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Chapter 6

Creating Strategic-Alternative Bundles

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Learning Objectives

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By the time you have completed this chapter, you should be able to do the following:

Develop strategic issues from having done a full situational analysis. Understand what it means to develop strategic alternatives and why many companies don't do it. Develop strategic alternatives from the list of key strategic issues. Create strategic-alternative bundles that meet certain criteria. Understand why the key strategic issues and bundle elements should match.

This chapter shows how to develop a set of key strategic issues that summarize the most critical elements of the entire situation analysis, and from such issues create a small number of viable strategic alternatives, or bundles, for the company to seriously consider.

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6.1 Key Strategic Issues

Identifying key strategic issues is an act of synthesis, that is, taking what you know about the organization and its changing environment (the situation analysis) and pinpointing the key questions and concerns the organization must address in its strategic plan. Strategic issues derive from both external and internal sources. The former includes the company's industry, competitors, customers, suppliers, opportunities and threats, and other environmental forces. The latter includes key organizational resources, culture, technology, or strategic decisions that the company must address. For example, consider a medium-sized private university based in the United States. Some critical external strategic issues may include the nature of private higher education in the United States; the attitude toward it of the surrounding community; legislation and policy governing higher education; the pool of graduating PhDs, which represents potential faculty; economic forces in�luencing education in general and private education more speci�ically; the comparable universities that prospective students consider; and the pro�ile of students the university attracts. Some internal issues may include the size of the university's �inancial endowment, scholarship monies available, aspects of the university's history and culture, the relationship between faculty and administration, resources available for faculty research and teaching, and technologies available to students and faculty.

Together, these strategic issues form the basis for generating the strategic alternatives. Too often, alternatives are generated from only a subset of these categories, which means leaving out a lot of information that is probably known and should be considered.

External issues may take the form of a trend, for example, likely increases in the interest rate, price of a critical raw material, or the frequency and severity of terrorist acts. Another form of external issue is an impending event such as legislation that is about to be enacted or a large competitor about to enter the competitive arena, perhaps with strategic consequences for the �irm. Internal issues may present as a strategic decision or choice, something that will have a dramatic impact on the �irm and the way it does business. For example, a company may need to decide whether to merge or acquire another �irm, go public, form strategic alliances, go international, vertically integrate, change its vision and core character, and so on.

Even after identifying a strategic issue, determining whether it is really critical is still dif�icult. It is useful to think of a strategic issue as something that keeps the CEO up at night.

Andy Grove is the author of Only the Paranoid Survive and former chairman and CEO of Intel. In the book's preface, Grove describes himself as a worrier who was concerned with everything from manufacturing issues and competition to the ability to attract and maintain talented employees. While such concerns kept him awake at night, he believed strongly in the "value of paranoia." So when reviewing a list of strategic issues, use this imagery as a way of pruning from the list those that do not merit such obsessive attention. Try also looking at a particular

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strategic issue in relation to others on the list; is it as important or less important? Ultimately, the �inal decision is subjective; what one person might consider critical another might cross off the list. More to the point, a CEO or top manager should rely on gut instincts when creating the list of strategic issues: What are the real issues, problems, or dilemmas facing the �irm (Roberto, 2009)?

Case Study Riverbank University

We have just described how the list of strategic issues used by an organization to formulate a plan may be either too limiting or too broad and that to inform strategy effectively, the issues must be thoughtfully generated and edited. The following brief case study summarizes how a recently hired university chancellor and her cabinet wrestled with the strategic issues needing to be faced by a small, private liberal arts college in the Northwest United States. (The identity of both the university and the individuals has been masked.)

Riverbank University was situated in a metropolitan area with many public and private higher education institutions. It had a long tradition of excellent undergraduate teaching that primarily attracted local and in-state students. Professors were known for the long hours they spent advising students on both course-related and personal issues, and for their strong mentoring skills. Research was not part of the landscape for either professors or students at this undergraduate-only institution. Faculty at Riverdale regularly invited students to their homes for meals and participated in on-campus events that afforded them informal opportunities to meet and get to know students. Most Riverbank faculty had spent their entire careers there, and turnover among professors and administration was very low.

In the late 1990s, as Riverbank's board of trustees and administration designed a strategic plan for the new millennium, there was talk about the desire to become a nationally, rather than regionally, known and respected university. Of�icials reasoned that attracting a more diverse pool of students as well as benefactors would enhance the university's pro�ile and set the stage for continued growth and competitiveness into the 2000s. With this goal in motion, a search ensued for a quali�ied chancellor (chief academic of�icer) that had experience in leading the transformation from a regionally to nationally recognized institution and eventually, one was selected.

When Dr. Irene Carson arrived on campus to begin assessing the climate and identifying the critical issues at hand, she quickly became overwhelmed with the internal and external factors that both inhibited and encouraged growth. Professor satisfaction and morale were huge issues: Faculty at Riverbank liked things the way they were and had no experience with an "outside"

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administrator being hired and setting the agenda for them. University relationships with key stakeholders—donors, board members, and other "friends" of the school—were delicate and needed to be carefully managed. The city where the school was located was resistant to growth of the physical size of the university. The structure of the university's academic schools and departments seemed unbalanced and illogical. Many professors were using outdated and outmoded teaching methods. The university offered no online courses in an era when all other schools did. Physical infrastructure, such as technology and lab space, was lacking. Moreover, Dr. Carson knew that universities don't rise to national prominence based on excellent teaching. She knew that she needed the resources to attract some star researchers.

