Strategic Formulation HCAD 5390

Strategies

4 Adaptive Strategies

5 Expansion Adaptive Strategy: – Orientation toward growth Expand, cut back, status quo? Concentrate within current industry, diversify into other industries? Growth and expansion through internal development or acquisitions, mergers, or strategic alliances? Adaptive Strategies

6 Basic Growth Strategies: Concentration – Current product line in one industry – Vertical Integration – Market Development – Product Development – Penetration Diversification – Into other product lines in other industries Adaptive Strategies

7 Expansion of Scope Basic Concentration Strategies: Vertical growth Horizontal growth Adaptive Strategies

8 Vertical growth – Vertical integration Full integration Taper integration Quasi-integration – Backward integration – Forward integration Adaptive Strategies

10 Horizontal Growth – Horizontal integration Adaptive Strategies

Concentration on a Single Business Advantages – Operational focus on a single familiar industry or market. – Current resources and capabilities add value. – Growing with the market brings competitive advantage. Disadvantages – No diversification of market risks. – Vertical integration may be required to create value and establish competitive advantage. – Opportunities to create value and make a profit may be missed.

12 Basic Diversification Strategies: – Concentric Diversification – Conglomerate Diversification Adaptive Strategies

13 Concentric Diversification – Growth into related industry – Search for synergies Adaptive Strategies

15 Unrelated (Conglomerate) Diversification – Growth into unrelated industry – Concern with financial considerations Adaptive Strategies

Reasons for Diversification Reasons to Enhance Strategic Competitiveness Economies of scope/scale Market power Financial economics Incentives Resources ManagerialMotives

Incentives with Neutral Effects on Strategic Competitiveness Anti-trust regulation Tax laws Low performance Uncertain future cash flows Firm risk reduction Incentives Resources ManagerialMotives Reasons for Diversification

Incentives to Diversify External Incentives: Relaxation of anti-trust regulation allows more related acquisitions than in the past Relaxation of anti-trust regulation allows more related acquisitions than in the past Before 1986, higher taxes on dividends favored spending retained earnings on acquisitions Before 1986, higher taxes on dividends favored spending retained earnings on acquisitions After 1986, firms made fewer acquisitions with retained earnings, shifting to the use of debt to take advantage of tax deductible interest payments After 1986, firms made fewer acquisitions with retained earnings, shifting to the use of debt to take advantage of tax deductible interest payments

Incentives to Diversify Internal Incentives: Poor performance may lead some firms to diversify an attempt to achieve better returns Poor performance may lead some firms to diversify an attempt to achieve better returns Firms may diversify to balance uncertain future cash flows Firms may diversify to balance uncertain future cash flows Firms may diversify into different businesses in order to reduce risk Firms may diversify into different businesses in order to reduce risk

Resources and Diversification Besides strong incentives, firms are more likely to diversify if they have the resources to do so Besides strong incentives, firms are more likely to diversify if they have the resources to do so Value creation is determined more by appropriate use of resources than incentives to diversify Value creation is determined more by appropriate use of resources than incentives to diversify

Managerial Motives (Value Reduction) Diversifying managerial employment risk Increasing managerial compensation Incentives Resources ManagerialMotives Reasons for Diversification

Managerial Motives to Diversify Managers have motives to diversify – diversification increases size; size is associated with executive compensation – diversification reduces employment risk – effective governance mechanisms may restrict such motives

Bureaucratic Costs and the Limits of Diversification Number of businesses – Information overload can lead to poor resource allocation decisions and create inefficiencies. Coordination among businesses – As the scope of diversification widens, control and bureaucratic costs increase. – Resource sharing and pooling arrangements that create value also cause coordination problems. Limits of diversification – The extent of diversification must be balanced with its bureaucratic costs.

