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Management Strategy
Achieving Sustained Competitive Advantage

Management Strategy
Achieving Sustained Competitive Advantage Third Edition
Alfred A. Marcus
Anne N. Cohen
MANAGEMENT STRATEGY: ACHIEVING SUSTAINED COMPETITIVE ADVANTAGE, THIRD EDITION

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Library of Congress Cataloging-in-Publication Data
Marcus, Alfred Allen, 1950- author | Cohen, Anne N., author.
Management strategy: achieving sustained competitive advantage/Alfred A. Marcus, University of
Minnesota, Anne N. Cohen, University of Minnesota.
Third edition. | New York, NY : McGraw-Hill Education, [2017]
LCCN 2016005843 | ISBN 9781259345487 (1-259-34548-3 : alk. paper)
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www.mhhe.com
To my wife, Judy, and to my sons, David

Isaac and Ariel Jonathan, philosophically
inclined and always questioning everything.
Alfred A. Marcus
To my wonderful husband, Dwayne, and to

our charming sons, Brendan and Christopher.
Anne N. Cohen
About the Authors

Alfred A. Marcus
Alfred A. Marcus is currently the Edson Spence Chair of Strategy and Technological
Leadership at the University of Minnesota, Carlson School of Management and the
Center for Technological Leadership. He has been on the faculty at Minnesota since
1984. His articles have appeared in the Strategic Management Journal, Academy of
Management Journal, Academy of Management Review, and Organization Science,
among other places. He is the author or co-author of many other books including Inno-
vations in Sustainability, published by Cambridge University Press, The Future of
Technology Management and the Business Environment: Lessons on Innovation, Dis-
ruption, and Strategy Execution, published by Pearson, Financial Times, Strategic
Foresight, published by Palgrave MacMillan, and Big Winners and Big Losers, pub-
lished by Wharton School Press. His PhD is from Harvard, and he has undergraduate
and graduate degrees from the University of Chicago. Prior to joining Minnesotas fac-
ulty he taught at the University of Pittsburgh Graduate School of Business and was a
research scientist at the Battelle Human Affairs Research Centers in Seattle, Washing-
ton. He has consulted or worked with many corporations including 3M, Corning, Excel
Energy, Medtronic, General Mills, and IBM and spent a sabbatical year at the Sloan
School of Management, MIT. Besides teaching in the Carlson School and the Techno-
logical Leadership Institute at the University of Minnesota, he teaches in the Technion
MBA program in Israel. He also has taught strategy or management courses in Norway,
Hungary, the Czech Republic, Romania, and Costa Rica and was involved in a multina-
tional research project sponsored by the NSF involving companies in the U.S., Finland,
Israel, and India.
Anne N. Cohen
Anne N. Cohen is a Senior Lecturer at the Carlson School of Management, an active
consultant to businesses, an executive coach, and a board member for medium to
large private enterprises. After receiving an undergraduate degree in mathematics,
she began her professional career in the insurance and transportation industries. Her
roles focused on the development and managerial oversight of critical information
technologies and infrastructures supporting actuarial, purchasing, logistics, and fuel
hedging functions. Upon receiving her MBA, Anne launched her own business
which served both the residential and commercial market for furnishings and
finishes. Her client base included individuals around the globe as well as various
hotels, offices, institutions, municipalities, and resellers. The success of this firm
p ermitted both her transition to the classroom, and the launch of her current
consulting business.
vii
viii About the Authors
Anne currently teaches courses at both the undergraduate and MBA levels in
strategic management, entrepreneurial management, and strategic leadership. She has
also been active on campus as a mentor to a number of startups, as a member of the
Carlson Schools ethics coursework committee, as a summa cum laude advisor, and as
the public and nonprofit program advisor. Off campus, she is highly engaged in the
business c ommunity, focused on providing strategic guidance to senior leaders, help-
ing build high-performance leadership teams, and serving on the local economic
development authority.
Preface
This is a practical book designed to assist those who engage in the art and practice of
strategy in organizations large and small in countries throughout the world.
Strategy is probably the most basic and at the same time the most advanced discipline
in management. It is a discipline whose principles need to be considered by managers at
the most advanced levels of the private sector, understood by individuals pursuing
careers in institutions in the public and non-for-profit sectors who regularly come into
contact with business, and absorbed by undergraduates just starting out in their
businesscareer.
Instruction in strategy takes place in the worlds leading business schools in execu-
tive, MBA, and undergraduate programs and in in-house corporate programs designed
for managers and executives, and this text has been designed to comfortably support the
rigors of such programs with copious lessons and examples.
Yet, it is also critical to recognize that employees at all levels, and within all sectors,
should be provided with a common language of strategy. All must understand the basic
principles of strategy so that they can be more fully attuned to the many competitive fac-
tors that can be most easily monitored from the organizations front lines. So, this text
aims to provide a reference that is accessible to key employees at all levels of the orga-
nization, to offer clear frameworks for strategic thinking and action, and to help these
employees formulate effective arguments for strategic change when they sense shifts in
todays dynamic marketplace.
This book is the third edition of a previously published text. The main change in this
edition is that the book now has a co-author, Anne N. Cohen., a full-time instructor in
strategy at the Carlson School of Management and a long-time practitioner of strategy as
a consultant and employee of major U.S. companies. Anne is an enthusiastic and knowl-
edgeable teacher with real-world savvy. Her contribution has made possible vast im-
provements in the organization and structure of each of the chapters of this book and the
insertion of numerous new examples and other materials. This edition has been vastly
improved by Annes contributions, which are very much appreciated.
The new edition has been thoroughly updated. Material no longer relevant has been
discarded and new material introduced. This book remains short and to the point. It is
conceptual in nature, although it has numerous examples, and it should be used in con-
junction with the many fine cases available in strategic management.
Many books purport to give instruction in the fundamentals of strategy; however, as
the academic discipline of strategy has evolved in arcane and specialized ways, these
books often miss the most basic ideas in strategy. For example, in his classic and
landmark 1980s books on strategy Michael Porter of the Harvard Business School estab-
lished that sustained competitive advantage is strategys basic purpose, but even Porter
failed to clearly define what sustained competitive advantage actually meantand as a
ix
x Preface
consequence, his methods were over determined and ultimately too complex for most
practicing managers. He never provided a simple analytical method or series of steps the
strategist could employ.
The definition of sustained competitive advantage used in this book, therefore, is that
of consistent superior performance in comparison to key competitors over a long period
of time. It is not about winning one championship, but about being a dynasty that always
performs substantially better than other companies in an industry. Achieving this goal is
never easy, so this book provides its readers with a simple but disciplined approach to
engage in the effort to attain sustained competitive advantage.
After establishing in Chapter 1 that the goal of strategy is to achieve sustained com-
petitive advantage (SCA), each subsequent chapter takes up in turn the remaining ele-
ments of a model or formula for achieving SCA.
Specifically, Chapter 2 presents three approaches to doing external analysis (EA),
including classic industry analysis, an assessment of the macro-environment, and the
application of stakeholder analysis to managing the external environment.
Chapter 3 then takes up various methods for doing internal analysis (IA) including
frameworks like the 7 Ss and the value chain, and a newer method for analyzing
strengths and weaknesses that came to prominence in the 1990s, the resource-
based view (RBV). RBV will introduce you to ideas about an organizations
capabilities and competencies as well as its resources. With these tools in hand for
external and internal analysis, you can approach the formidable problem of actu-
ally making moves (M).
Once you have a clear perspective of the firms external and internal environments,
the book introduces four types of general moves that you might consider. These moves
are not discrete and separate choices but can be and often are carried out together or as a
sequence of moves depending on the situation. That is, one move may very well hinge
on or follow another as in chess or war where a series of moves have to be made to
achieve victory.
Chapter 4 is a pivotal chapter inasmuch as it treats both the timing of moves that your
organization can make by going over the elementary principles of game theory and
the actual content of moves at the business levelgeneric positioning or Porters
ideas about low cost and differentiation and the space in-between, which Porter
maintains is to be avoided, but which this book considers essential territory to occupy
and labels best value. Chapter 4 is about business strategy (BS).
Chapter 5 is also pivotal in that it treats not competition within an established busi-
ness as Chapter 4 does, but introduces you to competition at the corporate level where
the main questions are: what are the businesses in which an organization should par-
ticipate, and what should be the scope of its activities? The main tools for determin-
ing the outcome of these decisions are mergers, acquisitions, and divestitures. Chapter
5 is about corporate strategy (CS).
Chapter 6 builds on and deepens central concepts of business and corporate-level
strategy by considering another type of move, that is, globalization, or how to best
align a firms resources, capabilities, and competencies to meet competition in a hotly
contested global marketplace. Chapter 6 is about global strategy (GS).
Preface xi
The final type of general move that the strategist can make is to be entrepreneurial
and to innovate. The perils and pitfalls of being entrepreneurial and innovating are
the subject of Chapter 7. Chapter 7 is about innovation strategy (IS). The last two
chapters cover implementation (I) and reinvention (R).
The final chapters of this text are focused on the implementation of strategy and the ne-
cessity of continual reinvention. Good moves must be well implemented, and Chapter 8
provides solid and practical advice on how to best implement a strategy. Chapter 9 empha-
sizes that the strategic management process is an iterative one. It has to be repeated again
and again. A firm does not simply once have its employees scan the external and internal
environment and take a series of moves, but it has to be constantly engaged in these activi-
ties, refining, refocusing, and repositioning itself over time. There is nothing more common
in business than a stale strategy whose basic assumptions have not been criticized based on
performance feedback, and that has not been thoroughly reexamined and reset so that the
firm is repositioned and better equipped to withstand ongoing competitive challenges. This
final chapter also provides a summary of the strategic management process in its entirety.
In short, the strategic model that is central to this book is the following:
SCA = [EA + IA] + [BS + CS + GS + IS] + I+R
Analysis Moves Implementation &
Reinvention
Thus, this book has nine basic chapters very tightly and logically linked with a goal
in mind, SCA, and a series of steps laid out to help the strategist reach that goal. For
those teaching strategy at any level, this is an ideal book as these relatively short but
deep chapters can be assigned with one or two cases that can come from any number of
sources. As indicated, the use of cases to supplement the chapters is critical, for it is es-
sential that those who wish to gain mastery of the art and craft of strategy practice it.
Each chapter begins with a profile of an executive or academic who has made a sig-
nificant contribution to strategy (Andy Grove, Michael Porter, Michael Dell, Michael
Eisner, Gary Hamel, and Bill Gates), or a short vignette of a situation that illustrates the
main chapter theme (KFC goes to Japan). Each chapter also portrays the main concepts
with which it deals with discussion of businesses that have been competitors (e.g.,
Intelversus AMD, Amazon.com versus Barnes & Noble, Dell versus Gateway, Best Buy
versus Circuit City, Disney versus AOL Time Warner, Coke versus Pepsi, and Walmart
versus Spartan Foods.). This book is rich in examples and practical applications.
To sum it up, the rationale for the book is the following:
Most strategy books have lost sight of the basic purpose of strategymaking a series
of moves, which are designed to achieve sustained competitive advantage.
Most books fail to relate moves back to their outcomesthe extent to which these
moves actually affect business performance.
This book is focused on the moves corporations can make and the types of analyses
required to make these moves effective.
It shows managers how to undertake an analysis of the industry environment and an
analysis of a companys internal resources before making moves.
It provides solid advice on how to implement a strategy, once it is formulated.
xii Preface
The main moves that flow from the analysis are positioning of the firm in relation to
its competitors in terms of the cost and quality of its products, positioning it in terms of
the scope of businesses in which it is involved, positioning it in terms of its global versus
domestic reach, and positioning it with respect to the extent to which it will strive to be
an innovator as opposed to a follower.
The exhibit below indicates in detail how the third edition compares with the books
prior edition.
EXHIBIT Main Changes from Edition Two to Edition Three
Chapter 1 New examples. Added a step to making winning moves called ongoing evaluation and implementation;
WINNING MOVES removed sections on balanced scorecard and industry boundaries which are covered elsewhere.
Chapter 2 New examples. Started with broader picture of external analysis (macro-analysis) and then discussed the spe-
EXTERNAL ANALSYSIS cifics of industrial organization analysis, the five forces, with emphasis on the five-force dynamism. Updated
discussion of pharmaceutical and airline industries, added entirely new section on strategic group analysis
with mobile phone and restaurant examples. Extended discussion of scenario analysis and system analysis.
Chapter 3 New examples. Reversed the order of discussion with the resource-based view coming first. Emphasized
INTERNAL ANALSYSIS examples like Moneyball more. Showed systematically how resources, capabilities, and competencies are
linked and emphasized the need for their replenishment. Integrated financial analysis with value chain analy-
sis. Reorganized section called management theory under title of assuring accounting and ended the chapter
with a summary of how to do a SWOT (strengths, weakness, opportunities, threats) analysis.
Chapter 4 New examples. Reversed the order of discussion with positioning coming before timing and a new section
POSITIONING, TACTICS, on tactics coming between positioning and timing. Section on tactics, offensive and defensive is quite unique
AND TIMING and special. Discuss life-cycles in section on timing. Game theory comes at end and not beginning of chapter.
Updated early/late mover discussion.
Chapter 5 New examples. Retitled chapter Corporate-Level Strategy and Diversification as opposed to Mergers, Acquisi-
CORPORATE-LEVEL tions, and Divestitures. Introduced new section on tactics short of full-scale merger and acquisition. Put
STRATEGY AND greater emphasis on examples of good deal making and effective management. Further developed section
DIVERSIFICATION on why mergers and acquisitions fail. Maintained discussion of portfolio models and more explicitly featured
transaction cost reasoning in section on vertical integration.
Chapter 6 New examples. More managerial with section on options for global expansion and global success factors.
GLOBALIZATION Landscape of future discussion is more succinct and up to date.
Chapter 7 New examples. Reorganized to make more managerially relevant. Introduced distinction between incremen-
INNOVATION AND tal and radical (seismic) innovation and provided extended examples from smartphone and other industries.
ENTREPRENEURSHIP Explicated uniqueness of Apple and its accomplishments. New section on process of innovation with four fac-
tors discussed: the innovator, the organization, finance, and government. New section on the business model
with managerially relevant process laid out of how to determine opportunities to pursue, external and internal
consideration, vetting ideas, creating prototypes and pilots, and scaling up. Extended discussion of barriers
to innovation to diffusion curves, time, flawed processes as well as risk and uncertainty. Moved leading edge
industries and environment as business opportunity to last chapter.
Chapter 8 New examples. Changed order with this chapter coming before last chapter and not being last chapter. Chap-
IMPLEMENTATION ter remains very managerial with bad examples followed by a 10-step process for effective implementation.
Chapter 9 New examples. New sections develop idea that strategy is about preparing for inevitable turmoil and uncer-
CONTINUOUS tainty; it involves a portfolio of initiatives that must be managed, and requires a regular reinvention of the
REINVENTION business model. Open sources, minimally viable models, and eco-system are introduced as part of what can
be used to reinvent the business models. Discussion of leading-edge industries is now found here. Continued
to wrap up book with recapitulation of model strategy as external, internal analysis, moves, implementa-
tion, and reassessment. Incorporated judo strategy discussion in final examples of Microsoft and retail
foodindustry.
Acknowledgments
So much of what I know about strategy I have learned from my colleagues in the Strategic
Management and Organization Department at the Carlson School of Management. They let
me serve as department chair from 1994 to 2000 (I kept urging them to have a coup detat),
and in that capacity, I read their papers and came to especially value and appreciate their
work. Fundamental to my thinking about strategy are ideas about the external environment
and how to analyze it. At Minnesota, we always have been strong in this area, and I would
like to especially thank my colleagues Aks Zaheer, Andrew Van de Ven, Shaker Zahra, Joel
Waldfogel, Myles Shaver, Mary Benner, Paul Vaaler, Sri Zaheer, Dan Forbes, Stu Albert,
Jiao Luo, Russell Funk, Aseem Kaul, Harry Sapienza, Gurneeta Vasudevia, Ian Maitland,
and Sunasair Dutta. Past colleagues such as Margie Peteraf (Dartmouth), Bala Chakravarthy
(IMD), Phil Bromiley (University of California, Irvine), P. K. Toh (University of Texas),
Richard Wang (Babson), and Stefanie Lenway (University of St. Thomas) also have influ-
enced me. I have learned an enormous amount from Ari Ginberg at NYU. I owe debts of
gratitude to former PhD students such as Adam Fremeth at Western Ontario, Bill McEvily
at the University of Toronto, Sumit Majumdar at University of TexasDallas, Marc Ander-
son, who is at Iowa State, Tim Hargrave, who is at Simon Fraser University, Mazhar Islam,
who teaches at Tulane, and especially to Joel Malen at Hitotsubashi University in Tokyo.
In addition to teaching at the Carlson School, I have taught strategy in the Manage-
ment of Technology program at the University of Minnesota. This program is sponsored
by the engineering school of the University of Minnesota and is mainly composed of
mid-career engineers from local companies. From my students in this program I have
learned and continue to learn a great deal. The head of this program, Massoud Amin, is
a true gem and a great colleague. Other faculties there are in the same category. The
students have to write capstone papers, and they must present them to faculty commit-
tees. The capstones involve real-world company problems, and I have learned a great
deal from how the students have approached these problems and tried to solve them. The
staff at the Carlson School and at the Management of Technology program are superb
and have assisted me a great deal in all the work that I have done there.
I teach part of the year at the Technion in Israel. Eitan Naveh of the Technion in
Israel, who was a post-doc at Minnesota who worked with me for a number of years, is
an excellent colleague. I also want to acknowledge Mia Erez and Dovev Lavie as excel-
lent Technion colleagues from whom I have learned a great deal as well as PhD student
Ella Glickson and the many superb Technion students who have been in my classes.
And of course, there is my wife who has not complained (or has not complained a lot)
about my constantly working. My older son David has become a writer and editor of
note himself. He co-edits Dissent Magazine. My younger son, Ariel, works for Spotify,
which brings us sweet music by which to live. Ariel has a keen sense for the strategies of
startups, and I have learned a great deal from him as well.
Alfred A. Marcus
xiii
xiv Acknowledgments
Nanos gigantum humeris insidentes . . . It is at times like these that I realize I am but a
dwarf standing on the shoulders of giants, and that Im extremely fortunate to have so
many giants in my lifethose that have contributed to my formation and have helped
me along the way:
Im indebted to those that have shaped my journey to the front of the classroom, from
my initial inspiration, David Stenson, who could hold the rapt attention of math
students with his graphs of 3D rotations (all done in chalk pastels in those days), to
Tim Robertson, my first teaching mentor, to Phil Anderson, my first department chair
who first informed me that I had caught the teaching bug, to Myles Shaver, Harry
Sapienza, Steve Spruth and Svetlana Madzar, who served on my hiring committee at
Carlson School.
Im humbled by the talents of my co-author, Alfred Marcus, who invited me to par-
ticipate in the writing of this edition. It has been a joy to engage and collaborate with
such a gifted and prolific strategist as we developed this editions topics. He has been
a wonderful colleague.
I am also thankful to all those that helped us cross the finish line with this editions
manuscript. Thank you Merav Levkowitz, Arpana Kumari, Ann Cutaia, Jenilynn Mcatee,
Laura Spell and the many dedicated professionals on this books production team.
Im grateful for my clients, students and wonderful team of assistants. They energize
me and teach me just as much as I teach them by sharing their perspectives, their
goals, their challenges and their talents.
Im also greatly blessed with a loving family that provides unwavering support: Dwayne,
my husband, and Brendan and Christopher, my two sons. Dwayne, who started his
career as an aircraft engineer, now serves as regional manager for Eaton. Brendan works
on multi-billion-dollar energy infrastructure projects at Xcel. Christopher, our car nut,
works for Audi in sales. My extended familyas anchored by my Aunt Pat in Ohio
(Sr. Patricia Conway), Aunt Jane in California (Mrs. David Volz), and cousin Lynn
Conway in Floridahas also been a source of great love and strength. Life is good.
Lastly, I will always remember my very first giants, two great parents, Jordan and
Agnes Ussai, who throughout their lives so selflessly gave our family countless and
enduring gifts of knowledge, courage and faithfulness.
Anne N. Cohen
Brief Contents
Prefaceix 5 Corporate-Level Strategy and
Diversification109
1 Winning Moves 1 6 Globalization139
7 Innovation and Entrepreneurship 157
PART ONE
External and Internal Analysis 23
PART THREE
2 External Analysis 24 Implementation and Reinvention 185
3 Internal Analysis52 8 Implementation186
9 Continuous Reinvention 203
PART TWO
Making Moves 81
GLOSSARY229
4 Positioning, Tactics, and
Timing82 INDEX237
xv
Contents
Prefaceix Scale Economies and Learning Curves 32
Government Policies 32
Chapter 1 Demographics, Natural Resources, Technology,
Winning Moves 1 and Culture 33
The Five Forces 33
Introduction1 Rivals 34
Sustained Competitive Advantage 2 New Entrants 34
Making Winning Moves 4 Substitutes 35
Step 1: Analysis 5 Suppliers and Customers 35
Step 2: Moves 5 Sustained Competitive Advantage 36
Step 3: Implementation and Ongoing Industry Dynamics 36
Reinvention 6 PharmaceuticalsA Five-Star Industry
Understanding Management Strategy: Three underFire 37
Analogies6 AirlinesA No-Star Industry
A Chess Analogy 6 Redeemed 38
A War Analogy 11 Transient Industry Attractiveness 40
A Sports Analogy 16 Stakeholders 40
Measures of Overall Dominance 19 Strategic Group Analysis 42
Summary20 Mobile Phones 42
Reflections for the Practitioner 21 Restaurants 43
An Assignment for the Traditional Student 21 Scenarios45
Endnotes21 Simple Extrapolation 45
Defining Bookends 46
PART ONE Leading Indicators 47
Systems Analysis 47
EXTERNAL AND INTERNAL
Summary49
ANALYSIS23 Exercises for the Practitioner and
the Student 50
Chapter 2 Endnotes51
External Analysis 24
Introduction24 Chapter 3
Industry Definitions 25 Internal Analysis 52
External Pressures Lead to Industry
Movement27 Introduction53
Industry Moves, Implications, and The Resource-Based View 53
Trade-Offs28 Resources, Capabilities, and Competencies 55
A Framework for External Analysis 29 The VRIO Test 58
Deciding If the Game Is Good 30 From Capabilities to Competencies 60
The Best Game 31 An Organizations Distinctive Competence 62
xvii
xviii Contents
Replenishing Resources, Capabilities, and Exercises for the Traditional

Competencies 64 Student106
Value Chain Analysis and a Firms Exercises for the Practitioner 107
Financials64 Endnotes107
Value Chain Linkages 66
Virtual Integration and Outsourcing Schemes 66 Chapter 5
Value More than Costs 67 Corporate-Level Strategy and
Three Levels of Important Financial Diversification109
Considerations68
Assuring Accountability 71 Introduction109
Task- and Team-Oriented Organization 72 Reasons for Diversification 110
Contingency Theory 73 Types of Diversification 112
The Seven Ss 75 Tactics Short of Full-Scale Merger and
Strengths, Weaknesses, Opportunities, and Acquisition 114
Threats (SWOT) 76 Merger, Acquisition, and Divestiture Results 115
Summary77 A Shifting Landscape 117
Exercises for the Practitioner and Examples of Good Deal Making 120
the Student 77 The Global Economic Meltdown 122
Endnotes78 Why Do Mergers and Acquisitions
Fail?124
Why Do Acquisitions and Mergers
PART TWO Succeed?126
MAKING MOVES 81 Mergers of Equals 126
Effective Multi-Business Management 127
Chapter 4 Portfolio Models 129
Positioning, Tactics, and Timing 82 The BCG Matrix 129
The GE/McKinsey Model 130
Introduction82 Breaking Down the Corporate Hierarchy 131
Positioning83 Is Vertical Integration the Answer? 133
Low-Cost Positions 84 Transaction Costs 135
Differentiation Positions 86 Summary136
Are Low Cost and Differentiation Exercises for the Practitioner and
Compatible? 88 the Student 137
Repositioning 90 Endnotes137
Many Ways to Differentiate 93
Tactics94 Chapter 6
Offensive Tactics 95
Globalization139
Defensive Tactics 96
Timing96 Introduction139
Life Cycles 96 Reasons for Globalization 140
Early Movers versus Late Starters 97 Life Cycle Factors 141
The Value of Rapid Adjustment 99 Options for Global Expansion 143
Game Theory 100 Product-Market Approaches 145
Expanding the Assumptions 103 Local Adaptation 146
Learning from Game Theory 104 Deciding Where to Invest 148
Summary106 Global Success Factors 150
Contents xix
The Landscape of the Future 151 PART THREE

Labor, Capital, and Technology 151
IMPLEMENTATION AND
Open Economies 153
REINVENTION185
Insecurity 153
Youth 154
Chapter 8
Summary155
Exercises for the Student 156 Implementation186
Exercises for the Practitioner 156 Introduction186
Endnotes156 The Anatomy of Failure 187
The Root Causes of Failure 189
A Comprehensive Implementation
Chapter 7 Framework190
Innovation and Entrepreneurship 157 Step 1: Assess Change Readiness 190
Step 2: Install Integrative Leadership 192
Introduction157 Step 3: Create a Consistent Message 193
Reasons for Innovation and Step 4: Appoint Cross-Functional Program
Entrepreneurship158 Teams 193
Incremental Changes 159 Step 5: Solicit Change Program
Seismic Shifts 159 Proposals 194
Both Incremental Changes and Seismic Shifts 160 Step 6: Select and Prioritize Proposed Change
The Process of Innovation 161 Programs 194
Passionate and Determined Innovators 162 Step 7: Assign Process Owners and Align
Organizations That Transform Innovative Resources 195
Ideas into Reality 164 Step 8: Secure Funding, Formalize Operational
The Performance/Innovation Gap 165 Objectives, and Design Incentives 197
Patient Capital 166 Step 9: Advance and Continually Monitor
Other Funding Sources for New Ventures 167 Initiatives 198
Government Support 168 Step 10: Fortify Gains and Refine the
The Business Model 169 Implementation Process 199
Determining the Opportunities Summary200
to Pursue 170 Questions for the Practitioner 201
External Sources of Opportunity 170 Questions for the Student 201
Internal Sources of Opportunity 173 Endnotes201
Vetting Ideas 174
Creating Prototypes and Pilots Chapter 9
Concepts 176
Continuous Reinvention 203
Scaling Up and a Full Rollout 177
Barriers to Innovation 177 Introduction203
Long S-Shaped Diffusion Curves 178 Preparing for Inevitable Turmoil and
Many-Year Investments 178 Uncertainty204
Flawed Processes 180 A Portfolio of Initiatives 204
Risk and Uncertainty 180 Managing the Portfolio 207
Summary182 Public-Private Partnership Models 209
Exercises for the Practitioner 183 Reinventing the Business Model 210
Exercises for the Student 184 Open Source Options 212
Endnotes184 Minimally Viable Models 213
xx Contents
Eco-System Development 214 Moves after External and Internal Analysis 222
Technology Push versus Market Pull 214 Recognizing Customer Needs 223
Finding Technological Opportunities 215 Summary226
Leading-Edge Industries 215 Questions for the Practitioner 226
Biotechnology 216 Questions for the Student 227
Low-Cost Environmental Solutions 217 Endnotes227
High-Value Environmental Solutions 218
Wrapping Up: The Dilemma of Strategic Glossary229
Change219
Sustained Competitive Advantage 220 Index237
C H A P T E R O N E
Winning Moves
A key warning sign [of] a strategic inflection point is when all of a
sudden, the company you worry about has shifted. You dealt with
one competitor all your life, and all of [a] sudden you do not care about
them, you care about somebody else. A mental silver bullet test [is] if
you had one bullet, whom would you shoot with it? If you change the
direction of the gun, that signals you may be dealing with more
than an ordinary shift in the competitive landscape.1
Andy Grove, former CEO of Intel Corporation
Chapter Learning Objectives

Understanding strategy as a set of both planned and reactive moves taken in the pursuit of
competitive advantage.
Identifying inflection pointsextraordinary shifts in the competitive landscape that change the basis
for sustained competitive advantage (SCA).
Comprehending that SCA is the result of making winning moves over the long term, not just producing
a few years of good performance.
Using analogies from chess, war, and sports to help understand the many facets of making winning
moves, including knowing the enemy and yourself, attending to the rules, concentrating forces,
relying on teamwork, staying agile, and keeping score.
Being aware that firms are simultaneously located in the past, striving to achieve their current mission,
while, at the same time, trying to move toward a vision of the future where they desire to excel.
Understanding the strategic management processan approach designed to help an organization
better understand the strategic context within which it operates, select the best moves in light of its
situation, and successfully execute these moves.
Introduction
A strategic inflection point occurs when a company faces major changes in its
competitive environment. These changes may arise from new technologies, different
regulatory conditions, or transformations in customer values and preferences. In the
1
2 Chapter 1 Winning Moves
21stcentury, such inflection points occur at a more rapid pace and come from many
directions. Here are but a few examples:
Digital mobile media have changed how consumers access information and how they
shop. They have revolutionized every industry from publishing to dating. Gartner
Group forecasts that there will be 7.3 billion smartphones, tablets and PCs, and
26billion other Internet-connected products by 2020.2 This growing base of devices
is having multiple impacts on just about every business.
Regulatory changes in the U.S. health care system have quickly shifted the tides for
medical practices, hospital systems, medical device manufacturers, developers of infor-
mation technologies, and employers. Health care and health carerelated industry players
have to react to these extraordinary and dramatic shifts in the competitive environment.
An increased desire for healthier living is providing opportunity for producers of
organic foods, suppliers of alternative fuels/transport, and pioneers in customized
genomic medicine.
Companies that fail to react appropriately to strategic inflection points will struggle,
while savvy and agile firms will recognize these points, modify their strategies, and gain
market share.
It is incumbent on everyone in an organization to be alert to these strategic inflection
points as top management teams often are isolated and do not see them coming.3 Lower-
level employees on a companys front lines frequently are the ones that detect the inflections
first. Their job is to bring the inflection point to the organizations attention and mobilize
support for changes in a companys strategy. Gaining recognition for spotting inflection
points and introducing strategic change in a company is a method for career advancement.
Those who notice and help make the needed changes can be rewarded for their efforts.
This book, therefore, is meant for everyone in a company, not just top management. It
is meant to sensitize everyone in an organization to the need to identify inflection points.
It provides its readers with the tools for strategic analysis and emphasizes that the goal of
strategy is to achieve long-term or sustained competitive advantage (SCA). These tools
permit readers to make sound arguments for changes that put their companies in a better
position to meet these challenges, and move them from the realm of threats to the orga-
nization to that of opportunities.
This first chapter is meant to acquaint readers with the basics of strategic manage-
ment. It establishes the framework for strategic assessment and analysis that is used in
the book. The framework provides a means to better understand and evaluate a firms
external environment and its inner strengths, to weigh its strategic options, and to make
and carry out recommendations for strategic adjustment. This chapter compares strategy
to three analogous activitieschess, war, and sportswhere the goal is also long-term
strategic advantage.
Sustained Competitive Advantage

The goal of strategy is sustained competitive advantage (SCA) or above-average per-
formance in an industry for a period of ten years or more.4 Though many firms perform
better than their main competitors for a short time, very few companies have consistently
Chapter 1 Winning Moves 3
outperformed their industry for more than 10 years.5 Dominant winners are rare, and the
companies that achieve SCA in most industries areoutliers.
Natural parity is the condition found in most industries. Over a long period, the
performance in most industries converges toward a mean. Many top management teams
have no better aspiration than to keep up with industry norms. They benchmark what
others are doing, rather than trying to be industry leaders. The inability of companies to
maintain competitive advantage for long periods suggests that firms have not typically
recognized inflections and change within their industries. They must adjust existing
models to novel circumstances.
According to one study, only about 5 percent of firms achieve sustained competitive
advantage with respect to an indicator of profitability (return on assets), and only about
2 percent do so with respect to an indicator of stock market performance.6 Surprisingly,
these high performers are not regularly cited in the business press as exemplars. They
often operate under the radar, and their stories are not told. How do these companies
achieve SCA?
Choosing a route to sustained competitive advantage depends on being in a strong
industry or having the resources and capabilities to compete effectively in industries that
are waning. A company must scan the external environment to find good industries in
which to compete, and it must build internal resources and capabilities to be a strong
competitor within the industries it chooses.
Some companies achieve SCA by choosing industries with high mean returns and
trying to dominate them. All the firms in such an industry thrive, and thus the industry is
an attractive one in which to compete. The implication of this route to success is to
choose a successful industry or industry niche and ride its overall success. Take advan-
tage of the good economic conditions in such a segment to grow revenues and profits.
The path to success is to select the right industry or industry niche in which to operate.
If the segment does not exist, play a leading role in its creation.
Not all companies have the freedom to move from industry to industry, however, they
too can achieve SCA by being the dominant player in a consolidating or declining
industry. Such an industry has low mean returns, and the deviation in these returns is
high. If the deviation is high, there is still room for some companies to excel. Companies
that achieve SCA in this type of setting stand out by means of their superior resources
and capabilities. They dominate industries in decline. Being a dominant player in a weak
industry means possessing the unique resources or capabilities that permit a company to
win in a demanding setting of market shrinkage. The moves companies make to achieve
SCA then must be backed up by moves to protect their leadership position once it has
been achieved. The path to SCA consists of choosing the market segments in which to
compete which fit well with a companys strengths and weaknesses.
In order to help companies realize SCA, Chapter 2 introduces external analysis (EA)
and Chapter 3 discusses internal analysis (IA). EA permits you to identify the opportu-
nities and threats a company confronts in its industry, and IA allows you to analyze the
strengths an organization can utilize to take advantage of the opportunities and to defend
itself from the threats.
Industry structure is the main focus of Chapter 2. If an industry is very concentrated,
some firms have high market share, and there are strong barriers to entry, then the indus-
trys prospects are promising and long-term above-average returns are more likely.
A companys strengths and weaknesses are the main focus of Chapter 3. Peculiar
configurations of resources, capabilities, and competencies make the positions of lead-
ing firms especially hard to copy and highly valuable. These firms maintain an advan-
tage because of their rare, nonsubstitutable internal assets. However, even these assets
can be challenged. Organizations must be perpetually vigilant against competitors that
devise better business models. Thus, it is incumbent on all firms to continuously adjust
their business and corporate strategies.
Smart strategic moves can help a business compete by positioning it with respect to
the cost and quality of the goods and services it offers. That is the domain of business
strategy (BS). Continuous positioning and repositioning via moves a company makes is
the main focus of Chapter 4. An understanding of external and internal environments
also helps with the decision about which types of businesses in which to compete. That
is the domain of corporate strategy (CS). Changing businesses via mergers, acquisi-
tions, divestitures, and alliances is the main focus of Chapter 5.
Company moves also entail choices about globalization and innovation. Global
strategy (GS) is essential for any business today. What will be the scope of its activities?
Where will a company sell its products? Where will it source its raw materials, design
and make its products, and do research and development? Chapter 6 focuses on the
opportunities and threats offered by globalization.
Companies also must be ready to abandon existing products and business models,
find new opportunities, and make the leap into fresh fields of endeavor. Having a vig-
orous innovation strategy (IS) that rests on the understanding that todays markets are
not permanent is also essential. Chapter 7 is about entrepreneurship and the striving
for innovation.
Implementation (I) is the alignment of a strategy with the management systems and
tools to carry it out successfully. Management may have a bold and exciting vision about
where to go next, but if it lacks the means to carry out its vision, its creativity and imag-
ination in establishing that vision are likely to be in vain. Chapter 8 emphasizes the tools
managers need to successfully implement strategy.
Firms must constantly position and reposition themselves in relation to their
competitors. This process is not a one-time event. Repositioning (R) is the constant
adjustment and revisiting of strategy that are essential for every firm. In repositioning, a
firm can engage in tactics borrowed from judo to keep its opponents off balance. Chapter 9
focuses on the role that judo strategy plays in repositioning.
Altogether, this book brings you the formula for making winning moves dia-
grammed in the following section. First, do EA and IA; then choose from a reper-
toire of moves that include BS, CS, GS, and IS; and finally engage in continuous
Iand R. Thus, SCA = EA + IA followed by some combination of BS + CS + GS + IS,
which is to be followed byI+ R.
Making Winning Moves

The main message of the book is that in response to changing external circumstances, an
organization constantly must endeavor to find new sources of competitive advantage. This
requires that the organization make a sequence of short-term maneuvers and long-term
EXHIBIT 1.1
Three-Step
Model for
Sustained
Competitive
1
Advantage EA IA
(SCA) External Analysis Internal Analysis
General Environment Resources, Capabilities
Competitive Forces & Competencies
Evaluation of
3
Selection of Options
Performance
Business, Global and Corporate Level
&
Strategies & Tactics
Continuous
BS + GS + CS + IS
Reinvention
2 Implementation
Marshalling Resources & Making Moves
SCA = [EA + IA] + [BS + CS + GS + IS] + [I + R]

Analysis Moves Implementation
&
Reinvention
changes in directions that add up to a unique position against which competitors cannot make
serious inroads. Critical to an organizations long-term advantage is positioning its products
and markets in a space free from competitors. In strategizing, a three-step process is needed,
which involves analysis, moves, ongoing evaluation, and implementation (see Exhibit 1.1).
Step 1: Analysis
Before exploring the various moves a company can make to achieve SCA, it is important
to do the types of analyses that will increase the chances that the moves a company
makes will yield success. The two types of analysis needed are (1) an analysis of the
companys external environment, EA (see Chapter 2), and (2) an analysis of its internal
environment, IA (see Chapter 3). Assessing a companys external opportunities and
threats and matching them with its internal strengths and weaknesses provide it with the
ability to make better moves. How to estimate and match these factors is covered in
detail in the books next two chapters.
Step 2: Moves
The moves that flow from such analyses better position a company to prevail in the
ongoing competitive challenges it confronts. This book explores moves that position the
firm in relation to its competitors with respect to the cost and quality of the products and
services the firm provides in Chapter 4 (BS); the scope of its activities in Chapter 5
(CS); its global, as opposed to domestic, reach in Chapter 6 (GS); and the extent to
which it innovates and searches for new business opportunities as opposed to exploiting
existing ones in Chapter 7 (IS).
Step 3: Implementation and Ongoing Reinvention

The need to implement a strategy well once it is chosen is the lesson of Chapter 8, while
repeated repositioning of a company vis--vis its competitors is emphasized in Chapter9.
The whole process of deliberating how to achieve SCA as a function of EA, IA, moves,
and sound implementation must be continuous. The analytical process cannot come to a
halt. Distinct stages of formulation and implementation should not be separated out, but
rather ongoing evaluations, adjustment of strategies, and continuous reinvention should
be the norm.
Understanding Management Strategy: Three Analogies

The tools of strategic management are best understood through analogies with other
areas in life in which competition is fierce, such as chess, war, and sports. Each of these
bears important resemblances to strategy.
A Chess Analogy
Strategy is like chess in that the goal may be seen as checkmate, or thwarting an oppo-
nent so that escape is nearly impossible (see Exhibit 1.2). In driving Borders and Circuit
City to bankruptcy, Barnes and Noble and Best Buy came close to this goal, but in busi-
ness, the results are rarely so definitive. Rather, the best companies can hope for is sus-
tained dominance, similar to that achieved by Microsoft and Intel in their markets during
the 1990s. In disabling their competitors, Microsoft and Intel each captured more than
90 percent of the market in operating systems and microprocessors, respectively.
EXHIBIT 1.2
Strategy and
Chess
Anne Cohen.
Operating by the Rules

In both business and chess, dominance has to be achieved according to rules. Following
the rules and playing fairly guarantee that the results are a consequence of skill rather
than of illegal or unfair practices. In the world of commerce, skill means being better
able than ones opponents to meet customer needs.
The rules of chess are very well defined and have remained the same for centuries, so
few questions arise about the legality or ethics of the moves. In strategy, by contrast,
companies operate with a legal framework that is less precise and static, so it is some-
times difficult to ascertain what is permissible. As a result, firms may believe that their
job is to test the laws limits. Managers may have the view that innovative theories pro-
moted by consulting firms and management theorists give them the license to stretch
what the law allows. However, when gains are achieved by questionable moves, the
extent to which these gains endure depends on how the legal system judges them. The
courts may reverse apparent victories. The stories of Enron, Arthur Andersen, World-
Com, Adelphia, and other companies that came to light after 2000 provide stunning
examples and warnings against engaging in illegal activities. They show that society will
not tolerate some moves. Blatant cheating, when detected, does not go unpunished.
Therefore, the moves firms make must be above board and in accord with prevailing
legal doctrine and ethics.
Milton Friedman, who maintained that it was the purpose of managers to maximize
shareholder returns, held that doing so must occur within the confines of law and ethics.7
However, the law is not always clear regarding some strategic issues. The judgments of
legal authorities clarify what the law says and establish precedents for how the game is
played. Regulations dealing with competition, for instance, have shifted over time,
depending on who the legal authorities were and how they interpreted the law. The
Kennedy administrations view of antitrust law was much stricter than todays under-
standing of this phenomenon. The European Union (EU) struck a major blow against
Intel in 2009 when it imposed a huge fine on the company for violating its antitrust laws.
Microsoft has been treated similarly by the EU, and the EU has been preparing action
against Google for quite some time, while U.S. antitrust laws have moderated. Compa-
nies must take into account not only the rules in their countries of origin, but the rules
globally in every nation in which they operate.
According to legal doctrine in the United States in the early 1960s, simply having
very high market share was proof of possible illegality. Today, high market share does
not have this connotation in the United States, but it may in other countries. The United
States requires proof of actual anticompetitive behavior. For example, when Microsoft
was sued by antitrust authorities it was not because it had more than 90 percent of the
market in operating software, but because it was alleged to have taken specific actions to
exclude a competitor, Netscape, from installing a browser on newly manufactured per-
sonal computers. The legal challenges Microsoft faced threatened to reverse the gains
the company had made in the 1990s. To continue as the worlds leading software com-
pany, it had to defend itself in the courts. In the face of this challenge, Microsoft almost
was broken up into several firms.
Intel, too, has been embroiled in frequent legal controversies in the United States with
major competitors such as AMD. It tried, for example, to use the legal system to block
Via Technologies, a Taiwanese company and AMDs primary chipset partner, from mak-
ing chipsets that would be compatible with Intels Pentium 4 chips. Via turned around
and sued Intel for trying to abridge its rights to operate.
Changing the Rules

Legal suits and countersuits affect the strategic battles in which companies are engaged.
Microsofts opponents, including Sun and Oracle, pressured federal officials to be tough
on the software giant. This pressure was a primary reason antitrust authorities acted
against Microsoft.
Thus, companies must be aware that the rules of the game of strategy tend to shift
over time. These shifts occur not only because of variations in the legal and ethical cli-
mate, but also because of changes in technology and economics. These shifts in the
environment in which firms operate are the types of inflection points to which reference
was previously made. To some extent, the forces that change the rules of the game are
outside the control of a company, but often companies have influence over the rules
under which they operate. Nonetheless, the forces of external changes are not entirely
within the control of companies. Some of the changes are hard to direct or block entirely.
Once they gain momentum, they can have overwhelming power to change an industry,
and a company and its employees have no choice but to adjust.
At the start of the 21st century, executives of Microsoft, Intel, and other leading high-
tech companies discovered how strong these forces were when the bubble burst in their
industry, terror struck, global security became an overriding issue, and extremely tough
economic conditions set in. Plus, as these events occurred, users were starting to install
Linux, a virtually free operating system that could replace Windows.
Fundamental new forces in the external environment such as these require an altera-
tion in firm strategy. All of the employees in a company must analyze these changes and
consider the moves a company can make to better position itself in the face of chal-
lenges. For example, employees can promote the idea that a company should shift all or
some of its resources to areas in which it can compete better. Companies can be prospec-
tors, aggressively pursuing new growth opportunities, or defenders, clinging to their
existing niche and trying to protect their turf. They also can be analyzers, both searching
for new market opportunities and protecting an existing position. In the worst case, they
can be reactors, incoherently responding to the changed circumstances.
The success of the moves a company makes ultimately depends on how much
flexibility it has to maneuver. Companies always find themselves between two
polesthe past and the future. Their mission typically represents the companys cur-
rent purpose and what it has been good at in the past, while their vision, on the other
hand, normally is based on their futurewhat they would like to be good at next
(see Exhibit 1.3).
Envisioning Where to Go Next

In chess, its critical to think several moves ahead, but even if the employees in a com-
pany have a vision of where they would like the company to go, it may not be possible
to achieve this vision quickly. Because of fixed physical or human assets, bureaucracy,
or the inflexible worldviews of top managers, the company might not easily make the
transition from where it is now to where it would like to be next.
EXHIBIT 1.3
A Companys Int Ext
er ern
Mission and na a
lF l&
Vision or
ce
s
Vision
Proactive &
Reactive
Moves
Mission
Andy Grove recommends that companies be agile giants.8 They need agility to
move quickly to new competitive ground (this is their vision), but once they occupy that
ground, they must be giants, capable of defending it (this is when their vision becomes a
mission). In the mid-1980s, Intels main product was computer memory. When Intel
could no longer compete with large and better-capitalized Japanese firms in this busi-
ness, its employees realized the company had to concentrate on the one thing it did best:
focus on an area in which it had comparative advantage. So, Intel shifted to micropro-
cessors based on the reasoning that it was better to be positioned as the top player in
microprocessors than to be a mediocre player in both microprocessors and memory.
Comparative advantage means that a company pursues what it does best. This is the
foundation for sustained competitive advantage. Doing what a firm does best, doing
what no other firm can do as well in meeting customer needs and expectations, is the key
to sustained competitive advantage.
A company incorporates these strengths into its mission but, while pursuing its mis-
sion, it must also have a vision for where it wants to go next, as conditions do change.
Companies such as Intel and Microsoft constantly balance between what they have
proven good at in the past and what they would like to be good at in the future. They are
trying to develop new options they might use to achieve advantage when their current
businesses slacken. Another firm that has been grappling with how to adjust its strate-
gies to react to changing conditions is Medtronic. Its recent moves are summarized
inExhibit 1.4.
In business, it is also possible to create new games. A company can redefine the game
that is in process, play a different game, or walk away from a game and refuse to c ompete.
Usually, change is gradual and incremental, but it can also be massive and sudden, like
Andy Groves inflection points. Because change cannot be predicted with great cer-
tainty, employees must be alert to a variety of different contingencies. They need to
develop and propose options that will give their firms the flexibility to move in a number
of directions regardless of how external conditions evolve.
EXHIBIT 1.4 The Medtronic mission has endured for many years. It is so deeply engrained that every new employee at the
Where company receives a medallion with this mission as a reminder of the honor and responsibility that they have in
Medtronic Is contributing to human welfare by the application of biomedical engineering to alleviate pain, restore health, and
Headed Next extend life.
Yet, even this biomedical giant understands the importance of developing new options for maintaining competitive
advantage. An external analysis (EA) reveals that the med-tech industry is plagued by several issues, including
pricing concerns, hospital admission and procedural volume pressure, Medicare reimbursement issues, and
regulatory overhang. An internal analysis (IA) shows that the firm has a portfolio of market-leading products, deep
clinical knowledge, global in-hospital footprint, health care economics expertise, lean sigma resources, and a
strong financial position.
In response, Medtronic has made the following moves:
1. Forming a Hospital Solutions business unit after successful pilot ($6 million saved per year) at Maastricht
University Medical Center in The Netherlands.
2. Securing contracts to manage catheterization labs for the University Hospital of South Manchester and Imperial
College Healthcare in London.
3. Purchasing NGC (which manages Italian hospital heart imaging facilities), and plans to expand NGCs business
into additional markets.
4. Undergoing a major merger with Covidien for the tax advantages and increased market scope.
Medtronic has recognized inflection points on the horizon and diversified its lines of business in response to
threats to its core device business. The essence of its strategy is to achieve a balance between the companys
past and its future, to adhere to a core mission while trying to realize a new vision for tomorrow.
Weathering Reversals of Fortune

In business, as in chess, one player dominates for a period but then is replaced by another.
Dynasties do not last that long. Many companies during the 1990s seemed to have a lock
on the top position, only to see reversals of fortune in the early 2000s. Coca-Cola, for
instance, lost its dominance over PepsiCo, General Electric over United Technologies,
and Nike over Reebok. In each instance, the reversal was caused by moves the companies
made: Despite 80 percent of its profits coming from overseas, Coca-Cola stumbled in
Europe as a result of product recalls; PepsiCo, in contrast, bought Gatorade from Quaker
and introduced numerous new beverage products, including bottled water, earlier than
Coca-Cola did. PepsiCo beat both the average stock performance of soft-drink companies
and the stock performance of Coca-Cola in this period. General Electrics financial divi-
sion, GE Capital, which had been its star business unit, went downhill in the early 2000s.
United Technologies (UT) stock performance was better because of the defense buildup
and the strategic initiatives the company took in areas such as quality and globalization.
UT performed at about the same level as companies in its industry, while GE did much
worse. Nike encountered a public outcry against foreign sweatshops and lost its sponsor-
ship of professional sports leagues and its contracts with well-known athletes. Reebok
picked up these sponsorships. Its stock performance was far better than the average foot-
wear company in the early 21st century, whereas Nike performed at about the average.
Dominant companies can stumble, while companies that are behind can moveahead.
Some firms cannot recover after a stumble and find themselves swept into a downward
vortex, which leads to failure (see Exhibit 1.5). They lose market share to rivals, which
reduce profitability levels. Lower profits begin to strain their finances. Their range of
EXHIBIT 1.5 Key Strategies Fail

The Vortex of Loss of
Failure Market Share
Loss of
Profitability
Loss of
Flexibility
Employee
Reductions
Employees Lose
Confidence
Investors
Withdraw
Funds
Bankruptcy
Liquidation
strategic options is thus reduced. Sometimes a firm will reduce employees or pay in
order to sustain margins and keep investors happy. The firms best employees will then
begin to look for opportunities outside the firmand some will be hired by smart
rivals. The mass exodus of employees then leads to operational and productivity
issues. Investors take note and begin to withdraw funds. The firm runs out of options
and may seek the courts protection. Finally, some firms that seek the courts protec-
tion fail to emerge from bankruptcy and liquidate their assets. Other firms, such as
IBM, have escaped the vortex and have come roaring back from the brink under strong
strategic leadership. Yet IBM again faces the prospect of continued declines in
revenue. Thus, strategy is as much about the ability to make comebacks as it is about
achieving dominance in the first place.
Making Moves That Matter

As in chess, the premise of strategy is that the moves companies make matter. The out-
comes are determined by moves that may be negative as well as positive. Enron, for
instance, made notoriously wrong moves, despite the fact that they were grounded and
rationalized in the thinking of the best management consultants of the time. Just as right
moves lead to success, the wrong moves can destroy a company. Of course, Enron self-
destructed for many reasons including fraud, deception, and greed.
Many contests are undecided. The superiority of the players is not apparent, and the
games are in a stalemate. Many companies have been neck and neck for a long period,
and it is unclear which company will prevail, which will fall, and why. That is why it so
important for employees to continually observe the external environment to determine
what opportunities their companies have and what threatens their companies, to analyze
the significance of changes they see, and to always try to break the stalemate by making
recommendations for changes in their companys strategic direction.
A War Analogy
Another useful analogy in strategy is war. Though perhaps extreme, it provides several
principles of importance, from knowing your enemy to hedging against uncertainties.
Know Your Enemy, and Know Yourself

Sun-Tzus Art of War was published more than 2,500 years ago. In it, he wrote: If you
know the enemy and know yourself, you need not fear the result of a hundred battles. If
you know yourself but not the enemy, for every victory gained you will also suffer a
defeat. If you know neither the enemy nor yourself, you will succumb in every battle.9
During World War II, Winston Churchill echoed this principle of knowing your enemy,
when he warned against the treachery of numbers in calculations that did not include
the great unknown variable of the enemys reaction.10 Napoleon, too, said, A general
should say to himself many times a day: If the hostile army were to make its a ppearance
in front, on my right, or on my left, what should I do? And if he is embarrassed, his
arrangements are bad; there is something wrong, he must rectify his mistake.11
In strategy, therefore, employees must examine the external situation in which their
company finds itself, and understand its strengths and weaknesses. The moves a company
makes must be designed to strengthen its competitive position either by changing the
external circumstances or by upgrading its internal resources and capabilities.
Knowing the enemy goes beyond tabulation of numbers and capabilities; it requires
an understanding of culture, values, intentions, customs, organizational doctrines, and
operational preferences as well as the personalities of key commanders and staff
officers.12 Knowing an enemys idiosyncrasies can provide great leverage if properly
exploited. Some enemies, for instance, act according to reason; others according to
emotion. Some wait for events to happen; others make them happen. Some act primarily
out of self-interest; others act selflessly. All are creatures of habit; only the habits differ.
Some can think clearly through shock; most cannot. All act on the basis of what they
believe the situation to benot necessarily on what the situation is. Most are influenced
by what they want to believe.
According to military doctrine, knowing the enemy must be supplemented by insights
into ones own characteristics and traits. These insights aid efforts to unify action, con-
centrate strengths, and offset vulnerabilities.13 These two principles, knowing the
enemy and knowing yourself, are fundamental in both war and strategy.
Not Just Detailed Planning

Like warfare, management strategy also is not just about detailed planning.14 According
to Napoleon, War consists of nothing but accidents and a commander should never
overlook anything that might enable him to exploit these accidents.15 The Prussian mil-
itary strategist Carl von Clausewitz wrote in his book On War, published in 1832, that
detailed planning necessarily fails due to the inevitable frictions encountered: chance
events, imperfections in execution, and the independent will of the opposition.16 The
Prussian general staff did not expect a plan of operations to survive beyond the first
contact with the enemy. It set only the broadest of objectives and emphasized seizing
unforeseen opportunities as they arose.17
Strategy is not necessarily a lengthy action plan. It is the evolution of a general idea
through continually changing circumstances. The results are a consequence of action-
response cycles: Both sides (ones enemy and oneself) act and both respond.18 The out-
comes are not likely to be the intended ones; they materialize from actual encounters
with the enemy.
Strategy is as much about this process as it is about design.19 As design, strategy

means planning, rationally choosing alternatives, and implementing the alternatives as
close as possible to how they were devised, a model that is unrealistic because it ignores
competitors responses. Competitors react to intended strategies in ways that negate what
the firm wishes to do. Then it becomes a matter of adjusting to the actual situation on the
ground. The original plans no longer match reality as the situation unfolds, and rigid
adherence to the plans is not fruitful.
Realized and Intended Strategies

Realized strategies differ from intended ones. They incorporate the response and
counter-response of other decision makers that affect the result. In many circumstances,
the situation changes so much that one would not want to achieve what was originally
intended. Strategy as a process introduces flexibility, which strategy as a formal plan-
ning exercise eliminates.
Implementing a strategy is not entirely different from formulating one (see
Chapter8). Both require on-the-spot adjustment. In Strategies for Change, James Brian
Quinn, professor of management at Dartmouth College, argues that strategies should
develop around a few key concepts and thrusts that provide cohesion, balance, and
focus.20 The essence is to build a posture that is flexible enough and strong enough for
a company to accomplish what it aims to achieve no matter what occurs.
Concentrating Forces
In a letter to one of his generals, Napoleon advised to always keep in mind concentra-
tion of strength.21 Concentrating ones forces, as illustrated in Exhibit 1.6 is the
methodto follow in achieving winning strategies over time. In an ever-shifting battle-
field, one must apply superior resources where needed to achieve victory. Even a
smaller and weaker foe can win if it has mobility to define how encounters take place.
If it can mobilize superior means and apply them at critical junctures, the smaller force
can win. Thus, speed and flexibility in mobilization and application of resources are as
important as possession of these resources.
EXHIBIT 1.6
Concentrating
Distincti
and Deploying ve Comp
etence
Forces Rooted
in Firms
Distinctive
Competencies Distinctive Competence RIVAL
ce
peten
ctiv e Com
Distin
Time
The corporations management, therefore, must:

Determine what confers superiority.
Create a distinctive competence in which the company has comparative advantage.
Apply this competence decisively at the proper time and place to increase the chances
of winning.
This approach may mean conceding certain positions to concentrate forces where the
chances of success are greater. Surprise, speed, and secrecy are needed to move forces to
a favorable position. A company may also have to keep capabilities in reserve to be
deployed in the face of unexpected contingencies.
Outwitting competitors not only means knowing when, where, and how to fight,
but it also means knowing when not to fight and when to retreat. An excellent example
is Intels switch from computer memory to microprocessors as its main product. As
mentioned earlier, under Andy Groves leadership, the company realized it would
never be able to compete with Japanese manufacturers in the computer-memory
market. It did not have access to enough financial capital to build the huge factories it
would need. It could never keep up with the low costs of production that other manu-
facturers such as NEC, with its attention to detail and incremental process improve-
ment, were capable of attaining. Although computer memory had been the basis of
Intels business until about 1985, the company no longer had a comparative advantage
in this product. It had to concede defeat in this market and fight a different battle. The
company switched to microprocessors, where it concentrated forces and achieved
superiority. The decision, according to Grove, was whether to be a weak and mediocre
producer in both computer memory and microprocessors and risk losing on both fronts
or to focus all the companys resources in the one area where it had the chance of
being dominant.22
Redeploying Assets
In his book Only the Paranoid Survive, Grove discusses the importance of being able to
recognize key turning points and redeploy assets.23 Major changes occur in the com-
petitive environment at these inflection points. Conditions change because of shifts in
technologies, government regulations, customer values, and other factors.
According to Grove, people at the top of corporations have difficulty recognizing
such changes and responding. Just as generals may not get the signals emanating from
the battlefield in time to respond effectively, top managers might also not recognize, or
be willing to acknowledge, what is actually occurring. Thus, employees throughout the
company must be enlisted to provide their insights into the signals that are changing
conditions on the frontlines and their recommendations for altering the strategic moves
a company is making.
Obtaining good signals is not just a matter of having good intelligence; it also involves
being receptive to that intelligence. As Grove points out, despite emotional resistance to
change, a company must be willing to shed preconceptions and redeploy company assets,
see where a new opportunity lies and know how the corporations existing base of assets
can be reconfigured to meet it. These insights do not belong to people at the top of a firm
alone. They are insights had by all employees, and their knowledge of conditions the
company confronts must be brought to the attention of decision makers. Thus, employ-
ees at all levels need the tools of strategic analysis to make forceful and persuasive
arguments about what a company should do.
Hedging Against Uncertainties

How does a company respond to changing circumstances? As times become more uncer-
tain and the future less predictable, hedging against uncertainty becomes increasingly
important. The economist Frank Knight distinguished risk from uncertainty based on the
capacity to place objective odds on conditions such as flipping a coin or rolling dice.24
Risk can be objectively calculatedand planned foras opposed to conditions of
uncertainty where the odds are subjectively assigned, where they essentially are made up
based on judgment. According to Knight, competitive advantage and superior economic
performance emanate mainly from bets placed under conditions of uncertainty. When
the risk is known, all rivals can effectively grasp the situation, and the competition is too
intense to earn anything but the most mundane returns.
As Exhibit 1.7 indicates, hedging strategies depend on whether an outcome can be
well described and/or quantitative odds can be assigned.25 A brief discussion of these
strategies follows.
Gamble on the Most Probable Outcome Companies may act based on what they
perceive to be a likely outcome. They make bets with confidence, only to be surprised
later if the world does not evolve as they assumed. A prime example of a company that
made a large bet based on what it believed to be the most probable future was Iridiums
$5 billion investment in its satellite network. When it made this bet it was reasonable to
assume that demand would be large, but events did not turn out as Iridium expected.
However, making bets of this kind is reasonable in some instances. Investments in new
stores by established companies like a McDonalds or a Home Depot are good examples
of extending the scope of proven business models and winning by virtue of superior
execution without being concerned about the risk of serious upheaval.
Take the Robust Route Rather than bet on a single future, companies can choose a
robust strategy, or one that is viable regardless of what occurs. This kind of strategy may
EXHIBIT 1.7 HEDGING STRATEGIES Extreme Moderate Moderate Low

Hedging Uncertainty Uncertainty Risk Risk
Strategies and Qualitative Qualitative Quantitative odds A single best
Levels of outcomes cannot outcomes can be can be ascribed forecast can be
Uncertainty be described described to the outcomes made
Gamble on most probable
outcome X
Take the robust route X X
Delay until further clarity
emerges X X
Commit with fallbacks X X X
Shape the future X X
be referred to as no regrets. Often regulated utilities have taken this route. They hedge
their bets against a number of possibilities. For instance, the key future question may be
about the relative cost of different fuel sources. Utilities create scenarios in which natu-
ral gas or wind is the low-cost fuel and invest in both.
Delay until Further Clarity Emerges In the face of uncertainty, a firm may decide to
stay the course for now. It delays taking action until the situation becomes clearer. While
waiting, the firm makes flexible commitments that minimize downside losses should
worst-case situations take place. It can divide its investments into small increments, not
fully committing at once but gradually over time in accord with additional clarity it
gains and confidence it acquires from moving forward slowly in trial-and-error fashion.
The risk is that when the firm decides to fully put its stake in the ground it may be too
late. Its competitors will already be there, and it will not be able to dislodge them. Such
was the case with both Xerox and Kodak in their slow adjustments to a digital world.
Delay, on the other hand, may work in the case of Boeings decision not to pursue the
super-jumbo-jet option.
Commit with Fallbacks An alternative is to fully commit, but with fallbacks, should
the plans be unrealistic. This path is not a refusal to commit. It is not avoidance of going
full thrust. Instead, the company can justify the risk it is taking because it is convinced
that its initial position and capabilities provide it with a long-run competitive advantage.
It thoroughly analyzes the risk on this basis. Do its initial position and capabilities justify
the action? Major petroleum companies created fallback positions in renewable energy
in the event that fossil fuel supply is severely constrained. BPs beyond petroleum
initiative was not just a public relations gimmick, but a fallback position meant to pre-
serve the companys flexibility. Committing to fallbacks works best if there is a payoff
structure such that investments that fail entail tiny losses, while those that succeed yield
very high returns.
Shape the Future Another alternative is not to be passive in the face of diverse futures,
but to try to actively drive and influence what takes place.26 A firm uses the resources it
commands to increase the odds that the most desirable outcome, the one it wants the
most, prevails. A shaping strategy revolves around a point of view of where an industry
will evolvewhere the company wants to see itself in five or ten years. Examples include
FedExs overnight delivery methods, Southwest Airlines no-frills model for domestic air
travel, and the pioneering efforts of Amazon and eBay in Internet commerce. Trying to
shape the future makes the most sense when there is rapid discontinuous change and the
future is very hard to forecast. The returns may be great, but so are the risks.
A Sports Analogy
Another useful analogy for strategy is sports. In sports, the goal is not to win just one
championship, but to be perpetually successful, to create a dynasty. The goal is not
achieving a fluke triumphthe one-time trip to the Super Bowl.
There are coaches who have created dynasties such as Vince Lombardi, who steered
the Packers to five NFL Championships, and John McGraw whose MLB teams finished
815 games over .500. These coaches are certainly great strategists and have much to
teach the business strategist. They are masters of their teams capabilities, the rules of
the game, and the competitive environment. They understand each players strengths and
weaknesses and concentrate on eliminating weakness. They leverage the full breadth of
the teams strengths and insist on team play (whereas weaker coaches rely on just a
handful of stars and recycled plays).
Excellent coaches also know their rivals extremely well. They attend rivals games,
filming them, and analyzing the films for weaknesses to exploit. They carefully craft and
select strategies pre-game but are also quick to react and effectively modify tactics based
on the ever-changing dynamics of each game. They leverage their success as they recruit
for the future. The models to emulate are the perennial powerhouses in sports.
Building Early Momentum

How can such long-term success be accomplished? A sports team that is the first to
introduce a system can stay ahead of its competitors by refining that system before they
make headway against it. San Franciscos National Football League dynasty during the
1980s and 1990s was built on innovations in a West Coast offense that other teams tried
unsuccessfully to copy; the other teams were unable to keep up with the refinements and
adjustments made by Bill Walsh and his successors.
The same principle can hold in management strategy. A company that is the first to
introduce a product or ideaa company that gets it earlymay be able to build the
momentum to win title after title. When a company gets one thing right, it creates
momentum that enables it to get other things right. Exhibit 1.8 depicts the chain of ben-
efits set in motion: Because a company has attracted favorable attention from customers,
investors come on board. Because the customers and investors have come on board,
highly talented people think the company would be a good place to work, and thus it
becomes easier to recruit top-notch individuals. With more highly talented people in
place, it is easier to get more customers on board, and the investment community
becomes more excited and pours more money into the company. A virtuous cycle is
created. In contrast, vicious cycles are also possible: A companys failures can snowball
into defeat. Being first is not always the surest route to success, however, as will be
EXHIBIT 1.8
Investors
The Chain of
Benefits: Talent
Customers
Investors Customers
Talent
Investors
Value
Source: Adapted from Customers

Profit Patterns, by
Adrian J. Slywotzky, Investors
David J. Morrison,
Ted Moser, Kevin A.
Mundt, and James A. Talent
Quella. Times Books/
Random House, New Customers
York: 1999.
Time
EXHIBIT 1.9
Leveraging the Full Breadth of Team Strengths
Anne Cohen.
shown in Chapter 4. Often, fast followers, such as Microsoft, prevail over the early leaders.
They learn from what has been done before, concentrate superior forces, and counterat-
tack. An early leader can never be sure that its lead will stand.
Relying on Teamwork
Management can learn another lesson from sports. Accomplishment comes as much
from teamwork as from outstanding stars. Most sports teams have great individual
stars, but winning persists because of how teams recruit, socialize, and motivate all
players to work together (see Exhibit 1.9). Coaches play a significant role. Their
understanding of the contributions of superstars and role players is as critical as their
philosophies of preparing for a game and calling the plays. A teams management
keenly analyzes the situation and makes the right moves that bring together the parts
needed for success.
Championship teams do not have to excel at everything, but they have to be able to
blend the different parts to create a winning combination. The best teams have a
unique character. One will win with an innovative offense and just an adequate d efense.
Another will dominate because its defense is superior, while its offense barely gets the
job done.
Planning and Improvising

Winning involves a mix of planning and improvising. A football coach scripts the first
10 to 15 offensive plays of the half, but then changes plans in response to what happens.
A pitcher adjusts to the way batters have been reacting to his pitches. Plays that have
been run to perfection in practice can break down in actual games. Some options in a
possible breakdown are anticipated and practiced; others are made up on the spot, so
players must be creative. How well such improvising works is often the difference
between winning and losing.
Keeping ScorePerformance Measurement

Another sports analogy of relevance is keeping score. Companies have economic, legal,
and ethical obligations to many stakeholders who affect and are affected by what the
firm does. Poor strategies and ill-advised moves obviously affect the employees of a
firm, but the repercussions of failure travel beyond organizational boundariesto sup-
pliers, customers and the community at large. An unsuccessful strategy that leads to
bankruptcy, for example, reduces or eliminates employment opportunities not only
within the firm, but also within the firms suppliers and the community at large. Imagine
being a key supplier to an organization, and finding out that a bankruptcy court has
determined that your company will receive only 5 cents on every dollar that it has billed
the firm. Many airline suppliers suffered this fate during the recent economic crisis and
airline industry shakeout.
To assess how well they are meeting these responsibilities, therefore, companies
must constantly measure their performance. There are various ways to do so.
Companies evaluate strategic plans on the basis of growth in revenues and market
share. They assess product lines and individual businesses by calculating gross margins
and cash flows. They appraise individual business units in terms of return on assets.
Capital investments are analyzed according to net present value, and prospective
acquisitions are examined on the basis of their likely contribution to earnings. Several
of the most important approaches to the measurement of company performance are
discussed below.
Measures of Overall Dominance

Overall dominance is typically measured by two means:
Accounting data, which are based on past performance.
Stock market data, which is typically a reflection of the firms outlook.
Both have their limits. Accounting data, despite the best efforts of the accounting profes-
sion and legal authorities to prevent distortion, can be skewed. Firms can manipulate
accounting results by recording revenue too soon or too late, recording revenue of ques-
tionable quality or of a bogus nature, boosting income with one-time gains, shifting cur-
rent expenses to later or earlier time periods, and failing to record liabilities or improperly
reducing them. Companies such as Cendant, Sunbeam, Waste Management, Lucent,
Dynegy, and Global Crossing, as well as Enron and WorldCom, have been caught engag-
ing in accounting fraud.
Without adequate accounting data, investors can be fooled and stock prices can be
based on inaccurate information. Investors do not always have the analytical capability to
accurately assess a companys likely future performance. Stock market data depend on
investor psychology, and investors are not entirely rational; they become caught up in
fads and get swayed by irrational fears as well as enthusiasms.
Economic Value Added

Another method of keeping score in business came to prominence in the 1990s: evalu-
ating its economic value added (EVA). EVA is defined as net operating profit minus the
opportunity cost of capital. It measures how much better or worse a companys earnings
are than the amount investors could obtain by putting their money in alternative invest-
ments of comparable risk. Typically, more than 50 percent of the top U.S. companies do
not have a positive EVA, which means they did not earn more than their cost of capital.
Investors probably would have done better if they put their money in Treasury bonds.
Surpassing the rate of return from Treasury bonds is a minimal test of the performance
of a companys strategy.
Investors Business Dailys Rankings

The newspaper Investors Business Daily (IBD) aims to provide a more balanced, com-
posite score for firms by combining a number of elements:
1. Accounting performance (earnings per share).
2. Market performance (relative price strength in the past 12 months compared to all
other firms).
3. Industry performance (a market rating).
4. An amalgam of accounting components (sales plus profit margins plus return on
equity).
5. Investor psychology (amount of buying and selling of the companys shares in the
last 12 months) and stock price.
The IBD ratings rely on accounting (number 1) and stock market performance (num-
ber 2), both of which are relevant to strategy. The use of an industry index (number 3) is
also relevant in that strategy is based on the premise that industry matters. A large
element of the success of a company can be predicted on the basis of its industry (see
Chapter 2). Similarly, the use of sales and profit margins (number 4) is relevant; the two
main positions a business can occupy are low cost, which necessitates a high level of
sales, or differentiation, which rests on high profit margins (see Chapter 3). Investor
psychology plays a role in determining stock market returns (number 5). Thus, overall,
the IBD ratings provide good surrogates for strategic performance. However, they are
based on past performance and say nothing about how well a company will do next.
Summary Sustained competitive advantage is achieved through a series of strategic moves over
time. To make winning moves, a company must be aware of the rules of the game and
changes in the rules of the game, and have a vision of where to go next. It must anticipate
inflection pointsmajor transformations that require adjustments in strategyand
develop contingency moves to meet different external conditions. SCA typically involves
competing in more than one area at a time and dealing with likely reversals in fortune.
To win, employees in a firm must know their enemiesthose against whom they
competeand themselves. They engage in action-response cycles with their competi-
tors, in which focus and flexibility are needed. They have to recognize patterns that
emerge during the competition and adjust accordingly in order to create a winning
dynasty. Doing so means instituting systems for both planning and improvisation and
relying on performance measurement systems that are as accurate as possible. SCA
involves not just doing well for a few years, but having persistent performance that is
superior to that of competitors.
This chapter has used analogies from chess, war, and sports to help you think about
how to achieve SCA. Some of the lessons to be learned are to concentrate forces and rely
on teamwork. Companies must be conscious of the connection between SCA and
c omparative advantage. Employees must also know how to keep score. Theyand the
sum total of the firms stakeholdersare all impacted by the successes or failures of
their firms strategies. Some of the more important measures of SCA have been pre-
sented in the chapter.
A firm is simultaneously located in the past, striving to achieve what it was good at
previously (its mission), and at the same time moving toward a vision of what it would
like to excel at next. To consistently receive strong returns, it has to make better moves
than its competitors. To do so, its employees have to develop the ability to analyze
external opportunities and threats and internal strengths and weaknesses. The frame-
works and methodologies you can use to conduct this type of analysis are the subject of
the next two chapters.
Reflections for the Practitioner

1. What is your firms mission? Its vision?
2. Does it effectively scan the horizon for inflection points that may pose either oppor-
tunities or threats?
3. Which strategy analogywar, chess or sportsresonates the most with your own
experience? Why?
4. How would you characterize your firms strategic planning process?
5. Are employees at your firm equipped to analyze the environment and recommend
strategic change?
An Assignment for the Traditional Student

Select a firm from the Fortune 500 that interests you and visit its Investor Relations site. Scan
their most recent Annual Report and collect evidence of the following within the firm:
Clear mission and vision for the future.
Awareness of both its external and internal environment.
Adjustments to its strategy based upon the situation that it faces.
Endnotes 1. A. Grove, On Competitiveness, Academy of Management Executive 13, no. 1 (1999), p. 16.
2. Gartner Says the Internet of Things Installed Base Will Grow to 26 Billion Units By 2020,
December 12, 2013, http://www.gartner.com/newsroom/id/2636073.
3. A. Marcus, Strategic Foresight (New York: Palgrave-MacMillan, 2009).
4. M. Porter, Competitive Advantage: Creating and Sustaining Superior Performance (New
York: Simon and Schuster, 2008).
5. R. Wiggins and T. Ruefli, Sustained Competitive Advantage: Temporal Dynamics and the
Incidence and Persistence of Superior Economic Performance, Organization Science 13,
no. 1 (2002), pp. 82107; G. Hawawini, V. Subramanian, and P. Verdin, Is Performance
Driven by Industry or Firm- Specific Factors? Strategic Management Journal 24, no. 1
(2003), pp. 117; and T. Powell, Varieties of Competitive Parity, Strategic Management
Journal 24, no. 1 (2003), pp. 6187.
6. Hawawini, Subramanian, and Verdin, Is Performance Driven by Industry or Firm-Specific

Factors?
7. M. Friedman, The Social Responsibility of Business Is to Increase Its Profits, in The
Management of Values, ed. C. McCoy (Boston: Pitman, 1985), pp. 25360.
8. Taking Risks at Intel: Andy Grove, CEO, Intel Corp., PBS video, Hedrick Smith, The View
from the Top: Managing Change in the Global Marketplace, 1994.
9. See E. Luttwak, Strategy: The Logic of War and Peace (Cambridge, MA: Harvard University
Press, 1987), p. 55.
10. See J. Quinn, Strategies for Change: Logical Incrementalism (Burr Ridge, IL: Richard D.
Irwin, 1980).
11. J. Toth, handout, Industrial College of the Armed Forces, 2001, www.ndu.edu/icaf/.
12. Ibid.
13. Ibid.
14. H. Mintzberg, B. Ahlstrand, and J. Lampel, Strategy Safari: A Guided Tour through the Wilds
of Strategic Management (New York: Simon and Schuster, 1998).
15. Ibid.
16. The Return of von Clausewitz, The Economist 362, no. 8263 (September 2002), pp. 1821.
17. Ibid.
18. C. Grimm and K. Smith, Strategy for Action: Industry Rivalry and Coordination (Mason, OH:
South-Western College Publishers, 1997).
19. Mintzberg, Ahlstrand, and Lampel, Strategy Safari.
20. Quinn, Strategies for Change.
21. The Return of von Clausewitz.
22. Taking Risks at Intel.
23. A. Grove, Only the Paranoid Survive (New York: Random House, 1996).
24. F. Knight, Risk, Uncertainty, and Profit (New York: Houghton Mifflin, 1921).
25. See A. Marcus, Strategic Foresight (New York: Palgrave MacMillan, 2009); H. Courtney,
20/20 Foresight (Boston: Harvard Business School Press, 2001); and M. Raynor, The Strategy
Paradox (New York: Doubleday, 2007).
26. On shaping the future, see G. Hamel and C. Prahalad, Competing for the Future (Boston:
Harvard Business School Press, 1994).
P A R T O N E
External and Internal

Analysis
1
EA IA
External Analysis Internal Analysis
Evaluation of
3
Performance
&
Continuous
BS + GS + CS + IS
Reinvention
2 Implementation
C H A P T E R T W O
External Analysis
The essence of strategy is competition. Yet it is easy to view
competition too narrowly Competition is not manifested only in the
other players competitive forces exist well beyond the established
combatants. The corporate strategists goal is to find a position in the
industry where his or her company can best defend itself against
(the sum of) these forces or can influence them in its favor.1
Michael Porter, professor of strategy, Harvard Business School
The airline industry is a volatile industry, but if you think about the
global economy, many industries are subject to external volatility. The
question is what you do about your business model to buffer and make
the enterprise successful.2
Richard Anderson, Former CEO, Delta Airlines

Understanding how to analyze the external environment of the firm.
Being aware that the external environment consists of several layersfrom the broader general
environment to the more immediate competitive environment, which is comprised of both rival and
stakeholder groups.
Taking note of the many dramatic changes that can occur within the external environment and can
reshape an industry over time.
Using your analysis of an industrys characteristics and trends to identify the inflection points and
other opportunities and threats a firm faces.
Understanding how stakeholder relations, strategic group analysis, scenarios of possible futures, and
response repertoires can be used to construct moves to counter divergent contingencies.
Introduction
Like the chess player described in Chapter 1, a skilled strategist will also scan the board
and analyze an organizations strategic situation prior to making moves. This analysis
24
Chapter 2 External Analysis 25
EXHIBIT 2.1 St
ake The Firm
The External ho
Environment ld
er Industry
Gr
ou Environment
ps
Macro-environment
typically begins with a careful look at the dynamic external environment within which the
firm operates.
The external environment consists of several elementsfrom the immediate industry
environment, where the presence of rivals, customers, and suppliers can impact the
day-to-day moves a firm makes, to the broader macro-environment, where shifts in politics,
laws, technology, demography, society, and economy can fundamentally alter the rules of
the game. The strategist must also examine stakeholder groups and groups that affect and
are affected by the firms activities, and determine how the firm will relate to these groups.
The sum of these three assessmentsof the industry environment, the macro-
environment, and stakeholder relationsconstitute external analysis (see Exhibit 2.1).
This chapter provides a working knowledge of external analysis and explains how it can
be used along with internal analysis (Chapter 3) to make better moves.
Industry Definitions
An industry refers to a group of companies offering products or services that satisfy
similar customer needs. This definition highlights important rivalries that exist between
products and services that are substitutes for each other. For example, a metropolitan
restaurant does not just compete with other eating establishments in a city. From the
customers point of view, a traditional restaurant provides only one means by which to
satisfy the basic need for food. The restaurant competes with many dining options,
including company cafeterias, food trucks, fast food eateries, bistros, cafes, convenience
stores, and groceries.
Industries can also be defined by various classifying systems. The North American
Industry Classification System (NAICS) is the standard that Federal statistical agencies
use to group similar businesses into clear categories and subcategories. Businesses
within each category share similar characteristics and are subject to similar market
forces. For example, the major classification of transportation contains a subclass for
scheduled airline businesses. These airlines all face similar FAA regulations, fuel supply
risks, and customer pressures. Use of the system, therefore, can help analysts mine for
competitively important data. Exhibit 2.2 compares the NAICS, which is hosted by the
U.S. Census Bureau, the International Standard Industrial Classification (ISIC), part of
the UN Statistics Division. Many similarities exist, but there are also differences in the
detailed subcategories that the two systems use. For example, the ISIC has scheduled
and nonscheduled categories that the U.N. Statistics division does not use.
26 Part One External and Internal Analysis
EXHIBIT 2.2 NAICS Classifications for

A Comparison
ISIC Classifications for
of Classification Air Transport Air Transport
Systems for Structure
481 Air TransportationT
theAir
4811 Scheduled Air TransportationT Hierarchy
Transportation
48111 Scheduled Air TransportationT Section: I - Transport, storage and communica-
Industry 481111 Scheduled Passenger Air Transportation tions
481112 Scheduled Freight Air Transportation Division: 62 - Air transport
4812 Nonscheduled Air TransportationT
48121 Nonscheduled Air TransportationT Breakdown:
481211 Nonscheduled Chartered Passenger Air This Division is divided into the following Groups:
Transportation
481212 Nonscheduled Chartered Freight Air 621 - Scheduled air transport
Transportation 622 - Non-scheduled air transport
481219 Other Nonscheduled Air Transportation
In fact, given their usefulness in analysis, one will find a number of different clas-
sifications that have been created by major business newspapers and magazines like
The Wall Street Journal, Financial Times, Fortune, Forbes, Bloomberg Business Week,
and The Economist. Googles and Yahoos finance websites have their own ways of
classifying firms. Research organizations like IBIS, MarketLine Reports, and Euro-
monitor will often point to the NAICS and ISIC systems, but will also create their own
industry classifications in order to keep pace with the continual emergence of new
industry structures.
Its important to note that companies generally belong to multiple categories within
these industry classifications and taxonomies. One might ask, for example,
Is General Electric a bank or a manufacturer of industrial equipment?