So, Dr. Carson set about having strategic conversations with key constituents: members of faculty senate, deans, board members, students, community members, and other university of�icials. Through these private meetings, informal conversations, and public town hall events, Dr. Carson and her team began to clarify, prune, and prioritize the list of strategic issues into manageable, realistic, and relevant order. This bundle of strategic issues allowed Riverbank to move forward toward its goal of national recognition.

First, Dr. Carson identi�ied structural problems and corrected them by moving some academic departments to different schools within the university where they made more sense and stood a better chance of becoming accredited. For example, a School of Performing Arts was created to house theatre and dance, because Riverbank's dance department's primary barrier to national accreditation was the lack of such a school. Next, the chancellor leveraged important and longstanding relationships with key benefactors and the board of trustees to gain commitments toward new facilities that would enhance the university's goal of attracting high-pro�ile, high-achieving research faculty. With these two critical strategic issues covered, the new chancellor and her team then focused on recruiting "stars."

Within �ive years, Riverbank was home to a growing number of graduate programs, a Nobel laureate, numerous prestigious faculty members recruited from well-known research universities, and a student body that, for the �irst time, represented all 50 states in the United States. All concerned acknowledged that the university's strategy was working.

Questions for Critical Thinking and Engagement

1. When you consider Riverbank's history and the case presented, do you believe that Dr. Carson's eventual list of priorities (key strategic issues) was appropriate? Why or why not? (Note that the question uses the term "appropriate" rather than "successful.")

2. Based on your reading and analysis of this brief case, was the list of critical issues thorough enough? Was anything left off the list that should have been there?

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3. Without any additional personal knowledge of this institution, continue writing the case study. The case ends on a note of success, but what "fallout" might you expect based on the background you were given? Be as speci�ic as possible.

4. Comment on Dr. Carson's practice of strategic conversations with key constituents. Based on your reading of this chapter to this point and your own experience, did she do the right thing? Why or why not?

The strategy development process is not a time to pull punches or shy away from the truth. As Dennis Rheault, former vice president responsible for corporate strategy and development at Motorola, wrote, "The purpose of an effective strategy-development process is not to avoid but to confront uncertainty: to pose the really tough questions that you do not have the answers to—the issues and opportunities that can make or break the business" (Rheault, 2003, p. 33). This is not a time to parrot what the CEO wants to hear. Unless these issues are real and phrased in plain terms, the resulting strategic alternatives that are designed will likely not be in the company's best interest. Having strategic conversations with colleagues or outside experts over the course of a year will help to unearth the real issues that the company must confront. As has been emphasized earlier, this process is most fruitful if it is undertaken on an ongoing basis rather than as an annual exercise.

Strategic Conversations

A strategic conversation is a free-ranging discussion on a topic of strategic interest to an organization. Because of its characteristic "no- holds-barred" freedom to say whatever needs to be said, it invariably produces ideas and thinking that are ultimately useful in the strategic- planning process and that might not be captured in any formal process.

All major strategic planning, according to Peter Schwartz, cofounder of the Global Business Network, does not, in fact, take place during the strategic-planning process (Abraham, 2003). What goes on in a formal process is almost always a rati�ication of what has already happened. A strategic conversation is an attempt to understand the real strategic-planning process and often takes place entirely informally. Schwartz's colleagues at Bell South used to call it the HERs process—hallways, elevators, and restrooms— because that's where the most interesting conversations take place. While real decisions got made, real issues got confronted, real knowledge was developed, almost all of it took place in this conversational mode. And that is how real learning also takes place. If you are going to have good strategy, it involves good learning— learning about new realities, new facts, new competition, new opportunities, new directions—and challenging old knowledge. Simply writing a strategic plan as an act of listing a set of new objectives for the coming year as if nothing had changed is pointless. The problem is that if everything has changed and you need to come up with a plan, how are you going to learn about those changes?

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One informal strategic planning process involves "HERs"—hallways, elevators and restrooms. These informal meetings can be where the most interesting conversations take place.

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Furthermore, again paraphrasing Schwartz, it is one thing to do this for an individual, but how do you get a group of decision makers, who almost always have to act together, to acquire that knowledge and to develop and implement strategic plans? He maintains that the only way you learn together is through conversations (Abraham, 2003). Whether formal or informal, a strategic conversation is the learning vehicle through which the group adjusts to a new worldview to enable strategic plans to be developed and implemented. The steps in the process often follow this sequence: shared conversations, shared learning, change one's mental models, then develop better strategic plans. Tony Manning echoes Schwartz in endorsing the value of informal dialogue:

Strategic conversation is far more than just an occasional practice that can be adopted or abandoned at will: it is without doubt the central and most important executive tool. . . . What senior managers talk about—clearly, passionately, and consistently—tells me what they pay attention to and how sure they are of what they must do. (Manning, 2002)

The viewpoint of most strategic analyses is assumed to be that of the CEO or leader of the organization and may include the top-management team. When examined from the viewpoint of a board of directors, other variables could be added to the list of strategic issues, such as whether to go public, and even whether it is time to replace the CEO.

There is one �inal check on whether you are dealing with the proper set of strategic issues. Because they constitute the critical questions and issues a company should address, they should all be taken into account explicitly when forming strategic alternatives. In the event that the alternatives fail to take into account one of the strategic issues, it could mean that either (a) the strategic alternatives have not been properly formulated and should be further modi�ied to take it into account, or (b) the issue in question is not as important as was initially

assumed, and thus could be deleted.

