakeholders of their educational institution and evaluate how stakeholders’ claims are being and should be met.

● Ethics Exercise. The ethics exercise has replaced the Exploring the Web feature (now online). This feature has been developed to highlight the importance of ethical decision making in today’s business environment. With today’s current examples of poor decision making (as seen in Enron, Tyco, and WorldCom, to name a few), we hope to equip students with the tools they need to be strong eth- ical leaders.

● Article File. As in the last edition, this exercise requires students to search busi- ness magazines to identify a company that is facing a particular strategic manage- ment problem. For instance, students are asked to locate and research a company pursuing a low-cost or a differentiation strategy, and to describe this company’s strategy, its advantages and disadvantages, and the core competencies required to pursue it. Students’ presentations of their findings lead to lively class discussions.

● Strategic Management Project. In small groups, students choose a company to study for the whole semester and then analyze the company using the series of questions provided at the end of every chapter. For example, students might se- lect Ford Motor Co. and, using the series of chapter questions, collect informa- tion on Ford’s top managers, mission, ethical position, domestic and global strat- egy and structure, and so on. Students write a case study of their company and present it to the class at the end of the semester. In the past, we also had students present one or more of the cases in the book early in the semester, but now in our classes, we treat the students’ own projects as the major class assignment and their case presentations as the climax of the semester’s learning experience.

● Closing Case Study. A short closing case provides an opportunity for a short class discussion of a chapter-related theme.

In creating these exercises, it is not our intention to suggest that they should all be used for every chapter. For example, over a semester, an instructor might combine a group Strategic Management Project with five to six Article File assignments and five to six Exploring the Web exercises, while doing eight to ten Small Group Exercises in class.

We have found that our interactive approach to teaching strategic management appeals to students. It also greatly improves the quality of their learning experience. Our approach is more fully discussed in the Instructor’s Resource Manual.

Taken together, the teaching and learning features of Strategic Management provide a package that is unsurpassed in its coverage and that supports the integrated ap- proach that we have taken throughout the book.

For the Instructor

● The Instructor’s Resource Manual: Theory has been completely revised. For each chapter, we provide a clearly focused synopsis, a list of teaching objectives, a comprehensive lecture outline, suggested answers to discussion questions, and

xiv Preface

Teaching and Learning Aids

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comments on the end-of-chapter activities. Each chapter-opening case, Strategy in Action boxed feature, and chapter-closing case has a synopsis and a correspon- ding teaching note to help guide class discussion.

● The HMTesting CD has been revised and offers a set of comprehensive true/false and multiple-choice questions, and new essay questions for each chapter in the book. The mix of questions has been adjusted to provide fewer fact-based or sim- ple memorization items and to provide more items that rely on synthesis or ap- plication. Also, more items now reflect real or hypothetical situations in organiza- tions. Every question is keyed to the teaching objectives in the Instructor’s Resource Manual and includes an answer and page reference to the textbook.

● The video program highlights many issues of interest and can be used to spark class discussion. It offers a compilation of footage from the Videos for Humani- ties series.

● An extensive website contains many features to aid instructors, including down- loadable files for the text and case materials from the Instructor’s Resource Manu- als, the downloadable Premium and Basic PowerPoint slides, the Video Guide, and sample syllabi. Additional materials on the student website may also be of use to instructors.

● Eduspace®, powered by Blackboard®, is a course management tool that includes chapter outlines, chapter summaries, audio chapter summaries and quizzes, all questions from the textbook with suggested answers, Debate Issues, ACE self-test questions, auto-graded quizzes, Premium and Basic PowerPoint slides, Class- room Response System content, links to content on the websites, video activities, and test pools. A Course Materials Guide is available to help instructor organiza- tion.

● Blackboard®/Web CT® includes course material, chapter outlines, chapter sum- maries, audio chapter summaries and quizzes, all questions from the textbook with suggested answers, Premium and Basic PowerPoint slides, Classroom Re- sponse System content, links to content on the websites, video activities, and Test Bank content.

For the Student

● The student website includes chapter overviews, Internet exercises, ACE self- tests, audio summaries and quizzes, case discussion questions to help guide stu- dent case analysis, glossaries, flashcards for studying the key terms, a section with guidelines on how to do case study analysis, and much more.