Relationship Between Diversification and Performance Performance Level of Diversification Dominant Business Unrelated Business Related Constrained

Restructuring: Contraction of Scope Why restructure? – Pull-back from overdiversification. – Attacks by competitors on core businesses. – Diminished strategic advantages of vertical integration and diversification. Contraction (Exit) strategies – Retrenchment – Divestment– spinoffs of profitable SBUs to investors; management buy outs (MBOs). – Harvest– halting investment, maximizing cash flow. – Liquidation– Cease operations, write off assets.

Why Contraction of Scope? The causes of corporate decline – Poor management– incompetence, neglect – Overexpansion– empire-building CEO’s – Inadequate financial controls– no profit responsibility – High costs– low labor productivity – New competition– powerful emerging competitors – Unforeseen demand shifts– major market changes – Organizational inertia– slow to respond to new competitive conditions

The Main Steps of Turnaround Changing the leadership – Replace entrenched management with new managers. Redefining strategic focus – Evaluate and reconstitute the organization’s strategy. Asset sales and closures – Divest unwanted assets for investment resources. Improving profitability – Reduce costs, tighten finance and performance controls. Acquisitions – Make acquisitions of skills and competencies to strengthen core businesses.

Adaptive Strategies Maintenance of Scope Enhancement Status Quo

Market Entry Strategies Acquisition: a strategy through which one organization buys a controlling interest in another organization with the intent of making the acquired firm a subsidiary business within its own portfolio Acquisition: a strategy through which one organization buys a controlling interest in another organization with the intent of making the acquired firm a subsidiary business within its own portfolio Licensing: a strategy where the organization purchases the right to use technology, process, etc. Licensing: a strategy where the organization purchases the right to use technology, process, etc. Joint Venture: a strategy where an organization joins with another organization(s) to form a new organization Joint Venture: a strategy where an organization joins with another organization(s) to form a new organization

Acquisitions Reasons for Making Acquisitions Increase market power Overcome entry barriers Cost of new product development Increase speed to market Increasediversification Reshape firm’s competitive scope Lower risk compared to developing new products Learn and develop new capabilities

Reasons for Making Acquisitions: Factors increasing market power Factors increasing market power – when a firm is able to sell its goods or services above competitive levels or – when the costs of its primary or support activities are below those of its competitors – usually is derived from the size of the firm and its resources and capabilities to compete Market power is increased by Market power is increased by – horizontal acquisitions – vertical acquisitions – related acquisitions Increased Market Power

Reasons for Making Acquisitions: Barriers to entry include Barriers to entry include – economies of scale in established competitors – differentiated products by competitors – enduring relationships with customers that create product loyalties with competitors acquisition of an established company acquisition of an established company – may be more effective than entering the market as a competitor offering an unfamiliar good or service that is unfamiliar to current buyers Cross-border acquisition Cross-border acquisition Overcome Barriers to Entry

Reasons for Making Acquisitions: Significant investments of a firm’s resources are required to Significant investments of a firm’s resources are required to – develop new products internally – introduce new products into the marketplace Acquisition of a competitor may result in Acquisition of a competitor may result in – lower risk compared to developing new products – increased diversification – reshaping the firm’s competitive scope – learning and developing new capabilities – faster market entry – rapid access to new capabilities

Reasons for Making Acquisitions: An acquisition’s outcomes can be estimated more easily and accurately compared to the outcomes of an internal product development process An acquisition’s outcomes can be estimated more easily and accurately compared to the outcomes of an internal product development process Therefore managers may view acquisitions as lowering risk Therefore managers may view acquisitions as lowering risk Lower Risk Compared to Developing New Products

Reasons for Making Acquisitions: It may be easier to develop and introduce new products in markets currently served by the firm It may be easier to develop and introduce new products in markets currently served by the firm It may be difficult to develop new products for markets in which a firm lacks experience It may be difficult to develop new products for markets in which a firm lacks experience – it is uncommon for a firm to develop new products internally to diversify its product lines – acquisitions are the quickest and easiest way to diversify a firm and change its portfolio of businesses Increased Diversification