While it is possible that a �irm could have any number of strategic issues at a given point, the larger the number of issues proposed, the higher the chances are that some of them are not as critical as others. Long lists of over 12 items should be pruned down, eliminating those that are not so critical or combining some of them. If the list cannot be reduced at this stage, another chance to do so will be when the strategic alternatives have been created if it is found that they have still not taken into account every issue.

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When considering strategic issues, lists of 12 items or more should be reduced to 8–10 items by the CEO and/or the top management team.

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Strategic issues are typically expressed in one of two forms: either as a statement or as a question. For example:

Whether the company should acquire XYZ Corporation. Should the company acquire XYZ Corporation?

The second is phrased as a question and is the recommended form because, if the outcome is known with certainty—"Yes, the company should acquire XYZ Corporation"—then the issue is not a strategic issue; it is a decision the company has already taken. It is not suf�icient, however, that one simply pose a question on a matter of strategic concern. Consider the following:

Should the company try to lower costs? How can the company lower its costs?

The strategic issue is not whether to lower costs; the answer to that question is that of course it should. Rather, the strategic issue might be "How can the company lower its costs?" because that answer may be uncertain, so it could be included as a bona �ide strategic issue.

Thus, one criterion for a strategic issue is that the answer to the issue is uncertain. The way in which that uncertainty is resolved is through the design of strategic alternatives and choosing a preferred one. Given a strategic issue, "Should the company broaden its product line?" one alternative could say, "Broaden it" and another, leave it out altogether (not broaden it). Thus, through deciding which alternative is preferred, the one that is chosen automatically "resolves" the uncertainty inherent in the issue.

Discussion Questions

1. Having done a thorough situation analysis—both external and internal—do you agree that it makes sense to synthesize the results? Explain your answer.

2. In your view, would the external analysis previously done be more useful in scenario planning than in forming strategic issues? Why or why not?

3. It's possible that managers don't go through a process of coming up with strategic issues because it involves phrasing questions to which the answers are unclear. Could there be any truth to such a view?

4. Suggest ways of shortening a list of 20 strategic issues to a more manageable number of about 12.

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6.2 Strategic Alternatives

An ordinary alternative is one of several means by which a goal is attained or a problem solved. A strategic alternative is one of many routes a company might take to gain market advantage, realize its goals, or, if no speci�ic goal has been declared, decide where it might go and what it might accomplish. Notice two things about the de�inition: (a) The designation "strategic" is necessary because alternatives are fashioned in a competitive environment, where actions and retaliations of competitors must be taken into account; and (b) the alternatives are created at the level of the whole �irm and not any one of its functions or units. In addition, they provide choices about marketplace strategy or about con�iguring the organization, address issues of central importance to the organization, have uncertain outcomes, and require resources to develop before action can be taken (Lyles, 1994).

Alternatives are of three general types. "Obvious" alternatives arise from current strategies or simple extrapolations of what the organization is currently doing. For example, utilizing Facebook, Twitter, and a blog to communicate with consumers represents an obvious strategic alternative. "Creative" alternatives take different conceptual approaches than existing strategies do and break away, to some extent, from the assumptions and beliefs underlying current strategies. A training-and-development organization specializing in the creation and facilitation of live, face-to-face, trainer-led instruction might pursue a creative alternative by entering the e-learning market.

"Unthinkable" alternatives re�lect a radical departure from the organization's historic mindset (Lyles, 1994). For instance, as a result of the organization's organizational culture and values, alcoholic beverages have never been made available for sale within Disney theme parks. The idea that the sale of liquor could enhance pro�it or attract new customers would represent an unthinkable strategic alternative. As in the Disney example, an unthinkable alternative might be appropriately labeled as such because it violates some demonstrated, effective core value of the organization. However, sometimes alternatives are unthinkable simply because no one before has bothered to break the rules of what is appropriate for how an organization does business—even when experimenting with such alternatives might be the right move. Typically, such alternatives have little chance of being accepted by management unless arguments for their adoption are persuasive and made by someone who commands respect in the organization. Unthinkable alternatives illuminate the current situation in a radically different light and inspire other managers to propose creative solutions. However, this typology, while insightful, is typically not advocated as a framework to generate alternatives.

For some companies, the decision-making about their future may involve tweaking their present strategy slightly. This might be something as simple as adding a distribution channel or starting to advertise on television. Although the company might claim that this represents a change in strategy, it is, in fact, simply a change in implementation. Dutch digital-navigation-equipment developer TomTom recently announced that it would scale back the personal-navigation-device division that had made it famous and shift focus to its built-in automotive-navigation

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Pep Boys, an auto-service �irm in Southern California, created a strategic alternative to their business strategy when they decided to start advertising on television.

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systems. TomTom had consistently lost pro�it on the small personal-navigation devices since consumers began relying on free or low cost mapping applications on smartphones and tablets. Conversely, �inancial reports suggested the strategy shift: The built-in-automotive systems is the fastest growing division in the company (TomTom shares, 2011).

For other companies, the strategy itself may remain unaltered, but the objectives may change, such as from 10% per year to 15% per year growth in revenues or pro�its. Companies may mistakenly characterize this as a change in strategy; however, if the basic way in which the company competes has not changed, then this is not a change in strategy.

Obstacles to Creating Strategic Alternatives

What many companies do when planning ahead, it would appear, involves simpleminded extrapolations of past accomplishments involving no change in strategy, or they make the �irst change that occurs to them that makes sense at the time. Sometimes it works or works only for a short time, but more often it does not. As naıv̈e as this analysis sounds, how else can we account for so many poor decisions made by various companies over the years? Even the best decision made at a given time can lead to a poor result because of unforeseen events and actions. Poor results are notoriously the inevitable byproduct of poor execution, even with an otherwise sound strategy in place.

