The two internal dimensions represented on the axes of the space matrix are

5

part 2 • strategy formulation

Matching Key External and Internal Factors to Formulate Alternative Strategies

Key Internal Factor

Key External Factor

Resultant Strategy

Excess working capital (an internal

+

20 percent annual growth in the cell phone

= Acquire Cellfone, Inc.

strength)

industry (an external opportunity)

Insufficient capacity (an internal

+

Exit of two major foreign competitors from

= Pursue horizontal integration by buying

weakness)

the industry (an external opportunity)

competitors' facilities

Strong R&D expertise (an internal

+

Decreasing numbers of younger adults (an

= Develop new products for older adults

strength)

external threat)

Poor employee morale (an internal

+

Rising healthcare costs (an external threat)

= Develop a new wellness program

weakness)

20 percent annual growth rate (an external opportunity) by acquiring Cellfone, Inc., a firm in the cell phone industry. This example portrays simple one-to-one matching. In most situations, external and internal relationships are more complex, and the matching requires multiple alignments for each strategy generated. The basic concept of matching is illustrated in Table 6-1.

Any organization, whether military, product-oriented, service-oriented, governmental, or even athletic, must develop and execute good strategies to win. A good offense without a good defense, or vice versa, usually leads to defeat. Developing strategies that use strengths to capitalize on opportunities could be considered an offense, whereas strategies designed to improve upon weaknesses while avoiding threats could be termed defensive. Every organization has some external opportunities and threats and internal strengths and weaknesses that can be aligned to formulate feasible alternative strategies.

The Strcr«yihs-Weaknesses-Optpor«:ynriii:iss-Threats (SWOT) Matrix

The Sirenglhs-Weaknesses-Opportunities-Tlueats (SWOT) Matrix is an important matching tool that helps managers develop four types of strategies: SO (strengths-opportunities) Strategies, WO (weaknesses-opportunities) Strategies, ST (strengths-threats) Strategies, and WT (weaknesses-threats) Strategies.3 Matching key external and internal factors is the most difficult part of developing a SWOT Matrix and requires good judgment—and there is no one best set of matches. Note in Table 6-1 that the first, second, third, and fourth strategies are SO, WO, ST, and WT strategies, respectively.

SO Strategies use a firm's internal strengths to take advantage of external opportunities. All managers would like their organizations to be in a position in which internal strengths can be used to take advantage of external trends and events. Organizations generally will pursue WO, ST. or WT strategies to get into a situation in which they can apply SO Strategies. When a firm has major weaknesses, it will strive to overcome them and make them strengths. When an organization faces major threats, it will seek to avoid them to concentrate on opportunities.

WO Strategies aim at improving internal weaknesses by taking advantage of external opportunities. Sometimes key external opportunities exist, but a firm has internal weaknesses that prevent it from exploiting those opportunities. For example, there may be a high demand for electronic devices to control the amount and timing of fuel injection in automobile engines (opportunity), but a certain auto parts manufacturer may lack the technology required for producing these devices (weakness). One possible WO Strategy would be to acquire this technology by forming a joint venture with a firm having competency in this area. An alternative WO Strategy would be to hire and train people with the required technical capabilities.

ST Strategies use a firm's strengths to avoid or reduce the impact of external threats. This does not mean that a strong organization should always meet threats in the external environment head-on. An example of ST Strategy occurred when Texas Instruments used an excellent legal department (a strength) to collect nearly $700 million in damages and royalties from nine Japanese and Korean firms that infringed on patents for semiconductor memory chips (threat).

1 part 2 • strategy formulation

chapter 6 • strategy analysis and choice 2

Rival firms that copy ideas, innovations, and patented products are a major threat in many industries. This is still a major problem for U.S. firms selling products in China.

WT Strategies are defensive tactics directed at reducing internal weakness and avoiding external threats. An organization faced with numerous external threats and internal weaknesses may indeed be in a precarious position. In fact, such a firm may have to fight for its survival, merge, retrench, declare bankruptcy, or choose liquidation.

A schematic representation of the SWOT Matrix is provided in Figure 6-3. Note that a SWOT Matrix is composed of nine cells. As shown, there are four key factor cells, four strategy cells, and one cell that is always left blank (the upper-left cell). The four strategy cells, labeled SO, WO, ST, and WT, are developed after completing four key factor cells, labeled S. W, 0, and T. There are eight steps involved in constructing a SWOT Matrix:

1. List the firm's key external opportunities.

2. List the firm's key external threats.

3. List the firm's key internal strengths.

4. List the firm's key internal weaknesses.

5. Match internal strengths with external opportunities, and record the resultant SO Strategies in the appropriate cell.

6. Match internal weaknesses with external opportunities, and record the resultant WO Strategies.

7. Match internal strengths with external threats, and record the resultant ST Strategies.

8. Match internal weaknesses with external threats, and record the resultant WT Strategies.

Some important aspects of a SWOT Matrix are evidenced in Figure 6-3. For example, note that both the internal/external factors and the SO/ST/WO/WT Strategies are stated in quantitative terms to the extent possible. This is important. For example, regarding the second SO #2 and ST#l strategies, if the analyst just said, "Add new repair/service persons," the reader might think that 20 new repair/service persons are needed. Actually only two are needed. Always be specific to the extent possible in stating factors and strategies.