Reasons for Making Acquisitions: Firms may use acquisitions to reduce their dependence on one or more products or markets Firms may use acquisitions to reduce their dependence on one or more products or markets Reducing a company’s dependence on specific markets alters the firm’s competitive scope Reducing a company’s dependence on specific markets alters the firm’s competitive scope Reshaping the Firms’ Competitive Scope

Reasons for Making Acquisitions: Acquisitions may gain capabilities that the firm does not possess Acquisitions may gain capabilities that the firm does not possess Acquisitions may be used to Acquisitions may be used to – acquire a special technological capability – broaden a firm’s knowledge base – reduce inertia Learning and Developing New Capabilities

Acquisitions Problems With Acquisitions Integrationdifficulties Inadequate evaluation of target Large or extraordinary debt Inability to achieve synergy Too much diversification Managers overly focused on acquisitions Resulting firm is too large

Problems With Acquisitions Integration challenges include Integration challenges include – melding two disparate corporate cultures – linking different financial and control systems – building effective working relationships (particularly when management styles differ) – resolving problems regarding the status of the newly acquired firm’s executives – loss of key personnel weakens the acquired firm’s capabilities and reduces its value Integration Difficulties

Problems With Acquisitions Evaluation requires that hundreds of issues be closely examined, including Evaluation requires that hundreds of issues be closely examined, including – financing for the intended transaction – differences in cultures between the acquiring and target firm – tax consequences of the transaction – actions that would be necessary to successfully meld the two workforces Ineffective due-diligence process may Ineffective due-diligence process may – result in paying excessive premium for the target company Inadequate Evaluation of Target

Problems With Acquisitions Firm may take on significant debt to acquire a company Firm may take on significant debt to acquire a company High debt can High debt can – increase the likelihood of bankruptcy – lead to a downgrade in the firm’s credit rating – preclude needed investment in activities that contribute to the firm’s long-term success Large or Extraordinary Debt

Problems With Acquisitions Synergy exists when assets are worth more when used in conjunction with each other than when they are used separately Synergy exists when assets are worth more when used in conjunction with each other than when they are used separately Firms experience transaction costs (e.g., legal fees) when they use acquisition strategies to create synergy Firms experience transaction costs (e.g., legal fees) when they use acquisition strategies to create synergy Firms tend to underestimate indirect costs of integration when evaluating a potential acquisition Firms tend to underestimate indirect costs of integration when evaluating a potential acquisition Inability to Achieve Synergy

Problems With Acquisitions Diversified firms must process more information of greater diversity Diversified firms must process more information of greater diversity Scope created by diversification may cause managers to rely too much on financial rather than strategic controls to evaluate business units’ performances Scope created by diversification may cause managers to rely too much on financial rather than strategic controls to evaluate business units’ performances Acquisitions may become substitutes for innovation Acquisitions may become substitutes for innovation Too Much Diversification

Problems With Acquisitions Managers in target firms may operate in a state of virtual suspended animation during an acquisition Managers in target firms may operate in a state of virtual suspended animation during an acquisition Executives may become hesitant to make decisions with long-term consequences until negotiations have been completed Executives may become hesitant to make decisions with long-term consequences until negotiations have been completed Acquisition process can create a short-term perspective and a greater aversion to risk among top-level executives in a target firm Acquisition process can create a short-term perspective and a greater aversion to risk among top-level executives in a target firm Managers Overly Focused on Acquisitions

Problems With Acquisitions Additional costs may exceed the benefits of the economies of scale and additional market power Additional costs may exceed the benefits of the economies of scale and additional market power Larger size may lead to more bureaucratic controls Larger size may lead to more bureaucratic controls Formalized controls often lead to relatively rigid and standardized managerial behavior Formalized controls often lead to relatively rigid and standardized managerial behavior Firm may produce less innovation Firm may produce less innovation Too Large

Strategic Alliance A strategic alliance is a cooperative strategy in which A strategic alliance is a cooperative strategy in which – firms combine some of their resources and capabilities – to create a competitive advantage A strategic alliance involves A strategic alliance involves – exchange and sharing of resources and capabilities – co-development or distribution of goods or services