Is IBMs main line of business servers, software, or consulting?
How should Dell be classified now that its broadened its position from desktop com-
puting to security, service, software, and advice?
Is PepsiCo a soft drink or beverage company, or is it in the snack food business?
Is 3M an automotive and defense industry supplier, a health care and medical products
company, or a maker of innovative tapes, abrasives, adhesives, and special m aterials?
Indeed, these possibilities do not exhaust everything 3M does. It is also active in the
fields of energy and electronics and it has safety, and graphics businesses.
And how does one even start to classify ever-expanding corporations like Apple?
Apple is a PC maker, software company, and designer and seller, but not manufac-
turer, of mobile devices. It has retail outlets that compete with Best Buy, for example.
At the same time, Best Buy sells Apple products in its stores. To feed these busi-
nesses, Apple has created by itself, and in conjunction with software developers,
anearly seamless personal technology ecosystem. The company has evolved from
being a desktop PC manufacturer to a firm that spans many businesses. The range of
industries in which Apple now competes is wide-ranging, and it extends from PCs to
mobile devices (including smartphones and tablets), to entertainment media and
mobile payments.
External Pressures Lead to Industry Movement

Many companies today will migrate from industry to industry. Industry definitions are
dynamic, and industries are hard to pin down because firms external environments are
changing so rapidly. This puts pressure on them to create new niches and create new
industry definitions. Regulatory and competitive forces have quickly blurred the lines
between banks, brokerages, insurance companies, finance companies, and credit card
issuers, for example. Traditional cable operators have seen drastic changes in their indus-
try as well (see Exhibit 2.3).
Another example of the impact of external pressure and opportunity comes from
Medtronic. External pressure and opportunity have compelled this company to move
away from its original heart pacer and stent products. Technological innovation in the
medical device industry has not proceeded fast enough for the company to bring to
market additional blockbuster products. Government regulations have tightened. Cost
concerns have reduced its margins. As a consequence, the company decided to acquire
Covidien, becoming, in the process, an organization similar in size and diversity to
Johnson and Johnson. The new Medtronic is competing in such businesses as weight-
loss surgery and laparoscopy, baby wipes, vitamins, allergy relief, and hospital furniture.
Inacquiring Covidien, Medtronic also obtained intellectual property (IP) and service
offerings while hedging its exposure not only to the U.S. regulatory, but also to the U.S.
tax environment. Medtronic no longer is headquartered in the U.S. and is not subject
toU.S. corporate taxes.
Perhaps the most striking example of industry migration is provided by Amazon. In
what industry does Amazon, active in bookselling, online retailing, the streaming and
EXHIBIT 2.3 Traditionally a cable operator, Comcast has spent the past several years responding to opportunities and threats that
Comcast and originate in technological change (the ubiquity of the Internet and streaming), government regulation, which favors an
the Evolution open Internet that does not permit Comcast to prioritize and charge more for some customers access, and changes
of the Cable in customer tastes (cord cutting or the fact that many customers no longer are interested in paying for a full array of
Industry stations on cable television). These developments are not all related but together inasmuch as they take away from
Comcasts control over its customers, they pose a very strong challenge to the companys business model.
In a preemptive move it chose to acquire Universal production studios and NBC from GE. In doing so, it sought to
enhance its bargaining position vis--vis the providers of the programming it buys from the other studios and
networks. Comcast is trying to compensate for its loss of control over its customers with greater control over its
suppliers. If customers are going to have more choices, Comcast is going to try to ensure that its suppliers, the
studios from whom it buys programming, have fewer choices. By owning its own network, Comcast is making the
statement that it is going to be less dependent on these studios.
In making this move Comcast has pushed the limits of conventional industry boundaries. It is now itself a studio as
well as a provider of cable and Internet services. Comcast has pushed industry boundaries several times as it has
evolved from its roots as a cable TV operator to phone, Internet, and content provider because of opportunities
and threats that arose in the external environment.
Yet how easy will it be for Comcast to manage its diverse businesses? Companies that have gone through a similar
evolution have not always fared well. When Westinghouse bought TV network CBS and Sony bought movie studio
Columbia, their fortunes declined. They were neither strong competitors in their existing industries nor in the new
industries into which they had drifted.
production of entertainment, the running of large warehouses, and the operation of one
of the worlds most sophisticated logistic systems, not compete? The companys most
profitable unit rents space to large organizations like the U.S. Defense Department on
the cloud. In an article in the New Yorker, George Packer describes it as a global
superstore like Walmart, a hardware manufacturer like Apple, a utility like Con
Edison, a video d istributor like Netflix, a book publisher like Random House, a pro-
duction studio like Paramount, a literary magazine like The Paris Review, and a grocer
likeFreshDirect.3
The company is moving in the direction of one day possibly becoming a package service
deliverer like United Parcel Service (UPS), bringing goods to homes not via truck but via
drone. Amazon founder and chief executive, Jeff Bezos, also owns the Washington Post.
Other than the firms already mentioned, its rivals also include Barnes & Noble, eBay,
Google, and Time Warner.
Amazon is sui generis or a category of one. Though nearly every firm competes with
it, none is quite like it. It has established its own niche, one without direct competitors,
but what it lacks in direct competitors it makes up for in indirect competitors. Is it better
for a company to be locked in to competition with a few major rivals or to be spread out
like Amazon and engaged in separate battles with many competitors? Today, with nearly
every firm straddling industry boundaries, migrations across industry boundaries may
place fast-moving, flexible firms like Amazon in unique positions to achieve competi-
tive advantage.
Industry Moves, Implications, and Trade-Offs

The opportunities and threats entailed in industry hopping are best understood via an
analysis of a firms external environment. Tough questions must be confronted. For
instance, given the state of the economy and changing demographics, how should a firm
position itself for success across the breadth of industries it has created or joined over the
long term? What is the best way to grapple with emerging technologies and rivals?
Should a company remain focused and increase its own R&D efforts? in order to become
a technology leader? Or should it seek economies of scale and the relative safety of
acquiring a firm in a similar or an adjacent industry instead?
These choices mandate trade-offs. Which strategic moves should a firm emphasize?
Should it aim for radical and disruptive innovation or more modest, incremental innova-
tion, or emphasize dominance in an already well-established and even stagnant industry
space? Each of these moves can lead to growth or decline in revenue and profitability.
Each has consequences for the character of a business, the type of employees it attracts,
and company identity.
Consider the consequences of making the wrong move. An example would be
Target. Rather than further differentiating itself from mass market rival Walmart and
developing its chic fashion-based image, the company chose to expand into Canada,
where it failed miserably. Had its top management made a different choice, the com-
pany might not have incurred a vast amount of debt and put itself in the position where
it had to lay off thousands of employees. Target responded wrongly to the economic
downturn that began with the Great Recession of 2007. It concluded that it had to
compete based on price and economies of scale rather than on further differentiating its
products. The macro-environmental shock of the financial decline elicited what, in
retrospect, was the wrong response from its top managers. Competitive advantage can
be lost as well as gained by choices top executives make in response to changes in
macro-environmental conditions.
A thorough external analysis is needed to address the opportunities and threats that
emanate from changes in the macro-environment, but it must be applied carefully and
systematically and used thoughtfully, knowing that the perfect adjustment to changing
external conditions is unlikely to be achieved. Team judgements play a role in what cor-
porations decide to do, and the judgements of teams are far from perfect.
This process is not mechanical. A company must monitor the implementation of its
moves to discover what is resonating with customers, countering competitive forces
and delivering resultsand what is not. It has to be willing to make strategic retreats
in a timely manner. Ideas must be tested against reality, and moves must be continually
recalibrated as information is gathered. Hard questions need to be addressed, such as:
How long should a company stick to a course of action that seems to be failing? When
does it know for certain that it cannot achieve desired results if it stays its course?
Companies need the flexibility to adjust quickly and to move in and out of initiatives,
yet not to be so agile as to lack the patience to make a go of needed efforts.
A Framework for External Analysis

With the aim of choosing a dominant strategy, and the flexibility to include some
hedges should the dominant strategy not work out, it is good practice to focus on three
key questions:
1. Is the game good? Michael Porter, professor of strategy at the Harvard Business
School and the originator of industry analysis, offers this first and most critical
question.4 The answer to this question lies in each industrys basic economic features,
its competitive forces (customers, suppliers, competitors, substitutes, and new
entrants), and the influential role that stakeholders play. Together, these elements
reveal whether an industry is inherently more attractive and profitable than others.
Being in a profitable, growing industry provides a unique advantage, as most
academic studies suggest that 20 percent or more of competitive advantage is
determined by industry.5
2. What is our position in this game? Sustained competitive advantage does not arise
simply from being in a good industry. It is critical to position a firm advantageously
relative to its competition, and to capitalize on this advantage. Positioning can deter-
mine whether a firm is a laggard or a dominant force.
3. Should we stay in this position for the long term? In the short term, there may be
ample profits and growth in a strong position or segment in a declining industry,
but that position may not be viable in the long term. A company must be able to
plan exit and switching strategies that match different time horizons. This question
requires the strategist to examine the dynamic driving forces shaping an industry
over time.
Industries are not stable. They are continually transformed by changes in macro-
environmental conditions, including a fluctuating economy, the vicissitudes of govern-
ment policies and regulations, developments in technology, changing demographics, and
perturbations in the natural world, such as the availability of resourcesair, water, and
land, for exampleon which economic activity depends. These macro-environmental
forces alter the relations between a firm, its customers, suppliers, rivals, new entrants, and
substitutes. It is critical to scan for changes in these conditions in different time horizons.
They must be identified and tracked because of their effects on an organization.
Questions a firm should pose are: How long should it stay in the businesses in which
it currently operates, when might it leave these businesses, and where should it go if it
leaves? Where are there better opportunities than the current set in which it operates?
The future cannot be predicted or forecast with certainty, so the best that can be done is
to define a set of likely scenarios that account for the risks and uncertainties an industry
inevitably will confront.6 Consider the likelihood of the best possible outcomes, the
worst possible outcomes, and a set of surprises that might take place. Does a company
have an action plan that will help bring about the best possible outcomes, that will help
avoid the worst possible outcomes, and that will help the organization deal with sur-
prises that could take place?
The organization must be ready for different possibilities. Industry analysis is not
static. Industries are forever changing. Thus, answering these questions is needed to help
prepare for the future, to help decide whether to stay engaged in an industry and seg-
ment, or instead to capitalize on opportunities emerging in other industries and seg-
ments, and move.
Deciding If the Game Is Good

A growing industry offers the average player the chance to realize growth, whereas a declin-
ing one provides scant opportunities even for very strong competitors. So, it can be very
helpful to consider the overall size of the industry and where it is in the industry life cycle
whether it is a growing, maturing, or declining industry (see Exhibit 2.4).
It also is necessary to know a firms rivalshow many exist and whether and to what
extent their offerings are similar or different than those of the firm in question. The game
quickly descends into a pricing war if customers do not perceive any differences in the
EXHIBIT 2.4
The Industry
Life Cycle
Introduction Growth Maturity Decline (or Rebirth)

products and services offered. With many rivals and little differentiation, margins narrow
and industry profitability suffers.
Companies in mature and declining markets, such as Hormel, attempt to create
differentiation. Hormel evolved from a firm that competed as a commodity fresh pork
products producer to a firm that has strong branded presence with numerous value-
added, shelf-stable, ready-to-eat offerings. Such moves allowed it to escape the down-
ward spiral of a declining industry. They allowed for a rebirth with positive effect on the
firms stock price and its ability to sustain shareholder dividends. Similarly, Campbells
condensed soups were a commodity that struggled against private label brands that
delivered similar value to customers at lower prices. To fight off decline, Campbells
reinvented its soups as chunky, home-style, organic, and convenient.
The Best Game

Industrial organization (IO) economics suggests that the best game is one with virtually
no competition. It instructs a firm to strive to be a monopolist, but do it fairly so that federal
antitrust officials do not bring it to court. Current antitrust doctrine has no problem with
very high market shares so long as there is free entry and a company plays by the rules.
Only if there is evidence that it achieved a high market share by means of anticompetitive
practices is a firm likely to be taken to court. According to IO economics, the best games
have more features of a monopoly than of perfect competition. There are fewer firms,
higher barriers to entry, and fewer homogeneous products. The firm benefits at the expense
of customers and suppliers, who have no choice but to deal with that firm.
To reduce competition, the aim of the firm should be to create highly sought-after,
unique offerings. If customers and suppliers exhibit a need for that category of offerings,
they have nowhere else to turn but to the firm in question. The firm should raise as many
barriers to imitation as possible so that it can maintain its virtual monopoly in its chosen
segment for as long as possible. Consider Intel. It has had a semi-monopoly position of
at least 80 percent of the PC/server microprocessors market for more than 30 years. It
protects this position in many ways including regular innovation, scale economies, and
bringing expensive patent infringement suits against competitors.
In creating barriers to entry, consider also geographic scope. If a firm achieves econ-
omies of scale and global scope, it may be in a better position to withstand the competi-
tion. Also, if a firm is supported by generous subsidies and favorable government
policies, it is difficult for other firms to mount a challenge against it. Companies that
have achieved a global footprint and have been afforded government protection are more
likely to maintain competitive dominance.
Capacity utilization is another factor that plays a large role in suppressing competi-
tion. Firms should build capacity globally and make sure they have sufficient market
demand to use it fully. Firms with idle assetsfacilities, people, and so onbear the
large costs of maintaining idle and unproductive assets and, therefore, are highly moti-
vated to lower prices and engage in aggressive price wars to win business. Under these
conditions, everyone in an industry suffers.
The steel industry provides an example of how low-utilization rates ruin a game (see
Exhibit 2.5). Production has remained fairly consistent while utilization has dipped
significantly (due to a number of factors). Excess, underutilized capacity has placed a
EXHIBIT 2.5 Global Crude Steel Production, Capacity, and Capacity

Low Utilization Utilization, 20002013
Rates in the 2,500 90
Steel Industry,
20002013
2,000 85
Source: http://www.
Millions of metric tons
epi.org/publication/
surging-steel-imports/.
80 Capacity Utilization
1,500 Rate (%)
Percent
Excess Capacity
1,000 75 Production
500 70
0 65
20 0
02
05
20 6
20 9
08
20 3
20 4
20 7
20 1
10
12
13
20 1
0
0
0
0
0
0
1
20
20
20
20
20
20
significant cost burden on manufacturers while prices continue to drop in response to

ever-abundant supplies. As a result of these dynamics, the OECD has predicted that the
operating profitability of steel manufacturers will remain at unsustainable levels since
global capacity utilization is not likely to exceed 75percent in coming years.7
Scale Economies and Learning Curves

Scale economies and learning curve effects require a company to increase its size and
experience in order to be competitive. These are powerful barriers to industry entrants.
Those without scale or experience find an industry unattractive and unprofitable. They
do not have the leverage needed to obtain good pricing from suppliers, nor can they
match the highly honed and efficient processes of firms with experience.
The ability to learn and achieve scale quickly also has a significant impact on a firms
ability to survive and thrive. When McDonalds invested in Chipotle in 1998, it infused
a 14-store experiment based in Denver with its cash and knowledge. The new chain
flourished. By 2005, there were 460 Chipotles restaurants, and the chain was adding
100restaurants a year. Scale economies and leavening effects contributed to Chipotles
rapid ascent. Startups could not easily meet Chipotles numbers, which were supported
by McDonalds size and experience. It is estimated that each outlet brought in yearly
sales of $2.1 million and throws off cash flow of $574,000.8
Government Policies
Government policies can totally change the rules of the game. Some of the most
noteworthy impacts on industry viability come from them. Regulation and taxation are
especially critical. They can change buyer behavior via subsidies, loan guarantees, price
controls, and other means. Prevailing politics provide industries with opportunities and
hamper their growth, hence the presence of lobbyists at the state and federal levels.
Governments pick winners and losers when they impose taxes and tariffs; thus, govern-
ment lobbying strategy is needed.
An interesting example of how firms respond to government policies is the current
trend toward corporate inversions. An inversion takes place when a firm reincorporates
outside of its current national jurisdiction in order to reduce its tax burden. Inversions
point to the significant effects of tax policies. Procter & Gamble and Unilever both
sell detergent all over the world, but their tax situations are quite different because
P&G is based in Ohio in the U.S., and Unilever is based in Rotterdam in the
Netherlands. The U.S. cannot tax Unilevers non-U.S. profits; meanwhile, Unilevers
home countries (Britain as well as the Netherlands) have corporate tax systems that
favor big businesses. Simply because of divergent tax policies, Unilever is better
positioned than P&G.9
Some government policies limit access to the game by imposing requirements
smaller businesses cannot meet. High pollution-control costs are a bigger burden on
small businesses, as are costly measures to ensure worker safety and provide employee
benefits. Labor laws may make it difficult for businesses to operate in certain coun-
tries. For example, facing a 35-hour working week, entrenched union rights within
companies, and a strict 3,500-page labor code, it is hard for companies to operate in
France and other EU countries.10
Demographics, Natural Resources, Technology, and Culture

Demographics, natural resources technology, and culture also differ in the various coun-
tries in the world with firms in some industries being impacted more severely than firms
in other industries. Firms in some industries, for example, benefit from the aging of the
population. Pharmaceutical and medical devices companies benefit from greater demand
when populations age. Firms in other industries, like social media and entertainment,
disproportionately benefit when the population is young. Energy costs are not the same
everywhere. They disproportionately affect firms in industries like airlines, electric
utilities, and trucking more than firms in other industries. Firms in some industries do
well when technologies change rapidly, while firms in other industries do well when the
pace of technological changes slows down. Changes in culture, which affect patterns of
leisure behavior and discretionary spending, disproportionately influence companies in
some industries more than others. These macro-forces affect the structure of an industry
and determine the extent to which the game that the players in an industry are playing is
a good one.
The Five Forces

External factors cause inflections to take place in the five forces that determine i ndustry
profitability. The five forces framework, a simple, but powerful and elegant, tool for
understanding where the power lies within an industry, best summarizes the factors
affected.11 Beyond established rivals, an industry consists of four other competitive
forces: substitutes, customers, suppliers, and potential entrants. Only with a clear under-
standing of these forces is it possible to assess the overall attractiveness of a companys
industry and to act decisively to improve and strengthen its position (see Exhibit 2.6).
EXHIBIT 2.6
The Five-Forces Entrants
Framework
Source: http://hbr.
org/2008/01/the-five-
competitive-forces-that-
shape-strategy/ar/1. Rivalry
Between
Suppliers Existing Buyers
Competitors
Substitutes
Rivals
Rivals are an organizations existing competitors that engage in repeated and regular
moves against each other. In some industries, rivalry is exceedingly high, and profits are
eroded due to each firms competitive moves. In other industries it is not high because
there is mutual forbearance, and exceptional margins and profits are easier to sustain.
Based on the nature of the industry, the moves rivals make to undercut each other include
price cutting, increased advertising, product/service giveaways, and rapid innovation.
Each of these moves adds to a firms costs. The presence of aggressive rivals keeps a cap
on prices. If profit margins are squeezed by a high level of competition, the industry is
less than an ideal one.
Factors that increase rivalry are:
A large number of undifferentiated firms competing for the same customers and
resources.
Low switching costs for customers who shop for the best deals.
Slow or declining industry growth, which, in contrast to rapid growth, requires firms
to seize market share from other companies to improve their top-line revenues.
High overhead that motivates firms to raise their scale of operations to cover fixed costs.
Rapid product perishability and high inventory-storage costs, which necessitate that
firms move their products quickly.
Barriers to exit exist when firms make investments in highly specialized capital
equipment or assets that cannot be easily transferred. Manufacturers, whose equipment
often serves very specialized purposes, face exit barriers. They would rather fight to the
death than take a massive loss on the sale of these assets.
New Entrants
Existing rivals are not the only concern. Profitable industries with high growth inevita-
bly attract new entrants. Industries that do not change rapidly provide opportunities for
such entrants to introduce product and service innovations. They can tweak the grounds
for competition in an industry by offering much cheaper and stripped-down products and
services. An example is ARM Holdings, PLC simplified, low-power architecture for
mobile telephony and other applications. New entrants can also change the grounds for
competition by offering much-higher-priced luxury goods. An example is Teslas move
into the auto industry with its luxury vehicle offering.
The threat of potential entry is easier when access to supply and distribution is open,
capital investment requirements are minimal, customer loyalty is weak, and existing
competitors are unable to retaliate against new competitors. Powerful, well-capitalized
firms in adjacent industries constantly threaten to break down industry boundaries as
these boundaries become more permeable, and they see opportunities in moving outside
their sphere of influence. Monster Beverage is a good example. Once a fruit juice
company called Hansens that was commonly found in health food stores, it saw an
opportunity in the adjacent industry of energy drinks and transformed itself into a
company devoted to this beverage type. Monster grew very rapidly in the face of
weakening demand for the conventional soft drinks offered by Coca-Cola and Pepsi.
Substitutes
Monsters energy drinks became an established player in the energy drinks space, it
became a viable substitute for the carbonated beverages that Coca-Cola and Pepsi
offered. The power of substitutes is another factor affecting industry attractiveness.
Other substitutes to soft drinks are milk, tea, juices, water, coffee, beer, and various
spirits. Inmany applications, plastic, aluminum, metal, paper, and other materials substi-
tute for each other. There are many substitutes for a persons leisure time, such as follow-
ing professional and college sports teams, fitness centers, concerts, movies, books,
TVshows, hiking, fishing, churchgoing, and other activities.
Good substitutes lower industry prices and decrease profitability. Customer loyalty is
weakened. Quality and switching costs play a role, but they cannot block the attraction
of substitutes that fulfill similar needs. E-mail and electronic bill paying quickly made a
large inroad on the business of the mail service. ATM machines rapidly encroached on
the space once reserved for local bank branch offices and tellers. The new technologies
are faster and often more secure. Given the presence of technology-based substitutes for
letter-sized deliveries, the U.S. Post Office has had to switch its focus in order to com-
pete with FedEx and UPS for parcel delivery business.
Suppliers and Customers

Suppliers and customers also have major impacts on industry attractiveness. Suppliers
and customers with credible options to turn elsewhere are less dependent on a firm and
can bargain away the profits a company hopes to earn.
Companies that depend on just a few suppliers and have nowhere else to go for criti-
cal inputs are in a weak position. Strong suppliers with many options for selling their
goods and services can exact a high price from companies and erode the profits they
hope to earn. A supplier with the right capabilities can move forward in the supply
chain and pose a direct challenge to a business. Rather than provide inputs for products,
it can make the product itself and become direct competitor. If a firm is a retail channel
to customers, manufacturers can sell directly to customers and thereby weaken the
firms position. Dell sold its PCs and servers directly to businesses with the intent of
eliminating the firms in the middle.
If a firms customers have many choices and free access to competing products
and services, the firms position is weakened. It may have to drastically lower its
prices to maintain sales, thus diminishing its profits. The more choices customers
have, the less power firms have over them. Like suppliers who move forward in the
value chain, customers can move backward when faced with unfavorable conditions,
such as limited supply, high costs, or low quality. If they have the capacity to acquire
critical inputs and the skills to combine them into finished goods, they can threaten to
make these goods themselves. Delta Airlines purchase of the Trainer refinery in
2012 was a move designed to reduce its dependence on its suppliers and control its
largest input cost, fuel.

Within the framework of the five forces, sustained competitive advantage (SCA) consists
of having power over suppliers, customers, competitors, new entrants, and substitutes so
that they are dependent on a company and not vice versa. Power is the key to SCA.
Power in the IO economics framework defines a good industry. With power over the five
forces, a company has competitive advantage. If it holds onto this power for a long
period of time, it has sustained competitive advantage. Without this power, it is vulner-
able. It cannot demand the best input prices, capture and retain the most profitable cus-
tomers, and insulate itself from the competition, no matter whether the competition is
existing rivals, potential entrants, or substitutes.
Industry Dynamics
Historically, one of the most attractive industries in which to participate was the phar-
maceutical industry, and one of the least attractive was the airline industry, but how
times have changed! According to Morningstar, the five-year return on the airline
industry as of 2015 topped 20 percent while profits were contracting in pharmaceuti-
cals (see Exhibit2.7).12
Industry dynamics, which include the five forces, constantly evolve in the face of
the pressures from the macro-environment and the moves firms make. Industries expe-
rience inflections where their directions shift. A company operates with great peril if
it fails to grasp the essential point that i ndustries are dynamic.
EXHIBIT 2.7 A Ranking of the Airline and Pharmaceutical Industries by Stock Return,
20102015
Source: http://news.morningstar.com/stockReturns/CapWtdIndustryReturns.html.
Total Returns (August 17, 2010August 17, 2015)
Industry Name 1-Year 3-Year 5-Year

Airlines 28.19 36.65 20.75
Pharmaceuticals 12.76 22.16 19.24
PharmaceuticalsA Five-Star Industry under Fire

Pharmaceuticals were once considered a five-star industry because all five forces were
aligned to the industrys benefit. Historically, companies in this industry were friendly
competitors that did not try to undermine each other through ruthless price cutting.
The competitive positions of pharmaceutical companies were based on smalldifferencesin
brand and reputation. Within the industry, there was room for each company to earn veryhigh
returns. Barriers to entry into the pharmaceutical industry were high for the f ollowingreasons:
Pharmaceutical companies had large sales forces of so-called detail people, who made
regular visits to physicians, informed them about new drugs, and gave them plenty of
samples, which the physicians valued. The physicians tended to become familiar with
these sales reps and to trust them. It was difficult for an industry newcomer (potential
entrant) to duplicate the relationships the detail people had developed with doctors.
The cost of research and development was extremely high. A new entrant could not
easily duplicate the trained staff and laboratories of an established company because
of the difficulties involved in attracting scientific talent and setting up complex and
sophisticated laboratories. Furthermore, a new entrant did not have experience
obtaining government approval for new drugs, an arduous process that contained
many pitfalls and could constitute more than 60 percent of drug development costs.
Only experienced pharmaceutical companies were likely to have the requisite social
and political capital and the know-how to not only develop a drug, but also get it
approved. With entry barriers such as these, it was little wonder there were few new
entrants into the industry.
Because the pharmaceutical companies held patents on their new products, substi-
tutes were scarce or nonexistent.
The buyersdoctors, patients, and health insurance companieswere not particu-
larly price sensitive. According to the physician, the patient had to have the drug in
questionthere was no choice. If the patients illness was life threatening or
extremely debilitating, the patient was not likely to bargain about price. In addition,
because health insurance organizations were increasingly covering the costs of drugs,
many patients had little incentive to protest. Consumer bargaining power was weak.
The bargaining power of suppliers also was weak. The ingredients in most drugs
were not very expensive; they were commodities and accounted for only a fraction of
the cost of finished products. There were many suppliers, so a pharmaceutical com-
pany could choose where it would buy ingredients.
But the favorable forces that historically had prevailed in pharmaceuticals began to
erode. Four important changes occurred:
The buyer, who previously had been indifferent about price, became increasingly cost
conscious. With the price of pharmaceuticals rising much more rapidly than the infla-
tion rate, insurance companies and government agencies became concerned and
began to demand cost containment.
The Food and Drug Administrations (FDA) approval of new drugs moved at a gla-
cial speed. Just 18 to 24 new drugs were approved per year from 2005 to 2008. This
pace was not sufficient to make up for the large number of looming expiring patents.
Generic drugs became more widely available as substitutes for brand-name drugs.
Generic drugs provide the same therapeutic properties and benefits as name brands,
but at a lower cost. Government insurance programs, as a consequence of concern
about the costs of health care, required that generics be dispensed when available,
rather than brand-name drugs.
Advanced research methods lowered the cost of drug development, weakening barriers
to entry. Companies with skills in biotechnology, such as Genentech, were able to enter
the industry. They had the potential to revolutionize the drug development process and
thereby undermine the structure of the industry and lower its overall profitability.
In an effort to improve this situation, companies have unveiled a flurry of mergers or
hostile bids and have cut thousands of jobs. According to consulting firm Challenger,
Gray & Christmas, the pharmaceutical industry has cut 297,650 jobs since 2000.13 Phar-
maceutical manufacturers must search for new niches to expand their existing product
pipelines. They are also trying to develop generic biotech drugs, called biosimilars, as a
new type of revenue source. The FDA finally is approving some biosimilars for patient
use. Other generic biotechs, which have been sold in Europe, are just on the cusp of FDA
approval in the U.S. Although the game is still undecided, it is certainly not as great to
be in this industry as it was in the past.
AirlinesA No-Star Industry Redeemed

The deregulation of the airline industry in the 1980s, on the other hand, led to a no-star rank-
ing of the airlines compared to the pharmaceutical industrys five stars. With the stroke of a
pen, the government permitted new entrants into the industry, prices were no longer fixed,
customer choices and power improved, and airlines were forced to compete on nonessentials,
such as food or the color of their planes. Profits quickly deteriorated for the following reasons:
1. Buyer loyalty was low because there was little differentiating one airline from
another. Thus, ticket price became the main factor determining which airline a
consumer would use.
2. Although travelers had always had the choice of traveling by car, rail, bus, or boat,
advances in telecommunications enabled further substitution. Business conferences
could be conducted remotely.
3. The main suppliers to the industry also had power. The companies that manufactured
the engines, assembled the planes, and supplied the fuel were large corporations with
clout. The pilots themselves were a highly skilled group with influence.
4. Government meddling with free-market forces persisted for years. As airlines were
considered a critical part of the infrastructureand those on Capitol Hill feared for
their political lives if routes to their hometowns were cutmany of the U.S.s large
carriers were propped up and continued to operate despite the fact that there were
significant amounts of excess capacity throughout the system.
5. The airlines had little power over customers, and their rivalry was intense and some-
times bitter. Since carriers were going to make scheduled flights regardless of how
full the planes were, the costs of adding an incremental passenger to sparsely booked
flights were low. Thus, price wars among carriers ensued, and these wars lowered the
profit levels of all the carriers.
In response to this vexing situation, the industrys existing carriers began to make a se-
ries of moves. Gradually, the government began permitting mergers of major carriers,
and the excess capacity was eradicated from the system through the following:
Carriers created hub-and-spoke systems. A hub is a central airport through which
flights are routed, and spokes are the routes that planes take out of the hub airport. The
hub-and-spoke system attempts to make sure that planes are fuller. Inaddition to fill-
ing planes, these systems give the airlines greater power over customers by limiting
choices. Some cities are served by only a single airline, leaving customers no choice.
The carriers established frequent-flyer programs in an attempt to raise customer
switching costs. In addition, they created sophisticated management information sys-
tems used for ticketing and routing. Developing these systems involved huge invest-
ments that raised the barriers to entry.
To keep their costs in line, the airlines renegotiated contracts with the powerful pilots,
flight attendants, and mechanics unions. The power dynamics have shifted drastically,
with many carriers outsourcing heavy maintenance to the provider that can offer an
acceptable level of quality work at the lowest price.
Carriers also purchased newer, more fuel-efficient aircraft. The creation of the highly
subsidized European Aeronautic, Defense and Space Companynow called the Air-
bus Groupprovided carriers with an attractive alternative to Boeing aircraft.
Pricing models changed, and seat configurations were optimized. Planes were designed
to pack as many revenue passengers as possible per square inch of cabin space. As a
result, carriers commanded a premium for additional legroom and no longer bore the
costs of many amenities. In addition, most baggage fees, booking fees, Internet, and
food service have been passed on to the consumer, allowing airlines to achieve
competitive base pricing while giving customers the freedom to customize their own
flying experience.
Lastly, the push by major carriers for industry consolidation finally began to pay off.
The U.S. Department of Justice began to permit a series of industry mergers. The
U.S. airline industry has been whittled down to four major carriers (see Exhibit 2.8).
These deliberate strategic moves, coupled with the changes in the industrys macro-
environment, have increased the power of the airlines over their suppliers and customers.
EXHIBIT 2.8 Airline 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

The AMERICAN
Consolidation TWA
American
of Major U.S.
America West
Airlines
US Airways
Source: Based on
infographic provided
DELTA
Delta
at http://money.cnn. Northwest
com/infographic/news/
companies/airline- UNITED
merger/. United Continental
Continental
SOUTHWEST
Southwest
Airtran
Now,potential entrants must also overcome greater barriers to survival as they compete
against carriers with massive scale and market knowledge. Although this game is cer-
tainly still a tough oneand carriers are still quite vulnerable to external shocks to the
economy, drastic swings in fuel prices, and disease and terror concernsthe airline
industry posts much stronger profitability, and its players are in a far better position to
weather storms that may come their way.
Transient Industry Attractiveness

Industry attractiveness is inherently transient. Airlines are now among the top perform-
ers, while pharmaceutical manufacturers must grapple with a much more challenging
external environment. The same type of twist in fortunes can take place in any industry.
Thus, firms must be on guard and carefully monitor the macro-environment and its
impacts on the five forces. They must be one step or more ahead of the pack in the moves
they take to counter these trends or to adjust to their inevitability.
The choices are to stick it out and fight for what remains in industries that may be
losing their attractiveness or to make the difficult journey of entering a new industry that
for the time being appears to be more attractive. In the new industry, a firm will have to
contend with the existing players, and unless it brings some fundamental innovation to
customers, it is likely to be crushed by the existing competitors. Yet fundamental disrup-
tion is possible if prices are cut drastically, superior features are introduced even at pre-
mium prices, or breakthrough technologies are presented.
Thus, though planning and executing a move from industry to industry is far from a
simple matter, it is not impossible. A pharmaceutical company can never easily switch
its assets to the airlines industry nor can an airline company ever easily switch its assets
to the pharmaceutical industry, no matter what the relative attractiveness of the indus-
tries is. However, within the domains of their existing industries, firms do have options
for revitalizing stagnant business models.
Stakeholders
By positively interacting with its stakeholders, a company may gain the leverage it
needs to make difficult industry transitions. A stakeholder is any group that affects,
and is affected by, a firm. External stakeholders include not only the five forces and
many elements contained in the macro-environment as discussed previously, but also
scientific and technical organizations, local communities, the media, the general
public, and representatives from the many groups in society. A company must also be
heedful of internal stakeholder groups, such as shareholders, board members, manag-
ers, and employees.
Agency theorists hold that the primary stakeholderthe one that corporations must
serve firstis the owner/shareholder.14 This group, they argue, takes on the biggest
risk: In the event of bankruptcy, owners are residual claimants and are the last to be
paid back. These theorists, therefore, maintain that the sole purpose of managing rela-
tions with other stakeholders is to maximize returns to shareholders. A firm has legal
and ethical, as well as economic, obligations to each of its stakeholders, but the obliga-
tion to shareholders comes first.
Agency theorists also caution that giving managers latitude to prioritize other
stakeholder needs over those of the owners and investors can lead to abuse: Managers
can say they are serving the interests of other stakeholders when, in fact, they are
operating the corporation for their own benefit and enriching themselves at the expense
of shareholders. Despite the role that boards are supposed to play on behalf of share-
holders in controlling corporate management, these abuses have been common. The
top management in companies such as Enron, WorldCom, and Tyco were accused of
looting their companies at the expense of s hareholders.
Stakeholder theorists, on the other hand, dispute the claim that the primary stake-
holder has to be the shareholder.15 They hold that a firms management can actually
choose which group it would like to be the primary stakeholderand that the firm will
see a benefit when it (1) fully understands the relative impact of each of its stakeholders
and (2) can effectively prioritize the management of these groups. The actual approach
that organizations take toward their stakeholder groups varies across the globe. Japanese
firms, for example, tend to have a more balanced view of their responsibilities and the
groups they serve than do U.S. firms. They often mention employees and society before
shareholders, while most U.S. firms continue to declare that their primary obligation is
to shareholders. Under legal structures called co-determination in law, European firms
have obligations to both shareholders and workers.
In the U.S., firms incorporated in Delaware, the most common state for incorpora-
tion, are, within certain limits, required to put shareholders first. However, some
states, like Minnesota, have a broader conception of the relations between a firm and
its stakeholders and give firms the right to serve the interests of multiple stakeholders.
What firms are legally required to do, what they proclaim they do, and how they
behave are not necessarily consistent. Typically, corporate publications put customers
first, not shareholders.
Yet r egardless of whether a firm chooses to place top priority on shareholders or on
other stakeholders, it is prudent for a business corporation to carefully consider the needs
of all stakeholder groups. Some groups have to be managed very closely and handled
carefully, while others can simply be monitored. A tool such as an influence/impact ma-
trix can help organizations assign priorities to the stakeholder groups that vie for their
attention. Exhibit 2.9 shows how such a matrix could be used to prioritize a medical de-
vice manufacturers external stakeholders.
EXHIBIT 2.9
The Needs of a
Medical Device Low Interest High Interest
Doctors &
Manufacturers HMOs High Influence High Influence
Regulatory
& Insurers Keep Manage
External Authorities
Satisfied Closely
Stakeholders
Interest
Low Interest High Interest Level
Low Influence Low Influence
Community Monitor Keep Informed
at Large Patients
Establishing strong ties of reciprocity with stakeholders where incentives are given
for them to ally and affiliate with a firm and contribute to its success is one way of coun-
tering competitive threats and mastering the five forces. Strong ties of this nature may
also allow a company to establish itself within a weak industry as a strong player. Within
a rising industry, it can assist a company in becoming a leader.
Strategic Group Analysis

The second question of this chapters external analysis framework is Whats our posi-
tion in this game? Conducting a strategic group analysis can provide valuable answers
to this questionand it can also help a firm grapple with the transiency of competitive
advantage over time.
A strategic group map can help answer these key questions:
Where are the relevant players positioned in an industry?
Is our firm in a crowded groupone of many firms competing in similar ways for the
exact same set of customers?
Or, does the company hold a unique position that allows it to stand out from the crowd?
What strategies and/or events have led to the unique position each holds?
Between which groups is rivalry the greatest?
Which players are strongest or weakest?
Do external pressures favor some groups over others?
Which strategic moves are the rivals with strategic groups likely to make next?
With the above in mind, does our firms current position provide it with relative
advantage or disadvantage in comparison to its competitors?
Mobile Phones
The strategic group map shown in Exhibit 2.10 provides an understanding of how the
mobile phone industry evolved between 2011 and 2014. During that time, the industry
EXHIBIT 2.10 A Strategic Group Map of the Mobile Phone Industry, 2011 and 2014
2011 2014
High High
APPLE APPLE
Reliance on Proprietary
Reliance on Proprietary
RIM BB
NOKIA
OS Platform
OS Platform
Samsung
ZTE Huawei Samsung

LG
Xiaomi ZTE NOKIA
Sony LG
HTC Huawei Lenovo
Low Low
Narrow Broad Narrow Broad
Corporate-Level Diversification Corporate-Level Diversification
included firms that were narrowly focused on telecommunications and others that were
broadly diversified, like Samsung. Samsungs product families, for example, ranged
from smartphones to appliances. Its position along the x-axis of the strategic group map
(representing corporate-level diversification) was farthest to the right.
Industry participants were also differentiated based on the operating systems that
they utilizedsome chose to create proprietary software, while others did not. This
choice has been mapped on the y-axis. The players and positions that claimed the great-
est shares of the market inhabit the circles with the largest areas. Revenue changes are
shown by the dotted line and solid line comparisons. The insertion of arrows indicates
directional shifts.
In 2011, Research in Motion, the maker of Blackberry phones, had a unique position
in this industry. The company focused on a fairly narrow range of products and placed
bets that its phones proprietary operating system would provide a sustainable advantage
across business and government segments of the market. The rapid acceptance of
Apples iOS and the sheer size of Nokia with its proprietary Symbian platform seemed
to suggest that these companies, which had unique platforms, would be successful.
Samsung, too, began to move in this direction with the introduction of the Bada operat-
ing system for its mid-to-higher-end phones.
Unfortunately for Blackberry, its proprietary platform and narrow focus hampered its
ability to adapt to the industrys competitive dynamics. Its market share was quickly
eroded by competitors that offered more functionality, more user applications, and better
cross-platform integration. Nokia, Samsung and others abandoned their proprietary
operating systems, embracing the Android open source operating system instead. Phones
that used Android captured almost 85 percent of the market. Recent upstarts, such as
Xiaomi, began to flood into the lower end of the market, offering cheap Android-based
alternatives to Samsungs higher-end offerings. Samsung was feeling the pinch. Its mar-
ket share declined from 32.1 percent to 24.4 percent in the smartphone segment in
2015.16 Apples was the only truly proprietary system left and did well mainly because
of the product ecosystem the company had built around it. The question facing all the
firms in this industry concerned what to do next.
Restaurants
An examination of strategic groups within the restaurant industry also reveals interesting
dynamics. In the heart of the recent Great Recession, local fine dining establishments
suffered.17 They began offering lower priced options in order to survive. McDonalds and
other bargain fast food options seemed to fare much better, but franchisees complained that
popular dollar-menu offerings did not provide sufficient profit margins. The best position
was occupied by fast casual restaurants, such as Panera and Chipotle, which offered mid-
cost, high-value menu items, prompt service, and fresh dcor (see Exhibit2.11).
By 2015, the fine dining establishments were regaining their strength, but the fast c asual
position continued to be the most attractive. It expanded and thrived as trends toward con-
venience and healthy options remained strong. Traditional fast food restaurants and new
industry entrants were to join this thriving strategic group. By 2013, fast casual had gained
control of 8 percent of the total market, from just 1 percent in 2000.
However, the industry as a whole remained weak and the market was not growing,
and fast casual stood as a strong segment in a weak industry (see Exhibit 2.12). It took
EXHIBIT 2.11
A Strategic
Group Map of High Individual Fine
the Restaurant Dining Fine Dining Chains
Industry, 2014 Establishments McCormick & Schmick,
Ruths Chris, etc.
P/Q Mix
Individual
Family
Restaurants Fast
Casual
McDs and
other fast-
food
Brands
Low
Local Geographic Reach International
market share away from other categories rather than expanding the market as a whole.
Companies like McDonalds, Wendys, and Subway tried to mimic what companies in
the fast casual category had done. McDonalds created a build-your-own-burger,
Wendys remodeled restaurants in an effort to make them more comfortable, and Subway
generated a healthy narrative that incorporated ingredients like avocado associated with
higher-end offerings. These reactions were not successful. They went against the grain of
what these companies previously stood for. The transition was not an easy one for them
to make. In McDonalds case, to recover in an industry that no longer was attractive, the
company would have to create an entirely different segment with renewed customer
appeal, perhaps one based on the successful Shake Shack or Chipotle experience. How-
ever, if even it does so, McDonalds will be a latecomer and will have to overcome severe
image problems related to its history as an unhealthy fast food establishment.
EXHIBIT 2.12 10
8%
2013
Restaurant 8
6%
Traffic Growth
by Segment 6
2
0% 1% 2%
0
4 QSR Fast Casual Casual Dining Midscale Fine Dining

The key takeaway is that the most favorable position is that of a strong segment in a
growing industry (Apple). If this type of positioning is not possible, the next best
choices are to be in a weak segment in an expanding industry (Samsung in the non-
proprietary space) or a strong segment in a tough industry (Panera and Chipotle in the
cyclical restaurant business). Yet even in expanding industries like mobile phones, there
are companies that lose out because they are in the wrong segment (Blackberry and
Nokia). They are in the wrong segment because they are not quick enough to move into
the rapidly taking off smartphone, which is dominated by new competitors Apple and
Samsung. Each takes hold of a key segment within this rapidly changing industry.
Scenarios
Maneuvering around strategic groups within an industry is only the start. The external
analysis framework is not complete without asking, should we stay in this position for
the long term? Where, for instance, do Panera, Chipotle, and Apple, intend to go next?
How do they intend to build on their success? With Apple, the next product launch was
a watch, a wearable device. Was this wearable device only the beginning of establishing
an entirely new category of c onsumer electronics, the Internet of Things, in which nearly
everything is wired into and able to communicate with nearly everything else?
Understanding how an industry is likely to evolve over the long term and what the
strategist can do to shape its future direction are ongoing challenges with no easy
answers. Scenarios are but one of several techniques used to create a range of possible
futures. A range is necessary because a company cannot predict or forecast with cer-
tainty what is likely to happen next. Other techniques used to create scenarios include
simple extrapolation, bookends, leading indicators, and systems analysis.
Simple Extrapolation
Simple extrapolationa back of the napkin exerciseis most helpful in short-range
planning when industry conditions are stable, and demand is relatively smooth over
time. Some firms just dont feel the same pinch as others when faced with turbulent
conditions. Demand for their products and services plods along well during the best and
worst of times. One e xample of such an industry is waste disposal. Neighborhoods and
businesses certainly will not allow trash to pile up around their establishments, no matter
the external conditions. The demand, therefore, is relatively smooth and simple forecasts
are considered generally reliable.
Power generation is another critical service that cannot be shut off. Thus, utility plan-
ners may be convinced that future growth in demand will be relatively smooth. However,
electrical demand is heavily impacted by economic conditions, technological advances,
peoples willingness to conserve electricity, the social acceptability of different forms of
power generation, public subsidies to different forms of power generation, and other fac-
tors not considered in simple trend extrapolations (see Exhibit 2.13). In the 1970s, pro-
jections of smooth demand growth for electricity did not materialize and many
large-scale investments in nuclear power had to be abandoned with very large economic
losses. So, instead of simple straight-line projections, it is much better to subject certain
projections to stress tests at the extremes.
EXHIBIT 2.13 Aug 2012 - Updated Need Forecast

Demand 800 MW 552 MW
Extrapolations 452 MW
600 MW
in the Electric 319 MW
Power Industry 400 MW Updated Need
121 MW
200 MW 25 MW Uncertainty Range
0 MW
2015 2016 2017 2018 2019 2020
200 MW 117 MW
400 MW
Defining Bookends
Defining bookends, or extreme possibilities in terms of where the future may lead, can
provide insights when demand and prices are highly volatile, as they have been in the oil
and gas industry. Over time, the price swings have been substantially more than
$50/barrel, and there are reasons to believe that price swings of this nature will continue
into the f uture. Players in this industry must be able to sustain operations when prices
swing either to the lower bookend or to the upper one. Frackers who made calculations
based on the upper end faced liquidation when prices shot down.
The Shell Oil Company prominently displays scenarios on its web page. It bookends
two types of worlds that could come into existence, which offers both opportunities and
dangers of various kinds:
The first scenario, labeled mountains, sees a strong role for government and the
introduction of far-reaching policy measures. These help to develop more compact
cities and transform the global transport network. New policies unlock plentiful natu-
ral gas resourcesmaking it the largest global energy source by the 2030sand
accelerate carbon capture and storage technology, supporting a cleaner energy
system. For Shell, this world has many positive implications. It requires that the com-
pany build its capacity as a supplier of natural gas.
The second scenario, called oceans, describes a more prosperous, but also a more vola-
tile, world. Energy demand surges due to strong economic growth. Power is more widely
distributed, and governments take longer to make major decisions. M arket forces, rather
than policies, shape the energy system: oil and coal remain part of the energy mix, but
renewable energy also grows. By the 2070s, solar becomes the worlds largest energy
source. For Shell, this world can be a threat as it implies that fossil fuels play less of a role.
Given these widely divergent scenarios, shell must figure out its place in such a world
and build an alternate strategy around it. It can have a primary commitment to fossil
fuels, but at the same time, must hedge its bets that a world dominated by fossil fuels
may come to an end.
Another example would be pharmaceuticals and stem cell research centers. Four
futures may come into existence without companies in this industry knowing for sure
which one is most likely and with a need to make bets now even though what is likely to
take place next is nearly impossible to fathom. On the one hand, a lack of social accep-
tance of stem cell research and therapies may make any of its stem-cell related
EXHIBIT 2.14 Four possible outcomes for stem-cell

Pharmaceutical related technologies.
Research Social Social
Scenarios Acceptance Acceptance
Without With
Technological Technological
Viability Viability
Social Social
Rejection Rejection
Without With
Technological Technological
Viability Viability
investments a money loser. Without social acceptance, no matter how quickly the tech-
nology advances and how far it goes, the possibility of commercializing stem cell treat-
ments is likely to be low. On the other hand, society may tolerate stem cell research and
treatment and open the door to potential advancements in stem-cell related therapies.
However, if the science stalls and goes n owhere, making investments in this technology
will still be a money loser. If both social acceptance is low, and the science does not
develop, surely the future is dim for this technology. The only scenario with a big payoff
is one where both society accepts the technology, and the technology itself makes suffi-
cient progress that it is a useful cure for various ailments. Pharmaceutical companies
have to consider all of these scenarios in their planning (see Exhibit 2.14).
Leading Indicators
A company can go beyond simple projections and examine the leading indicators and driv-
ing forces that can create a range of possible outcomes. Construction equipment manufac-
turers like Caterpillar, for example, closely observe indicators such as new home starts,
while cement manufacturers like CEMEX watch for accelerations in GDP, which come
before the need for roads, bridges, and other infrastructure.
A company must continually scan the environment for the driving forces behind the
changes that are creating new engagement rules for the bets it is placing on the future.
Ecolab is a firm that has been on the lookout for such forces at play. The company is care-
fully examining the implications of an aging baby boomer generation. In 2015, 10,000 of
the nations 76 million baby boomers were reaching age 65 every day, an indicator of
change that is expected to continue until 2029. What meaning should be attached to this
phenomenon? Ecolab has identified a business opportunity in offering sanitizers, deter-
gents, and disinfectants and services for senior housing. The 19 million 85-year-olds
expected to live in assisted-living centers throughout the U.S. in 2050 are ripe targets for an
expansion of Ecolabs business.
Systems Analysis
However, even following such leading indicators and driving forces of change is not
sufficient. To really get a grasp on what might happen next, a company must do systems
analysis to have insights about changes that are likely to occur on multiple fronts. Incon-
structing scenarios, elements in the external environment must be seen as a system with
multiple linkages. Changes in one element in the external environment (such as global
security, energy prices, and the environment) induce changes in another (the economy),
which in turn bring about changes in a third (public policies), which, in turn, change the
culture and society, and so on. These changes are interconnected. Complex systems can
be in equilibrium for certain periods, but countervailing forces exist and systems, there-
fore, migrate quickly in surprising directions. The financial meltdown of the end of the
first decade of the 21st century is an example of a system in disequilibrium whose disin-
tegration was felt in many domains. Three types of uncertainty a lways exist:18
State uncertainty refers to incomplete knowledge about the components in the model
(e.g., oil supply and demand, the world economy, technology, social forces, and the
environment) and how they relate to each other. There also is uncertainty about how
macro-elements affect the five forces in the industry model. What is their impact on
the structure of an industry? Does the industry become more or less attractive?
Effect uncertainty refers to the impacts on a particular firm. Even with near-perfect
information about the macro-environment and an industry, a company still may not
be certain what the effects will be on it.
Response uncertainty refers to lack of knowledge about a firms response options.
This type of uncertainty is the most profound, for even if a company has perfect grasp
of the macro-environment, the industry, and the impact, it may not have sufficient
imagination and creativity to craft adequate responses, predict the likely consequences
of response choices, and secure backing for them from people in theorganization.
Companies, therefore, should ask:
Which elements of the external environment currently appear to be most important?
Which emerging trends may turn around these elements?
What might the scope, direction, speed, and intensity of the changes be?
What are a companys choices for coping with this type of changes?
Scenarios require a picture of a romantic future with better-than-expected outcomes, a
tragic future with worse-than-currently-imaginable outcomes, and a comedic future with
many surprises. Companies should have plans of action for each of these possibilities
plans to bring about a romance, avoid a tragedy, and cope with surprises. Scenarios are
not predictions but goads to action to shape the future so that an organization does rea-
sonably well regardless of the future events that take place.
A cross-impact matrix is a useful tool for creating scenarios. It shows how one trend
may intersect with another. In Exhibit 2.15, four scenarios were developed around possi-
ble regime changes in Saudi Arabia. In the first scenario, the United StatesSaudi rela-
tionship remained fairly stable. In the second scenario, radicalization increase in Saudi
Arabia. The third scenario consider what could happen if the government were taken over
by religious extremists. The fourth scenario developed what would take place were
SaudiArabia to modernize relatively rapidly and develop institutions similar to those of
Western Europe and the U.S. Potential changes in oil supply and demand, the world econ-
omy, technology, social forces, and the environment were considered, with the final rows
being reserved for estimates about world oil prices in different time periods. With oil
prices in 2016 so low, these projections might miss the mark.
EXHIBIT 2.15 Four Scenarios of Future Oil Prices Based on Regime Change in Saudi Arabia
1. Saudi Status Quo 2. Saudi Arabia Radi- 3. Saudi Arabia with 4. Saudi Arabia
calized Iranian Style Revolu- Modernization
tion
U.S. Politics U.S.-Saudi relations U.S.-Saudi relations U.S.-Saudi relations U.S.-Saudi re-
basically the same rupture totally break down; newed friendship
2 nations become
implacable enemies
Oil supply & demand World demand in- Demand up, supply Demand rises sharply; Adequate supply to
creases due to devel- decreases; no new no new sources dis- meet demand
oping countries sources discovered covered & worldwide
embargo on supplies
to western nations
World Economy Does not substantially Recession Massive slump in Flourishes
go down world economy
accompanied by high
levels of inflation;
return of 1970-like
stag-flation
Technology No big breakthroughs Drivers appear for Intense pressures to Alternative energy
possible substitutes develop substitutes to technologies in
fossil fuels; some widespread use
become commercially
ready
Social Forces Gradual but contained Further radicalization Entire Middle East in- Increased global
Middle East radicaliza- in many countries flamed; anti-western harmony & cele-
tion sentiment grows in bration of diversity
non-Islamic countries as positive force
Environment Degrades gradually Negative effects of Severe climate Environment im-
global warming start change impacts felt in proves because
to appear many places in world, new technologies
especially poorer in widespread use
countries
2013 $/barrel $85 $100 $175 $75
2018 $/barrel $95 $115 $190 $65
2023 $/barrel $115 $140 $235 $100
Summary When examining the external environment, the strategist should aim to seize opportuni-
ties that present themselves and work to counter forces that are expected to have a nega-
tive impact. Unfortunately, the game is not always good. The structures of some
industries may be such that the forces cannot be influenced for the better. There may be
fundamental changes in industry structure brought on by changes in macro-environmental
conditions such as society, politics, the economy, technology, and the natural world over
which a firm and its leadership have little control. Often, the only options are shift
positions or migrate to a new industry altogether. If neither exiting nor defensive
repositioning is possible, as is often the case, the strategist must be careful that the
moves chosen do not cause the industry structure to deteriorate further. For example, a
favorite category of movesprice cuttingcan be ruinous. The actions a strategist
takes can just as easily weaken an industry as they can strengthen it. The moves pro-
posed must be tested. Will they improve the conditions in an industry?
The tools presented for analyzing the external environment in this chapter are related,
supplement each other, and can be used together for assessing external opportunities and
threats. Industry definitions and boundaries shift. New industries are created. Old indus-
tries lose their appeal. These are the important swings, some predictable and some not,
in the attractiveness of industries to be aware of. Analysis of the five forces and the
macro-environment can lead to understanding of change. It can yield insight into inflec-
tion points a company confronts. It can also shape the recommendations of moves the
firm can make. Among other examples in this chapter, the pharmaceutical and airline
industries provided examples of industry changes and moves firms can make to alter
industry conditions, but there are limitations to these moves in fundamentally changing
industry prospects.
In the end, stakeholder relations, strategic group analysis, and the creation of scenar-
ios that point to possible outcomes that may come into being because of the effects of
the macro-environment on industry conditions are useful tools for giving indications of
possible futures a company may confront. With this type of understanding, a company
can build repertoires of moves it can take to meet different challenges. It can better
hedge its bets accordingly and rehearse various responses to the different possibilities it
could confront. The internal environment, the subject of the next chapter, also must be
understood and analyzed.
Exercises for the Practitioner and the Student

Reflect on your own employers external environment. If you are a student, please select
a publicly held firm to analyze.
1. How would you define this industry?
2. Search for relevant NAICS codes at http://www.census.gov/eos/www/naics/.
3. Are industry boundaries shifting over time?
4. What are the basic economic features of this industry?
5. Which of the five forces are most significant for industry participants? Which are the
least significant? How would your answers vary if you were conducting this analysis
for a larger or smaller industry participant? What types of tactics can an industry
player use to push back against the strongest forces?
6. Identify the key external and internal stakeholders for this company and industry.
7. How do your industrys players differ in their approach to the market? How have
their positions and shares been changing/trending over time? How does the profit
potential of each strategic group vary? Sketch a strategic group map to clearly illus-
trate how industry participants are positioned.
8. Which driving forces are at work in your industry? Are they expected to grow or
shrink? Where are the trends pointing?
9. Which of the techniques presented provides the most useful long-term perspectives
for your industry? Define a couple of scenarios describing how your industry may
evolve over time. What types of issues could unfold over time for your company, its
rivals, and the industry as a whole? How can you utilize this analysis to prepare for
the future and increase the agility of your organization?
Endnotes 1. M. Porter, How Competitive Forces Shape Strategy, Harvard Business School Press,
MarchApril 1979, p. 137; also see M. Porter, Competitive Strategy: Techniques for Analyz-
ing Industries and Competitors (New York: Free Press, 1980); M. Porter, Competitive Advan-
tage: Creating and Sustaining Superior Performance (New York: Free Press, 1985).
2. Richard AndersonDelta Air Lines, Flightglobal, http://www.flightglobal.com/interviews/
year/14/richard-anderson/interview/, accessed August 15, 2015.
3. George Packer, Cheap Words: Amazon Is Good for Customers, But Is It Good for Books?
New Yorker, February 17, 2014, http://www.newyorker.com/magazine/2014/02/17/cheap-words.
4. Porter, How Competitive Forces Shape Strategy.
5. G. Hawawini, V. Subramanian, and P. Verdin, Is Performance Driven by Industry or Firm-
Specific Factors? Strategic Management Journal 24, no. 1 (2003).
6. A. Marcus, Strategic Foresight (New York: Palgrave-MacMillan, 2009); also see P. Schwartz,
The Art of the Long View, 2nd ed. (New York: Currency Doubleday, 1996).
7. T. Stewart, E. Drake, J. Wang M. Bell, and R Scott, Surging Steel Imports Put Up to Half a
Million U.S. Jobs at Risk, Economic Policy Institute, May 13, 2014, http://www.epi.org/
publication/surging-steel-imports/.
8. Robin Farzad, Chipotle: The One That Got Away from McDonalds, Bloomberg Business-
week, October 3, 2013, http://www.businessweek.com/articles/2013-10-03/chipotle-the-one-
that-got-away-from-mcdonalds.
9. Josh Barro, Inverting the Debate over Corporate Inversions, the New York Times, August 6,
2014, http://www.nytimes.com/2014/08/07/upshot/inverting-the-debate-over-corporate-
inversions.html?_r=0.
10. Not What It Seemed, The Economist, April 14, 2014, http://www.economist.com/blogs/
charlemagne/2014/04/frances-6pm-e-mail-ban.
11. Porter, How Competitive Forces Shape Strategy.
12. Domestic Airlines in the US: Market Research Report, IBISWorld, May 2015, http://www.
ibisworld.com/industry/default.aspx?indid=1125.
13. Frank Vinluan, Pharma Jobs Report Card: 297,650 Jobs Cut in the Last Decade, MedCity
News, April 15, 2011, http://medcitynews.com/2011/04/pharma-jobs-report-card-297650-
jobs-cut-in-the-last-decade-morning-read/.
14. M. Jensen and W. Meckling, Theory of the Firm, Managerial Behavior, Agency Costs, and
Ownership Structure, Journal of Economics 3 (1976), pp. 22539.
15. R. Freeman, Strategic Management: A Stakeholder Approach (Boston: Pitman, 1984).
16. Gartner Says Sales of Smartphones Grew 20 Percent in Third Quarter of 2014, Gartner
Newsroom, December 15, 2014, http://www.gartner.com/newsroom/id/2944819.
17. R. Ferdman, The Chipotle Effect, Washington Post, February 2, 2014, http://www.washing-
tonpost.com/news/wonkblog/wp/2015/02/02/the-chipotle-effect-why-america-is-obsessed-
with-fast-casual-food/.
18. F. Milliken, Three Types of Perceived Uncertainty about the Environment: State, Effect, and
Response Uncertainty, Academy of Management Review 12, no. 1 (1987), pp. 13343.
C H A P T E R T H R E E
Internal Analysis
Core competencies are the collective learning in organizations, espe-
cially how to coordinate diverse production skills and integrate multiple
streams of technologies. Core competence is communication,
involvement, and a deep commitment to working across organizational
boundaries. Few companies are likely to build world leadership in
more than five or six fundamental competencies. A company that com-
piles a list of 20 to 30 capabilities has probably not produced a list of
core competencies. Still, it is probably a good discipline to generate a
list of this sort and to see aggregate capabilities as building blocks.1
C. K. Prahalad and Gary Hamel, The Core Competence of the Corporation

Providing a process for analyzing a firms internal situation that includes both qualitative and
quantitative approaches.
Understanding the resource-based view (RBV) framework and how it differs from the industrial
organization (IO) viewpoint introduced in Chapter 2.
Identifying key resources, capabilities, and competencies that are embedded across the firms value
chain.
Using VRIO analysis (is a resource valuable, rare, costly to imitate, and is the firm organized to
capture the value of the resource?) to determine where the firms resources are most (or least) likely
to provide sustained competitive advantage (SCA).
Through value chain analysis, delving into a firms financials for further insights into its strengths and
weaknesses.
Understanding mechanisms of accountability including the hierarchical, organic, and contingency
approaches to management.
Examining strategic options/moves that take into consideration both the internal and external
environments of the firm.
52
Chapter 3 Internal Analysis 53
Introduction
Walmart, Target, and Kmart all compete in a similar industry environment. Over the past
several decades, they have had access to many of the same opportunities and have faced
the same general threats. They have occupied similar strategic spaces in the world of
retailing as well-known discounters. So, why does their performance differ so greatly?
This question can only be answered by examining the internal resources and capabilities
that each firm has developed over time. Their resource and capabilities are different, and
these differences have influenced their performance and the degree to which they have
been able to achieve SCA.
The book Moneyball and the subsequent movie about the Oakland Athletics provides
another clear example of how firms leverage their unique capabilities. The story
explainshow an organization with a relatively small resource endowment in comparison
to teams like the New Yankees and Los A ngeles Dodgers could develop the internal
capabilities to compete with these baseball teams that were far better endowed than
itself.2 The internal strengths on which the Oakland Athletics built its competitive suc-
cess did not come just from the, resources which it had but in how these resources were
deployed and used as a unique competence in player selection and talent development.
Other teams initially did not understand what Oakland was doing and could not copy the
distinctive way that Oakland chose and developed its players. Oakland broke the old
rules with respect to assessing its internal strengths in comparison to its competitors, and
by breaking the rules of internal analysis it achieved many years of success that objective
observers would have predicted were beyond its reach.
Internal analysis (IA) is the process of examining an organizations strengths and
weaknesses in order to bolster an organizations competitiveness and enable it to achieve
SCA. IA focuses on the question of how organizations can go beyond the resources they
have been bestowed with and enhance their competitive capabilities. It provides insights
regarding what can be done to ensure that firms survive and thrive in the long term by
using the resources they have to their utmost.
Both external (EA) and internal (IA) analyses are necessary to select options and craft
a firms strategy. In chess, the strategist examines how his or her own pieces are aligned
as well as how those pieces can be maneuvered versus an external opponent. In the
military, one must know the enemy, but also know oneself to win battles. In strategy
making, winning moves depend on alignment between internal strengths and external
opportunities. The purpose of this chapter, therefore, is to provide tools for carrying out
internal analysis that enables a firm to utilize its resources to succeed within the external
environment in which it finds itself.
The Resource-Based View

The resource-based view (RBV) of the firm, partially derived from ideas originally
formulated by C. K. Prahalad and Gary Hamel, is examined in this chapter.3 It is the
foundation for internal analysis. Michael Lewis applied this theory in analyzing the
Oakland Athletics success. An alternative to the industrial organization (IO) economics
approach to strategy that was the focus of the last chapter, RBV emphasizes internal
strengths rather than industry conditions as the main factors driving sustained competi-
tive advantage (SCA). RBV sees the organization as a combination of resources, capa-
bilities, and competencies and attempts to understand how these factors influence the
firms performance.
Though academic research has not determined exactly what percentage of competi-
tive advantage derives from internal strengths and weaknesses, and what percentage
derives from the external environment, it has established that internal strengths are criti-
cally important. How a firms resources, capabilities, and competencies are arrayed is
essential for establishing the foundation for a firms long-term success.
RBV starts with the assumption that organizations differ in the resources that they
command. The Moneyball example focuses on the differences between the resources that
teams like the New York Yankees and the Los Angeles Dodgers had in comparison to
the Oakland Athletics. Yet despite these resource differences, the Athletics were com-
petitive with these better-endowed teams. While these teams faced similar competitive
conditionsthey all played 164 games against a similar group of opponentsthey
achieved different results because of the different way they acquired and configured the
internal resources they had. Based on the way internal resources are managed, perfor-
mance differences within a category of organizations like industry groups and industry
segments can be as significant as those between them. Thus, for a company it is not suf-
ficient to just choose the most attractive industry group or segment. It must develop the
internal capabilities to manage the resources it has effectively and thereby to stand out in
whatever industry group or segment it chooses.
The central conclusion of Chapter 2 was that by analyzing the organization of an in-
dustry, companies can choose the best industry groups and segments in which to com-
pete. This model of the industrial organization (IO) route to SCA needs to be compared
with the RBV model. Exhibit 3.1 summarizes the key differences between the IO and
RBV models. Because of their differences, IO and RBV put emphasis on different areas
regarding how to achieve superior performance. IO economics starts with e xternal analy-
sis and proposes that the most important action a firm can take is to move to an attractive
industry or industry segment. Then it analyzes the main internal means a corporation
must acquire to support a strong external position. RBV, in contrast, starts with internal
analysis. It proposes that a corporations most important actions involve bolstering its
internal strengths. It then calculates the best external position to occupy given the firms
array of internal strengths and weaknesses. In other words, IO fits the firm to the exter-
nal threats, and opportunities it confronts, whereas RBV molds the external environment
around the opportunities generated through what the firm does best.
According to RBV, if no external niche exists for what the firm does best, then the
firm can leverage its internal resources and capabilities to create a new niche that is more
to its liking. The firm can be a first or early mover and occupy a new competitive space
where it will face little or no serious competition. For instance, before Dells arrival,
the direct marketing model was not believed to be a viable model for long-term success
in the personal computer business. Thus, IBM ceded first-mover advantage to Dell,
which developed the capabilities necessary to compete in the niche of direct marketing.
Dells competitors had to copy its capabilitiesno easy taskand then become direct
marketers after Dell already was well entrenched.
EXHIBIT 3.1 Industrial Organization Economics Resource-Based View

A Comparison
of IO and RBV The external environment is the primary determi- An organizations deployment of its resources
Approaches nant of organizational strategynot the internal and capabilities have the greatest impact on firm
decisions of managers. performancenot external environmental conditions.
Assumptions: 1. Resources are highly mobile Assumptions: 1. Resources and capabilities are
between firms. 2. All competing organizations not highly mobile across organizations and, once
control or have equal access to resources. acquired, are retained. 2. Valuable resources are
The environment presents threats and opportunities costly to imitate and nonsubstitutable.
that must be addressed. Organizations can deploy internal strengths to
Organizational success is achieved by offering mold their external environment.
goods and services at lower costs than competitors, Competitive advantage is gained through the
or by differentiating products to bring premium acquisition and value of organizational resources
prices. and capabilities.
In stressing the centrality of internal analysis, RBV helps to explain the contin-
ued blurring of industry boundaries and the creation of new industry categories as
Chapter 2 discusses. New industry categories, according to RBV, arise out of unique
internal strengths. The way firms structure their resources, capabilities, and compe-
tencies in comparison to other firms is a source of innovation. It can be the basis for
industry transformation.
To fully understand a firms internal strengths, it is necessary to grapple with a
number of key questions:
1. Does the firm currently have the resources, capabilities, and competencies necessary
to compete and win?
2. If it lacks resources, capabilities, and competencies that it needs, does it have the ca-
pacity to acquire or develop them?
3. What combination of acquisition and developmental activities is needed in order to
possess the resources, capabilities, and competencies to address critical threats and
seize important opportunities?
4. How can the firm become dynamic enough to continuously acquire and develop the
resources, capabilities, and competencies to succeed in the long term?
For a firm to understand whether it has the current resources, capabilities, and compe-
tencies needed to compete and win, it must understand which are needed and how to
combine and use a full set of these elements to deliver value to the marketplace.
Resources, Capabilities, and Competencies