In each of these cases, is the strategy the company chose the best one it could have adopted in the circumstances? The only way to tell, really, is to have analyzed the subset of all plausible alternative strategies and chosen one for very good, defensible reasons. If this is done, then any challenge or question about what else might have been done can be preempted because one can argue convincingly why the chosen strategy is superior or at least preferable to any other that might be proposed.

Focus on Perceived Costs

Why don't companies develop alternative strategies routinely? Many companies forego developing strategic alternatives because they perceive obstacles, real or imagined. An excuse commonly heard is that it takes a lot of effort and time: "We're in a hurry and can't afford to

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Small groups of managers sometimes brainstorm ideas that later become strategic alternatives. This process must begin with framing a problem and identifying a list of alternatives.

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wait." In fact, to do something well does require time and effort, so claiming to be in a hurry is just a convenient excuse. True, circumstances sometimes demand a quick decision, but even so, making a decision without considering alternatives is foolhardy. Besides, to make any decision at all, one needs at least two alternatives.

Another reason offered for not constructing strategic alternatives is that the exercise doesn't guarantee the "right" answer, so it may be a waste of time and resources. It is true that no one can guarantee the correctness of a decision whose consequences play out in the future, but by considering the signi�icant trends and impacts, including the relevant variables, assessing the �it with the company's capabilities and resources, and considering plausible strategic alternatives, the chances of making the "right" decision for the company are substantially enhanced. Only when 3, 5, or even 10 years have passed, can you look back in hindsight and know whether a strategic decision was good or not. Otherwise, one has to make the decision while not knowing how things will actually turn out. All one can do in the circumstances is one's best. But companies that skip the process entirely for lack of certainty do not give themselves a �ighting chance to make the best decision they can; they short-change themselves.

Focus on the Past

Many managers are more comfortable thinking about and analyzing the past than the future. They seem to �ind nothing wrong about examining past data and then making a decision that will play out in the future. The past is certain; the future is not. In these days of rapid, even discontinuous change, past data are often irrelevant. What we need to examine are trends about everything that is changing and likely future moves of competitors. How are industries changing? What will merging industries become? How will technology affect our lives, what we buy, how we use products, how we think, how we do business? People are less comfortable in the future because they are unable to predict or forecast it, unable to extrapolate, and unused to ambiguity and uncertainty. An oft-repeated joke is that people would rather be certainly wrong than not sure whether they were right. The thought that they might even in�luence the outcome of future events even escapes them. Many people simply regard the future as something beyond their control.

Complacency

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There are managers who don't take the responsibility for strategic planning seriously enough, or they don't devote enough time to ask themselves really tough questions that might put their companies on a stronger, albeit different course. It is much easier to keep doing what the company has been doing, particularly if the company is performing reasonably well. Setbacks can be blamed on a competitor, an unexpected piece of new legislation, a downturn in the economy, or a rise in supplier prices. True, the unexpected often happens, but in hindsight, many "unexpected' occurrences could have been anticipated and taken into account had strategic planning been properly done.

Insuf�icient Training

Many people who don't know how to do strategic planning would rather avoid admitting so to save face and will instead do what they think is strategic planning—as they have always done it. This may be a valid reason but, if that is the case, the company is at risk unless and until it has management in place that is trained in strategic planning. While there is no foolproof way of coming up with a good strategy, the process relies to a very large extent on strategic thinking, and the results achieved depend in large part on one's strategic-thinking ability and on experience with and commitment to the approach. Even after a company has decided on a strategy, it must be fully invested in making it succeed. It will require the leaders of the company to provide ideas, motivation, arguments, and skill at implementation that will bring the results desired. So, although it is more convenient to stay in one's comfort zone, it may not be the best way to chart the company's future course.

In many companies, staff planners and even some line managers who value the process of strategic planning �ind only lip service paid to it because of disinterest or a lack of commitment on the part of top management. This might be the product of a tradition or culture of risk avoidance or entrenched and threatened interest groups raising impediments to the process. Finally, top management's reluctance to embrace the process may stem from simple ignorance about what strategic planning really is and is supposed to do.

Myopia

Companies put a far greater emphasis on short-term �inancial results than on longer-term strategic performance. While short-term �inancial performance is important, it should never come at the expense of longer-term performance. CEOs who feel threatened with losing their jobs or whose judgment may be in�luenced by the value of their stock holdings may tend to focus on the short term. Boards of directors concerned principally with the company's stock price or the company's immediate survival also represent instances where shortterm considerations dominate. In this environment, the company's long-term future and potential are often sacri�iced, as when expenditures for R&D, new- product development, advertising, and training programs are slashed to show pro�its for the quarterly and year-end reports. Clearly, such decisions are suboptimal and not made in the long-term best interests of the company. Such decisions also adversely affect any strategic alternatives the company may consider and the strategic direction the company pursues.

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Discussion Questions

1. Which of the obstacles to creating viable strategic alternatives are most easily removed? Which ones might be the most dif�icult to mitigate? Discuss.

2. Think of a personal decision you made for which you actually considered at least one other alternative. Could you have made the decision without considering the alternative? If so, why did you consider the alternative? Was your decision affected by having considered the alternative?

3. If you follow sports, try to imagine your favorite team. As hard as it may be for that team to win games, the real strategic decisions are made away from the arena and probably in the off-season. Which players to trade? Who would improve the team, and could the team acquire that person? How to lower the total payroll and still �ield a winning team? Describe which people in the organization participate in such strategic decision making and whether in your opinion they go through a systematic process of creating and weighing different alternatives.