CombinedResourcesCapabilities Core Competencies ResourcesCapabilities ResourcesCapabilities Strategic Alliance Firm A Firm B Mutual interests in designing, manufacturing, or distributing goods or services

Types of Cooperative Strategies Joint venture: two or more firms create an independent company by combining parts of their assets Joint venture: two or more firms create an independent company by combining parts of their assets Equity strategic alliance: partners who own different percentages of equity in a new venture Equity strategic alliance: partners who own different percentages of equity in a new venture Nonequity strategic alliances: contractual agreements given to a company to supply, produce, or distribute a firm’s goods or services without equity sharing Nonequity strategic alliances: contractual agreements given to a company to supply, produce, or distribute a firm’s goods or services without equity sharing

Strategic Alliances Margin Primary Activities Support Activities Service Marketing & Sales Outbound Logistics Operations Inbound Logistics Firm InfrastructureHuman Resource Mgmt.Technological DevelopmentProcurement Margin Primary Activities Support Activities Service Marketing & Sales Outbound Logistics Operations Inbound Logistics Firm InfrastructureHuman Resource Mgmt.Technological DevelopmentProcurement Vertical Alliance Supplier vertical complementary strategic alliance is formed between firms that agree to use their skills and capabilities in different stages of the value chain to create value for both firmsvertical complementary strategic alliance is formed between firms that agree to use their skills and capabilities in different stages of the value chain to create value for both firms outsourcing is one example of this type of allianceoutsourcing is one example of this type of alliance

Strategic Alliances Margin Primary Activities Support Activities Service Marketing & Sales Outbound Logistics Operations Inbound Logistics Firm InfrastructureHuman Resource Mgmt.Technological DevelopmentProcurement Margin Primary Activities Support Activities Service Marketing & Sales Outbound Logistics Operations Inbound Logistics Firm InfrastructureHuman Resource Mgmt.Technological DevelopmentProcurement Buyer Potential Competitors horizontal complementary strategic alliance is formed between partners who agree to combine their resources and skills to create value in the same stage of the value chainhorizontal complementary strategic alliance is formed between partners who agree to combine their resources and skills to create value in the same stage of the value chain focus on long-term product development and distribution opportunities the partners may become competitorsthe partners may become competitors requires a great deal of trust between the partnersrequires a great deal of trust between the partners Buyer

Types of Business-Level Strategies Business-level strategies are intended to create differences between the firm’s position relative to those of its rivals Business-level strategies are intended to create differences between the firm’s position relative to those of its rivals To position itself, the firm must decide whether it intends to perform activities differently or to perform different activities as compared to its rivals To position itself, the firm must decide whether it intends to perform activities differently or to perform different activities as compared to its rivals

Five Generic Strategies Competitive Advantage Competitive Scope CostUniqueness Broad target Narrow target Cost Leadership Differentiation Focused Cost Leadership Focused Differentiation Integrated Cost Leadership/Differentiation

Cost Leadership Strategy An integrated set of actions designed to produce or deliver goods or services at the lowest cost, relative to competitors with features that are acceptable to customers – relatively standardized products – features acceptable to many customers – lowest competitive price

Cost Leadership Strategy Cost saving actions required by this strategy: – building efficient scale facilities – tightly controlling production costs and overhead – minimizing costs of sales, R&D and service – building efficient manufacturing facilities – monitoring costs of activities provided by outsiders – simplifying production processes

How to Obtain a Cost Advantage Cost Drivers Value Chain Determine and control Reconfigure, if needed Alter production process Change in automation New distribution channel Direct sales in place of indirect sales New advertising media New raw material Backward integration Forward integration Change location relative to suppliers or buyers

l Product features l Performance l Mix & variety of products l Service levels l Small vs. large buyers l Process technology l Wage levels l Product features l Hiring, training, motivation Factors That Drive Costs l Economies of scale l Asset utilization l Capacity utilization pattern Seasonal, cyclical l Interrelationships l Order processing and distribution l Value chain linkages Advertising & sales Logistics & operations