This book is the product of far more than two authors. We are grateful to Lisé John- son, our sponsor; Suzanna Smith, our editor; and Nicole Hamm, our marketing manager, for their help in promoting and developing the book and for providing us with timely feedback and information from professors and reviewers, which allowed us to shape the book to meet the needs of its intended market. We are also grateful to Carol Merrigan and Kristen Truncellito, project editors, for their adept handling of production. We are also grateful to the case authors for allowing us to use their mate- rials. We also want to thank the departments of management at the University of Washington and Texas A&M University for providing the setting and atmosphere in

Preface xv

Acknowledgments

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Ken Armstrong, Anderson University Richard Babcock, University of San Francisco Kunal Banerji, West Virginia University Kevin Banning, Auburn University – Montgomery Glenn Bassett, University of Bridgeport Thomas H. Berliner, The University of Texas at Dallas Bonnie Bollinger, Ivy Technical Community College Richard G. Brandenburg, University of Vermont Steven Braund, University of Hull Philip Bromiley, University of Minnesota Geoffrey Brooks, Western Oregon State College Amanda Budde, University of Hawaii Lowell Busenitz, University of Houston Charles J. Capps III, Sam Houston State University Don Caruth, Texas A&M Commerce Gene R. Conaster, Golden State University Steven W. Congden, University of Hartford Catherine M. Daily, Ohio State University Robert DeFillippi, Suffolk University Sawyer School of

Management Helen Deresky, SUNY – Plattsburgh Gerald E. Evans, The University of Montana John Fahy, Trinity College, Dublin Patricia Feltes, Southwest Missouri State University Bruce Fern, New York University Mark Fiegener, Oregon State University Chuck Foley, Columbus State Community College Isaac Fox, Washington State University Craig Galbraith, University of North Carolina at Wilmington Scott R. Gallagher, Rutgers University Eliezer Geisler, Northeastern Illinois University Gretchen Gemeinhardt, University of Houston Lynn Godkin, Lamar University Sanjay Goel, University of Minnesota – Duluth Robert L. Goldberg, Northeastern University James Grinnell, Merrimack College Russ Hagberg, Northern Illinois University Allen Harmon, University of Minnesota – Duluth David Hoopes, California State University – Dominguez Hills Todd Hostager, University of Wisconsin – Eau Claire Graham L. Hubbard, University of Minnesota Tammy G. Hunt, University of North Carolina at Wilmington James Gaius Ibe, Morris College W. Grahm Irwin, Miami University Homer Johnson, Loyola University – Chicago Jonathan L. Johnson, University of Arkansas – Walton College

of Business Administration Marios Katsioloudes, St. Joseph’s University

Robert Keating, University of North Carolina at Wilmington Geoffrey King, California State University – Fullerton John Kraft, University of Florida Rico Lam, University of Oregon Robert J. Litschert, Virginia Polytechnic Institute and State

University Franz T. Lohrke, Louisiana State University Paul Mallette, Colorado State University Daniel Marrone, SUNY Farmingdale Lance A. Masters, California State University – San Bernardino Robert N. McGrath, Embry-Riddle

Aeronautical University Charles Mercer, Drury College Van Miller, University of Dayton Tom Morris, University of San Diego Joanna Mulholland, West Chester University of Pennsylvania John Nebeck, Viterbo University Richard Neubert, University of Tennessee – Knoxville Francine Newth, Providence College Don Okhomina, Fayetteville State University Phaedon P. Papadopoulos, Houston Baptist University John Pappalardo, Keene State College Paul R. Reed, Sam Houston State University Rhonda K. Reger, Arizona State University Malika Richards, Indiana University Simon Rodan, San Jose State Stuart Rosenberg, Dowling College Douglas Ross, Towson University Ronald Sanchez, University of Illinois Joseph A. Schenk, University of Dayton Brian Shaffer, University of Kentucky Leonard Sholtis, Eastern Michigan University Pradip K. Shukla, Chapman University Mel Sillmon, University of Michigan – Dearborn Dennis L. Smart, University of Nebraska at Omaha Barbara Spencer, Clemson University Lawrence Steenberg, University of Evansville Kim A. Stewart, University of Denver Ted Takamura, Warner Pacific College Scott Taylor, Florida Metropolitan University Bobby Vaught, Southwest Missouri State Robert P. Vichas, Florida Atlantic University Edward Ward, St. Cloud State University Kenneth Wendeln, Indiana University Daniel L. White, Drexel University Edgar L. Williams, Jr., Norfolk State University Jun Zhao, Governors State University