It is also important to include the "SI. 02" type notation after each strategy in a SWOT Matrix. This notation reveals the rationale for each alternative strategy. Strategies do not rise out of the blue. Note in Figure 6-3 how this notation reveals the internal/external factors that were matched to formulate desirable strategies. For example, note that this retail computer store business may need to "purchase land to build new store" because a new Highway 34 will make its location less desirable. The notation (W2, 02) and (S8, T3) in Figure 6-3 exemplifies this matching process.

The purpose of each Stage 2 matching tool is to generate feasible alternative strategies, not to select or determine which strategies are best. Not all of the strategies developed in the SWOT Matrix, therefore, will be selected for implementation.

The strategy-formulation guidelines provided in Chapter 5 can enhance the process of matching key external and internal factors. For example, when an organization has both the capital and human resources needed to distribute its own products (internal strength) and distributors are unreliable, costly, or incapable of meeting the firm's needs (external threat), forward integration can be an attractive ST Strategy. When a firm has excess production capacity (internal weakness) and its basic industry is experiencing declining annual sales and profits (external threat), related diversification can be an effective WT Strategy.

Although the SWOT matrix is widely used in strategic planning, the analysis does have some limitations.4 First, SWOT does not show how to achieve a competitive advantage, so it must not be an end in itself. The matrix should be the starting point for a discussion on how proposed strategies could be implemented as well as cost-benefit considerations that ultimately could lead to competitive advantage. Second, SWOT is a static assessment (or snapshot) in time. A SWOT matrix can be like studying a single frame of a motion picture where you sec the lead characters and the setting but have no clue as to the plot. As circumstances, capabilities, threats, and strategies change, the dynamics of a competitive

environment may not be revealed in a single matrix. Third, SWOT analysis may lead the firm to overemphasize a single internal or external factor in formulating strategies. There are interrelationships among the key internal and external factors that SWOT does not reveal that may be important in devising strategies.

Tils?-" S'wi'Sst&iSik !': zi'y-: '-'"':'■)<■',■. '-j'-m->>■■ '. -mCE} Mafa'fo

The Strategic Position and Action Evaluation (SPACE) Matrix, another important Stage 2 matching tool, is :llustrated in Figure 6-4. lis four-quadrant framework indicates whether aggressive, conservative, defensive, or competitive strategies are most appropriate for a given organization. The axes of the SPACE Matrix represent two internal dimensions [financial position [FP] and competitive position [CP]) and two external dimensions (stability position [SP] and industry position [IP]). These four factors are perhaps the most important determinants of an organization's overall strategic position.5

Depending on the type of organization, numerous variables could make up each of the dimensions represented on the axes of the SPACE Matrix. Factors that were included earlier in the firm's EFE and IFE Matrices should be considered in developing a SPACE Matrix. Other variables commonly included are given in Table 6-2. For example, return on investment, leverage, liquidity, working capital, and cash flow are commonly considered to be determining factors of an organization's financial strength. Like the SWOT Matrix, the SPACE Matrix should be both tailored to the particular organization being studied and based on factual information as much as possible.

The SPACE Matrix

3

chapter 6 • strategy analysis and choice

CP

Conservative

· Market penetration

· Market development

· Product development

· Related diversification

J I I I I L

FP

+6 +5 +4 +3 +2 + 1 0

Aggressive

· Backward, forward, horizontal

integration

· Market penetration

· Market development

· Product development

· Diversification (related or unrelated)

J I L

ip

181

chapter 6 • strategy analysis and choice

-5

Defensive

· Retrenchment

· Divestiture

· Liquidation

-1 0 -1

-2 -3 -4 -5 -6 -7

+ 1 +2 +3 +4 +5 +6 +7

Competitive

· Backward, forward, horizontal

integration

· Market penetration

· Market development

· Product development

181

chapter 6 • strategy analysis and choice

·

SP

Source: Adapted from H. Rowe, R. Mason, and K. Dickel. Strategic Management and Business Policy: A Methodological Approach (Reading, MA: Addison-Wesley Publishing Co. Inc., © 1982): 155.

181

chapter 6 • strategy analysis and choice

Example Factors That Make Up the SPACE Matrix Axes Internal Strategic Position External Strategic Position Financial Position (FP) Stability Position (SP) Return on investment Technological changes Leverage Rate of inflation Liquidity Demand variability Working capital Price range of competing products Cash flow Barriers to entry into market Inventory turnover Competitive pressure Earnings per share Ease of exit from market Price earnings ratio Price elasticity of demand Risk involved in business Competitive Position (CP) Industry Position (IP) Market share Growth potential Product quality Profit potential Product life cycle Financial stability Customer loyalty Extent leveraged Capacity utilization Resource utilization Technological know-how Ease of entry into market Control over suppliers and distributors Productivity, capacity utilization Source: Adapted from H. Rowe, R. Mason, and K. Dickel, Strategic Management and Business Policy: A Methodological Approach (Reading, MA: Addison-Wesley Publishing Co. Inc.,© 1982): 155-156.The steps required to develop a SPACE Matrix are as follows:

1. Select a set of variables to define financial position (FP), competitive position (CP), stability position (SP), and industry position (IP).