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To unlock your imagination and visualize ideal solutions, consider the future needs of your ideal company or industry, the perfect product and packaging, and the ideal service or system for your company.

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6.3 Creating Strategic Alternatives

One typical way that strategic planning is conducted is for a small group or team of managers to brainstorm ideas that later become alternatives. Some follow a speci�ic process, some don't. Marjorie Lyles (1994), suggests a process that begins with framing a problem, identifying an initial list of alternatives, extending the list if resources and time permit, then narrowing the list through a process of evaluation and consolidation. However, who is to say that the resulting list contains good rather than mediocre or unimaginative alternatives? Clearly, a worthwhile strategy cannot come from poorly conceived alternatives. Lyles speci�ies certain criteria as to what makes a list of alternatives useful:

The variety of alternatives Differences among them compared to the present situation The costs and dif�iculties of implementation; if they are all too easy to implement, the organization is not stretching itself or being ambitious enough The degree to which they challenge existing goals, aspirations, long-held assumptions, and beliefs (Lyles, 1994)

Edward de Bono (1992) makes the distinction between choosing from alternatives that already exist, such as ties in a closet or menu choices at a restaurant, and alternatives that do not exist and need to be found. In the latter case, one cannot suggest just any alternative and have that alternative make sense. It has to be related to a reference point. For example, what alternatives are there to achieving this purpose or carrying out this function?

To help in coming up with alternatives, de Bono suggests thinking of groups, resemblances, similarities, or concepts. For example, as an alternative to an orange, do you search for other citrus fruit, domestic fruit, refreshing beverages, or colors? His technique of lateral thinking is directly concerned with changing concepts and perceptions, especially when used to come up with alternatives in solving problems (de Bono, 1992). It is a systematic way of generating new ideas and new concepts. Besides leading to a defensible strategy, coming up with suitable strategic alternatives is an excellent opportunity to explore whether the organization should be heading in another direction or doing business a different way. Of course, companies that have been operating in a certain way for years experiencing satisfactory results are not inclined to change their way of doing business, because there is no perceived need to do so. One

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overlooked reason for complacency is that it is almost impossible even to think about doing business in a different way or heading in a different direction when you are an intrinsic part of the organization and have become used to doing things the way you do. In fact, this is an ideal, if somewhat counterintuitive, time to explore other options. Many companies fall into the mindset of "If it ain't broke, don't �ix it," and they are dif�icult to persuade otherwise. They address the issue only when their strategy falters, or when competitors overtake them, or some other threat looms, by which time it's often too late. Opportunities go unrecognized because they are seldom sought or considered, which is yet another reason to be doing strategic thinking all the time. In cases like this, the organization may well bene�it from an outside facilitator and speci�ic exercises to stimulate creativity.

James Bandrowski offers one of the most powerful techniques for using creative imagination to �ind alternatives or, more accurately, breakthroughs (Bandrowski, 1990). He suggests visualizing the ideal solution and then "�illing in the feasibility" afterwards, that is, �iguring out how to achieve that ideal solution (Figure 6.1). The advantages include coming up with something radical, leapfrogging the competition instead of just catching up, getting ready for tomorrow's markets, and injecting new life into a possibly complacent and mentally tired organization.

Figure 6.1: The creative leap

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Rather than just blindly searching for ideal solutions, Bandrowski offers the following suggestions for making a creative leap, all of which will improve your ability to think strategically and supplement the ideas discussed in Chapter 3:

Year 2020—Pick a date in the future such as the year 2020. Call it "Challenge 2020," a technique employed by 3M. Unlock your imagination and visualize what your industry, products, services, markets, and so on will be like then. Bandrowski says, "The future will be invented by those who see it today." Ideal company—What would the ideal company look like? Who is the best competitor in the industry? What do you most covet in this competitor? What company would you most like to acquire and why? Bandrowski quotes Lee Iacocca's description of an ideal automobile company: "It would combine German engineering, Japanese production ef�iciency, and American marketing." Ideal industry—Reconceptualize your entire industry. How could it become more pro�itable? How could technology revitalize it? Would it make sense for it to merge with another industry? How could you tilt the playing �ield in your favor? Sweeping solution—Start with a blank canvas and try to �ind a total solution, rather than trying to improve various components such as production, marketing, and distribution. Is there a completely different way of doing business that is better?

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Hyundai's cars were once considered inferior products until the company retooled its strategic intent and upgraded the quality of its cars. It paid off with increasing market share.

Spencer Platt/Getty Images

Perfect product—What ideal products could be provided to either existing or new customers, assuming no �iscal or technical constraints? Customers should be included in this fantasy exploration; in fact, how might customers be persuaded to help co-create value? One place to start might be to list or collect data about all the shortcomings of existing products. Perfect package—How could packaging most bene�it the product? Could it make the product easier to use, last longer, more convenient, more transportable, and the like? Could it be combined with the product or even eliminated? Ideal service—Ask what customer needs are directly or even indirectly related to the product the customer buys. Any time you can make your product easier to use, save your customer money or time, or increase your customer's sales, it may provide an opportunity to improve your service to that customer. Ideal information—What information must you have to win? What don't you know that is hampering your efforts or causing you to be uncompetitive? Include information also about trends and the future. Rank the list in terms of importance to the company, not in terms of what is possible or what costs the least. Ideal system—Focus on new ways of increasing throughput, reducing costs, reducing cycle time, or bringing new products to market faster. This is an area in which business-process reengineering traditionally takes place. But what do you do for an encore after your reengineering has taken place?