Charles W. L. Hill Gareth R. Jones

which the book could be written, and the students of these universities who reacted to and provided input for many of our ideas. In addition, the following reviewers of this and earlier editions gave us valuable suggestions for improving the manuscript from its original version to its current form:

xvi Preface

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O P E N I N G C A S E

Dell Computer

Dell Computer has enjoyed a decade of very high profitability. Between 1998 and 2006, its aver- age return on invested capital (ROIC) was a staggering 48.3%, far ahead of the profitability of competing manufacturers of personal computers (see Figure 1.1). Moreover, while the prof- itability of its competitors fell sharply during 2001–2004, reflecting a tough selling environment in the personal computer industry, Dell managed to maintain a very high ROIC. Clearly, Dell has had a sustained competitive advantage over its rivals. Where did this come from?

An answer can be found in Dell’s business model: selling directly to retail customers. Michael Dell reasoned that by cutting out wholesalers and retailers, he would obtain the profit they would otherwise receive and could give part of the profit back to customers in the form of lower prices. Initially, Dell did its direct selling through mailings and telephone contacts, but since the mid-1990s, much of its sales have been made through its website. Dell’s sophisticated website allows customers to mix and match product features such as microprocessors, memory, monitors, internal hard drives, CD and DVD drives, keyboard and mouse format, and so on, to customize their own computer systems. The ability to customize orders kept retail customers coming back to Dell and helped to drive sales to a record $55.9 billion in 2004.

Another reason for Dell’s high performance is the way it manages its supply chain to mini- mize the costs of holding inventory. Dell has about 200 suppliers, over half of them located out- side the United States. Dell uses the Internet to feed real-time information about order flow to its suppliers so they have up-to-the-minute information about demand trends for the compo- nents they produce, along with volume expectations for the upcoming four to twelve weeks. Dell’s suppliers use this information to adjust their own production schedules, manufacturing just enough components for Dell’s needs and shipping them by the most appropriate mode so that they arrive just in time for production. This tight coordination is pushed back even further down the supply chain because Dell shares this information with its suppliers’ biggest suppliers.

Dell’s goal is to coordinate its supply chain to such an extent that it drives all inventories out of the supply chain, apart from those actually in transit between suppliers and Dell, effectively re- placing inventory with information. Dell has succeeded in driving down inventory to the lowest

Strategic Leadership: Managing the Strategy-Making Process for Competitive Advantage

1

1 C H A P T E R

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2 PART 1 Introduction to Strategic Management

level in the industry. In mid-2006, it was turning its in- ventory over every five days, compared to an average of forty-one days at key competitor Hewlett-Packard. This is a major source of competitive advantage in the computer industry, where component costs account for 75% of rev- enues and typically fall by 1% per week due to rapid ob- solescence.

Despite its high profitability, between mid-2005 and mid-2006, Dell’s stock lost half its market value, sliding from $42 a share to $22. There were several reasons for this. First, after years of trying, three of Dell’s competi- tors, Acer, Hewlett-Packard, and Lenovo, had reduced their cost structure and become more competitive with Dell, enabling them to match Dell on prices and still make profits. Second, by 2005, the consumer market for PCs in developed nations had become mature. To keep growing, Dell tried to expand its share of the business market—but here it faces tough competition from Hewlett-Packard, which can offer business users a wider range of products, and extensive consulting services and

after-sales service and support, all things that business users value highly. Third, Dell’s growth had been hurt by poor customer service. Dell had outsourced customer service to India in an attempt to reduce costs, only to find that poor service alienated its customers. Even though Dell moved customer service for business users back to the United States, some damage had already been done, and this only served to emphasize the difference between Dell and HP in the minds of business customers. Fourth, in an attempt to gain market share from competitors, Dell cut prices in 2005 and 2006, but it gained little in sales volume, made less profit per computer, and experi- enced only sluggish profit growth for 2006.