Cost Leadership Strategy and the Five Forces of Competition Rivalry Among Competing Firms Can use cost leadership strategy to advantage since: l competitors avoid price wars with cost leaders, creating higher profits for the entire industry Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Threat of Substitute Products Five Forces of Competition

Cost Leadership Strategy and the Five Forces of Competition Bargaining Power of Buyers Can mitigate buyers’ power by: l driving prices far below competitors, causing them to exit and shifting power with buyers back to the firm Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Threat of Substitute Products Five Forces of Competition

Cost Leadership Strategy and the Five Forces of Competition Bargaining Power of Suppliers Can mitigate suppliers’ power by: l being able to absorb cost increases due to low cost position l being able to make very large purchases, reducing chance of supplier using power Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Threat of Substitute Products Five Forces of Competition

Cost Leadership Strategy and the Five Forces of Competition Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Threat of Substitute Products Five Forces of Competition Threat of New Entrants Can frighten off new entrants due to: l their need to enter on a large scale in order to be cost competitive l the time it takes to move down the learning curve

Cost Leadership Strategy and the Five Forces of Competition Threat of Substitute Products Cost leader is well positioned to: l make investments to be first to create substitutes l buy patents developed by potential substitutes l lower prices in order to maintain value position Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Threat of Substitute Products Five Forces of Competition

Major Risks of Cost Leadership Strategy Dramatic technological change could take away your cost advantage Dramatic technological change could take away your cost advantage Competitors may learn how to imitate value chain Competitors may learn how to imitate value chain Focus on efficiency could cause cost leader to overlook changes in customer preferences Focus on efficiency could cause cost leader to overlook changes in customer preferences

Differentiation Strategy An integrated set of actions designed by a firm to produce or deliver goods or services (at an acceptable cost) that customers perceive as being different in ways that are important to them – price for product can exceed what the firm’s target customers are willing to pay – nonstandardized products – customers value differentiated features more than they value low cost

Differentiation Strategy Value provided by unique features and value characteristics Value provided by unique features and value characteristics Command premium price Command premium price High customer service High customer service Superior quality Superior quality Prestige or exclusivity Prestige or exclusivity Rapid innovation Rapid innovation

Differentiation Strategy Differentiation actions required by this strategy: – developing new systems and processes – shaping perceptions through advertising – quality focus – capability in R&D – maximize human resource contributions through low turnover and high motivation

How to Obtain a Differentiation Advantage Cost Drivers Value Chain Control if needed Reconfigure to maximize customer perceptions of uniqueness customer reluctance to switch to non-unique product Raise performance of product or serviceRaise performance of product or service Lower buyers’ costsLower buyers’ costs Create sustainability through:Create sustainability through:

Factors That Drive Differentiation Unique product features Unique product features Unique product performance Unique product performance Exceptional services Exceptional services New technologies New technologies Quality of inputs Quality of inputs Exceptional skill or experience Exceptional skill or experience Detailed information Detailed information

Achieving Superior Customer Responsiveness Developing a customer focus: – Top leadership commitment to customers. – Employee attitudes toward customers. – Bringing customers into the company. Satisfying customer needs: – Customization of the features of products and services to meet the unique need of groups and individual customers. – Reducing customer response times: Marketing that communicates with production. Flexible production and materials management. Information systems that support the process.

Differentiation Strategy and the Five Forces of Competition Rivalry Among Competing Firms Can defend against competition because: l brand loyalty to differentiated product offsets price competition Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Threat of Substitute Products Five Forces of Competition

Differentiation Strategy and the Five Forces of Competition Bargaining Power of Buyers Can mitigate buyer power because: l well differentiated products reduce customer sensitivity to price increases Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Threat of Substitute Products Five Forces of Competition

Differentiation Strategy and the Five Forces of Competition Bargaining Power of Suppliers Can mitigate suppliers’ power by: l absorbing price increases due to higher margins l passing along higher supplier prices because buyers are loyal to differentiated brand Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Threat of Substitute Products Five Forces of Competition