The distinction between resources, capabilities, and competencies has been described as
subtle at best.4 Yet this distinction is fundamental to understanding what an
organization needs to achieve sustained competitive advantage. Every organization is a
combination of resources, capabilities, and competencies, and each of them plays a role
in determining an organizations strengths and weaknesses.
Resources are a firms basic financial, physical, and human capital. Based on a com-
panys line of business, its resources may include tangible assets, such as cash, buildings,
machinery, and people, and intangibles, such as patents, trademarks, brand reputation,
and so on. Resources are best characterized by the fact that (1) they are protected by
legal rights of ownership, and (2) they can be bought and sold.
Capabilities are what allow a firm to exploit resources, for without the ability to
exploit them they have little economic value and are instead just a series of separate
resources that can be transferred and traded in the market. An organization needs the
managerial skills to exploit these resources. It must be able to orchestrate their use and
conduct productive business activities based on their possession.
For example, having a computer has little value if a person does not know how to use
it. Based on the computer skills they have, different people are able to extract different
levels of value from their computer ownership. Owning the rights to a baseball player
offers another example of the distinction between resources and capabilities. The play-
ers value to a team arises from the role the player is assigned, the position he plays, his
spot in the batting order, and the capabilities the teams management has in synchroniz-
ing the players talents with other players and maximizing the players usefulness. With-
out these managerial interventions, an assembly of very talented players, no matter how
gifted individually, does not create a consistent winner. The capability of management to
forge together the talents of many players and develop a winning approach based on their
complementary endowments gives them value. The analogies in Exhibit 3.2 help to clar-
ify the differences between resources and capabilities.
Organizations must have many capabilities to succeed. For a football team to become
a consistent winner, its players must be able to run, block, tackle, punt, pass, catch the
ball, and so on. Its coaching staff must be able to select and call plays, organize prac-
tices, motivate, watch tapes of past games, and extract useful lessons from these tapes.
The coaching staff must also evaluate and choose talent and keep the teams morale high
even in the face of adversity. Intangible capabilities like restraining the egos of talented
but insecure individuals and eliciting high levels of team spirit and effort at critical junc-
tures in games are needed as well. The organization must take the human resources it has
collected and display an aptitude for uniting disparate individuals for successful collec-
tive action.
As exceptional as the capabilities are that allow a group of individuals to cohere into a
winning team, the competencies that describe the distinct manner in which a team wins
are rarer still. In a dictionary, the terms capabilities and competencies have the same
meaning. They refer to aptitudes, proficiency, and know-how, but in the arcane language of
the RBV, they are different. Competencies link capabilities together into a distinct style of
winning. To revert to the football analogy, some teams win thanks to a tight defense that
rises to the occasion with game-winning turnovers and goal-stopping stands, while
EXHIBIT 3.2
The Resources are like ingredients, while capabilities are like recipes.
Differences Resources are like hardware, while capabilities are like software.
between
Resources are like an artists brushes, canvases, and paint,
Resources and while capabilities are like an artists sensibility and technique.
Capabilities
other teams win with an explosive offense. Some teams carry out methodical and time-
consuming comebacks at a games close. Others rely on big plays early in a game that
blow an opponent away with large leads. Some teams squeak by with victory after vic-
torybecause they have an uncanny ability to deal with pressure, while others regularly
collapse even if they play superbly early in a game. These character traits of winning
teams show up again and again. The ability of coaches and managers to adjust a winning
style to the talent they have is the supreme competence. The organizations capabilities
are channeled in a distinct way to achieve victory. They harness key capabilities to create
a style and method of winning that the organization is able to reproduce again and again.
The distinct way organizations harness capabilities to satisfy customers sets them
apart from their rivals. For instance, some restaurants satisfy their customers with a
combination of capabilities that provide a special atmosphere, with music and lighting
and particularly good service. The food is more than adequate, but it does not necessarily
stand out from the food other restaurants serve. Other restaurants focus mainly on the
quality and taste of the food. That is where they apply their capabilities. Perhaps they
cultivate a competence in a particular type of ethnic food. Perhaps, they hire especially
inspired, imaginative, and well-regarded cooks whose original creations are regularly
reviewed in upscale publications. In each case, the competence is different and is based
on the combination of a different set of capabilities.
Given that a competence is based on this combination of separate capabilities, it is
very hard for competitors to imitate it. Since competitors cannot easily copy it, it can
serve as the basis for sustainable competitive advantage. No competitor, for instance, can
quite capture the distinct taste of a creole fried shrimp soup served with local flair and
organically grown vegetables. No competitor can match the gourmet status of an upscale
French restaurant whose cooks are world renowned, whose service is impeccable, and
whose wines are vintage varieties that are hard to get anywhere else. The ability to con-
sistently make money supplying cheap food to budget-minded families also requires the
competence of uniting disparate capabilities in an overall eating experience that is not
just about the food.
RBV sees organizations as collections of primary productive resources and capabili-
ties that can be combined into different types of hard-to-imitate competencies, which
have enduring marketplace value. How these resources and capabilities are combined
depends on the choices managers make.
Resources and capabilities, then, are bundles of services that can contribute to the
production of different goods and services that customers value. Organizations are dis-
tinguished by how they convert these resources and services into experiences customers
appreciate. The organizations leaders can combine its resources and capabilities in dif-
ferent ways that yield different outcomes. For instance, the Oakland Athletics General
Manager Billy Beane could not buy extremely gifted athletic players with the muscle
power to regularly hit homeruns, the rocket arms to mow down hitters, and the excep-
tional swiftness to steal base after base. Beane and his staff were confined to a more
limited resource base than their competitors. So, they had to devise methods to get more
out of the players they could assemble with the fewer dollars they had to spend. Thus,
they relied on their capabilities in statistics to select low-paid, young talent with poten-
tial for development, and veteran over-the-hill eccentric players that had some remaining
special abilities. Then they combined these less well-regarded players by conventional
standards into teams with a distinct approach to winning that went against the prevailing
wisdom in other baseball front offices of the late 1990s.
RBVs understanding of the firm brings the managerial creativity required to trans-
form resources into distinct competencies to the forefront. The strategic challenge man-
agers of business corporations face lies in taking the disparate resources and capabilities
an organization has collected and forging them into entities with unique identities that
consistently provide customers with valuable goods and services. From this perspective,
the value organizations deliver to customers represents only one of several ways in which
an organization can use its resources and capabilities. Resources and capabilities can be
combined in many different ways with better management figuring out how to extract
the most value from the resources and capabilities they have. With greater and more
creative understanding of the market, resources and capabilities can be reconstituted to
yield something greater than their returns they currently achieve in an existing configu-
ration. The need is to innovate and go beyond the obvious and prevailing wisdom in how
an organizations resources and capabilities are used in order to develop a unique
approach to winning.
To again use a football example, New England Patriot coach Bill Belichick reassem-
bles the talent on his team each year and gives it a different emphasis depending on the
types of players he has, none of whom typically are high draft picks. He reconfigures the
resources and capabilities he has to give his teams a unique edge. The same can be said
of symphony orchestras. Each is assembled from slightly different talent pools and
molded together in a unique way by conductors to create distinctive sounds that give
pleasure to listeners.
The takeaway is that an organizations performance does not result from the mere
possession of resources and capabilities, but from the ingenuity its managers apply in
combining these resources and capabilities in novel and improved ways, for example, by
a bank allocating financial capital to uses that produce greater returns or in a manufac-
turing site by assigning workers to areas where they achieve higher productivity.
The VRIO Test

The competitive significance of resources and capabilities can be determined by using
the VRIO test, which poses the following questions:5
1. Are the resources and capabilities the organization has valuable? Do they enable the
organization to exploit an important opportunityor thwart a significant threat?
2. Are they rare? Are they held by very few firms?
3. Are they inimitable? Are they difficult to copy via development or acquisition?
4. Is the firm organized and ready to exploit them for the benefit of customers?
Exhibit 3.3 provides some examples of how this type of analysis might be used to assess
a restaurants internal strengths and determine its relative advantage/disadvantages. A
high-visibility corner location might be valuable to the restaurant; however, if rivals can
also build at high-visibility locations, the best a firm can expect is competitive parity
based on its location. A restaurant that holds a technology patent but has no way of prof-
iting from the use or sale of the technology has an unused advantage. A restaurant with
exclusive access to a rare ingredient that will have customers lining up has more of a
EXHIBIT 3.3 Resource or Organized

VRIO Analysis Capability Valuable? Rare? Inimitable? to Exploit? RESULT
of a Restaurant
Dilapidated Building NO Disadvantage
High-Visibility Corner Lot YES NO Parity
High-Tech Tabletop
Customer Interface YES YES NO Temporary
Advantage
Technology Patent YES YES YES NO Unused
Advantage
Exclusive Access To Ground-
Breaking Ingredient Used
in Special Recipes by
Gourmet Cook YES YES YES YES SCA
foundation for sustained advantage, but it is the unique combination of all these elements
that might make the organization stand out and give it the chance to have a distinctive
competence and become a dynasty.
Under optimal conditions, resources and capabilities not only complement each other,
but also increase each others competitive significance and value. Consider their inter-
play in the following ways:
Measurement. If tangible, resources are found in financial statements; they appear on
an organizations balance sheet and are valued in its books. However, the capabilities
that the organization has developed for combining, recombining, and using its
resources can propel the value of these resources far beyond their accounting value.
Market exchange. Except for patents, which are based on legally enforceable prop-
erty rights, intangible resources, such as a reputation for toughness or quality, cannot
be easily traded. They are dependent on particular organizational processes that make
it difficult to remove them from their context. Similarly, capabilities, such as the
loyalty of dealers and trust of customers, which have been nurtured through a history
of honest dealing cannot be easily transferred.
Difficult to imitate. As mentioned above, an organizations specialized experience in
combining and using resources should lead to valuable capabilities that cannot be
easily imitated by its rivals. Such capabilities are both complex and path dependent;
that is, they are the cumulative outcomes of historical decisions in which there has
been substantial trial-and-error learning to which key rivals have not been privy.
They require long-term, careful development. They cannot be just purchased off
theshelf.
For a competitor, attempting to imitate the long-term leader in an industry is likely to be
very time-consuming and costly, with little chance of success. That is the aim of leader-
ship, to put plenty of competitive space between an organization and its major rivals.
New entrants are therefore discouraged as well.
An organizations unique combination of resources and capabilities provides it with a
head start, leaving competitors with the difficult task of trying to catch up quickly (e.g.,
by running crash advertising or R&D programs, which usually are less effective than one
carried out over a longer period). In addition, even if the needed resources can be
acquired and the capabilities learned, the competitors still face the major problem of
identifying the precise sequence and pattern for organizing the resources and capabilities
to deliver distinctive customer value.
Thus, a focus in understanding an organizations internal strengths and weaknesses
should not be on resources and capabilities per se. Nor should an organization be mainly
interested in acquiring more resources and adding additional capabilities. The key ques-
tion is how an organization combines its resources and capabilities into distinctive com-
petencies that deliver customer value that competitors cannot easily copy.
From Capabilities to Competencies

Capabilities are the essential building blocks for the distinctive competencies an organi-
zation wishes to create. The most important of these capabilities are embedded in human
networks within the organization and with other organizations with which employees
regularly interact. In a business context, the most important of these capabilities include
leading, planning, and obtaining feedback; engaging in dialogue; and motivating, com-
pensating, appraising, communicating with, and rewarding employees. They involve the
functional relationships among organizational members as shown in Exhibit 3.4, as well
as outside commitments that have been obtained from customers, suppliers, and finan-
cial backers. Such relationships may arise from many different basesphysical, techno-
logical, and financial, but they go well beyond when they are combined in unique ways
to deliver value to customers.
Time-consuming, and difficult to cultivate and assemble, capabilities are hard to rep-
licate because they cannot be purchased with money alone. While an organization can
buy a talented employee with a lucrative contract, the right to a promising technology
through licensing the patent, or even money itself by paying interest and taking out a
loan, capabilities are not really up for sale. From the perspective of understanding an
organizations strengths and weaknesses, they derive from interrelationships and connec-
tions that make up the organizations inner and outer workings. To go back to the foot-
ball analogy, it is not just a capability for blocking that is important, but also the
coordination and linkages among a series of blockers who apply their skills differently
depending on specific situations in a game.
EXHIBIT 3.4 Marketing Operations R&D IT HR Finance

Valuable
Organizational Respected Low-cost Rapid Well-developed Recruitment and Strong balance
brand image production development infrastructure development sheet
Capabilities
processes of distinctive capable of of top talent
Across the Strong ads & Steady growth
products & delivering info
Value Chain promos Superior services across Facilitation of in income
quality output positive, high-
Highly organization A sizable war
Flexible & performance
professional, Efficient global chest
relevant Attractive culture
customer- distribution invention e-commerce
centric sales capability platform interface
force
Capabilities are not the individual skills employees bring to the job, but connections
and relationships they have, often outside the team, and it is how these individual skills
get c oordinated into a greater collection of value. They include the talents, experience,
judgment, intelligence, insights, and training of individual employees, but only start
there. Relationships, openness to new technologies, and other intangibles are what make
these individual skillsets distinctive and valuable. These elements cannot be owned,
transferred, traded, bought, or sold in the same way that physical and other types of
property can. Thus, an organizations capabilities, as indicators of its strengths and
weaknesses, are hard to characterize and assess. Retrospectively, they are easier to
understand and identify than prospectively.
Culture as the Backbone of Capabilities

The backbone of the capabilities that get transformed into competencies is culture. A
culture is made up of key managerial values, beliefs, and assumptions about how people
in the organization conduct their business. A culture dictates how an organization treats
its employees, customers, and suppliers, and fosters innovativeness and flexibility in the
relations among them so that the sum of these parts constitutes something far greater
than each of the separate individual inputs.
A culture is imperfectly imitable if other organizations cannot easily duplicate what
the culture has to offer. For this to be the case, the culture cannot be easy to characterize.
It should be idiosyncratic in some ways, a reflection of the organizations founding,
development, unique personalities, and experiences. If path-dependent and historically
bound in this way, a culture can contribute to long-term advantage. The qualities that
best capture capabilities are likely to adhere to the people in the organization and how
they relate to each other over time. Googles culture, as described on its webpage, is
highlighted in Exhibit 3.5.
Note that this description of Google just starts with hiring talented people. It goes on to
tout a distinct set of values, the companys goals and vision, the importance of diversity and
inclusiveness, openness, idea sharing, communicating, both horizontally and up the hierarchy
to the organizations top rungs, and the importance of having fun as well as working hard.
From the perspective of RBV, culture is a source of advantage if it contributes to a
competence in low-cost or unique products and services that satisfy customers and that
competitors cannot easily copy. Culture adds value to the organization when it yields
higher sales, greater innovation, lower production costs, and higher margins. When rare,
a culture enables the organization to be something others cannot be or to do things that
EXHIBIT 3.5 Its really the people that make Google the kind of company it is. We hire people who are smart and determined,
Googles (now and we favor ability over experience. Although Googlers share common goals and visions for the company, we hail
Alphabets) from all walks of life and speak dozens of languages, reflecting the global audience that we serve. And when not
Culture at work, Googlers pursue interests ranging from cycling to beekeeping, from Frisbee to foxtrot.
We strive to maintain the open culture often associated with startups, in which everyone is a hands-on contributor
and feels comfortable sharing ideas and opinions. In our weekly all-hands (TGIF) meetingsnot to mention over
email or in the cafeGooglers ask questions directly to Larry, Sergey and other execs about any number of com-
pany issues. Our offices and cafes are designed to encourage interactions between Googlers within and across
teams, and to spark conversation about work as well as play.
cannot be done, or done as well, by other organizations. For example, a strong culture
can result in a fixation with customer service and satisfaction and closeness to the cus-
tomer that yields timely market information and intense brand loyalty.
An Organizations Distinctive Competence

As indicated, the many different capabilities the organization possesses are the building
blocks for its competencies; competencies, in turn, integrate and consolidate component
capabilities. Thus, behind every realized competence, there is a blend of many capabilities.
For example, a competence such as low-cost competing (see Chapter 4) is not based
only on efficient production, but also depends on many complementary elements,
including skilled people, low-cost supply sources, and efficient delivery and ordering
systems. All of these must be brought together and related in complex ways.
Similarly, competing based on a flow of product enhancements and new products
depends not just on product conception, design, and development, but also on timely
information about how customers use products, their level of satisfaction, and their
future requirements. These, in turn, depend on formal market research, training of the
sales force, feedback, and interaction among engineers, designers, and customers.
Additionally, it may be necessary to have computer software that facilitates flexible
manufacturing and testing as well as managerial philosophies that espouse patience in
building margins and market share. Exhibit 3.6 shines the spotlight on one of Targets
valuable competence fro design.
Competencies consist of a management logic and belief about how to harmonize the
organizations diverse resources and capabilities. They are the patterns the organization
uses to deploy its skills and assets in ways that give value to customers. While their specific
aspects vary from company to company, competencies typically are broad in scope. Be-
cause they involve such a complex harmonization of separate parts, competencies are
difficult to imitate. Indeed, the more complex the integration among discrete elements, the
more difficult it is for competitors to comprehend and copy what the organization does and
thus the easier it is for the organization to sustain a competitive position.
Unlike physical assets, which wear out and deteriorate over time, competencies may
improve. Relatively mobile, they are likely to have important protean qualities; they
can provide access to a wide variety of markets beyond those the organization is cur-
rently serving.
For example, 3M built on the capabilities it had in substrates, coatings, and adhesives
to expand into a diverse array of products such as sticky tape, removable notes, magnetic
tape, photographic film, and pressure-sensitive tapes. Canon applied the capabilities it
had in optics, imaging, and microprocessor controls to expand into copiers, laser p rinters,
EXHIBIT 3.6 Over the past two decades, Target has honed its ability to seek out and secure productive collaborations with a
Targets steady stream of the hottest designers from Joseph Altuzarra to Lilly Pulitzer. The company boasts one of the larg-
Design est design houses in the country an organization that is able to design massive collections and provide exclu-
Collaborations sivity on a mass scale.
Targets Missoni collection, for example, includes everything from sweaters and ties to furniture and bicycles. The
discounters is true to its philosophy: Design for all . . . and exclusivity on a mass scale.
cameras, and image scanning. Target put together partnerships and collaborations to
create exclusivity on a mass scale, such as its collaborations with famous fashion labels
like Missoni and Alexander McQueen.
Competencies represent the coalescing of capabilities in old and new ways. They give
the organization the ability to take advantage of new opportunities and to repulse threats.
Because they can be used for more than a single product or service, they enable the
organization to invent new markets, to quickly enter emerging ones, and to make shifts
in product lines and services.6
A distinctive competence is the unique accumulation of capabilities and rigidities
that an organization has acquired over time. In assessing an organizations strengths and
weaknesses, it is important to identify the distinctive competence that gives the
organization its special character. An organization develops such a competence by
accepting commitments in the course of adapting to internal and external pressures.
Once institutionalized, the adaptations affect the ability the organization has to frame
and execute desired policies, but they apply more broadly.
A distinctive competence is not only a tool, but also a source of employee gratifica-
tion, institutional integrity, value, and reason for being. Five elements typically coalesce
in an organization to create a distinctive competence:
1. The knowledge and techniques needed to create useful products and services. The
creation and distribution of goods and services depend on value chain expertise
expertise in the flow of inputs, their conversion to outputs, the distribution of the
outputs, and the disposal of waste. The organization is proficient in some combina-
tion of R&D, design, manufacturing, physical distribution, retail sales, post-sale ser-
vice, and handling and minimizing waste.
2. Acquiring and generating resources beyond the supply the organization directly
owns and controls. The organization acquires additional resources through value
chain linkages. Working beyond its boundaries and establishing collaborative ar-
rangements with external entities help it to expand available resources. It must estab-
lish strong relationshipsnot just financial and economic, but also psychological and
emotionalwith external groups (see the discussion of stakeholders in Chapter 2).
3. Dealing with novel problems. Capabilities are embedded in routines. However,
excessive reliance on routines poses the problem of inflexibility: An organization
can remain committed to familiar tasks even when the evidence strongly argues
against it. Search procedures to deal with novel problems are themselves based on
existing routines.7
4. Looking toward the future. An organization is a flow of ad hoc adjustments to exter-
nal conditions, compromises, and best judgments. The present is a moving front, a
transitory position. An organization must look toward the future. How should it rede-
ploy assets to achieve new objectives?
5. Positioning and repositioning. Managerial skills are needed to advantageously posi-
tion and reposition the organizations capabilities. For this to be accomplished,
knowledge of competitive relations, the psychology of interfirm rivalries, and evolv-
ing social, legal, technical, economic, and political factors are essential. To position
and reposition itself, an organization must be able to adjust to changing conditions.
(Positioning is discussed in Chapter 4.)
A core competency, according to Prahalad and Hamel, has three main attributes: It
(1)provides access to new markets, (2) gives customers benefits, and (3) is difficult for
competitors to imitate.8 Unlike physical assets, which decline over time, a core compe-
tency is the engine for new business growth and development, clearly vital in tough
economic times. A core competency entails learning, coordinating, integrating, and
operating outside the organizations boundaries.
Using the organizations inherited resources, managers can create an image of the
possibilities the organization faces and the obstacles it must overcome. This image,
along with the managers views of the organizations competitive position, affects mana-
gerial decisions on ways to combine resources into products and plan for future expan-
sion. These managerial decisions are a key component of an organizations strengths and
weaknesses.
Replenishing Resources, Capabilities, and Competencies

To adjust to the challenges it faces, an organization must decide which combinations of
resources, capabilities, and competencies should be assembled and reassembled, and in
which sequence. The process of acquiring resources, capabilities, and competencies is
affected by uncertainty. It cannot be optimally derived from normative theory.9 Uncer-
tainties exist about possible future states and competitive interactions in those states.
Complexity is inherent in developing an appropriate mix of resources, capabilities,
and competencies. It involves not only identifying and coordinating the needed elements,
but also planning their future deployment. Organizations must continuously reappraise
their resources, capabilities, and competencies, discarding those they no longer need and
acquiring those they do need. Three steps exist in this process:
1. Looking outside the organization for talent and technology and establishing partner-
ships and alliances.
2. Finding ways to synthesize, harmonize, and integrate the acquisitions within the
organization.
3. Discarding resources that no longer provide value.
The goal is not simply to accumulate disparate resources, capabilities, and competen-
cies, but to join them in a tapestry that creates a greater whole. A company must con-
tinuously identify, acquire, build, deploy, and discard resources, capabilities, and
competencies. Clearly, some organizations are better at this process than others. To the
extent that they are better, they are stronger and more likely to achieve sustained com-
petitive advantage.
Value Chain Analysis and a Firms Financials

Digging deeper into a firms strength and weaknesses requires financial analysis. One
approach is to start with the value chain. The set of activities that the firm performs in
order to deliver value to the marketplaceas illustrated in Exhibit 3.7is called the
value chain. Each element in this chain should deliver profitsthat is, the returns from
the activities should exceed the costs. Each activity should have a positive margin. Each
of these activities together should have a positive return.
EXHIBIT 3.7 Resource Procurement

The Value
Chain Technology Development
*M
ar
gi
Human Resource Management
n
Administration
M
Inbound Outbound Marketing Customer ar
Operations gi
Logistics Logistics & Sales Service n
*Margin = Value Cost
The primary activities shown across the base of the value chain illustration are:
Inbound logisticsreceiving, storing, and internally transporting product inputs.
Dock scheduling, raw materials inventory control, and any necessary returns to sup-
pliers fit in this category.
Operationstransforming product inputs into product outputs via assembly, machin-
ing, packaging, testing, etc.
Outbound logisticsdistributing goods to customers. Tasks such as finished goods
warehousing, order processing, and delivery scheduling fit in this category.
Marketing and salesmaking the product known to buyers and persuading them to
buy. This category includes advertising, pricing, product promotion, sales force work,
and channel selection.
Customer serviceproviding customers with after-sales service to keep up or
improve the value of the product. Tasks such as installation, training, repair, and
supplying of parts are in this category.
The support activities listed at the top of the chain are:
Resource procurementbuying inputs such as machinery, buildings, office and lab-
equipment, raw materials, supplies, and other items that are used in all value-creating
activities including support activities. These purchases are made according to rules
for dealing with vendors and require information systems for record keeping.
Technology developmentdeveloping the know-how to carry out the firms many
activities and tasks from running equipment to writing documents, from making products
to transporting goods, from designing products to enhancing their reliability, and so on.
Technology development may depend on a variety of scientific disciplines and subspe-
cialties such as nanotechnology, precision mechanics, fine optics, and bioengineering.
Human resource managementrecruiting, hiring, training, developing, and compen-
sating the firms personnel. These practices have an important effect on employee
socialization and their motivation and skills.
Administrationfinance, accounting, legal affairs, public affairs, planning, and strategy.
Some of these activities may be carried out at the business-unit level, and some may
be carried out at the corporate level.
EXHIBIT 3.8
Value Chain Manufacturers Distributors Retailers Shippers
Linkages
Each firm conducts a different set of value-creating activities based on its mission and
purpose. Thus, the option of purchasing versus carrying out the activity within an
organization exists. An organization can specialize in activities in which its margins are
highest and outsource the rest. If the return from an activity is higher if it is outsourced
than if it is done internally, it is incumbent on a company to consider purchasing the
activity from an outside provider; likewise if the external transaction costs are less than
the internal production costs. With few exceptions based on concepts that will be covered
later in this text, the financials of each activity should be positive.
Value Chain Linkages

Value chain linkages exist (see Exhibit 3.8). Manufacturers create value by transform-
ing raw materials into more useful end-products. They typically deal in the business-
to-business world, selling their outputs to distributors who add value by stocking
sufficient i nventories and filling orders. Retailers add value when they manage most of
the end-customer relationshippresenting a desirable range of products, selling them
in appropriate quantities, and supporting them in a way that greatly appeals to the
end-customer.
Service providers add value when they can provide their customers with benefits
faster, better, and/or more economically than the customers creation of such benefits
alone. Shipping firms such as UPS count on their ability to make package deliveries
more effectively and efficiently than if their customers arranged them without their ser-
vice. A multitude of online retailers across the globe count on their logistics services to
safely transport their products to their customers doorsteps.
Thus, it is clear that the value chain of one firm is not isolated from the value chain of
many other firmsand that these linkages between firms can be a source of strength or
weakness. Coalitions of firms functioning together bring value to customers. Therefore,
firms need to assess not only their own internal strengths and weaknesses, but also those
of the companies in their value chain and choose where they want to place themselves in
the value chain based on a comparative assessment of which activities they perform best.
Which value chain activities for them are the most valuable?
Virtual Integration and Outsourcing Schemes

Dells direct model is based on virtual, as opposed to vertical, integration. It acts as a
broker between manufacturers and end-customers, and when it sells to institutions, it
eliminates the role that a retail channel partner can play. It made this choice at the very
start of its existence because it understood that the highest margins it could earn were not
in manufacturing or elsewhere in the value chain, but by being a broker among the
activities that typical vertically organized corporations, like IBM, at the time a major
competitor, would play. Though Dell did some light assembly, its role primarily was as a
distributor, which eliminated the role of retailers in the value chain.
As emphasized, when certain activities can be done more effectively outside the
organization, those activities should be outsourced. Others examples from the computer
industry are HPs and Apples contractual agreements with low-cost global manufactur-
ers that can produce their finished goods in a more cost-effective manner and with equiv-
alent or better quality than the firm could produce internally. Service provider ADP
counts on its ability to process payrolls and manage a firms payroll-and-benefits admin-
istration activities more efficiently and effectively than most firms can manage i nternally.
The successful outsourcing of noncore activities can allow a firm to focus on its most
strategically important activities while reducing production costs and general overhead
and increasing bottom-line profits.
Many U.S. firms have become basically design and marketing firms and do the bulk
of their raw material acquisition and manufacturing abroad. Increasingly, they even have
chosen to outsource some of their R&D. These decisions are based on calculations of
which activities in the value chain bring them the highest margins and which can be
better purchased from outside vendors.
On the other hand, there are times that a firms partnerships become overly
costly,ineffective, or inefficient because the relations with the outside vendors lower
quality. Dell had this problem when it outsourced customer support. Consumer com-
plaints skyrocketed.
Such negative impacts can ripple through the value chain, sap profits, and poten-
tially damage customer relationships. Suppliers can fail to deliver quality raw materi-
als on time causing a work stoppage and a shortage of finished goods. Under these
conditions, it makes sense to have greater control and predictability and to maintain
activities in the value chain within the firm even if they are not profitable or not as
profitable as buying them from outside vendors. A firm may decide to maintain some
of these activities internally simply as an insurance policy should an outside vendor
not be fully reliable.
An organization must continually evaluate its outside vendors. In response to poor
external performance, a firm may choose to change providers or even conduct most of
the activity internally. Rather than risk having their products be poorly represented to the
end-customer, high-end luxury brands frequently sell wares in settings in which they
have had complete control over all activities in the value chain, such as at high-priced
retail boutiques.
Value More than Costs

No matter whether activities are conducted inside or outside a firm, a firm is profitable
only if the total value that it creates and captures is greater than the costs that it incurs
while creating that value.
Profit margin = Value created & captured Cost to create value
An organization must be able to deliver superior value, lay claim to that value, and
convince customers to pay for this full value. A key to SCA, therefore, is to understand
how each of the individual and the sum of the firms activities can create products and
services that provide superior value for customers. When an organization is capable of
providing more value than its rivals can, it builds sustained competitive advantage.
Delving into a firms financials, therefore, is critical.
Three Levels of Important Financial Considerations

As shown in the example from Medtronic below, at least three levels of analysis are
needed in order to understand a firms financial strengths and weaknesses.
Level One At the broadest level, a firm must determine how it compares to its industry
and the marketplace as a whole. For public firms, such research can be conducted quickly
utilizing a variety of financial sites such as YahooFinance or MSNMoney. Private firms
also can be benchmarked; however, the quantity and quality of readily available data are
limited. Nevertheless, it is very important for managers of both public and private entities
to understand how the firm stacks up. The following are some basic questions to ask:
How do a companys revenues and profits compare with the broader industry and
marketplace? (Exhibit 3.9)
Are they growing faster, slower, or at the same pace? (See Exhibit 3.10.)
At the broadest level, does a company seem to be providing a solid investment
opportunity as compared to other options available to the public? (See Exhibit 3.11.)
EXHIBIT 3.9 Medtronic Margins versus Medical Device Industry Averages

PROFIT MARGINS % COMPANY INDUSTRY
Gross Margin 74.32 64.39
Pre-Tax Margin 21.14 15.4
Net Profit Margin 17.35 13.31
EXHIBIT 3.10 Medtronic Growth Rates versus Medical Device Industry Averages
INDUSTRY: Medical Devices
GROWTH RATES % COMPANY INDUSTRY
Sales (Qtr vs year ago qtr) 4.7 2.66
EXHIBIT 3.11 90% 85.86

Medtronic, Sep 18, 2009Sep 12, 2014
75% MDT BSX 74.03
St. Jude, 64.06
60% STJ !SPX
andBoston
Scientific 45%
andthe S&P
since 2009 30%
15% 13.95
0%
15%
30%
45%
60%
2009 2010 2011 2012 2013 2014
Exhibit 3.12 Trend Analysis of Key Financial Indicators of Medtronic, St. Jude, and Boston Scientific
Part ALevel 2 Analysis of Medtronics Income Statement
MEDTRONIC (MDT) 2013 %comp 2012 %comp 2011 %comp 2010 %comp 2009 %comp CAGR
Total Revenue 17005 100.0% 16590 100.0% 16184 100.0% 15508 100.0% 15817 100.0% 1.8%
Cost of Revenue1 4333 25.5% 4126 24.9% 3889 24.0% 3700 23.9% 3812 24.1% 3.3%
Gross Profit 12672 74.5% 12464 75.1% 12295 76.0% 11808 76.1% 12005 75.9% 1.4%
Selling, General and Administrative2 5847 34.4% 5698 34.3% 5623 34.7% 5427 35.0% 5415 34.2% 1.9%
Research and Development3 1477 8.7% 1557 9.4% 1490 9.2% 1472 9.5% 1460 9.2% 0.3%
Depreciation, Amortization and Depletion 349 2.1% 331 2.0% 335 2.1% 339 2.2% 0 0.0%
Special Income/Charges 1069 6.3% 525 3.2% 541 3.3% 614 4.0% 424 2.7% 26.0%
Acquisition Expense 117 0.7% 49 0.3% 12 0.1% 14 0.1% 23 0.1% 50.2%

Interest Income/Expense, Net-Operating 0 0.0% 0 0.0% 149 0.9% 278 1.8% 246 1.6%
Total Operating Expenses 8859 52.1% 8062 48.6% 8150 50.4% 8144 52.5% 8036 50.8% 2.5%
4
Operating Income 3813 22.4% 4402 26.5% 4145 25.6% 3664 23.6% 3969 25.1% 1.0%
NOTES:
1
20112013 shows >1% increase in cost of revenues as a percent of total revenues.
2
SG&A percents are similar at Medtronic and St. Jude.
3
Medtronics R&D in absolute terms exceeds all competitors; however, in relative terms, they are able to capture some scale economies in R&D and spend at lower %.
4
The industry as a whole is facing some headwinds. Operating income is down for all competitors this year All players are impacted.
Part BLevel 2 Analysis of St. Judes Income Statement
ST JUDE MEDICAL (STJ) 2013 %comp 2012 %comp 2011 %comp 2010 %comp 2009 %comp CAGR
Total Revenue 5501 100.0% 5503 100.0% 5612 100.0% 5165 100.0% 4681 100.0% 4.1%
Cost of Revenue5 1574 28.6% 1538 27.9% 1533 27.3% 1410 27.3% 1253 26.8% 5.9%
Gross Profit 3927 71.4% 3965 72.1% 4079 72.7% 3755 72.7% 3428 73.2% 3.5%
Selling, General and Administrative 1884 34.2% 1891 34.4% 2084 37.1% 1818 35.2% 1675 35.8% 3.0%
Research and Development6 691 12.6% 676 12.3% 709 12.6% 643 12.5% 560 12.0% 5.4%
Special Income/Charges 0 12.6% 0 12.3% 171 12.6% 17 12.5% 80 12.0%
Total Operating Expenses 2876 52.3% 2865 52.1% 2964 52.8% 2477 48.0% 2315 49.4% 5.6%
Operating Income 1051 19.1% 1100 20.0% 1115 19.9% 1277 24.7% 1113 23.8% 1.4%
NOTES:
5
20112013 shows >1% increase in cost of revenues as percent of total revenues for St. Jude as well... Gross profit% lags Medtronic, but growth in GP exceeds Medtronic.
6
St. Jude is focusing on the future with relative increase in R&D.
Part CLevel 2 Analysis of Boston Scientifics Income Statement

BOSTON SCIENTIFIC (BSX) 2013 %comp 2012 %comp 2011 %comp 2010 %comp 2009 %comp CAGR
Total Revenue 7,143 100.0% 7,249 100.0% 7,622 100.0% 7,806 100.0% 8,188 100.0% 3.4%
Cost of Revenue7 2,174 30.4% 2,349 32.4% 2,659 34.9% 2,599 33.3% 2,576 31.5% 4.2%
Gross Profit 4,969 69.6% 4,900 67.6% 4,963 65.1% 5,207 66.7% 5,612 68.5% 3.0%
Selling, General and Administrative8 2,814 39.4% 2,688 37.1% 2,659 34.9% 2,765 35.4% 2,826 34.5% 0.1%
Research and Development9 861 12.1% 886 12.2% 895 11.7% 939 12.0% 1,035 12.6% 4.5%
Depreciation, Amortization and Depletion 410 5.7% 395 5.4% 421 5.5% 513 6.6% 511 6.2% 5.4%
Special Income/Charges 764 10.7% 4,799 66.2% 84 1.1% 1,646 21.1% 2,118 25.9% 22.5%
Operating Expenses 4,849 67.9% 8,768 121.0% 4,059 53.3% 5,863 75.1% 6,506 79.5% 7.1%
Operating Income10 120 1.7% 3,868 53.4% 904 11.9% 656 8.4% 894 10.9% NA
NOTES:
7
Boston Scientific is obviously struggling with declining revenues and gross profitsand higher COR% than rivals Medtronic and St. Jude.
8
Boston Scientific also has significantly higher SG&A% than rivals Medtronic and St. Jude.
9
R&D is being trimmed faster than SG&A (another cause for concern).
10
Tiny 2013 margins and recent wild swings in operating income indicates the the firm is still in the woods as of 2013... Special charges = restructuring charges, net,
certain litigation charges, net, acquisition-related items, or certain tax adjustments.
Level Two Strategists must also understand how components of the firms revenues and
costs compare to those that are being realized by other firms in the industry. How do the
companys profit margins, ratios, and other financial indicators (including credit rating) stack
up against its rivals? Is it beating (or falling behind) the trends? Such an analysis can high-
light differences in a firms revenue composition, its research and plant investment priorities,
and exactly where a firm is seeing stronger or weaker results than its rivals.
See Exhibits3.12 for a comparative analysis of three major medical device firms income
statements. This analysis shows the lead that Medtronic and St. Jude have leads over rival
Boston Scientific in a number of key areas including cost of revenue and selling, general, and
administrative expenses. St. Jude alone has the lead in R&D, while Medtronic has the lead in
operating income.
Answers to the questions are much more readily available to analysts researching
publicly held firms, while those attempting to gather such information on privately held
firms must craft estimates based on information that can be gleaned from public sources.
Level Three Analysis This most granular level of quantitive analysis is designed to help
leaders benchmark the firms key activities and outcomes. Oftentimes, these measures
offer important insights into a firms relative advantage and the behavior of its bottom line
Are the companys products per channel getting stronger? Are its brand families gaining
popularity? Can the company demonstrate continuous improvement of internal processes
such as inventory management, employee productivity, delivery times, defect rates, safety/
compliance, employee satisfaction, and engagement? At level three, managers must be
aware of important measures for their specific lines of business and unique internal pro-
cess requirements. For example, supply chain traceabilitya critical success factor that
is closely monitored in the medical device industryis not a meaningful factor to track
for a retailer or an airline. Retailers closely track sales per square foot and inventory
turns, while airlines monitor measures of delayed departures and lost baggage claims.
Assuring Accountability
The ultimate accountability for a companys performance lies with the board and top
management. The classic ideas of management theory are hierarchical. Managers are the
agents of the owners. Owners in publicly traded corporations are stockholders. Managers
are not supposed to pursue their own interests at shareholders expense.10 A company
needs a strong top leadership team headed by a talented, experienced, and accomplished
chief executive officer (CEO) who can deliver high returns. Quantifiable financial results
motivate the top management team, which is held accountable by the board of directors,
who represent shareholder interests.
To achieve these quantifiable goals, the top management team must continually reart-
iculate the companys mission (what it has been good at in the past) as well as the vision
of where the company should be going (see Chapter 2). It has to establish structure and
values for assuring that the companys strategy is carried out.
Accountability comes from the top down in response to shareholder needs. The board
of directors monitors, controls, and advises the top management team. It approves its
strategy and aligns strategy with the interests of shareholders. A sufficient number of
independent outsiders should be on the board to bring fresh ideas and perspectives and
to ensure accountability.
This type of accountability closely corresponds to Frederick Taylors scientific
method of dividing the work based on the specific tasks involved and investigating sys-
tematically the best way to carry out each task.11 Top management assigns to everyone in
the organization a specific role and function that best serves shareholder interests.
According to classic management theory, the organization, therefore, must have:
A well-defined hierarchy.
A division of labor to allow high degrees of specialization.
A very specific and well-defined set of assignments of authority and responsibility.
Unity of command and direction so that there is subordination of individual interests
to the good of shareholders.
Accountability is best understood in terms of the top management team and its interac-
tion with the board and employees.
Task- and Team-Oriented Organization

Because of its suppression of bottom-up initiatives and individual creativity, this type of
accountability has limitations. In its rigidity, it is a caricature of bureaucracy run wild.
Not all organizations are likely to thrive under this model; thus, for example, advertising
agencies, consultancies, and movie studios typically do not organize themselves in this
fashion. More democratic, task- and team-oriented, each project on which they work is
somewhat different. Organizations of this nature provide ample opportunity for e mployee
participation. They need employees to feel free of arbitrary constraint, so they can
express their originality.
Firms that operate in fast-moving environments understand that there is no one best
way to assure accountability. The work that they do requires resourcefulness and respon-
siveness to unpredictable demands, which a rigid hierarchy will stifle. Accountability
depends more on the extent to which the individual creativity of employees is set free. Is
the organization flexible and capable of rapid adjustment to shifting external demands?
Does it innovate quickly?
Because of the drawbacks of this approach to accountability, it has been supple-
mented by a variety of approaches. For instance, the human relations approach to man-
agement theory is considered by proponents to be more employee-friendly.12 It stresses
motivation and values. It asserts that:
Informal coordination in groups should replace centralized controls.
Communications between employees and managers should be two-way.
Compensation should be based on performance, not on following orders.
Management should foster an environment that is conducive to employees develop-
ment and learning.
An indicator of organizations strengths and weaknesses might be the extent to which
employees are given an ownership stake through employee stock ownership plans
(ESOPs). This model is not just confined to small firms. Walmart, for example, is one
company that has tried to install it. While Walmart forbids unionization and stifles
attempts at unionizing, it also tries to avoid antagonism between employees and manage-
ment by means of a servant leadership model in which employees are provided with the
tools they need to succeed and are given substantial leeway to carry out their tasks.
Though Walmart expects employees to work hard for low wages, it incents them to do so
by making them partial owners. Employees share in the profits when the companys
stock price goes up.
Contingency Theory
Contingency theory holds that depending on the external environment a company faces,
there are two models it can follow: mechanistic and organic.13 The mechanistic model
relies on hierarchy, functional specialization, and a formal and impersonal structure. Em-
ployee rewards are primarily economic, in the form of wages; employees rarely have own-
ership rights. The organic form, in contrast, is less rigid and hierarchical than the
mechanistic. It relies more on decentralization, participation, and a democratic personal
structure. Employee motivation is less dependent on economic rewards; it arises from
employees sense of belonging and their identification with the organizations mission
and values. The task of analyzing an organizations strengths and weaknesses comes
down to understanding which of these forms is most appropriate, given external demands.
Contingency theorists argue that the mechanistic model works better in stable organi-
zation environments, while the organic model works better in turbulent environments. A
problem with the theory has been how to best distinguish a stable from a turbulent envi-
ronment. Turbulence might be a regular occurrence in highly creative industries that are
always changing like advertising or movie production, while stability might be more
common in manufacturing industries trying to achieve high levels of quality or effi-
ciency and reliability (for example oil refining), but even these industries are not pure
types, with some aspects of the movie business being mechanistic and some aspects of
manufacturing being organic because they are constantly changing. The theorys basic
proposition is that corporate performance is a consequence of a fit between the external
environment and the organizations internal characteristics, yet e xternal environments
are hard to describe and an appropriate fit must be regularly adjusted if it is to be
achieved. Accountability depends on whether the appropriate level of fit has been
achieved. However, this is hard to determine. The precise meaning of fit with an
organizations external environment is unclear, and the process of clearly identifying and
measuring external and internal environments is problematic.
With regard to the external environment, a number of questions arise: Is it best to
assess it in terms of industry variables (the five forces), macroeconomic factors (govern-
ment, economics, technology, social structure, and the natural environment), strategic
group analysis, and/or stakeholder relations? (see Chapter 2) In what ways do these
interact to define an organizations external environment? Similarly, what is the best way
to assess an organizations internal environment? Such an analysis could be based on
many factors. For instance, an organizations capabilities can be described in terms of:
Leadership. The leadership style in an organization includes the types of motivation
systems used, patterns of communication in the organization, and interpersonal inter-
actions and relations.
Decision making. This includes not only the way in which decisions are made, but
also the goals that are pursued and the control systems that are in place to ensure that
these goals are met.
Performance mechanisms. These are the mechanisms used for performance assess-
ment, training, and socialization.
Division of labor. How is labor divided? Is it divided on the basis of products, markets
(industrial, commercial, and government), functions (production, sales, marketing,
finance, administration, and R&D), technologies, or geographic locations? Indeed,
many firms have a hybrid structure, with some divisions devoted to functions, some
to clients, and some to geographic areas. Other organizations have a matrix structure,
in which employees have dual reporting arrangements on the basis of functional
expertise, customers served, and/or geographic area. Which of these involve a better
fit and constitute a strength rather than a weakness?
Integrating mechanisms. They determine how the organization brings together peo-
ple, products, and processes, rather than separating them into different roles and func-
tions. These mechanisms are important. In each organization, they tend to vary and
might include informal contacts among employees, the use of task forces, and/or per-
manent and temporary coordinating teams. How do the integrating mechanisms con-
tribute or fail to contribute to an organizations strengths and weaknesses?
Culture. An organizations culture also can be a key strength. As discussed, cultures
are a building block for an organizations capabilities. Cultures vary from strong to
weak, depending on a variety of attributes: attitudes toward customers and competi-
tors, levels of individual autonomy and management support, achievement orienta-
tion, compensation equity, moral and ethical integrity, professionalism, and tolerance
for risk and conflict. Some corporate cultures are obsessed with product quality; oth-
ers consider product innovation or market growth more important than product qual-
ity. Which culture is a best fit with external conditions?
Contingency analysis is hindered by the presence of multiple contingencies. Under
what circumstances are a mix of organizational components appropriate in different en-
vironments? When are different combinations a strength rather than a weakness? Given
economic uncertainty, for instance, it is unclear how organizations should respond.
When resources are shrinking, job mobility is slim, and layoffs are common, what
should organizations do?
The best way to organize is hard to determine. Meanwhile, Dilbert cartoons that
represent peoples growing frustration with dysfunctional organizations proliferate. Many
organizations, allegedly including high-tech leader Amazon, have overworked and
stressed-out personnel and hostile, counterproductive work climates. According to a New
York Times article, at Amazon, workers are encouraged to tear apart one anothers ideas in
meetings, toil long and late (e-mails arrive past midnight, followed by text messages ask-
ing why they were not answered), and held to standards that the company boasts are un-
reasonably high. The internal phone directory instructs colleagues on how to send secret
feedback to one anothers bosses. Employees say it is frequently used to sabotage others.14
In many organizations, a lack of coordination among key divisions also exists. There is
excessive decision making at the top and inexplicable duplication among functions.
The Seven Ss
The popular business book of the 1980s, Tom Peters and Robert Watermans In Search
of Excellence, brought together elements of the mechanistic and organic model. The 7S
framework in the book came from McKinsey & Company, where Peters and Waterman
had worked as consultants.15
According to this approach, there are seven attributes (seven Ss) or basic levers that
management can manipulate to steer large and complex organizations. Anchored by
shared values, these integrated attributes are depicted in Exhibit 3.13.
1. Strategythe extent to which an organization has a logical sense of the actions it
must take to gain sustainable competitive advantage over the competition, im-
prove its position in relation to customers, and allocate resources to high-return
activities.
2. Structurethe extent to which an organization has a coherent form for dividing
labor, allocating responsibilities, coordinating tasks, and ensuring accountability.
3. Systemsthe extent to which an organization has explicit descriptions in place to
show how processes work and tasks are accomplished in critical areas such as capital
budgeting, manufacturing, customer and supplier relations, accounting and perfor-
mance measurement, and carrying out mergers and acquisitions.
4. Stylethe degree to which there is tangible evidence that the time, attention, and
behavior of management and employees actually are devoted to, and aligned with, the
organizations real strategic needs (not just lip service, but real action).
5. Staffingthe degree to which management and employee expertise and experience
match the jobs that have to be carried out, the extent to which the personalities in
EXHIBIT 3.13
The 7S
Framework Structure
Strategy Systems
Shared
Values
Skills Style
Staff
place are capable of working together, and the degree to which there is sufficient
diversity among staff to allow opposing and dissenting voices to be heard.
6. Skillsthe extent to which an organization as a whole, as opposed to its employees,
has the capabilities not only to compete in existing businesses, but also to develop
new businesses and generate corporate growth.
7. Shared valuesthe extent to which there is unity of purpose behind a common vision
and culture that is taking the organization to where it should be going.
Peters and Waterman faulted U.S. managers for tending to focus almost exclu-
sively on the mechanistic elements or the tighter side of organizationsstrategy,
structure, and systemswhile missing the importance of the soft, organic stuff
style, staffing, skills, and shared values. The qualities that arose from the blending
of these elements were:
A bias for action.
Closeness to the customer.
Autonomy and entrepreneurship.
Productivity through people.
Hands-on and value-driven operations.
A willingness to stick to the knitting.
A simple form and lean staff.
Simultaneous loose-tight properties
Peters and Waterman defined an excellent company as one in the top half of its
industry on financial indicators and identified eight qualities shared by companies
they considered excellent. Unfortunately, the 7S approach proved to be a very
unreliable indicator of future performance. Many of the excellent companies
Peters and Waterman analyzed did not survive or became poor performers, including
Digital Equipment, Westinghouse, Xerox, Kodak, Wang Laboratories, Polaroid, and
Kmart. Over time, these firms were unable to sustain their excellence and focus on
these attributes.
Strengths, Weaknesses, Opportunities, and Threats (SWOT)

Ultimately, internal analysis comes down to adjusting a firms strengths (S) and weak-
nesses (W) to the opportunities (O) and threats (T) it confronts (see Exhibit 3.14). SWOT
analysis enables an organization to grasp the strategic choices it faces and generate
options that the firm could pursue. Doing this is not easy.
Strengths and Opportunities (SO) How can a company use its strengths to take ad-
vantage of the opportunities?
Strengths and Threats (ST) How can it take advantage of its strengths to avoid real
and potential threats?
Weaknesses and Opportunities (WO) How can it use opportunities to overcome the
weaknesses it is experiencing?
Weaknesses and Threats (WT) How can it minimize the weaknesses and avoid the
threats?
EXHIBIT 3.14 External Opportunities (O) External Threats (T)

SWOT
Analysis SO ST
Internal Strengths (S) Strategies that use strengths to Strategies that use strengths
maximize opportunities to minimize threats
WO WT
Strategies that minimize Strategies that minimize
Internal Weaknesses (W) weaknesses by taking weaknesses and avoid
advantage of opportunities threats
Summary A number of different approaches are available to analyze a firms strengths and
weaknesses. This chapter has focused first on the resource-based view (RBV). This
approach, as emphasized in this chapter, has many qualitative elements. It differs in
fundamental ways from the IO approach introduced in the last chapter. These
differences have been highlighted. A more quantitative approach is to dig down into a
firms financials by taking apart the activities in the value chain and comparing the
firms performance of these activities with that of other firms. The aim is to determine
the profitability of the activities in comparison to costs and returns if they were to be
performed outside the firm.
Once a firm understands its financial situation, it is incumbent on it to improve its
situation. Assuring accountability for improvement was another subject of this chapter.
Classic theories of hierarchical management have been contrasted to the human relations
and contingency approaches.
The failed attempt by Peters and Waterman to bring together mechanistic and organic
management in the 7S framework has been discussed. Ultimately, accountability arises
from doing SWOT analysis and assuring that there is alignment between the firms ex-
ternal environment and its internal strengths and weaknesses, which leads to sustained
competitive advantage.

Reflect on your own employers external environment. If you are a student, please select
a publicly held firm to analyze.
1. Do a SWOT analysis of the company:
a. Start with the main opportunities and threats that the company faces.
b. List the types of resources and capabilities the company has to take advantage of
the opportunities and avoid the threats.
2. To what extent do these resources and capabilities add up to a distinctive competence
that meets a VRIO test?
3. To what extent must the company acquire or develop new resources and capabilities
to meet a VRIO test?
4. How should it go about acquiring and developing these resources and capabilities?
5. Trace the companys value chain and its value chain linkages, and conduct a financial
analysis of the firm.
a. Where are its margins the highest and lowest?
b. Where might the company be better off if it sourced key functions from outside
vendors?
6. Describe the companys top management and board structure. How strong is corpo-
rate governance in the company?
7. Has the company attained the right balance between a top-down hierarchical structure
and a bottom-up team-based structure? Where can improvements be made given the
key tasks the company faces?
Endnotes 1. C. Prahalad and G. Hamel, The Core Competence of Corporations, Harvard Business
Review, MayJune 1990, pp. 7991.
2. M. Lewis, Moneyball (New York: Norton, 2004).
3. See Prahalad and Hamel, The Core Competence of Corporations. RBV has had nearly
40years of development, starting with Edith Penroses 1955 classic, Theory of the Growth of
the Firm, and culminating in a flurry of attention in the past 15 years. E. Penrose, The Theory
of the Growth of the Firm (Oxford, England: Basil Blackwell, 1959); R. Amit and
P.Schoemaker, Strategic Assets and Organizational Rent, Strategic Management Journal 14
(1993), pp. 33346; J. Barney, Strategic Factor Markets: Expectations, Luck, and Business
Strategy, Management Science 32, no. 10 (1986), pp. 123141; J. Barney, Organization
Culture: Can It Be a Source of Sustained Competitive Advantage? Academy of Management
Review 11, no. 3 (1986), pp. 65665; J. Barney, Gaining and Sustaining Competitive Advantage
(Reading, MA: Addison-Wesley, 1997); A. Brumagin, A Hierarchy of Corporate Resources,
Advances in Strategic Management 10 (1994), pp. 81112; I. Dierickx and K.Cool, Asset
Stock Accumulation and Sustainability of Competitive Advantage, Management Science 35,
no. 12 (1989), pp. 150413; G. McGrath, R. MacMillan, and S.Venkatraman, Defining and
Developing Competence, Strategic Management Journal 16 (1995), pp. 25175; R. Hall,
A Framework Linking Intangible Resources and Capabilities to Sustainable Competitive
Advantage, Strategic Management Journal 14 (1993), pp. 60718; A. Lado, A. Boyd, and
P.Wright, A Competency-Based Model of Sustainable Competitive Advantage: Toward a
Conceptual Integration, Journal of Management 18, no. 1 (1992), pp.7791; R. Nelson and
S. Winter, An Evolutionary Theory of Economic Change (Cambridge, MA: Harvard University
Press, 1982); R. Reed and R. DeFillippi, Causal Ambiguity, Barriers to Imitation, and
Sustainable Competitive Advantage, Academy of Management Review 5, no. 1 (1990),
pp. 88102; B. Wernerfelt, Resource-Based View of the Firm, Strategic Management
Journal 5 (1989), pp. 17180. D. Miller and J. Shamsie, The Resource-Based View of the
Firm in Two Environments, Academy of Management Journal 39, no. 3 (1997), pp. 51943.
4. Barney, Gaining and Sustaining Competitive Advantage, p. 144.
5. J. Barney and W. Hesterly, Strategic Management and Competitive Advantage: Concepts and
Cases (Upper Saddle River, NJ: Pearson/Prentice Hall, 2008).
6. Prahalad and Hamel, The Core Competence of Corporations.
7. Nelson and Winter, An Evolutionary Theory of Economic Change.
8. Prahalad and Hamel, The Core Competence of Corporations.
9. Amit and Schoemaker, Strategic Assets and Organizational Rent.
10. F. Hayek, The Corporation in a Democratic Society: In Whose Interests Ought It and Will It
Be Run, in Business Strategy, ed. H. Ansoff (New York: Penguin, 1977), pp. 22539.
11. F. Taylor, The Principles of Scientific Management (New York: Harper, 1911).
12. F. Roethlisberger and W. Dickson, Management and the Worker (Cambridge, MA: Harvard
University Press, 1939); F. Herzberg, Work and the Nature of Man (New York: Crowell,
1966).
13. J. Woodward, Industrial Organization (London: Oxford University Press, 1965); S. Ellis, T.
Almor, and O. Shenkar, Structural Contingency Revisited: Toward a Dynamic System
Model, Emergence 4, no. 4 (2002), pp. 5184.
14. Jodi Kantor and David Streitfeld, Inside Amazon: Wrestling Big Ideas in a Bruising Work-
place, New York Times, August 15, 2015, http://www.nytimes.com/2015/08/16/technology/
inside-amazon-wrestling-big-ideas-in-a-bruising-workplace.html?_r=0.
15. T. Peters and R. Waterman, In Search of Excellence (New York: Warner Books, 1982).
P A R T T W O
Making Moves
EA IA
External Analysis
General Environment
Competitive Forces
1 Internal Analysis
Resources, Capabilities
& Competencies
Evaluation of
3
Performance
&
Continuous
BS + GS + CS + IS
Reinvention
2 Implementation
C H A P T E R F O U R
Positioning, Tactics,
and Timing
The art of war teaches us to rely not on the likelihood of the enemys
not coming, but on our own readiness to receive him; not on the chance
of his not attacking, but rather on the fact that we have made our posi-
tion unassailable.
Sun Tzu, The Art of War1

Defining the five generic strategic positions that can be occupied by firms.
Understanding how a firm can leverage its value chain in order to gain advantage at its
chosen position.
Recognizing the increasing importance of the best-value position.
Being aware of the variety of ways a product or service can be segmented.
Viewing strategy in a dynamic senseas a continual series of tactical offensive and defensive maneuvers.
Appreciating the importance of timing in making strategic and tactical moves.
Gaining an elementary comprehension of game theory and its contribution to strategy.
Recognizing examples of company repositioning over time.
Introduction
This book has suggested several ways to achieve sustained competitive advantage thus far,
largely focusing on creating unassailable positions. In Chapter 2, it was shown that the most
profitable industry positions could be sought out, and barriers to entry could be raised, in
order to secure an advantage. Chapter 3 showed that the firm could also m arshal its own
internal resources and build competencies that would provide advantage. These traditional
models, however, are largely static. They pay insufficient attention to the dynamic element
in strategyhow the external and internal environments of the firm are constantly chang-
ing, and how new moves must be always be made in order to win over the long term.
82
Chapter 4 Positioning, Tactics, and Timing 83
As the book segues into Part 2, it examines such moves in detail. The integrated
model introduced in Chapter 1 suggests that flexibility, rapidity of movement,
concentration of resources, and choosing the best battle venue are important. This
chapter illustrates the importance of picking which battles to fight and timing the firms
moves, knowing that its competitors are poised to challenge it.2
Therefore, this chapter focuses on three key areas:
1. The generic strategic position a company selects given its internal strengths and
external contexts, and how that position can be built and strengthened across the
value chain.
2. The offensive and defensive tactics the company can utilize to claim and defend its
position, and with which specific rivals it should engage. As Richard DAveni argues,
The value, risks, and effectiveness of every move must be seen in relation to the
actions of competitors.3 When a firm makes a move, it must anticipate the counter-
moves of its competitors. The firm must be vigilant and ask, What will our
competitors do next? Game theorys elementary principles are used to assist with
this analysis.
3. The timing of the firms moves given the state of the industry and the presence of
rivals simultaneously seeking advantage. Once a firms position is clarifiedand
the firm is experiencing some success in that positionrivals may take notice
and try to copy what the firm has done. Some may try to leapfrog a leading com-
panys position. Addressing such competitive threats is importantand the care-
ful timing of a firms moves dictates whether it will maintain advantage over the
long term.
These three elementspositioning, tactics, and timingdefine business-level strategy
(BS), and provide the firm with a foundation for broader moves at the corporate level
and across its global frontiers. Indeed, all of the firms strategies must be aligned and all
moves must be coordinated; the quest for advantage cannot be approached in a piece-
meal fashion.
Positioning
To determine the position of a firm, its critical to understand how it can utilize its
strengths to secure profitable customer relationships. Understanding the threats and
opportunities from the external environment helps the firm select a defensible position
and clarify exactly where it should set its sights:
Should the firm aim to utilize its capabilities to provide distinctive benefits to
its customers and charge a premium for the increased value that it delivers, or
should it opt to drive costs down while merely maintaining an acceptible level of
quality instead?
Should it serve a broad swath of customers and offer a wide variety of products or is
it better suited to specialize in a particular type of product, customer, or geography?
Answers to these questions can be mapped on a two-by-two matrix (see Exhibit 4.1) that
reveals five generic positions.4
84 Part Two Making Moves
EXHIBIT 4.1
Generic
Strategic
Products or Geographies
Broad Broad
Kinds of Customers,
Positions
Low Cost Differentiation
Best Value
Focused Focused
Product/Service Premium
at Each Link on Value Chain
Key to this analysis is a solid understanding of the firms current and potential
capabilities. Strategies poorly matched to capabilities cannot secure advantage. It would
be like a slow 60-year-old trying to compete in the 100 yard dash in the Olympics. That
60-year-old must find an appropriate venue in which to compete.
If there is not an existing venue in which the firm can stand out, can it create a new
one where its strengths are applicable? These strengths must not all be internal to the
firm. The firm can leverage its strengths across the value chain, relying on a network of
relationships, contacts, and alliances to bolster its capabilities and then make choices
about where to compete.
Low-Cost Positions
A firm seeking to claim one of the low-cost positions found in the leftmost quadrants of
Exhibit 4.1 intends to win the game by driving down costs across the value chain, build-
ing high volumes and selling at thin margins. Such firms offer products that are typi-
cally no frills, but still meet consumer needs and basic quality standards.
Superior advantage in a low-cost position comes from creating a significant and sus-
tainable cost gap relative to competitors. Low-cost aspirants will make moves to reduce
the cost of inputs and devise more efficient supply chains with less input variation. They
go to great lengths when working with suppliers to identify and eliminate unnecessary
input costs. They are demanding and accomplished negotiators who apply relentless
pressure. Walmart, for example, insists that suppliers keep costs low, and that any ship-
ments are delivered reliably. They have also developed unmatched expertise in forecast-
ing and inventory logistics.
Moving forward on the value chain to production activities, the low-cost leader may
also limit the firms product lineup and streamline operations, knowing that large
numbers of stock keeping units (SKU) and tasks only add complexity and cost.
Southwest Airlines, a pioneer in low-cost airline operations, chooses to fly only Boeing
737 aircraft for this reason. Focusing on only one aircraft type lowers the costs of
maintenance and training, reduces costly aircraft parts inventories, and greatly simplifies
key operating activities. While limiting product lineups, the low-cost player seeks to
accelerate learning to become more efficient, to boost scale to capture economies, and to
right-size production to maximize the utilization of existing capacity. When capacity is

underutilized, each unit produced bears the costs of unproductive assets and those
saddled with such idle assets quickly fall behind.
At the distribution end of the value chain, low-cost leaders continue to trim costs.
Packaging can be designed to reduce bulk for economical shipping, firms can opt for
lower-cost transport options, such as sea and rail container, and economical decisions
can even be made about the format of the product that customers receive. IKEAs
practices, as outlined in Exhibit 4.2, provide an excellent example of the low-cost
strategy in action.
The Unique Advantage of Low-Cost Leadership

Firms that are able to attain low-cost leadership have two powerful options. They can
either market their products at or near industry pricing averages and reap superior profit
margins, or they can reduce prices to levels that cannot be matched by rivals over the long
term. When prices are set at industry average, the low cost leader builds a war chest that
can be deployed in future competitive battles. When prices are lowered to just above the
EXHIBIT 4.2 A quick visit to IKEA reveals the companys low-cost position and its highly disciplined approach to cost c ontainment:
IKEA
Products are shipped to carefully procured store locations in major cities only. Deal-hungry shoppers make a
trip to one of IKEAs stores even if it means a lengthy car ride.
None of the companys locations are underutilized. IKEA merchandise is flat-packed without excess padding,
and the cardboard is just thick enough to protect the contents.
Inside each package, customers find products that are sourced from across the globewherever prices and
capabilities are most competitive.
Product-assembly instructions, such as those shown below, are wordless and feature simplistic drawings. Such
instructions are universally understandable and require no multilingual translations.
Store layouts are strictly utilitarian with clear signage, centralized checkouts, and often long pickup lines that
are minimally staffed.
Standardized hinges and other spare parts are readily available to consumers so that customer service personnel
do not have to be burdened by simplistic and repetitive requests and can attend to only the most critical tasks.
Yet customers leave the store happy. They receive what they perceive to be a great deal on their furniture, acces-
sories, and even Swedish meatballs.
EXHIBIT 4.3 Set price near industry Set lowball price

Strategic average, and build financial OR and drive rivals away
Options advantage on superior margins
Available to
True Low-Cost Co. B Price Co. B Price
Co. A Price
Leader
Co. A Price
Company B Company B
Company A Costs Company A Costs
Costs Costs
low-cost leaders costs, rivals are driven out of business. (see Exhibit 4.3). A particularly
interesting example of the second option plays out whenever OPEC opts to flex its mus-
cles as a low-cost leader in oil production.5 Its costs have been estimated at $23/barrel,
while crude from fracking in the Dakotas costs an average of $45/barrel. In 2015, Saudi
Arabias oil minister, Ali al-Naimi, saw low prices as a strategic weapon. His philosophy
was that oil-producing countries could accept temporary pain to drive down prices to
the point where fracking becomes unprofitable. Under this scenario, OPEC achieves a
win when highly leveraged North American producers go out of business.
Differentiation Positions
To claim differentiated positions in the rightmost quadrants of Exhibit 4.1, a company
must examine the value chain to determine where and how it can emphasize uniqueness
and add value. A companys differentiators come at a cost, however, so to win via dif-
ferentiation, a company must offer differentiated benefits only where a substantial num-
ber of customers are willing to pay a significant premium for a unique product.
While there are many ways for the low-cost player to reduce costs, there are even
more ways for the differentiator to add customer value. A company can examine the
entire value chain to find tangible and intangible benefits that appeal to both emotion
and practicability:
Tangible benefits can be created by melding superior engineering, top-quality materi-
als, and exacting manufacturing into high-performance equipment.
Intangible benefits that customers crave can be created via exclusivity, brand mys-
tique, and high-sheen, high-service selling environments.
The tangible aspects include all the observable product characteristics, such as size,
color, and materials used to make the product, packaging, and complementary services.
The intangible aspects include unobservable and subjective qualitiesimage, status,
exclusivity, and identity. The total value of a product to the customer is conveyed not just
by the functions the product performs, but by the entire relationship a firm has with the
customer. There are many ways to bundle or separate aspects of the product or service to
create exclusive categories.
A company must appeal to the elementary need that all people have for status, iden-
tity, and image, as it is an excellent source of differentiation. People define themselves in
terms of what they buy. Those who shop at Target as opposed to Walmart, Kmart, or
Family Dollar say something different about the type of person they are. Harley-Davidson
is more than a motorcycle company, and Starbucks is more than a coffee shop. They are
EXHIBIT 4.4
Types of Style & Self Expression
Differentiators: Affiliation (w/cool crowd)
Tangible and Freedom/Independence
Intangible Power/Control
Benefits Emotional
Perceived by Benefits
the Target Great Deal or ROI
Low Cost Ownership
Customer
Saves Time
Reduces Errors Raw Capabilities
The Interoperability
Upgradability
Customer
Flexibility
Reliability
Economic Functional
Benefits Benefits
near cults in the type of loyalty they command and commitment they obtain. Brands re-
inforce the identities people already have and appeal to people with these identities.
Those who use alternative medicines make a different statement about their identity than
do those who rely on conventional medicines. Those who buy Ivory soap express differ-
ent views of themselves than do those who use perfumed or deodorant soap.
Differentiators, whose products often lack the broader, utilitarian appeal of low-cost
offeringsonly succeed when their customers recognize the benefits of their products
and services, and are willing to pay a price that is high enough to generate a more sig-
nificant margin. For example, a high-performance, exclusive automobile can command
a much higher price and margin than a compact, mass-market model. Such a margin
permits the differentiator to remain in business and continue to serve the discerning
buyer despite a low volume of sales.
Segmenting the Market

The ability to find new opportunities for differentiation comes from observing product
attributes that are not well covered in the market. The evolution of pain relievers pro-
vides an interesting example. At one time, there was the high-on-effectiveness, low-
gentleness cluster, which consisted of Excedrin, Anacin, and Bufferin. Of these, Excedrin
was highest on effectiveness and lowest on gentleness, while Bufferin was highest on
gentleness and lowest on effectiveness, and Anacin was somewhere in between (see
Exhibit 4.5). All three were considered to be an improvement over plain aspirin. Tylenol
had the gentleness space to itself, although it was not perceived to be as effective as the
other analgesics. The highly effective, extremely gentle pain reliever segment remains an
open target. The search for a product to fill this segment continues.
Buyerslike productscan be segmented in many ways.6 For example, Industrial
buyers can be divided by industry, strategies that these firms pursue in their industry (low-
cost or differentiation), size and type of ownership, decision-making unit or process, order
pattern, technical sophistication, and the extent to which they serve original equipment
manufacturers (OEM) or the replacement market. Household buyers can be divided by
EXHIBIT 4.5 High

Perceptions of
Painkillers Meditation
Source: Adapted from

R. Grant,
Tylenol ?
Contemporary Massage
Strategy Analysis, 4th
ed. (Oxford:
Blackwell, 2002),
p. 284. Acupuncture
Bayer
Low High
Private Bufferin EFFECTIVENESS

label
aspirin
Anacin
Excedrin
Ibuprofen
Darvon
Low
GENTLENESS
demographics, lifestyle, physical size, price level, packaging, promotion, color, a ppearance,
physical feel, and other product features, technology, design, inputs or raw materials
needed to use the product or service (e.g., an ink cartridge for a printer), actual perfor-
mance characteristics in comparison to other products or services of its type, or the presale
and post-sale services provided. Products and services can be grouped in this way to meet
different customer needs. Distribution channels can be partitioned in many ways. They can
be divided into direct distributors, wholesalers, brokers, and other intermediaries, as well
as retail, mail order, phone, and the Internet. These channels can be exclusive or nonexclu-
sive, generalists or specialists. Each has appeal to a different customer segment.
Even geographic areas can be segmented. They can divided by locality, region,
nation, blocs of nations, continents, weather zones, and other distinguishing features.
Industrial buyers can be divided by industry, strategies that the firms pursue, size and
type of ownership, decision-making unit or process, order pattern, technical sophisti-
cation, and the extent to which they serve a different market. There are many ways to
bundle and separate aspects of the product or service mix to create different categories.
Are Low Cost and Differentiation Compatible?

Porter argues that it is important for the managers of a company to understand which
position to occupylow cost or differentiation. He maintains that the internal resources
and capabilities needed to support one are not compatible with the internal resources and
capabilities needed to support the other (see Exhibit 4.6).7 In retailing, for example,
Walmarts disciplined cost cutting philosophy is worlds apart from that of luxury retailer
Neiman Marcus. Companies such as, Sears and JCPenney, have struggled to stake a clear
EXHIBIT 4.6 Cost Leadership Differentiation

The
Incompatible Scale-efficient plants/locations Branding and advertising
Capabilities of Standardization Custom design and special services
Control of overhead Unique features
Cost Leaders
Tight process controls Emphasis on creativity
and
Differentiators
position in the middle because the resources and capabilities needed to maintain a mid-
dle position are not compatible.
Why is it so difficult to occupy the middle? Think of the differences between a
famous artist, who has to sell only a few paintings at very high margins to survive, and a
pin manufacturer, which must sell millions of pins at very low margins to survive. Now,
imagine trying to combine both approaches successfully. Pablo Picasso would never
punch a time clock at the pin manufacturer. Only the most capable organizations can
strike the right balance and successfully stake out a best value position.
Best Value
Contrary to Porters argument, some firms have found success in the middle. Such
bestvalue competitors will draw customers from lower- and higher-end rivals by casting
a wide net and offering a selection of products and services that appeal to bargain seekers
and that luxury buyers also find special enough to meet their needs. Best-value companies
often take advantage of behind-the-scenes low-cost processes while providing high-
quality interactions that end-customers especially appreciate.
One of the most successful best value players today is Trader Joes. The firm has
parsed its value chain, ruthlessly cutting behind-the-scenes costs that most customers do
not notice while elevating the shopping experience in their stores. Trader Joes adheres
to a limited selection, high-volume model that yields significant cost reductions. Their
peanut butter is an example. The company sells 10 types, while most supermarkets sell
about 40. If both a typical supermarket and a Trader Joes store sell 40 jars a week,
Trader Joes sells an average of four of each type, while the average supermarket might
sell only one. With high turnover on few items, Trader Joes can purchase large quanti-
ties at deep discounts. The whole business, therefore, from stocking shelves to checking
out customers, operates according to a very simple model.
Trader Joes management keeps costs down by minimizing the number of product trans-
actions. It purchases directly from manufacturers, not through wholesalers, who ship their
wares directly to the companys distribution centers. Attention to costs also is evident in
Trader Joes store design. To show that more help is needed at the registers, simple low-
tech bells ring to alert employees. The purchasing space is not cluttered with a conveyor
belt or scale. Perishables are sold by unit and not by weight, adding to speedy checkout.
Though all these features simplify the selling experience, product quality and customer
service remain paramount. Customers accept that the selection for particular product cat-
egories is limited, but they trust that those few items have unique and special features that
they otherwise could not access in a conventional grocery. To find these items, Trader Joes
searches the world. Its biggest R&D expense is travel to find new and unique products.
Finally, compensation at Trader Joes encourages employees to deliver outstanding
service. Store managers have six-figure incomes, and the full-time crew members can earn
up to the $60,000 range in starting salaries and benefits. On top of the pay, Trader Joes
annually contributes more than 15.4 percent of its workers gross incomes to tax-deferred
retirement accounts. This best-value combination of outstanding attention to customer
service and product quality coupled with disciplined behind-the-scenes operations and
well-compensated staff has allowed this German-owned grocer to rapidly grow its revenues.
The Impact of Position on Margin

The adoption of a clear position with appeal to a companys target market yields per-unit
profit margin advantages. The low-cost leader has greater margins than the average in-
dustry competitor even if its prices are low due to its ability to trim costs across the value
chain. The differentiator has greater per-unit margins than the low-cost leader as it com-
mands higher prices for the additional value it delivers. Best-value players have better
margins when the benefits that their products and services justify higher prices, and their
disciplined operations reduce costs. Exhibit 4.7 summarizes each position and illustrates
the trade-offs.
Repositioning
Companies have the capacity to regularly reposition their products and services. The
positions they hold in the market are not stable. Companies are dynamic: Over time, in
response to competitive challenges, they switch positions. A major challenge a company
faces is knowing when and how to make these switches. Best Buy moved from a narrow
differentiated position to a narrow low-cost one (see Exhibit 4.8).8 It started as a high-
quality stereo store for audiophiles, with a few stores in Minneapolis/St. Paul, Minnesota,
before it moved to its current niche as a low-cost electronics outlet, but it did not stop
there. Concept One was introduced in 1983 because the company feared extinction and
involved Best Buy expanding its floor space and selection, pricing competitively, and
creating a very exciting store environment. Best Buy wanted to be the fun place to
shop for the 18-to-25-year-old male. In 1989, the company rolled out Concept Two. No
longer satisfied with its position as a low-cost leader, it combined mass-market and spe-
cialty retailing. It offered value products in select categories without the selling pressure
of a commissioned sales force. Best Buy was, in a sense, returning to its roots as a spe-
cialty storethe Sound of Music, which was its previous name.
EXHIBIT 4.7 14
Trade-Offs
12
among
Strategic 10
Positions Price
8
Cost
6 Margin
0
Average Industry Low Cost Leader Successful Savvy Best Value
Competitor Differentiator Player
EXHIBIT 4.8 Best Buy has repositioned itself several times:

Movement 1. Founded as specialty Sound of Music
among store in focused differentiation position
Broad Broad
Kinds of Customers,
Strategic 2. Shifted to narrow low-cost position as it
Low Cost 3 Differentiation grew into electronics superstore
Positions at
Best Buy, 3. Currently in best value position, serving
Best Value mass market selling both commodity and
Schwab and
specialty items at very competitive prices
Morgan
2 1
Stanley, and Focused Focused
Ivory Low Cost Differentiation
Schwab & Morgan Stanley have both moved

toward the middle:
1. Schwab was a traditional low cost player,

Broad Broad
Kinds of Customers,
while Morgan Stanley held a differentiated

Low Cost 2 Differentiation position
2. Schwab moved to the middle upon the
1 Best Value 1 emergence of (lower cost) online brokers
Morgan Stanley also saw best value oppor-
tunities with purchase of Dean Witter
Focused Focused
Even the iconic Ivory brand has moved:

1. Ivory was a differentiator before Dial, and
Dove challenged their position

Broad Broad
Kinds of Customers,
2. They moved to a low cost position after

Low Cost Differentiation they were challenged
Best Value
2 1
Focused Focused
Concept Two was extremely successful, allowing Best Buy to overtake Circuit City in
sales, but the run-up in sales was not matched by a concomitant growth in earnings.
Concept Three was designed to address the earnings problem by positioning the company
as even more of a hybrid. Best Buy offered both high-margin myth products and low-
margin commodity elements. This strategy mixed low cost and differentiation and
moved the company closer to the middle. Each phase in Best Buys development built on
the previous one. As it repositioned again and again, the company held on to elements of
its old position even while it branched out and developed a new ones. Fast movement
allowed Best Buy to widen the gap between itself and Circuit City. Customers liked the
company because it offered everyday low prices, and its stores were bright, fun, and
leading edge.
Considerable repositioning has occurred in the securities industry as well (see
Exhibit 4.8). Schwab moved from its low-cost position as a discount broker to a middle
position by offering full services to high-net-worth individuals. At the same time that
Schwab was undergoing its transformation, full-service brokers, such as Morgan Stanley,
also made changes. Morgan Stanley made its move toward the middle by purchasing
Dean Witter in 1997. It obtained more than 10,000 brokers whose clients were not the
high-net-worth individuals to whom Morgan Stanley traditionally had catered. The
culture of exclusivity had to give way to a more common appeal as the firm merged two
powerful, very different organizations.
Porter provides an extremely interesting example of historical product repositioning
(see Exhibit 4.8).9 Ivory started as a differentiated soap. In 1879, when more than
300 companies produced crude, inexpensive soaps, Ivory was the first to offer a pure and
mild product. It had no harsh ingredients, and it floated. Ivory was heavily advertised,
and the companys message was purity (99.44 percent pure). It aggressively used com-
parison ads and the endorsements of chemists and physicians to certify the pure image.
Early on, it adopted the image of a baby and the slogan mild enough for a baby. Ivory
sold at a premium price and commanded a leading share of the market until it was chal-
lenged by Dial, the first deodorant soap, and by Dove, the first beauty bar. In response to
these challenges, Procter & Gamble decided not to add these features but to reposition
Ivory as a basic, good-value soap.
Ivory went from differentiation to cost leadership (see Exhibit 4.8). It quickly estab-
lished itself in a leading market position as the simple, no-frills soap that was sold in the
package with no shiny paper or garish colors. Procter & Gamble pioneered the idea of
bundling bars of soap by selling six bars of Ivory together. Its advertising stressed that
Ivory was a great soap for the money: We probably should charge more for great soap
like Ivory. Contributing to Ivorys low cost was its air bubbles, which not only allowed
it to float, but also reduced the material needed to manufacture it. It also lacked expen-
sive additives like those in Dials and Doves products. Its simple packaging was inher-
ently cheaper, and its long and consistent brand image controlled advertising costs. Since
the brand was well-known and had such a long history, it also was a traffic builder for
retailers, so Procter & Gamble did not have to spend much on trade promotion.
The history of Ivory as well as the other companies demonstrates the idea of a prod-
uct life cycle in which maturity is not inevitable. Companies can change position to
prolong the product life cycle. There are many changes, but the changes are based on
continuity and a products past history and inherited qualities. Brands are like
personalities that move and change over time, but also have stable features. They have a
set of traits that consumers immediately recognize and to which they relate because of
a companys or products history.
Many Ways to Differentiate

As these examples suggest, there are many ways to differentiate. The analysts job is to
identify the principal variables that distinguish strategic groups (see earlier discussion in
Chapter 2) that follow similar strategies. In the pharmaceutical industry, there are price
and R&D distinctions. Companies high on both attributes sell patented medicines, while
companies with the opposite tendencies sell generic medicines. These are the two most
important strategic groups in the pharmaceutical industry (see Exhibit 4.9). The
resources, capabilities, and competencies needed to compete in these groups are differ-
ent; thus, the barriers to entering them are not alike. Movement from segment to seg-
ment is not necessarily easy, as doing so requires the acquisition of new resources,
capabilities, and competencies.
Nonetheless, Forest Labs did make this move. It moved from the generic drug group
to the proprietary (patented-drug) group on the basis of its successful antidepressant
drug Celexa. Forest Labs was a very agile company. It started in 1956 as a vitamin and
candy company. Then, it moved into generic drugs, competing with the likes of Watson
Pharmaceuticals. Next, it started marketing an angina drug (Tiazac) in Europe, followed
by its marketing of Celexa, a Danish-produced, high-efficacy antidepressant with few
side effectsa move that brought Forest into competition with the large pharmaceutical
companies. Forest Labs moved into this position in a relatively short time. In 2003, it
achieved a 9.8 percent market share in the very lucrative U.S. antidepressant market,
with sales of Celexa accounting for 70 percent of the companys revenues. Its small size
in comparison to the pharmaceutical giants allowed it to make a rapid thrust into a new
competitive space. Forest was very focused; it vigorously marketed only a few drugs at a
time, and it started to engage in large-scale R&D in competition with the major drug
companies like Merck and Pfizer. The drugs in its pipeline focused on diseases of the
elderly, a strong future market. A segment, while it can be very competitive within,
should be protected from outside by entry barriers, but Forest Labs demonstrated that the
standard entry barriers in the pharmaceutical industry could be breached.
Within every segment, positioning leaves empty spaces for new players. In low-cost,
mass-merchandise retailing, Target tries to be more upscale, Kmart tries to compete as
the low-cost alternative, and Walmart is in the middlenonetheless, opportunities still
EXHIBIT 4.9 Forest Labs hurdled typical entry barriers with

Forest Labs its moves:
Move to a New 1. The firm entered the pharma industry in the
Broad Broad
Kinds of Customers,
Strategic low cost (generics) space competing

Low Cost Differentiation against firms, such as Barr Labs and Biovail
Group
2. It then proceeded to challenge
Best Value differentiated incumbents Merck,
1 2
Pfizer and GlaxoSmithKline
Focused Focused
exist for differentiation. Family Dollar went after low-income families by opening small
neighborhood stores. It created a new segment based on a different business model, one
that matched buyers and products in a novel way: a discount chain that offers customers
value via low-cost, basic merchandise in stores less than one-tenth the size of a typical
Walmart. The first store opened in 1959 in Charlotte, North Carolina; by 2002, Family
Dollar operated 4,693 stores in 41 states and employed more than 25,000 people. The
company expanded solely by relying on retained earningsit had zero debt. The stores
are in both rural and urban areas, but the companys recent expansion has been concen-
trated in inner-city, urban neighborhoods. The stores offer a variety of products includ-
ing clothing, blankets, sheets, towels, household chemical and paper products, candy,
and health and beauty aids. All stores are similar in appearance, and they have the same
policies (e.g., none accepts credit cards or extends credit).
Tactics
Once a firm has staked a strategic position, it attracts the attention of industry rivals that have
a companys customers in their sights. A company must attend to these emerging threats. Yet
not all threats are equal. Some rivals are smarter and more capable. Others are very easily
neutralized. Thus, a company must pick its battles with care to engage where it is most likely
to winand to avoid becoming entangled in hopeless conflicts that leave all combatants
worse off. Battles are not always won by firms that have clear advantages. Better capabilities
alone do not guarantee victory. New entrants often beat large established players.
Therefore, competitive intelligence is needed to understand a company rivals
abilities, their motivations, and whether its wise or foolish to make a move against them.
Exhibit 4.10 outlines several questions that a company should answer before it launches
an attack against its rivals. Possessing such intelligence reduces strategic risk and
increases the likelihood that the company will prevail in competitive battles.
Aggressive organizations know their rivals well, choose their battles carefully, and
take full advantage of their rivals misfortune. AT&T and Verizon, for example, have
moved against a weakened Sprint for many years. They lowered prices right after Sprints
EXHIBIT 4.10 What are my rivals capabilities?