Many investors, deciding that Dell’s years of rapid profit growth might be over, sold the stock. Looking for- ward, analysts think that Dell’s profitability, as measured by ROIC, will decline from over 60% in 2006 to 30% by 2009 as competitors like Acer, Lenovo, and Hewlett- Packard start to match Dell’s cost structure, and differen- tiate themselves from Dell in ways that users value.1

Re tu

r n

o n

I n

v e

st ed

C ap

ita l (

% )

Apple Dell Gateway Hewlett- Packard

1998 2000 20022001 2003 200620051999 2004

40

50

60

70

80

90

10

20

0

30

Profitability of U.S. Personal Computer Makers

F I G U R E 1 . 3F I G U R E 1 . 1

Source: Value Line Calculations. Data for 2006 are estimates based on three quarters.

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Why do some companies succeed while others fail? Why has Dell Computer been able to do so well in the fiercely competitive personal computer industry, while competitors like Gateway have struggled to make money? In the airline industry, how is it that Southwest Airlines has managed to keep increasing its revenues and profits through both good times and bad, while rivals such as US Airways and United Airlines have had to seek bankruptcy protection? What explains the persistent growth and profitability of Nucor Steel, now the largest steel maker in America, during a period when many of its once larger rivals disap- peared into bankruptcy?

In this book, we argue that the strategies that a company’s managers pursue have a major impact on its performance relative to its competitors. A strategy is a set of related actions that managers take to increase their company’s performance. For most, if not all, companies, achieving superior performance relative to rivals is the ultimate challenge. If a company’s strategies result in superior performance, it is said to have a competitive advantage. Dell Computer’s strategies produced superior per- formance during the late 1990s and first half of the 2000s; as a result, Dell enjoyed a competitive advantage over its rivals. How did Dell achieve this competitive advan- tage? As explained in the Opening Case, it was due to the successful pursuit of a number of strategies by Dell’s managers. These strategies enabled the company to lower its cost structure, charge low prices, gain market share, and become more profitable than its rivals. We will return to the example of Dell several times through- out this book in a Running Case that examines various aspects of Dell strategy and performance.

This book identifies and describes the strategies that managers can pursue to achieve superior performance and provide their company with a competitive advan- tage. One of its central aims is to give you a thorough understanding of the analytical techniques and skills necessary to identify and implement strategies successfully. The first step toward achieving this objective is to describe in more detail what superior performance and competitive advantage mean and to explain the pivotal role that managers play in leading the strategy-making process.

Strategic leadership is about how to most effectively manage a company’s strategy-making process to create competitive advantage. The strategy-making process is the process by which managers select and then implement a set of strategies that aim to achieve a competitive advantage. Strategy formulation is the task of selecting strategies, whereas strategy implementation is the task of putting strategies into action, which includes designing, delivering, and support- ing products; improving the efficiency and effectiveness of operations; and design- ing a company’s organization structure, control systems, and culture. Paraphrasing the well-known saying that “success is 10% inspiration and 90% perspiration,” in the strategic management arena we might say that “success is 10% formulation and 90% implementation.” The task of selecting strategies is relatively easy (but re- quires good analysis and some inspiration); the hard part is putting those strate- gies into effect.

By the end of this chapter, you will understand how strategic leaders can manage the strategy-making process by formulating and implementing strategies that enable a company to achieve a competitive advantage and superior performance. Moreover, you will learn how the strategy-making process can go wrong and what managers can do to make this process more effective.

O V E R V I E W

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Strategic Leadership, Competitive Advantage, and Superior Performance

Strategic leadership is concerned with managing the strategy-making process to in- crease the performance of a company, thereby increasing the value of the enterprise to its owners, its shareholders. As shown in Figure 1.2, to increase shareholder value, man- agers must pursue strategies that increase the profitability of the company and ensure that profits grow (for more details, see the Appendix to this chapter). To do this, a com- pany must be able to outperform its rivals; it must have a competitive advantage.