Discussion Questions

1. De Bono talked about alternatives to an orange being other citrus fruit, domestic fruit, refreshing beverages, or colors. How would you apply this kind of lateral thinking to the problem of how customers buy? What unusual alternatives might this suggest for a company?

2. Which of Bandrowski's suggestions for brainstorming strategic alternatives appeals to you most and why? Which ones would you as a student �ind most dif�icult to do? Give your reasons.

3. Companies are often stymied in pursuing different options—even what they feel they need to do—because of some perceived insurmountable obstacle ("just can't be done"). Do you believe that trying to focus on a desirable end-state (taking a "creative leap") and working backward would help managers? If so, what would be most dif�icult about persuading them to do this?

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6.4 Creating Strategic-Alternative Bundles

The process proposed here starts with the list of key strategic issues discussed in the previous section. Because these strategic issues represent the most pressing and important problems and issues facing the organization, any subsequent plan or strategy that is developed should address all of them. So, starting with that list, create two to four alternatives that meet certain criteria. Most organizations manage to come up with three; identifying more than four is extremely dif�icult. You must be wondering, "Surely one can come up with many more than four?" Read on, these are not "ordinary" alternatives.

Because of the large number of possible strategies available, my students have always found it extremely dif�icult to create good strategic alternatives other than the obvious "safe" ones. Consider for a moment the full range of strategies discussed in Section 3.2, which are organizationwide "master" or "grand" strategies, and do not include functional or operational strategies, classi�ied as programs in this book. An organization could choose a particular combination of strategies to adopt, but in order to show that it is the best choice at the time, it would have to compare it to all other combinations of strategies, a Herculean and impractical task. It took several years to make the conceptual leap and ask, "What if there were only a small number, say two to four choices, available? And what if they constituted "either/or" choices such as choosing A or B or C, rather than saying that A + B together was better than A alone, or A + B was better than C + D? As the technique took shape, it seemed to make more and more sense, but making it practical proved to be elusive for a while.

What also became clear was that these alternatives did not consist solely of strategies but rather "bundles" that comprise strategies, strategic intent, core competence, programs (which are an operational component of a strategy), �inancing method, geographic scope, and any other element that would help de�ine and clarify a future course of action to an observer. The bundles would be derived in large part from the key strategic issues that, in turn, were derived from a comprehensive situation analysis of the external and internal environments. This sequence of dependencies gives the method a logic that is easy to grasp and learn.

As we shall see later, these bundles are one step away from being business models. That is why creating more than a few is extraordinarily dif�icult—companies are hard pressed to come up with one alternative business model, let alone up to four.

Strategic Intent

Most well-managed companies try to achieve an overall purpose and vision. The strategies it chooses have to be aligned with this purpose and vision. So what is strategic intent? Strategic intent is the market position and market share that a company sets as its goals. Strategic

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intent is, of course, related to the strategies the �irm has decided to pursue. Market position is the position in an industry that a company occupies ranked by market share; the market leader is #1, followed by #2, #3, and so on.

It is a given in any industry that the #2 company ranked by market share has a strategic intent of overtaking the leader and becoming #1. Likewise #3 sets a goal of becoming #2. In practice this may take some years depending on the industry, relative market shares, and other factors. However, when a company is ranked #23 in market share, it doesn't set a goal of becoming #22, because at that level, it doesn't even know it's #23. In many industries, market shares are not monitored or known. In such cases, the strategic intent is expressed in terms of either increasing or maintaining market share.

What exactly is involved in gaining market share? Figure 6.2 shows a hypothetical industry in which sales are growing at a constant 7% per year. For simplicity this is assumed to grow in a straight line with no seasonal variation. In order to gain market share, a company would have to grow at a rate higher than 7% per year (as Company X in the �igure) and at an equal rate to maintain market share. And even though a company in this industry might be growing at 5% per year (Company Y in the �igure), it would actually be losing market share.

Figure 6.2: Gaining, maintaining, and losing market share

Google's Chrome browser represents a contemporary example of strategy driving market-share gain. Poised to overtake both Firefox and Internet Explorer, Chrome is a byproduct of Google's strategy to draw people into the Internet, then search the Web using Google, thus

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engaging with the company's pro�itable advertising system. Chrome offers Internet surfers a simple, clean interface with Google's online empire. Chrome keeps users focused on Google's products including cloud applications (Google Docs, for example) and other offerings (such as Google maps). The marketing strategy (and dollars) behind this push is resulting in the growth of Chrome's market share while Firefox and Explorer remain more static.

Again, strategic intent and strategy have to be aligned. If pursuing a particular strategy results in the company just keeping up with industry growth, then it cannot "overtake" a competitor in terms of market position, and it cannot increase market share.

Major Programs

For purposes of developing a bundle, only the new major programs or operational tasks called for by the strategies in the bundle need be identi�ied. Later, during operational planning, which precedes implementation, the programs and objectives are �leshed out by every operating unit and department in the company. Programs in every alternative bundle can and should include successful and needed programs that the company is currently implementing, usually by inserting a catchall like "continue current programs." Without doing this, the implication is to stop doing everything the company is currently doing in favor of only what is in the bundle, clearly an unrealistic situation. In addition, the company may have to initiate new programs called for by the strategy. Programs implemented the very next year are often called tactics.

Every strategy implies a set of programs, shown in general form in Table 6.1.