Getting to Where are they stronger/weaker than us? Are they agile?
Know a Hows their financial war chest? Can they survive a sustained attack?
Companys Do they hold fortified positions in other markets or lines of business?
Rivals
How are my rivals track records?
Do they tend to react swiftly and effectively to competitive threats?
How predictable are they? Do I know enough about those that lead these firms?
Do I understand my rivals motivations?

What compels them to act aggressively?
What do they stand to gain if they make a move against my firm?
Can I forecast with certainty the moves they will make?
To what extent are my rivals aware of our firm and its capabilities?
If we choose to pursue our rivals key customers, can we fly under their radar and evade detection?
How are they likely to retaliate?
disastrous Nextel merger, when Sprint could ill afford to lose more customers, and lob-
bied against Sprints Softbank merger, which offered its main hope for rebuilding its for-
tunes as a strong competitor.
Once a company knows its rivals intentions, it is able to select offensive tactics to
advance a company position, but in doing so, it should not neglect having defensive tac-
tics to protect it. Eight classic moves can be utilized as standalone tactics or combined
into powerful, coordinated maneuvers to provide a company with continual advantage.
Five are offensive tactics, and three are defensive tactics.
Offensive Tactics
1. Direct frontal assaultswhere a firm moves to match or exceed the strengths of a
rivalshould be launched with caution. A firms resources, capabilities, and compe-
tencies must be clearly superior. Frontal assaults fought on all fronts can be a losing
proposition. Before XM and Sirius merged, they were engaged in tremendous colli-
sion with each other. Each raced to launch more satellites than the other and added
stations in rapid succession to woo the same target customers. They spent a half
dozen years battling for subscribers, bidding up programming costs, and putting each
other out of business in a lot of ways. This battle was characterized by a long series of
frontal assaults that left both firms bloodied and almost on the brink of extinction.
2. Given the difficulty of winning frontal engagements, it makes more sense to engage in
a flanking attack, where a company capitalizes on the weakness of its rival. Numerous
TV and Internet-based ads are very thinly veiled attempts to attack the flanks of rivals.
When iMovie was introduced in the mid-1990s, Apple launched a series of amusing ads
mocking its rival iMovie as the PC Home Movie. When Android phones were intro-
duced, Google launched a series of ads that pointed out Apples relative disadvantages,
from not having a removable battery to not allowing the open development of apps.
3. The pre-emptive strike is an offensive maneuver that aims to seize an opportunity
before a rival can act upon it. Global consumer businesses, such as P&G, have raced
to establish themselves in emerging markets before their rivals can enter. Hoteliers
hurry to secure the best vistas for up-and-coming vacation destinations. Prospectors
hustle to lock up mining and drilling rights before others arrive on the scene. Pre-
emptive strikes are designed to thwart those that might be planning for a late arrival.
4. The bypass (also called the end-run or blue ocean strategy) is designed to minimize
direct conflict. Firms adopting this approach aim to set new standards that create a
unique and uncontested space. Examples of this tactic can be seen across a variety of
industries. Cirque du Soleil created a new space in the live entertainment industry as it
melded the best in theatrics with traditional circus elements. NetJets led the way in
creating an answer to those not satisfied with any of the commercial airlines, yet un-
willing to purchase their own aircraft. Nintendos Wii had smashing success by avoid-
ing the highly intense battles for the adolescent male gamer. It chose to appeal to a
much broader audience with its low-tech but highly user-friendly gaming interface.
5. Guerilla moves have traditionally been deployed by only the smallest and weakest of
competitors. They are designed for maximum impact at low cost. Beer maker Kirin
Ichiban engaged in such a maneuver. Anheuser-Busch spent millions to secure
o fficial sponsorship rights for the 2002 FIFA World Cup. Inside the stadium, fans
could see only the brewing giants Budweiser banners, colors, and beer. Yet right
outside of the stadium, Ichiban had carefully procured the most visible billboards
declaring their beer as the un-Official beer. Ichiban representatives passed out free
samples to thirsty fans as they approached the stadium. Their low-cost guerilla tactics
won the hearts of soccer fans that day. Large firms have taken notice of how effective
guerilla tactics can be and now mimic this approach. Social media campaigns, previ-
ously the guerilla tactic of choice for small firms, today are regularly used by large
firms. There are few companies today that do not have and invest in a significant so-
cial media presence.
Defensive Tactics
Defensive maneuvers are needed to respond to a rivals offensive moves and to react to
threatening situations:
1. The most obvious of defensive maneuvers is retaliation. Price wars are sparked in the
airline industry when one carrier launches a fare reduction, and their rivals retaliate
by matching or beating the rivals price. In response to Androids attack on the
iPhone, Apple launched a series of retaliatory ads mocking Androids shortcomings.
2. Blocking can be another effective defensive tactic as it prevents a rival from moving
in the first place. As moats and massive doors have protected ancient castles from
marauding enemies, blocking maneuvers aim to raise barriers to industry entry. Lob-
bying for tariffs against foreign competitors is an example of such a blocking maneu-
ver. Blocks can also lock up supply and distribution channel access or limit access to
intellectual property. Pharmaceutical firms employ blocking when they reformulate
drugs just before patent expiration. New, more customer-friendly branded formula-
tions pose an effective block to the advances of generic producers.
3. A final defensive tactic is retrenchment, primarily a move of last resort pursued
when a firm is in distress and must shift to survival mode. Retrenching firms pare
their businesses down to the core and rid themselves of unnecessary overhead. A firm
may discontinue unprofitable operations, sell noncore assets, and eliminate nones-
sential employees. When it is weak and bloatedand survival of the firm is at
stakeretrenchment takes hold. It is a form of divestment discussed further in
Chapter 5 on corporate strategies.
Timing
Examine the external environment, assess a company firms internal strengths and weak-
nesses, and be ready to make moves, but also be aware that timing matters. It makes a
difference if a company chooses to be an early or late mover. Some maneuvers are better
suited to earlier or later stages in the industry life cycle.
Life Cycles
The moves a company decides to pursue are related to its stage in the industry life cycle
as introduced in Chapter 2 (see Exhibit 2.4 to review its characteristic curve). Earlier
stages call for different moves than later stages. Companies in younger industries make
different competitive moves than companies in more mature industries. They make dif-
ferent strategic choices because each phase in the industry life cycle has a different type
of product, customer, and competitor. A company must gauge where its products are and
react to its special circumstances.
The life cycle implies that products evolve through four stages: introduction, growth,
maturity, and decline.
Firms in the introductory stage favor offensive moves that capitalize on the weak-
nesses of the status quo, while their new concept is being proven. This stage inspires
defensive moves to block entrants via locking up sources of supply, building network
effects, and patenting products, while a company proves that its business models and
technologies are viable opportunities. The introductory stage, by its nature, calls for a
pre-emptive approach.
The growth stage offers firms across the industry an opportunity for unfettered prog-
ress. Industry participants need not attack each other in order to grow and claim a
sizeable piece of the pie. In this phase, companies race to set standards to trump their
rivals. They work to improve processes. They try to fill the pipeline through modular-
izaton and the creation of adjacent products and/or services. The larger the footprint,
the stronger their brand is. Companies stake out clearly defined, broader, market po-
sitions in preparation for the unavoidable industry shakeout that takes place next as
the industry matures.
Firms reaching the maturity stage see their growth hit an inflection point. Demand
has begun to level out. Maturity is characterized by intense direct rivalry and industry
consolidation. Incumbents launch offensives to steal profitable customers from rivals.
Mergers and acquisitions enable former competitors to join forces, combine top-line
revenues, trim organizational redundancies to reduce costs, and realize greater prof-
its. Firms move to prune marginal product lines. Those that survive the shakeout no
longer have the luxury to attend to unprofitable business.
Firms in the decline stage have few choices. They can exit quickly, remain until in-
dustry death, or revitalize an industry via globalization and/or innovation. Those that
choose to exit quickly might see the greatest profit opportunity in selling to a stron-
ger, more committed rival. Others may choose to stop investing in a dying business,
but still harvest profits from the sales that remain. If there is to be revitalization, it
hinges on the efforts of globalizers who expand industry scope and innovators who
bring to market new products and services. Without these forms of renewal, an indus-
try can decline and die.
Early Movers versus Late Starters

Timing makes a difference. First movers are the aggressive newcomers that take early
risks in anticipation of high returns. If their new ventures and undertakings work as
expected, they gain a head start on the competition and enjoy many of the advantages
summarized in Exhibit 4.11, but in moving first they also incur high development
costs and assume risks. If these risks are not acceptable, a company may choose to
delay and allow its competitors to occupy this position with the knowledge that it
EXHIBIT 4.11 Pros Cons

The
Advantages Ability to create/protect intellectual property Higher R&D costs than later movers
and (patents, trademarks, etc.) First to make mistakes from which the rivals can
Disadvantages Ability to set standards benefit
of Moving First Head start on competitors Higher market entry expenses
Early market share and customer loyalty Need to blaze trail in establishing supply chains, etc.
Head start on learning and scale economies IP can sometimes be circumvented
Can tie up strategic resources Higher risk of missing the product, service, or pro-
Can erect some early barriers raise switching cess expectations of the customer
costs for customers and producers
might be able to catch up later. Through reverse engineering, second movers can copy
what first movers do and avoid costly and expensive errors that the first movers make.
If second movers move very aggressively, they can overtake the first movers. First
movers can lose their initial advantage if they fail to effectively respond to the second
movers challenges.
Being the first company to make a move, whether introducing a new product or a new
business practice, creates a hard-to-challenge advantage. However, being a first mover is
risky, and aggressive second movers often succeed where first movers fail. Consider
Best Buy. In 1991, Best Buys sales were $0.66 billion, substantially behind Circuit
Citys sales of $2.36 billion. But in 1996, Best Buy overtook Circuit City, with sales of
$7.21 billion compared to Circuit Citys $7.02 billion. Best Buy surpassed Circuit City
by rapidly making strategic moves that Circuit City did not match:
Best Buy made its stores exciting, fun places to shop.
Best Buy removed its high-pressure, commissioned sales force and replaced it with a
more laidback, salaried sales force. Circuit City stuck with commissioned sales.
Best Buys policy of everyday low pricing meant it offered good values at different
price points. It did not mean that everything in its stores was sold at a rock-bottom
price; Best Buy carried so-called myth items (exciting, high-energy, leading-edge) as
well as commodity ones. Over time, Best Buy increased its emphasis on the myth
items so that it would continue to appeal to techno-savvy shoppers, who by their very
presence gave Best Buy stores a certain allure.
Best Buy attacked its competitor at its coreafter-sale service. Circuit City had
achieved 75 percent of its operating profit from the sale of extended warranties, so
Best Buy offered competing performance service plans at 30 percent less than
Circuit Citys prices.
As a second mover, Best Buy was very aggressive. By taking these steps, Best Buy
differentiated itself from Circuit City. More nimble and strategically adroit than Circuit
City, it devised a series of innovative moves that stymied its larger rival. When Circuit
City failed to respond effectively, Best Buy surpassed it. When the 2008 economic melt-
down struck, Circuit City went bankrupt. Best Buy checkmated its opponent, and Circuit
City went out of existence. For the first movers, sustaining the initial benefits of being a
first mover can be very difficult. In some cases, they ultimately triumphed, but in many
other cases, victory was claimed by fast followers (see Exhibit 4.12).
EXHIBIT 4.12 Product First Mover Later Mover Ultimate Winner

Leaders, (Innovator) (Follower)
Followers, and
WinnersCan Commercial Jets deHavilland Boeing/Airbus Followers
Ball Point Pen Reynolds Bic Follower
the Leader
Light Beer Rheingold Miller Follower
Win? CAT Scan Imaging EMI GE Follower
Source: Adapted from Float Glass Panes Pilkington Corning Innovator
R. Grant, Fiber Optics Corning Several Followers Innovator
Contemporary Diet Cola R.C. Coca Cola Follower
Strategy Analysis, 4th
ed. (Oxford:
Video Games Atari Nintendo Follower
Blackwell, 2002), Copiers Xerox Canon Unclear
p. 347. Windows-Type Op System Apple Microsoft Follower
Internet Browser Netscape Microsoft Follower
Digital Music Player Several Apple Follower
The Value of Rapid Adjustment

The ability to rapidly adjust to changing circumstances is a competency each firm should
endeavor to acquire. For most firms, the competitive landscape alters rapidly because of
the moves made by its competitors and transformations in factors, such as the global
economy, government regulation, technology, and knowledge. The relentless pace of
change blurs traditional industry boundaries. For example, the computer, telecommuni-
cations, and entertainment industries have been merging such that companies like
Microsoft, Comcast, AT&T, and Time Warner compete against each other in many dif-
ferent domains. Commercial and investment banking, brokerage, and insurances indus-
tries also have amalgamated, turning giant firms, such as Citigroup and Goldman Sachs
into competitors operating in similar realms.
After the Great Depression, the U.S. Congress required that banks engage in only one
type of banking activity. Commercial banks provided checking accounts, savings ac-
counts, and money market accounts. They accepted time deposits. Investment banks
raised capital, traded in securities, and managed corporate mergers and acquisitions.
Under the Glass-Steagall Act of 1933, such combinations had been illegal. The Gramm-
Leach-Bliley Act of 1999, however, allowed banks to carry out functions of both com-
mercial and investment banks. As the competition between commercial and investment
banks picked up, they competed actively for real estate loans. They acquired mortgages
by purchasing them from mortgage bankers or dealers. Many of the mortgages issued
were to subprime borrowers with little ability to repay. Investment banks securitized
these loans; however, when U.S. house prices began to decline in 200607, and mort-
gage delinquencies soared, many of the securities backed with subprime mortgages lost
most of their value, and the upshot was a huge capital crisis. This crisis had its roots in
weak financial regulation. In response, almost all of the major investment banks became
commercial banks, so they could receive Troubled Asset Relief Program (TARP) money.
External shocks transform many industries. The key attributes for ongoing business
success are flexibility, innovation, and speed. The ability of firms to experiment and
achieve new resource configurations more rapidly than their competitors is a dynamic
capability.10 Their ability to renew, augment, adapt, and reinvent themselves over time is
a rare and valuable factor that helps them sustain competitive advantage. Of the top 25
U.S. corporations in 1900, only two remain today. In a typical year, more than 150,000
business bankruptcies occur, most of them involving firms that have failed to react ade-
quately to change. Of the many reasons for firms lack of response, inertia and prior
strategic commitments stand out. The Icarus paradox highlights the effects of failing to
adapt.11 Icarus, a figure in Greek mythology, was being held hostage on a besieged is-
land. To help him escape, his father made him wings of wax and feathers. Because flying
saved his life, Icarus loved to fly. He soared higher and higher until he came too close to
the sun, which melted the wax in the wings, and Icarus plunged to his death.
Similarly, many companies become so committed to the existing business models that
brought them success that they continue to use them despite new conditions that make
these models obsolete. Their absorption in what they once did well keeps them from
learning and adapting and leads to their undoing. A good example is Xerox, which chose
not to make the changes that could have ensured future prosperity. Today, consumers do
not associate Xerox with the personal computer revolution; the names that come to mind
are Apple, Microsoft, Intel, and Dell. Yet Xeroxs research division in Palo Alto, California,
pioneered almost all the elements that ultimately went into PCs, from the mouse to the
printer. Steve Jobs picked up ideas from Xerox researchers, but years after its involvement
in this revolution, Xerox was still in the copying business, and even in this business,
which it should have dominated, its rivals were overtaking it. Though Xeroxs managers
had the potential to be first in the personal computer market, they made a conscious
choice to stay out of it, reasoning that PCs were not the firms line of business. Their
timing was notoriously bad.
Douglas Smith and Robert Alexander document the companys choice to forgo PCs in
a wonderful look at Xerox called Fumbling the Future.12 By examining company records
and interviewing executives, the authors show how bureaucratic infighting killed the PC
business at Xerox. Factions in the firm that favored being first in the PC market lost out
to factions that favored sticking to Xeroxs existing lines of business. Xeroxs inability to
react is a classic example of how a company can miss a once-in-a-lifetime opportunity.
The Xerox example illustrates that the timing of moves is highly important. Determining
the optimal timing depends on competitors timing as well as ones own. This game is
not carried out in isolation. A way to conceptualize the dilemma is to use game theory.
Game Theory
There are two types of gamessimultaneous ones, like online fantasy football, and se-
quential ones, like chess.13 In a simultaneous game, two or more players act at the same
time; in a sequential game, one player goes first and the other player gets to observe the
results before making his or her move. In both types of games, a decision not to go for-
ward is just as important as a decision to go forward. The choice, in business terms, is
whether to stick with an old product, practice, or business model, like Xerox sticking
with the copier, or to start rolling out a new one, like Xerox developing the PC while
continuing with the old. Such choices are timing dilemmas.
Simultaneous Game
In a simultaneous game with two players (here, two firms), each has the choice of pro-
ducing only its old product or going with the old one plus a new product. The payoffs
EXHIBIT 4.13 MY COMPANY

Simultaneous
Game: Payoff Old Product Old & New Product
Matrix. (My MY RIVAL
Old Product $100 / $100 $250 / $30
Payoff/My
Rivals Payoff) Old & New Product $30 / $250 $0 / $0
vary depending on what the other party does. In Exhibit 4.13, if both parties stick with
the old product, their payoff is $+100 each; if they both innovate and go with old and
new products, their payoff is $0 each. When two parties make the same move at the same
time, each one cancels out the gains the other could have achieved. The two parties, in
essence, neutralize each other.
So far, the choice seems clear. It is safer to stay with the old product than to innovate
and add a new one when the other party might do the same. However, what if one party
innovates, producing both the old and the new products, and the other does not? Then
the payoff is $+250 to the innovating party, while the party that holds to the status quo
loses $30. Now the choice is between possibly winning $+250 or possibly losing $30.
Assuming that each side is just as likely to innovate as it is to stay the course, the odds
favor innovation: Staying with the old product yields payoffs of $+100 and $30, for an
average gain of $+35, while innovating yields payoffs of $+250 or $0, for an average
gain of $+125. Both parties, being rational, will choose to innovate, and in doing so,
each will cancel out the others gain. Where both could have achieved $+100 if they had
been satisfied with staying the course, now both get nothing from innovating.
In game theory, this kind of situation is called the prisoners dilemma. In such a game
the two partners in crime Dorothy and Alberto have been arrested for robbing the Left
Wing Peoples Saving Bank. In the classic example, both accused persons get a one-year
sentence if each refuses to squeal on the other. If one testifies against the other, she or he
goes free and the other accused party faces a sentence of six years. If both parties testify
against each other, both go to prison for three years. In the prisoners dilemma, as long
as the parties are unable to communicate with each other, it is rational for both of them
to squeal. When these criminals rat on their partners in crime, society benefits, but the
two prisoners suffer. Neither achieves an outcome that is in her or his best interest. In the
example of the new-product dilemma, society also benefits because the innovation is
pursued and the new product comes to market, but neither of the innovating parties
gains. Companies, such as Xerox or Circuit City, may have understood the downside of
playing this game and thus chose to be cautious about innovating. Their deliberations
may have led them to a bias against change. Why should a company innovate if a game-
like scenario indicates that neither it nor its rival is likely to be better off?
In the real world, the payoffs are not known in advance; they can be only roughly
approximated. The analyst must calculate the probability of gain or loss times the mag-
nitude of that gain or loss, but both calculations are estimates and, if they are off by even
a small amount, can compound the errors. To make these calculations, the analyst may
need to use some type of confidence interval. For example, there may be an 80 percent
chance that the payoffs are as specified and a 60 percent chance that the parties will act
in accord with the models assumptions of rationality. But not all rivals are likely to be
perfectly rational. It may even serve their purposes to surprise one another by being in-
tentionally irrational.
In making estimates about the payoffs and what the two sides will do, the analyst has
to consider motivations and level of awareness. A good question, for instance, is: why
wasnt Circuit City more aggressive in responding to Best Buys moves? The analyst
would also have to investigate organizational politics because they are likely to play a role,
as they did in the Xerox case. A sensitivity analysis based on different assumptions about
motivations, levels of awareness, and organizational politics may be needed to establish
odds for a number of outcomes.14 Without precise numbers for the probable gains and
losses and the various moves a competitor might make, the range of results may be so
great as to be uninterpretable. These uncertainties plague managers trying to make timing
decisions. The longer they work on resolving the uncertainties, the more time they lose.
Sequential Game
As mentioned, in a sequential game, the parties alternate their moves in a series of
rounds rather than moving simultaneously in a one-time event. With each round, the par-
ties understand the game and the tendencies of their opponents better. Since the parties
know that they will be dealing with each other repeatedly and recognize that mutual self-
destruction is foolhardy, the likelihood of their cooperating should increase. With coop-
eration, the prisoners dilemma can be solved to each of the parties benefit. Both realize
that they walk away with a shorter prison sentence if neither party squeals. Simulations
with the prisoners dilemma have shown that when one party introduces cooperative
behavior, the other parties are likely to respond in a tit-for-tat fashion, but these simula-
tions have not been supported by experiments showing that in repeated games coopera-
tors learn from defectors and copy their behavior. The sequential game concept is a
useful model for repeated interactions because its iterative cycles introduce realism.
However, as with the simultaneous game model, the payoffs and the odds of what each
side will do must be estimated, and their estimation is hampered by uncertainty. Indeed,
with an iterative process, there are more calculations and thus greater chances of error.
To illustrate this, lets return to the original example: First, one company decides
whether to innovate or not. The payoffs of its decision have to be calculated on the basis
of what its rival is likely to do next. As shown in Exhibit 4.14, there are four payoffs, or
outcomes (O), to be calculatedO1, O2, O3, and O4. So far, the sequential game is
similar to a simultaneous game. However, the sequential game enables modeling what
will occur after the initial payoff, as the assumption is that the game will continue with
additional rounds. Suppose that in the first round a company decides that it is going to
stick with its old product, and its rival then decides it will not innovate. The company has
to decide whether to innovate or not in the next round, so it must calculate the second-
round payoffs on the basis of the first-round results. These outcomes are represented by
O5 and O6 in Exhibit 4.15. Now suppose that in the first round the company decides it is
going to stick with its old product and its rival then decides to innovate. The company
must decide its round-two move and calculate the payoffs on the basis of this result.
These additional outcomes are represented by O7 and O8.
More rounds will occur, and more outcomes will have to be estimated and compared.
The sequential-game model helps prepare the analyst for the repeated character of
competitive interactions by forcing the analyst to think several steps ahead, rather than
EXHIBIT 4.14
My Company (05)
Sequential
Maintains Old Product Line
Game Decision
Tree My Rival (01)
My Company (06)
Adds a New Line
My Company
My Company (07)
My Rival (02)
Adds a New Line
My Company (08)
Adds a New Line
My Rival (03)
My Company
Adds a New Line
My Rival (04)
Adds a New Line
one step at a time. The timing of a move is not a one-only decision for either party. As
the rounds continue, important decisions will need to be made at each interval. In a se-
quential game, the payoffs and the odds of what a player might do must be recomputed
often. These repeated calculations compound the possibility of error.
Expanding the Assumptions

The examples discussed above show some of the problems that occur in conceptualizing
strategy as a game. A number of assumptions should be questioned. One is that rivals
have only two optionsto innovate or not to innovate. Obviously, the real world provides
more possibilities than this schematic choice. There are other options than a company
abandoning its old product, or hedging its bets with some proportion of new and old
products. The choices depend on a companys creativity. Decision making is not limited
to either-or, yes-or-no thinking. It encompasses more than totally supporting or opposing
innovation. Moreover, with each iteration in the game, the company can become more or
less committed to innovating or to sticking with what it had been doing previously.
Another assumption to be questioned is that only two parties are competing. Most
real-world situations involve competition between more than two parties. For instance, in
a game between cereal makers General Mills and Kellogg, the two sides can go two
rounds, first matching each other by offering the right to buy a box of cereal and get one
free and then matching each other by removing this promotion. Neither really gains from
this game. The moves of one party are neutralized by the moves of the other. The game
ends in stalemate. However, there are two other cereal makers in this game. If Post and
Ralcorp continue offering the promotion after General Mills and Kellogg have stopped
offering it, they may be able to gain market share. As weaker players in the industry, they
may prefer market share over profitability. Their actions, as well as those of General
Mills and Kellogg, affect the outcome. Games that have more than two players are more
common than games involving only two players, but they are harder to model. Sophisti-
cated game theorists understand this problem and have explored complicated games that
have many players over much iteration.15
Learning from Game Theory

Though it has these limitations, game theory presents a number of enduring lessons.16 It
emphasizes the importance of considering the timing of the moves of ones competitors
along with the timing of ones own moves. The strategist must:
Identify the competitors in a game.
Try to understand their options.
Try to compute the payoffs from the various decisions that can be made by combin-
ing options.
Try to understand the sequence of possible moves.
The timing and ordering of strategic moves can significantly affect their outcome.
Using these methods, a company can make better, if not optimal, strategic choices.
Every strategic move has a timing dimensionthe firm can act first or wait. In the real
world, however, timing decisions rarely are formally modeled. The decisions are reasoned
through verbally without the full elegance of a formal game-like model. The protagonists
often resort to historical analogy. They recall prior experience and base their claims on
prior successes and failure.
Yet arguments made based on past successes and failures are only sometimes right.
Wang Laboratories, for instance, was a pioneer in creating word-processing software
and office equipment to replace the typewriter, but it was unable to reason through
what it should do next. It did not maintain the momentum of the prior moves it made
and lost out when PCs became common. In contrast, pharmaceutical giant Hoffman-
LaRoche repeatedly has reinvented itself, moving from vitamins at its origins to sulfa
drugs in the 1930s and later into the tranquilizers Librium and Valium. There is no
evidence that e ither company used a formal game-theory-like model to argue about
what it should do next.
The lesson any company should learn is that being a first mover once is not enough.
A company must repeatedly assess whether it should be a leader. The arguments for
leadership include:
The lags in time it will take a follower to catch up, during which time the leader can
earn substantial profits.
The ability during these lags to erect learning and scale barriers to entry.
The ability to establish a reputation and to erect switching costs that make it hard for
customers to abandon the firm.
The preemption of scarce assets and resources, such as raw materials and distribution
channels, which a follower cannot obtain.
However, followers are not without adequate defenses, such as:
If they can reverse-engineer what the leader has accomplished and do it better, or if
they can avoid high development costs and learn from the leaders mistakes, they
actually may be in a better position than a first mover.
They have options, such as adding bells and whistles to a stripped-down product or
service. They can outflank a first mover by creating products that are smaller or
larger, more convenient, or lower-priced.
They can reconceptualize products in ways that may not be open to the leader, which
may find it hard to do anything other than what it has so far perfected. Followers may
be able to leapfrog the first movers accomplishments.
Not all first movers dominate, and few dominate forever. Intel made a name for itself by
being a leader in computer memory and microprocessors, whereas Microsoft has never
been a first mover but, rather, has been an aggressive follower that invaded and con-
quered markets pioneered by other firms (operating systems and browsers).
As DAveni points out, a leader can retain the initiative throughout each interaction,
the follower can seize the initiative and retain it or can move back and forth.17 To para-
phrase Abraham Lincoln, who said during his run for the presidency that he had to focus
on his competitors moves even more than his own moves,18 the key is not to view the
situation exclusively from a companys perspective but to be cognizant of competitors.
Slip into their shoes, and understand how they view the situation. Effectiveness is
determined not by the companys moves alone, but by how it anticipates and addresses
the moves and countermoves of competitors.
Be aware that a company can win a game but still lose. In weakening a stronger
opponent, it can bring ruin upon itself. When Monsantos patent on NutraSweet, the ar-
tificial sweetener pioneered by Searle, a division of Monsanto, expired in 1987, H olland
Sweetener attacked (see Exhibit 4.15).19 In Europe, it introduced a cheap g eneric substi-
tute. Monsanto had to lower the price of a pound of NutraSweet from $100 to $26. In
Europe, Holland Sweetener brought a successful antidumping suit against Monsanto. It
also made an aggressive bid for Monsantos Coca-Cola and PepsiCo contracts, forcing
Monsanto to give the cola companies combined savings of more than $200 million on
their contracts for artificial sweeteners. Monsantos actions forced Holland Sweetener
out of the U.S. market and drove the Dutch company to near bankruptcy. Monsanto
EXHIBIT 4.15 Monsanto Holland Sweetener

NutrasweetA
Losing Game Patent expires 1987 Attacks in Europe
Lowers price from $100 a pound to $26 Brings successful antidumping suit; makes aggres-
Forced to give Coke & Pepsi combined savings of sive bid for Coke & Pepsi contracts
$200 million Exits U.S. market near bankruptcy
protected its NutraSweet franchise, but neither company came out a winner. How much
better would it have been, at least for the companies, if not consumers, if the companies
had been able to cooperate, but that would have been against antitrust laws. Competitive
moves and countermoves can be harmful to the competitors involved.
In the end, game theorys lesson is that one companys success is critically dependent
on what other companies do. Best Buys success depended on what Circuit City did;
Circuit Citys failure depended on what Best Buy did. The fates of Monsanto and
Holland Sweetener were linked. Charles Schwabs success has relied on what Morgan
Stanley did; Morgan Stanleys success has depended on what Charles Schwab is doing.
Coca-Colas success is tied into the actions of PepsiCo; PepsiCos success depends on
what Coca-Cola does. Competitors exist in an interdependent world, as companies do
not operate in a vacuum. The actions of one firm elicit responses from its competitors,
which, in turn, elicit responses from the original firm. Even when a firm decides to do
nothing, it is making a conscious decision, with the decision not to make a move being
as important as the decision to make one.
Summary Making moves is a serious business. This chapter provides an understanding of some of
the positions a company can occupy, and how it can move from position to position.
Low cost and differentiation are not the only options. There are many ways to segment
an industry. Best-value positions can be very attractive. Positioning is dynamic. Firms
regularly change positions on their own initiative and in response to the moves made by
other firms. Sometimes all the firms in an industry are forced to switch positions because
of changes in law, regulation, technology, and other macro-forces. Where once they
were not rivals they become rivals. New groups of competitors form in new niches
where competition did not previously exist. Firms stretch beyond their existing niches
and move into the spaces that other firms previously dominated.
In this dynamic world of shifting positions, a company has to rely on both offensive
and defensive tactics. It has to understand when to move and when not to move. Timing
is critical. Should it go first or be a fast, or even slow, follower? It must monitor chang-
ing industry conditions. Are products and markets growing or are they mature and
declining? Is it best to compete vigorously or to retreat and exit from a position it may
have long occupied? This chapter concludes with some insights from game theory on
how to make these decisions. However illuminating, these games are abstract and
depend on assumptions that may not prevail in the real world. The real world of moves
is precarious with no certainty; it must be navigated carefully.
Exercises for the Traditional Student

1. Identify the generic strategic position that has been adopted by the makers of your
favorite consumer brand. Is the companys overall strategic position clear? Or is the
organization trying to be everything to everybody?
2. Examine this firms recent investor presentations. Look for evidence that this organi-
zation is leveraging the breadth of its value chain in order to push for competitive
advantage with its positioning.
3. Select a few of this firms current ads and analyze them to determine which offensive
tactics the firm is choosing to employ.
4. Is the firm a first mover? If so, what advantages has it secured by moving first?
Exercises for the Practitioner

1. Identify the generic strategic position(s) that your employer has adopted within each
of its main business units. Does its position fit its internal/external situation?
2. How do the activities related to your current job support an organizations desired
position? Do any activities seem to contradict the organizations stated position?
3. Review the range of offensive and defensive maneuvers that your firm can utilize.
Which of these does your organization utilize most frequently? Do you agree with the
tactical choices that your organization makes? Why or why not?
4. Is your companys industry new or mature? How do the moves that it is currently
making compare to the moves prescribed in this chapter for each stage in the industry
life cycle?
5. Does your firm tend to move first, or follow its industry rivals?
Endnotes 1 Sun Tzu, The Art of War (London: Luzac, 1910), https://openlibrary.org/books/OL7101974M/
The_art_of_war.
2. On timing, see S. Albert, When: The Art of Perfect Timing (San Francisco: Jossey-Bass,
2013). This book is excellent.
3. R. DAveni, Hypercompetition (New York: Free Press, 1994).
4. M. Porter, Techniques for Analyzing Industries and Competitors (New York: Free Press,
1980); M. Porter, Competitive Advantage: Creating and Sustaining Superior Performance
(New York: Free Press, 1985).
5. Jay Solomon and Summer Said, Why Saudis Decided Not to Prop Up Oil, The Wall Street
Journal, December 21, 2014, http://www.wsj.com/articles/why-saudis-decided-not-to-prop-
up-oil-1419219182.
6. R. Grant, Contemporary Strategy Analysis, 4th ed. (Oxford, England: Blackwell, 2002),
p. 121.
7. M. Porter, Competitive Strategy.
8. B. Charkravarthy and V. Kasturi, Best Buy, Harvard Business School/Strategic Management
Research Center University of Minnesota case 9598016, revised October 28, 1967.
9. Michael Porter on Competitive Strategy, Harvard Business School video, 1988.
10. K. Eisenhardt and J. Martin, Dynamic Capabilities: What Are They? Strategic Management
Journal 21 (2000), p. 1107; D. Teece, G. Pisano, and A. Sheun, Dynamic Capabilities and
Strategic Management, Strategic Management Journal 18 (1997), pp. 50933.
11. D. Miller, The Icarus Paradox (New York: Harper Business, 1990).
12. D. Smith, R. Alexander, and D. Robinson, Fumbling the Future (New York: William
Morrow, 1988).
13. Oster, Modern Competitive Analysis, 2nd ed. (New York: Oxford University Press, 1994).
On the Web, a game theory simulator can be accessed at http://broadcast.forio.com/
sims/pricing/.
14. S. Makridakis and S. Wheelwright, The Handbook of Forecasting, 2nd ed. (New York: Wiley,
1987).
15. Readers of this book can consult such works on game theory as Morton Daviss Game Theory:
A Non-Technical Introduction (Dover Publications, 1997); also see http://www.gametheory.
net/.
16. D. Spulber, Management Strategy (New York: McGraw-Hill/Irwin, 2004).
17. DAveni, Hypercompetition., p. 99.
18. A. Brandenburger and B. Nalebuff, Co-Opetition (New York: Currency Doubleday, 1996),
p. 61.
19. Ibid., pp. 7276.
C H A P T E R F I V E
Corporate-Level
Strategy and
Diversification
When it comes to mergers, some are so successful that we cant remember
a time when the companies were distinct: Where would Disney be without
Pixar, or J.P. Morgan without Chase? But many mergers fall flat on their
faces. The newly created company goes bankrupt, executives are fired,
and the merged companies disband in a sort of corporate divorce.
CNBC, The Top 10 Best (and Worst) Mergers of All Time

Recognizing the difference between business- and corporate-level strategies.
Understanding why certain firms choose to diversify.
Being cognizant of the various types of diversificationrelated and unrelated, horizontal, and vertical.
Becoming acquainted with many tactics that businesses use to diversifyalliances, joint ventures,
mergers/acquisitions, and internal startups.
Understanding the risks and outcomes of various corporate-level strategies and tactics.
Realizing how regulatory factors have altered up the pace of corporate-level structural changes.
Building familiarity with portfolio management techniques, such as the BCG matrix and the GE/
McKinsey model.
Introduction
This chapter shifts our focus from the business to the corporate level.1 The business-level
strategies discussed in our last chapter indicate how the firm approaches its customers and
deals with its rivals. Should it adopt a low-cost or differentiated position? What types of
competitive tactics should it utilize to secure this position? Corporate-level strategies (CS)
109
determine the scope of the firms involvement across various businesses and industries.
They involve questions, such as the following:
In what businesses should the firm compete?
Which industries should it enter and exit?
How should it enter and exit these businesses?
How narrow or broad should be the range of the businesses in which it competes?
Should the firms business units participate across the length of the value chain or
should they concentrate on just a few activities?
How should the firms portfolio of businesses fit together and interact with each other
to boost the firms overall value?
Might the firm be better off if it sold its poorly performing businesses and redirected
its efforts toward new opportunities?
Boeing, for example, has business-level strategies for each of its main strategic business
units (SBUs)a separate SBU for the commercial side of its operations and a separate
SBU for the defense side:
The commercial side of the business competes with firms, such as Airbus, Bombar-
dier, and Embraer for the airline customer. Its differentiated position, products, and
services are tailored to the needs of passenger and freight operations around the
globe, and its competitive tactics are industry appropriate.
On the other hand, the defense side of Boeings business works to satisfy the needs of
governments to protect their citizens. It operates within a highly competitive environ-
ment filled with many rivals that do not compete in commercial aviation, such as
Lockheed Martin, Northrop Grumman, Raytheon, General Dynamics, and BAE Sys-
tems. As a competitor in the defense industry, Boeing has to tailor its strategies to
meet a different customer. Government requirements and security constraints are the
main influences on this part of its business.
Boeings corporate-level strategy takes place at a higher level and informs its deci-
sions on where the company should invest across these SBUs and whether to further
penetrate its existing commercial and defense markets, develop new markets within
these spaces, or pursue new opportunities.
Boeing corporate also leverages its assets across this commercialdefense divide.
Knowledge of materials and manufacturing methods are shared. Technologies the firm
originally created for military use, such as navigation, heads-up displays, and verbal
warning systems, often get released over time to the commercial side.
This chapter considers why firms decide to be in different businesses. How do they
manage the conflicts between different business units that might arise? How can they en-
hance the value of their operations if the needs of their different business units conflict?
Reasons for Diversification

There are many reasons that firms decide to enter into new markets or industries. The
typical reasons for diversifying are the following:
1. To grow. If a firms industry is maturing and little opportunity for continued organic
growth exists, it has to compete vigorously with other industry players to increase
Chapter 5 Corporate-Level Strategy and Diversification 111
market share. For example, with a slowdown in the agricultural seed market,
Monsanto made a play to acquire one of its main competitors, Syngenta (the other
main competitor was DuPont, which merged with Dow Chemical). With a slowdown
in the generic pharmaceutical market, Teva made a play to acquire its main competi-
tor Mylan. Syngenta rebuffed Monsantos efforts to acquire it, and Mylan rebuffed
Tevas efforts; however, Mylan did decide to accept a counteroffer from another
competitor in the generic drug market, Perrigo. Teva, meanwhile, acquired Allergan
Generics, as this market became increasingly concentrated. Rapid growth is often
achieved by such acquisitions, yet growth can also be achieved through internal
(organic) efforts or external partnerships.
2. To reduce costs. By combining assets with those of its existing rivals, a firm can real-
ize increased economies of scale. By centralizing value-chain activities, such as
design, purchasing, production, branding, or distribution, it can eliminate redundancy
and achieve economies of scope. Exxons acquisition of Mobil achieved both types
of economies. The combined company had lower per-unit production costs and
reduced overhead expenses. It closed overlapping gas stations in saturated markets,
consolidated exploration and production activities, and increased its buying power
with suppliers. To compete with Exxon Mobil, Chevron acquired Texaco, and BP
acquired Amoco, Total merged with Petrofina, and Elf Aquitine, and Conoco merged
with Phillips. In each instance, greater economies of scale and scope were achieved.
These companies consolidated to reduce costs, improve efficiency, and defend them-
selves against larger rivals.
3. To cross-subsidize. A diversified firm can direct skills and dollars from one strategic
business unit (SBU) to another. Along with accelerating the growth of promising SBUs
by providing fresh ideas, skills, and managerial talent, cross-subsidization may facilitate
the turnaround of ailing SBUs. Hospitals, for example, have to provide a wide range of
services under government regulations, some of them very unprofitable. Corporate-
level moves to acquire and merge allow hospitals to find the right mix of profitable and
unprofitable units. The more-profitable units subsidize the less-profitable ones and keep
these units functioning when their continued existence otherwise could not be justified.
4. To hedge risk and balance industry cyclicality. Diversification also allows firms to
hedge against the risks of seasonal and cyclical businesses. By not putting all of
their eggs in one basket they are able to use their resources more fully. A firm that
focuses on selling chemicals wholesale, for example, might decide to offer pesti-
cides and fertilizers to the market in the summer and ice pellets, salt, and sand to
clear snow in the winter. Polaris Industries sell all-purpose recreational vehicles in
the summer, snowmobiles in the winter, and military vehicles all year round.
Hedges against seasonality make firms more recession-proof and protect them from
the business cycle.
5. To learn and access protected technologies. Diversification provides opportunities to
access the knowledge resources of other firms and to transfer their best practices. Firms
buy other firms for their intellectual capital and patents. In pharmaceuticals, where it
requires an average of eight to 12 years to achieve profitability and generate cash flow
from new drugs, acquisitions lower new-product cost and development times. Software
companies also find that they save money and shorten development times if they
purchase firms on the external market rather than develop new software internally. For
example, Google spent $28 billion acquiring 163 companies between 2001 and 2003,
including Android, YouTube, DoubleClick, Nest Labs, Waze, Boston Dynamics, Deep-
Mind Technologies, Neural Networks, Titan Aerospace, Zagat, and Makani Power.
6. To gain sheer profit. There are times when firms acquire failing or declining compa-
nies at depressed prices in the hope that they can fix and sell them for extraordinary
profits. Private equity firms, such as Cerberus Capital Management, have injected
significant amounts of capital and talent in order to bring dying firms back to life
and their successes have resulted in significant profits. However, such massive
paydays can also attract some unsavory characters such as Dennis Kozlowski.
Mr.Kozlowski, who gained attention for his lavish lifestyle and ultimately served jail
time, built Tyco, a small New Hampshire company, into a $40-billion-a-year revenue
behemoth by acquiring hundreds of companies that Tyco tried to turn around, includ-
ing Simplex, Ludlow, Rockwood, James River, All State Fire Protection, Tectron,
Promed, Thorn, Zettler, ADT, CIPE, US Surgical, GSI, and Paragon Trade Brands.
Types of Diversification
There are many ways to diversify (see Exhibit 5.1). A firm can dabble in diversification
and still maintain a dominant business model in which at least 70 percent of its business
comes from a single commercial endeavor, or it can divide up its activities across many
different businesses.2 Another possibility is to expand into closely related enterprises
where its current capabilities can be shared, as, for example, Sony has done in trying to
bring together media content, TVs, and game systems.
Should the firm pursue related or unrelated opportunities? The Tata Group and Virgin
Group have taken the latter route and these firms are comprised of many business units
competing across a variety of industries. Tata is an Indian powerhouse involved in many
sectors from hospitality to steel, tea, and automobiles. The UK multinational Virgin
Group is i nvolved in travel, entertainment financial services, transport, health care, food,
drink, and telecommunications. Google is another example of a corporation that is
broadly diversified.
Googles mission is to organize the worlds information and make it universally
accessible and useful. To accomplish this mission, it is in a variety of businesses, including
its search engine from which it derives most of its revenue ($45 billion in 2015) from
advertising fees. Yet, Google is not just a web search; it is a browser (Chrome), it provides
EXHIBIT 5.1
Types of
A Taxonomy of
Diversification
Corporate-
Level
Diversification
Related Unrelated
Horizontal Vertical
software for mobile phones (Android), it supplies analytics to help businesses analyze how
many site visits they get on the Internet, it runs YouTube, it owns Picassa, a service that
allows people to edit and share their photos, it has specialized search engines for scholars,
images, and videos, and it runs Gmail, Google Wallet, and Google Store among other
businesses. It also is developing products for the future including a self-driving car. In
addition, it has been a major investor in solar and wind power energy projects.
Many of these businesses have come to Google via acquisition including Android and
Picassa. Google has been an investor in Nest, the energy saving thermostat company, and
in ride-sharing company Uber. How do all these vast and diverse holdings fit together?
What is the justification for them being in the same company?
In 2015, Google restructured into two main units, one devoted to its exotic non-
money-making ventures like driverless cars and anti-aging research and one dedicated to
its money-making ventures like the search engine. The non-money-making businesses
were spun off as a separate company that has its own CEO. The money-making
businesses stick with the Google name. The name of the overall company is Alphabet.
Whether this restructuring provides Google with a better management logic and structure
is yet to be seen. In making this move, Google is admitting how difficult it is to manage
new ventures, which are not yet profitable with old ventures that are very profitable.
Likewise, most Korean businesses belong to chaebols, global multinationals that own
multiple international enterprises. In 2015, Samsung was the worlds largest information
technology company, second-largest shipbuilder, 14th-largest life insurance company,
15th-largest advertising agency, and 36th-largest construction company. The company also
operated the oldest theme park in South Korea. Would Samsung be better off if it separated
these different businesses from the parent and allowed them to operate independently?
What advantages do these businesses derive from being part of the same o rganization?
Very few companies have been successful at melding together such unrelated enterprises.
In fact, the conglomerate strategy has not been broadly adopted because it can be very
difficult to manage such diverse business units. GE, the largest and best-known U.S.
conglomerate, has gradually trimmed its holdings, selling its appliance business and the
bulk of its financial services units to focus on industrial technology.
In fact, most companies, to be successful, strive to find a well-defined focus. Related
businesses try to limit the purchases of other firms to companies that are in the same or
similar industries. Often, they share with these companies technology, size, or culture.
Related acquisitions allow companies to extend their existing product and service
offerings. When a firm chooses this route, it is able to utilize its existing capabilities in
the newly acquired areas.
In related horizontal acquisitions, firms purchase other companies that are in similar
business lines. For example, Darden Restaurants acquired Yard House, thus bringing yet
an additional popular eating concept into its mix of restaurants.
Another type of related diversification is vertical integration. Vertically integrated
firms operate across several links of the value chain; for example, a firm decides to
combine production, distribution, and/or sales in the same company. Large petroleum
companies are classic examples. They simultaneously explore for oil, transport it, refine
it, sell and use the chemical by-products, and operate retail gas stations. A less-obvious
example of vertical integration is Apple. It creates both software and designs devices
that use this software like iPhones and iPads. Microsoft as well creates software and
designs hardware like the Xbox. Oracle acquired Sun Microsystem in order to integrate
its software capabilities with Suns hardware.
Stratasys is a company that relies on both horizontal and vertical integration. It has
acquired competing 3D printer firms and now designs and manufactures products for
businesses and end-consumers. Yet, it also provides services, a downstream activity.
Comcast made a vertical move when it acquired content provider, NBC/Universal,
but it was blocked when it then tried to make a horizontal move and acquire Time
Warner Cable. The Justice Department effectively put a stop to this undertaking.
Tactics Short of Full-Scale Merger and Acquisition

A firm that has decided to pursue diversification has many tactical options besides full-
scale merger and acquisition (see Exhibit 5.2). One such option is to form an alliance.
This move entails entering into a contractual agreement with another firm to pursue a
shared objective. For example, an airline code-sharing alliance allows passengers a
seamless flight experience as they transfer from carrier to carrier. Each airline cooperates
and hands off key customer information. It costs very little to forge and participate in this
alliance, while the dissolution of such an agreement is relatively simple as well. Because
it is so easy to exit an agreement, partnerships can be quite short-lived. The Ford-Toyota
alliance, which was designed to help Ford learn about hybrid technology, while Toyota
learned about making trucks, soured quickly, and was dissolved after just, two years.
Another well-known example of such an alliance is Starbucks working with Barnes &
Noble. Inside many Barnes & Noble bookstores, one finds Starbucks coffee shops. Less
well known is an alliance Apple formed with IBM to help it get Apple products into the
large businesses where IBM serves as the trusted consultant. The alliance was meant to
have the IBM consultants promote Apple products in a market in which Apple is rela-
tively weak.
Franchising and licensing agreements allow firms to branch out and diversify their
income sources without taking on the capital expenses required to build retail locations or
EXHIBIT 5.2
The Breadth of
Available LO Risk & Control HI
Diversification
Tactics
Alliances, Joint Venture Takeover, M&A of Internal

Franchise/License Existing Business Startup
PRO: Cost reductions, PRO: Aimed at PRO: Speed of PRO: Total
cross-branding via mutual success while access to customers, control/ownership
collaborative contractual insulating partners skills, etc.
agreements core businesses.
CON: Least CON: Less CON: inherited CON: time-
operational control, control, risk of elements can cause consuming and
greatest risk of IP losses knowledge losses to trouble often very costly
rival to develop
full-blown production facilities. Restaurant chains like Subway, McDonalds, KFC,

Burger King, and Pizza Hut all have been built with this model. Franchisees and licensees
gain from franchisers brand recognition and their operational and technological prowess,
while franchisers benefit from the use of capabilities, techniques, and their quality meth-
ods, selling, and marketing by others. Franchisers minimize their financial risk and have
the potential to maximize their profits. These advantages depend on the ability of fran-
chisers to develop relationships with the franchisees based on trust and control.
Joint ventures (JVs) are business agreements in which companies jointly invest in, and
exercise control over, a new enterprise and share the revenues and expenses needed to pursue
the JVs objectives. HULU, a joint venture started by Fox, NBC, and ABC, is an example.
All the partners in the venture have a significant interest in finding ways to monetize their
investments in the TV shows they produce. When a customer subscribes to HULU, all its
partners share in the revenue and in any profit earned. The joint venture form of cooperation
protects the partners in that if the JV fails, the partners original businesses are not harmed.
Internal startups maximize the control and ownership of outcomes. For example,
MasterCard has been trying to build a platform called Shops, which allow people to buy
products directly from a digital magazine page without leaving that page. It has pursed
this project by itself. GE has a 31-person in-company startup that is attempting to com-
mercialize a cheaper and cleaner type of solid oxide fuel cell, which transforms natural
gas into electricity.
Merger, Acquisition, and Divestiture Results

Firms increasingly rely on options other than mergers, acquisitions, and divestitures
because the record of carrying these options out is not particularly good. While the
share price of firms that are sold in an acquisition usually goes up, the buyers share
prices most often go down. The reason is that the buyers decision making is often
flawed causing it to pay too much for the firms it acquires, or that it cannot execute on
its designs and effectively integrate the new unit. In a study of acquisitions of greater
than $500 million in value from 1990 to 1995, Mercer Management Consulting found
a success rate of just 17 percent.3
In 2002, BusinessWeek wrote:
The M&A (mergers and acquisition) bonanza during . . . 19952001 . . . was five times
greater than any previous M&A boom in U.S. economic history. Why were sharehold-
ers left with such a hangover after the binge? The main conclusions of our study: Fully
61 percent of buyers destroyed their own shareholders wealth. A year after their deals,
the losers average return was 25 percentage points below their industry peers. The
gains of the winning minority could not make up for the buyers losses: The average
return for all buyers was 4.3 percent below their peers and 9.2 percent below the
S&P4 . . . An army of consultants and bankers has tried to help CEOs improve their
success rate. But theyve failed.
In 2012, the consulting company Accenture pegged the success rate of mergers at just
58%.5 Clearly, the M&A process is fraught with obstacles, and these
If the results are so poor, why is this activity so common?
What is the relationship between company motivations for M&As and their outcomes?
What can be learned from the experience that can make M&As more likely to succeed?
An example of a deal considered nearly the worst acquisition in history was

Sprints 2005 $35 billion purchase of Nextel. The iDEN and WiMax networks that
were combined did not fit together well nor were they as strong as those of Sprints
competitors, Verizon and AT&T. The marquee phone of the combined company, the
Palm Pre, had no traction. The firms kept separate headquarters, Sprint in Overland
Park, Kansas, and Nextel in Reston, Virginia, and customers were confused. Down-
loading on Sprint took longer than on the other networks. Sprints bureaucratic culture
never jelled with Nextels entrepreneurial culture. Cultural clashes between the two
companies meant that employees did not execute post-integration plans. All of these
factors led to poor performance. The combined firm was dysfunctional and it showed
up in the bottom line.
Another poor deal was Daimler-Benzs purchase of Chrysler, which also suffered
from culture clash and in the end Daimler divesting Chrysler at a great loss. Promised
synergies and merger-related cost savings never materialized. They were supposed to
amount to $3 billion yearly by 2001, but they were not achieved because of tension
between Daimler-Benz and Chrysler leadership. In 2007 the German automaker reversed
its mistake by selling the bulk of Chrysler to private equity firm Cerberus because of the
large financial losses it experienced (see Exhibit 5.3). Fiat ultimately bought Chrysler
from the private equity firm.
From 1998 through 2000, nearly $4 trillion was spent on mergers and acquisitions
more than in the previous 30 years combined.6 Blockbuster deals took place between
Pfizer and Pharmacia, Hewlett-Packard and Compaq, and other companies. The deals
were concentrated in certain industries. The telecommunications and communications-
equipment industries led the way with five out of the top 15 deals in the 1998-to-2000
period. The banking, financial, and insurance industries were not far behind, with four
out of the top 15 deals. The largest deal, valued at $165.9 billion, was between AOL
and Time Warner.
External factors influenced this activity. Competition intensified in the United States
and other countries because of deregulation and privatization, rapid technological
change, and in some instances industry maturity. Globalization played a part, as did the
EXHIBIT 5.3 The Value of a Deal

The Daimler- Share prices, November 12th 1980 = 100
140
BenzChrysler
Deal 130
DaimlerChrysler
Source: Primark 120
Datastream.
110
Daimler-Benz
100
90
80
MERGER
70
Chrysler
60
50
1996 97 98 99 2000
development of the Internet. With traditional industry boundaries blurring, searching for
the right mix of businesses to ensure corporate survival was a trial-and-error effort. Be-
cause the environment was turbulent, it made sense for firms to restructure.
Much of this restructuring, however, was not successful. For example, AT&T spent
$7.5 billion in 1990 to buy the computer manufacturer NCR, only to dispose of it five
years later, taking a $1.2 billion charge, laying off 10,000 employees, and losing
$500million. Many firms, including AT&T, ITT, Hanson PLC, W. R. Grace, Sprint,
Tenneco, Sears, and GM, had to reverse steps they had taken. They liquidated assets
and broke up portfolios because the mix of businesses they assembled did not work
well together.
Bad deals are very common. eBay overpaid for the Internet telephone service Skype
in 2005; it had to take a $1.4 billion write-down in 2007. Microsoft bought Skype from
eBay at a very low price. The Time Warner and AOL deal, which never worked as
planned, was also among the worst combinations in history. News Corps purchase of
social networking site MySpace once showed promise, but it, too, is now considered a
debacle. The results of News Corps purchase of The Wall Street Journal are yet to be
fully seen. In contrast, the 1965 deal that brought together PepsiCo and Frito-Lay is seen
as a great success, as is Disneys 1996 purchase of Capital Cities.
A Shifting Landscape
Though they frequently fail, mergers, acquisitions, and divestitures shift the corporate
landscape. For example, in the corporate hub of Minneapolis-St. Paul, where many For-
tune 500 firms are located, there has been huge turmoil:
Grand Metropolitan Ltd., the large U.K. food conglomerate, acquired Pillsbury;
Silicon Graphics acquired Cray; Federated Department Stores acquired Fingerhut;
and Conseco acquired Green Tree Financial.
Grand Metropolitan then sold Pillsbury to General Mills, and with the collapse of
Fingerhuts business, Federated divested it. Nearly the same fate befell what re-
mained of Green Tree Financial.
3Ms spinoff of its magnetic media division (now called Imation) was notable, as was
Honeywells divestiture of Alliant Tech, and Control Datas breakup into a number
of parts.
Mergers included Norwest Bank with Wells Fargo, First Bank with U.S. Bank,
Honeywell with Allied Signal, and Northern States Power (NSP) with New Century
Energy (NCE).
United Health, Medtronic, and other companies made steady streams of small acqui-
sitions. United Health became a behemoth by means of its many small acquisitions.
SuperValu and St. Paul Companies, on the other hand, made big acquisitions,
with SuperValu buying Albertsons and the St. Paul Companies buying Travelers.
In 2013, SuperValue had to divest most of what it bought from Albertson, and the
St. Paul Companies left the Twin Cities and relocated to Connecticut, Travelers
home state.
Cargill acquired fertilizer manufacturer IMC Global, only to spin it off as a separately
traded company, Mosaic, in which it held a controlling interest.
An important factor spurring mergers and acquisitions in many industries has been
deregulation. The process started in the United States in 1978 with deregulation of air
transportation and natural gas. It continued in the 1980s and 1990s with deregulation in
railroads, trucking, telecommunications, cable television, financial institutions, and elec-
tric utilities. As a result, these formerly protected industries were exposed to competition
and market forces. At first, many new firms flocked into the newly deregulated sectors,
but then a series of mergers and acquisitions led to extreme consolidation. In telecom-
munications, for instance, AT&T was broken up into a long-distance company that
retained the AT&T name, an equipment company (Lucent), and seven Baby Bells, or
local service operators. Aggressive new entrants, such as WorldCom, a ppeared on the
telecommunications scene, followed by a host of mergers and acquisitions. WorldCom
failed amid a huge financial scandal. Of the original seven Baby Bells, only a few are
left. SBC Communications, one of the seven Baby Bells, ultimately bought AT&T, since
AT&Ts original long distance business model no longer was valid, and took on its
name. Sprints purchase of Nextel was describedpreviously.
The role of deregulation also had significant impacts on M&A activity in the airline,
railroad, and banking industries. Critics claimed that lower rates would prevail in an
unregulated environment, so in 1978, under the Carter administration, the Airline
Deregulation Act was passed. At the start of 1979, 43 large, certified carriers were in
operation. At the end of that year, there were 60 carriers22 airlines had entered and
five had exited. The number of carriers continued to grow until 1984, when it reached 86.
Market concentration decreased from 1978 through 1985, but then it started to rise
sharply and has stayed high above its 1978 level since. Initially, deregulation provided
many opportunities for new entrants. Frank Lorenzo created a national airline, Continen-
tal, through a series of mergers, reasoning that regional airlines would not survive. The
companies he brought together included Peoples Express, Texas International, and East-
ern. By 2002, however, all the major airlines were in trouble with the exception of South-
west, which operated under a different business model. The industry consolidated rapidly.
Deltas purchase of Northwest in 2008 for a time made it the largest U.S. c arrier, until
American Airlines purchased US Airways. United bought Continental. By 2015, there
were only four major airlines left in the U.S.: Delta, American, United, andSouthwest.
Before 1980, the federal government set railroad shipping rates through the Interstate
Commerce Commission (ICC).7 The Staggers Act of 1980 partially deregulated the
industry but left the ICC, replaced by the Surface Transportation Board (STB) in 1995,
with oversight powers to approve mergers and review shipping prices. Because the rail-
roads were in such a weak financial condition, the STB rejected few applications for
mergers. Several reasons existed for the abundance of mergers, but most had as their
main motivation the desire to improve revenue and earnings in a slow-growth industry
that was struggling to maintain market share against inroads made by other means of
transportation (trucks, boats, and planes). After all the merger activity, the railroad
industry was reduced to five major players that accounted for more than 90 percent of
the traffic by 1999: the Union Pacific, BNSF, CSX, Norfolk Southern, and Canadian
National (see Exhibit 5.4).
Deregulation in the banking industry occurred gradually, starting at the state level in
the late 1980s and continuing through 1999.8 Before deregulation, the most significant
piece of federal banking regulation had been the 1933 Glass-Steagall Act, which limited
EXHIBIT 5.4 Company Total Track Routes (miles) Revenues ($billions)

Railroad
Industrys Burlington Northern Santa Fe 33,500 9.1
Major Players, Union Pacific 33,400 10.2
CSX 23,000 6.6
1999
Norfolk Southern 21,600 5.2
Canadian National 17,000 3.6
banks products and prices and disallowed investment banking by commercial banks.
Commercial banks could not sell securities or insurance nor could they integrate check-
ing and investments. In addition, as late as 1975, no state permitted out-of-state com-
mercial banks to own in-state banks, and only 14 states allowed statewide commercial
banking.9 These regulations protected the commercial banks from competition, but also
allowed them to become inefficient and suppressed innovation, thus creating fertile
ground for competitors.
Investment banks saw the opportunity and responded. In 1972, investment banks
offered the first money market mutual funds. In 1974, they started to offer check-writing
capability. In 1978, they offered cash management accounts (CMAs). Meanwhile, the
product restrictions and geographic limitations imposed on commercial banks by regula-
tion left them vulnerable to bank failures, such as those associated with the 1980s
savings and loan (S&L) crisis.
To compete with investment banks, the commercial banks found loopholes in the laws.
In 1977, Citibank took advantage of such loopholes to do the first-ever mass mailing of
credit cards. In 1982, Bank of America tried to enter investment services by purchasing
Charles Schwab & Co., a marriage that ended in divorce in 1987. In 1986, Citibank got legal
approval to set up its own mutual funds. In 1987, the Federal Reserve allowed Citicorp,
J.P. Morgan, and Bankers Trust to underwrite securities. By 1992, all states except Hawaii
allowed interstate banking, and all states except Arkansas, Minnesota, and Iowa permitted
statewide branching. Further deregulation came in 1993 when Mellon Bank bought Dreyfus
Corp. mutual funds and in 1998 when Citicorp merged with Travelers Group (including
Smith-Barney Investment Banking). In addition, competition grew on the lending side from
such organizations as consumer finance companies, interstate thrifts, GE Capital, and credit
cards. Foreign banks were able to enter U.S. markets as well. By 1997, commercial banks
had lost a significant share oftheir business, which had dropped from 94 percent of all
deposits in 1973 to just 50percent (see Exhibit 5.5).
The Financial Modernization Act, passed in 1999, allowed the commercial banks to
offer a broad range of products, including investment banking, brokerage services, and
insurance, and permitted interstate banking. The act enabled commercial banks to com-
pete on a more equal footing with their many competitors. The Federal Reserve reviewed
M&A proposals of banks but denied few of them.
EXHIBIT 5.5
Banking
Industry 1973 1981 1990 1997
Deposits Traditional commercial bank deposits and mutual funds 682 1,580 3,450 3,790
(in$trillions Investment bank money market funds, bonds and stocks 46 241 1,060 3,790
ofassets)
Substantial consolidation occurred within the banking industry (see Exhibit 5.6). In
1998, Nations Bank merged with Californias BankAmerica, creating Bank of A merica
at the time, the second-largest U.S. bank holding company. In 2004, Bank One merged
with J.P. Morgan Chase, creating a banking colossus, JPMorgan Chase & Co. Citicorp
merged in 1998 with Travelers Group, a financial institution with a broad array of services,
and the stock price soared. It ultimately divested Travelers Group. Nonetheless, Citicorp,
renamed Citigroup, became one of the largest and most influential banks in the United
States. N orwest Bank bought Californias Wells Fargo Bank in 1998. In 1996, through a
hostile takeover, Wells Fargo acquired a competing California bank, First Interstate.
Norwest renamed itself Wells Fargo and the new Wells Fargo continued to purchase dozens
of small financial services firms each year as long as the price was reasonable.
After the Great Financial Crisis of 2008, there was even more consolidation in the
industry. Banks became too big to fail. Lehman Brothers had collapsed. Bear Stearns was
absorbed by JPMorgan Chase. Morgan Stanley and Goldman Sachs changed themselves
into commercial banks in order to reduce their debt levels. Merrill Lynch merged with
Bank of America, and Citigroup, after taking bailout money from the federal government,
had to raise cash by shedding assets in one of the great garage sales in Wall Streets history.
Critics of the U.S. banking system did not consider the situation stable. While in
1990 the 10 largest U.S. financial institutions held 20 percent of total financial assets,
in 2010 they held 54 percent. The number of banks declined from more than 12,500 to
about 8,000.
Examples of Good Deal Making

Some companies, nonetheless, have good track records in making deals. Cisco Systems
processes for selecting targets and integrating businesses after a deal are outstanding.
The computer network companys purpose in making acquisitions has been to enhance
its existing lines of business, open new ones in adjacent markets, and obtain promising
technology. Other examples of good deal making follow.
A Consolidator
In 1997, Amphenol merged with NXS Acquisition, a subsidiary of the investment
bank Kohlberg Kravis Roberts & Co. (KKR), which was best known for its 1989 take-
over of RJR Nabisco. The capabilities of KKRs management team provided
additional capital and provided Amphenol with the chance to be an aggressive con-
solidator. Through its acquisitions, Amphenol consolidated interconnected compa-
nies, an opportunity that e xisted because of a fragmented and declining market. The
companys acquisitions broadened and enhanced its product offerings and expanded
its global reach.
A Move to New Industries

In 1995, SPX designed and made specialty tools, a business that had numerous competi-
tors and low operating margins. To combat the cyclical nature of SPXs business as well
as low profit margins, the company searched for customers in new industries. U.S. auto-
makers constituted 37 percent of its revenues. By 2002, they constituted less than
20 percent of the companys revenues. SPX transformed itself through acquisitions. Two
of them were very large. In 1998, it bought General Signal, nearly twice SPXs size, and
EXHIBIT 5.6 Banking Industry Consolidation, 19962009

Source: Federal Reserve; GAO.
19901995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
TRAVELERS GROUP
CITICORP CITIGROUP
EUROPEAN AMERICAN BANK CITIGROUP
BANAMEX
WASHINGTON MUTUAL
GREAT WESTERN FINANCIAL WASHINGTON MUTUAL

H.F. AHMANSON WASHINGTON MUTUAL
DIME BANCORP
FIRST CHICAGO
BANC ONE BANK ONE
FIRST COMMERCE
JP MORGAN CHASE
JP MORGAN
CHASE MANHATTAN JP MORGAN CHASE

CHASE MANHATTAN
CHEMICAL BANKING
BEAR STEARNS
US TRUST
MBNA
CONTINENTAL BANK
BANK AMERICA
SECURITY PACIFIC BANCORP BANK OF AMERICA
NATIONS BANK
FLEET FINANCIAL GROUP BANK OF AMERICA
BANC BOSTON HOLDINGS

BANK BOSTON
BAY BANKS FLEET BOSTON FINANCIAL
SUMMIT BANCORP
SUMMIT BANCORP
UJB FINANCIAL
COUNTRY WIDE FINANCIAL
MERRILL LYNCH
WELLS FARGO
WELLS FARGO
FIRST INTERSTATE BANCORP
WELLS FARGO
NORWEST HOLDING COMPANY
WELLS FARGO
SOUTH TRUST
WACHOVIA
WACHOVIA WACHOVIA
CENTRAL FIDELITY NATIONAL BANK
WACHOVIA
CORESTATES FINANCIAL
FIRST UNION FIRST UNION
THE MONEY STORE

in 2001, it acquired United Dominion flow technology business, a company with reve-
nues roughly equivalent to General Signals.
Purchasing Talent
The gaming company Activision aggressively acquired other companies. From 1997 to
2002, it made 14 acquisitions that allowed it not only to diversify its operations, add
channels of distribution, and expand its library of titles, but also to develop a new pool
of talent among the companies it purchased, such as Head Games Publishing, Expert
Software, and Elsinore Multimedia.
Broadening Scope
Insurance company Brown and Brown grew through mergers and acquisitions. From
1992 to 2003, it acquired 118 small insurance companies, broadening its scope and ex-
panding from its base in Florida to include California, Connecticut, Indiana, Michigan,
Minnesota, Nevada, New Jersey, and more. The companys aim was to acquire small,
profitable companies to branch out into underutilized, niche markets with high margins.
Buying Competitors
The packaging business in which Ball competed was mature and had low profit margins.
Companies in this industry faced intense pricing pressures and the threat of consolida-
tion. To achieve a stronger position, Ball successfully acquired and integrated major
competitor Reynolds Metals in 1998, expanding Balls aluminum can business, and in
2002, it acquired Germany-based Schmalbach-Lubeca, the second-largest beverage can
manufacturer in Europe.
The Global Economic Meltdown

M&A activity occurs in waves. Cycles of vast amounts of this activity follow periods
when it slows considerably. The global economic meltdown of 2008 greatly diminished
the prospects for mergers and acquisitions. Thousands of deals were delayed or aban-
doned. U.S. deal volume plunged because of a tightening in credit markets and lack of
confidence in the direction in which the economy was heading. For instance, Dow
Chemicals proposed acquisition of rival Rohm & Haas, which had been considered a
sure thing, stalled when the Kuwaiti government withdrew from a joint venture that
would have provided Dow with funding. To pay for the purchase of Rohm & Haas,
Dowwould have had to draw down on a billion-dollar short-term bank loan, sell assets it
would acquire in the deal, and lay off thousands of workers. Financing of deals during
the economic meltdown was difficult.
Often deals were done out of necessity. An example is the previously described forced
buyout by Bank of America of troubled investment bank Merrill Lynch. Merrill Lynch
had little choice but to go along with this deal. Another example is Oracles purchase of
Sun Microsystems. A high-flying startup and a major seller of high-end servers to the
financial sector, Sun struggled after the dot-com bust and had trouble reorienting its
business to low-cost servers that relied on Intel and AMD chips. Under duress, Sun
approached HP, Dell, and IBM, hoping to be acquired. IBM was Suns preferred choice
for an acquirer, but when IBM decided it could not take the risk of trying to rescue Sun,
Oracle decided to step in and buy the ailing company.
Though the economic difficulties created many opportunities, deals did not happen
because capital was not available, business prospects were poor, and it was uncertain
how the Justice Department would view the proposals. Instead, most companies followed
more conservative survival strategies. Instead of trying to expand, they conserved cash,
minimized overhead, and reduced their workforces. Though restructuring was perhaps
needed, most companies were just cutting back.
An industry that has continued to experience major restructuring was pharmaceuti-
cals (see Exhibit 5.7). A drive toward consolidation was spurred by a decrease in the
EXHIBIT 5.7 Pharmaceutical Company Restructuring

Source: Credit Suisse; company reports; Bloomberg The New York Times
Drug Industry Consolidation

A series of mergers has winnowed the drug industry to a few major players.
DATES DEALS WERE ANNOUNCED
'93 '95 '97 '99 '01 '03 '05 '07 '09
American Home Products Wyeth (renamed 2002)

American Cyanamid
Pfizer
Warner-Lambert
Pharmacia Pharmacia & Upjohn
Monsanto was spun off as an
Upjohn agricultural products company.
Monsanto Monsanto
Wellcome
Glaxo Glaxo Wellcome GlaxoSmithKline
SmithKlineBeecham
Synthlabo
Sanofi Sanofi-Synthlabo Sanofi-Aventis
Rhne-Poulenc Aventis
Hoechst
Merck
Schering-Plough
Zeneca AstraZeneca
Astra
Sandoz Novartis
Ciba-Geigy
Roche
Genentech (Roche bought most of the company in 1990 but has announced a deal to buy the rest)
number of patentable products in the pipeline. Pfizers purchases of Warner-Lambert in

2000 and Pharmacia in 2003, however, did not replenish its roster of new drugs, and the
company therefore kept making more acquisitions.
Almost all the major players in this industry have been involved in consolidation. In
March 2008, Roche successfully purchased Genentech, in a deal that came just a fter
Mercks agreement to acquire Schering-Plough. Earlier in 2008, Pfizer had taken over
Wyeth. The other large drug companiesEli Lilly, Bristol-Myers Squibb, A straZeneca,
Sanofi-Aventis, and Johnson & Johnsonwere not sitting idly on the sidelines in the
wave of consolidation. In 2015, Novartis and GSK, Bayer and Merck, and Roche and
InterMune all closed deals.
Consolidation in the pharmaceutical industry was meant to lower costs for drug com-
panies as they combined research and sales efforts and laid off workers. The prospect of
health care reform by the federal government motivated large pharmaceutical firms to
consolidate, believing they would be better able to bundle products and have more power
in price negotiations with the government. However, an industry dominated by excep-
tionally large firms raised questions about the future of pharmaceutical research. Would
patients be well served by just a few large giants?
Why Do Mergers and Acquisitions Fail?