Maximizing shareholder value is the ultimate goal of profit-making companies, for two reasons. First, shareholders provide a company with the risk capital that enables managers to buy the resources needed to produce and sell goods and services. Risk capital is capital that cannot be recovered if a company fails and goes bankrupt. In the case of Dell, for example, shareholders provided the company with capital to build its assembly plants, invest in information systems, build its order taking and customer support system, and so on. Had Dell failed, its shareholders would have lost their money; their shares would have been worthless. Thus, shareholders will not provide risk capital unless they believe that managers are committed to pursuing strategies that give them a good return on their capital investment. Second, share- holders are the legal owners of a corporation, and their shares therefore represent a claim on the profits generated by a company. Thus, managers have an obligation to invest those profits in ways that maximize shareholder value. Of course, as explained later in this book, managers must behave in a legal, ethical, and socially responsible manner while working to maximize shareholder value.

By shareholder value, we mean the returns that shareholders earn from purchas- ing shares in a company. These returns come from two sources: (a) capital apprecia- tion in the value of a company’s shares and (b) dividend payments. For example, be- tween January 2 and December 31, 2003, the value of one share in the bank JPMorgan increased from $23.96 to $35.78, which represents a capital appreciation of $11.82. In addition, JPMorgan paid out a dividend of $1.30 a share during 2003. Thus, if an investor had bought one share of JPMorgan on January 2 and held on to it for the entire year, her return would have been $13.12 ($11.82 + $1.30), an impres- sive 54.8% return on her investment. One reason JPMorgan’s shareholders did so well during 2003 was that investors came to believe that managers were pursuing strategies that would both increase the long-term profitability of the company and significantly grow its profits in the future.

4 PART 1 Introduction to Strategic Management

● Superior Performance

Shareholder value

Effectiveness of strategies

Profit growth

Profitability (ROIC)

Determinants of Shareholder Value

F I G U R E 1 . 2

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One way of measuring the profitability of a company is by the return that it makes on the capital invested in the enterprise.2 The return on invested capital (ROIC) that a company earns is defined as its net profit over the capital invested in the firm (profit/capital invested). By net profit, we mean net income after tax. By cap- ital, we mean the sum of money invested in the company: that is, stockholders’ equity plus debt owed to creditors. So defined, profitability is the result of how efficiently and effectively managers use the capital at their disposal to produce goods and serv- ices that satisfy customer needs. A company that uses its capital efficiently and effec- tively makes a positive return on invested capital.

The profit growth of a company can be measured by the increase in net profit over time. A company can grow its profits if it sells products in markets that are growing rapidly, gains market share from rivals, increases the amount it sells to exist- ing customers, expands overseas, or diversifies profitably into new lines of business. For example, between 1996 and 2005, Dell increased its net profit from $531 million to $3.825 billion. It was able to do this because the company had a low cost structure, which enabled it to take market share from rivals such as Gateway, Hewlett-Packard, and IBM. In addition, the entire PC industry was growing at a healthy pace during this period, further boosting Dell’s profits.

Together, profitability and profit growth are the principal drivers of shareholder value (see the Appendix to this chapter for details). To both boost profitability and grow profits over time, managers must formulate and implement strategies that give their company a competitive advantage over rivals. Dell’s strategies achieved this until 2005. As a result, investors who purchased Dell stock on January 1, 1996, at $1.11 a share, and held that position until December 30, 2005, when the stock was worth $29.95, would have made a 2,700% return on their investment! However, as noted in the Opening Case, now Dell is finding it increasingly difficult to achieve profit growth and high profitability. Indeed, Dell’s net profits shrank between 2005 and 2006. As a result, the shares traded as low as $18.95 in 2006, even though the company remained very profitable. To get the share price up, managers at Dell need to pursue strategies that reignite profit growth while maintaining the company’s his- torically high profitability.

One of the key challenges managers face is to simultaneously generate high prof- itability and increase the profits of the company. As Dell’s managers have discovered since 2005, companies that have high profitability but whose profits are not growing will not be as highly valued by shareholders as a company that has both high prof- itability and rapid profit growth (see the Appendix for details). At the same time, managers need to be aware that if they grow profits but profitability declines, that too will not be as highly valued by shareholders. What shareholders want to see, and what managers must try to deliver through strategic leadership, is profitable growth: that is, high profitability and sustainable profit growth. This is not easy, but some of the most successful enterprises of our era have achieved it—companies such as Microsoft, Intel, and Wal-Mart, and until 2005 at least, Dell.