Differentiation Strategy and the Five Forces of Competition Threat of New Entrants Can defend against new entrants because: l new products must surpass proven products or, l new products must be at least equal to performance of proven products, but offered at lower prices Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Threat of Substitute Products Five Forces of Competition

Differentiation Strategy and the Five Forces of Competition Threat of Substitute Products Well positioned relative to substitutes because: l brand loyalty to a differentiated product tends to reduce customers’ testing of new products or switching brands Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Threat of Substitute Products Five Forces of Competition

Major Risks of Differentiation Strategy Customers may decide that the price differential between the differentiated product and the cost leader’s product is too large Customers may decide that the price differential between the differentiated product and the cost leader’s product is too large Means of differentiation may cease to provide value for which customers are willing to pay Means of differentiation may cease to provide value for which customers are willing to pay

Major Risks of Differentiation Strategy Experience may narrow customer’s perceptions of the value of differentiated features of the firm’s products Experience may narrow customer’s perceptions of the value of differentiated features of the firm’s products Makers of counterfeit goods may attempt to replicate differentiated features of the firm’s products Makers of counterfeit goods may attempt to replicate differentiated features of the firm’s products

Focused Business-Level Strategies A focus strategy must exploit a narrow target’s differences from the balance of the industry by: – isolating a particular buyer group – isolating a unique segment of a product line – concentrating on a particular geographic market – finding their “niche”

Factors That May Drive Focused Strategies Large firms may overlook small niches Large firms may overlook small niches Firm may lack resources to compete in the broader market Firm may lack resources to compete in the broader market May be able to serve a narrow market segment more effectively than can larger industry-wide competitors May be able to serve a narrow market segment more effectively than can larger industry-wide competitors Focus may allow the firm to direct resources to certain value chain activities to build competitive advantage Focus may allow the firm to direct resources to certain value chain activities to build competitive advantage

Major Risks of Focused Strategies Firm may be “outfocused” by competitors Firm may be “outfocused” by competitors Large competitor may set its sights on your niche market Large competitor may set its sights on your niche market Preferences of niche market may change to match those of broad market Preferences of niche market may change to match those of broad market

Choosing a Business-Level Strategy Focus strategy success is affected by: – Competitor entry into focuser’s market segment. – Suppliers capable of increasing costs affecting only the focuser. – Buyers defecting from market segment. – Substitute products attracting customers away from focuser’s segment. – New entrants overcoming entry barriers that are the source of the focuser’s competitive advantage.

STUCK IN THE MIDDLE MY FIRM HAS A COMPETITIVE ADVANTAGE MY FIRM HAS A COMPETITIVE ADVANTAGE Choosing a Generic Business-Level Strategy

Cost Leadership and Differentiation CostLeadershipBenefits DifferentiationBenefits

Choosing a Generic Business-Level Strategy Cost Leadership and Differentiation CostLeadershipBenefits DifferentiationBenefits FlexibleManufacturingTechnologies CombinedBenefits

Advantages of Integrated Strategy A firm that successfully uses an integrated cost leadership/differentiation strategy should be in a better position to: – adapt quickly to environmental changes – learn new skills and technologies more quickly – effectively leverage its core competencies while competing against its rivals

Benefits of Integrated Strategy Successful firms using this strategy have above- average returns Successful firms using this strategy have above- average returns Firm offers two types of values to customers Firm offers two types of values to customers – some differentiated features (but less than a true differentiated firm) – relatively low cost (but now as low as the cost leader’s price)

Major Risks of Integrated Strategy An integrated cost/differentiation business level strategy often involves compromises (neither the lowest cost nor the most differentiated firm) An integrated cost/differentiation business level strategy often involves compromises (neither the lowest cost nor the most differentiated firm) The firm may become “stuck in the middle” lacking the strong commitment and expertise that accompanies firms following either a cost leadership or a differentiated strategy The firm may become “stuck in the middle” lacking the strong commitment and expertise that accompanies firms following either a cost leadership or a differentiated strategy