Mergers and acquisitions fail for many reasons. When a rapidly growing company uses
its high-price stock to make acquisitions, it can be vulnerable to careless mistakes. For
example, it can easily go beyond its core competency and buy a firm that contributes
little to what it does best. Since the acquisition may lead to an immediate increase in
earnings per share, this type of foolish acquisition is hard to resist.
A comprehensive list of the reasons for failure includes the following:10
Flawed Business Logic

Should not have been acquiring
Wrong strategy
Opportunism
Did not consider the alternatives
The purpose of mergers and acquisitions may be to gain access to sought-after prod-
ucts, services, or technologies, but managers of acquiring companies often do not assess
the target company carefully enough to ensure that the products, services, and
technologies they are obtaining have sufficient value. This task is often difficult to per-
form a dequately in the time allotted. In merging with Electronic Data Systems (EDS),
for instance, GM expected to get from EDS the ability to automate its factories, but EDS
lacked this kind of experience and was of no real help to GM in this area.
Flawed Understanding of the New Business

Misjudged the market
Did not understand the business model
Overestimated the possible synergies

Problem areas not identified in due diligence
Acquiring companies as well often expect that an acquisition will provide market-
ing leverage. The acquirer may believe that the new products it has acquired can be
sold to its existing customers. However, the acquirer tends to overestimate the cross-
selling potential and to underestimate the need to retrain its sales force to sell the
newgoods.
Flawed Deal Management

Price too high
Poor negotiation
Hampered by process
Integration plan not developed in advance
A huge problem is paying too high a price for an acquired company. Due diligence
has to occur before the acquisition to ensure that the buyer knows what it is getting,
but even with due diligence, serious mistakes often are madeThe banks discussed
previously often paid too high a price for other banks, as did Westinghouse for CBS
in 1995. This acquisition contributed mightily to the companys ultimate breakup
anddemise.
Flawed Integration Management

Poor communication
Lack of clear leadership
Wrong steps to implement change
Scale of task underestimated
For most acquisitions, it is important that the buyer retain the key personnel in the
acquired company. The failure to do so is particularly a problem when the takeover is
hostile, and the corporate cultures clash, but even in friendly mergers, management has
to keep valuable people. When these people leave, it is much more likely that the merger
or acquisition will fail.
Acquirers often believe they can bring about a rapid turnaround in the acquired com-
panys performance. However, the managers of the acquiring firm often overestimate
their ability to solve the problems of the acquired company. Unforeseen problems may
arise, such as the discovery of unacceptable accounting procedures. The merger may
also alienate the acquired companys customers. These factors often are not taken into
account by the overconfident management of the acquiring firm.
Flawed Corporate Development

Changes were inappropriate
Cultural differences/problems
Customers ignored during integration
Own business ignored during integration
A major difficulty in almost every M&A is combining divergent corporate cultures.

Divergent cultures and management styles present significant barriers to achieving
success. These differences can impede the process of consolidation and cost cutting,
result in increased unhappiness among employees, and diminish productivity. The previ-
ously mentioned General MotorsEDS merger did not work because it combined
radically different cultures. GMs elaborate bureaucracy and strong unions clashed
sharply with EDSs fiercely independent employees. Unfriendly takeovers add to the
problem of merging diverse cultures. When anger and resistance are prevalent, it is hard
to integrate the component pieces.
Why Do Acquisitions and Mergers Succeed?

There is no doubt that acquisitions are risky, yet very few businesses succeed without
them. Todays strategists are increasingly utilizing techniques, such as retention agree-
ments (for key resources) and contingent earnouts (to mitigate pricing risks).
What factors have to work out for acquisitions and mergers to be successful? Each
proposed acquisition and merger is slightly different and has to be assessed on its
merits. To increase the chances for a success, key issues should be addressed
beforehand:
Does the acquirers management team know enough about the acquired companys
businesses to competently run them?
Are the businesses of the acquired company more attractive than the businesses in
which the acquiring company is engaged?
Are the costs of entry so high that they will destroy the added income the acquiring
company hopes to gain?
Is it really possible to establish synergies between the new and old businesses?
The synergies (economies of scope) that might be established are critical elements in
successful M&As. Synergies include:
Sharing of tangible resources (research labs, distribution systems) across multiple
businesses.
Sharing of intangible resources (brands, technology) across multiple businesses.
Transferring of functional capabilities (marketing, product development) across
multiple businesses.
Applying general management capabilities to multiple businesses.
Synergy is crucial, but it may be very hard to achieve.
Mergers of Equals
Mergers of equals are more likely to succeed than mergers of dissimilar firms. Exhibit5.8
compares two utilities that merged in 1999 and had a relatively easy time with their
merger. As the data indicate, the companies were quite similar. Management estimated
net cost savings over 10 years of about $1.1 billion as a result of combining operations.
These potential expense reductions were the result of carefully identifying duplicate
EXHIBIT 5.8 Northern States Power New Century Energies

Merger of
Equals: Total revenues (1998) $2.82 billion $3.61 billion
Northern Net profits (1998) $282 million $342 million
1998 Growth rate in number of customers 1.4% 2.2%
States Power
Allowed rates of return MN: 11.47% (1993) CO: 11.0% (1993)
and New WI: 11.3% (1996) TX: 15.05% (1986)
Century 1998 rate of return 11.3% 13.8%
Energies
Markets:
Electricity 84% of total sales 75% of total sales
Generating fuel mix:
Coal 44% 48%
Nuclear 25% 0%
Hydro and other 4% 3%
Natural gas 0% 30%
Purchased electricity 27% 19%
Natural gas 16% of total sales 23% of total sales
Total full-time employees (1998): 7,492 6,375
c orporate and administrative functions that could be eliminated by consolidating and

integrating the companies. Substantial cost savings also were derived from the scale
economies of combining production units.
Effective Multi-Business Management

Ultimately, M&A success depends on how effectively the newly merged and acquired
companies are managed. Some companies are very good at this. Their ability to close
deals and manage acquired firms is a core competency at companies that have been
successful acquirers over time.
In successful M&As, top managements role is critical. In theory, the top executives
in a company, those in corporate headquarters positions, create value by acquiring new
businesses, restructuring inefficiently managed businesses, and allocating capital and
labor among businesses (see Exhibit 5.9). The executive team transfers skills and capa-
bilities to divisions. It shares activities, establishes linkages, and determines the logic of
integration. The synergies it creates have to consist of more than just sharing corporate
services, such as finance, legal, taxes, research, public relations, and investor relations.
They must also consist of sharing tangible and intangible resources and functional capa-
bilities and applying general management tools and techniques.
In practice, large, complex organizations often are rife with conflict between the
corporate office and the divisions over strategic and operational issues. Headquarters is
inclined to favor uniformity, but differences might create advantages. Managing the
interrelationships among divisions requires intricate systems that push top executives
and people in the divisions to the limit and stretch what they can do effectively. For
instance, top management may decide to superimpose functional and geographic
divisions on top of product and market divisions and create matrix structures. These
systems may not work well or may not work as intended. Exhibit 5.9 summarizes the
theory-versus-practice issues in the role of top management.
EXHIBIT 5.9 In Theory In Practice

Top
Managements Creates value Is often in conflict with divisions over strategic and
Role: Theory Acquires new businesses operational issues
and Practice Restructures inefficiently managed businesses May try to impose uniformity despite advantages
of differences
Transfers skills and capabilities to divisions ay be pushed to limit by complex systems for
M
managing interrelationships
Establishes linkages
Determines logic of integration
Over the past century, managements corporate strategy role has moved in four
directions largely in response to changes in the external and internal environments of
businesses at the time:
1. Expansion. Starting in the early 20th century, with the growth of the typical firms
products and geographic scope, the value chain got bigger, but administrative costs
did not go up. Declining administrative expenses were made possible by advances in
transportation, communication, and information. They were also a consequence of
developments in management sciences in such areas as accounting and finance.
Organizational capabilities grew. The modern firm with several distinct functions,
such as accounting, finance, marketing, and operations, took shape. These helped
with the management of much larger, more complex entities.
2. The M-form. A new type of structure for the firm, called the M-form, came into
being. This structure improved efficiencies. At the top was a tier of high-level
executives who made strategic choices. They interacted with shareholders and
allocated resources to separate, independent business units, each with its own
management that made everyday decisions. Thus, the executives at headquarters
offices were not overly involved in the day-to-day activities of the firms separate
business units. Instead, they held each units management accountable for its
profitability and performance as measured by such quantitative indicators as
market share.
3. Portfolio management. In the mid-1970s, many theorists championed an important
extension of the M-form, which was known as portfolio planning. Portfolio-
planning models helped large, complex organizations manage their separate busi-
ness units. These models focused on the direction, coordination, control, and
profitability of the different business units. More will be said about portfolio
models in the next section.
4. Contraction. By the late 1970s, however, serious questions were raised about how
efficient the M-form and portfolio-planning models really were. A large, complex
corporation run in this way could not keep up with small, nimble competitors. It
lacked the flexibility to deal with growing market turbulence, deregulation, and tech-
nological change. Many management specialists advocated contraction in the size
and scope of the firm to provide it with speed, flexibility, and responsiveness. The
trend shifted to a preference for a more focused organization.
Portfolio Models
Despite this change, portfolio models in vogue in the mid-1970s have continued to be used
by many companies through today. Once decisions about a firms scope are made, the
main task of corporate strategy is to create cohesiveness and direction. Management must
allocate resources to the assembled units and hold them accountable for performance. The
two most commonly used portfolio models corporations have used to achieve these
purposes have been the BCG matrix, developed by the Boston Consulting Group, and
theGE/McKinsey model.
The BCG Matrix

Large corporations face a significant challenge in determining how resources should be
allocated across their strategic business units. Should they invest in the business units
that show the most upside potential? Should they focus on those that are strong and pro-
vide a secure steady flow of business? Is it worth the effort to try to turn ailing units
around? The Boston Consulting Group understood this challenge and, in the 1970s,
developed a model for managing a portfolio of different business units (or major product
lines) called the BCG growth-share matrix. The matrix attempts to simplify the invest-
ment decision process, displaying the firms various business units on a graph of the
market growth rate versus market share relative to competitors (see Exhibit 5.10).
BCG argued that investments should be allocated to business units according to
where they are situated on their grid. In the lower-right quadrant, are the Cash Cows
SBUs that have large market shares in mature, slow-growing industries. They serve an
important purpose in that they generate cash that can be invested in other business units
while requiring very little investment for their own continuing operations.
In the upper-right corner are the Stars of a corporate portfoliobusinesses that
have large market shares in fast-growing industries. They generate cash, but they also
EXHIBIT 5.10 HI
The BCG
Matrix
Market Share Growth Rate
Selectively Hold Hold/Increase
Harvest/Divest Hold/Maintain
LO
LO Relative Market Share HI
require significant investment to grapple with rapid industry evolution and to maintain
their lead. If successful, stars become cash cows when the industry matures.
Question Marks are found in the upper-left quadrant. These business units have just
a small market share in a high-growth market. Like Stars, these business units also
require firms to commit resources in order to grow market share. The catch is that a high
level of uncertainty surrounds the Question Marks. The industry may have great poten-
tial, but the Question Mark has not yet proven whether it can succeed. If successful,
however, the Question Marks will become Stars.
Dogs are business units that have smaller market shares in mature or declining
industries. They tie up capital that may be better deployed elsewhere. With this in mind,
unless a Dog has the potential to seize market share from rivalsor if it has some other
significant strategic purpose (i.e., its outputs serve as important inputs for Cash Cows or
Stars)it should be liquidated. Liquidated assets can then be reinvested in ways that will
lead to more profitability across the SBU portfolio.
The BCG matrix is not without faults, however. It has been criticized on a number
offronts:
Focusing solely on market share versus profitable market share. There have been
companies with high market share, such as General Motors, that were low on profit-
ability, and there have been companies with low market share, like mini mills in the
steel industry, that were high on profitability. The low-cost strategy, which is used to
build high market share, might not translate into a profitable strategy if an industry is
very competitive and prices are declining. Niche strategies that involve differentia-
tion and focus, but low market share can be profitable ones.
Using industry growth rate as the sole indicator of industry attractiveness. The
highest growth rate of nearly any industry in the 1990s was that of Internet compa-
nies, but companies like Amazon, though they were thriving in other ways, often lost
money and were not profitable.
Discounting the fact that increasing market share can be very expensive. The BCG
does not provide a way to account for the added costs associated with building share.
Ignoring the potential of declining markets. The focus is entirely on high-growth
markets.
The GE/McKinsey Model

The GE/McKinsey 9-Cell Matrix is a more robust model. It considers market growth
rate to be only one of many factors that make an industry attractive and relative market
share only one of many factors when assessing a business units competitive strength
(see Exhibit 5.11).
Working with the consulting firm McKinsey & Company, General Electric developed
a different approach to assessing competitive strength and industry attractiveness.
Recognizing that internal strengths and weaknesses are more than just market share and
that external opportunities and threats are more than just market growth, this approach
examines an array of factors. The strength of the GE/McKinsey model is its realismit
does not see internal strengths and weaknesses as being just market share and external
opportunities and threats as just market growth.
EXHIBIT 5.11 Competitive Strength Industry Attractiveness

GE/Mckinsey
Model: Market share Market growth rate
Evaluation Sales force Market size
Marketing Cyclicality
Criteria
Customer service Competitive structure
R&D Barriers to entry
Manufacturing Industry profitability
Distribution Technology
Financial resources Inflation
Image Regulation
Breadth of product line Social and environmental issues
Quality/reliability Political and legal issues
Managerial competence
The weakness of such a model is that it depends on qualitative judgment to deter-

mine internal strengths and weaknesses and industry attractiveness. In a firm with
numerous SBUs, each one wanting to claim a portion of overall corporate resources,
this allocation method opens up the possibility of bitter bureaucratic infighting and
power struggles. Unless it is managed carefully, this type of portfolio management can
be very difficult to use.
Nonetheless, portfolio-planning models offer several advantages, including the ability
to see the big picture in a single diagram on which each SBU is positioned and the ability
to apply the same method to many types of businesses. Portfolio models may be a good
starting point for more sophisticated analysis. They can be augmented, but then they lose
an important advantage, their simplicity. They have many problems. They try to reduce
to a minimum the factors that determine internal strengths and industry attractiveness,
they do not eliminate subjective judgment, and they are ambiguous. In addition, they
depend on how a market is defined, and in an environment in which markets and indus-
tries are rapidly changing, market definition is difficult to determine.
A huge issue with portfolio-planning models is that they do not consider synergy, or the
interdependencies among SBUs. The Dogs in portfolios may be wagging the Stars tails.
Without the Dogs, the Stars would be poorer performers. Corporate performance is a team
effort. In well-managed companies, SBUs are more than separate entities with their own
profit and revenue streams. They share resources, link capabilities, leverage competencies,
and achieve synergies. The corporation as a whole, and not its individual units, develops
sets of skills that have the capacity to open doors and create opportunities for the firm.
Breaking Down the Corporate Hierarchy

In the 1990s a number of new trends in the role of headquarters came to the forefront.
During this period, GE showed that a large diversified conglomerate could be very
profitable and deliver high returns to shareholders if it was well managed. GE took a
series of steps to reinvent the company. It delayered the organization, from nine or
10layers of hierarchy down to four or five. It decentralized decision making whenever
possible so that low-level managers had the discretion to respond quickly to emerging
issues. It reformulated strategic planning, changing it from a formal, document-intensive
activity to a series of face-to-face discussions. It tried to redefine the CEOs role from
that of checker, inquisitor, and authority to one of facilitator, helper, and supporter. To
some employees, this redefinition that the CEO was a helper and not an antagonist was
believable; to others, it was not.
Jack Welch, the CEO at the time, laid off vast numbers of employees in restructurings
and became known as neutron Jack, which led to his losing credibility among some of
his employees. If his purpose was to help them, why was he eliminating so many jobs?
Many companies have followed suit. They have stripped down the central rung of man-
agement and laid off many employees. They have eliminated elements in the corporate
hierarchy for the ostensible reason of increasing decision-making speed.
Welch reasserted the importance of the coordinating role played by top executives in
the company. The purpose of breaking down boundaries was to allow ideas to flow
freely and to make innovations common. Top executives were to function as change
agents and be driving forces of renewal. As part of the effort to continually reinvent GE,
Welch held open-ended workout sessions with employees at all levels to hear their
concerns and respond to them.
In the first decade of the 21st century, GEs methods of effectively managing a con-
glomerate did not succeed as well under Welchs successor, Jeff Immelt. In 2011, GEs
stock was down 61 percent from when Immelt took over from Welch 10 years earlier.
After the great financial crisis of 2007, GEs financial arm, the dominant one in the
company, proved to be a huge liability. The company was forced to withdraw from
finance and focus on its industrial core, but in that core it often lagged behind stronger
competitors like United Technology and Honeywell. As a conglomerate, GE took hits for
each of the great crises of the 21st century. In addition to the great financial crisis, its
airline business was crippled by 9/11, its industrial sales were flattened by recession, its
oil and gas divisions were hurt by the collapse in oil prices, and it was GE-designed
reactors that gave way at Japans Fukushima nuclear plant. While in theory diversifica-
tion is supposed to shield a company from risk, at GE it magnified the risk to investors.
Other firms went even further in breaking down the corporate hierarchy in the 1990s.
The Swiss-Swedish firm ABB, a competitor of GE, was also a leader in power and automa-
tion technologies. The ABB Group operated companies in hundreds of countries and
employed thousands of people. In the 1990s, it radically decentralized its operations to rely
on bottom-up management. With a corporate staff of less than 100 people, individual coun-
try subsidiaries were encouraged to make their own decisions. The firm was divided into
many small- and medium-sized businesses, which negotiated relations among one another
without central direction. Each business had its own balance sheet by which it was judged.
While ABB initially succeeded with this model, it, too, ran into serious trouble for a
variety of reasons. One was old asbestos-related suits in buildings it had helped to con-
struct. The company approached the brink of bankruptcy in the early 2000s because of
the overall debt it accumulated. While it returned to financial health by settling the
asbestos liability claims, it never really reestablished its strong footing. In 2015, investors
viewed the company as being overexposed to low-margin power generation, transmis-
sion, mining, and oil and gas businesses and underexposed in aerospace, nonresidential
construction, building controls, and health care. Its portfolio selection process was
flawed, no doubt because it was so decentralized and placed such little emphasis on
essential corporate control and direction. Between being too top-down and too bottom-
up, companies have to find a balance.
Is Vertical Integration the Answer?

Instead of using sophisticated portfolio approaches to run firms as conglomerates, might
vertical integration be a better response to the problem of corporate risk? A key question
for the large diversified firm is whether it should move up or down the supply chain and
become vertically integrated.
Vertical integration in industries, such as pharmaceuticals, was once common, but
management soon realized that it was not a good way to achieve sustained competitive
advantage. Both Lilly and Merck purchased distribution arms (PCS Health Systems and
Medco Containment, respectively), but both companies quickly sold these units. Medical
products company Medtronics, however, bought Covidien in 2015 and thereby became a
vertically integrated company, a designer and manufacturer of sensitive heart-related and
other medical devices as well as a manufacturer and distributor of many different types
of medical supplies.
To better understand the pluses and minuses of vertical integration, it is useful to look
at the entertainment industry.11 This industry had converged toward a single model that
combined production of content with multichannel distribution (see Exhibit 5.12). Com-
panies attempted to sell content in many ways, for example, through movies, TV shows,
books, theme parks, and increasingly Internet channels. Some companies bought distri-
bution channels (Disney purchased television network ABC), while others built their
own networks (News Corp started Fox). A new challenge was to combine content with
the added distribution possibilities of the Internet.
In the entertainment industry companies are involved in vertical integration through
direct ownership as well as many alliances via long-term contracts and one-time spot
market transactions. The old studio system tied actors to studios for long periods. In
todays industry, actors sign contracts to do x number of pictures with a studio. Pro-
duction companies can be either independent or owned by integrated entertainment
companies. In either case, production is sold to the highest bidder, not necessarily to the
company that produced the content. Local television affiliates and movie theaters are
sometimes bound by contract, sometimes entirely independent, and sometimes owned by
an entertainment company. This last situation is common in large metropolitan areas,
where the major companies want close links to viewers. Agents and other facilitators
play a role in bringing together the parties in the value chain.
Before government regulation in the 1950s, the large Hollywood studios were
vertically integrated. A few large studios owned most production and worldwide
distribution. This system was broken up by government regulation. It was not until
EXHIBIT 5.12 CONTENT DISTRIBUTION

Vertical
Integration:
Resources Creation Delivery Retail
Entertainment
Industry Actors Television production Broadcast television Local Affiliates
Writers Movie production networks
Cable television networks Local cable companies
Movie distribution Local theaters
thelate 1980s that the federal government again allowed companies owning studios
(TV production units) to also own TV broadcast networks (distribution). In recent
years, several rationales have supported vertical integration. One reason has been the
convergence of computing, telecommunications, information, and entertainment.
Convergence has created a hierarchy in which content, the scarcest commodity, is the
most valuable resource.
Content, however, is a high-overhead, high-risk, and low-margin business. The cost
of making and marketing movies continues to increase; yet the likelihood of success is
more and more a matter of guesswork. The odds are no better in TV production. Thus,
a rationale for joining production and distribution is to guarantee outlets for a firms
production. Captive outlets provide a built-in output for content. Networks cut costs by
owning and/or supplying their own prime-time programming. Networks are tolerant
toward their own production units, but there are limits because production companies
cannot force bad shows on networks, and hot networks can demand high prices for
airing shows.
Another rationale for vertical integration is that it enables big entertainment companies
to sell content, that is, to market the same character or idea in many ways. The content of
the entertainment companies can originate anywheremovies, TV, music, publishing,
merchandising, theme parks, and Internet sites. It can be repeatedly recycled in new
formats to maximize returns. For this to work, synergy must exist along the value chain.
Different parts of the business have to be aligned so that they add value to each other.
Vertical integration can mean lower risk (regardless of where the profits are, the com-
panies have a foothold) and can lock in distribution for high-risk production. But produc-
tion companies supply all networks and networks access all suppliers, so the motive for
consolidation is as much to gain bargaining leverage as to lock in distribution. All
companies are aiming for synergies, cross-selling to end users, and cross-platform-
selling to advertisers.
Each revolution in distribution and transmission has given companies with content
(production) more outlets for their creative products. Compared with network TV, cable
not only gave customers more distinct viewing options, but also provided the owners
with revenues from both subscriptions and advertising like print journalism. The evolu-
tion has progressed from broad mass audiences via TV networks, to aggregations of
specific audiences (children, news, movies, comedy) via cable, to individual interests via
direct satellite services and digital cable, to the potential of markets of one and entertain-
ment on demand on Internet sites, such as YouTube. An Internet site like Google thrive
on its ability to capture advertising revenue and now Amazon has discovered the power
of a subscription service, i.e. Amazon Prime.
Entertainment companies have tried to acquire complementary assets (e.g., Viacom
was strong with a young audience, while CBS was strong with an old one). Nonetheless,
much of the consolidation in the industry has not lived up to its billing. It is arguable
whether or not Time Warner and News Corp were better off after their major acquisi-
tions. Viacom, for instance, decided to divest and separate into two units, Viacom and
CBS. After years of mergers and acquisitions, divestitures have been the next major
trend in this industry, with almost every major media company shedding assets and
becoming leaner and more focused.
Though the entertainment industry offers good examples of the potential for vertical
integration along the value chain, the results have not lived up to expectations. The
great period of vertical merger and acquisition among entertainment companies has
come to an end. A number of conclusions about vertical integration, therefore, can
bereached:
In theory, there are many potential advantages, including risk reduction (regardless of
where profits move, a company is in a position to gain), but these advantages are hard
to achieve.
If distribution is purchased, it makes sense not to lock it in; rather, distribution should be
used as a bargaining tool (ends dependence, provides credible threat to go elsewhere).
On the other hand, an advantage of acquiring distribution is that it provides closeness
to customers. This may translate into the possibility of cross-selling, developing new
products, differentiating existing products, and catering to individual customer needs.
And catering to individual needs can yield higher profit margins than selling an un-
differentiated commodity.
Once acquisition of distribution occurs, however, synergy may be hard to achieve.
Management of the complementary assets is a huge challenge, one that has yet to be
effectively carried out by the large entertainment conglomerates.
Transaction Costs
Vertical integration raises a variety of questions. What is more efficientspecialist
firms linked by market exchanges or firms combined under a common ownership? Why
is common ownership needed when in so many industries firms can unite to achieve
common purposes on a project basis? The wool industry, for instance, involves indepen-
dent spinners, weavers, and merchants coming together to produce final goods for sale to
consumers. The remodeling industry involves builders, plumbers, electricians, and paint-
ers working together on a project basis. Movies typically are made in a similar manner.
Why should all these activities come under the purview of one firm?
In deciding whether to combine or leave activities separate, managers must compare
external market transaction costs to internal administrative costs. Which are greater?
High market transaction costs are a good reason to unite activities in one firm, while
high administrative costs are a good reason to keep these activities in separate entities.
The external transaction costs of operating in the market have to be compared with the
internal administrative costs of operating inside the firm.12
Within a firm, managers cannot just command employees to do their bidding. They
incur monitoring and incentive costs when they try to ensure employee compliance.
These costs may be greater than the costs of transacting in the market. Also, the informa-
tion a firms top executives receive from their subordinates may not be better than the
information they receive from outside the firm. Employees may misrepresent situations.
So, why have them as employees? Instead, hire them on an as-needed basis. The cost of
uniting disparate elements in the firm includes the hassles of dealing with potentially
recalcitrant employees who have to be motivated to do the job right. These costs affect
many different stages in the production process, such as manufacturing, marketing, and
distribution, when they take place in the same firm. Compare them with the discussion
of outsourcing in the chapter on internal strengths and weaknesses.
Between pure market transactions and vertical integration, there are a number of
hybrid-like options like those discussed earlier in this chapter:
A firm can have long-term contracts and partnerships with suppliers.
It can have franchising agreements with independent or semi-independent distribu-
tors rather than incorporate them in the firm.
It can create joint ventures.
These arrangements may compensate for the limits of internalization and for the
limits of market exchange. In each instance, the issue is how to best design the arrange-
ment. The parties have to be able to answer questions, such as how to allocate risk and
what are the incentives to work together. These alliance-like options have gained consid-
erable attention in management circles in recent years and frequently are resorted to
instead of mergers and acquisitions. They may be a preliminary stage, a trial period, in
what later becomes an outright merger and acquisition.
Summary The reasons for mergers and acquisitions are many. They include getting around anti-
trust laws, dealing with decline in a corporations core business, coping with slow
growth, trying to achieve turnarounds, gaining access to attractive products and tech-
nologies, building in distribution or production capacity when they are lacking, and
taking advantage of a bull market. Deregulation and privatization have played a major
role in the restructuring of many industries. In airlines, railroads, and banking, the
number of firms has shrunk.
Some firms have coped with this situation much better than others. Merger and acqui-
sition winners have a few characteristics in common. They are good at dealing with the
cultural problems that emerge after a merger or acquisition has been completed. They
dont overpay for the companies they buy. They make sure they know what they are
getting. They operate well in the post-merger or acquisition environment, achieving
marketing leverage and other synergies. They make sure to retain the key personnel of
the merged or acquired company. And they strive to gain the benefits from complemen-
tary core competencies.
Mergers of equals are more likely to succeed than mergers of vastly different companies.
Still, it is necessary for management to plan carefully before engaging in a merger or acqui-
sition. Synergy is the key, but achieving it is far from easy.
Theories of managing a large, diversified organization have transitioned from encour-
aging expansion to policies of contraction and focus. Portfolio management tools like
those BCG and GE/McKinsey developed were once very popular. They divided firms
into separate business units and viewed the units as independent entities. Although they
are still popular today, firms more and more are looking for boundary-free arrangements
where capabilities are linked, competencies leveraged, and synergies achieved.
The vertical integration decision, as discussed in this chapter, is a complicated one
since in many instances, it may make more sense for the firm to buy the goods and
services it needs in the market rather than to produce them itself. The firms top
e xecutives have to decide where the firms comparative advantage lies and concentrate
on this domain rather than spreading the company too thinly. The market transaction
costs of vertical integration have to be compared with the administrative costs of inter-
nalizing an additional function in the firm. The complicated nature of the vertical inte-
gration decision is apparent in the entertainment industry, where most of the large
acquisitions and mergers of recent years have not worked as well as expected.

Reflect on your own employers external environment. If you are a traditional student,
please select a publicly held firm to analyze.
1. Has the firm recently been involved in a merger, acquisition, or divestiture? How
would you assess the results? What has gone well? What challenges still lie ahead?
2. To what extent is the firm involved in tactics that fall short of full-scale mergers and
acquisitions? Have these tactics succeeded? What are the challenges that lie ahead?
3. In which business or businesses has the firm chosen to participate? Are the businesses
largely related or unrelated? Why has the firm chosen to compete in these businesses?
Are there businesses that the firm should divest? Are there businesses that the firm
should acquire? Identify a number of targets for acquisition. Justify your choices.
Explain how the firm should go about trying to carry out the acquisition.
4. Should the firm look for additional acquisition targets that are vertically or horizon-
tally related to it? Why?
5. What are the external environmental factors and industry changes that should drive
the firms merger and acquisition strategy?
6. What capabilities have been required to make its merger and acquisition decisions?
Does the possess the appropriate internal capabilities for M&A-related decision making?
7. What type of corporate managerial model does the firm use to manage its separate
business units? What are the pluses and minuses of this approach? How could the ap-
proach be changed for the better?
Endnotes 1. D. Brito and M. Catalao-Lopes, Mergers and Acquisitions: The Industrial Organization
Perspective (Leiter, Netherlands: Kluwer, 2006).
2. R. Rumelt, Strategy, Structure, and Economic Performance (Boston: Harvard Business
School Press, 1986). Rumelt found that concentrating on a single field was more profitable
than moving boldly into uncharted territory. He blamed unrelated diversification on manage-
ment fashion and argued that related diversification was a better strategy. He warned against
conglomerates and unrelated acquisitions.
3. A. Fisher, A. Michels, and J. Antony, How to Make a Merger Work, Fortune, January 24,
1994, pp. 6670. Consulting firm McKinsey & Company, in a 1994 study, found that only
23 percent of mergers examined over a 10-year period generated returns in excess of the costs
incurred in the deal. Also see D. Ravenscraft and F. Scherer, Mergers, Sell-Offs, and Economic
Efficiency (Washington, DC: Brookings, 1987). Ravenscraft and Scherer, in a study of the
post-acquisition performance of acquired firms, found that profit levels and market shares on
average did not grow.
4. Mergers: Why Most Big Deals Dont Pay Off, pp. 6068.
5. Why One and Done M&A Is No Longer Effective, http://www.accenture.com/us-en/
outlook/Pages/outlook-journal-2012-mergers-acquisitions-create-value.aspx.
6. The 1990s saw even greater activity than did the 1980s. In 1988, the decades peak year,
$246.9 billion was invested in M&As. In 1995, the total transaction value was more than
$450billion, in 1996 more than $470 billion, and in 1999, a staggering $1.4 trillion (the cur-
rent record)see BusinessWeek, October 14, 2002.
7. Sources on the railroad industry include Alfred Marcus, The Adversary Economy (Westport,
CT: Quorum Books, 1984); Mercer Management Consulting, The Impact of Deregulation;
and H. Sun, The Sources of Railroad Merger Gains, Transportation Journal 39, no. 4,
pp.1426.
8. Sources on the banking industry include R. Eisenbeis, Mergers of Publicly Traded Banking
Organizations Revisited, Economic Review 84, no. 4 (1999), pp. 2637; J. Jayaratne and
P. Strahan, The Benefits of Branching Deregulation, Regulation, Winter 1999, pp. 816;
A. Kover, Big Banks Debunked, Fortune, February 21, 2000, pp. 18794; R. Kroszner,
The Economics and Politics of Financial Modernization, Economic Policy Review 6, no. 4
(2000), pp. 2537; and B. Shull and G. Hanweck, A New Merger Policy for Banks, Antitrust
Bulletin 45, no. 3 (2000), pp. 679711.
9. In the 19th century, branch banking had been regulated to ensure easy access by customers
and prevent local market concentration.
10. See Why Acquisitions FailThe 20 Key Reasons, http://www.pearsoned.co.uk/bookshop/
article.asp?item=439.
11. Sources on the entertainment industry include Marc Gunther, TVs Rerun from Hell: Para-
dise Lost, Fortune, February 5, 2001, pp. 2830; Television Takes a Tumble, The Econo-
mist, January 20, 2001, pp. 5961; J. Angwin and M. Peers, The New Media Colossus, The
Wall Street Journal, December 15, 2000, pp. B1, B7; Stephen Battaglio, TV Networks Are
More Than Just Survivors, Fortune, September 18, 2000, pp. 5657; J. Lipman and
B.Orwall, Whos Left at the Media Ball? The Wall Street Journal, September 8, 1999,
pp. B1, B4; Marc Gunther, Viacom: Redstones Remarkable Rise to the Top, Fortune, April 26,
1999, pp. 13037; A Brand New Strategy, The Economist, November 19, 1998, special
section; and Frank Rose, Theres No Business Like Show Business, Fortune, June 22, 1998,
pp. 8698.
12. O. Williamson, Economic Institutions of Capitalism: Firms, Markets, Relational Contracting
(New York: Free Press, 1991).
C H A P T E R S I X
Globalization
Conventional wisdom argues that domestic competition is wasteful:
It leads to duplication of effort and prevents companies from achieving
economies of scale. (Yet) domestic rivalry, like any rivalry, creates
pressure on companies to innovate and improve. Another benefit is
the pressure it creates for constant upgrading of the sources of competitive
advantage It is also vigorous domestic competition that ultimately
pressures domestic companies to look at global markets and toughens
them and having been tested by fierce domestic competition, the
stronger companies are well equipped to win abroad.1
Michael Porter, The Competitive Advantage of Nations

Recognizing that strategic management has a global dimension.
Appreciating the reasons for a firms expansion across national boundaries.
Seeing how the CAGE framework and Porters diamond can help shape a firms international strategy.
Being aware of the range of global strategies that can be adoptedfrom multidomestic to transnational.
Comprehending the degree of local adaptation required when a firm enters foreign markets.
Understanding the tactics that support global strategysuch as licensing, franchising, and
greenfieldoperations.
Seeing the parallels between global and domestic strategy.
Introduction
Along with decisions about diversification and corporate-level strategy, decisions about
global moves are among the most important ones the strategist makes. This chapter
examines these moves.
At first glance, it seems that operating abroad only adds to the costs of doing
businessextra communication and transportation costs, extra costs of training staff and
moving individuals to different countries, and the expense and time required to learn
about diverse cultures and languages. In addition, in order to enter and operate in global
139
markets, barriers against gaining access to key business and partnerships must be sur-
mounted. Local firms have built-in advantages: They know the situation better than any
foreign firm could, and they have better understanding of the domestic market, business
conditions, and prevailing culture. The liability of foreignness means that firms may
decide to remain domestic players and respond to international threats as they occur
from a more focused domestic stance.2
Despite all the hurdles and barriers at hand, however, some firms commit to operating
abroad. This chapter outlines reasons these firms decide to go global. Life cycle and
other environmental factors, as introduced in Chapter 2, often compel firms to craft a
more global strategy, as do internal factors mentioned in Chapter 3, especially the need
to replenish and expand a firms capabilities. Firms entering international m arkets
succeed only when they possess a unique set of r esources, capabilities, and competencies
that they can apply in global markets in ways that domestic firms cannot match.
A firm choosing to pursue international operations has a wide range of strategic o ptions
from a multidomestic to a transnational approachand an even greater range of tactics
that can be selected based upon the firms unique situation. Some international opportunities
are best addressed when a firm utilizes a narrower exporting approach, while others demand
a more integrated strategy and more direct foreign involvement and investment. In the end,
the key to developing a successful international strategy is to understand the unique charac-
teristics and requirements of the markets b eing considered and the capabilities of a firm in
light of those factors. Also critical is the capacity to s ecure partnerships and resources to
capture a critical mass of profitable business abroad.
This chapter assists in navigating the complex global landscape and formulating moves
for a winning global strategy. A winning global strategy is not carried out inisolation, but
rather must be combined with other moves, including business, c orporate, and innovation
strategies undertaken by a firm.
Reasons for Globalization

Given the difficulties firms have in entering foreign markets, why do they do it? In
todays world, the scope of the firm and its competition extends well beyond national
boundaries. Inputsboth human and physical resourcescome from all over the world.
Potential as well as actual customers are found in every country. The reasons firms
operate internationally are numerous:
They may be responding to an onslaught of globally positioned rivalsor racing to
secure a foreign market position before a key rival can gain a foothold.
They may be responding to life cycle factors that have led to a diminishment of
demand domestically.
They may be seeking to capture scale economies, or to simply achieve minimum ef-
ficient scale. Domestic markets may no longer be able to absorb production at a min-
imum efficient scale. To drive the production costs of a unit low enough to be
competitive, some firms have to produce millions of units per year, not thousands.
They can find markets this large only if they operate globally. The costs per unit pro-
duced would be too high if these companies sold just to the local market.
They can better exploit their technological advantages or brand name if they diffuse
their wares across the globe to a broader audience.
Chapter 6Globalization141
EXHIBIT 6.1
Reflection of
United 747 at
Frankfurt Gate
Captain Brian
Cohen.
They may desire better and/or cheaper sources of raw materials and energy from
channels abroad.
They may want to obtain access to low-cost factors of production such as labor.
They may be attracted to certain countries because of the subsidies those countries provide.
They may be seeking opportunities for economies of scope (synergy) and for learning.
Life Cycle Factors

As discussed in Chapter 2, industry structures change in fundamental ways over time,
and this evolution impacts the approach each firm takes to export and other global
opportunities.3 In an industrys embryonic stage, when its products are just getting off
the ground, there are likely to be few exports. Efforts to push products across the globe
at this stage are often difficult. Prices tend to be high, and margins and profits low.
Production runs are short and require skilled labor. Specialized channels are needed for
distribution, and relatively few companies are in the industry. There are many product
variations, no standards, and frequent design changes. Companies face high advertising
and sales costs to persuade buyers to make a purchase.
In the growth stage, exports pick up. Although products continue to have technical
and performance differences, efforts to improve product reliability by standardization
start to pay off. There is a widening group of buyers and a shift to mass production and
distribution. Prices go down and profits up. Competitors enter the industry in increasing
numbers. Rivals start their race for dominant share.
As maturity sets in, exports grow even more to pick up slack. At home, there are few
new buyers; most are repeat buyers. Competitors struggle for the same customers. Over-
capacity develops. To extend the life cycle, companies segment the market into more and
more categories across the globe. They provide deals to customers to gain market share
and compete bitterly with regard to price and factors such as packaging. Competitors look
for market opportunities abroad. Coca Cola, for example, recognized long ago that U.S.
consumers could devour only so much soda the domestic carbonated soft drink industry
had hit an inflection point and was maturing (see Exhibit 6.2). In response to the decel-
eration of demand, the company expanded abroad and today is a dominant global player.
EXHIBIT 6.2 About two-thirds of the Coca Colas sales and 80 percent of its profits now come from abroad. The hyper-
Soda Market competitive environment in the United States has forced Coca-Cola to look favorably at opportunities
Maturity abroad. The company has been locked in a decades-long duel with PepsiCo that involves the pressures of
high-cost advertising and the difficulties of maintaining access to shelf space in supermarkets, keeping
fountain business in restaurants, and developing vending business. Gigantic outlets such as Walmart and
other mass distributors have demanded huge discounts, plus they have developed their own in-house
labels to compete with Coke and Pepsi.
Consumers are no longer as enamored with soft drinks as they once were and are wary of the artificial sweeteners
found in diet varieties. Bottled water, juices, and so-called new-age beverages with captivating names like Escape,
Enrich, Appeal, Allure, and Comfort and unique flavors have been taking domestic share away from both C oca-Cola
and PepsiCos core cola and cola-related products. Even the best-case scenarios forecasted by market experts
show negative trends in the domestic soft drink market.
The Declining U.S. Soft Drink Market
50
(billion)
45
$41.1
Best Case (billion)
40 $41.3
35 Mintel Forecast
Total Sales ($ billions)
(billion) $33.5
30
Worst Case (billion)
25 $25.5
20
15 Confidence Intervals
95%
10
90%
5 70%
50%
0
2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Est
Actual Forecast
Ref: Mintel Carbonated Soft Drinks in the U.S., 2014
To keep costs down, both Coca-Cola and PepsiCo have had to carefully manage their relations across their
supply chains. The inroads that Coca-Cola and PepsiCo have made on smaller soft-drink companiesvia
competition or acquisitionhave limits, and restrictions exist on the two companies abilities to innovate and
introduce new products as they seek to differentiate their existing products. They do not want to cannibalize
their existing business.
As PepsiCo keeps making in-roads on Coca-Colas U.S. market share, Coca-Cola has recognized that it has to be
even more aggressive in looking abroad for new business, where it has greater brand recognition than PepsiCo.
However, PepsiCo cannot allow Coca-Cola to win market share abroad uncontested or else Coca-Cola could
seriously damage PepsiCo domestically, so it has followed Coca-Cola and challenged it throughout the world.
Although behind Coca-Cola in nearly every market, PepsiCo has made the effort to be a formidable global
competitor so that Coca-Cola does not overtake it domestically.
Beverage Industry Global Market Shares
Coke
18%
Pepsi
Other 11%
63%
Nestle
8%
Data as Reported in the 2015 IBISWorld Soft Drink & Bottle Water Manufacturing Report.
If exportsor other forms of foreign operationscannot pick up the slack, decline

sets in. In the decline stage, there is less and less product differentiation. Spotty product
quality reemerges. There are falling prices and margins and fewer competitors. The pro-
cess of commoditization makes once attractive industries much less attractive.
Changes in domestic demand over the life cycle lead firms to operate internationally.
When products become standardized, competitors enter the industry, and firms compete
more on the basis of price. However, whether it is U.S. products sold in foreign markets
or foreign products sold in U.S. markets, products that are common at home are seen as
exotic abroad. Away from the home country, the products become premium, deluxe
goods that command higher margins; they have snob appeal. Consider foreign alcoholic
beverages sold in the U.S. that have cachet simply because they are made abroad. Thus,
the pressure of life cycle competition and the lure of global markets drive companies to
seek markets abroad.
Options for Global Expansion

Similar to the corporate-level tactics for diversification, the methods of international
expansion run the gamut. Prior to committing to a particular avenue, it is necessary to
consider several factors:
From an internal resource perspective, does the firm possess the necessary financial
capabilities? Does it have the capacity to satisfy increased global demand? Does it
have the country-specific knowledge to market and/or operate abroad?
From an external environment perspective, is potential demand sufficient in a firms
target markets? Will the product need to be modified? How much will it cost to pro-
duce and/or ship abroad? How much political or intellectual property (IP) risk can a
firm endure?
The answer to these questions help determine which tactics make the most sense for
a particular firm.
The simplest of avenues is to export products identical to those sold domestically. This
option makes the sense when the import policies of a target country are liberal, the sales po-
tential is either limited or unknown, little product adaptation is required, or a countrys pro-
duction costs are prohibitive. This tactic is also advisable when there is a high degree of
political turmoil or unrest, which would place direct foreign investments at risk. The pros of
this approach are speed of entry and the ability to maximize scale economies at existing
facilities. In some industries, such as aircraft manufacturing, the maximization of plant utili-
zation is imperativeplus, if the product is an airplane, it can deliver itself directly from the
plant to the customer.
Of course, there are trade-offs to consider. For most firms, the sheer cost of transpor-
tation can place it at a disadvantage relative to companies that can produce in closer
proximity to their target customers. Target customers may perceive the exporter as an
outsider, and the firms access to actionable market intelligence can be severely lim-
ited. The risk of inventory slippage or breakage is also increased when finished goods
travel long distances to foreign markets.
In order to address cultural barriers and the perception of foreignness, firms can instead
choose to license their intellectual property for foreign production and salesor franchise
their business concepts to foreign operators. In such agreements, a foreign firm (the fran-
chisee or licensee) produces the product/service in their own country, have to do most of
the day-to-day work, and bear most of the business risk. The franchisor or licensor who
permits the franchisee/licensee to use its intellectual property assumes much less overall
risk (as illustrated in Exhibit 6.3)and financially sees only the upside of franchising/
licensing fees and royalties. However, the franchisor/licensor also forfeits the lions share
of potential profits and cedes some control of production and operations. In fact, the for-
eign firms to whom it licenses the product or franchises the concept may steal or inappro-
priately utilize the companys intellectual property. The company also has less ability to
coordinate its international holdings and increase its own operational efficiencies.
Alliances and joint ventures, discussed in Chapter 5, are best pursued when potential re-
turns in a particular market are more certain and great enough to justify the overhead of such
agreements. Their positives are numerous as they help a firm overcome foreign ownership
restrictions and cultural distance. The local company can provide the skills, resources, brand
name and distribution network for the products and services generated. Alliances and joint
ventures combine the resources of two firms and boost the learning potential for all partners.
EXHIBIT 6.3 Potential HIGH END

Range of of Licensee/Franchisee Gains
Potential Gains
and Losses for
the Licensor/ Range of
Franchisor vs. Licensor/Franchisor Gains
Profits
the Licensee/
Franchisee Time
Potential LOW END

of Licensee/Franchisee Losses
The international joint venture between U.S. cereal giant Kellogg and Asias lead-
ing agribusiness Wilmar has been designed to capitalize on the strengths of each
partner. Wilmar has provided infrastructure, supply-chain scale, an extensive sales
and distribution network in China, and local China market expertise to the joint
venture. Kellogg contributes a portfolio of globally recognized brands and products,
along with deep cereal and snacks category expertise. The joint venture has relied on
the Kelloggs (cereal) and Pringles (chips) brands. Together, Kellogg and Wilmar
have been leveraging their complementary expertise to maximize marketing and
manufacturing synergies.4
Alliances and joint ventures are not without risk, however. Conflicts occur over asym-
metries in investments or profit splits. They can be difficult to manage and control. As
each firm has more skin in the game, there is more potential for financial and knowl-
edge (IP and trade secret) losses. A partner, armed with insider information, can quickly
become a competitor. Safeguards must be built to minimize the potential for such losses.
An exit plan, which allows a JV partner to be bought out based on a prearranged valua-
tion, is just one such safeguard.
A company achieves maximum control if it establishes its own greenfield operations
in the foreign country, as Cargill, international producer and marketer of food, agricultural,
financial, and industrial products and services, often does when it operates abroad. This
approach involves the company making direct foreign investments (DFI), which allow it to
control everything from production to marketing and distribution. It is better able to protect
its technology from appropriation by a foreign partner, and it is in a better position to
engage in global strategic coordination and to achieve operational efficiencies.
However, greenfield operations are very challenging if the company does not have
prior foreign experience or experience in a particular country. The costs and risks are
great. Best Buy, for example, has estimated that its international retreat from its green-
field operations cost the company $245 millionand this is just one recent example of a
retailer finding that stores dont always perform as well on foreign soil.5 Similarly,
Targets failure to expand in Canada was a major blow to the company.
Product-Market Approaches
Firms tend to position themselves according to one of three classic international strate-
gies: multidomestic, global, or transnational (see Exhibit 6.4). Each of these strategies
reflects trade-offs that are made between responsiveness (to each local market) and
global production efficiency. Each is tied to business level decisions that accentuate a
firms basic low-cost, differentiated, or best-value position (as introduced in Chapter 4).
A global strategy features a single dominant design or business model worldwide;
this approach takes advantage of economies of scale and is a highly efficient, low-
cost way to expand internationally.
A multidomestic strategy adapts and modifies a firms products and services to each
separate country or region and charges a premium price for customized goods that
meet the needs of individual markets. This differentiated approach is designed to ex-
tract high margins.
A transnational strategy combines global efficiencies with local responsiveness. To
achieve the best value, it both exploits scale economies and adapts to local conditions.
EXHIBIT 6.4
Trade-Offs in
Global
Global
Expansion
Production Efficiency
Transnational
Multidomestic
Local Market Responsiveness
When pressures to be cost efficient are high, and pressures for local responsiveness
are low, companies can use uniform global strategies. When cost pressures are low and
pressures for local responsiveness are high, multidomestic strategies can be followed to
adapt to the needs of each local market. The former is similar to a low-cost business
strategy, and the latter is similar to a differentiated strategy. If cost pressures are high and
the pressures for local responsiveness are also high, companies may be forced to move
toward the middle and carry out transnational strategies that have some elements of
global homogenization and some of local adaptation.
When entering global markets, a firm may have to meet the pressures for both low
cost and local responsiveness. Low cost may, for example, be best achieved by a single
brand produced in a uniform way for all markets everywhere, thus reducing design
costs, lowering manufacturing costs, and achieving greater efficiencies. However, given
the existence of different infrastructures, distribution patterns, and government de-
mands, it may not be possible to achieve uniform policies throughout the world. Local
acceptance is likely only by accommodating local tastes and adapting to traditional
practices. Accommodating local needs, however, is costly and difficult, as the following
example indicates.
Local Adaptation
A U.S. firm entering another market must be sensitive to differences it will experience.
Its success often depends on its ability to adapt to these differences. The expansion of
fast-food companies into Japan provides a good example.6 At the start of the 1990s, the
fast-food business in Japan was rapidly expanding. People were spending a larger portion
of their incomes on eating out. Although Japan was the second-largest consumer market
in the world, it was an alien place to many U.S. franchises. The Japanese people were
friendly to the Americans, but many U.S. businesses that tried to move into Japan failed.
Kentucky Fried Chicken (KFC), on the other hand, found great success in adapting to the
market utilizing the tactics described in Exhibit 6.5.
EXHIBIT 6.5 KFC in Japan

The key to KFCs success in Japan was that it had a multi-point plan that married modern business practices with Japans century-old traditions:
Adapting to local customs. The head of KFC operations in Japan, an ex-IBM employee, was willing to adapt to local customs. At busi-
ness gatherings, he would say a few words in Japanese no matter how difficult it was for him. He understood that he had to socialize,
network, and form personal bonds with KFCs franchisees and other business partners. In Japan, business relations are built on trust, a
handshake, and a glass or two of sake. KFCs head in Japan was an outgoing person, enjoyed the sake, was proud of his fiberglass
liver, and liked attending geisha parties.
Delegating authority. The KFC head in Japan also understood that he had to delegate real authority to his Japanese staff. His executive vice
president was a 27-year-old local man, whom he immediately hired to be his peer and with whom he shared an office and developed a friend-
ship. He gave this man the opportunity to expand the business with him. Usually in Japan an employee cannot climb to the position of chief
operating officer until the age of 40, but KFC Japans second-in-command had a large say in decision-making from the outset.
Training for life. At KFC in Japan, employees did not work for the company, but belonged to it. Since employees were going to stay
with the company for their entire careers, the head of KFC Japan believed the company could invest heavily in training. The training
was not only in methods, but also in the spirit of the company. Employees started each day with a pledge to serve customers promptly,
be polite, maintain the stores in spotless condition, and pay attention to hygiene. They took these company slogans very seriously.
They were shown behind-the-counter techniques and drilled until they got it right. For instance, when an order was taken, they had to
remember that a packer was behind them and they had to repeat the order to the packer. They had to use both hands when giving the
product to the customer, and they had to say very politely, Here you are.
Locating stores effectively. The location of new stores was chosen carefully because overhead was high in comparison to that in the
United States. A new store could cost the equivalent of $400,000 to build and equip and $28,000 a month to maintain, so it had to
generate at least $85,000 a month in revenue. An algorithm was developed to predict business per month based on foot traffic, popu-
lation density, and other factors.
Sizing stores appropriately. The first stores that KFC built in Japan were exact replicas of its U.S. stores. As KFC Japans chief operating
officer remarked, they were like full-size Cadillacs. In Japans crowded and narrow streets, they were not appropriate, so they had to
be redesigned. To suit local conditions, everything was reduced to one-third the size of a U.S. KFC store, but the smaller stores were
expected to do three times the business of their U.S. counterparts.
Changing the menu. The menu was adapted to Japanese tastes, with additional items such as smoked chicken, yogurt, and fish and
chips being available. French fries replaced mashed potatoes, and the coleslaw was less sweet than the U.S. version.
Having display samples. Japanese consumers demanded display samples that were exact replicas of the food they ate. These were
designed, built, and showcased in each store.
Displaying statues of the colonel. The head of KFC Japan found old life-size statues of the Colonel in a U.S. warehouse. He placed
them on the sidewalk in front of each store to show the authenticity of the product.
Advertising to Japanese customers. A Japanese agency developed the TV advertising campaign, which cost $5 million annually. The
advertisements stressed the products association with America and its aristocratic elegance. They also showed satisfied, smiling
faces the world over. The appeal was not the good basic food at a reasonable price, but the unusual, distinctive food from Kentucky
(the theme song was My Old Kentucky Home) that came from the Colonels home kitchen. The associations with the products noble
and fine features allowed KFC Japan to earn higher margins.
Having a committed partner. Mitsubishi, the trading company, was a half-owner of KFC Japan and was the main supplier of the meat. It
invested heavily in KFC Japan to expand the market for chicken, in which it had also invested. Mitsubishi was patient with KFC Japan,
allowing it to miss profit projections, while it built market share. Mitsubishi had a longer-term time horizon than the U.S.-based KFC and
less pressure from investors and financial analysts.
Co-opting local competitors. Usually, there were many Japanese competitors in the neighborhoods where KFC stores openedsushi
and noodle shops and local butchers that sold smoked chicken on the side. KFC Japan mounted public relations efforts whenever it
opened a new store. Before opening the store, representatives from KFC Japan would tour the neighborhood, giving gifts and discount
coupons, introducing the store supervisor, and asking for support. All of this was done to prevent local opposition and to combat the
feeling that outsiders were not welcome.
Using local rituals. A centuries-old Shinto ritual with a Buddhist priest was performed at a stores inauguration ceremonies. The prayers
were derived from seventh-century texts, and on an altar were items such as the branch of a tree, sake, rice cakes, and dried squid, all
of which were prescribed by Shinto law.
Fighting off U.S. competitors. All the care KFC Japan took did not prevent other U.S. firms from trying to follow in its footsteps. Churchs
Fried Chicken soon entered the Japanese market and claimed that its quality and service were better than those of KFC, its chickens
were larger and juicier, its slices were bigger, and its products taste was better because its chicken was marinated and fried, rather
than pressure-cooked, and therefore crispier.
Deciding Where to Invest

In making choices about where to pursue global expansion, several specific questions arise:
Which regions or countries are most ripe for global expansion?
How similar are these regions to the home market?
To what degree should the firm invest in different regions?
It is important to look beyond unilateral market factors such as size, growth and income level
per capita. Both the closeness and competitiveness of each nation must also be considered.
Pankaj Ghemewat, professor at the University of Navarra in Barcelona, developed the
CAGE framework to help business understand the multiple dimensions of closeness and
to balance these dimensions as they consider strategic moves abroad. Nations are considered
closest when they have multiple cultural, administrative, geographic, and economic simi-
larities. According to CAGE, for example, Spain would be considered closer to Chile than to
the U.S. despite the fact that by geographic measures alone, the trip from Spain to Chile is
over twice as long. The cultural, administrative, and economic commonalities between Chile
and Spain help businesses in the two countries span their significant geographic separation.
Firms can use the CAGE framework to help them pinpoint where to move next. This
framework can also be used to identify key differences across countries that might hand-
icap their efforts when competing with a specific countrys local firms. Walmarts dif-
ficulties in Germany and Best Buys struggles in China can be clearly traced to
differences that the firms could not overcome. In both cases the companies have had to
withdraw after making efforts to expand in these countries. Walmart left Germany in
2006, abandoning that potentially lucrative market after nine years. Best Buy sold its
division in China to a real-estate group in 2014 after it failed to make positive returns on
its investment in that country. There are many reasons for Walmarts failure. One reason
is that Walmart was not sustainable enough. Its environmental practices were not up to
German standards. Another reason is Walmarts anti-union policies did not fit into
German culture. Still another reason was anti-American attitudes on the part of German
consumers. Yet, there were fundamental cultural differences that also played a role, such
as Walmart requiring its employees to chant WALMART! WALMART! WALMART!
while carrying out group calisthenics that offended the post-war anti-authoritarian
German psyche. Another example was Walmart making its employees smile at custom-
ers, which many German workers considered silly or embarrassing.
Exhibit 6.6 offers a summary of the distance factors that businesses should consider
when determining where to invest. Of course, some of these factors pose greater
EXHIBIT 6.6 Distance Factors

Cultural Administrative Geographic Economic
Measures of Distance Language Colonial Ties Physical Distance Consumer Income
Commonalities will reduce Ethnicity Trading Blocs Land Border Resource Availability
the perceived distance Social Networks Currency Weather/Climate Human
between markets Religion Laws/Legal System Time Zone Organizational
Financial
Differences will National Work Systems Level of Corruption
Natural
impedebusiness Values, Norms & Political Stability
Infrastructure
Dispositions Hostilities/Unrest
Distribution Networks
c hallenges based on the product and industry. Food manufacturers, for example, must be
especially attuned to cultural norms and religious requirements of consumers across the
globe. Steel and textile manufacturers must often grapple with tariffs and other adminis-
trative hurdles created by protectionist governments. Providers of perishable, bulky, or
breakable goods are challenged most by geographic hurdles. Economic barriers have led
to innovations in agricultural equipment, and the lack of reliable infrastructure within
emerging markets has forced many firms to rethink product design and delivery practices.
Porters diamond framework, shown in Exhibit 6.7, helps businesses determine
where specific industries tend to thrive and why. Four national/regional characteristics
are key to a firms innovation, improved competitiveness, and the development of advan-
tage that can be leveraged abroad:
The first characteristic, factor conditions, describe the inputs provided by a nation or
region to a firms production. Any nation or region that can provide easier access
whether from local or international sourcesto high-quality and/or specialized inputs
provides a source of advantage to its firms. Such inputs include human resources,
administrative, technological and physical infrastructure, natural resources, etc.
Demand conditions reflect the quality of customers available. A nation or region that
can offer its firms relatively sophisticated consumers and standards pressure its firms
to innovate faster and to create more advanced products than those of competitors
across the globe. The firms general context provides a picture of the national or re-
gional environment within which the firm operates. A location where the rule of law
prevails, intellectual property protection exists, and capital is accessible provides fer-
tile ground for the growth of its firms. Rigorous, open competition toughen the re-
gion/nations firms for battle on the international stage. This competitive element in
the diamond incorporates new entrants and substitutes as well as existing competi-
tors, and it, too, is not confined to national borders.
Lastly, any related and supporting industries within a region or nation can offer further
benefit. For example, the presence of research institutions or the proximity of other com-
plementary businesses is certain to provide both innovation and marketing advantages.
This framework highlights the fact that the firm needs allies, especially when operating
internationally. Without allies, the firm cannot succeed globally; these allies are found
EXHIBIT 6.7
Firms
Where
General
Industries Context
Thrive and
Why: The
Diamond Factor
Demand
(Input)
Conditions
Conditions
Related &
Supporting
Industries
EXHIBIT 6.8 Manufacturing in Mexico as a maquiladora offers significant benefits for foreign manufacturersespecially those
Mexican selling in the U.S. market. A number of the factors highlighted in both the CAGE framework and Porters diamond
Manufacturing clearly are promoted in this region. The Mexican government initially established the maquiladora program in the
Source: 2014 KPMG
1960s as a way to reduce unemployment along the borders, and in its early years the maquiladora industry mostly
Competitive attracted unsophisticated assembly (primarily in the textile, industrial, and simple electronics industries). Nonethe-
Alternatives Study. less, the program continued to gain momentum and by the 1980s was the largest source of foreign exchange in
Mexico. With the introduction of the North American Free Trade Agreement (NAFTA) in 1994, maquiladoras quickly
became the countrys second-largest industry. The Mexican government responded to the growth with both new
infrastructure and a strategic plan for better education and training for its citizens. By the turn of the 21st century,
the maquiladora industry was completely transformed into a highly supportive manufacturing ecosystem.
By 2015, the Mexican city of Tijuana, which borders the U.S. state of California, a hotbed of medical device
innovation, had the largest concentration of medical device manufacturers in all of North America. The factors
contributing to this regional success are clear:
The region provides a highly trained, quality-conscious workforce.
Its large manufacturing firms operate under FDA or European marking regulatory requirements.
There is a high concentration of English speakers, which facilitates communications and training.
The region offers abundant and flexible real estate.
It has a well-developed infrastructure with highways to support the mass transport of finished goods.
Its power and broadband connectivity are abundant.
It enjoys the support of strong Mexican government intellectual property rights protections.
Its unions are generally employer friendly.
It offers an 18.7% cost advantage relative to the U.S.
everywhere the firm competes. The attractiveness of an industry is determined by global

as well as domestic conditions. Mexico provides an example of a nation that has devel
oped a clear advantage in manufacturing through both factor conditions and supporting
industries. The maquiladora model is outlined in Exhibit 6.8.
Global Success Factors

To what extent global expansion results in positive or negative net benefits for firms is
unclear. Firms face the greatest costs at globalizations earliest stages. These costs may
be overcome with experience and learning, but they may grow again at globalizations
later stages when conditions change again. Whether the net benefits are positive or nega
tive depends on a number of factors:
Does global expansion allow a firm to hedge economic risk?
Can it benefit from differences in economic cycles? One countrys GDP may be on
the rise, while anothers is slowing.
Does global expansion yield increased flexibility?
Does it bestow useful managerial and technical knowledge and competence?
The positives must outweigh the negatives. The costs of coordinating and communicating
with foreign subsidiaries are likely to be high. As the locus of control diffuses among the
subsidiaries, the home office is required to exert great effort and expend resources to main
tain control. Political and economic risks from operating in foreign countries are likely to be
greater than those encountered when operating domestically. An example is the risk of natio
nalist expropriation. Most large oil company saw resources they controlled abroad expropri
ated and nationalized. These factors lead to foreign subsidiary risk and underperformance.
The Landscape of the Future

Pursuing global expansion depends on determining which regions in the world are most
attractive.7 By 2050, the distribution of the worlds people will be quite different than it
is today. In Europe, the population is expected to decline by about 9 percent, while in
Africa it is expected to grow by 120 percent. Within regions there is likely to be hetero-
geneity. Throughout the world, the movement from countryside to city is expected to
continue. By 2020, there are expected to be more than 30 mega-cities, many of them in
developing countries.
If the past provides a guide to the future, the pace of change will continue to be rapid.
By 2011, for example, there were more than one billion Internet users, but prosperity
spreads unevenly. It is accompanied by social and economic ills, population dislocations,
social upheavals, sickness, poverty, and debt. About a quarter of the worlds population
lives in poverty, and as many as one billion people are malnourished. In many parts of
the world, markets are underdeveloped, and it is not clear how to develop them, whether
through microfinancing loans tailored to help the poor, or outright aid.
The U.S. continues to be the worlds leading economic power, but will this trend con-
tinue? How quickly will lagging economies catch up and how? Who will set the stan-
dards for future economic growth? Will it be Asian countries or those in North America?
In 2007, five of the worlds 10 largest companies (Walmart, Exxon Mobil, General
Motors, Chevron, and Conoco-Phillips) were headquartered in the United States. (The
other four were Shell, BP, Toyota, and Daimler.) In 2015, the worlds four largest com-
panies were Chinese banks. The U.S. economy has weaknesses. It requires sufficient
early-stage venture capital to flourish. R&D has been moving outside the United States.
Technology alliances between foreign-owned firms and U.S.-owned companies have
mushroomed. Asian workers constitute a growing percentage of the worlds global R&D
workforce. Many factors have permitted nations throughout the world to begin catching
up with major industrial powers like the U.S.
Labor, Capital, and Technology

According to economists, labor, capital, and technology are the main factors that account
for differences in national economic growth rates. Labor consists of weekly working
hours, while capital is increments in investment minus depreciation. Labor can be aug-
mented by improvements in educational quality and work intensity, by increased capital,
and by better technology.
The productivity of people in the worlds different countries is affected by differences
in education.
Germany, for instance, is known for its high-quality scientific and technical educa-
tion and specialized training. It has distinctive industrial apprenticeship systems
that few countries can match. Japanese workers are known for their skills in sub-
jects such as mathematics and for their discipline, willingness to work hard, and
group orientation.
Japan has a large pool of well-trained engineers and excellent in-house company
training programs. Japans strengths in elementary and secondary education and in-
house training compensate for weaknesses in its colleges and universities.
Great Britain has an outstanding tier of people noted for their creativity, inventive-
ness, and independent thinking and their capabilities in areas such as pure scientific
research, but its overall educational system lags behind that of other countries.
Technical colleges have very low status in the U.S., and there are no well-developed
apprenticeship systems. The U.S. possesses very high-quality schools at the top, but
the percentage of students with science, technology, engineering, and math skills is
low. Public elementary and high schools in the United States have difficulty provid-
ing training in the sciences and mathematics as well as foreign languages. A major
U.S. strength is its openness to immigrants and its ability to attract talent from
throughout the world.
Investing in capital can partially make up for workforce quality. Economists have
found that the most significant predictor of economic growth is the accumulation of
capital, measured by investment in GDP. However, capital augmentation does not just
come from the replacement of old capital with new. It also results from the experience
and the knowledge that employees gain on the job and from the recombining and retro-
fitting of existing capital.
The Austrian economist Joseph Schumpeter argued that technical change plays a very
important role.8 New capital replaces old (creative destruction) in waves as particular
sectors (e.g., textiles, steel, railroads, automotive, and chemicals) dominate the world
economy at certain intervals, only to be replaced by other sectors (e.g., pharmaceuticals,
telecommunications, computers, and biotechnology).
Two kinds of technological change occur. Process technologies enable firms to improve
their ability to make goods and services, while product technologies are improvements in
the goods and services that are marketed to consumers. Historically, Japanese firms ex-
celled at process technologies, and U.S. firms excelled at new-product innovations. Amer-
icans, for instance, invented the videocassette recorder, but the Japanese lowered the costs
of manufacturingimproved the processso they could sell VCRs at low cost.
U.S. firms once managed the R&D process quite differently from Japanese firms, but
they have since copied much of what the Japanese do: deliberately creating excess infor-
mation and sharing it among horizontally and vertically linked groups outside and inside
the firm, regularly consulting vendors and subcontractors during the development pro-
cess, and overlapping development phases to speed up market entry and gain early con-
sumer information.
Technological improvement does not just come about because of technological push.
It also arises out of market demand. Japanese demand for compact, portable, quiet, light,
multifunctional products comes from the crowded living conditions and small plants,
offices, and warehouses throughout the country. These conditions led to innovations in
the use of materials, energy, and logistics. Pioneering in space-saving and just-in-time
production was necessary to meet the demands of Japanese consumers. Japans consum-
ers also are known to be sophisticated and quality-conscious.
Growth in the Japanese economy, however, has virtually stopped. Europe, too, is stag-
nant, and China is slowing down. Countries like Russia and Brazil, heavily dependent on
raw materials have not been sources of dynamic global growth. From where will future
growth come? Will it be India? Africa? The Middle East? Regardless, firms will have to
adjust the products they make, logistics, and manufacturing to new consumer demands.
Open Economies
In some countries, the domestic markets are not large enough to support cost-efficient
firms, but this weakness does not matter when the trade sector grows and becomes part
of global commerce. Countries such as Singapore, Thailand, the Philippines, South
Korea, Taiwan, and Indonesia have large trade sectors and have benefited. Economists
consistently emphasize that open economies perform better than those sheltered from
global competition.
Economists argue that increased world trade has allowed nations to concentrate on the
things that they do best (their comparative advantage), while trading for those things
that they do less well. The gains from such specialization have been mutual; as each na-
tion concentrates on what it does best, its trading partners consume a larger bundle of
goods than they could produce by themselves.
South Koreas growth has also involved heavy exposure to international markets, but
the South Korean government assumed control over the private sector with the purpose
of creating significant export-led growth. Inflows of foreign credit came to South Korea
from financial institutions such as the World Bank and International Monetary Fund.
Few other countries have had such a high dependence on foreign trade as South Korea.
The only comparable nations are Hong Kong, Singapore, and Taiwan.
Both Taiwan and South Korea made enormous strides in the postWorld War II
period, but they did so in quite different ways. Both had few resources, little arable
land, and high population densities. Both countries pursued export-led growth poli-
cies, but Taiwan was much less aggressive in protecting its domestic industries and
relied more on the free market. Similar to South Korea, Taiwan used a highly
educated, technically trained (more than one-third of Taiwanese students in higher
education study engineering), and enterprising workforce to make its advances, but
unlike South Korea it mostly financed its companies through equity markets. These
companies were mostly lightly leveraged and small. In comparison, South Koreas
large conglomerates, known as the chaebol, were highly concentrated and heavily
leveraged firms (e.g., Samsung, Hyundai, Lucky-Goldstar, Daewoo) that received
heavy government support.
Insecurity
Another important issue has been global security. Violent conflict has serious effects on
the global economy. It decimates populations, diminishes human and social capital, and
destroys physical infrastructureroads, power and communication systems, transport
links, public and private buildings, and essential physical assets. Corporations must
spend heavily to protect both people and property. Violent conflict destabilizes govern-
ments, reducing their capacity to fight corruption and making them less able to guaran-
tee contracts and more likely to impose exorbitant taxes. Because of violent conflict,
governments can be overthrown and replaced by regimes that can renegotiate the terms
under which companies operate. Though violent conflict adds to the dangers of doing
business and raises the likelihood that revenue streams will be curtailed or eliminated,
corporations have not stopped increasing their activities in many violent-prone nations
that have extractive natural resource-based industries, such as mining, oil and gas, and
forestry.
Firms can take a number of steps to mitigate the dangers of operating in violence-
prone nations. They can rely on the early warning systems that track structural condi-
tions such as social solidarity (religious and ethnic heterogeneity), economic
development, and government capacity. A mechanism companies can use to mitigate the
dangers is to hedge their bets. Companies may decide to invest in a guarded or step-by-
step fashion, diversify, and/or find partners before investing.
Youth
Since the role of young and educated people is an important factor in the development of
a countrys economy and society, their role must be better understood. Young and edu-
cated people can be divided into two main groups: The first group can be called Gra-
cious Living. This group is optimistic and entrepreneurial. It favors the opening of
societies and the introduction of cosmopolitan ideas from throughout the world. Another
group may be referred to as Disappointed and Disillusioned. This group has a far dif-
ferent orientation. These young people also tend to be educated, compared to others in
their society, and relatively well off, but they also are resentful, and they tend to believe
that they have no future and that there is little hope that things can get better.
Because of these differences between groups of youth, it is in the interest of companies
to help spread a message of confidence and hope. The combined message of skills, op-
portunity, and hope are emphasized in the bottom of the pyramid advocacy of such
strategic thinkers as Prahalad and Hart.9 Money can be made by providing essential goods
and services that poor people need like cell phones, health care, better nutrition, and en-
ergy. While the opportunity is great, the challenges in reaching markets at the bottom of
the pyramid are also substantial. The market serving the poor is not homogenous, nor
does it have well-developed infrastructure. Those at the bottom of the pyramid are found
in many different circumstances. They live in both rural and urban settings. In India, most
are rural, and their access to markets and Western-style purchasing environments is very
limited. In Latin America, they are predominately urban. They are packed into dangerous
slums of large cities. Different types of technology are needed to serve the varied seg-
ments of the poor. The solutions to the problems of the poor must be delivered at an af-
fordable price, but with so much variety, it is nearly impossible to reach the economies of
scale in terms of production and distribution that would enable reduced costs.
Nonetheless, the needs of the poor for the products and services (that people higher
up in the income pyramid take for granted) are great. These needs include communica-
tion, health, clean water, energy, food, hygiene, and jobs. To meet these needs, it is not
always possible to just copy or strip down the technologies used in developed nations or
wealthier markets; rather, adaptation is needed. To reduce costs and get these products
and services to the poor, significant innovation in product design, supply chain manage-
ment, inventory control, delivery, and post-delivery maintenance is necessary. If mass
production is not possible when people are scattered and carrying out their crafts in
separate locations, then virtual, as opposed to actual production, scaling must be intro-
duced to bring costs down and provide jobs. Information technology, if deployed in in-
novative ways, can be a useful way to bridge this gap.
For businesses, the benefits of moving in the direction of making cheap, high-quality
products and services available to the poor are not only to generate growth and profits, but
also to answer the critiques of stakeholders who question the purpose of businesses. Another
side-benefit of serving the poor is the chance to experiment with new concepts for which they
may not otherwise be taken seriously. It may be possible to transfer the innovations that are
introduced to serve the poor to more mainstream markets. An example is a very small fuel
efficient nano-car. If it can be made very inexpensive and even less energy consuming, it
could eventually be adopted in cramped urban settings by drivers of all economic classes.
Serving the bottom of the pyramid can be an inspirational goal of business that can
inspire young people to have greater confidence in the business system. Such confidence
is critical; it is a stabilizing force. If instability overtakes the world, the benefits of glo-
balization become more difficult to realize. Thus, corporations and governments of the
world must make the effort to educate the young and harness their drive, energy, creativ-
ity, and ambition. Many competing institutions are in conflict with todays nation-state
and test its capacity to maintain peoples loyalty. Nonstate and superstate actors abound,
some of them threatening to the state and some supportive. They include terrorist orga-
nizations like ISIS and Hezbollah as well as NGOs such as Greenpeace and the World
Wildlife Fund and supra-government organizations like the United Nations, the World
Bank, and the World Trade Organization. Along with corporations and governments,
positive and constructive global institutions must be enlisted to create a better world.
Summary Every aspect of strategic management has a global dimension: corporate performance,
the firms decisions about expansion and entering new markets, the external and internal
analyses managers carry out, the business-level moves they make relating to timing and
product positioning, and the corporate-level moves they make relating to mergers, acqui-
sitions, and divestitures. This chapter has provided reasons firms globalize with empha-
sis on the life cycle factors that take place with product maturation. It has discussed the
options for globalization, the product-market approaches, and the need for local adapta-
tion. It is critically important for a company to adapt to local customs when entering a
country. The nature of this adaptation has many dimensions, from delegating authority
to local managers to having local partners and following local customs. A company can
enter foreign markets in a variety of ways, including direct export, franchising, licens-
ing, greenfield operations, or joint ventures.
This chapter has shown how the CAGE framework and Porters diamond can help
shape a firms international strategy and better enable it to answer the question of where
to invest. These frameworks were applied to Mexicos U.S. border regions, where a re-
naissance in global manufacturing has taken place. Four global success factors have
been enumerated, including: does global expansion allow a firm to hedge economic risk,
can it benefit from differences in economic cycles, does global expansion yield increased
flexibility, and does it yield useful managerial and technical knowledge and compe-
tence? Various factors to consider in examining the global landscape of the future have
been discussed including the importance of labor, capital, and technology, open econo-
mies, global peace and violence, and youth.
Developed nations are mature markets. They may be saturated with the product a
company provides and thus be capable of less long-term growth. Will the future of the
global economy come from the pyramids bottom? This challenge is of utmost impor-
tance to anyone interested in global business.
Exercises for the Student

Select a publicly held firm that has global exposure, markets, and operations. Examine
their most recent Annual Report and Investor Presentations.
What appears to be the rationale behind their global efforts?
Are specific modes of entry discussed such as exporting, alliances or greenfield in-
vestments?
How would you classify their approach to the international scene: global, multido-
mestic, or transnational?
What risks have they identified related to their current globalization strategies?