Managers do not make strategic decisions in a competitive vacuum. Their company is competing against other companies for customers. Competition is a rough-and- tumble process in which only the most efficient and effective companies win out. It is a race without end. To maximize shareholder value, managers must formulate and implement strategies that enable their company to outperform rivals—that give it a competitive advantage. A company is said to have a competitive advantage over its rivals when its profitability is greater than the average profitability and profit growth

CHAPTER 1 Strategic Leadership: Managing the Strategy-Making Process for Competitive Advantage 5

● Competitive Advantage and a

Company’s Business Model

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of other companies competing for the same set of customers. The higher its prof- itability relative to rivals, the greater its competitive advantage will be. A company has a sustained competitive advantage when its strategies enable it to maintain above-average profitability for a number of years. As discussed in the Opening Case, Dell had a significant and sustained competitive advantage over rivals such as Gateway and Hewlett-Packard between 1996 and 2004. That competitive advantage may now be starting to dissipate.

If a company has a sustained competitive advantage, it is likely to gain market share from its rivals and thus grow its profits more rapidly than those of rivals. In turn, com- petitive advantage will also lead to higher profit growth than that shown by rivals.

The key to understanding competitive advantage is appreciating how the differ- ent strategies managers pursue over time can create activities that fit together to make a company unique or different from its rivals and able to consistently outper- form them. A business model is managers’ conception of how the set of strategies their company pursues should mesh together into a congruent whole, enabling the company to gain a competitive advantage and achieve superior profitability and profit growth. In essence, a business model is a kind of mental model, or gestalt, of how the various strategies and capital investments made by a company should fit to- gether to generate above-average profitability and profit growth. A business model encompasses the totality of how a company will:

● Select its customers

● Define and differentiate its product offerings

● Create value for its customers

● Acquire and keep customers

● Produce goods or services

● Lower costs

● Deliver those goods and services to the market

● Organize activities within the company

● Configure its resources

● Achieve and sustain a high level of profitability

● Grow the business over time

The business model at Dell Computer, for example, is based on the idea that costs can be lowered by selling directly to consumers and avoiding using a distribution chan- nel (see the Opening Case). The cost savings that are attained as a result of this model are passed to consumers in the form of lower prices, which has enabled Dell to gain mar- ket share from rivals. Over time, this business model proved superior to the established business model in the industry, which involved selling computers through retailers.

Dell outperformed close rivals, like Gateway, who adopted the same basic direct- selling business model because Dell implemented its business model more effectively. Most important, Dell did a much better job of using the Internet to coordinate its supply chain and to match orders for computers to the delivery of inventory from suppliers, so that it increased its inventory turnover and reduced its costs.

The business model that managers develop may not only lead to higher prof- itability and thus competitive advantage at a certain point in time, but it may also help the firm to grow its profits over time, thereby maximizing shareholder value while maintaining or even increasing profitability. Dell’s business model was so

6 PART 1 Introduction to Strategic Management

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efficient and effective that it enabled the company to take market share from rivals and thereby increase its profits over time.

It is important to recognize that in addition to its business model and associated strate- gies, a company’s performance is also determined by the characteristics of the industry in which it competes. Different industries are characterized by different competitive conditions. In some, demand is growing rapidly, and in others it is contracting. Some might be beset by excess capacity and persistent price wars, others by excess demand and rising prices. In some, technological change might be revolutionizing competition. Others might be characterized by a lack of technological change. In some industries, high profitability among incumbent companies might induce new companies to enter the industry, and these new entrants might depress prices and profits in the industry. In other industries, new entry might be difficult, and periods of high profitability might persist for a considerable time. Thus, the different competitive conditions prevailing in different industries might lead to differences in profitability and profit growth. For ex- ample, average profitability might be higher in some industries and lower in other in- dustries because competitive conditions vary from industry to industry.