2. Assign a numerical value ranging from +1 (worst) to +7 (best) to each of the variables that make up the FP and IP dimensions. Assign a numerical value ranging from —1 (best) to —7 (worst) to each of the variables that make up the SP and CP dimensions. On the FP and CP axes, make comparison to competitors. On the IP and SP axes, make comparison to other industries.

3. Compute an average score for FP, CP, IP, and SP by summing the values given to the variables of each dimension and then by dividing by the number of variables included in the respective dimension.

4. Plot the average scores for FP, IP, SP, and CP on the appropriate axis in the SPACE Matrix.

5. Add the two scores on thex-axis and plot the resultant point on X. Add the two scores on the v-axis and plot the resultant point on Y. Plot the intersection of the new xy point.

6. Draw a directional vector from the origin of the SPACE Matrix through the new intersection point. This vector reveals the type of strategies recommended for the organization: aggressive, competitive, defensive, or conservative.

Some examples of strategy profiles that can emerge from a SPACE analysis are shown in Figure 6-5. The directional vector associated with each profile suggests the type of strategies to pursue: aggressive, conservative, defensive, or competitive. When a firm's directional vector is located in the aggressive quadrant (upper-right quadrant) of the SPACE Matrix, an organization is in an excellent position to use its internal strengths to (1) take advantage of external opportunities, (2) overcome internal weaknesses, and (3) avoid external threats. Therefore, market penetration, market development, product development, backward integration, forward integration, horizontal integration, or diversification, can be feasible, depending on the specific circumstances that face the firm.

4

part 2 • strategy formulation

When a particular company is known, the analyst must be much more specific in terms of implied strategies. For example, instead of saying market penetration is a recommended strategy when your vector goes in the Conservative quadrant, say that adding 34 new stores in India is a recommended strategy. This is a very important point for students doing case analyses because a particular company is generally known, and terms such as market development are too vague to use. That term could refer to adding a manufacturing plant in Thailand or Mexico or South Africa—so students—Be specific to the extent possible regarding implications of all the matrices presented in Chapter 6.

The directional vector may appear in the conservative quadrant (upper-left quadrant) of the SPACE Matrix, which implies staying close to the firm's basic competencies and not taking excessive risks. Conservative strategies most often include market penetration, market development, product development, and related diversification. The directional vector may be located in the lower-left or defensive quadrant of the SPACE Matrix, which suggests that the firm should focus on rectifying internal weaknesses and avoiding external threats. Defensive strategies include retrenchment, divestiture, liquidation, and related diversification. Finally, the directional vector may be located in the lower-right or competitive quadrant of the SPACE Matrix, indicating competitive strategies. Competitive strategies include backward, forward, and horizontal integration; market penetration; market development and product development.

A SPACE Matrix analysis for a bank is provided in Table 6-3. Note that competitive type strategies are recommended.

A SPACE Matrix for a Bank

Financial Position (FP) Ratings

The bank's primary capital ratio is 7.23 percent, which is 1.23 percentage points over the generally required ratio of 6 percent. 1.0

The bank's return on assets is negative 0.77. compared to a bank industry average ratio of positive 0.70. 1.0

The bank's net income was $ 183 million, down 9 percent from a year earlier. 3.0

The bank's revenues increased 7 percent to $3.46 billion. 4.0

9.0

Industry Position (IP)

Deregulation provides geographic and product freedom. 4.0

Deregulation increases competition in the banking industry. 2.0

Pennsylvania's interstate banking law allows the bank to acquire other banks in New Jersey. Ohio, Kentucky, the

District of Columbia, and West Virginia. 4.0

10.0

Stability Position (SP)

Less-developed countries are experiencing high inflation and political instability. —4.0

Headquartered in Pittsburgh, the bank historically has been heavily dependent on the steel, oil, and gas industries. —5.0 These industries are depressed.

Banking deregulation has created instability throughout the industry. -4.0

-13.0

Competitive Position (CP)

The bank provides data processing services for more than 450 institutions in 38 stales. —2.0 Superregional banks, international banks, and nonbanks are becoming increasingly competitive. —5.0 The bank has a large customer base. -2.0

-9.0

Conclusion

SP Average is -13.0 + 3 = -4.33 IP Average is +10.0 + 3 = 3.33 CP Average is -9.0 + 3 = -3.00 FP Average is +9.0 ^ 4 = 2.25 Directional Vector Coordinates: x-axis: —3.00 + (+3.33) = +0.33

y-axis: -4.33 + (+2.25) = -2.08 The bank should pursue Competitive Strategies.

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