Is your employer a global player?
Does it compete with or partner in any way with global competitors?
What are the benefits and the risks of your employers current global strategies
andtactics?
What are the benefits and risks of your competitions global approach?
Fast-forward five years. Do you see your company gaining or losing ground in the
international marketplace? Why?
What can be done now to improve long-term results?
Endnotes 1. M. Porter, The Competitive Advantage of Nations (New York: Free Press, 1990).
2. S. Zaheer, Overcoming the Liability of Foreignness, Academy of Management Journal 38,
no. 2 (1995), pp. 34164.
3. M. Porter, Competitive Strategy (New York: Free Press, 1980).
4. Kellogg Company and Wilmar International Limited Announce China Joint Venture,
September 24, 2012, http://newsroom.kelloggcompany.com/2012-09-24-Kellogg-Company-
And-Wilmar-International-Limited-Announce-China-Joint-Venture.
5. David Phelps, Exporting Retail Brands Can Be Tough Sell, StarTribune, February 26, 2011,
http://www.startribune.com/exporting-retail-brands-can-be-tough-sell/116947673/.
6. The Colonel Comes to Japan, Enterprise Series, Learning Corporation of America Video.
7. A. Marcus, Strategic Foresight: A New Look at Scenarios (New York: Palgrave MacMillan,
2009).
8. J. Schumpeter, Capitalism, Socialism and Democracy (New York: Harper, 1975) [orig.
pub.1942].
9. C. Prahalad, The Fortune at the Bottom of the Pyramid: Eradicating Poverty Through Profits
(Upper Saddle River, NJ: Wharton School Press, 2006); and S. Hart, Capitalism at the Cross-
roads. (Upper Saddle River, NJ: Wharton School Press, 2007).
C H A P T E R S E V E N
Innovation and
Entrepreneurship
What good will it do to follow the rules when some companies are
re-writing them? Shackled neither by convention nor by respect for
precedent [the rule breakers] are intent on overturning the industrial
order. They are the malcontents, the radicals, the industrial revolutionaries.
Never has the world been more hospitable to industry revolutionaries
and more hostile to industry incumbents.1
Gary Hamel, professor, Woodside Institute

Exploring the rationale for innovation and entrepreneurship.
Examining forms of innovation and entrepreneurship that allow organizations to thrive.
Understanding the innovation processfrom opportunity identification through value creation.
Explaining the factors needed for successful innovation and entrepreneurship.
Identifying barriers to innovationincluding risk and uncertaintyand presenting processes designed
to overcome these barriers.
Introduction
Firms must be able to innovate and initiate change; however, they are generally conser-
vative, and for good reason. Few new undertakings yield positive returns. Even fewer
become highly profitable. Honestly calculating the expected costs and benefits before-
hand is almost certain to diminish the ardor for innovation and entrepreneurship. Yet, the
threat of disruption to any existing product offerings, consumer experiences, and busi-
ness models is great. Without innovation and entrepreneurship, all of the moves dis-
cussed so far in this book (positioning; mergers, acquisitions, and divestitures; and
globalization) are likely to be undermined eventually.
157
Though most firms go to great lengths to ballyhoo the importance of innovation and
entrepreneurship, few are really good at these activities. The number of failures they
experience is many times the number of successes. Only a minority of firms seems to
have truly mastered the innovation process. Many flounder. They initiate short-term ini-
tiatives that tap into their employees creativity but fail to do sufficient follow-up to en-
sure that these initiatives are successful. Rather than their breakthroughs being an
outcome of a reliable process, they are often attributed to the outstanding efforts of indi-
viduals, or to sheer luck. This is not a sustainable approach to innovation.
This chapter explores not only the deep-seated reasons firms must innovate in the
turbulent environments in which they operate, but also the processes for innovation and
entrepreneurship that make these activities more reliable. The risks and uncertainties
inherent in any effort to bring about change for the better are apparent. This chapter sug-
gests what can be done to mitigate, contain, and control these hazards. It highlights the
barriersinternal and externalthat stand in the way of commercializing ideas with
promise and suggests how they might be overcome.
Reasons for Innovation and Entrepreneurship

Confidence in a static world is misplaced. Customer loyalty cannot be guaranteed. Tech-
nological advancements offer an unending wave of better, faster, and cheaper products
and services. Rivals, substitute products, and new entrants rely on these continual
advancements, using new and improved offerings to make inroads and steal away cus-
tomers. Disruption is everywhere. Grappling with uncertainty is essential. As a result,
firms pursue innovations that range from minor, incremental improvements to signifi-
cant, seismic shifts (see Exhibit 7.1).
EXHIBIT 7.1
Incremental
Improvements Minor Incremental Improvements Major Seismic Shifts
and Seismic
Shifts
Focus on more efficient Focus on total reinvention

processes or additional Drastically modified lineup
features of offerings and value capture
Same basic product and Entirely different target market
service lineup Must build/buy both
Same customer base capabilities and customers
Focus on market presenceawareness Focus on internal startups or M&A

and distribution capabilities of existing New product and service mix
value proposition Existing target markets
Same basic product and service lineup
New market channels, demography or
geography
Chapter 7 Innovation and Entrepreneurship 159
EXHIBIT 7.2
Downsizing 1 Load 47 Loads
Bubble Wrap
=
iBubble Original
Bubble
Wrap
Incremental Changes
Sealed Air Corporation provides an example of incremental change.2 The producer of the
iconic Bubble Wrap (see Exhibit 7.2) recently rolled out a revamped version of its signature
product dubbed iBubble, which it is selling in flattened sheets that shippers inflate when
needed. With the surge in online shopping and, consequently, shipping and the advent of
consciousness of space of online global retailers, the firm saw the opportunity of moving
away from giant air-filled rolls. The iBubble product occupies far less warehouse space
than Bubble Wrap, and it can be shipped economically outside of a 150-mile radius. By this
change, Sealed Air hopes to re-inflate its iconic brand, which had suffered share losses.
The recreational vehicle industry provides an example of a more significant change,
with Polaris moving beyond its heritage of making snowmobiles and expanding into a
broad range of utility vehicles. It now makes machines for use in factories and by the
military, going beyond its reliance on the consumer market. It also detected new global
trends in motorcycles and capitalized on the opportunity to serve motorcyclists around
the world. With these changes, it has broken sales records in contrast to its main rival
ArticCat whose pace with regard to new product introductions is more plodding. Polaris
is typically on the third or fourth iteration of a product by the time ArticCat can launch
its first iteration. Polariss returns to shareholders, as a result, have soared. ArticCat in-
ventories have swelled, and it regularly sustains losses. To refresh the companys product
pipeline, its management must remove excess inventories before it can innovate.
Seismic Shifts
The development of the iPhone and the iTunes/AppStore ecosystem signaled a seismic
shift for Apple. It cannibalized the firms prior iPod products and made accessible a per-
sons e-mail and the Internet in a single place and combines a camera, media player, and
the capacity for GPS navigation with the functionality of digital assistant, as well as an al-
most limitless number of downloadable applications that can personalize the experience
and further enhance the products usefulness. Throughout the world, this product has revo-
lutionized p eoples habits as the smartphone has become an extension of their everyday
decision making and has even begun to organize their lives.
As a result, Apples smartphone innovation was quickly succeeded by similar offer-

ings from other companies, such as HTC and Samsung. The introduction of the iPhone
vastly increased Apples revenue and the valuation of its stock. Not to be outdone,
Google quickly responded with its Android software, which competes with iOS in the
devices other smartphone makers produce.
That Apple, and not some other company, would achieve this breakthrough was not a
given. In 1999, the Japanese firm NTT DoCoMo released a smartphone that had 40 million
Japanese subscribers. However, NTT DoCoMo did not follow up, improve the product,
and introduce it globally. In fact, Apple had many worthy and capable competitors in the
PC, cellphone, wireless services, and software businesses. Companies like HP, Dell,
Lenovo, Toshiba, Sony, Intel, IBM, Acer, Samsung, Nokia, Motorola, E ricsson,
Blackberry, AT&T, Verizon, Sprint, T-Mobile, Google, and Microsoft could have gone
in this direction. Almost all of these firms were aware of the opportunity. Nokia,
Motorola, and Blackberry to some extent had started to develop smartphones. Yet only
Apple, and to a lesser extent Google, with Samsung as its main partner, succeeded in
making smartphones a worldwide phenomenon.
These other firms did not act quickly enough. By selling smartphones, Dell and Acer
made feeble, but ultimately futile, attempts to challenge Apples dominance. They suf-
fered setbacks, retreated, and became different companies than they were before. HP
ultimately laid off more than 100,000 of its workers partly as a result of its inability to
enter the smartphone market, as did many other companies. Almost all these companies
also had to restructure. They were acquired (Motorola), went private (Dell), divested
critical units (Nokia and HP), or made other moves in an effort at revitalization.
Apples triumph left many victims in its wake. The survival of Blackberry and Acer
has been in jeopardy. To the extent that these companies continue to exist, they exist in a
significantly diminished way. These once-indomitable phone giants have become shells
of their old selves. Would anyone bet on their comeback? Microsoft and Intel tried, and
continue to try, to catch up with what Apple started, but so far they have not been suc-
cessful. AT&T, Verizon, and Sprint get by because they are part of the smartphone
ecosystem and deliver service plans and devices to customers.
The stakes are high. Races to make good on the next technological innovation put vast
pressure on firms. The winners may take nearly all the spoils. The failure to embrace in-
novation can be deadly for many companies. Remember Blockbuster stores and Kodak
films? Blockbuster, underestimating the potential impact of the Internet on the entertain-
ment industry, declined the opportunity to purchase Netflix for a mere $50 million in 2000.
By 2014, Blockbuster had ceased all operations, while by 2015 Netflix was valued at over
$47 billion. Kodak, the inventor of digital technology, also lost out. It feared the cannibal-
ization of its film business, giving up on the development of digital cameras after its first
offering was met with a lukewarm reception.
Both Incremental Changes and Seismic Shifts

Apple recognizes that seismic shifts alone are not sufficient. It needs to make some in-
cremental shifts as well. Its better to self-cannibalize than to have a rival do so. iPad
tablets impacted Mac laptop sales, and larger iPhones nibbled away at older and smaller
iPads, but Apple did not stop introducing products that replaced what it already sold.
Even a firm with as revolutionary a past as Apple must continue to regularly engage in
incremental innovation.
As Apple has pursued the growth of its iPhone line, it has made small adjustments to
the iPhones dimensions, displays, cameras, and processors. It has penetrated new geo-
graphic markets with this product, while the basic product and the competencies required
to build and market each subsequent version remain the same. For example, when selling
iPhones in China, Apple makes but small concessions and modifications for the Chinese
consumer. It designs, sells, and markets the same type of smartphone with the same type
functionality as it does in the U.S.
Today, Apple is on a continual search for the next seismic change. Its long-term
growth targets cannot be fully satisfied with small enhancements in its current product
lineup so it continues to launch products such as the iWatch and ApplePay. The perfor-
mance gap between growth that can be attained with existing offerings and the expecta-
tions that investors have of Apple is too great.
Thus, all companies need to pursue incremental innovation and seismic shifts simul-
taneously. They should rely on familiar products and technologies for their growth while
at the same time placing bets on unfamiliar markets and unproven technologies. These
are hedges against an uncertain future. Regardless of how the future evolves, a company
must be ready for it. This approach to the uncertainty of what comes next is found in
almost all business sectors and markets. Whether a company is in pharmaceuticals,
entertainment, software, or bookselling, finding big hits is incredibly lucrative, yet the
search for them also leads to dead ends and the need to continuously exploit existing
hits for whatever remaining value they have. Pharmaceutical firms will capitalize on
the full lifespan of their patented formulations while spending millions in the lab to
achieve the next break-through. Hollywood studios will extract as much revenue as pos-
sible from replays of their old TV shows on cable TV while they pilot new offerings with
the hopes that one will become a blockbuster hit.
Will the Apple Watch gain sufficient traction to justify Apples development costs
and the marketing expenses, or will it be a bust and will Apple mainly be dependent on
modifications of the iPhone for its future revenue? The same question can be asked
about whether Apple Pay survives the battle for primacy in the point-of-sale payment
space. This question can be extended to Apple Music and how it fares versus Spotify and
Pandora. The jury is still out on all these questions, yet Apple still has the iPhone on
which to fall back. These innovations represent Apples attempt to keep demonstrating
that it is a leader. Companies must take advantage of what they have been good at in the
past by making incremental improvements but cannot rest on their laurels; rather, they
must show the potential for continued dynamism and growth.
The Process of Innovation

Races to make good on the next technological innovation are not just about technology.
Rather, and more importantly, they are about incorporating diverse technological possi-
bilities into new business models. The iPhone was not a success simply because of its
touch navigation technology but because of the extensive eco-system of applications that
surrounded it that made this technology so useful. Thus, it is not technologies themselves
that lead to the most seismic of shifts and wide-scale adoption but it is the business mod-
els behind them. Given the complexity involved in molding together new technologies
with new business models, only a few firms carry it out well.
Every successful innovator needs an innovation ecosystem that will promote and pro-
pel growth. Without such an ecosystem, it is highly improbably that ideas will gather
enough momentum to evolve through the stages of introduction/initiation, growth, and
product maturity. Some new businesses achieve sustained growth in just a few years,
while others may take half a century or more to take off.3 Yet, some new ventures never
get to the point of sustained growth, or the process unfolds over a very long time with
great frustration, companies exiting the scene, and turnover and loss of interest among
those who have been involved.
Therefore, an innovative eco-system wherein new business models can best develop
consists of at least four elements:
1. Passionate and determined innovators.
2. Organizations that can make their ideas a reality.
3. Financial backersinside and outside these organizationswho recognize the ideas
commercial potential and back new ventures through the setbacks and impediments
they inevitably experience.
4. Positive governmental support.
With these elements in place, a new idea has a greater chance of gaining widespread ac-
ceptance in the marketplace.
Passionate and Determined Innovators

Innovators must be persistent and have considerable commitment if they are to suc-
ceed. The difficulties they face are great. They include dealing with the competition,
accessing capital, and hiring and training a talented, dedicated cadre of workers to
whom they must provide sufficient rewards to assure ongoing commitment. Innovators
must also understand government regulation, taxes, and requirements that impinge on
their ventures success. The numerous obstacles to success deter many from taking on
this role. As shown in Exhibit 7.3, the endpoint is not necessarily success, or failure.
Prolonged gestationa state of neither complete take-off nor complete failurealso
is possible.
Persistence in an innovative endeavor is especially necessary between the time of an
ideas take-off and its sustained growth. During this period, the founders or their succes-
sors have the challenge of sticking with it and maintaining their commitment even
though their business is not meeting expectations. Often innovators must be stubborn
dreamers who cling to their ideas despite the fact that the odds seem stacked against
them. They have to be risk takers who take on risk in anticipation of high rewards.
Those who start new businesses must try to minimize the risks. Thus, they often
commence their businesses in niches they already know well from previous experience,
take on seasoned partners, obtain advice from well-regarded financial backers, or begin
as franchisees of larger firms that provide them with proven business models.
Innovators must carry out many tasks at once. They must establish record-keeping
systems to track revenues and expenses; set up contracts with suppliers; price, advertise,
EXHIBIT 7.3
Business
Evolution Take-Off
Short of Take-
Sales
Off
Prolonged Gestation
Time
Initiation Start-Up Shakeout Maturity Decline
and market the product or service; get feedback from early customers to improve quality;
acquire a physical location and needed furnishings, machinery, and equipment; hire,
manage, and staff the businesss employees; develop efficient operating processes; and
understand legal requirements.
They require a convincing business plan. To get funding they must have one, whether
they follow it precisely or not. The plan describes the business and has an external
analysis that covers such essentials as suppliers, customers, and competitors; an inter-
nal assessment of the businesss capabilities and its functional plans; an implementa-
tion schedule; an end-game strategy that indicates when the business will be profitable;
financial projections; and a risk analysis. Linear movement toward a well-defined goal
is rare. Innovation requires adaptation and learning. Simple planning is not likely to
work well.
Innovators also require creativity, intuition, and the ability to make on-the-spot
choices without too much formal analysis. However, it is possible to exaggerate the ex-
tent to which innovators are not deliberative and rational and to glorify and romanticize
their illogical, seat-of-pants decision making. To the extent that they apply and employ
known methods, these actually tend to be experimental ones. They use what amounts to
the scientific method to test hypotheses and learn from their experience. Innovators also
often rely on bootstrapping or bricolage; that is, they make do with the means or re-
sources at hand, rather than having all the means and resources they need from the start.
Each endeavor an innovator begins is likely to be a bit idiosyncratic. Each differs some-
what and is likely to involve a degree of improvisation.
Many ideas show promise but fail to take off. Others take off but hardly expand.
Getting to sustained growth when a business can endure over the long haul requires
critical mass and momentum. Average time for a business moving from initiation to
sustained growth has been estimated to be 29 years, with a standard deviation of
15 years.4 Typically it takes many more years for a business to gain momentum than
the founders and initial innovators anticipate. This group does not always have the
skills, determination, or will to overcome the setbacks.
Inexperienced innovators lack requisite skills. New players must be found to take a
venture to the next stage. If they are not found, abandoning a business between initia-
tion and take-off may happen even if an idea has intrinsic promise.
New ventures fail for many reasons. Among the most common are inadequate cus-
tomer development and lack of market knowledge and market planning.5 Reasons for
abandoning a venture include few customers, technological glitches, waning financial
support, and/or negative cash flow.
Many types of people have taken on the role of innovators. As opposed to working for
a large organization, there are personal reasons individuals have for pursuing this role.
They can range from a desire for more autonomy to the potential for great personal wealth.
Intrinsic rewards can drive the individual down an innovative path as well as extrinsic
ones. Some individuals find pleasure immersing themselves in new endeavors, solving
problems, building organizations, and providing opportunities within their communities.
They feel that as innovators, they have more freedom to engage in such pursuits. Some
innovators lack formal degrees or other credentials and find it difficult to thrive in large
organizations. This type of person can be a classic inventor/entrepreneur, one who is not
likely to be interested in managing a business if it becomes big.
Some people specialize in innovation, eventually becoming serial innovators who go
after one business opportunity after another and then sell ventures to other companies
and pursue new opportunities instead of managing existing ventures. Dean Kamen is an
example of this type. A college dropout, Kamen holds more than 150 U.S. and foreign
patents, many of them for innovative medical devices. While still a young man, he in-
vented the first wearable medical infusion pump, which rapidly gained acceptance in
diverse medical applications. In 1976, he founded AutoSyringe, Inc., a medical device
company, to manufacture and market these pumps, but at age 30, tired of managing what
was becoming a big business, he sold AutoSyringe to Baxter. Since then, he has worked
on a number of business ideas for larger companies, a dialysis machine for Baxter, and a
patient mobility system for Johnson & Johnson. He is also the developer of the Segway,
the worlds first dynamically stabilized, self-balancing human transporter guided by the
riders natural motions.
Organizations That Transform Innovative Ideas into Reality

Organizations that transform innovative ideas into reality must be willing to support in-
novatorsthose individuals who identify valuable opportunities, understand how to as-
semble the resources and capabilities needed to derive benefit from them, and launch
new ventures despite the inherent uncertainty. Organizations of this nature do not wait
for change to happen to them. Rather, they act to initiate the process by encouraging this
type of individual. Yet, there is no simple formula for doing this. Different innovative
ventures combine different qualities in different ways. It is within organizations of some
kind that business plans and strategies are created and ideas are marketed, made into
attractive business propositions, and brought to customers so they can be widely adopted.
Though small companies employing fewer than 500 people account for a large propor-
tion of innovative activity, the role large corporations play is significant as well. Organi-
zations use structural measures such as venture capital funds, spinouts, incubators, and
business development centers to enhance their entrepreneurship. These can lead to such
results as high R&D as percentage of sales, new product introductions, and basic innova-
tions in business models. However, oftentimes, these measures do not fully capture
firms innovative activities.
Some organizations have more innovative corporate cultures than others. Their strate-
gies incorporate innovation as a key theme. Examples of companies that tout their com-
mitment and have been recognized for their contributions to innovation include Google,
Apple, Gilead Sciences, Virgin, Tesla, Cree, and Kickstarter.
Still, all companies must balance exploration (risk-embracing search and discovery of
future opportunities) with exploitation (a more risk-averse, approach which favors incre-
mental change). As pointed out in earlier chapters, exploration and exploitation require
different organizational structures, systems, skills, styles, and processes. In many firms,
exploitation drives out exploration. For other organizations, it is hard to carry out the
two activities simultaneously.
Small firms or small units or groups within large firms, therefore, more often tend to
be the home for innovation than large firms or big units within large firms that already
have well-established business models, structures, and processes. Innovation within
large firms must overcome obstacles. Large firms have entrenched rules, routines, and a
dominant logic, as opposed to small ventures that can create new rules, new routines,
and a new dominant logic.
Nevertheless, as Gary Hamel argues, every company has revolutionaries.6 These
people are likely to be found among the young and among newcomers at the bottom of
the corporate pyramid, where there is more diversity. They are often to be found on the
margins, for instance, in foreign operations, where groupthink is less prevalent. Closed-
minded decision making at the top stifles those on the periphery. For managers who
wish to jump-start innovation at a firm, it may be necessary to remove people from their
usual setting. For instance, holding off-site meetings with a group of recognized cre-
ative, critical thinkers may fire employees up emotionally and make their innovative
initiatives contagious.
Internal cultures that support innovation tend to encourage personal growth and risk
taking. In such cultures, top management supports innovation, and there also are organi-
zational champions below. Teamwork and collaboration are encouraged. For innovation
to succeed, hierarchies cannot be so overwhelmingly strong as to suppress it. The ap-
proval process for starting work on new ideas must be partially decentralized. The focus
should be on learning, and employees given time to pursue individual projects. Stress in
innovation pursuing organizations tends to be very high. Rigid bureaucracies, authoritar-
ian leadership, and harsh penalties for failure tend to discourage innovation. An innova-
tive company must tighten up its approach to market an innovation before competitors
do. Organizational characteristics needed to generate new ideas are not necessarily the
ones needed to implement them and make them successful business endeavors.
The Performance/Innovation Gap

Organizational dissatisfaction often motivates innovation within companies. It stems
from two sources: a companys strategic goals and financial results. If a firm is lagging
behind its industry in market share, brand recognition, customer satisfaction, or profit-
ability, it may become highly motivated to close the performance gap via innovation.
However, innovating is not the only choice open to such an organization. It must compare
the potential of further exploiting its current business undertakings with the potential
that might be achieved were it to innovate. If it can get by with its current offerings and
EXHIBIT 7.4 Performance Goals

Innovation and
Performance
Gaps
n Existing Potential
va tio
In no
Current Goal
Year Year
does not have to endure the uncertainty of innovation, where the returns might be higher
but are less sure, it may opt out of pursuing new directions.
Logic would dictate that the larger the performance gap, the greater the need for more
fundamental innovationand the further innovation efforts will take an organization
from its core (see Exhibit 7.4). However, big gaps between a firms goals and its current
performance require giant leaps with unknown outcomes. Smaller gaps can be filled by
incremental innovations, whose results can be better anticipated. As pointed out, incre-
mental innovations can utilize the firms existing resources and competencies and thus
are typically easier to carry out. Noncore efforts greatly increase the percentage of time,
effort, and resources needed to innovate.
Organizations with large performance gaps, moreover, often do not have the resources
to make the gigantic leaps they need to make to survive. AMD is an, example. In 2014
and 2015 it kept losing money, yet to end this downward spiral and make a leap forward,
it needed to garner enough resources, which it did not have. AMD has been stuck. It
needs the resources to make a large leap forward and yet its performance has been too
weak to assemble such resources. Thus, it has been in a downward spiral from which it
has been very hard for it to escape.
Thus, large leaps forward may be left to organizations with greater resources to pur-
sue them. However, the organizations that have the resources to make seismic shifts
typically have not experienced sufficiently large performance gaps. Their motivation for
going beyond incremental change is not great. Inertia is greater in these organizations,
and therefore, innovation is stifled because organizations most able to make far-reaching
changes have little interest in taking on these ambitious tasks.
Patient Capital
The capital that supports new ideas must be patient. Short-termism can quickly derail
innovation-based strategies. As shown in Exhibit 7.5, short-termism has derailed
innovation at Procter and Gamble (P&G), one of the worlds largest and most suc-
cessful firms.7
Large corporations, like P&G, must invest in new ventures. They need to spend
retained earnings on R&D and market research, and provide employees the opportunity
EXHIBIT 7.5 In 2000, P&Gs CEO Lafley sought to increase the rate of new product development by collaborating with outside
Short-Termism partners who could assist in areas like packaging and product design. These partnerships gave P&G access to
at P&G important technologies, such as Sedermas wrinkle-reducing formulations. Sederma became a key ingredient in
P&Gs best-selling and highly profitable Olay Regenerist line.
Lafley stumbled, however, when he assigned new product development efforts to business unit heads, each of
whom had immediate profit concerns. By 2008, sales of new P&G launches fell by half, fewer than six break-
throughs were made per year, and the innovation process had devolved into a series of incremental adjustments
to the current product line-up.
Bob McDonald, who replaced Lafley in 2009, recentralized R&D, but P&G still struggled to regain its innovation
momentum. Lafley came back, but revenues and profits continued to slide. P&G insider David Taylor then took
the helm.
The revolving door in the executive suite shined a spotlight on the key issue: the dearth of innovation, which hurt
the companys premium pricing strategy. Customers only paid a premium for cutting-edge products.
Over the years, P&G had delivered a lineup of outstanding innovations. For example:
First synthetic detergent Dreft (1933)
First fluoride toothpaste Crest (1955)
First stackable chip Pringles (1968)
Superior floor cleaning process Swiffer (1999)
However, P&G had become conservative and was held back from introducing bold new concepts by the need to
satisfy investors quarterly profit expectations. The corporation no longer demonstrated strength in innovation
because of its focus on meeting Wall Street goals.
Competitors advanced at its expense. Unilever, with R&D spending very close to P&Gs, greatly accelerated new
rollouts showing a clear innovation process advantage, while Henkel AG, a German-based multinational that
competed in both consumer and industrial brands, surpassed P&Gs R&D spending.
As of June 2015, P&Gs revenues and profits continued to shrink, and many of its biggest hits were at least a
decade old. Weak innovation left P&G with some the tough choices regarding cutting costs to free up funds for
innovation and spinning off noncore businesses.
to develop new entrepreneurial ventures. Yet, the impact of leaders whose focus is solely
on maximizing share price in the short term all too often cripples innovation efforts.8
Innovation needs ongoing corporate support over the long term.
Other Funding Sources for New Ventures

In addition to corporate funding for innovation, new ventures can rely on four other
sources:
Innovators use personal fortunes and contacts to get them started.
Commercial banks provide loans. In developing countries, where stock markets are
weak, they tend to be a very important source of venture formation.
Venture capitalists can take an equity position in a business.
If an idea shows considerable promise, an initial public offering (IPO) of the stock
may be issued to raise additional funds. Working with an investment bank, a firm a
draws up a prospectus and presents it to potential shareholders.
Often more than one of these methods is used to propel an innovative idea from
startup to take-off. Personal funds, coupled with those of friends and family, are often
required at the earliest stages. Banks and other sources will engage only when a concept
is proven. Its also important to note that there are often multiple rounds of funding
throughout the life cycle of a firm. Therefore, continuously demonstrating progress to
the ventures backers is a key to maintaining the flow of resources that startup enter-
prises need. The pressure is high because the proof is in their performance.
However they are funded, innovators need patient backers, but funding sources,
whether inside a corporation or outside it, tend to ebb and flow depending on many fac-
tors, including the overall state of the economy. The economic downturn at the end of
the first decade of the 21st century was not hospitable to new ideas. If backers are not
patient, they can kill ideas that are just starting to show promise.
Government Support
Governments play a large role in determining whether new endeavors succeed. They
may carry out the R&D on which an innovation is based, help fund the activity, or their
help can come in other ways, such as subsidies, standards, or a favorable infrastructure.
Conversely, haphazard and unpredictable government policies also can harm innova-
tions progress. The rationale for the involvement of governments is that the payoff to
societynew jobs, and new industriesis greater than that to any individual investor or
company. Innovation, and entrepreneurship therefore would be underfunded without
government involvement. Rational individuals and firms would forgo the effort, because
they could not appropriate all the benefits on their own.
Virtually every country in the world has policies to encourage business startups.
Germany, Switzerland, and Japan once used mainly market-driven approaches, while
the United States, United Kingdom, and France relied more on top-down approaches
closely associated with the military. The U.S. governments postWorld War II tech-
nology policy nurtured more than 700 national labs that supported basic research for
both military and civilian purposes. The government also funded research in many
U.S. universities and private labs. The United States tended to be a leader in basic re-
search, but it started to lag behind other countries in applications. Since the research
effort did not result in enough commercial products, Congress showed less willingness
to pay for it. Instead, it increased financing for the commercialization of technologies
that already showed promise.
As a result, the federal labs started to switch from basic to applied research. Many had
cooperative R&D arrangements with private companies. The National Institute of Stan-
dards and Technologys (NIST) Advanced Technology Program (ATP) gave grants to
companies that developed promising but risky technologies. The amounts it gave were
relatively small. The companies had to be able to convince NIST that the ideas had tech-
nical merit and practicality and that they could be exploited commercially. The Com-
merce Department also had a strategic partnership initiative in which innovative
companies that produce new technologies had the opportunity to meet potential custom-
ers. The funding by the Defense Advanced Research Products Administration (DARPA)
served dual purposes, both military and commercial. The Pentagon, though, was the
largest funder of research in the U.S., the results of which have had a positive impact on
the civilian sector.
New products can be greatly helped by government supportand equally damaged

when support is uncertain. Technological innovations that have received highly benefi-
cial support include:
The Internet, GPS, and Siri were beneficiaries of the DARPA program.
Various vaccines and the Human Genome Project obtained funding from the National
Institutes of Health.
iRobot and Symantec received grants from the governments Small Business Innova-
tion Research Program (SBIR).
Financial assistance and regulatory policies, however, quickly change based on
changes in the political climate. Long-term government funding is in no way guaranteed.
Political interest can quickly wane. Lobbyists for special interest groups affect the distri-
bution of government dollars. The government funding game is highly dynamic and
uncertain and the winners and losers are not clear. Funding is just part of the story, as
government also impacts innovation through myriads of regulations.
The Business Model

Many inventions are packaged into single products or services. A product or service
requires the assembling of diverse inventions into useable form. The assembling of
diverse inventions into useable form distinguishes mere invention from innovation.
Simply creating a new product or service out of a bundle of patents is not sufficient.
The new product or service must rest on an innovative business model designed to
bring the product or service to a broad consumer base; otherwise, the investment
costs of an organization do not justify the development costs of the new product
or service.
Inventions, innovations, and an organizations business models are different.
Acompanys patent portfolio is considered its inventions, which are not the same as a
full-scale innovation.
Invention is the creation of a new idea or process, usually in a laboratory. It is a test
of the principle involved, an act of technical creativity in which a concept that may be
suitable for patenting is described. Many inventions, though, go nowhere. They are
patented and accumulate as intellectual property without much commercial benefit.
That is why innovation is so much more important than invention.
Innovation is the process of trying to put inventions into widespread use. It is the ef-
fort to commercially exploit inventions for an organizations benefit. Yet no matter
how promising new technologies may be, many fail to be adopted in a wide-scale
way because they do not have a full and well-developed business model for their
wide-scale use and rapid diffusion.
The aim of the business model, therefore, is to stimulate the innovations rapid adop-
tion. For a product such as the iPhone to gain mass appeal, it must be vigorously
promoted, advertised extensively, and reviewed in appropriate publications and me-
dia outlets. A way to shop for the product and buy it must be created.
Inventing a product is just the first stepand a meaningless one if not followed by a
comprehensive process of advertising and physically getting the product to the customer.
In itself, business model innovation can be lucrative for a company. Consider Dells
initial business model, which eliminated the reseller. The company was not a technology
leader. It was an assembler of other companies technology and a broker between suppli-
ers and customers. Its innovation lay in its business model. Similarly, Trader Joes has a
unique business model, which mixes a gourmet deli with a discount retailer. It is not a
technology leader. The success of Internet banks does not come from technology they
use, but rather from an innovative business model, which increases customer access and
volume because these banks are open around the clock and can be accessed from a per-
sonal computer or even a mobile phone.
Technology does not guarantee success. Success comes from a capacity to convert
technology into profitable business models. Profitable business models rely on deter-
mining the types of business opportunities to pursue, vetting the ideas that are generated,
forming a team to pursue prototypes and pilots that are selected, and scaling up and roll-
ing out new business models to the broader world.
Determining the Opportunities to Pursue

Aspiring innovators at different levels within a firm (so-called intrapreneurs) and outside
of the firm (entrepreneurs) regularly generate new business ideas. They identify promis-
ing opportunities in the course of their everyday activities or by means of careful and
prolonged search processes. The number of new business ideas that such individuals
identify, though, always exceeds the number that can be competently carried out. Very
few of these ideas generate sustained revenue for organizations and become widely dif-
fused in society.
The path to successful commercialization of new business ideas typically starts with
some type of dissatisfaction with the status quo, and, as indicated, the process does not
necessarily follow a logical path. It is filled with trials and errors, false hopes, and
dashed expectations. Different opportunities for commercialization constantly compete
with each other within organizations such that organizations do not know where to turn.
On which options should they focus? Where should they bet their talent, money, and
expertise? Innovation is an investment decision in which the choice of how to allocate
scarce resources is vital. To what extent should an organization hedge the risks by bet-
ting on many options? On the other hand, to what extent should it maintain an unwaver-
ing focus on a single or just a few options? Once there is a clear understanding of the
extent of resources available for innovation, the organization must decide which types of
the many opportunities that exist to pursue.
Many firms struggle to identify these opportunities, or end up chasing after too many
options and not giving a single one the necessary amount of focus and attention. A
disciplined approach may work best using the following lenses as a guide to decision
making as they can help organizations generate ideas that best align with their external
opportunities and internal capabilities.
External Sources of Opportunity

Can the organization capitalize on various macro-trendsdemographic, regulatory,
social, or other changes that are occurring?
Every time a new regulation is introduced, a flood of firms offering administrative

services rushes in. When Sarbanes-Oxley (SOX) was introduced to protect investors
and improve the accuracy of public disclosures, SOX experts came out of the wood-
work, and software developers raced to develop software-as-a-service (SaaS) solu-
tions to facilitate compliance. The passage of the ACA (Affordable Care Act) had a
similar impact on the market for health carerelated compliance specialists and soft-
ware applications.
Changing demographics also can create significant opportunities. For example, there
has been a recent rise in home health care options. Baby boomers are aging, while
costs of institutional care are skyrocketing. Successful home health services organiza-
tions tap into this problem. They allow the elderly to retain independence and remain
in the comfort of their homes for as long as possible. Firms that can capitalize on
macro trends have an advantage in generating revenue and profits from innovation.
Firms need to expand their horizons and embark on global learning about evolving cus-
tomer perspectives in order to generate industry-leading ideas. Many firms have limited
human interaction across channels and borders. Broad, on-the-ground, and face-to-face
customer exposure is a significant source of ideas and inspiration. What are the plans
and unmet needs of key customers? The majority of new product and service ideas seem
to arise from consumers problems or pain points. Where the consumer suffers pain,
the innovator seeks a solution and begins vetting the opportunity. Exhibit 7.6 provides
some examples of consumer pain that have been resolved via innovation.
Market need must also be considered in tandem with the latest technological
progress. Opportunities rest on market pull and technology push. Will the application of
new technologies allow organizations to alleviate customer problems in ways that are
better, faster, or cheaper than competitors?
An example of market demand and technological capability coming together may
be found in the widespread adoption of mobile devices coupled with the Internet of
Things. This confluence of technology and customers has the potential to make every-
day life more and more convenient. Appliance makers tout functionality that allows a
EXHIBIT 7.6 Decade Pain/Problem Solution/Opportunity

Customer
Pain as 1970s Dragging heavy luggage through an airport Wheeled bags of various
Innovation shapes, sizes and lightweight
materials
Opportunity
1970s Appointments and long waits for basic/repetitive auto work Fast tire/oil change facilities
1980s High-cost and time-consuming maintenance required of Disposable, soft gas permeable
permanent contact lens wearers lenses
1980s Phone access limited to home, business or coin-operated Mobile phones
phone booths
1990s Difficulties sharing and updating research The World Wide Web
1990s Bulky, outdated paper-based map books Global positioning systems
2000s Limited consumer knowledge/power about retailers, Online product/business forums
restaurants and other service providers and rating sites
2000s Health issues stemming from sedentary lifestyles Treadmill desks and wearable
fitness monitors
2000s Inconvenience of car ownership, especially in urban areas Sharable cars
person to preheat the oven before arriving home. Light fixtures are being designed to
activate and illuminate a persons path as he or she reaches the driveway. Locks can be
biometrically triggered, eliminating the need to fumble for keys. Whole-home automa-
tion has become the new thrust for firms that used to develop a limited lineup of
switches and dimmers.
Health care also has been greatly impacted by technological advancements that bring
together customer need with what technologies provide. The best hospitals can now pro-
vide better access to care, faster service, and more convenience for patients who must be
continually monitored. High-tech monitors are capable of transmitting data directly to
the doctors office, and videoconferencing technologies can provide patients and doctors
the opportunity to communicate face-to-face with housebound patients. Technology al-
lows doctors to communicate with patients and enables digitized, consolidated medical
records, among other features.
The opportunities offered by technology are almost limitless, yet not all firms are in a
position to take advantage of them. The challenge innovators and entrepreneurs face is to
match technological opportunity with market need. Former 3M CEO James McNerney
once quipped in a speech: At 3M, we are absolutely great at innovation . . . so great that
we have warehouses full of our (unsold) innovations! The essence of successful innova-
tion is that it fuses technological possibility with market demand. For managers at all
levels, it can be quite challenging to bring together different in-house functions (such as
marketing, R&D, and manufacturing) with knowledge of consumer needs and scientific
and technical developments.
Competitive pressure also can be a source of insights into where opportunities exist.
Are rivals pursuing technologies that will limit a firms options in the long term? Are
they introducing products or services that the firm should try to mimic or leapfrog?
Innovation gaps are frequently filled when a firm is inspired by the offerings of a rival.
Rival success can be both a strong motivator and deep source of ideas for a firms inno-
vation strategy. In the restaurant industry, fast casual models have been embraced by a
large number of consumers since Chipotle introduced the concept. In retail, the success
of online platforms has spurred traditional brick-and-mortar retailers to develop multi-
channel positionsand successful brick-and-click establishments have pushed Amazon
to build brick-and-mortar locations. Design cues taken from top luxury automakers are
frequently utilized by lower-cost rivals attempting to chip away at their lucrative profits.
Safety tools such as backup cameras have been copied so quickly over the years that to-
days consumer would be hard-pressed to identify the original backup camera innovator
as Toyota. Googles ongoing development of self-driving cars and Ubers growing pres-
ence in ride-hailing has been the cause of both interest and great concern in the
automobile industry.
Carmakers are determined to retain control of data generated by drivers worldwide
and unwilling to cede control over value-added technological components. As a result,
they have actively moved to protect their turf and rectify an important knowledge re-
source gap. In August 2015, the top three German automakers purchased Nokias Here
navigation technology and mapping unit. Losing control over a mapping technology
present in over 80 percent of automobiles was not an option that Audi, Mercedes, and
BMW could tolerate. They had to prevail over Uber and Google in the bidding war for
this technology.
Internal Sources of Opportunity

Another source of insight into opportunities is a firms employees. To what extent have
an organizations employees incubated new ideas and processes that can be scaled for the
benefit of the whole organization and its customers?
Any employee or team that has developed new offerings or improved processes within
a function or department can be a source of competitive advantage. Leaders should
encourage innovative behavior, providing resources that will foster a culture of innova-
tion, creating platforms for the best ideas to gain full acceptance and organization-wide
adoption, while also outlining for each employee the desired balance between current
(sustaining) operations and new frontiers.
Two firms that have implemented successful employee innovation programs are
AT&T and Whirlpool:
With a $100 million dollar investment, AT&T created its Foundry, several centers
where employees have the opportunity to experiment. At the Foundry, employees
generate ideas and pitch them to teams of executives using VC-style presentations.
Products emerging from the Foundry have included a service that allows AT&T cus-
tomers to send and receive text messages from any connected car, several home auto-
mation and security solutions, and even smart trashcans.
Appliance maker Whirlpool also encourages innovation by opening up corporate ide-
ation sessions to any employee who wants to contribute. Once an idea is generated,
employees then make a business case for their idea, compete for its development, and
participate in the concepts testing and experimentation before full-scale commercial-
ization takes place.
While generating innovative ideas clearly is useful, questions also must be raised
about the extent of fit of the new ideas with the organizations resources and capabilities.
To what extent are a firms internal resources and capabilities aligned with the opportu-
nity? A sweet spot rests at the intersection of three firm-based factors: (1) the firms
unique ability to understand customer perspectives and devise solutions for customer
problems, (2) a strategy that leverages such opportunities for a firms ongoing advan-
tage, and (3) exclusive access to resources and capabilities required to deliver solutions
(see Exhibit 7.7).
Organizations must scan the external environment and then determines if they possess
special resources and capabilities and can marshal them in ways in introducing new
EXHIBIT 7.7
An Innovation
Customer
Sweet Spot Perspectives Innovation
Sweet
Spot
Relevant Clear
Resources Strategy
EXHIBIT 7.8 In 2010, brewing giant MillerCoors created a separate subsidiary company, Tenth & Blake Beer Company, to
MillerCoors address new frontiers, namely the strategic opportunities present in the craft-brewing segment. Customers had
Tenth and begun flocking to the segment as Fortune magazine soon reported:
Blake Beer
Big, global breweries have taken notice of the craft beer movementmostly because thats where actual growth exists in
Company
the otherwise stagnant beer industry. In 2011, craft brewing saw growth of 13% by volume, while overall U.S. beer sales
were down an estimated 1.3% by volume. And even though craft beer still accounts for less than 6% of all beer sales,
anyone remotely connected to the business knows it will play a big part in the industrys future. Craft beer delivers higher
profit margins, it attracts consumer spending, sought-after clientele for bars and restaurants, and many people are
passionate about craft beer, similar to the same way people are passionate about wine.
For Tenth & Blake to succeed, there was a clear need for specialized capabilities and a degree of separation from
its corporate parent company. Many of the branding, sourcing, and manufacturing practices of craft brewers were
perceived as highly inconsistent with larger-scale brewing operations. A balance had to be struck in this situation.
Tenth & Blake customers can find a variety of unique, high-quality brews. It is committed to identifying and
incubating the most promising new offerings from small brewers around the world, and preserving many of the
traditional practices, which lend craft brews their unique profiles, while providing financial support and other
resources.
products and services that rivals cannot easily imitate. They also must deliberately prepare
for successive innovation frontiers, while simultaneously scanning for opportunities and
building the necessary resources, capabilities, and partnerships to support their existing
revenue sources. Brewing giant MillerCoors has seemingly addressed these s imultaneous
frontiers by creating an entirely separate division as illustrated in Exhibit 7.8.
Vetting Ideas
Most filters for thoroughly testingor vettingideas aim to connect the dots between a
firms capabilities and available technologies, prospective customers, and the concepts
profit potential. The vetting process assures that the organization is not wasting resources
on ideas that have little chance for success in the marketplace. Both AT&T and Whirl-
pool require employees to move beyond the process of idea generation and prove that
their ideas are worthy of attention and resources required for full commercialization.
Several screening devices have been developed to help determine whether to continue to
honeor abandona new product or service concept. At Google, for example, they
subscribe to share everything and fuel with data philosophies that encourage teams
to aggressively test and iterate promising ideas.
An enduring model for vetting concepts is the Real-Win-Worth It screen.9 The idea
is to test each product or service concept to determine if the market and product are
real, if the potential offering and a company can be competitive and win, and
whether its worth it from both financial and strategic perspectives. The R-W-W is
meant to expose faulty assumptions, gaps in knowledge, and potential sources of risk,
and (ensures) that every avenue for improvement has been explored. 10 Most impor-
tantly, however, this screen helps innovation teams maintain momentum. Significant im-
pediments on concept development projects are quickly identified and rectified, or they
are deemed impossible to rectify and the concept is abandoned without delay. Exhibit7.9
provides an overview of this framework.
A recent Harvard Business Review article offers another more simplified
approach, which encapsulates a number of points that have been discussed in this
EXHIBIT 7.9 A true customer need?

The Real-Win- From a Market Affordability & willingness to
Worth It Perspective... pay?
Screen Market size sufficiency?
Is it Real?
Clear concept?
From a Product
Manufacturable/deliverable?
Perspective...
Product satisfies customer?
Does it have the potential for

From a Product
SCA?
Perspective...
Expected rival responses?
Can We
Win?
Clear concept?
From a Company
Manufacturable/deliverable?
Perspective...
Product satisfies customer?
From a Product Forecasted benefits > costs?

Perspective... Is risk level acceptible?
Is it Worth
it?
Does this fit our grand strategy?
From a Strategic
Will corporate leaders get behind
Perspective...
it?
c hapter. It recommends that innovators vet possibilities in their pipeline with simple
questions such as:11
Is this idea consistent with an area of strategic opportunity in which the company has
a compelling competitive advantage?
Does a companys development team have an empathetic understanding of the cus-
tomer? Can it clearly define the first customer and the path to reaching others?
Can the team describe the business model in detailfrom suppliers to channels to
money-making hypotheses?
The depth and intensity of the vetting process is a product of the firms industry and
competitive considerations. In hypercompetitive markets, concept life cycles are short.
Teams must be adept at quickly generating and filtering concepts lest they be left behind.
The bottom line is that no matter the industry or competitive conditions, and no mat-
ter which vetting process an organization selectswhether more intensive or more
abbreviateda disciplined approach to filtering ideas and focusing an organizations
innovation efforts is a key to successful innovation.
Creating Prototypes and Pilots Concepts

Designing new products or services that can delight customers and yield profits is both
challenging and risky. Often, the key to success is an organizations ability to produce a
prototype or pilot offeringone that does not consume an excessive amount of re-
sources prior to being presented to potential customers for hands-on testing. These pro-
totypes or pilots are created solely for the purpose of gathering specific feedback.
How does the product function outside of a controlled lab environment and in the
hands of customers?
Does the service flow as efficiently as expected while meeting the customers expectations?
Now that the customers have experienced the new offering, are they excited about its
utility and willing to pay?
If a pilot or prototype falls short in any way, it can travel quickly back to the drawing
board where the team working on it can discuss how adjustments should be made and
whether further adjustments are feasible.
Is the technology robust enough to address the additional requirements that have been
uncovered via your testing?
Will these extra features lead to higher levels of acceptance and profitability?
If the answer is yes to these internal screens, subsequent iterations of the product/
service can then follow the same cycle until the offering is ready for prime time.
Exhibit7.10 shows the cyclical nature of the product/service design process. When the
cycle begins again, choices must be made about whether to tweak the product/service or
look for an entirely different one.
In some industries with longer product development life cycles (such as pharmaceuti-
cals and oil exploration), a rapid prototyping cycle is not possible. The key for the
EXHIBIT 7.10 1. Build an 2. Research

The Iterative Understanding Options for
Product/ of Customer Satisfying
Service Design Requirements Requirements
Process
5. Deliver
3. Select the
Prototype to
Most Viable
Customer for
Options for
Testing
your Firm
4. Build
Prototype or
Pilot Program
o rganization is to dedicate resources that will help it chart a path to the future, no matter
how long the journey may be.
While the innovation team in charge of prototyping and piloting concepts can be very
lean, it is critical that it be allowed to pursue innovation projects full time. The team
must also be composed of individuals that have a deep understanding of and close prox-
imity to the customer, and it must be given the resources and the latitude to craft multiple
iterations. A team of inexperienced part-timers not likely to have success in creating
innovative solutions for customers when its competition is hungry, new, VC-backed
startups totally dedicated to success.12
Scaling Up and a Full Rollout

Once a concept has been proven, the organizations efforts must turn to packaging, mar-
keting, and delivering the product or service and offering it at scale. The resources and
capabilities required to execute on these activities are far different than those that an in-
novation team has, so a structured hand-off process from the innovation team to produc-
tion and marketing teams should be seriously considered.
Innovation teams that fight to develop the concept and its full range of features are not
in the best position to make the trade-offs necessary to make the new offering profitable
at scale. Delivering consistent and profitable products at scale requires an entirely new
mindset, one that is dedicated to the replicable and reliable, rather than the unique and
exciting. The production team must be aware of the activities and investments required
to forge a support network of business-to-business partnerships and to build relation-
ships with wider business-to-consumer markets. Forging this support network requires
adequate budgeting, planning, and incentives that are often at odds with the spirit of
new-product and service innovation processes.
Barriers to Innovation
The factors for innovation success are hard to assemble. Even one missing element can
undo a sound process (see Exhibit 7.11). Internal to an organization, there is need for a
clear leader vision and action plan, relevant skills, appropriate incentives, and supporting
resources. Innovators must pay close attention to the organizations needed to commercial-
ize a new product or service, gather both financial and strategic resources, and build com-
petencies. Firms need a supportive and permanent innovation/change structure. As shown
in Exhibit 7.11 any gaps in organizational preparation can quickly derail best intentions.
EXHIBIT 7.11
All the Pieces
That Must Be
in Place for Vision Plan Skills Resources Incentives Degree of Success Realized
Successful X X X X Mass confusion
Innovation X X X X False starts until plan solidifies
X X X X Anxiety over underperformance
Source: Managing
Complex Change,
X X X X Frustration at lack of support
2001, http://cydjournal. X X X X Slow pace, little momentum
org/Brandeis/ X X X X X Change/progress made!
smith_0322.html.
EXHIBIT 7.12
The S-Curve
Market Acceptance
Time/Money Invested in New Concept
Long S-Shaped Diffusion Curves

Innovation rarely is instantaneous. Products, services, and technologies change as they
diffuse. They improve in reliability, quality, and flexibility. In a series of small steps and
refinements, they develop an evolving range of applications. Innovation usually starts as
a solution to a narrow problem, and innovators rarely know all the ramifications. IBMs
Thomas Watson, for instance, thought the computer would be of limited use. He believed
the single computer his company made in 1947 would solve all the worlds scientific
problems, but had no commercial application.
Diffusion of new products, services, and technologies is very uneven. Diffusion fol-
lows the classic S-shape curve shown in Exhibit 7.12. The first adopters are daring.
Other people are slow to change, and only much later do they respond. Large firms in
rapidly growing industries are sometimes the first to innovate because they have the
necessary financial strength and access to information, but this innovation pattern is not
always the case. The early market for new products, services, and technologies is hard to
establish. Expectations that prices will fall retard adoption. People wait before they buy
because they believe that with further progress, prices will go down (think of the market
for personal computers). Meanwhile, inventors and developers, who endure most of the
risk, may not have the staying power, and second- and third-movers exploit their inven-
tions. Imitators face lower costs, so the incentive to innovate is not large.
The entities that make discoveries are not always the ones that benefit the most from
them. The EMI scanner, for example, was an enormous scientific discovery, as important
as anything since X-rays, but EMI suffered great losses in developing it and sold the
rights to the technology at a cut-rate price. Relatively small engineering companies rou-
tinely produce innovations, such as the barcodes on retail products, that others use. Sup-
pliers are the originators of many new ideas for their customers. Developers frequently
do not profit from the commercial application of their ideas. None of these organizations
benefit as much as society does from the innovations they introduce.
Many-Year Investments
After analyzing numerous innovations, Van de Ven and colleagues concluded that the
innovation process typically goes through stages across many years, as outlined in
Exhibit7.13. The gestation period can last for many years, after which seemingly coin-
cidental events occur that set the stage for initiation. Often, internal or external shocks to
EXHIBIT 7.13
Coincidental events initiate the generation of new ideas
The Harrowing and the gestation of inventions. Without external
Innovation shocks or threats to the firms environment, however,
Journey the level of organizational apathy can be great Some
form of deep dissatisfaction is required in order to make
changes from status quo.
Wellintentioned goforward plans might be presented

to resource controllers in form of sales pitches lacking
real analysis.
At formal project kickoff time, there may also be some

significant disagreements and lack of clarity about the
direction that should be taken with the invention Ideas
proliferate, making managing difficult.
Over the many yearsand many budget cyclesa lack

of continuity is found among personnel and other
resources.
Emotions run high, leading to frustration setbacks,

mistakes, and blame. Problems snowball and the
patience of resource providers weakens. A struggle for
power can ensue. Resources may run out before the
organizations dreams are fulfilled.
an organization get things going. Dissatisfaction is needed to move people from the
status quo.
The plans submitted by the developers of an innovation to the resource controllers are
too often in the form of sales pitches, not realistic assessments of the costs and the ob-
stacles as the innovation unfolds. Once development begins, those involved usually dis-
cover there is disagreement and lack of clarity about what the innovation entails. Ideas
proliferate, making the challenge of managing the innovation very difficult. Continuity
among innovation personnel is broken as people come and go for many reasons, includ-
ing frustration with the process as well as alternative career opportunities. Emotions run
high, and frustration levels build as normal setbacks are encountered, mistakes are made,
and blame is apportioned.
At first, schedules are adjusted and additional resources are provided to compensate
for the unanticipated problems, but as the problems snowball, the patience of the
resource providers weakens. The goals of the resource providers and innovation manag-
ers may begin to diverge and a struggle for power emerges about project goals and how
the project should be evaluated.
Resources tend to get tight and can run out before the dreams of the developers are
fulfilled. Innovations often are terminated because new resources are not forthcoming.
The ideas continue to show promise, but the resource providers lose patience. The ability
to see a project to the end is critical to the successful completion of an innovation, but it
is a very hard undertaking.
Flawed Processes
Flawed organizational processes spawn employee attitudes that inhibit innovation. Many
employees notice a significant disconnect between executive platitudes that tout the im-
portance of innovation and the realities of their day-to-day efforts. Organizations treat
intellectual property (IP) as a valuable resource, but few seriously go about developing
all the IP they have to produce revenue and profits. Not many employees believe that
they will obtain the recognition they deserve for commercializing new ideas. As a result,
they often consider their efforts wasted. Ideas are poorly analyzed or reviewed, and firms
lack the resources needed to pursue the best ideas.
A survey of 150 innovation workers at American companies revealed many unpro-
ductive organizational processes around innovation:13
Fewer than 30 percent of respondents organizations regularly measure and report on
innovation.
Half of all organizations resort to either spreadsheets or e-mail to manage their inno-
vation efforts; such methods are seen as insufficient to manage the full scope of re-
quired processes.
Only 5 percent of American workers feel highly motivated to be innovative. They
tend to work at companies that do not have an effective process to encourage ideas,
strong management commitment and goals, prompt feedback, or performance-based
metrics, and they do not view IP as a strategic asset.
The CEO of the company that did the survey sums up these issues as companies
failure to have quantifiable, visible procedures in place to translate intellectual prop-
erty into bottom-line performance. He maintains that many employees believe their
ideas will be ignored or simply dont matter.14
Risk and Uncertainty

When the odds of success are known with certainty (e.g., flipping a coin), it is called risk,
while conditions where the odds of success are not known with certainty are called
uncertainty. This classification is a matter of degree. Uncertainty of varying levels can
quickly cloud a managers risk calculations. The art of assigning statistical probabilities is
just thatan art. When the odds are known with certainty, the situation is insurable; con-
versely, technical innovation is an uninsurable phenomenon. The odds of success cannot
be stated with precision. Even the best manager may not be able to manipulate a situation
to his or her liking in order to produce desired results. After the fact, it may be easy to say
why success or failure occurred, but before the fact, it is not easy to know what to do.
Most managers, therefore, have powerful reasons for keeping risk to a minimum. In
deliberating about whether to undertake an entrepreneurial project, they have to consider
both technical and commercial feasibility. They have to estimate:15
The probable development, production, and marketing costs.
The approximate timing of these costs.
The probable future income streams.
The time at which the income streams are likely to develop.
Its obvious that these calculations are highly complex and many of the variables are
not completely known at project launch. There is a significant degree of uncertainty
buried in the risk calculation itself. Thus, businesses tend to concentrate on incremental
changes where success is easy and uncertainty is much lower.
In order to lower uncertainty, managers are naturally attracted to simple, well-trod
areas, such as new generations of existing products versus the creation of new product
lines (see Exhibit 7.14). Licensing others inventions, imitating others product introduc-
tions, modifying existing processes, and making minor technical improvements increase
odds of success. An automobile with a new type of engine, for instance, is less likely to
be introduced than an auto with simple modifications of existing engines. New models
and features are continually brought to market in the auto industry, but rarely do those
features require significant redesign efforts.
For a groundbreaking technological product to be launched, managers must have an
optimistic bias. There are just too many unknowns. Glass half empty leaders would
rather let their rivals explore the bleeding edge. Those that are willing to start from a
blank sheet of paper are rare, are often privately financed, and are exceedingly patient.
In 2015, Tesla Motors CEO Elon Musk told an auto industry gathering that the luxury
electric-car company would not be profitable until 2020. Will Toyota and GM decide to
shift gears and take aim at his company when it reaches critical mass and begins to show
a profit? Even after prototype testing, pilot plant work, trial production, and test
marketing, technical uncertainty is likely to exist in the early stages of technical product
EXHIBIT 7.14 The Keys to Minimizing Innovation Risk

Minimizing
Innovation Focus on simple, well-trod areas
Risk Establish new generations of existing products
Introduce new models
Anne Cohen. Differentiate product rather than create different product
License others inventions
Imitate others product introductions
Modify existing processes
Make minor technological improvements
development. The question typically is not whether a product will or will not work;
rather, the issues at this stage are what standards of performance the product will achieve
under different operating conditions and what the costs will be of improving performance
under these conditions. Unexpected problems can arise before a product like Teslas
reaches the market, in the early stages of a promising commercial launch, and after
product introduction. A company like Tesla must be keenly aware of uncertainty that
emanates from technological change, business conditions, market disruptions, and
government policy that are hard to predict.
For example, unexpected problems affected the pharmaceutical company Syntex
even before its new product, Enprostil, reached the market. Syntex needed a new prod-
uct because the patent on its major moneymaker, an anti-inflammatory drug called
Naprosyn, was about to expire. It thought it had come up with a new ulcer drug that
not only eased the pain of ulcers, but also lowered cholesterol. With millions of people
worldwide suffering from ulcers, drugs that treat the problem yield substantial profits.
However, the individual who pioneered Enprostils development spotted a dangerous
side effect of the drug: blood clots that could produce new ulcers. Test-tube clotting
suggested the drug could pose a risk of heart attack or stroke. Enprostil had trouble
winning FDA approval.
Serious setbacks can also occur in the early stages of a promising commercial
launch. For instance, Weyerhaeuser Company sought to become an important player in
the disposable diaper market with its Ultrasofts product. Ultrasofts had superior fea-
turesa cloth-like surface and superabsorbent pulp material woven into the pad to
keep babies dry. Consumer tests showed that parents favored it two-to-one over com-
peting brands. The advertising and promotion campaign offered coupons that saved
parents $1 per package for trying the product. Procter and Gamble and Kimberly-
Clark, which together had 85 percent of the disposable diaper market, responded with
aggressive cost-cutting and promotion campaigns to keep customers loyal. However,
early in production, manufacturing problems occurred in Weyerhaeusers Bowling
Green, Kentucky, plant. The system that sprayed the superabsorbent material into the
diapers malfunctioned and started a fire. Weyerhaeuser had to raise prices to retailers
by 22 percent to cover its unexpected expenses. The retailers responded by refusing to
give the product adequate shelf space. Weyerhaeuser then had no choice but to
withdraw the product from the marketplace.
Summary Achieving success in new business ventures is a long process that involves many
stages. Reasons exist for firms to undertake both incremental innovations and radical
innovations, both of which are necessary. For new products and services to be com-
mercialized, entrepreneurs, innovative companies, investors, and government support
are needed. The process requires determined entrepreneurs, dynamic companies,
willing and able financial backers, and government support that is long lasting
andpredictable.
Commercialization means not only finding new opportunities for business innova-
tion, but also exploiting these opportunities. Exploiting the opportunities rests on busi-
ness models companies develop. They help companies determine which opportunities to
pursue and how to pursue them. In choosing these opportunities, companies must take
into account external and internal factors, which work together in the successful launch-
ing of new ventures. New opportunities can be discerned from observing macro-trends,
contact with customers, and exposure to technological progress and competitive pres-
sures. Internal factors of importance are employee initiatives and alignment with re-
sources and capabilities.
Evaluating the promise of a new venture requires careful assessment of both the
maturity of the technologies on which it is based and their market potential. It is neces-
sary to match market demand with technological capabilities. Companies must have
good systems in place for vetting ideas. They need teams that prototype and pilot
concepts before they are ready for scaling up and fully rolling out.
Innovators and entrepreneurs must have the staying power and commitment needed
to see ideas through to realization. Many barriers have to be overcome. Long S-shaped
diffusion curves, multi-year investments, and flawed processes hinder innovation. Since
entities that make discoveries often are not the ones that profit from them, innovation is
rarely instantaneous, and because diffusion is uneven, the incentive to innovate is not
great. Often, innovation takes years, and resource providers may abandon projects before
they are successfully realized.
The obstacles to innovation and entrepreneurship start with uncertainty about the
future. Because the uncertainty is great, managers, especially in existing firms, tend to
be very cautious. They typically innovate slowly, reluctantly, and only on the margin,
driven by personal circumstances or identification of a pain, to name a few motives.
Uncertainty prevents them from moving forward. There is considerable uncertainty
before, during, and after a product reaches the market; and uncertainty about customers
as well as about government support.
For innovation to take place, both managers and entrepreneurs must have an optimis-
tic bias, even if it is not always warranted. Because of the many disappointments that
exist in developing new business ideas, they must play hunches and work against odds.
If they are to calculate in a dispassionate and even-handed way the odds of success
against the risk of failure, they might not proceed. If they do not proceed, they, and their
companies, are not the only ones who suffer. Rather, everyone in society is likely to be
worse off. Persistence in pursuing innovative ideas provides social benefits above indi-
vidual self-interest in change.