Figure 1.3 shows the average profitability, measured by ROIC, among companies in several different industries between 2002 and 2006. The drug industry had a fa- vorable competitive environment: demand for drugs was high and competition was generally not based on price. Just the opposite was the case in the air transport in- dustry, which was extremely price competitive. Exactly how industries differ is dis- cussed in detail in Chapter 2. For now, the important point to remember is that the profitability and profit growth of a company are determined by two main factors: its relative success in its industry and the overall performance of its industry relative to other industries.3

A final point concerns the concept of superior performance in the nonprofit sector. By definition, nonprofit enterprises such as government agencies, universities, and charities are not in “business” to make profits. Nevertheless, they are expected to use their resources efficiently and operate effectively, and their managers set goals to measure their performance. The performance goal for a business school might be to

CHAPTER 1 Strategic Leadership: Managing the Strategy-Making Process for Competitive Advantage 7

● Industry Differences in

Performance

● Performance in Nonprofit Enterprises

Return on Invested Capital in Selected Industries, 2002–2006 Source: Value Line Investment Survey.

F I G U R E 1 . 3

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n In

ve st

ed C

ap ita

l ( %

)

2002 2003 2004 2005 2006

15

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25

5

0

10

Air transport Computer software Hotel/gaming Retail

Drug

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get its programs ranked among the best in the nation. The performance goal for a charity might be to prevent childhood illnesses in poor countries. The performance goal for a government agency might be to improve its services while not exceeding its budget. The managers of nonprofits need to map out strategies to attain these goals. They also need to understand that nonprofits compete with each other for scarce re- sources, just as businesses do. For example, charities compete for scarce donations, and their managers must plan and develop strategies that lead to high performance and demonstrate a track record of meeting performance goals. A successful strategy gives potential donors a compelling message about why they should contribute addi- tional donations. Thus, planning and thinking strategically are as important for managers in the nonprofit sector as they are for managers in profit-seeking firms.

Strategic Managers

Managers are the linchpin in the strategy-making process. It is individual managers who must take responsibility for formulating strategies to attain a competitive advan- tage and for putting those strategies into effect. They must lead the strategy-making process. The strategies that made Dell Computer so successful were not chosen by some abstract entity known as the company; they were chosen by the company’s founder, Michael Dell, and the managers he hired. Dell’s success, like the success of any company, was based in large part on how well the company’s managers per- formed their strategic roles. In this section, we look at the strategic roles of different managers. Later in the chapter, we discuss strategic leadership, which is how man- agers can effectively lead the strategy-making process.

In most companies, there are two main types of managers: general managers, who bear responsibility for the overall performance of the company or for one of its major self-contained subunits or divisions, and functional managers, who are re- sponsible for supervising a particular function, that is, a task, activity, or operation, such as accounting, marketing, research and development (R&D), information tech- nology, or logistics.

A company is a collection of functions or departments that work together to bring a particular good or service to the market. If a company provides several differ- ent kinds of goods or services, it often duplicates these functions and creates a series of self-contained divisions (each of which contains its own set of functions) to man- age each different good or service. The general managers of these divisions then be- come responsible for their particular product line. The overriding concern of general managers is for the health of the whole company or division under their direction; they are responsible for deciding how to create a competitive advantage and achieve high profitability with the resources and capital they have at their disposal. Figure 1.4 shows the organization of a multidivisional company, that is, a company that com- petes in several different businesses and has created a separate self-contained division to manage each. As you can see, there are three main levels of management: corpo- rate, business, and functional. General managers are found at the first two of these levels, but their strategic roles differ depending on their sphere of responsibility.

The corporate level of management consists of the chief executive officer (CEO), other senior executives, and corporate staff. These individuals occupy the apex of de- cision making within the organization. The CEO is the principal general manager. In

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● Corporate-Level Managers

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consultation with other senior executives, the role of corporate-level managers is to oversee the development of strategies for the whole organization. This role includes defining the goals of the organization, determining what businesses it should be in, allocating resources among the different businesses, formulating and implementing strategies that span individual businesses, and providing leadership for the entire or- ganization.

Consider General Electric as an example. GE is active in a wide range of busi- nesses, including lighting equipment, major appliances, motor and transportation equipment, turbine generators, construction and engineering services, industrial electronics, medical systems, aerospace, aircraft engines, and financial services. The main strategic responsibilities of its CEO, Jeffrey Immelt, are setting overall strategic goals, allocating resources among the different business areas, deciding whether the firm should divest itself of any of its businesses, and determining whether it should acquire any new ones. In other words, it is up to Immelt to develop strategies that span individual businesses; his concern is with building and managing the corporate portfolio of businesses to maximize corporate profitability.