Table 6.1: Program components of common strategies

Product development

Market expansion Acquisition Turnaround Diversi�ication Differentiation

R&D programs Market research De�ine criteria Control cash Choose industry Market research

Engineering design Hire sales force Search broker lists

Meet with creditors Set criteria Develop concept

Develop prototypes

Train sales staff Analyze candidates

Talk to major customers

Acquire company

Invest capital

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Testing Mount ad campaign Conduct due diligence

Divest assets Invest capital Develop ad campaign

Quality program Secure distribution channels

Negotiate deal Reduce staff Negotiate objectives

PR campaign

Get �inancing Form new strategy Redesign product

Consolidate Raise price

Other common programs include hiring a new CEO or vice president, seeking a strategic alliance with an external organization such as an international distributor, installing an integrated accounting system, or improving product quality. Remember that key programs are already included in the chosen strategic-alternative bundle.

Bundles should also describe in speci�ic terms the method by which the strategies and associated activities would be �inanced. An organization can derive funds from three sources:

Cash—including actual cash and assets that can quickly generate cash such as marketable securities, disposing of excess inventories, factoring accounts receivable (i.e., selling them at a discount to a factoring �irm for ready cash), or selling assets no longer needed. Taking on debt or additional debt—such as extending existing lines of credit from banks or certain suppliers (paying late), taking on additional long-term debt, or in more dire circumstances, trying to get customers to prepay for goods not yet received. Getting an infusion of equity capital—such as issuing new stock if a public company, or �inding an investor.

Notice that these sources of funds are available to the �irm in cash. To fund anything it does in the future, it needs cash, either what it has or can secure through a loan or equity investment. As previously discussed, a business cannot, for example, spend "retained earnings."

It is useful to think of funds available to the business as being of two kinds. The �irst is baseline funds that are needed to support the �irm's current business and ongoing operations, that is, pay current operating expenses, maintain adequate working capital, and maintain current plant and equipment. The second is "strategic" funds that could be invested in new strategic initiatives, that is, purchase assets such as facilities, equipment, and inventory, increase working capital, increase R&D or marketing/promotion expenses, or acquire another company (Rowe, 1987). Increasing market share usually requires strategic funds, while maintaining market share needs only baseline funds. Firms are in serious trouble when they do not even have the level of baseline funds they need to maintain current operations.

Discussion Questions

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Millennium Images/SuperStock

1. Does trying to achieve a strategic intent complicate what a company is trying to do or does it help? Isn't trying to achieve a vision, strategy, and objectives enough? Explain your answer.

2. Increasing or maintaining market share applies only to the industry in which the company competes. What happens when it enters another industry or the boundaries of the current industry change?

3. Discuss developing a strategic intent for a company with markets in several different countries. 4. When one talks about one or two companies in an industry gaining market share over time, must others in the industry lose market share? Is it a zero-sum game?

5. In developing alternative bundles and, naturally, the winning bundle, one has to include not only the strategy that sets each bundle apart but also the major programs needed to implement the strategy. Are such programs enough to do detailed operational planning later, or should more detail be added at this stage?

6. Judging from Table 6.1, coming up with major programs seems straightforward. Would you agree? Or does it require substantial real-world experience?

7. Do you think that knowledge of the major programs in a bundle affects the decision as to which bundle to choose as "best"? Explain your answer.

Carmike Cinemas, Inc.

The chapter concludes with a case study on Carmike Cinemas, Inc., a movie- theater chain in the Southeast United States in the mid-'80s, which forms a perfect vehicle for illustrating how bundles are formed from key strategic issues and how the strategic issues are modi�ied later to match the bundle elements.

In 1986, Carmike Cinemas was the �ifth largest movie-theater chain in the United States and the largest in the Southeast region. Carmike was being run con�idently and entrepreneurially by CEO Mike Patrick, and he believed that Carmike was not only a strong competitor but also smarter than most of the others. Revenues and NIAT were growing at an average 15.3% per year and 50.2% per year respectively between 1982 and 1985. In 1986, a year in which the major movie studios produced fewer commercially successful pictures, revenues and NIAT dropped 11.6% and 44.4% respectively. Its debt/equity ratio in 1986 was 1.66, down from 6.66 in 1983 when it acquired another

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If Carmike was to go national as part of its alternative-strategy bundle, it would consider acquiring small-town theaters starting in the Southeast, then Midwest, then the Southwest and West.

movie theater chain principally through debt. The company was well managed and growing aggressively through acquiring failed theater chains throughout the Southeast, staying mainly in small towns where often it would be the only theater; in effect, these small towns represented blue oceans. Like other

chains at that time, it was rapidly multiplexing, that is, converting single-screen theaters into multiscreen theaters (Taylor, 1996).

Some strategic issues arising from a situation analysis include the following initial list.

Should Carmike:

Stay regional or expand nationally? How fast and where should it grow? ("Should Carmike grow?" is not an issue as its recent history suggested strong growth, and the CEO's style and characteristics lean toward aggressive growth.) Increase its debt or go public to secure additional capital? Invest in screen/projection/sound technology? Upgrade the quality and amenities of its theaters? Experiment with serving hot food and coffees in its theaters? Sell memorabilia associated with the movies it shows? Show foreign, classic, cult, or other types of movies? Get into domestic or foreign distribution? Stay in small towns or expand into urban areas and cities? Continue to grow through acquisition?

If in doubt as to whether or not to include something as a strategic issue, go ahead and include it. Err on the side of having too many strategic issues. Later in the process, you will come to realize which of them are real issues and which are not important enough, so you can then delete them. With experience, you will be able to gauge which strategic issues are meaningful and �ind yourself adding very few that are later deleted. The process is iterative.