1. How motivated is your organization to innovate and why? Is its performance gap
significant?
2. Does your firm clearly support individual innovators in its ranks? If so, how does it
show its commitment to innovators?
3. Describe your organizations innovation process in detail. Identify the strengths and
weaknesses of the process. How do you believe that the process has impacted the
long-term performance of your firm?
4. What types and degree of uncertainty does your firm face as it pursues innovation?
Which tactics does your organization use to reduce the uncertainties of innovation?
Exercises for the Student

1. Examine the annual reports of the publicly held firm of your choice, and calculate the
ratio of dollars spent on R&D to revenues.
2. Look for new product and/or service announcements made by this firm. Is the firm an
innovation leader in its industry? Or does it tend to be a second/late mover instead?
Given what you know about the organization, does this posture make sense?
Endnotes 1. Gary Hamel, Strategy as Revolution, Harvard Business Review, JulyAugust 1996, p. 69.
2. Loretta Chao, Revamped Bubble Wrap Loses Its Pop, The Wall Street Journal, July 1, 2015,
http://www.wsj.com/articles/revamped-bubble-wrap-loses-its-pop-1435689665.
3. H. Aldrich and C. Fiol, Fools Rush In, Academy of Management Review 19 (1994),
pp. 64570.
4. Ibid.
5. J. Harrison, Strategic Management (New York: Wiley, 2003).
6. Hamel, Strategy as Revolution.
7. Lauren Coleman-Lochner and Carol Hymowitz, At Procter & Gamble, the Innovation Well
Runs Dry, BloombergBusiness, September 6, 2012, http://www.bloomberg.com/bw/
articles/2012-09-06/at-procter-and-gamble-the-innovation-well-runs-dry.
8. Steve Denning, Why U.S. Firms Are Dying: Failure to Innovate, Forbes, February 27, 2015,
http://www.forbes.com/sites/stevedenning/2015/02/27/is-there-an-innovation-crisis-at-us-
firms/.
9. It was initially developed by Dominick M. Schrello, principal of Schrello Marketing. Versions
of this model have been circulating since the 1980s and have been adopted by several leaders
in innovation including General Electric, Honeywell, and 3M.
10. George Day, Is It Real? Can We Win? Is It Worth Doing? Managing Risk and Reward in an
Innovation Portfolio, Harvard Business Review, December 2007, https://hbr.org/2007/12/is-
it-real-can-we-win-is-it-worth-doing-managing-risk-and-reward-in-an-innovation-portfolio.
11. Scott Anthony, David Duncan, and P. Siren, Assessment: Should We Pursue This New
Project? Harvard Business Review, February 2015, https://hbr.org/2015/02/assessment-
should-we-pursue-this-new-project.
12. Your organization also needs at least one individual, but preferably a small handful of indi-
viduals, who will get up every morning and go to sleep every night thinking about nothing but
innovation. Scott Anthony, David Duncan, and P. Siren Build an Innovation Engine in
90 Days, Harvard Business Review, December 2014, https://hbr.org/2014/12/build-an-
innovation-engine-in-90-days.
13. MindMatters Technologies, Inc., Survey: American Corporations Suffer from an Innovation
Crisis, with Insufficient Resources to Develop, Track New Ideas, March 3, 2015, http://
www.mindmatters.net/News/MindMattersInnovationSurvey2015.aspx.
14. Ibid.
15. C. Freeman, The Economics of Industrial Innovation, 2nd ed. (Cambridge, MA: MIT Press,
1982); and F. Knight, Risk, Uncertainty, and Profit (New York: Houghton Mifflin, 1921).
P A R T T H R E E
Implementation and
Reinvention
1
EA IA
External Analysis Internal Analysis
Evaluation of
3
Performance
&
Continuous
BS + GS + CS + IS
Reinvention
2 Implementation
C H A P T E R E I G H T
Implementation
The value of an idea lies in the using of it.
Thomas A. Edison, American inventor

Being aware that implementation is a highly dynamic process.
Understanding that skillful implementation is required to drive results; it should be viewed as a core
competence.
Revealing common obstacles to implementation and emphasizing the need for a more masterful
approach to the process.
Discerning whether an organization is ready to embark on a strategic change initiative.
Comprehending the activities required to fundamentally transform the firm into one that will always
stand ready for strategic challenges.
Being conscious of the need to continuously monitor the competitive environment, nurture the
organization, and improve the implementation process itself.
Introduction
Implementation is the process of translating a strategy into actionbringing the ideas
and decisions covered in previous chapters to life. If an organization cannot effectively
manage the implementation process, it will lag behind its rivals in the marketplace.
Unfortunately, this process is often fraught with obstacles: Resources are scarce,
resistance to change is great, persistent yet agile leadership is rare, and consistent, trans-
parent patterns of communications are atypical. As a result, numerous organizations
have struggled to realize the benefits of well-conceived strategic plans. This books
analytical process for analyzing the external and internal environments and choosing the
optimal sequence and combination of moves will come to naught if implementation is
not effective.
The purpose of this chapter, therefore, is to examine successes and failures in strategy
execution while providing a framework to use in implementationa dynamic framework
that is closely integrated and synchronized with the analysis and moves covered in previ-
ous chapters. The implementation component of the strategic management cycle never
stands alone (see Exhibit 8.1).1 Implementers must be willing to regularly rethink the
tactics necessary to achieve their objectives.
186
Chapter 8Implementation187
EXHIBIT 8.1
Implementation
Must Be
Synchronized
Formulate Implement
With Strategy
Formulation &
Evaluation
Evaluate
The Anatomy of Failure

Managers have grappled with the gap between organizational strategy and the attainment
of objectives for quite some time. A 2004 survey conducted by The Economist polled
both U.S. and Canadian senior operating executives across eight key industries and
found that 57 percent of companies did not successfully implement their strategic initia-
tives.2 The American Management Association and the Human Resources Institute
painted an even bleaker picture in 2006. Its survey of global executives and HR experts
revealed that just 3 percent of respondents rated their companies as very successful at
implementing strategies, while 62 percent described their organizations as mediocre or
worse.3 Success has not been the norm.
Mistakes in implementation result in an organization losing precious time, money, and
momentum versus its rivals. With this in mind, Exhibit 8.2 utilizes case study e xamples
to warn of obstacles that management could encounter along the way.
EXHIBIT 8.2 Home Depot: Performance-Enhancing Moves versus an Ingrained Culture

Significant
Implementation Home Depots overall performance had been lackluster when Robert Nardelli, a talented former executive at
General Electric, was recruited for the companys top spot. The organization recognized the need for change, but
Missteps
Nardelli brought the wrong toolbox to the job, mistakenly believing that the strategies and tactics that had been
Some Stories successful at GE could be readily transplanted to a big-box retail environment. In his efforts to streamline Home
and Important Depots business processes and 2,000 stores, he overfocused on the processes and trampled on Home Depots
Take-Aways highly customer-focused and entrepreneurial culture. He angered the management ranks by firing long-time Home
Depot executives to bring in GE alumni, and then he enraged investors by losing out to rival Lowes when it began
to invest heavily in new and more attractive stores.
When competition heated up, Nardelli employed manufacturing-appropriate methods to shore up the bottom line,
but his tactics, which cut costs by increasing the number of less-knowledgeable part-time workers, left full-time
employees fuming and crippled customer service. Though cuts allowed Nardelli to reach earnings-per-share and
other growth targetsa commendable job, according to Barry Henderson, an equities analyst at T. Rowe Price
investors questioned whether the companys top-line growth was sustainable. After years of a declining stock
price, Home Depot announced Nardellis resignation. The moral of the story is that implementation efforts will fail
if leadership does not acknowledge that cultural norms can place boundaries on the pace and extent to which new
behaviors can be integrated into the existing organizational systemand if executive incentives are not carefully
aligned with a comprehensive organizational vision.
188 Part Three Implementation and Reinvention
Circuit City: Me Too Moves versus Faster, More Savvy Foes

Circuit Citys Firedog offering was created to provide customers with an enhanced menu of services delivered at
cost levels comparable to the companys low-cost and best-value rivals. Pulling a page from Best Buys playbook,
the Firedog team was to handle technical services for both computer equipment and home theater installations in
a way that closely mimicked the Geek Squad.
Unfortunately, this move was made well past the companys prime. Complacence and inaction during prior industry
inflection points had created a significant long-term disadvantage. Starting in the 1880s, Circuit City failed to secure
prime real estate, while rivals were snapping up more convenient locales. The company reduced the breadth of its
product line when it stopped selling appliances, yet did not aggressively pursue the electronics niche with a strong
set of gaming offerings. It neglected to improve its Web presence, just as online retailers, such as Amazon.com
were hitting their stride. Then it lost to Best Buy in a contest to create an Apple presence in its stores.
Internally, old inventory levels began to swell, and soon Circuit City was unable to buy fresh products or pay off its
existing debts. Deep cuts at the front line (which were similar to Nardellis moves at Home Depot) eliminated over
8,000 of Circuit Citys most experienced employees, replacing them with cheaper workers. In the end, the organi-
zation only succeeded in mortally wounding customer service. Its descent was rapid, and by the end of 2008, it
announced its liquidation because it was not able to successfully implement its strategic initiatives. The moral of
the story is that poor timing coupled with inadequate management of market dynamics will sink any strategy.
United Airlines: A Low-Cost Segmentation Move versus Lack of Internal Commitment

Uniteds Ted concept was designed to give United a way to compete with low-cost airlines, such as Frontier, JetBlue,
and Southwest. Moves to standardize aircraft with no-frills configurations and maximize jet use through rapid turn-
arounds at airport gates were meant to reduce maintenance and operating costs significantly. With this plan in mind,
Ted began service February 12, 2004, in Denver, with 57 Airbus A320 aircraft, configured with 156 all-economy seats.
However, the airlines overall cost structure lacked alignment with the new initiative, and the low-cost offering was
never certified as a separate operating entity. Ted was simply a brand name applied in an attempt to differentiate
the all-economy service from Uniteds mainline flights. As a result, all Ted flights actually were operated by United
Airlines crews flying under the United Airlines operating certificateand those crews of pilots, flight attendants, and
mechanics were not always compensated per Teds low-cost design. Uniteds own operational needs also interfered
with the new brand implementation. Ted aircraft would be utilized as needed for mainline United flights, and main-
line United aircraft were operated as Ted flights, which only confused the customer base and weakened the brand.
As a result of this lack of full commitment to the concept, costs at Ted were never as low as those of a genuine dis-
count airline, and its operations led to significant losses. The fatal blow to the concept came when fuel prices spiked
and parent UAL dumped its gas-guzzling 737 models, reclaiming the A320s from the Ted operations and reconfigur-
ing them to carry higher-margin first-class passengers. On January 6, 2008, operations were officially folded back
into the mainline brand and Ted was dead. The moral of the story is that implementation efforts will fail without a
lack of full commitment and alignment of structures, procedures, and resources with an organizations strategy.
Swissair: Empire-Building Moves versus Resource Limitations and EU Law

The conventional wisdom of the airline industry, as in many other mature industries, has been that globalization
demands concentration into a small number of operators. Multiple carriers have formed alliances and merged to opti-
mize aircraft utilization levels and build scale economies, but this conventional wisdom is too often oversimplified.
Swissairs Hunter strategy was designed to set the airline on such a global path by focusing company resources on
markets with the largest growth potentialBelgium, Austria, Finland, Hungary, Portugal, and Ireland. Swissair
aimed to grow market share by acquiring small airlines instead of setting up alliance agreements. It acquired a sig-
nificant stakes in Air Europe, Sabena, Air Libert, AOM, Air Littoral, Volare, LOT, Turkish Airlines, South African
Airways, Portugalia and LTU, and considered acquiring stakes in Aer Lingus, Finnair, Malv, TAM and Transbras.
With the exception of Polish carrier LOT, however, all the companies that Swissair acquired were in a desolate finan-
cial situation and required significant managerial intervention. EU law, which demanded majority citizen ownership
as a condition of retaining an EU operating permit, also complicated Swissairs efforts. Swissair could own only
48.8 percent of each carrier on paper, yet it bore the full financial risk of ownership off balance sheet to obtain
immediate and direct managerial control. Soon, the funds invested were significantly higher than initially approved
by the board, which lacked any solid experience in managing an international airline.
The culture of excellence, which defined the Swissair brand, was also not as easily transferable to non-Swiss cul-
tures as initially estimated. Massive divestments were undertaken to reduce the steadily growing financing gap.
However, these divestments largely represented sale and leaseback transactions involving the groups aircraft
fleettransactions that yielded cash flow and improved the financial picture in the short run but resulted in lease
payments in subsequent years. Within two years, off-balance-sheet obligations increased by some CHF 5 billion,
and on October 1, 2001, Swissairs liquidity requirements exploded. Regular flight operations could no longer be
maintained, so these were suspended on October 2, 2001, and at 3:35 p.m., the airline was grounded. The moral
of the story is that to successfully implement complex moves, an organization must employ skilled foresightand
oversightof both internal and external dynamics. Inflection points can occur throughout the process.
Sources: Home Depot: Home Unimprovement: Was Nardellis Tenure at Home Depot a Blueprint for Failure? http://
knowledge.wharton.upenn.edu/article.cfm?articleid=1636.
Circuit City: A. Hamilton, Why Circuit City Busted, While Best Buy Boomed, http://www.time.com/time/business/
article/0,8599,1858079,00.html; M. Raby, Apple Expands Best Buy Relationship, Limits Deal with Circuit City, http://www.
tgdaily.com/content/view/34543/113/.
United Airlines: S. Freeman, United to Ground Its Ted Carrier Washington Post, June 5, 2008, p. D01; http://www.
washingtonpost.com/wp-dyn/content/article/2008/06/04/AR2008060400945.html.
Swissair: Results of Ernst & Youngs Investigation Regarding Swissair, Zurich, January 24, 2003, http://www.liquidator-swissair.
ch/uploads/media/untersuchung1_e.PDF.
The Root Causes of Failure

Although the failures detailed in Exhibit 8.2 involve a variety of strategic moves in dif-
ferent industries on separate continents, the decisions and behaviors of those charged
with the implementation of these strategies suggest that the root causes of failure are
universal. A strategy-to-performance gap comes about because of a combination of
factors, such as poorly formulated plans, misapplied resources, breakdowns in commu-
nication, and limited accountability for results.4 Exhibit 8.3 features a compilation of
EXHIBIT 8.3 Home Circuit United Swissair

Common Common Obstacles to Strategy Execution Depot City
Obstacles to
Inability to manage change effectively or x x x
Successful to overcome internal resistance to change
Strategy
Poor or inadequate information sharing x
Execution between individuals or business units
responsible for strategy execution
Trying to execute a strategy that conflicts x
with the existing power structure
Poor or vague strategy x x
Unclear communication of responsibility x
and/or accountability for execution
decisions or actions
Not having guidelines or a model to guide x
strategy-execution efforts
Lack of feelings of ownership of a strategy x x
or execution plans among key employees
Lack of understanding of the role of x

organizational structure and design in the
execution process
Inability to generate buy-in or agreement x
on critical execution steps or actions
Lack of incentives or inappropriate x x
incentives to support execution objectives
Insufficient financial resources to x x x
execute the strategy
Lack of upper-management support of x
strategy execution
Ignoring customer perspectives and impacts x x
the most common obstacles that have challenged successful strategy implementation
(and includes some of the specific obstacles encountered by the organizations featured in
Exhibit 8.2.)5 Its imperative for any manager to recognize and work to rectify these
obstacles as soon as they are encountered. A series of misstarts and hasty implementa-
tions attempted without sufficient commitment will eventually destroy the credibility of
the strategy an organization is trying to carry out.
A Comprehensive Implementation Framework

At the most basic level, implementation can be viewed as a structured process of
(1) creating a portfolio of change programs that will deliver the strategy, and
(2) attracting, allocating, and managing the necessary resources to deliver these change
programs.6 At first glance, the process may appear to be a straightforward task; how-
ever, genuine shifts in strategy imply a significant change in emphasis. Implementation
is felt throughout the organization. It typically involves changes in customers, suppli-
ers, and markets; new technologies, or business processes; and unfamiliar leadership
styles or management techniques. Managers must prepare carefully for implementation
by assessing an organizations change readiness.
Step 1: Assess Change Readiness

An organizations readiness for change varies greatly based upon the extent of the change
anticipated and its past experience with change. A strategic initiative requiring deep,
fundamental transformations of both business model and process may be overwhelming
for the current organization. Employees find it difficult to envision their future roles
when the extent of change is so great. A track record of failed past initiatives will also
erode trust and increase the probability of subsequent failures. Employees that have
experienced such failures will be, understandably, hesitant to get behind any new ideas.
As Mankins and Steele comment:
Unrealistic plans create the expectation throughout the organization that plans simply will
not be fulfilled. Then, as the expectation becomes experience, it becomes the norm that
performance (goals) wont be kept. . . . Commitments cease to be binding promises with
EXHIBIT 8.4 Forces Against Change versus Forces That Support Change
A Change-
Readiness
Assessment No Higher Management Powerful Pioneers of Change &
Commitment Top Management Commitment
Exhibit created by
Anne Cohen based
upon forces identified
by IBMs 2008
Making Change
Work survey.
Negative Mindset Change-Embracing
& Culture Culture
Lack of Transparency & High Degree of Employee Involvement

Poor Quality Information and Honest/Timely Communication
Complexity Underestimated, Lack of Change Efficient/Agile Organizational

Know-How, Major Process Changes & Tech Barriers Structure & Training Programs
Lack of Employee Motivation Adjustment of Performance Measures with

& Resource Shortages Monetary & Non-monetary Incentives
real consequences. . . . Managers, expecting failure, seek to protect themselves from the
eventual fallout. They spend time covering their tracks rather than identifying actions to
enhance performance (or stretching to ensure that commitments are kept). . . . The organi-
zation becomes less self-critical and intellectually honest about its shortcomings. . . . It
loses the capacity to perform.7
Before launching any new initiatives, therefore, managers should assess their organi-
zations readiness. Has management shown an unflagging and highly visible commit-
ment to past programs, or is it a fair-weather friend to change? Does information flow
freely, or do gatekeepers block and skew the process? The continua shown in Exhibit 8.4
help determine the level of resistance one can expect.
Once this initial assessment is complete, it is essential to develop strategies that leverage
the predominant forces for change in an organization and minimize the opposition. The
entire organization must be involved in adopting a state of change-readiness: The dynamic
environment within which todays organizations operate demands nothing less and quickly
dispatches those lulled into a false sense of security. Today, perpetual readiness and e xpertise
in change management is a highly valued organizational competence. The change-ready
organization is prepared for the inevitable bumps in the road. Its able to react more quickly
and pass more fluidly through all phases needed to implement new strategies.8
Step 2: Install Integrative Leadership

After the organization is readied for change, it must install decisive, yet integrative, leaders
to move the implementation process forward. Such integrative leaders are effective in
maneuvering organizations to resolve the strategy-to-performance gaps that exist in imple-
mentation. They are able learn new skills and master new approaches quickly. They have
the capacity to examine an initiative from multiple perspectivesfrom the strategic to the
organizational and operationaland to create action plans that both respect and stretch all
process and cultural boundaries. They consider both internal and external forces and,
unthreatened by weaknesses, deftly weave new resources into the organizational fold,
building competencies and competitive advantage. They are capable of overseeing a pro-
gram of ever-improving, interdependent activities while building a culture of cooperation,
confidence, and performance. They never forget the balance that must be struck between
day-to-day oversight and propelling the organization forward (see Exhibit 8.5).
Not every leader, however, is courageous enough to embark upon new initiatives in an
integrative manner. New initiatives can undermine established organizational priorities,
resource allocations, and reporting relationships. Implementation can challenge leaders
past decisions, their power, status, scope of responsibility, and business philosophies.
Some leaders will simply be incapable of grasping a new set of circumstances or learn-
ing new skills. These leaders will erect obstacles to change.
At the other end of the spectrum are leaders who lack discipline and throw caution to
the wind, making radical departures from the norm without considering current organi-
zational realities. For example, when Procter and Gamble launched its Organization
2005 initiative, CEO Durk Jager set out to grow profits and enhance its competitive posi-
tion with a series of highly aggressive moves: refocusing P&G on developing markets;
demanding a high rate of new global brand introductions; standardizing existing brands
across all geographic regions; redesigning the companys structure, processes, and cul-
ture; and reducing time to market. It soon became obvious, however, that Jagers pro-
gram was too forceful, his confrontational style and unreasonable demands alienated his
management team, the accelerated product pipeline generated products that were only
moderately successful, and the organization lost ground in established markets. Jager
was soon replaced by A.G. Laffley who took a much more integrative approach, one that
EXHIBIT 8.5
Leaders Must (Re-) Setting Propelling
Manage Both Organizational Organization
Day-to-Day Direction Forward
Management Analysis of
Competitive Context,
Examination of
Organizational Context,
and Forward Formulate Priorities Interactions,
and Moves Maintain Momentum
Movement
Day-To-Day Management & Administration

Operational leadershipWorking with people to ensure ST objectives are met
balanced existing strengths with competitive realities.9 Laffley retained pipeline

improvements made under Jager, yet reined new developments back to a more measured
pace. He leveraged existing retailer relationships while developing extensions for exist-
ing powerhouse brands. He reappropriated underperforming assets, dropping brands that
did not fit with P&Gs focus. He addressed existing weaknesses in the IT infrastructure,
which increased efficiencies across the supply chain. P&G was then able to pursue
acquisitions and new market development from a greater position of strength.
When an organization is compelled by competitive forces to make a radical shift in
strategy, integrative leadership quickly becomes a critical resource. Organizations, there-
fore, must encourage, develop, reward, and retain leaders that incorporate integrative
behaviors into their everyday management. These leaders are among the most important
factors needed to maintain a change-ready organization.
Step 3: Create a Consistent Message

Strategic change is typically aborted whenever leadership does not act consistently, or
fails to demonstrate the same commitment to change that they expect from others. The
installed leadership team, therefore, must immediately come together to negotiate how
each leader will be held accountable for specific elements of the implementation, and to
build consensus around a common message for all stakeholdersone that will be shared
with both shareholders and operational employees.
Shareholders can exert relentless pressure on an organization to boost profits quarter
after quarter. This pressure, often foisted by the board onto senior executives, must be
well managed and not allowed to derail the implementation of long-term strategies. A
consistent message, a clear plan of action, and open lines of communication from leader-
ship to the board and shareholders are vital to retaining support throughout the process.
Employees must also have a shared understanding of the desired end-state, yet most
companies do not communicate strategy broadly or effectively to their employees.
A 2005 study by Kaplan and Norton found that up to 85 percent of a companys employ-
ees are unaware of, or do not understand, its strategy.10 If, for example, an organizations
strategy is to become best in class, it must be made very clear to employees whether
that means to achieve top-quartile performance, to be the most profitable, to be the most
admired, or all of the above. The salesperson on the street, the call-center customer ser-
vice representative, and the operations manager should be interpreting the organizations
desired state in the same way.
To deliver such specific and targeted messages to employees, leaders need to have all
hands on deck, intermingling with groups and engaging employees across the organiza-
tion in discussions about marketplace realities and the organizations desired end-state.
Failing to create a common vision up front impedes future progress.
Step 4: Appoint Cross-Functional Program Teams

Strategic leadership teams alone are not in a position to identify and effectively define
the specific changes needed to successfully implement a strategy. Even if they are,
resentment is aroused when management simply announces a change and mandates the
specifics of implementation. The involvement and contributions of knowledgeable mid-
dle managers are necessary.
The placement of these middle managers on cross-functional program teams, which

are both highly visible and accessible, is strongly advised. Such accessible teams give
employees from each functional area an opportunity to engage in the implementation
process. They send a powerful message that the organization values its employee base. By
creating such program teams, leadership is saying, Thank you for all of your effortsthe
competitive intelligence you provide from the front lines, the customer insights youve
shared . . . With your input, weve been able to determine what must happen, what moves
we need to make in order to secure advantage for our organization . . . With your contin-
ued engagement, we will also understand how we can best achieve our shared objectives.
Ideally, the managers appointed to these program teams have been involved from the
earliest stages in the strategic leadership teams diagnosis of the business environment;
they have helped build scenarios of change imagining how best the organization can
respond to various strategic contingencies.11 With these middle managers in place and
employees on board, the organization can quickly begin work to more clearly identify
gaps between the organizations current and desired states. These gaps serve as the basis
for subsequent decisions and actions.
Step 5: Solicit Change Program Proposals

When cross-functional program teams effectively engage the employee base in discussions
about how to achieve strategic goals, the response is often significant. Employees are able to
inform management of additional resources they need, and functional groups can quickly
alert leadership if they will be significantly affected by the change. Ideas start to flow, specific
proposals begin to take shape, and the scope of the original strategic initiative tends to expand.
Unfortunately, financial and human resources are never unlimited, and are especially
stretched during times of transition. Even the process of reviewing proposals can become
overwhelming without a solid framework for submissions and selection. Each proposal that
gathers momentum, therefore, should be developed into a formal business case.12 The case-
writing process requires sponsors to consider all facets of implementation and demonstrate
how their proposed change programs will contribute to the achievement of the organiza-
tions strategic goals. Any acceptable submissions must include the following elements:
An identification of the necessary changes from the status quo.
An outline of new resource requirements, timelines, and costs (and how these will
compete with ongoing needs for continuity and cash flow).
A clear definition of the expected benefits.
A list of the individuals who, with the sponsor, will be responsible and accountable
for delivering the benefits.
This last element is crucial. Insisting on accountability at this stage eliminates a sponsors
tendencies to underestimate costs and overestimate benefits. Such accountability also
leads to more honesty downstream, when certain programs can become irrelevant due to
changing business conditions, and their adjustment (or abandonment) becomes necessary.
Step 6: Select and Prioritize Proposed Change Programs

To select and prioritize change programs, cross-functional teams and senior leadership must
utilize a prioritization planThis plan must rely on objective and transparent criteria to
EXHIBIT 8.6 Balance Program 1 Program 2 Program 3

Strategic Priority-Setting Criteria Criteria Wt.
Short-Term Long-Term Raw Wtd. Raw Wtd. Raw Wtd.
Program
Prioritization x x Builds our brand identity 10 9 90 5 50 4 40
Matrix x x Increases profitability 10 7 70 3 30 1 10
x Minimizes risk 6 8 48 9 54 4 24
Source: An adaptation x Provides positive ROI within 3 years 3 2 6 6 18 2 6
of the Project x Benefits our broader community 1 5 5 3 3 8 8
Prioritization Matrix
created by A. P. Combined Weighted Scores = 219 155 88
Brache and S. Bodley-
ScottHarvard
Management Update Resource Requirements
4/2009.
Marketing x
Operations x x
Finance x
HR x
IT x x
Expedite Delay Drop

Verdict
Program 1 Program 2 Program 3
blend current programs, products, and processes with the new strategy. These criteria may
include any number of factors, including expected ROI, risks, and so on. Such a prioritization
process helps functional areas, and the operational front lines balance the realities of a
dynamic competitive environment and the need for change with liquidity needs, cost control
programs, the sales of existing product lines, and the availability of new capital. The process
also helps the organization estimate how much time it will take to realize specific goals.
While an organization can transform its capabilities over time, there is a limit to how
far it can go and how fast. The decisions are never simple, and uncertainty always clouds
the decision-making process. However, without clearly defined priorities, employees are
only left to second-guess the intent of senior management as they attempt to resolve day-
to-day conflicts between operational and change resource requirements. Without resolu-
tion, most employees will focus on earning revenue from a demanding customer, leaving
implementation of the strategic initiative hanging.
In Which Initiatives Should You Implement, Brache and Bodley-Scott provide a
methodology that management can use to examine the complete portfolio of projects,
and to determine which projects must be expedited, which can be combined, and which
should be delayed or canceled. An adaptation of their prioritization matrix appears in
Exhibit 8.6.13 Raw is the raw score of the priority, but Brache and Bodley-Scott sug-
gest using a weighted score (Wtd).
Regardless of the selection criteria utilized, clear communications of which priorities are
to be pursued and funded, and why, illustrates clear leadership thinking and consistency. A
lack of priorities only leads to implementation overload, which wastes resources, distracts the
organization from its goals, and dulls its responsiveness to the competitive environment.14
Step 7: Assign Process Owners and Align Resources

Once program-specific priorities are set, the cross-functional teams must then select and
assign process owners to oversee the transition from the status quo. It is critical that the
selected process owners have adequate authority over all programs and areas involved in
the implementation of their processes, as they will also be held accountable for success
or failure. Mid- and top-level leaders are recommended.
Working in tandem with cross-functional teams and the sponsors of approved change
programs, the new process owners then begin to coordinate activities that span organiza-
tional functions. They define new process flows, audit policies, and determine whether
current resource levels are adequate to conduct the different phases of the transition.
Several questions designed to complete alignment of the new strategy with the existing
one must be answered as outlined in Exhibit 8.7.
Answers to these critical questions will help guide the organization as it shifts to its
desired state. Decision-making will be pushed to appropriate levels, preventing the forma-
tion of inefficient functional silos. In fact, as more efficient processes are designed, func-
tional boundaries will begin to fade and will be replaced with more fluid and productive
lateral collaborations. For example, the marketing analyst who needs information from
operations to determine the firms production capabilities will have a direct link to that unit.
The operations manager charged with boosting efficiencies at the plant level will have access
to finance department expertise. Even field and line employees will benefit from the collab-
orative environment and will gain a better grasp on the bottom-line impact of their decisions.
It is imperative, therefore, that these coordination activities not be short-circuited, and
that management resist the temptation to just strip costs indiscriminately. Modifying
structures, eliminating resources, and removing layers of management can reduce costs dras-
tically, but without fundamental changes that reduce process complexity and install strategy-
supportive incentives, an organization will eventually return to its original state. Structural
change must be the capstonenot the cornerstoneof any organizational transformation.15
EXHIBIT 8.7 Process Questions

Questions That
Must Be Asked How should work and process flows change to support new initiatives while improving efficiencies and reducing
to Align the redundancies across the organization?
Should specific decisions and activities be centralized or decentralized?
Current
How should changes to supplier or customer interfaces be managed?
Organization Which operating systems should be modified, and which information systems upgraded, to support new initiatives?
with a New
Strategy Structural Questions
Which employee groups and individuals will be most affected by the new priorities?
Must resource levels change on a permanent basis to address new workload levels per employee, or will
temporary assistance suffice?
Can projects be combined in any way to share physical assets or human resources?
Can resources be reappropriated from lower-priority/cancelled initiatives?
Do employees need to be relocated and/or retrained, or will new hires be required?
What other changes should be made to ensure that the structure is conducive to rapid, strategy-supportive
decision-making and knowledge transfer?
Policy and Culture Questions

Which policies create obstacles to the execution of new initiatives?
Do some incentives encourage the wrong behaviors?
What is the best way to maintain momentum and continue to nurture a strategy-supportive culture throughout
these changes?
Step 8: Secure Funding, Formalize Operational Objectives,

and Design Incentives
To proceed with implementation, each transition initiative requires funding to cover its
entire timeline. Assuring adequate funding requires knowing whether internal cash flows
will be sufficient to support new initiatives. If they are not, external sources must be
tapped and the decision to utilize either stock and/or debt instruments must be made.
Too much debt in an organizations capital structure can reduce the range of actions it
will be able to take in response to future threats that jeopardize its survival. On the other
hand, issuing an excessive amount of stock will dilute ownership control and affect stock
price overall. In the end, managers must determine the best mix of financing options for
their organizationstock, debt, or a combination of the twothat will provide maximum
earnings per share (which is assumed to be consistent with the maximization of share
price and immediate shareholder wealth) and will increase the odds that the organization
will continue to thrive. The tool of choice for such a decision is EPS/EBIT analysis,
which compares earnings per share (EPS) and earnings before interest and taxes (EBIT)
at various levels of salesoptimistic, pessimistic and most-likely scenarios.
Once funding is assured, all initiatives and their respective timelines must be divided
into annual budget cycles. These organizational time constraints force process owners to
parse multiyear transition initiatives into several phases. Specific goals must then be
defined for each phase, and the goals subdivided so that each phase goal can be linked to
each employees personal objectives and incentives. Employees must be provided with a
clear outline of the decisions and actions for which they will be held responsible and a
set of well-defined success criteria. These updated guidelines and criteria are the new
keys to their personal rewards and program success.
It is vital that employees not remain tied to reward schemes based upon objectives
that support the status quo. For example, if an organization has just set its sights on being
a service leader, managers should rethink any high-volume incentives that are in place to
reward customer service reps for keeping their calls short. Replacing such stopwatch
systems with customer satisfaction surveys and repeat-purchase data will motivate more
vision-supportive behaviors. If an organization is hoping to grow profits, it must reward
not only volume and market share, but also margin.
Additionally, managers must be sure to incorporate objectives and incentives that
reflect the fact that most employees are not operating in a vacuum, but rather are part of a
network. As a part of the network, they are responsible for delivering timely and high-
quality output to others (so that they can perform their own duties). Take, for instance, a
food-packaging manufacturer that hopes to increase profitability by 20 percent over the
next two years. At a basic level, this initiative places immediate pressure on the organiza-
tions sales force, and the sales force will require an increased number of quotations from
the home office. Generating these quotations, however, requires the input of both package
design staff and plant operations. Any delays in their inputs impacts the timely delivery
of quotations, reduces the confidence of the food producer in the capabilities of the pack-
aging manufacturer, and ultimately hurts the likelihood that the producer will enter into a
purchase agreement with the manufacturer.
In the end, there must be both vertical and horizontal consistency in the objectives-
setting process (see Exhibit 8.8). Vertical consistency yields a strategy-transparent
EXHIBIT 8.8
Horizontal and Fair & Accurate
Transfer Pricing
Vertical Corporate
Consistency in Level
Objectives
Support Business Business Business
Processes Level Level Level
Functional Functional Functional Functional Functional Functional

Level Level Level Level Level Level
Timely Input To
Operational Operational Decision Support Operational Operational Operational
Level Level Level Level Level
Frontline Teamwork
s ubdivision of duties and responsibilities from the executive to the operating levels, while
horizontal consistency encourages collaboration and simultaneous progress across func-
tions. Unfortunately, many organizations fail to persist in this comprehensive approach,
and as a result, their employees lack adequate direction and motivation, their budgets
swell, their timelines stretch, and they ultimately fail to reach their higher-level goals.
Step 9: Advance and Continually Monitor Initiatives

Armed with budget, clear objectives, and strategy-supportive incentives, programs are
now equipped to move forward. New processes are set into motion and monitoring
begins. Early wins should be celebrated, and any drift away from stated objectives should
be immediately corrected.
However, the monitoring process itself can be very challenging. The gathering of
accurate information can be both costly and time-consuming if systems designed to
improve processes have not been also designed to track the relevant activities of employ-
ees, the performance of vendors, the purchases and sentiments of customers, and the
countermoves of competitors.
When performance falls short, executives . . . often have no way of knowing whether critical
actions were carried out as expected, resources were deployed on schedule, competitors
responded as anticipated, and so on. Unfortunately, without clear information on how and
why performance is falling short, it is virtually impossible for top management to take
appropriate corrective action.16
Nevertheless, there are many tools that can help managers monitor both their progress
and their environment. Scorecards, such as Kaplan and Nortons balanced scorecard,
can be used as they measure both leading and lagging factors of an organizations overall
performance. Using such a scorecard, an organizations financial results, employee turn-
over, and inventory changes may be tracked along with the leading indicators from this
weeks customer focus group or the results of the last months employee survey. Dash-
boards also can be fully integrated into the operating systems of organizations to provide
relevant and timely performance data, aid in decision-making, and serve as a constant
reminder of the link between employee actions and results. When used properly, dash-
boards deliver a mix of operational, f inancial, and program-specific information that is
both timely and meaningful to stakeholders. A sales executives dashboard might extract
daily revenues from the accounting module of a firms ERP, unit sales from its CRM,
and market share against program objectives from industry research firms, while the
customer service centers dashboard provides its representatives with real-time call sta-
tistics, wait times, and kudos or complaints that reflect customers changing needs and
priorities. An effective dashboard can help an organization synchronize its internal
beliefs with its external realities.
The broad appeal of monitoring tools is based on their applicability to almost any
organizational situation; they can take the form of either manual or highly automated
systems. However, such monitoring alone is insufficient. Its imperative that leadership
is fully engaged in both measuring and adjusting to incoming competitive and opera-
tional signals. If leaders do not fully participate, the effectiveness of any system is
severely limited. Many complaints aimed at failed executives of the past have been traced
to such a laissez-faire approach to the monitoring and evaluation process.17
Whether manual or automated, the most effective monitoring systems are used to:
Alert executives to the development of dangerous economic and competitive trends.
Help managers identify and limit budget variances, which always spell troubleuse
too many resources one year and risk a poor evaluation or program cancellation;
use too few and risk future resource shortfalls and virtual program strangulation.
Help justify the program variances that do occurprotecting program resources and
helping the organization maintain positive momentum.
Provide an objective basis for the distribution of earned incentives across all levels of
the organization while helping an organization to identify and retain its best people
and practices, and pinpoint sources of underperformance for review and remediation.
Continually reinforce the link between an organizations strategy and the benefits
realized by both the organization and loyal employees.
Given ongoing financial and geopolitical uncertainties, organizations around the world
are forced to closely monitor events and quickly recognize and adapt to new realities.
Businesses must continually revisit priorities to get the most out of their existing resources.
Most must prune underutilized or nonperforming assets to survive. Though its painful,
the pinch yields both valuable lessons in financial discipline and investment opportunities
that set the stage for a period of growth once business conditions return to normal. Savvy
firms capitalize on the easy access to good talent and other valuable resources during any
downturns and expand when economies rebound. Those that invest during recessionary
times are positioned to leapfrog competitors who hesitate to make any such bold moves.18
Step 10: Fortify Gains and Refine the Implementation Process

Although this last step of the implementation framework seems to imply that this pro-
cess is coming to a close, in practice, an implementation cycle is never complete. It
continually overlaps with the design of new strategies, the evaluation of existing initia-
tives, and the redirection of current processes.
The organization, its environment, and its processes require constant attention, over-
sight, and fortification. Managers must recognize that an organizations internal culture
is under constant assault as it endures mergers and acquisitions, promotions and retire-
ments, and basic turnover and hiring. It is highly susceptible to failure unless leadership
takes an active role in continuously fortifying and protecting it.
Accomplishments must be consistently communicated to all employees, supply part-
ners, and key customers. This type of communication helps build a sense of pride and
loyalty in a brand. Successes must be promptly and generously rewarded. Such rewards
cement them into the psyche of the organization. Managers must encourage ongoing
strategic thinking and opportunity identification at all levels. This encouragement helps
the organization preserve its change-ready state and facilitates modifications as necessi-
tated by both internal and external forces. Leaders must not hesitate to continually test
assumptions, revise strategies when necessary, revisit and learn from previous forecast
errors, fine-tune the program prioritization process, cut any programs that are not yield-
ing expected benefits, reassign ineffective process owners, adjust policy, develop new
incentives, or replace monitoring systems that are no longer relevant to internal changes
or able to produce timely market and competitive intelligence.
Employees witnessing such a continuous improvement process will, in turn, become
more confident in leaderships ability to deliver positive change and embrace future ini-
tiatives with greater trust and enthusiasm. Yet the mastering the implementation process
is much like learning to successfully land an aircraft on a carrier: Its not simple and
never perfected the first time around. The seas are rough, and the runway target is con-
stantly moving. Only the most skillful and practiced hands consistently hit the flight
decks sweet spot and emerge from the cockpit ready for the next sortie.
Summary Failed initiatives leave in their wake suboptimal resultssignificant cost overruns,
demoralized employees and, in the worst of cases, a downward spiral of disgruntled
customers and shrinking market shares. Management must learn to identify and rectify
the most destructive implementation behaviors, and must begin to consider the process
of implementation as a core competence to be continually honed and developed. Imple-
mentation tasks are summarized in Exhibit 8.9 on next page.
This chapter provided a comprehensive framework that:
Helps managers and executives determine whether their organizations are ready for change.
Emphasizes the importance of developing and retaining integrative leaders.
Helps those leaders manage stakeholder pressures.
Devises special organizational structures and positions to support the change
processfrom cross-functional program teams to process owners.
Assists in the diagnosis of misaligned processes, structures, policies, and culture.
Outlines key funding and budgeting decisions.
Explains how to create strategy-supportive objectives and incentives.
Scrutinizes and adjusts both the process and organization as required by internal and
external dynamics.
EXHIBIT 8.9 Task Name

Summary of
1 Assess Change Readiness
Key
Implementation 2 Install Integrative Leadership
Activities 3 Create A Consistent Message
4 Appoint Cross-Functional Program Teams
5 Solicit Change Program Proposals
6 Select & Prioritize Proposed Change Programs
7 Assign Process Owners & Align Resources
8 Formalize Budgets, Operational Objectives & Incentives
9 Advance & Continually Monitor Initiatives
10 Fortify Gains & Refine The Implementation Process
The careful practice of this process delivers fundamental change and produces an
organization that is much more ready to adapt to the next, inevitable challengewhich
is strategys main point: the capacity to continuously adapt to the challenges an organi-
zation confronts.
Questions for the Practitioner

1. How well does your organization execute on its strategies? Has it experienced sig-
nificant failures or successes in the past? What are the root causes of its successes
and/or failures from your role and your perspective within the organization?
2. Does your firm have a systematic approach to implementation? If so, what is it, and how
can it be improved? How does it compare to the framework provided in this chapter?
3. Given your firms external environment and the competitive dynamics of your indus-
try, how is your firm doing? How do you believe that your firms approach to execu-
tion impacts the long-term performance of your firm?
Questions for the Student

1. Examine the annual reports of the publicly held firm of your choice, and assess stra-
tegic intent and implementation over time.
2. Look for strategies the firm has tried to carry out. Has the firm succeeded? Analyze
what happened and why? Make recommendations on how the firm could do better.
Endnotes 1. K. Nagendra, The Recession DilemmaTo Save or to Invest, ThoughtSpot, June 2, 2009,
https://thoughtspotblog.wordpress.com/2009/06/.
2. Key industries included manufacturing, oil, like, telecoms, health care, consumer goods and
retail. Strategy Execution: Achieving Operational Excellence, Economist Intelligence Unit,
http://graphics.eiu.com/files/ad_pdfs/Celeran_EIU_WP.pdf.
3. AMA/HRI survey included those in Europe and Asia. Most Companies Are Only Moderately
SuccessfulOr WorseWhen It Comes to Executing Strategy, Executives Say, http://press.
amanet.org/press-releases/87/most-companies-are-only-moderately-successful%E2%80%84or-
worse%E2%80%84when-it-comes-to-executing-strategy-executives-say/.
4. Michael C. Mankins and Richard Steele, Turning Great Strategy into Great Performance,
Harvard Business Review, JulyAugust 2005.
5. The Wharton-Gartner Survey (2003) was a joint project between the Gartner Group, Inc., and
Lawrence G. Hrebiniak, professor at the Wharton School of the University of Pennsylvania
and teacher at the Wharton MBA and Executive Education programs. The short online survey
was sent to 1,000 individuals on the Gartner E-Panel database. The targeted respondents were
managers who were involved in strategy formulation and execution. The survey yielded
responses from 243 individuals. Combined, the Wharton-Gartner Survey and the Wharton
Executive Education Survey provided responses on obstacles to strategy execution from more
than 400 managers. L. G. Hrebeniak, Making Strategy Work: Overcoming the Obstacles to
Effective Execution, Ivey Business Journal, MarchApril 2008.
6. G. Johnson, K. Scholes, and R. Whittington, Exploring Corporate Strategy, 7th ed. (Harlow,
England: Pearson Education Limited, 2005); W.D. Giles, Making Strategy Work, Long
Range Planning 24, no. 5 (1981), pp. 7581.
7. Mankins and Steele, Turning Great Strategy into Great Performance, pp. 6472.
8. From IBMs 2008 study, Making Change Work. IBM Global Business Services researched
change management practices across the globe. The study quizzed over 1,500 project leaders,
sponsors, project managers, and change managers from many of the worlds leading organiza-
tions, ranging from small to very large.
9. R. Martin, The Opposable Mind: How Successful Leaders Win Through Integrative Thinking
(Boston: Harvard Business School Press, 2007).
10. R. S. Kaplan and D. P. Norton, The Office of Strategy Management, Harvard Business
Review, October 2005, pp. 7280.
11. A. Marcus, Strategic Foresight (New York: Palgrave MacMillan, 2008).
12. A. Franken, C. Edwards, and R. Lambert, Executing Strategic ChangeUnderstanding the
Critical Management Elements That Lead to Success California Management Review 51,
no. 3 (Spring 2008), pp. 4873.
13. A. P. Brache and S. Bodley-Scott, Which Initiatives Should You Implement? Harvard Man-
agement Update, April 2008.
14. See, for example, P. Rothschild, J. Duggal, and R. Balaban, Strategic Planning Redux,
Mercer Management Journal 17 (2004), pp. 3545.
15. G. L. Nielson, K. L. Martin, and E. Powers The Secrets to Successful Strategy Execution,
Harvard Business Review, June 2008.
16. Mankins and Steele, Turning Great Strategy into Great Performance.
17. P. Burrows, Controlling the Damage at HP, BusinessWeek, October 8, 2006, http://www.
businessweek.com/magazine/content/06_41/b4004001.htm.
18. Nagendra, The Recession Dilemma.
C H A P T E R N I N E
Continuous
Reinvention
Competitive advantage comes in the form of the progress a company
makes while its competitors, paralyzed by confusion, complexity, and
uncertainty, sit on the sidelines 1
Lowell Bryan, Director, McKinsey & Co

Being aware that a firms strategy must be regularly reinventedthat the quest for SCA is continual.
Introducing alternative methods of selecting and valuing new initiatives.
Discussing some of the latest models for reinventionfrom open sourcing to reworking the business model.
Providing examples of how firms have reinvented their strategies through such means as achieving
greater closeness to customers, bridging supplier/customer gaps, and putting in place smart
businessdesigns.
Understanding the role that both leading-edge industries and environmental challenges play in
innovation andentrepreneurship.
Reviewing and summarizing the analytical approach to achieving sustained competitive advantage
(SCA) presented in this book.
Introduction
Firms cannot stand still; they must continually reinvent themselves. As argued in C hapter 1,
they find themselves between two poles: their mission, which reflects where they were,
what they were good at in the past, and where they had achieved some type of compara-
tive advantage, and their vision, where they would like to go and what they would like to
be good at in the future.
Attaining sustained competitive advantage (SCA) is rare. Many firms achieve temporary
advantage, but few make the advantage last. To succeed over the long term, businesses
must regularly remake themselves. In doing so, they confront two constants: first, the com-
petition that never lets up, and second, the internal lethargy that stands in the way of change.
203
Building upon the best practices of implementation discussed in Chapter 8, this final
chapter delves into the process of reinvention and presents various ways to increase a
firms overall odds of long-term success. It also reviews key lessons from the books
overall framework: systematically examining external opportunities and threats; analyz-
ing internal strengths and weaknesses; and implementing moves related to product
positioning, corporate scope, globalization, and innovation and entrepreneurship. It
concludes with a discussion of opportunities and business models that are emerging on
the frontiers of strategy.
Preparing for Inevitable Turmoil and Uncertainty

In the absence of a crystal ball, no one really knows what the future holds, how technol-
ogy will evolve or how consumers, or governments and capital markets will react. Over
the long term, few assumptions can be made. So, how can a firm prepare for inevitable
turmoil and uncertainty and be prepared for an ever-increasing range of possibilities?
Some companies will choose to be followers, allowing other firms to experiment and
identify feasible and lucrative paths. They are adept market readers, who imitate their
competitors actions, market innovations, and what works for these firms. They copy the
innovations, make slight adjustments, and arrive at their own versions. The market read-
ing and following strategy has worked extremely well for Samsung in its battles with
Apple.2 Samsungs aggressive following of Apple has landed it in courtyet the total
impact of the court ruling against the firm has been minimal compared to the gain real-
ized from an imitative strategy. K orean carmaker Kia is another example of a market
reader that has taken its cues from firms that have already found success in the market-
place. The design of the 2015 Kia Sportspace concept was based on the Audi, modified
in a way that makes it appear like an Italian version of this car.3
Some firms will choose to be more proactive than the followers, and move down a
path of incremental improvements to their offerings. They adjust their approaches to
customer engagement and reinvigorate their brands across new channels. They make
improvements to their internal structures and processes, or they team with other organi-
zations. These maneuvers are well within the capabilities of most customer-focused
organizationsand they can lead to some valuable, albeit temporary, advantages.
A Portfolio of Initiatives
The question remains, however, as to just how an organization can become a market
leader. How can it position itself to maximize gains before the followers and incremental
adjusters arrive? The answer to this question is rather complex, but it begins with having
a disciplined exploration/exploitation system. This system must strike a balance between
quick exploitative wins for temporary advantage and highly uncertain exploratory
maneuvers to create long-term advantages.
McKinseys portfolio of initiatives system is designed to help achieve this goal.4 This
system can be traced back to naval wartime strategy. Imagine that the objective is to
deliver supplies to troops that are positioned across the sea. Sending one ship with all the
necessary provisions would be foolish. Both air and sea are filled with aggressors
submarines lurking below, enemy crafts cruising the seas surface, and bombers above.
Rivals have unknown capabilities and plans to thwart the ship. Enemy agents aim to
Chapter 9 Continuous Reinvention 205
EXHIBIT 9.1 Initiatives Time

A Portfolio of A
Initiatives B
C Over time,
Source: Adapted from D only a
McKinseys Enduring E portion
Ideas Presentation
Series.
F of a firms
G high-risk,
H stretch
I initiatives
J will come
K to fruition
L
M
N
i nfiltrate the boats crew and sabotage the voyage. Other external factors, such as storms,
can erupt and destroy the vessel.
The militarys answer has been to send battle groups, multiple supply and troop-
carrying vessels accompanied by aircraft carriers, destroyers, and submarines. By
moving in a pack, the ability of each ship to survive its cross of the ocean increases. The
strategy raises the chance that the supplies traverse the ocean even if individual ships fail
to achieve this task.
Businesses faced with high levels of uncertainty will likewise benefit when they
spread their risks across a portfolio of initiatives (see Exhibit 9.1). In the quest to develop
truly groundbreaking products, services, and delivery mechanisms; enter new industries;
and expand a firms global reach, convoy-like strategies will increase the likelihood that
at least some ambitious objectives are reached, even if others fail.
Banks and financial institutions have utilized this strategy for years. Mortgage portfolios
are filled with individual bets that customers will pay their debts. Lenders realize profits
when the majority of their bets are sound. Venture capital firms also manage portfolios of
deals, with the objective of scoring at least a handful of lucrative wins in the long term.
In fact, any organization facing an uncertain future can adopt a portfolio strategy. The
key is to pursue a carefully curated selection of short and long-range initiatives:
Some of these efforts should be relatively safe bets to generate quick wins. These
moves will include extensions of current products, services, and customer markets.
These are first horizon bets.
Other, frontiers hold significant promise but require that a firm acquire new capabili-
ties, develop new businesses, and fundamentally alter its business models (see
Figure9.2). These are the firms second horizon bets. Their payoffs are not likely to
come until three to five years have passed.
The last frontier is the least certain, but can also hold the greatest promise. As a
result, firms will also make third horizon bets whose payoff comes in the more dis-
tant future, anywhere from five to 10 years forward.
In a dynamic and rapidly evolving business environment, where businesses must be prepared
for the unexpected, this type of hedging plays a role in strengthening an organization over
the long term. As circumstances change, organizations are ready for a range of outcomes.
EXHIBIT 9.2
Novel
Initiatives, Higher Risk Initiatives
New
Risk, and the Complex Organizational Transformations
Capacity to Most Significant Potential for SCA
Sustain
Competitive
Products & Services
Advantage
(SCA)
Lower Risk Initiatives

Existing
Simpler Organizational Processes

Quicker, Incremental Wins
Existing Customer Markets New
The Alchemy of Growth, published in 1999, also recommends that firms pursue these
three horizons.5 The first horizon encompasses efforts to extend and defend the core
business that are currently providing the income necessary to stay afloat, the second
horizon is devoted to building emerging businesses to which can drive growth in reve-
nues and profits in the near term, and the third horizon is meant to secure viable revenue
and profit options for the long term. Exhibit 9.3 offers a fascinating example of Disneys
development along these horizons. The firms early moves from animation and character
licensing to a nimated feature films are an example of an organizations ability to focus
on the first horizon while simultaneously developing second and third horizons of
related businesses. The creation of Disneyland was a significant leap into uncharted
waters, but as this horizon was transformed into a new reality, Disney did not stand still.
It pursued new horizons, acquiring ABC (and with it ESPN) an investment from which
it derived the majority of its profits and revenues in 2015.
Like the chess player mentioned in Chapter 1, companies must think more than one
step at a time into the future. At each stage, different initiatives are appropriate, and at
each stage, the company must consider not only the initiatives it is proposing, but also
how competitors will respond. Another key lesson is to pay attention to competitors
responses. The success of a companys initiatives is determined not by its initiatives
alone, but also by the initiatives of its competitors.
In fact, every employee of a company should embrace some form of horizon thinking.
Eric Schmidt, now executive chairman of Alphabet, one of Googles two main divisions,
uses the 70:20:10 Model for Business Innovation. It dictates that in order to cultivate
multiple-horizon thinking, employees should dedicate 70 percent of their time to core busi-
ness tasks, 20 percent to projects related to the core, and 10 percent to projects that are
totally unrelated to the core. Other companies noted for innovation, such as 3M, have long
employed a similar approach.
EXHIBIT 9.3 Disneys Ever-Expanding Horizon of Investments

Source: McKinseys Staircases to Growth.
Current
1990s &
1920s 1930s 1940s 1950s 1960s 1970s 1980s Industry
Beyond
Involvement
Records, Publishing &
Animation Licensing Music Books .. .. Disney Stores
S oftware Merchandising
Motion Touchstone, Mirimax Filmed
Films .. TV ..
P ictures Home Video Acquisition Entertainment
Disney K-CAL TV,
Broadcasting
Channel ABC-TV
Hockey, Live
Live Theatre
aseball
B Entertainment
Walt Disney Tokyo Euro Disney,
Disneyland EPCOT Theme Parks
World Disneyland Animal Kingdon
Disney
Vacations,
Vacations,
Resorts &
Hotels Resorts Planned
Property
Communities,
evelopments
D
Cruises
As uncertainty grows when the horizons are farther into the future, conservative
leaders too often err on the side of caution. They refuse to prepare, preferring instead to
simply wait things out. Yet there are significant advantages to be gained from prepara-
tion, even if many of the bets made on the future do not pan out and they amount to
nothing more than spaghetti thrown against the wall to see what sticks. Firms, like
individuals, need to learn from experiments where failure is possible.
Rapid experimentation is the key to learning. The more spaghetti thrown against the
wall, the greater the chances that some of it will stick. The Wright Brothers, for example,
tested hundreds of wing and airfoil models, at great personal risk, before they achieved
successful flight. While experimenting they achieved a deeper understanding of what
works and what doesnt. This type of trial-and-error learning process is useful in organi-
zations. It provides them with knowledge they need for long term survival.6
Managing the Portfolio

An organizations responsibility is to take prudent risks. It should not be immobilized by
uncertainty, nor should it embrace risk so wholeheartedly that the firms future survival
is jeopardized. Organizations must achieve an appropriate balance between sticking to
what is known to produce results in the here and now, and exploring bolder moves,
which can help the firm survive an uncertain future.
How is this balance to be achieved? As suggested in Chapter 8, internal project control
mechanisms can be put into place that set clear project milestones, utilize regular reviews,
and make continued investments contingent on a progress. Pilot programs and prototypes
(see Chapter 7) can build an understanding of what is possible and can fine-tune initial
efforts before costly expenditures are made to scale up investments. More significant
resources are secured only as product and market knowledge grows, and as time reveals
whether projects are economically and technically viable and politically feasible. With a
disciplined approach to learning, the range of possible outcomes may be reduced, and
some of the uncertainty eliminated.
Not every project that is subjected to this process is renewed. Not every project is
continued. Some are abandoned entirely. Others are put on hold and their pursuit is
delayed. If postponed, they still may be held in reserve for revival later. The organization
must systematically create a memory bank of what it has learned from both successful
and unsuccessful experiments, for who knows for certain when such knowledge may be
useful? To start afresh without the knowledge once gained would be a waste and, under
some circumstances, it can put the organizations far behind its competitors.
The firms ability to not only approve project continuance, but to also delay or aban-
don projects within a firms portfolio of initiatives, should always be considered a real
option that offers significant strategic value over time for the following reasons:
There is a strategic value in cementing an organizations exclusive rights to future devel-
opments and in opening the door to related investments. Such moves block rivals as time
passes, forging a clearer path to profitability and competitive advantage.
There is tactical value in maintaining flexibility and agility in the practice of making
a broad range of minimal upfront investments (and having the option to delay subse-
quent investments) over committing to just one long and costly path.
There is residual value to be claimed when it becomes clear that an investment will
not meet full expectations, but that the physical or intellectual property that remains
can be redeployed or sold.
The real estate development process offers a clear example of the value that can be cap-
tured by creating a portfolio of options. This process is summarized in Exhibit 9.4.
In pharmaceuticals, what is ground-breaking and competitive at one moment can be
significantly reduced in value by a regulatory change or a faster rival. On the other hand,
a formulation initially designed for a limited purpose can increase in value as physicians
EXHIBIT 9.4 Real estate developers are speculators who secure a wide range of properties with the expectation that some
How Real locales in their portfolios are likely to gain significant value over time. Many of these properties are purchased at a
Estate minimal upfront investment.
Developers
Build a At the time of purchase outcomes are unknown. A property near a newly announced transit route may increase
tenfold in value very quickly, while another property that seemed more valuable when purchased, but remains
Portfolio of
isolated, may never appreciate as expected.
Real Options
Thus, the real estate development process involves taking real options. Developers purchase of exclusive rights
not obligationsto exercise the options to develop, delay, or abandon the land in their portfolios.
A decision to develop a parcel can be immediate if market conditions indicate that a quick ROI can be
achieved.
The decision can delayed until the developer is more certain that parcel development will be profitable (until
commercial businesses or homebuilders are clamoring for space).
The decision can be made to abandon a parcel if it fails to show promise and is not feasible to develop. In this
case, the developers will still be able to capture some residual value.
The bottom line is that a well-balanced portfolio of carefully selected parcels of land, even one containing many
question marks, provides developers with the flexibility and the agility to gain both financial and competitive
advantage over time.
EXHIBIT 9.5 A Bad Investment Becomes a Good One

Comparing +100 +80
2/3
Project Success
Valuation 1/2 Mid-course
correction
Techniques +20
Source: Adaptation 1/3
Today 1/3
ofexample offered in
Real Options Fact &
Fantasy, Aswath Now 10
Damodaran, NYU 1/2
Stern. Failure 2/3
120 20 Stop
experiment with off-label applications. Development project valuations frequently

change over time as new information comes to light.
As seen on the left in Exhibit 9.5, at the start of a lengthy project, the uncertainty is
great, and the odds of ultimate success may be like a coin toss. If there is a 50 percent prob-
ability that a firm will earn $100 million, and a 50 percent chance it will lose $120 million,
this equates to an expected value of minus $10 million: EV = ()(100) + ()(120). See-
ing only these odds leads to the conclusion not to pursue the idea further because the loss
is too great. On the right in Exhibit 9.5, however, mid-course correction is possible. The
odds are easier to determine. Potential downside risks are lower. The total expected value
of the proposed project is now calculated at a positive $10 million: EV = [(2/3) (20) +
(1/3) (20)] + (1/3) [(2/3) (80) + (1/3) (10)], which should trigger further investment.
There are many opportunities to capture additional value during the product develop-
ment cycle. Drug companies, for example, rarely take a new formulation directly from
compound invention to full commercialization without some form of delay. Projects are
abandoned at any point that they fail to meet safety and efficacy expectations and regulatory
approvals. This option to stop, instead of forging ahead, increases the ultimate project value,
a nuance not always captured when traditional discounted cash flow analysis is used to
determine if a project should be launched. Formerly abandoned projects are resurrected and
can provide residual value when existing formulations are repurposed. By using existing
formulations for new purposes, firms avoid early development stagesan approach, which
brings down failure rates and is on average 40 percent less expensive than investing in a new
drug from scratch.7 New drug development costs can reach $1 billion, so such savings are
significant. For example, a compound called sildenafil, which was originally to treat angina,
did not function for this purposes, and it could have been abandoned, but it became a highly
effective treatment for impotence and was rebranded as a very profitable drug, Viagra. This
example shows that the potential residual value of real options cannot be ignored.
Public-Private Partnership Models

Public-private partnerships (PPP) can also help organizations manage the uncertainty
surrounding massive, long-term initiatives that are designed to benefit society as a
whole. They combine resources, management skills, and technology of the private sector
with the resources, regulations, and other protections that governments may provide. 8
This approach is especially useful in the delivery of services that touch on basic needs.
EXHIBIT 9.6
Degrees of
Degrees of Risk & Involvement Required
Private Sector
Risk and Low Medium High
Involvement
per PPP Model
(Project Type)
Design/Build Lease/Dev/Operate Design/Build/Finance/
Operate/Maintain
Operate/Maintain Design/Build/Operate
Build/Own/Operate
Build/Finance Design/Build/Finance/Maintain
Concession
Build/Finance/Maintain Design/Build/Finance/Operate
Health care is a prime example.9 Given that populations have gotten older and more
urban in almost every country, care needs have skyrocketed. The challenges are signifi-
cant, yetwhen PPPs are well designed and managed, they can begin to chip away at the
problem. The evolution of technology has presented a catch-22. Diseases and injuries that
once caused acute, fatal events, such as burns or cancer, have become more m anageable.
New treatments have developed, often with the help of publicly funded research. They
save and extend lives, but also increase costs. PPPs can reduce reliance on bureaucratic
government structures while putting protective guidelines in place for the c onsumer and
mitigating private sector risks. They can be a powerful tool for reinvention of entire indus-
tries, such as medical devices, pharmaceuticals, and insurance. Ultimately they can lead
to significant improvements in health-care quality, efficiency, and access.
Transition economies greatly benefit from PPPs. Citizens in countries with transition
economies typically face infrastructure deficits, such as congested roads, poorly main-
tained transit systems and recreational facilities, and deteriorating schools, hospitals, and
water and water treatment systems. Poor infrastructure translates into less productivity
and competitiveness. It leads to more accidents, health problems and lower life expec-
tancy. Governments with transition economies do not have the tax base needed to fund
improvements. PPPs, therefore, become valid methods to tackle the challenge. Business
leaders and public officials negotiate the best balance between fiscal responsibility, risk,
and control.10 There are a range of PPP models that allocate responsibilities and risks
between the public and private partners in different ways (see Exhibit 9.6).
Reinventing the Business Model

Business model innovation (see Chapter 7) focuses on improving how a company earns
revenues, incurs costs, and manages its risks; some initiatives can result in companies rein-
venting their business models, either in part or entirely. Business model reinvention takes a
company beyond just reimagining its products, technologies, and markets. A company
experiencing stagnating sales and declining profitability can search for new products and
services that it can offer to new customers in new ways. The business model encompasses
not only how products are created, but also how consumers interact and pay for them.
Several useful frameworks exist for business model reinvention. These frameworks
help firms analyze and make important trade-offs. As shown in Exhibit 9.7, even
EXHIBIT 9.7
Given our Given our Given the way
Business Model customer interactions with to we choose to
Reinvention target... this customer... create value...
Some
Considerations Can we
clearly state How can we
What will be
Source: https://www. an improved redefine our
our revised
capgemini-consulting. value revenue
com/resource-file- cost basis?
proposition? model?
access/resource/pdf/
Business_Model_
Innovation.pdf.
asimplified approach can help firms focus on what matters most: the value proposition,
revenues, and costs.
The value proposition consists of products and services created to fulfill customer
requirements. A deepened understanding of the market can reveal better targetsmore
lucrative segments and geographies. Allstate, for example, drove new growth by under-
standing and accommodating the needs of four different customer segments, each with
distinct interaction preferences. Its high-touch response to customers compares favorably
to the low-cost approach of rivals, such as GEICO and Progressive (see Exhibit 9.8).
The revenue model derives from the structure of customer interactionstheir inten-
sity, duration, channels, and payment methods. Shifts to decrease product touch times
or accelerate payments can provide significant top-line benefits. Subscription-based
revenue models are on the rise, and are replacing less convenient single purchases
while increasing top-line revenues over the long term. Netflix has a subscription-based
model that has been copied by Amazon Prime. Amazon originally launched Prime to
provide the convenience of an unlimited two-day delivery service for a n umber of its
products, a move that has led to significantly higher loyalty and average sales. Then it
added an on-demand video and media streaming service like Netflixs. Such subscrip-
tion models whet consumers appetites for repositories of content a ccessible from
home for a flat monthly rate. Dollar Shaves easy low-cost subscription model has
made inroads into a market P&Gs Gillette has long dominated. Gillette is now trying
to adjust its revenue model to incorporate elements of Dollar Shaves model. It is
trying to compete on value and pushing its own direct delivery service.
EXHIBIT 9.8
Allstates Full
Set of Value Encompass Answer
Propositions High Touch, Self-Serve,
Generic Generic
Source: http://
allstatenewsroom.com/
ar2012/segmentation-
strategy/.
Allstate Esurance
High Touch, Self-Serve,
Branded Branded
The cost basis is determined by how a company creates its outputs and fulfills its
value proposition. The development of simplified designs and delivery channels can
significantly reduce a firms costs. It all depends on how unique assets and capabili-
ties are deployed to generate superior customer value. The Trader Joes example,
featured in Chapter 3, illustrates the benefits of a simpler service design.
Open Source Options

In order to redefine their business models, some firms have been stretching beyond organi-
zational boundaries to engage innovation partners across the value chain. This technique
has been coined Open Source Innovation (OSI). Crowds are the open-source partner of
choice because of their ability to add product insights, enhancements, and solutions.11
Firms call on customers, suppliers, distributors, external experts, and other partners to
assist them, instead of relying solely on their R&D departments as the source for their inno-
vative ideas. This type of innovation offers scale, speed, and less failure. The problem is the
potential intellectual property risks and the administrative burdens. While the technique
produces solutions unattainable internally, it is loose, decentralized, and hard to control.
A number of crowdsourcing variations exist. Kickstarter and Indiegogo are two popular OSI
platforms. However, its important to select the right tool for an organizations unique needs:
1. If the task is highly challenging, technical, analytical, scientific, creative or aesthetic
in nature, a contest might be the best approach. Sites, such as Tongal, provide ready-
made platforms for contests (see Exhibit 9.9).
EXHIBIT 9.9
Contests Can
Help Firms Tap
into Crowd
Wisdom
2. If the task involves customer support, a collaborative community may work best.
Although it is impossible to control the actions of the community or the dissemination of
the IP the community creates (for example, if the purpose of the community is to develop
software), there are significant benefits in drawing on the skills of dispersed motivated
individuals who work either because of their altruism or the desire for recognition.
3. If the problem is to gain access to large pools of laborersand it is possible to
clearly define and evaluate the tasks to be doneit is possible to create a crowd-
based labor market that efficiently matches talent to the tasks that have been defined.
Firms, such as TaskRabbit, ClickWorker, and Upwork (the merger of Elance and
oDesk), have businesses based on this idea. Virtual workers from all over the world
participate, creating competition for workers in developed countries.
Minimally Viable Models

Still another reinvention tool is the minimally viable model (see Exhibit 9.10). This
iterative development methodology, fueled by an active customer feedback loop, yields
a series of minimum viable products (MVPs). This type of thinking started with the lean
movement of the 1970s. Variants of minimum viable processes are scrum and agile
methodologies, which dominate in software development.
Minimally viable thinking, however, is not limited to product or service development
activities. These concepts have been applied to many other innovative practices of orga-
nizations. Minimum viable teams skillfully perform the activities that the organization
needs to operate, nothing more. Nonproducers are not welcome. Cofounders of new ini-
tiatives have to grow or abandon them. A minimum viable organization is built to the
point where it can compete well and pivot quickly. It is designed to tie into flexible
resource global networks that span both spatial and geographic boundaries and are
reconfigured quickly, often by open source methods. These networks are made up of
autonomous teams, individuals, and assets.
Recent MVP successes, such as Dropbox and AirBnB, are mere connectors or reposito-
ries of externally sourced content. They own few assets themselves. Rather, they bring people
together and in contact with assets with whom they are in contact and with whom they work.
EXHIBIT 9.10 Bare bones products Products that satisfy a

Minimally that appeal to only the critical mass of the
most budget conscious buying public but are
Viable Models
consumer costly to product
Source: Jon Radoffs
blog.
Minimum Viable
Best mode for startupsor any

smart innovators. Faster
development at lower risk
Eco-System Development
As minimum viable enterprises, Dropbox and AirBnB rely on robust eco-systems. In fact,
Robust eco-systems are now mandatory for business model reinvention. Organizations that
deliver these eco-systems to their customers have many advantages. The eco-systems offer
ease-of-use advantages that single-product innovation cannot match. Apple blazed this frontier,
tightly integrating its hardware and software platforms, while insisting that external software
developers adhere to rigorous human interface standards. Apple continues to reject new apps
that do not follow its design and functionality guidelines, which have yielded a library of apps
sold on iTunes that, besides somewhat standardized design, are forward-compatible and oper-
ate intuitively as well as communicating across multiple hardware formats (iPhone, iPad, and
iWatch). The apps have greatly increased the value of the devices Apple sells to users. With
cloud and streaming capabilities that adhere to iOS design standards continuing to evolve,
Apples robust and user-friendly eco-system has been a clear source of its ongoing advantage.
Nest Labs, a producer of programmable, self-learning, sensor-driven, Wi-Fi-enabled
home automation products, has also followed this model. Founded in 2010, this com-
pany has created a full eco-system for its users. It strives to generate a sprawling network
of devices and companies that complement what it does, and function in tandem with its
products. Its acquisition of Revolv, a flexible platform to Nests library of p roducts, fur-
thers this goal. The company has started a program called Works With Nest for devel-
opers interested in linking to its products.
The efforts of Apple and Nest to create viable ecosystems to support their products stand
in contrast to those of ill-fated Google Glass.12 Google pursued the product as a technology
push initiative. It was a solution in search of a problem. Google Glass did not solve any exist-
ing consumer issue in an effective manner. Google was more interested in publicly
demonstrating that it was a technology first mover than in carefully packaging the product to
demonstrate its utility. The rough edges of the pilot products, the beta versions, did not satisfy
user needs. The lack of an eco-system with complementary products and at least a few killer
apps made the product less than user friendly. Google has repeatedly made this mistake and
has been forced to shelve Google Glass and a number of other promising products.
Technology Push versus Market Pull

The technology-push model of innovation starts with discoveries in basic science and engi-
neering. From these discoveries come new goods and services. Exceptionally creative entre-
preneurs and people in the research labs of large corporations harness the ideas of science
and technology and find useful applications. However, numerous empirical studies and
descriptions of innovation demonstrate the importance of a clear perception of market
needs.13 Schmookler argued that market factors are more important than technology and that
market growth and potential are the main determinants of innovation.14 Researchers have
concluded that it is the linking of both componentstechnology-push factors and market-
pull factorsover the product life cycle that is important.15 Studies show that the amount of
innovation coming from scientific and technical people is roughly equal to that from manu-
facturers and users. Frequent interactions between these groups are important. Users must be
sophisticated enough to make technically relevant recommendations and must be able to
purchase and use the products that incorporate their suggestions. Successful innovations need
both scientific/technical and market components.
The challenge innovators and entrepreneurs face is to match technological opportu-

nity with market need. For companies, this means bringing together different in-house
functions (such as marketing, R&D, and manufacturing) with knowledge of consumer
needs and scientific and technical developments. The essence of successful innovation is
that it fuses technological possibility with market demand. Technology-push and market-
pull models are atypical examples of a more general process in which constant interac-
tion occurs between market requirements and scientific achievement.
Finding Technological Opportunities

Technological developments provide the new ideas for innovation and entrepreneurship,
but finding the right technological opportunities is not easy. To forecast technological
change, it is necessary to anticipate breakthroughs early. The means of doing so include
trend analysis, monitoring expert opinion, constructing alternative scenarios, and
immersing oneself in leading- or cutting-edge technologies. The strengths and weak-
nesses of these approaches to technological forecasting are worth assessing.
Trends: Trends in one area often forecast trends in another (e.g., military jet speeds fore-
tell commercial jet speeds). One can extrapolate, for instance, the number of components
needed to manufacture one product to estimate the number needed to manufacture a similar
product. But trends must be analyzed with caution. Simple extrapolation can be deceiving if
it does not account for the impact of one trend on another, fails to consider how the human
response to trends can change their direction, and has no room for surprises. Economic
forecasts are good at predicting the future on the basis of the past as long as the future
resembles the past in important ways. However, radical breaks occur (e.g., the 1973 Arab oil
embargo, the fall of Communism, the 9/11 terrorist attacks, and the economic meltdown at
the end of the first decade of the 21st century), which few economists predicted.
Alternative Scenarios: Often, when the future is uncertain, the best coping method is to
construct alternative scenarios (see Chapter 2).16 Companies may create a series of possible
sequences of future events. Scenarios allow companies to think through what they would do if
unfavorable circumstances should arise and thus provide them with the opportunity to better
manage future contingencies when they come. Companies must monitor the environment for
signals that may be the forerunners of significant changes. To do so, they have to clarify which
indicators to follow. Then they have to understand how to interpret the information. Afree
society produces an immense amount of information. Professional conferences, technical
papers, and the media all yield data that vie for a managers attention. What to focus on and
what to ignorewhat is the true signal and what is the noiseis a perpetual problem.
Leading-Edge Industries
Leading-edge industries provide momentum for technological change. Companies monitor
them carefully. In these industries, they are likely to see the opportunities for profit. They can
then vigorously exploit the possibilities inherent in these sectors. The pioneers in a leading-
edge sector typically are followed by a swarm of imitators. The combined activity of the
pioneers and their followers generates boom conditions. Soon, however, there are so many
imitators that prices fall and bust follows. Lagging sectors fall behind, their time passes, and
they wither and die or are kept afloat by government subsidy and bailout. New leading-edge
industries are needed to spur a revival, a process that has been called creative destruction.17
Technological progress occurs in waves. The first wave after the Industrial Revolu-
tion (17821845) saw major innovations in steam power and textiles; the second wave
(18451892) saw major innovations in railroads, iron, coal, and construction; and the
third wave (18921948) saw innovations in electrical power, automobiles, chemicals,
and steel. The prosperity of the postWorld War II period was built on innovations in
semiconductors, consumer electronics, aerospace, pharmaceuticals, petrochemicals,
and synthetic and composite materials. Starting in 1993, the Internet and advances in
telecommunications started another wave of progress. Where future waves of innova-
tion will come from remains uncertain.
The current era has been called one of post-industrialism.18 Post-industrial societies
differ from industrial societies in a number of ways. There is a move from goods to ser-
vices and preeminence for professional and technical people. Control of technology and
technological assessment are primary activities. In post-industrial societies, physical
resources are less significant. Intellectual resources are at the center of economic activity
rather than the manipulation and movement of products made from natural resources and
physical labor. The microchip symbolized this shift from the materials to ideas, as the
material costs of the product are but a small fraction of the total cost of manufacturing.
The information component is of greater value than the material component. The most
valuable part of the technology is the idea for its design. Here are a number of examples:
biotechnology, low-cost environmental solutions, and high-value environmental products.
Biotechnology
The movement from industrial to post-industrial society can bring into existence a more
sustainable society, one in which peoples basic needs for food and a healthy environ-
ment can be better met. For instance, instead of being sprayed with pesticides, plants can
be genetically coded to repel or destroy harmful insects. This is a much smarter way of
doing business because up to 90 percent of what is sprayed on crops is wasted. Biotech-
nology can create smarter products that reduce chemical use. A bioengineered potato
that defends itself against the potato beetle and does not have to be sprayed with pesti-
cides is just one example. Bt cotton, which kills and repels budworms, is another.
By 2000 more than half of the U.S. soybean crop and more than one-third of the corn
crop involved bioengineered products. Scientists were able to protect crops, such as corn,
soybeans, cotton, potatoes, and tomatoes from pests. They were also working on taking
genes from fish that swim in icy water and injecting them into strawberries to enable the
strawberries to resist frost.
In addition to crop protection, biotechnology has promised advances in a number of
other fields:
Nutrition. Scientists may be able to extract genes from one species (a Brazil nut) and
put them into another species (the soybean) to increase the protein level to make the
soybeans more nutritional. They are trying to make soybeans taste better and to
remove some of the saturated fats to improve soybeans health benefits.
Pharmaceuticals. Scientists may be able to introduce genes into rice that will enable
it to produce beta-carotene and thus combat the vitamin A deficiency common among
people who rely on rice for sustenance. They also have been developing vaccines for
hepatitis B, diarrhea, and other diseases that can be incorporated into the cells of a
banana or a sweet potato and thereby distributed to people in developing nations who
may not otherwise be protected against these diseases.
Industrial. The aim is to make industrial materials, such as plastics, nylons, and other
petrochemical byproducts from genetically modified plants. These plants would re-
place world reliance on highly polluting hydrocarbons.
Some scientists and entrepreneurs hyped the chances of success, but there were difficul-
ties deciding which products should come first. What deserves rapid commercialization?
Government has played a large role in the use of biotechnology for pharmaceuti-
cals. Many federal agencies have some jurisdiction and guidelines are unclear.
While waiting for regulatory approval of a product, companies have to develop
manufacturing facilities that they cannot run at full capacity and sales forces that
cannot yet market the product. Many companies, therefore, have moved to nonphar-
maceutical industries.
In addition, many environmentalists criticize genetically engineered food as
being Frankenstein in quality. 19 They point to an incident in 1995 when a Brazil
nut gene had been spliced together with soybeans to increase the level of the amino
acids methionine and cysteine in the soybeans. The splicing together of the genes of
these plants produced nutritious animal feed; however, humans allergic to Brazil
nuts could die if they accidentally consumed a soybean or a soybean product with
the spliced gene. Environmentalists also publicized 1999 research by a Cornell Uni-
versity researcher showing that eggs of the monarch butterfly could perish if
exposed to Bt-modified corn pollen. The pollen destroyed three-day-old monarch
larvae 44 percent of the time in a laboratory study. When it comes to human con-
sumption, environmentalists insist on a precautionary principle: so long as risks of
any kind exist, the burden is on the introducer of a new product to demonstrate
complete safety. They argue that genetically modified seeds were rushed to the mar-
ket without adequate independent testing. Only minimal testing was done, or small
sample sizes were used, which did not pick up negative results. Though some of the
evidence has been speculative, environmentalists have warned against eating bioen-
gineered foods, and European governments have imposed regulations calling for the
separation of approved and unapproved strains, requiring labeling, and preventing
the sale of some products.
Low-Cost Environmental Solutions

At one time, environmental issues were regarded primarily as threats to business.
However, if extracting more economic value from fewer natural resources and raw
materials can improve existing products and services and lead to the development of
new ones, these challenges can be the catalysts for business innovation. Environmen-
tal considerations have played a central role in many companies optimization of pro-
duction processes not only in pollution-sensitive industries, such as petrochemicals
and electric power, and in basic manufacturing industries, such as auto, steel, paper,
and cement, but also in high-tech industries, such as semiconductors. While the
conventional view is that environmental challenges impose costs on business, slow
productivity growth, and hinder global competitiveness, a revisionist view sees them
as the driving force for cost reduction.
Pollution can be seen as a form of inefficiency that demands of firms that they lower
their costs.20 It is an indication of unneeded scrap, harmful substances, and energy that
is not completely used and creates no value for customers. Competitive advantage,
therefore, can be reached by developing environmental competencies in areas, such as
pollution prevention, and in developing new energy-efficient products and services.
Companies have to add up total production inputs and try to minimize them, carefully
examining production processes to ensure that they are maximally efficient and do not
waste inputs. Many companies have inventoried their wastes, evaluated the impacts,
and implemented successful reduction programs. A successful program requires that
the company pay attention to product and process design, plant configuration, informa-
tion and control systems, human resources, R&D, the suppliers role, and the corporate
organization. A team must be assembled, a method for measuring progress determined,
process flow diagrams prepared, and tracking systems for materials use set up. Opera-
tional and material changes have to be considered, including material use substitutions
and process and production changes. For such programs to succeed, employee involve-
ment and recognition are needed.
High-Value Environmental Solutions

For many companies, excellence in protecting the environment has created opportunities
for competitive advantage. These companies not only have been lowering costs and
achieving cost leadership by pursuing environmental efficiency, but they also are pursu-
ing a differentiation or focus strategy based on developing green products for niche mar-
kets. Winwin solutions mean that both the environment and society are better off.
A high-value environmental strategy does not just involve waste reduction; it also
entails developing new products and services. Consider the electric car as an example.
The 2009 Obama administration stimulus package included $2 billion in grants for elec-
tric car research and $25 billion in low-interest loans for green vehicle purchases. A way
to drive down electric car prices was to have customers lease the batteries from a third
party. Better Place, an Israeli startup, proposed to do this. Its business model was to own
and maintain the batteries and sell subscription plans for their use. It expected to operate
like a cell phone company that sold miles instead of minutes. Better Place, however,
overextended itself and went bankrupt.21
Other startups entered the electric car market, but the only one to survive and prosper
was Tesla. Its high-end Roadster sports car, priced at $109,000, accelerates from 0 to
60 miles per hour in less than four seconds and is faster than some Ferraris. Of great
importance is that the Roadster offered a solution to the range problem. Its lithium-ion
battery pack provided the car with a range of 245 miles. Compared to the Roadster, the
Leaf, Nissans mid-size all-electric vehicle, has a range of less than 100 miles.
Tesla overcame this longstanding barrier to the commercialization of an electric car by
designing a battery pack with 7,100 lithium-ion cells as opposed to the 192 cells in the
Leafs battery. Together with Panasonic, its battery supplier, Tesla created a sophisticated
computerized system for monitoring the batteries temperature and cooling them should
the batteries get too hot. Tesla also redesigned its car, placing the bulky battery packs
under the car, where they improved the cars stability and handling. The battery packs
heightened the driving experience rather than acting as a deficit. Also, the R oadster was
made from super-light high-tech materials in an extremely automated factory setting to
keep costs low, while the cars shape was aerodynamically designed to minimize the drag.
These design improvements were essential if there was any hope that the electric car
could become commercially viable.
With the Roadster, Tesla entered the high-end automotive market. In this seg-
ment, a small slice of customers was prepared to pay a high premium to purchase an
innovative vehicle. At its sale price, more than $100,000, the Roadster clearly was
not for the masses, but Teslas plan from the beginning was to take on each of the
commercialization barriers it faced one by one. The next barrier was to move down
market and lower the price of the electric vehicle. Its business plan involved, after
building and selling the Roadster, using the money it made to build a more afford-
able car and, after building a more affordable car, using those profits to build an
even more affordable one. The second model Tesla produced was called the Model
S, and it sold for $69,000, competing in the same category as the Audi A6 and the
BMW 5 series. The car was 10 percent faster than said vehicles and offered other
attractive features that allowed it to win Consumer Reports 2014 car of the year
award. The magazine gave it the highest rating it ever gave to a car, praising it for its
styling, handling, fuel efficiency, and safety.
However, Tesla would still have to create an even more affordable electric car, and
getting to the next level would not be easy. The batteries in a more affordable electric
vehicle, depending on how many there were in a pack, can cost anywhere between
$7,500 and $18,000. Can Tesla sell a mid-sized sedan for about $35,000 with batteries
this expensive? To lower costs, Tesla started to build a giant battery factory in the deserts
of Nevada with partner Panasonic. To ensure that there was sufficient demand for these
batteries, it opened up its electric vehicle patents to all comers, including conventional
automakers like GM in the hope they, too, would build this type of car in large numbers
and buy the batteries.
Wrapping Up: The Dilemma of Strategic Change

This book opened with a discussion of inflection pointsmomentous shifts in tech-
nologies, markets, laws and regulations, global conditions, and the economy that
create deep-seated departures from the pastand the significance of such points has
been emphasized throughout all nine chapters. When an inflection point occurs, the
pressure for change increases and firms have little choice but to try to remake them-
selves. Those that can better navigate such conditions are better able to thrive. They
struggle against vested interests that do not want to budge from the status quo. They
fight staff, for instance, that does not want to honestly confront the challenges that
lie ahead.
Yet firms often find that it is simpler to stick to the past than to move forward. Barri-
ers to change abound, and resistance comes from many quarters. Mobilizing the forces
of change to overcome these barriers is not easy. Just determining where the firm wants
to be next is a difficult decision. Many corporations focus on what the firm has been
good at in the past. They do not want to give up what they are currently doing, nor do
they want to move to an unknown destination. Developing new capabilities and compe-
tencies is demanding, and they are reluctant to do so.
There are several approaches firms can take when dealing with the prospect of
aking changes:
m
Some firms vigilantly guard the past. These are defenders.
Other firms have no hesitation about taking the next steps and moving into the future.
They vigorously search for new opportunities. They are prospectors.
Others try to simultaneously cultivate the past, while they journey into the future.
These are analyzers.
Still others, overwhelmed by change, become confused and do not know what to do.
These firms are reactors.
When inflection points bear down on firms, the reactors may well be the poorest perform-
ers. They are adrift without direction. They may just be trying to keep their options open.
At some point, they will have to decide on a direction. Defenders, too, may be in a poor
position. However, if they can effectively mobilize resources, they may be able to protect
their current position. As survivors in unattractive industries, they can defend remaining
niches. As other firms leave the industry, they can pick up revenue streams and profits.
Prospectors, those who seize opportunities before others realize their value, face many
challenges. Key among them is the risk of being too far out in front of competitors. Pioneers
rarely realize the full gains of the quick and early thrusts they make into new territory.
Early movers face many problems. For instance, they must convince recalcitrant buy-
ers to switch before a new product has been accepted and standards for its manufacture
and use have been established. The experiments in which they take part are costly. The
efforts they make are often premature; the mistakes are hard to undo. Aggressive second
movers learn from and capitalize on pioneers miscalculations; they take advantage of
the first movers misfortunes.
The managers of most firms tend to understand these risks. Seeing the failures of over
exuberance all around them, they do not have to be persuaded to be cautious. Many
choose to be conscious and deliberate analyzers. Perched between the past and the future,
they try to defend and exploit a successful niche and, at the same time, seek out new
opportunities for growth and expansion.
This approach requires maintaining a delicate balance. Pulled in two directions at once,
the position the firm tries to straddle may not be tenable. The organizational requirements
for exploiting a past niche are not necessarily compatible with those for exploiting a future
one. The former calls for the utmost efficiency to fend off encroaching competitors,
whereas the latter requires maximum creativity to move into uncharted territory.
While efficiency depends on having strict command and control structures that may
stifle employees ability to innovate, creativity depends on loosening constraints that
stand in the way of new ways of thinking and behaving. Thus, the middle position may
not be viable. A firm may have to decide whether to continue as dominant in what it has
been doing well or try to become dominantas soon as possiblein what it would like
to do well next. If it simultaneously tries to prospect and defend, it is likely to be medio-
cre at both and will fail because it has no comparative advantage.