It is not his specific responsibility to develop strategies for competing in the indi- vidual business areas, such as financial services. The development of such strategies is the responsibility of the general managers in these different businesses, or business- level managers. However, it is Immelt’s responsibility to probe the strategic thinking of business-level managers to make sure that they are pursuing robust business mod- els and strategies that will contribute toward the maximization of GE’s long-run profitability, to coach and motivate those managers, to reward them for attaining or exceeding goals, and to hold them accountable for poor performance.

Corporate-level managers also provide a link between the people who oversee the strategic development of a firm and those who own it (the shareholders). Corporate- level managers, and particularly the CEO, can be viewed as the agents of sharehold- ers.4 It is their responsibility to ensure that the corporate and business strategies that the company pursues are consistent with maximizing profitability and profit growth. If they are not, then ultimately the CEO is likely to be called to account by the shareholders.

CHAPTER 1 Strategic Leadership: Managing the Strategy-Making Process for Competitive Advantage 9

Corporate Level CEO, board of directors, and corporate staff

Business Level Divisional managers and staff

Functional Level Functional managers

Market A Market B Market C

Division A Division C

Business functions

Business functions

Head Office

Division B

Business functions

Levels of Strategic Management

F I G U R E 1 . 4

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A business unit is a self-contained division (with its own functions—for example, fi- nance, purchasing, production, and marketing departments) that provides a product or service for a particular market. The principal general manager at the business level, or the business-level manager, is the head of the division. The strategic role of these managers is to translate the general statements of direction and intent that come from the corporate level into concrete strategies for individual businesses. Whereas corporate-level general managers are concerned with strategies that span individual businesses, business-level general managers are concerned with strategies that are specific to a particular business. At GE, a major corporate goal is to be first or second in every business in which the corporation competes. Then the general man- agers in each division work out for their business the details of a business model that is consistent with this objective.

Functional-level managers are responsible for the specific business functions or opera- tions (human resources, purchasing, product development, customer service, and so on) that constitute a company or one of its divisions. Thus, a functional manager’s sphere of responsibility is generally confined to one organizational activity, whereas general man- agers oversee the operation of a whole company or division. Although they are not re- sponsible for the overall performance of the organization, functional managers never- theless have a major strategic role: to develop functional strategies in their area that help fulfill the strategic objectives set by business- and corporate-level general managers.

In GE’s aerospace business, for instance, manufacturing managers are responsible for developing manufacturing strategies consistent with corporate objectives. More- over, functional managers provide most of the information that makes it possible for business- and corporate-level general managers to formulate realistic and attainable strategies. Indeed, because they are closer to the customer than is the typical general manager, functional managers themselves may generate important ideas that subse- quently become major strategies for the company. Thus, it is important for general managers to listen closely to the ideas of their functional managers. An equally great responsibility for managers at the operational level is strategy implementation: the execution of corporate- and business-level plans.

The Strategy-Making Process

We can now turn our attention to the process by which managers formulate and im- plement strategies. Many writers have emphasized that strategy is the outcome of a formal planning process and that top management plays the most important role in this process.5 Although this view has some basis in reality, it is not the whole story. As we shall see later in the chapter, valuable strategies often emerge from deep within the organization without prior planning. Nevertheless, a consideration of formal, ra- tional planning is a useful starting point for our journey into the world of strategy. Accordingly, we consider what might be described as a typical formal strategic plan- ning model for making strategy.

The formal strategic planning process has five main steps:

1. Select the corporate mission and major corporate goals.

2. Analyze the organization’s external competitive environment to identify oppor- tunities and threats.

10 PART 1 Introduction to Strategic Management

● Business-Level Managers

● Functional-Level Managers

● A Model of the Strategic Planning

Process

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3. Analyze the organization’s internal operating environment to identify the organi- zation’s strengths and weaknesses.

4. Select strategies that build on the organization’s strengths and correct its weak- nesses in order to take advantage of external opportunities and counter external threats. These strategies should be consistent with the mission and major goals of the organization. They should be congruent and constitute a viable business model.