Sustained competitive advantage (SCA) is fleeting, and managers must be watchful of
major turning points in which the dilemma of where to go is most challenging. This
book has developed a sequence of steps that managers can take to deal with change. This
approach to strategy can be summarized as follows: SCA is equal to external analysis
(EA) plus internal analysis (IA) plus moves (M) that the strategist can take. That is,
SCA = EA + IA + M
The moves should be taken with as much knowledge as possible of the responses
opponents can make and the consequences of those responses.
External and Internal Analysis
External analysis (Chapter 2) and internal analysis (Chapter 3) both have a number of com-
ponents. External analysis (EA) is an assessment of industry attractiveness. The industry is
defined as best as possible, although industry definition is often problematic because
industry boundaries are shifting. In analyzing the external environment, the organization:
Examines the five forces (5F) in the industrysuppliers, customers, competitors,
new entrants, and substitutes. These determine the industrys attractiveness.
Assesses the macro-environmental forces (MF)economics, politics, technology,
demography, social conditions, and the natural environmentthat influence the five
industry forces.
Conducts a stakeholder analysis (SA)an assessment of such key constituencies as
shareholders, government, advocacy groups, and the media. This determines the net-
work of ties between the firm and its constituencies.
Each of these assessments should be conducted to the extent possible. Thus,
EA = 5F + MF + SA
Internal analysis (IA) is an assessment of the firms strengths and weaknesses. In
analyzing the internal environment, the organization:
Assesses the degrees to which it is mechanistic or organic and whether there is a good
fit with the environment.
Examines the seven Ss (7S) in the firmstrategy, structure, systems, staffing, skills,
style, and shared valuesto determine if there is balance among these factors.
Assesses the firms value chain (VC)its primary and support activities in areas,
such as inbound and outbound logistics. What are the linkages between the firms
value chain components and those of other firms?
Examines the firms resources, capabilities, and competencies (RCC)its strengths.
Are they combined in a way that provides something rare, hard to imitate, difficult to
substitute, and valuable?
Thus,
IA = 7S + VC + RCC
Each part of external and internal analyses provides a more complete picture, but time
constraints may preclude a thorough assessment of each element. Before choosing
moves, the analyst should ask:
Given the firms unique configuration of resources, capabilities, and competencies,
how defensible is its position?
Are the resources, capabilities, and competencies barriers to change, or can they be
the drivers of entrepreneurial activity and new business development?
Moves after External and Internal Analysis

External and internal analyses are only the start of the strategy process. They are
preliminaries to making actual moves (M). The firms possible moves depend on the
options available and on whether the firm should use or forgo them. Timing plays a role,
and competitors reactions must also be considered. The strategist needs to understand
the possible moves the organization can make. He or she must consider each move by
itself as well as combined with other moves in an ordered sequence. The strategist then
has to determine to what extent the moves have the potential to achieve the organiza-
tions goals, given the fact that competitors are also choosing or forgoing moves at the
same time.
A rational process would be to list all the options available, consider all the conse-
quences, and choose the best, but this degree of comprehensiveness may not be feasible.
Given the risks and uncertainties of each action and the limited time and calculating
ability of the analyst, precisely estimating results of following every potential course of
action is usually not possible. The analyst can, however, try to approximate this type of
estimation. A shortcut for generating a list of options is to think in terms of the moves
discussed in Chapters 4 through 7: positioning; mergers, acquisitions, and divestitures;
globalization; and innovation. Each of these chapters considered a type of generic move
that the analyst might think of pursuing.
Timing and Positioning

Chapter 4 dealt with the timing (T) of the moves a firm might make as well as the posi-
tioning (P). Should the moves be early or late, and what combination of low-cost and
high-quality attributes should be incorporated into a product or service to create a best
value proposition? These decisions are included in business strategy (BS):
BS = T + P
Mergers, Acquisitions, and Divestitures

Chapter 5 addressed mergers, acquisitions, and divestitures (MAD). At issue here are the
size and scope of the firm itself, the extent of its diversification, the degree to which it
should focus on one product or market or on many, and the degree to which it should be
integrated up or down the value chain. These decisions typically are included in the cat-
egory of choices called corporate strategy (CS):
CS = MAD
Global Expansion
Chapter 6 dealt with the rationale for a firms global expansion (GE). Should such
expansion be undertaken primarily for marketing, manufacturing, or other reasons?
Should it be carried out in a uniform way that promotes low cost or a customized way
that requires expensive adaptation? Another issue is the extent to which the firm should
outsource (OS) its global operations: Should it partner with local allies or internalize
them? These are some of the critical elements of global strategy (GS). Thus,
GS = GE + OS
Innovation, Entrepreneurship, and Implementation

Chapter 7 discussed innovation and entrepreneurship. The roles of entrepreneurs,
established firms, funding sources, and backers of the firm, including government,
have to be sorted out. The firm has to discover what opportunities (O) are available,
and it must analyze the obstacles to commercialization (C). It must achieve a match
between a technologys development stage and the markets readiness for that tech-
nology. This category of moves, which we refer to as innovation strategy (IS), can
be expressed as
IS = O + C
Finally, Chapters 8 and 9 dealt with implementation and reinvention. Without effective
implementation (I) all these moves are for naught. Without continual reinvention, the
firm stagnates and loses ground.
The Expanded Model

Together, the four categories of moves and the external and internal analyses create an
expanded model of SCA, as follows:
SCA = [EA + IA] + [BS + CS + GS + IS] + [I + R]
Analysis Moves Implementation &
Reinvention
If a firm continuously engages in this process, it will be better able to deal with inflec-
tion points, to redeploy assets, and to regularly reinvent itself. Two examples of reinven-
tion are discussed in Exhibit 9.11: first, Microsofts reinvention in response to Netscapes
emergence, and second, the reinvention of retail food companies in the face of Walmarts
emergence.
Recognizing Customer Needs

The challenge the retail food industry faced was similar to the challenges many
industries have faced. They have had to reinvent themselves by giving more promi-
nence to customer needs. This type of reinvention entails a view of the organization
as a feedback loop. It starts with recognition of customer needs and ends with an
attempt to satisfy these needs at a higher level. Companies must have aggressive
goals with respect to the speed and consistency with which they deliver goods and
services to their end-customers. It is essential to set up critical business processes,
as in the retail food industry, to accomplish these ends. Superior information is the
basis for meeting customer needs effectively. Companies have gone from products
to solutions (see Exhibit 9.11). Profits come not from a firms resource-intensive
assets, but from knowledge. To capture profitable niches in industries, companies
use their know-how.
EXHIBIT 9.11 Two Stories of Reinvention
Story 1 Browser Wars. Microsoft reinvented itself in the face of a challenge presented by Netscape. For new entrants like Netscape,
staying under the radar is very important. The struggle between Netscape and Microsoft over Internet browsers involved a fast, flexible
entrant, Netscape, which took on a dominant and powerful firm, Microsoft, in a judo-like struggle of a small flexible competitor against one
which was much larger and more powerful. Eventually, however, Microsofts Sumo-like tactics prevailed.
In 1997, at the height of the browser wars, Netscape had 700 employees and $80 million in sales, while Microsoft had 17,000 employees
and $6 billion in sales. In 1996, Netscape peaked with close to 90 percent of the browser market. One year later, its market share was
down to less than 50 percent. Ultimately, it was Microsoft, not Netscape that controlled this market.
Netscape achieved its initial dominance of the browser market in a number of ways. By releasing a beta version of Navigator in 1994, Netscape
received free assistance in developing the product from early users who acted as a quality-assurance team. It then separated the browser from
other Internet options sold by vendors (such as dial-up access and e-mail accounts) and virtually gave the browser away for free. The official price
was $39, but academics and nonprofit organizations did not have to pay, and anyone could download the browser for a free 90-day trial.
At first, Microsoft more or less ignored Netscapeit was preoccupied with bringing another Windows version to the market. But in December
1995, Bill Gates proclaimed that Microsoft was going to be hard core about the Internet. Netscapes aim was to build market share and set
the industry standard, and then make money through licensing fees for Navigator code used in browsers, intranet and extranet software,
e-commerce solutions, Web servers priced in the thousands of dollars, and a portal that competed with Yahoo!, AOL, and InfoSeek.
Microsoft matched these moves. Not only did it give away its Internet Explorer to all users, including corporate clients, but it also bundled it
with Windows 95. Internet Explorer popped up on the desktop of every Windows user. Microsoft also outbid Netscape for contracts with
Internet service providers, including giant AOL with its millions of customers. In putting AOLs icon on the Windows desktop, however,
Microsoft ceded ground to AOL and undercut its own online network, MSN.
Microsoft was determined to break Netscape, particularly because Netscapes managers claimed that their system would make the
Windows operating system unnecessary. By threatening the existence of Windows, Netscapes executives spurred Microsoft to retaliate.
Unlike in judo, Netscapes managers were not sufficiently prepared for Microsofts inevitable response and retaliation.
By means of its struggle with Netscape, Microsoft reinvented itself. Still, it was hurt by this battle. The Department of Justice challenged its tactics
as violating the Sherman Antitrust Act: As a company with a dominant positionmore than 90 percent of the operating-system marketMicrosoft
could not use its Windows monopoly to defeat a competitor in another market it wished to enter. Microsofts exclusive bundling deals and the
threat it made to cut customers off from Windows if they used Netscape went too far. Microsoft defeated Netscape, but its long clash with the
Justice Department seriously damaged the software maker. That clash made Microsoft a much less aggressive company.
Story 2 Retail Food. The retail food industry has experienced deep-seated transformation. Changing consumer demographics and
lifestyles, alternative whole-meal replacement chains, specialty stores, hypermarkets, cooperatives, deep discounters, and, most
significantly, general merchandisers, such as Walmart have eroded market positions among traditional grocery stores and supermarkets.
By 2000, Walmart had become the largest grocer in the United States.
Walmarts strategies posed basic challenges to the grocery industry. The companys distribution costs were about 3 percent of sales,
roughly half the cost of the typical supermarket chain. The grocery industrys response to these changes was a gargantuan campaign to
acquire new competencies in supplier and customer relations. The actions it took were meant to improve the efficiency of the supply chain,
a complicated undertaking involving both peoples skill levels and technology. With competition in the food industry rising and a rapidly
changing retail environment, acquiring capabilities in supplier and customer relations was a key to grocers survival. Firms in the industry
had to acquire new information systems that linked customers, wholesalers, and manufacturers; achieved enhanced food chain integra-
tion; and provided for stronger alliances between retailers and vendors, leaner inventories, lower inventory costs, and better logistics.
Thus, the industrys goal was an entire reinvention of all its business practices; it tried to reengineer the supply chain with new alliances
and incentives that would do away with waste. Stronger alliances between retailers and suppliers were expected to yield leaner inventories,
lower inventory costs, better logistics, and improved exchange of information. The goal was to get higher product turnover and greater
sales per square foot. The supermarket industry recognized the importance of supply chain management in achieving this goal.
Supermarkets are at the end point in a long chain of food distribution that starts with the grower and processor and manufacturer and
moves through an assortment of wholesalers, distributors, and warehouses before final purchase and consumption by consumers. The
average supermarket deals with many suppliers, and the industry understood that supply chain improvement was vital. The entire industry
effort was designed to have the right goods available to consumers at the right times and in the right proportions. The Walmart challenge
unleashed reinvention in the industry.
Precision merchandising eliminates mismatches between what is on the shelf and

what a firms customers want. Walmart, for instance, uses the data it collects on custom-
ers purchasing habits to create predictive algorithms for nearly every inch of shelf space
in its stores. If it can eliminate discrepancies between what customers want and what is
available, it not only reduces shortages, but also minimizes closeouts and losses on
excessinventory.
Many companies use their knowledge to micro-segment their customers (see C hapter 4).
There are significant differences in customer wants and needs based on age, income, gender,
and so on. Because one size does not fit all, some managers divide customers into finer and
finer segments, trying to serve a category of one, or nearly one, customer. M icro-segmenting
yields a market in which customers are willing to pay more for products because the products
are better suited to their needs, more personalized, and more functional.
A firm must use its data to figure out which groups of customers are profitable and
which are not. Managers must ask if there is any value to serving some customers at a loss.
Do the money-losing customers help to cover fixed costs? Can they be converted to profit-
able customers? If they have no value, why is the firm serving them? The firm must a nalyze
and reanalyze its customers to know which result in the most profit and how to manage
those that are not so good. It has to understand how the brands, styles, design, functions,
performances, and prices that it offers fit together to serve different customer classes.
Customer analysis (as illustrated in Exhibit 9.12) leads managers to examine the value
chain and think of ways of bringing customers and suppliers closer together. Since a
company cannot be good at everything, it should divide the value chain into separate ele-
ments and determine where it can derive the most value, concentrating on areas in which
it can establish leadership and outsource the rest.
To create smart business designs, companies must think in terms of customers, suppli-
ers, distribution channels, and competing value chains. These are the main building blocks.
The firms goal should be to establish a continuous flow of goods, services, and information
from suppliers to customers. The firm engages in numerous transactions and communica-
tions with customers, so it should try to move from ad hoc, episodic interactions to continu-
ous, accurate interactions. The types of interactions analyzed should reduce guesswork,
increase efficiency, and enhance the flexibility and fast response the firm needs.
EXHIBIT 9.12
Customer ProcessBEFORE Customer ProcessAFTER
Creating
Solutions for Inefficiency and confusion Supplier simplifies process
Customers
Components bought separately, Provides entire system and/or
integration incomplete or totally complete package of maintenance,
dysfunctional service and financing
Summary Firms must prepare for inevitable turmoil and uncertainty. To do so, they require a port-
folio of strategic initiatives that they must manage. The major challenges in managing
this portfolio are identifying the types of initiatives to be pursued, allocating limited
management resources across the portfolio, and appropriately managing the risk inher-
ent in each project. Firms that are successful on these fronts greatly improve their odds
of achieving sustained competitive advantage.
Firms rely on many methods for reducing the risks and uncertainties inherent across
their portfolios of initiatives. Public-private partnerships offer one way of containing the
uncertainty. Pared-down approaches to business model reinvention can also limit the
downside of venturing into unfamiliar territory. Methods that assist in reinvention
include open source innovation, minimally viable business models, and the development
of robust and vibrant eco-systems. To reinvent the business model, firms must search for
and find technological opportunities. Often these can be found among leading-edge
industries, which have shifted from a reliance on materials and physical capital to a reli-
ance on ideas and intellectual capital. Some examples of these are biotechnology and
low-cost and high-value environmental solutions, such as, in the case of the latter, the
electric car and Teslas efforts to remake the auto industry.
This chapter has also emphasized the main themes of this book. The purpose of strat-
egy is to achieve sustained competitive advantage. Doing so requires a good knowledge
of external opportunities and threats and internal strengths and weaknesses. Based on
this knowledge, a company is ready to recommend a series of moves it can make. These
moves can address the cost and quality of the products and services that the firm offers.
They can involve expanding or subtracting from the scope of the firms businesses via
mergers, acquisitions, and divestitures; globalizing the firms offerings; or engaging in
innovation and entrepreneurship with entirely new products, services, or lines of busi-
ness. Success of the moves depends on effective implementation.
The activity of gaining knowledge about the external and internal environment and
considering the moves that the firm can make is not a one-time event. Rather, the firm
must engage in it continuously and must be constantly alert to changes in its external and
internal environment and ready to make moves that reinvent its strategy. Two examples
of the need for reinvention come from Microsoft in its battle with Netscape and the retail
food industry in its battle with Walmart.
Lastly, this final chapter has shown how creative business redesigns can bring firms
into closer contact with their customers. Enhanced customer intimacy comes from busi-
ness designs that systematically collect detailed information about customers, break up
customers into smaller and smaller segments, and provide them with integrated packages
of solutions rather than separate products and services. Smart business designs break down
the barriers that stand between firms and their customers and then multiply the points of
access or contact points between the two parties. Firms move into uncontested spaces that
can be protected through smart business designs that bring closeness to customers.
Questions for the Practitioner

1. Does your firm adhere to Eric Schmidts 70:20:10 rule? If so, what types of third hori-
zon projects has it undertaken? If not, where should it begin expanding its horizons?
2. Is your firm organized to fully capitalize on a sufficient portfolio of longer-range op-

portunities? Explain.
3. Has your firm explored open source or public-private initiatives?
4. Does your firm (or any of its competitors) offer an eco-system of products and ser-
vices? If so, describe the eco-system and whether it provides a competitive advantage.
5. To what extent is your firm utilizing the range of strategic options presented in this
books SCA model? If minimal, why do you believe this is so? Propose two or three
alternatives to your firms current approach. Discuss the trade-offs that would be in-
volved in changing the types of maneuvers that are typically made.
Questions for the Student

1. Spend some time identifying some of the most groundbreaking innovations made
over the past two years.
2. Research the processes that were followed to arrive at these innovations. Were
they the result of MVP processes, public-private partnerships? Business model
innovations?
3. Given the direction of the latest innovations, what seems to be the best next hori-
zon? What types of resources and structures would be required of a firm undertaking
such next horizon development?
4. How can you personally utilize the concepts of external analysis, internal analysis,
strategies/tactics, and implementation to forge a personal competitive advantage as
you begin your career?
Endnotes 1. Lowell Bryan, Just-In-Time Strategy for a Turbulent World, McKinsey & Company,
June 2002, http://www.mckinsey.com/insights/strategy/just-in-time_strategy_for_a_tur-
bulent_world.
2. Max Nissen, Samsung Has a Totally Different Strategy from Apple, and Its Working Great,
Business Insider, March 15, 2013, http://www.businessinsider.com/samsung-corporate-
strategy-2013-3#ixzz3jpw1sQ74.
3. Andreie Nedelea, Kia Details the Design of Its Sportspace Concept, CARSCOOPS, Febru-
ary 27, 2015, http://www.carscoops.com/2015/02/kia-details-design-of-its-sportspace.html.
4. Bryan, Just-In-Time Strategy for a Turbulent World.
5. Mehrdad Baghai, The Alchemy of Growth: Practical Insights for Building the Enduring Enter-
prise (Basic Books: New York, 1999).
6. Tom Stafford, Fundamentals of Learning: The Exploration-Exploitation Trade-Off, June 6,
2012, http://www.tomstafford.staff.shef.ac.uk/?p=48.
7. A. R. Oxford, Drug Development Teaching Old Pills New Tricks, The Economist, February
13, 2013, http://www.economist.com/blogs/schumpeter/2013/02/drug-development.
8. Patrick Sabol and Robert Puentes, Private Capital, Public Good, The Brookings Institution,
2013, http://www.brookings.edu/research/reports2/2014/12/17-infrastructure-public-private-
partnerships-sabol-puentes.
9. Marc Mitchell, An Overview of Public Private Partnerships in Health, Harvard School of Public
Health, undated, https://www.hsph.harvard.edu/ihsg/publications/pdf/PPP-final-MDM.pdf.
10. United Nations Economic Commission for Europe, Guidebook on Promoting Good Gover-
nance in Public-Private Partnerships, United Nations, New York and Geneva, 2008, http://
www.unece.org/fileadmin/DAM/ceci/publications/ppp.pdf.
11. Kevin J. Boudreau and Karim R. Lakhani, Using the Crowd as an Innovation Partner, Harvard
Business Review, April 2013, https://hbr.org/2013/04/using-the-crowd-as-an-innovation-partner.
12. Elaine Chen, How a Technology-Push Process Led to the Reboot of Google Glass, Wired
Innovation Insight, March 27, 2015, http://insights.wired.com/profiles/blogs/how-a-technology-
push-process-led-google-glass-to-its-reboot#axzz3k3sCcMAl.
13. R. Rothwell and W. Zegveld, Reindustrialization and Technology (Armonk, NY: M. E.
Sharpe, 1985).
14. J. Schmookler, Invention and Economic Growth (Cambridge, MA: Harvard University
Press, 1966).
15. E. Von Hippel, Appropriability of Innovation Benefit as a Predictor of the Functional Locus
of Innovation, Sloan School of Management MIT working paper 108479, 1979.
16. A. Marcus, Strategic Forecasting: A New Look at Scenarios (New York: Palgrave McMillan, 2009).
17. J. Schumpeter, Business Cycles (New York: McGraw-Hill, 1939); N. Kondratiev, The Major
Economic Cycles, Voprosy Konjunktury 1 (1925), pp. 2879, English translation reprinted in
Lloyds Bank Review, no. 129 (1978); I. Kirzner, Perception, Opportunity, and Profit
(Chicago: The University of Chicago Press, 1979).
18. D. Bell, The Coming of Post-Industrial Society (New York: Basic Books, 1973).
19. A. Marcus, Innovations in Sustainability: Fuel and Food (Cambridge, UK: Cambridge
University Press, 2015); also see A. Marcus The Future of Technology Management and the
Business Environment: Lessons on Innovation, Disruption, and Strategy (New York: Financial
Times Pearson, 2015).
20. M. Porter and C. van der Linde, Green and Competitive, Harvard Business Review 73
(1995), pp. 12034.
21. Marcus, Innovations in Sustainability: Fuel and Food; and Marcus, The Future of Technology
Management.
G L O S S A R Y
A which indicates when the business will be viable,

financial projections, and an analysis of risk.
action-response cycles The strategic interactions business strategy A firms deliberate decisions
within an industrymoves and countermovesthat regarding how it can best position and present itself
continually shape competitive decisions and ultimately (vs. its rivals) in order to win customers and realize
determine the outcome of competitive battles. profitslow-cost, differentiated, or some combination
accounting data Financial performance data based of the two, such as best value.
on past company actions. bypass Also called the end-run or blue ocean
agency A theory holding that the obligation of the strategy, it is designed to minimize direct conflict by
company is to put shareholders first as they are the ones setting new standards that create a unique and
risking the most. uncontested space.
agile giants Companies that possess both the ability
to move quickly to new competitive ground (their
vision), and to assert their strength to hold/defend that C
ground (vision becomes mission).
CAGE framework An analytical outline that helps
firms identify and understand multiple dimensions of
global distancecultural, administrative, geographic,
B and economic.
capabilities The sets of skills and routines that allow
balanced scorecard Multidimensional approach of
the company to exploit its resources in ways that are
measuring corporate performance through the sum of
valuable and difficult for other firms to imitate. These
quantitative, qualitative, leading and lagging factors.
may include a firms coordination and control systems,
barriers to entry Barriers within an attractive the companys culture, its production knowledge, its
industry that deter new companies from entering. They experience and long-standing relations with a variety of
secure the place of existing companies. stakeholders, such as government, and knowledge of
best-value strategy How some companies combine customers; may be compared to software, while the
elements of low cost and differentiation positions to resources are the companys hardware.
create a competitive product and/or service that can chaebol A term that refers to Korean global multina-
attract a swath of both premium- and price-conscious tionals that own multiple international enterprises.
buyers.
classic approach to management theory A top-
blocking Defensive tactic as it prevents a rival from down approach, which relies on accountability and
moving in the first place. control starting with the board and top management and
bootstrapping or bricolage Making do with the extending to all employees, who are divided according
means or resources at hand, rather than having all the into specialties and issued commands they are expected
means and resources needed from the start. to follow.
bottom of the pyramid A focus on the worlds poor community model (of capitalism) Common in Japan
as the major market of the future where the opportunity and some European countries, this form of capitalism
is great, but the challenges in reaching this market are managers considers senior members in the company
also substantial. and shareholders as just one of many stakeholder
business plan A plan consisting of a description of groups that have to be satisfied; managers are freer
the business, an external analysis, an internal analysis, from short-term pressures imposed by stock market
an implementation schedule, an end-game strategy, prices and quarterly profits.
229
230 Glossary
comparative advantage What a company does best differentiated position A way a firm can distinguish
relative to all other firms. itself by adding distinct and valuable features to its
competencies Firm-based talents used to combine, product/service lineup. Differentiators aim to capture
transform, and channel key resources and capabilities in higher margins as they appeal to smaller (low volume)
strategically-supportive ways to satisfy customer needs; segments of the market.
they provide access to new markets, give customers distinctive competence Unique accumulation of
benefits, and are very hard for competitors to imitate. capabilities that lead to advantages that your rivals do
contingency theory States that a firm should select not share. Managers must be careful that these do not
its management stylemechanistic or organicbased evolve into rigidities.
on its situation. There is not just one best way.
co-opetition Ways in which companies are able to
compete and cooperate at the same time in order to E
broaden markets and create new valueand thereby
escape zero-sum games where one company benefits at eco-efficiency The process of reducing the ecological
anothers expense. impact that a company has while maintaining the deliv-
corporate strategy Focuses on the scope of the ery of competitively priced goods and services.
company; what businesses and industries it should economies of scope The cost savings realized by
participate in. reducing redundancies and sharing management structure,
cost basis How a company creates its outputs and administration systems, marketing departments, R&D, and
fulfills its value proposition. other functions across the business units of a corporation.
cross-impact matrix Used in the creation of scenarios economic growth A positive change in the level of
to illustrate how one trend may intersect with another. production of goods and services by a country over a
certain period of time.
culture The key values, beliefs, and assumptions
about how an organization should conduct its business; economic value added (EVA) Arguably, the most
treat its employees, customers, suppliers, and others; important way to judge over time whether a company is
and foster innovativeness and flexibility. winning competitive battles since it compares what the
company is earning for shareholders in relation to the
cost of capital.
D effect uncertainty The inability to predict the impact
of environmental factors on the firmwhat will
decline Stage within industry life cycle that sees fall- changes in conditions mean for a particular firm?
ing customer bases, prices, and margins; companies exit embryonic stage The beginning stage in the industry
or are squeezed out during this stage. life cycle when prices are high, margins low, and prof-
defenders Companies that cling to their niche and try its still not certain; products are of lesser reliability;
to defend their turf. competition has yet to take hold, and there is not much
defensive maneuvers Responses to rivals offensive export activity.
maneuvers and a reaction to threatening situations. entrepreneur An individual, group, or organization
Delphi method Developed by Rand Corporation as that discovers and starts to exploit new business or
way to elicit expert opinion about important trends in other opportunities while assuming the risks.
society, technology, and government, it combines the EPS/EBIT analysis Compares earnings per share
beliefs of different experts to sharpen the predictions (EPS) and earnings before interest and taxes (EBIT) at
made about developments in these areas. various levels of salesoptimistic, pessimistic and
diamond framework Porters explanation of why most-likely scenarios.
certain nations possess unique competitive advantages. exporting production Outsourcing or setting up
National advantages can be attributed to factor production and distribution in a foreign company.
conditions (production inputs), demand conditions, external analysis Determination of the opportunities
competitive conditions (firm, strategy, structure, and and threats facing an industry via an assessment of its
rivalry), and related and supporting industries. environment and stakeholder groups.
Glossary 231
F p roduct reliability increases as does the competition and

exports also begin to rise.
first horizon bets Relatively safe bets designed to guerilla moves Tactics often deployed by only the
generate some quick wins with time frames that are smallest and weakest of competitors and designed for
short and continuing to tap and extend the firms cur- maximum impact at low cost.
rent products, services, and customer markets.
first movers Aggressive newcomers that take risks in
anticipation of high returns.
H
flanking attack A company capitalizes on the weak- hedging Having a backup plan to deal with risk and
ness of its rival by attacking from the rivals edges. uncertain external conditions.
formulation Strategy design and creation as opposed horizontal integration A company increases market
to implementation. share by purchasing companies that share the same
franchising A company disseminates its business business line.
methods and models, provides franchisers with a brand human relations approach to management
identity and a business image, and gains a percentage of theory Rather than being hierarchical and based on
that franchised companys profit. command and control structures, this approach empha-
frontal assaults Best carried out if a firm matches or sizes employee development, motivation, and learning
exceeds the strengths of a rival. company values, informal coordination, two-way com-
munication, performance, and not following orders.
G I
GDP per capita Gross domestic product per capita is
the total output of goods and services for final use implementation The alignment of a strategy with
produced by an economy per person; it indicates how the management systems and tools to carry it out
wealthy the individuals in a country are at a given successfully.
moment in comparison to individuals in other countries. industry Organizations offering similar products or
global product-market strategy An approach to services that satisfy similar customer need that share
international competition that promotes the same product/ similar characteristics and are subject to similar market
service configuration worldwide. It takes advantage of forces.
economies of scale and scope and is a highly efficient, industry analysis An assessment of the environment
low-cost way to expand internationally. and conditions surrounding a businessincluding the
global strategy What will be the scope of the compa- impacts of its competitors, customers and suppliers.
nys global activities, where it will sell its products, industry environment The context in which a
source its raw materials, design and make its products, company operates.
and do research and development. industrial organization (IO) economics An
greenfield operations When a company starts up its externally-biased branch within the field of economics
own manufacturing, production, marketing, or other that focuses on the formation of monopolies and near-
sets of activities in a foreign country rather then relying monopolies.
on joint ventures, alliances, or acquisition to access inflection points Extraordinary shifts in the
already existing sources of that activity. competitive landscape that change the basis for
Gross Domestic Product (GDP) The total value of sustained competitive advantage.
goods and services produced by a nation over a given innovation The process of putting an invention or
period, usually one year, GDP consists of four compo- other important discoveries into widespread use.
nents: personal consumption, private investment, intangible benefits Valued product or service
government spending, and exports. features whose impacts are felt rather than seensuch
growth stage Industry life cycle stage where sales as exclusivity, brand mystique, and high-sheen, high-
steadily increase, prices go down, and profits rise; service selling environments.
232 Glossary
intangible resources Assets that are not physical in

nature, such as a reputation for toughness or quality or
M
loyalty of dealers and trust of customers, which have M-form A corporate strategy where high-level execu-
been nurtured through history. They cannot be easily tives make strategic choices, interact with shareholders and
traded, and are dependent on particular organizational allocate resources to separate, independent business units.
processes.
macro-environment Broad overarching forces that
internal analysis The processes that a company uses impact the industry environment, including law, poli-
to examine its strengths and weaknesses in order to bet- tics, technology, demography, society, economic cli-
ter compete with other companies. mates, and the physical environment.
introductory stage Stage favoring offensive moves management theory Various approaches to scrutiniz-
that capitalize on the weaknesses of the status quo, ing, investigating, and breaking down an organizations
while their new concept is being proven. strengths and weaknesses, including the classic approach,
invention Creation of a new idea and/or its demon- the human relations approach, and contingency theory.
stration in prototype form. material-balance models Models for analyzing an
inversion Takes place when a firm reincorporates organizations production processes based on an analy-
outside of its current national jurisdiction in order to sis of inputs and outputs, whose goal is to increase
reduce its tax burden. usable products and decrease waste.
maturity Stage within the industry life cycle where
J sales volumes level out, and profits are lower as more
companies are competing for market share; innovation
just-in-time (JIT) An approach to inventory manage- is rare and overcapacity begins; and exports blossom
ment where a company produces only what the cus- since there are few new consumers at home.
tomer wants, in the quantities the customer actually matrix structure A structure within a companys inter-
requires, and when the customer needs it. nal environment where an employee may have multiple
reporting arrangements based on the clients they serve, the
geography covered, and/or their functional expertise.
L micro-segmenting Dividing customers into finer and
finer segments in order to serve smaller and smaller cat-
leading-edge industries Industries that depend upon egories of customers and to provide them with more
newly emerging technologies that provide the impetus precisely what they need.
for economic growth.
minimally viable models Lean business designs that
learn This ability allows a company to achieve scale are crafted in a highly iterative fashionan approach
quickly, survive and thrive. that accelerates the product development and customer
legalistic model (of capitalism) Model of capitalism feedback loop.
that emphasizes the obligations that managers as employ-
mission Typically represents what the company has
ees of the owners (the shareholders) owe their employers.
been good at in the past, what it has accomplished,
liability of foreignness Means that because of the dif- where its employees take pride in their achievements.
ficulties of operating globally some firms decide to remain
multidomestic product-market strategy Adapts and
domestic players and respond to international threats as
modifies a product or service to each separate country
they occur from a more focused domestic stance.
or region; extracts high margins and charges a premium
licensing Rather than directly produce and sell its price for delivering customized products and services
products abroad, a company can establish a legal that meet the needs of individual markets.
arrangement with a foreign firm that can produce and
sell the companys products for a fee.
life cycle Implies that products evolve through stages
N
of introduction, growth, maturity, and decline. natural parity A state of equilibrium to which
low-cost position Distinguishing oneself through the competitive firms frequently returnone of equality
high-volume sale of low-margin items. (vs. one of competitive advantage).
Glossary 233
O R
open source innovation (OSI) An approach to readiness An unflagging and highly visible commit-
product/service development that engages external ment to execute an initiative.
partnerships across a firms value chain. realized strategies Actual outcomes that are not
outliers Companies that are able to break the natural determined by what any single company intends, but by
parity that prevails in their industries and sustain com- the moves and countermoves of competitors responding
petitive advantage (or on the other side companies that to changing conditions over time.
realize competitive disadvantage) for long periods, such Real-Win-Worth It screen Test of each product or
as a decade or more. service concept to determine if the market and product
are real, if the potential offering and a company can
P be competitive and win, and whether its worth it
from both financial and strategic perspectives.
Porters five forces An industry assessment frame- repositioning Constant adjustment and revisiting of
work that determines industry attractiveness based upon: strategy.
(1) competition among existing rivals, (2) new entrants,
resources An organizations basic financial, physical,
(3) substitutes, (4) customers, and (5) suppliers.
and human capital.
portfolio planning Corporate strategy that helps large,
resource-based view (RBV) An internally-biased
complex organizations manage their separate business
perspective that helps to explain why some firms within
units by focusing on the direction, coordination, control,
industries consistently outperform others; rather than
and profitability of the different business units.
market power (the industrial organization view) it em-
positioning A way to gain distinction in an industry phasizes the ability of firms to reap higher returns from
by occupying a unique market niche that other compa- resources through the way they configure their capabili-
nies cannot easily imitate. ties and competencies.
post-industrialism An era following industrialism, response uncertainty Uncertainty about what a firm
which is characterized by a move from goods to services; should do based on its knowledge of conditions in the
the prominence of theoretical knowledge; and the preem- macro-environment.
inence of technology and technological assessment.
retrenchment A move to reduce and refocus a firm
pre-emptive strike An offensive maneuver that aims to trim it back to a more defensible position. It is
to seize an opportunity before a rival can act upon it.
primarily a move of last resort pursued when a firm is
prototype (pilot offering) Does not consume an in distress and must shift to survival mode.
excessive amount of resources prior to being presented
revenue model How a firm intends to generate
to potential customers for hands-on testing.
receipts. It is based on the structure of customer
prisoners dilemma Situation in game theory where interactionstheir intensity, duration, channels, and
it is rational for each player, not knowing how the other payment methods.
player will act, to act in a way that will make both
risk Odds of success are known with certainty; to be
players worse off.
contrasted with uncertainty.
process technologies Enable firms to improve their
ability to make goods and services.
prospectors Companies that aggressively pursue new
growth opportunities.
S
product technologies Improvements in the goods and S-shape curve A pattern of industry growth which
services themselves. reflects that first adopters are daring; other people are
public-private partnerships (PPP) A way to manage slow to change, and only much later do they respond;
new initiative uncertainty by combining resources, meanwhile, inventors and developers, who endure most
management skills, and technology of the private sector of the risk, may not have the staying power.
with the resources, regulations, and other protections scenario A depiction of a possible future based on the
that governments may provide. intersection of various trends over time.
234 Glossary
second horizon bets More aggressive pursuits that stakeholder theory As opposed to agency, it holds
drive a firm into new and unfamiliar territory, and require that managers are accountable to an array of outside and
a higher risk tolerance that hold significant promise, but internal stakeholders to whom managers must provide
require that the firm acquire new capabilities, develop new incentives (wages to workers, taxes to government, prod-
businesses, and even fundamentally alter its strategy. Pay- ucts to customers, etc.) to induce their involvement.
offs may not come until three to five years have passed. state uncertainty Uncertainty about conditions in the
sensitivity analysis A study of various assumptions, macro-environment of the firm, for instance where the
the odds of outcomes based upon each assumption, and economy is headed, what the next government will be,
the payoffs that can be expected for each distinct how will technology change, and so on.
outcome.
stock market data Based on investors perceptions
sequential game A competitive contest where one of future company returns.
player goes first and the other player gets to observe the
strategic business units (SBUs) Operating divisions
results before making their move.
containing closely related businesses within a larger
serial entrepreneurs Go after one business opportu- parent company.
nity after another and then sell these ventures to larger
companies to pursue new opportunities instead of strategic groups Sets of industry competitors that are
managing existing ventures. utilizing similar approaches in an attempt to satisfy very
similar groups of customers. These companies must
seven S analysis The seven characteristics that Peters find finer and finer points of distinction between them
and Waterman used to describe excellent firms: in order to stand out.
(1)Strategy (2) Structure (3) Systems (4) Style
(5)Staffing (6) Skill (7) Shared values. strategic inflection point A major point of departure,
a point of no return, where a companys competitive
shared values Unity of purposea part of manage-
environment is radically altered due to new technolo-
ment that Peters and Waterman found was often
gies, different regulatory conditions, or changing
slighted by U.S. managers in comparison to their
customer preferences; in response to these changes, the
Japanese counterparts.
company is forced to alter its strategies.
simultaneous game A competitive contest where two
or more players act at the same time. strategy An organizations game plan for achieving
sustainable competitive advantage over the competition,
skill The capability to compete and generate new improving its position in relation to customers, and
businessa part of management that Peters and Water- allocating resources to high-return activities.
man found was often slighted by U.S. managers in
comparison to their Japanese counterparts. structure A coherent form dividing labor, allocating
responsibilities, coordinating tasks, and assuring
smart (business) designs Better ways of meeting
accountabilityan aspect of management that Peters and
customer needs through the use of detailed and system-
Waterman found was often overemphasized by U.S.
atic information about customers; this information
managers in comparison to their Japanese counterparts.
allows firms to satisfy customer needs for integrated
solutions rather than for separate products and services; style Extent of actual alignment between management
better designs often break down barriers between a and employees and the organizations real strategic
business and its customers by eliminating redundant needs as opposed to lip servicean aspect of manage-
supply channels; they take advantage of special niches ment that Peters and Waterman found was often
firms occupy in the value chain, and they tend to pro- slighted by U.S. managers in comparison to their
vide small segments of customers with customized Japanese counterparts.
products and services that meet their unique needs. sustainable society A society based on three princi-
staffing Matching jobs with the people available to ples: protection of the environment, economic equity,
hold them in an organizationa part of management that and economic growth; in such a society the needs of
Peters and Waterman found was often slighted by U.S. future generations are not sacrificed for the consump-
managers in comparison to their Japanese counterparts. tion of the current generation.
stakeholders Those who affect and are directly sustained competitive advantage (SCA) The goal of
affected by a companys actions and results. strategic management, which is to consistently
Glossary 235
o utperform relevant competitors for long periods of with Porters generic strategies, which assume that a
time, such as a decade or more; the aim of strategy, in firm has to choose between low cost or high quality.
other words, is to be a dynasty, not a one-time winner. Under TQM, a firm has a few trusted suppliers rather
One-time winners can succeed by luck. Being a dynasty than having power over many suppliers in accord with
requires skill. Porters framework.
sweet spot In a competitive context, this is the transnational product-market strategy Combines
optimal state that a firm can achieve. It is found at global design and local responsiveness; to achieve best
the intersection of 1) a firms unique ability to value, it both exploits scale economies and adapts to
understand customer perspectives and devise solu- local conditions.
tions for customer problems, 2) a clear strategy that
leverages such opportunities for a firms ongoing
advantage, and 3) the firms exclusive access to the U
resources and capabilities required to deliver such
solutions. uncertainty Odds of success are unknown; to be con-
SWOT analysis As assessment of the strengths, trasted with risk.
weaknesses, opportunities and threats that helps a firm
select appropriate strategies.
systems Description of how critical processes are car- V
ried out in an organizationan aspect of management
value chain The primary and support activities,
that Peters and Waterman found was often overempha-
which a firm undertakes to deliver products and ser-
sized by U.S. managers in comparison to their Japanese
vices to customers; each can be broken down to deter-
counterparts.
mine how profitable it is (what are its margins).
value net A tool that emphasizes opportunities for the
T mutual advancement of competitors, customers, and
suppliers within an industry. This approach stands in
tangible benefits Created by melding superior stark contrast to the concept of zero-sum game.
engineering, top-quality materials, and exacting manu- value proposition Products and services created to
facturing into high-performance equipment. fulfill customer requirements.
technology Knowledge of how to convert the factors vertical integration A company combines
of production into goods and services. production, distribution, and/or sales within its own
technology-push model Innovation starts with structure.
discoveries in basic science and engineering, and from vetting ideas Filters that aim to connect the dots
these discoveries come new goods and services to the between a firms capabilities and available technolo-
marketplace. gies, prospective customers, and the concepts profit
third horizon bets Firms willing to take on an indefi- potential.
nite unknown future; bets whose payoff may come in vision Typically based on an understanding that the
the distant future, anywhere from five to ten years senior leaders of a company have of a companys future
forward. possibilities and where it should be moving next. What
timing dilemmas The dilemmas that a company faces should the company be aiming for so that it can excel in
about whether to go first and be a pioneer with a new the future? A vision typically provides employees with
strategy or to be a fast follower and allow another firm a sense of direction. It tells them where the company
to take these risks; often the issue is deciding whether should be heading. All companies are caught between
to continue with an old product or utilize a new product, what they have been good at in the past (their mission)
business model, or practice. and what they would like to be good at in the future
total quality management (TQM) Management (their vision).
method established by such gurus as Edwards Deming, VRIO analysis Asks the question is a resource valu-
TQM is designed to achieve enhanced productivity and able, rare, costly to imitate, and is a firm organized to
greater quality at the same time; it, therefore, breaks capture the value of the resource.
Index
A Ansoff, H., 71
Antony, J., 115
ABB Group, 132 AOL, 117
ABC, 115, 133, 207 Apple, 2627, 28, 43, 44, 45, 67, 95, 96, 99,
Accountability, 7177 100, 113, 114, 159, 160161, 165, 188,
contingency theory, 7374 204, 214
seven Ss, 7576 ARM, 35
SWOT analysis, 7677 Arthur Andersen, 6, 7
task- team-oriented organization, 7273 ArticCat, 159
Accounting data, 19 Art of War (Sun-Tzu), 12, 82
Acer, 160 Assets, redeploying, 1415
Acquisitions. see Mergers and acquisition (M&A) AstraZeneca, 123
Action-response cycles, 12 Atari, 99
Adelphia, 6, 7 AT&T, 94, 99, 116, 117, 118, 160, 173, 174
Administration, 65 Audi, 172, 204, 219
Agency theorists, 4041
Agile giants, 9
Ahlstrand, B., 12, 13 B
Airbus, 39, 99, 110
Airline industry, 24, 36, 49 BAE Systems, 110
five forces example, 3840 Balaban, R., 195
Albert, S., 83, 101 Balanced scorecard, 198
Albertsons, 117118 Barnes & Noble, 6, 28, 114
The Alchemy of Growth, 206 Barney, J., 53, 55, 58
Aldrich, H., 162 Barriers to entry, 37
Alexander, R., 100 Barriers to innovation, 177182
Alexander McQueen, 63 flawed organizational processes, 180
Allergan Generics, 111 many-year investments, 178180
Alliances, 114 S-shape curve, 178
Alliant Tech, 117 Battaglio, S., 133
Allied Signal, 117 Baxter, 164
Almor, T., 73 Bayer, 123
Alternative scenarios, 215 BCG matrix, 129130
Amazon, 16, 28, 74, 130, 172, 188, 211 Bear Stearns, 120
AMD, 78, 123, 166 Bell, D., 216
American Airlines, 118 Best Buy, 6, 26, 90, 9192, 98, 102, 106, 145,
Amit, R., 53, 64 148,188,189
Amoco, 111 Best value, 8990
Amphenol, 120 Better Place, 218
Analyzers, 8 Bic, 99
Angwin, J., 133 Biotechnology, 216217
Anheuser-Busch, 9596 industrial material, 217
237
238 Index
Biotechnology(Cont.) Canon, 6263, 99

nutrition, 216 Capabilities, 6062
pharmaceuticals, 216217 culture and, 6162
Biovail, 93 replenishing, 64
Blackberry, 43, 44, 160 resources/competencies vs., 5558
Blocking, 96 significance of, 5860
Blue ocean strategy, 95 Capacity utilization, 3132
BMW, 172, 219 Capital, 151152
BNSF, 119 Catalao-Lopes, M., 109
Bodley-Scott, S., 195 Caterpillar, 46
Boeing, 16, 84, 99, 110 CBS, 27, 124, 134135
Bombardier, 110 CEMEX, 46
Bootstrapping, 163 Cendant, 19
Borders, 6 Chaebols, 112
Boston Consulting Group, 129 Change management
Boston Dynamics, 112 change program proposals, 194
Bottom of the pyramid, 154 consistent message, 193
Boyd, A., 53 cross-functional program teams, 193194
BP, 111, 151 prioritization plan, 194195
Brache, A. P., 195 process owners/align resources, 195196
Brache/Bodley-Scott prioritization matrix, 195 readiness for change, 190191
Brandenburger, A., 105 Change program proposals, 194
Bricolage, 163 Charkravarthy, B., 90
Bristol-Myers Squibb, 123 Charles Schwab & Co., 119
Brito, D., 109 Chess analogy, 611
Brown and Brown, 122 changing rules, 8
Brumagin, A., 53 envisioning where to go next, 810
Bryan, L., 203, 204 making moves that matter, 11
BS. see Business-level strategy (BS) operating by rules, 78
Burger King, 115 reversals of fortune, 1011
Burrows, P., 199 Chevron, 111, 151
Business-level strategy (BS), 4, 109 Chipotle, 32, 43, 44, 45, 172
multidomestic approach, 140, 145 Chrysler, 116
transnational approach, 140, 145146 Churchill, Winston, 12
Business model, 169177 Circuit City, 6, 92, 98, 102, 106, 188, 189
external sources of opportunity, 170172 Cirque du Soleil, 95
internal sources of opportunity, 173174 Cisco Systems, 120
opportunities to pursue, determination of, 170 Citicorp, 119, 120
prototypes/pilot offering, 176177 Citigroup, 99
reinventing, 210215 ClickWorker, 212
scaling up/full rollout, 177 Coca-Cola, 10, 35, 99, 105, 106, 141, 142
vetting ideas, 174175 Comcast, 27, 99
Bypass, offensive tactics, 95 Commit with fallbacks, 16
Company analysis. see Internal analysis (IA)
Compaq, 55, 116
C Comparative advantage, 9, 29, 203
Competencies, 6062
Cable industry, 27 organizations distinctive, 6264
CAGE framework, 148149 replenishing, 64
Canadian National, 119 resources/capabilities vs., 5558
Index 239
Competition and capabilities, 6162

commercial/investment banking, 99100 Customers, 3536
domestic, 139 Customer service, 65
Competitive advantage. see Sustained competitive
advantage (SCA)
Competitive intelligence, 94 D
Competitive position. see Positioning; Repositioning
Competitive pressure, 172 Daewoo, 153
Comprehensive implementation framework, Daimler-Benz, 116, 151
190200 Darden Restaurants, 113
change program proposals, 194 DAveni, R., 83, 105
consistent message, 193 Davis, M., 104
cross-functional program teams, 193194 Deals, track records in making, 120122
design incentives/operational objectives/secure Decision making, as organizations capability, 74
funding, 197198 Decline stage, 97, 143
initiatives, advance and continually monitor, DeepMind Technologies, 112
198199 Defenders, 8
integrative leadership, 192193 Defensive maneuvers, 96
prioritize change programs, 194195 DeFillippi, R., 53
process owners and align resources, 195196 deHavilland, 99
readiness for change, 190191 Dell, 26, 36, 55, 66, 67, 100, 123, 160, 170
refining process, 199200 value chain linkages example, 6667
Con Edison, 28 Delta Airlines, 24, 36, 118
Conoco, 111 Demographics, 33
Conoco-Phillips, 151 Deregulation, 118119
Consistent message, 193 in banking industry, 119
Contraction, 128129 role of, 118
Control Data, 117 Design incentives, 197198
Cool, K., 53 Determined innovators, 162164
Core competences, 52 Dial, 92
Corning, 99 Diamond framework, 149
Corporate hierarchy, 131133 Dickson, W., 72
Corporate-level strategy (CS), 4, 109110 Dierickx, I., 53
contraction, 128129 Differentiation positions, 8688
corporate hierarchy and, 131133 low-cost and, 8890
expansion, 128 Digital Equipment, 76
franchising, 114115 Disappointed and disillusioned, youth group, 154
licensing, 114115 Disney, 117, 133, 206207
M-form, 128 Distinctive competence, 6264
portfolio management, 128 Diversification
vertical integration, 113, 133136 reasons for, 110112
Cost base, 211 types of, 112114
Courtney, H., 15 Divestitures, 115117
Covidien, 27, 28, 133 Division of labor, as organizations capability, 74
Cree, 165 Dollar Shave, 211
Cross-functional program teams, 193194 Domestic competition, 139
Cross-impact matrix, 48 DoubleClick, 112
CS. see Corporate-level strategy (CS) Dove, 92
CSX, 119 Dow Chemical, 111, 122
Culture, 33, 74 Drake, E., 32
240 Index
Dreyfus Corp, 119 F

Duggal, J., 195
DuPont, 111 Failure
Dutch company, 106 anatomy of, 187190
Dynegy, 19 root causes of, 189190
Fallbacks, 16
FedEx, 16, 35
E Ferdman, R., 43
Ferraris, 218
EA. see External analysis (EA) Financial considerations, levels of, 6871
Earnings per share (EPS), 197 Financial Modernization Act, 1999, 119120
eBay, 16, 28, 117 Fingerhut, 117
Ecolab, 47 Fiol, C., 162
Economic value added (EVA), 1920 First horizon bets, 205
Economies of scope, 126 First movers vs. late starters, 9799
Eco-system, development of, 214 Fisher, A., 115
Edwards, C., 194 Five forces framework, 3336
Effect uncertainty, 47 airlines industry example, 3840
Eisenhardt, K., 99 new entrants, 3435
Eli Lilly, 123, 133 pharmaceuticals industry example, 3738
Ellis, S., 73 rivals, 34
Embraer, 110 substitutes, 35
Embryonic stage, 141 suppliers and customers, 3536
EMI, 99 sustained competitive advantage, 36
End-run strategy, 95 Flanking attack, 95
Enron, 6, 7, 11, 19, 41 Food and Drug Administration (FDA),
Entrants, 3435 37, 38
Entrepreneurs, 164 Ford, 114
Entrepreneurship, 157158 Formulating, strategy, 13
importance of, 158 Fox, 115, 133
EPS/EBIT analysis, 197 Franchise, 144
Ericsson, 160 Franchising agreements, 114115
Euromonitor, 26 Franken, A., 194
European Aeronautic Defense and Space Company, 39, 41 Freeman, C., 181
European Union (EU), 7 Freeman, R., 41
EVA. see Economic value added (EVA) Friedman, M., 4, 7
Expansion, 128 Frito-Lay, 117
Export products, 144 Frontal assaults, 95
External analysis (EA), 3, 24, 53, 221222 Frontier, 188
five forces framework, 3336 Fumbling the Future (Smith and Alexander), 100
framework for, 2930 Funding, 197198
industrial organization economics, 3132
industry, defined, 2527
industry dynamics, 3641 G
moves after, 222223
scenarios, 4549 Game theory, 100106
strategic group analysis, 4244 expanding assumptions of, 103104
trade-offs, 2829 learning from, 104106
External pressures and industry movement, 2728 prisoners dilemma, 101
Exxon Mobil, 111, 151 sensitivity analysis and, 102
Index 241
sequential game, 100, 102103 GSK, 123

simultaneous game, 100102 Guerilla moves, 9596
Gap, performance/innovation, 165166 Gunther, M., 133
Gartner Group, 2
Gatorade, 10
The Government Employees Insurance Company H
GEICO, 211
Genentech, 123 Hall, R., 53
General Dynamics, 110 Hamel, G., 16, 52, 53, 63, 64, 157, 165
General Electric (GE), 10, 26, 27, 99, 113, 115, 129, Hansen, 35
130, 131132, 187 Hanson PLC, 117
General Mills, 104 Harley-Davidson, 88
General Motors (GM), 117, 124, 130, 151, Harrison, J., 164
182, 219 Hart, S., 154
General Signal, 122 Hawawini, G., 3, 29
Generic strategic positions, 83, 84 Hayek, F., 71
Geographic scope, 31 Hedging against uncertainty, 1516
Gilead Sciences, 165 Herzberg, F., 72
Gillette, 211 Hesterly, W., 58
Glass-Steagall Act, 1933, 119 Hewlett-Packard (HP), 55, 67, 116, 123, 160, 199
GlaxoSmithKline, 93 Hoffman-LaRoche, 104
Global Crossing, 19 Holland Sweetener, 105106
Global economic meltdown, M&A and, 122123 Home Depot, 15
Globalization, 139155 Honeywell, 117, 132
CAGE framework, 148149 Hormel, 31
insecurity, 153154 HTC, 160
labor, capital, and technology, 151152 HULU, 115
local adaptation, 146 Human resource management, 65
mergers and acquisitions, 122123 Hyundai, 153
open economies, 153
product-market approaches, 145146
reasons for, 140143 I
success factors, 150
youth and, 154155 IA. see Internal analysis (IA)
Global strategy (GS), 4, 145 IBIS, 26
exporting production, 144 IBM, 11, 26, 55, 66, 114, 123, 160, 178
franchising, 144 Icarus paradox, 100
greenfield operations, 145 IMC Global, 118
licensing, 144 Implementation, 4, 186201
Goldman Sachs, 99, 120 anatomy of failure, 187190
Google, 7, 26, 28, 61, 95, 111, 113, 160, 165, 172, 174, comprehensive framework (see Comprehensive
207, 214 implementation framework)
Government, entrepreneurial endeavors and, 168169 cycle of, 187
Government policies, 3233 mistakes in, 187
Gracious Living, 154 readiness for change, 190191
Grand Metropolitan Ltd., 117 refining process, 199200
Grant, R., 87, 88, 99 Improvising, 1213, 18
Grove, A., 1, 9, 14 Inbound logistics, 65
Growth stage, 97, 141 Incremental changes, 159, 160161
GS. see Global strategy (GS) Indiegogo, 212
242 Index
Industrial organization (IO) economics, 3132 ISIC. see International Standard Industrial
resource-based view vs., 5355 Classification(ISIC)
Industry ITT, 117
defined, 2527 Ivory, 91, 92
dynamics, 3641
external pressures and movement, 2728
life cycle, 30 J
moves, 2829
transient attractiveness, 40 Japanese manufacturers, 14
Industry analysis JCPenney, 89
pharmaceuticals example, 3738 Jensen, M., 40
Industry evolution, 141143 JetBlue, 188
decline stage, 143 Johnson, G., 190
embryonic stage, 141 Johnson & Johnson, 27, 123, 164
growth stage, 141 Joint ventures (JVs), 115
maturity stage, 141 JPMorgan Chase, 119, 120
Inevitable turmoil, preparation for, 204210 JVs. see Joint ventures (JVs)
Innovation, 157158, 169
barriers to, 177182
importance of, 158 K
passionate and determined innovators, 162164
process of, 161169 Kaplan, R. S., 193, 198199
reasons for, 158161 Kasturi, V., 90
Innovation strategy (IS), 4 Kellogg, 104
Innovators Kentucky, 182
passionate/determined, 162164 Kentucky Fried Chicken, 146, 147
as risk takers, 162163 KFC, 115
In Search of Excellence (Peters and Waterman), 75 Kickstarter, 165, 212
Insecurity, globalization and, 153154 Kirzner, I., 215
Intangible resources, 59 Kmart, 53, 76, 88, 93
Integrating mechanisms, as organizations capability, 74 Knight, F., 15, 181
Integrative leaders, 192193 Kodak, 16, 76
Intel Corporation, 1, 6, 78, 9, 14, 31, 100, 105, 123,160 Kohlberg Kravis Roberts & Co., 120
Intended strategies, 13 Kondratiev, N., 215
InterMune, 123
Internal analysis (IA), 3, 5277, 221222
accountability, assuring, 7177 L
defined, 53
levels of financial considerations, 6871 Labor, 151152
moves after, 222223 Lado, A., 53
resource-based view, 5364 Lambert, R., 194
value chain analysis, 6467 Lampel, J., 12, 13
Internal startups, 115 Late starters, first movers vs., 9799
International Standard Industrial Classification Leadership, 73, 192193
(ISIC),26 Leading-edge industries, 215216
Introductory stage, life cycle, 97 Learning curve effects, 32
Invention, 169 Lehman Brothers, 120
Inversions, 33 Lenovo, 160
Investors Business Daily (IBD) ratings, 20 Lewis, M., 53
IS. see Innovation strategy (IS) Liability of foreignness, 140
Index 243
License, 144 Martin, J., 99

Life cycle, 9697. see also specific stages Martin, K. L., 196
industry, 30 Martin, R., 192
Lipman, J., 133 MasterCard, 115
Lockheed Martin, 110 Maturity stage, life cycle, 97
Logistics, 65 McCoy, C., 7
Low-cost positions, 8486 McDonald, 15, 32, 43, 115
advantage of, 8586 McGrath, G., 53
differentiation and, 8890 McKinsey & Co., 75, 129, 130, 131, 203, 204
Lucent, 19, 118 Measurement. see Performance measurement
Lucky-Goldstar, 153 Mechanistic model, contingency theory, 73
Luttwak, E., 12 Meckling, W., 40
Medicare, 10
Medtronic, 9, 10, 27, 28, 68, 117, 133
M Mercedes, 172
Merck, 93, 123, 133
M&A. see Mergers and acquisition (M&A) Mergers and acquisition (M&A)
MacMillan, R., 53 broadening scope, 122
Makani Power, 112 buying competitors, 122
Makridakis, S., 102 for consolidation, 120121
Management strategy and divestiture results, 115117
action-response cycles, 12 effective management of, 127129
asset redeployment, 1415 failures of, 123126
changing rules, 8 full-scale, tactics short of, 114115
chess analogy, 611 global economic meltdown, 122123
commit with fallbacks, 16 merger of equals, 127
concentrating forces, 1314 move to new industries, 122
delay until clarity emerges, 16 purchasing talent, 122
envisioning where to go next, 810 shifting landscape, 117120
gambling on most probable outcome, 15 success of, 126129
hedging against uncertainty, 1516 Merrill Lynch, 120, 122
know your enemy/yourself, 12 M-form, 128
making moves that matter, 11 Michels, A., 115
mergers and acquisition (M&A) and, 127129 Microsoft, 6, 7, 8, 9, 18, 99, 100, 105, 113, 117,
operating by rules, 78 160,223, 224
planning and improvising, 1213, 18 Miller, D., 53, 99, 100
reversals of fortune, 1011 MillerCoors, 174
robust route, 1516 Milliken, F., 47
sports analogy, 1619 Minimally viable models, 213
understanding of, 619 Mintzberg, H., 12, 13
war analogy, 1116 Mission, of company, 8, 9
Mankins, M. C., 189, 190, 191, 198 Missoni, 63
Many-year investments, 178180 Mitsubishi, 147
Marcus, A., 2, 15, 30, 151, 194, 215, 217, 218 Mobil, 111
Margin, impact of position on, 90 Mobile phone industry, strategic group map of, 4243
Market exchange, 59 Modularizaton, 97
Marketing and sales, 65 Moneyball (book/movie), 53, 54
MarketLine Reports, 26 Monopoly, 31
Market readers, 204 Monsanto, 105106, 111
Market segmentation, 8788 Monster Beverage, 35
244 Index
Morgan Stanley, 91, 92, 120 North American Industry Classification System
Most probable outcome, 15 (NAICS), 2526
Motorola, 160 Northern States Power, 117
Moves. see also Positioning Northrop Grumman, 110
after external/internal analysis, 222223 Norton, D. P., 193, 198199
first movers, 9799 Novartis, 123
guerilla, 9596 NTT DoCoMo, 160
industry, 2829 Nutrition, 216
winning, 46
Multidomestic approach, 140, 145
Mylan, 111 O
MySpace, 117
Organisation for Economic Co-operation and
Development OECD, 32
N Offensive tactics, 9596
bypass, 95
Nagendra, K., 186, 199 flanking attack, 95
NAICS. see North American Industry Classification frontal assaults, 95
System (NAICS) guerilla moves, 9596
Nalebuff, B., 105 pre-emptive strike, 95
Napoleon, 12, 13 Oil and Gas industry, 46
Natural parity, 3 Only the Paranoid Survive (Grove), 14
Natural resources technology, 33 On War (von Clausewitz), 12
NBC, 27, 114, 115 Open economies, 153
NEC, 14 Open source innovation (OSI), 212213
Neiman Marcus, 89 Operational objectives, 197198
Nelson, R., 53, 63 Operations, 65
Nest Labs, 112 Oracle, 113, 123
Netflix, 160, 211 Organic model, contingency theory, 73
NetJets, 95 OSI. see Open source innovation (OSI)
Netscape, 7, 99, 223, 224 Oster, S., 100
New businesses Outbound logistics, 65
funding sources for, 167168 Overall dominance, 1920
government support and, 168169 Oxford, A. R., 209
innovative companies and, 164165
innovators, passionate/determined, 162164
patient capital, 166167 P
prolonged gestation for, 162
New entrants, 3435 Panasonic, 218
New opportunities Panera, 43, 44, 45
determination of, 170 Paramount, 28
external sources of, 170172 Passionate innovators, 162164
internal sources of, 173174 Peers, M., 133
News Corp, 117, 133, 134 Penrose, E., 53
NGC, 10 PepsiCo, 10, 26, 35, 105, 117, 142
Nielson, G. L., 196 Performance/innovation gap, 165166
Nike, 10 Performance measurement, 1819
Nintendo, 99 economic value added, 1920
Nokia, 43, 44, 160, 172 Investors Business Daily (IBD) ratings, 20
Norfolk Southern, 119 overall dominance measurement, 1920
Index 245
Performance mechanisms, as organizations Prototypes, 176177

capability,74 Prudent risks, 207
Perrigo, 111 Public-private partnerships (PPP), 209210
Persistence, 162
Peters, T., 75, 76, 77
Petrofina, 111 Q
Pfizer, 93, 116, 123
Pharmaceutical, 33, 36, 37, 38, 40, Quinn, J., 12, 13
46, 49, 96
Pharmaceutical industry, 46, 216217
five forces example, 3738 R
mergers and acquisitions in, 123
Pharmacia, 116, 123 Ralcorp, 104
Phillips, 111 Ravenscraft, D., 115
Pilkington, 99 Raynor, M., 15
Pilot offering, 176177 Raytheon, 110
Pisano, G., 99 RBV. see Resource-based view (RBV)
Pizza Hut, 115 Reactors, 8
Planning, 1213, 18 Readiness for change, 190191
Polaris Industries, 111 Realized strategies, 13
Polaroid, 76 Real-Win-Worth It screen, 174
Porter, M., 2, 24, 29, 33, 83, 88, 92, 139, 141, 149, Redeploying assets, 1415
150,155, 218 Reebok, 10
Porters diamond framework, 149 Reed, R., 53
Portfolio management, 128, 207209 Reinvention, 203225
Portfolio models, 129133 business model, 210215
BCG matrix, 129130 inevitable turmoil/uncertainty, preparation for,
GE/McKinsey model, 130131 204210
Portfolios Repositioning, 4, 9092. see also Positioning
of initiatives, 204207 Best Buy example, 9092
managing (see Portfolio management) Ivory example, 9092
Positioning, 8394, 222. see also Moves; Resource-based view (RBV), 5364
Repositioning capabilities, 5558, 6062
differentiation positions, 8688 competencies, 5558, 6062
impact on margin, 90 industrial organization economics vs., 5355
low-cost positions, 8486 organizations distinctive competence, 6264
Post, 104 resources, 5558
Post-industrialism, 216 VRIO analysis, 5860
Powell, T., 3 Resource procurement, 65
Powers, E., 196 Resources
PPP. see Public-private partnerships (PPP) capabilities and, 5558
Prahalad, C., 16, 52, 53, 63, 64, 154 competencies and, 5558
Pre-emptive strike, 95 intangible, 59
Prioritization plan, 194195 replenishing, 64
Prisoners dilemma, 101 significance of, 5860
Procter & Gamble (P&G), 33, 92, 95, 166167, tangible, 59
182, 192193, 211 Response uncertainty, 47
Progressive, 211 Restaurant industry, strategic group map of, 4344
Prolonged gestation, for new businesses, 162 Retaliation, defensive maneuver, 96
Prospectors, 8 Retrenchment, 96
246 Index
Revenue model, 211 Seven-S framework, 7576

Reversals of fortune, 1011 shared values, 76
Reynolds, 99, 122 skills, 76
Rheingold, 99 staffing, 7576
Risks strategy, 75
prudent, 207 structure, 75
and uncertainty, 180182 style, 75
Rivals, 31, 34 systems, 75
RJR Nabisco, 120 Shake Shack, 44
Robinson, D., 100 Shamsie, J., 53
Roche, 123 Shared values, 76
Roethlisberger, F., 72 Shell, 151
Rohm & Haas, 122 Shenkar, O., 73
Rose, F., 133 Sheun, A., 99
Rothschild, P., 195 Simple extrapolation, 45
Rothwell, R., 214 Simultaneous game, 100102
Ruefli, T., 3 Skills, 76
Rumelt, R., 112 Smith, D., 100
Soft drink market
international market shares, 141
S product maturity of, 141
Sony, 27, 160
Samsung, 42, 43, 44, 112, 113, 153, 160, 204 Southwest Airlines, 16, 188
Sanofi-Aventis, 123 Sports analogy, 1619
Sarbanes-Oxley (SOX) Act, 171 getting it early, 1718
SCA. see Sustained competitive advantage (SCA) relying on teamwork, 18
Scale economies, 31, 32 scorecard, 1819
Scenarios, 4549 Sprint, 9495, 116, 117, 160
defining bookends, 46 Spulber, D., 104
leading indicators, 4647 SPX, 122
simple extrapolation, 45 S-shape curve, 178
systems analysis, 4749 St. Paul, 117118
Scherer, F., 115 Staffing, 7576
Schering-Plough, 123 Stakeholders, 4041
Schmookler, J., 214 Stakeholder theorists, 41
Schoemaker, P., 53, 64 Starbucks, 88, 114
Scholes, K., 190 State uncertainty, 47
Schrello, M., 174 Steele, R., 189, 190, 191, 198
Schumpeter, J., 152, 215 Stewart, T., 32
Schwab, 91, 92 Stock market data, 19
Schwartz, P., 30 Strategic change, 219225
Scorecard, 1819 Strategic group analysis, 4244
Sealed Air Corporation, 159 mobile phone industry, 4243
Sears, 89, 117 restaurant industry, 4344
Second horizon bets, 205 Strategic inflection points, 12
Segmentation, market, 8788 Strategic management, tools of, 619
Seismic shifts, 159161 Strategies for Change (Quinn), 13
Sensitivity analysis, 102 Strategy, 75
Sequential game, 100, 102103 blue ocean/end-run, 95
Serial innovators, 164 business-level (see Business-level strategy (BS))
Index 247
as design, 13 Technology development, 65

implementing/formulating, 13 Technology-push model, 214215
intended, 13 Teece, D., 99
realized, 13 Tenneco, 117
Strengths, weaknesses, opportunities, and threats Tenth & Blake Beer Company, 174
(SWOT) analysis, 7677 Tesla & Tesla Motors, 35, 165, 181, 182, 218, 219
Structure, 75 Teva, 111
Style, 75 Texaco, 111
Subramanian, V., 3, 29 Third horizon bets, 205
Substitutes, 35 Time Warner, 28, 99, 117
Subway, 43, 115 Timing, 96106, 222
Sun, H., 113, 118, 123 Best Buy example, 9899
Sunbeam, 19 early movers vs. late starters, 9799
Sun Microsystems, 113, 123 game theory (see Game theory)
Sun-Tzu, 12 life cycle, 9697
SuperValue, 117 value of rapid adjustment, 99100
Suppliers, 3536 Titan Aerospace, 112
Supply chain traceability, 71 T-Mobile, 160
Sustained competitive advantage (SCA), 24, 36, 203, Tongal, 212
220222 Toshiba, 160
resource-based view and, 54 Toth, J., 12
three-step model for, 56 Toyota, 114, 151, 172, 182
Syngenta, 111 Trade-offs, 28
Syntex, 182 Trader Joes, 89, 170, 212
Systems, 75 Transaction costs, 135136
Systems analysis, and scenarios, 4749 Transient industry attractiveness, 40
cross-impact matrix, 48 Transnational approach, 140, 145146
Trends, 215
Tyco, 41, 112
T
Tactics, 9496 U
defensive, 96
offensive, 9596 Uber, 113, 172
Tangible resources, 59 Uncertainty
Target, 93, 145 effect, 47
Target Corporation, 53, 62 hedging against, 1516
Tata Group, 112 levels of, 15
Taylor, F., 72 preparation for, 204210
Teams, cross-functional program, 193194 response, 47
Teamwork, 18 risk and, 180182
Technological opportunities, 215219 state, 47
alternative scenarios, 215 Unilever, 33
biotechnology, 216217 Union Pacific, 119
high-value environmental solutions, 218219 United Airlines, 188, 189
leading-edge industries, 215216 United Dominion, 122
low-cost environmental solutions, 217218 United Health, 117
trends, 215 United Technologies, 10, 132
Technological progress, 171 Upwork, 212
Technology, 151152 US Airways, 118
248 Index
V know your enemy/yourself, 12

most probable outcome, 15
Valuable, rare, inimitable, and organized (VRIO) planning and improvising, 1213, 18
analysis, 5860 realized strategies, 13
Value chain analysis, 6467 redeploying assets, 1415
administration, 65 robust route, 1516
customer service, 65 Warner-Lambert, 123, 134
Dell example, 6667 Waste Management, 19
human resource management, 65 Waterman, R., 75, 76, 77
inbound logistics, 65 Watson Pharmaceuticals, 93
linkages, 66 Wells Fargo, 117
marketing and sales, 65 Wendy, 43
operations, 65 Wernerfelt, B., 53
outbound logistics, 65 Westinghouse, 27, 76, 124
resource procurement, 65 Weyerhaeuser Company, 182
technology development, 65 Wheelwright, S., 102
Value proposition, 211 Whirlpool, 173, 174
van der Linde, C., 218 Whittington, R., 190
Venkatraman, S., 53 Wiggins, R., 3
Verdin, P., 3, 29 Williamson, O., 135
Verizon, 94, 116, 160 Wilmar, 145
Vertical integration, 113, 133136 Winter, S., 53, 63
Vetting ideas, 174175 Woodward, J., 73
Viacom, 134135 WorldCom, 6, 7, 19, 41, 118
Virgin & Virgin Group, 112, 165 Wright, P., 53
Vision, of company, 8, 9 Wyeth, 123
von Clausewitz, Carl, 12, 13
Von Hippel, E., 214
VRIO analysis. see Valuable, rare, inimitable, and X
organized (VRIO) analysis
Xerox, 16, 76, 99, 100, 102
Xiaomi, 43
W XM and Sirius, 95
W. R. Grace, 117
wall, B., 133 Y
Walmart, 28, 53, 73, 84, 88, 93, 94, 142, 148,
151, 223, 225 Yahoo, 26
Wang Laboratories, 76 Youth, and globalization, 154155
War analogy, 1116
commit with fallbacks, 16
concentrating forces, 1314 Z
delay until clarity emerges, 16
hedging against uncertainty, 1516 Zaheer, S., 140
intended strategies, 13 Zegveld, W., 214

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Achieving Sustained Competitive Advantage

Achieving Sustained Competitive Advantage Third Edition

MANAGEMENT STRATEGY: ACHIEVING SUSTAINED COMPETITIVE ADVANTAGE, THIRD EDITION

To my wife, Judy, and to my sons, David

To my wonderful husband, Dwayne, and to

About the Authors

viii About the Authors

EXHIBIT Main Changes from Edition Two to Edition Three

Replenishing Resources, Capabilities, and Exercises for the Traditional

The Landscape of the Future 151 PART THREE

Chapter Learning Objectives

2 Chapter 1 Winning Moves

Sustained Competitive Advantage

Chapter 1 Winning Moves 3

4 Chapter 1 Winning Moves

Making Winning Moves

Chapter 1 Winning Moves 5

SCA = [EA + IA] + [BS + CS + GS + IS] + [I + R]

6 Chapter 1 Winning Moves

Step 3: Implementation and Ongoing Reinvention

Understanding Management Strategy: Three Analogies

Chapter 1 Winning Moves 7

Operating by the Rules

8 Chapter 1 Winning Moves

Changing the Rules

Envisioning Where to Go Next

Chapter 1 Winning Moves 9

10 Chapter 1 Winning Moves

In response, Medtronic has made the following moves:

Weathering Reversals of Fortune

Chapter 1 Winning Moves 11

EXHIBIT 1.5 Key Strategies Fail

Making Moves That Matter

12 Chapter 1 Winning Moves

Know Your Enemy, and Know Yourself

Not Just Detailed Planning

Chapter 1 Winning Moves 13

Strategy is as much about this process as it is about design.19 As design, strategy

Realized and Intended Strategies

14 Chapter 1 Winning Moves

The corporations management, therefore, must:

Chapter 1 Winning Moves 15

Hedging Against Uncertainties

EXHIBIT 1.7 HEDGING STRATEGIES Extreme Moderate Moderate Low

16 Chapter 1 Winning Moves

Chapter 1 Winning Moves 17

Building Early Momentum

Source: Adapted from Customers

18 Chapter 1 Winning Moves

Planning and Improvising

Keeping ScorePerformance Measurement

Chapter 1 Winning Moves 19

Measures of Overall Dominance

Economic Value Added

20 Chapter 1 Winning Moves

Investors Business Dailys Rankings

Chapter 1 Winning Moves 21

Reflections for the Practitioner

An Assignment for the Traditional Student

22 Chapter 1 Winning Moves

6. Hawawini, Subramanian, and Verdin, Is Performance Driven by Industry or Firm-Specific

External and Internal