After much trial and error (adding, moving, erasing, changing items in each bundle), you can arrive at a set of strategic alternatives; at least two are required, otherwise there can be no decision. Creating two is not dif�icult—the strategy the company is currently pursuing and a different or potentially better alternative; creating three takes substantially more effort and thought, and four is extremely dif�icult. The reason is that these are not just strategic alternatives, but rather different business models with alternative visions (Collis & Rukstad, 2008).

Echoing Lyle's list, the best set of strategic alternatives should meet six criteria:

Be mutually exclusive—the bundles must be either/or choices.

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Contain signi�icant variety—that is, show that some creative and daring thinking has been done and are not so close to what the �irm is doing now, unless one of the bundles embodies the current strategy or the status quo. (Despite Lyle's criterion of variety, using a status quo alternative is quite understandable if the company is currently performing very well.) Be feasible—given the circumstances, resources, and capabilities of the �irm. Would all lead to success—even though the �irm might end up in a very different place with each alternative. Challenge the organization's existing goals, aspirations, long-held assumptions, and beliefs—to improve its performance, competitive position, value proposition, and economic value. Have addressed all the strategic issues.

Table 6.2 presents three "bundles" for Carmike Cinemas as an illustration. Giving each bundle a label helps distinguish it from the others and underscores how they are mutually exclusive. The �irst check is for mutual exclusivity—doing any one means not being able to do the others. Although components of one alternative might also be part of another one, the criterion refers to the whole alternative and not just particular components. The check shows the three bundles to be mutually exclusive. However, if it were to reveal that the bundles were not mutually exclusive, and if there were general agreement on that point, then the bundles would have to be recon�igured. Only when the resulting bundles meet all the criteria and do not change any more is this part of the process complete.

Do they contain suf�icient variety? Because of the subjectivity involved, the question is hard to answer. Imagine a continuum with no variety at one end (same strategy in every bundle, distinguished only by different rates of growth) and bundles quite unlike anything the company is doing at the other. The criterion of variety forces a search for strategies the company may not even be contemplating, while going out too far on a limb probably means the company is unable to implement it. So requisite variety is somewhere on the continuum and should be a balance between trying to be different and yet reasonable.

Table 6.2: Alternative strategy bundles for Carmike Cinemas (1986)

Bundle Element 1. Go national 2. Stay regional 3. Go international

Strategic intent Target #4 ranking near-term and #1 ranking nationally eventually

Maintain #5 ranking nationally but continue to dominate the Southeast region

Maintain #1 ranking regionally and become a major player internationally

Strategies Market expansion Market expansion and differentiation

International expansion

D/E comparison Increase D/E ratio Lower D/E ratio Maintain D/E ratio

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Contrasting purposes

Strive for market share Strive for pro�itability Strive for international recognition

Different acquisition programs

Look for acquisitions in small towns �irst in the Northeast, then Midwest, then Southwest and West

Look for acquisitions in small towns primarily in Florida but also in other Southeast and Southern states

Look for acquisitions in United Kingdom and Australia, Canada, European countires (in large cities), and also in the Southeast United States (small towns)

Whether to go public

Do not go public unless a very large acquisition is contemplated

Do not go public Go public to �inance international acquisitions

Other programs Develop a cost-effective national marketing campaign

Experiment with serving hot foods and coffee, and selling movie memorabilia in selected theatres

Set up a matrix organizational structure to manage the international company

Facility programs Maintain quality of theatres Upgrade facilities and technology of the worst 1/5 of all theatres

Maintain quality of theatres

Continue to do what the company is doing

Continue current programs Continue current programs Continue current programs

How to �inance Finance through debt and cash Finance through cash and some debt

Finance through cash, debt, and proceeds from IPO

Are the bundles feasible? Could the company actually implement each one were it to be accepted? People in the company would be in the best position to gauge feasibility, while those analyzing a company they are unfamiliar with have to go with their best educated guess.

Would the bundles lead to success? While "success" means different things to different people and companies, assume for the moment that it means becoming a stronger competitor and realizing a strategic intent. We are not concerned yet with organizational objectives. Some �irms set objectives �irst and then �ind a strategy to meet them. The process described here does it the other way around for good reasons that will soon become clear.

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You must involve key "idea people" in implementing your situational analysis. Your alternatives should challenge existing goals, aspirations, old assumptions, and beliefs.

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Do the bundles challenge the organization's existing goals, aspirations, long-held assumptions, and beliefs? The value of this criterion becomes clear in the case of companies that have been in a rut for a few years and have a culture that is content with "satis�icing" and the status quo. However, for companies striving to become a stronger competitor, the alternative bundles it chooses should all meet this criterion. Put another way, if the existing goals, aspirations, and beliefs are challenging to begin with, then the bundles don't have to challenge them.

When analyzing a company with which you are unfamiliar, it is important to juxtapose mentally each bundle with the situation analysis and determine whether the bundle is something that the company would implement, is capable of implementing, and would bene�it from if implemented. This is why the key people who would be involved in implementing the strategy must be part of this process. They will have a better feel for whether a particular bundle is feasible and what it might take to implement it. At this point it would be premature to argue which is the best bundle; the analysis is simply to determine whether each bundle meets the six previously stated criteria. If not, then the process of tweaking them should continue until they do.

So often, particularly in cases when an executive or analyst comes up with one strong strategic bundle, coming up with a second or even third one is very dif�icult. The strong proposal has preoccupied the person who has chosen it and any other alternative gets added as an afterthought. A common pitfall is deciding on the best strategy before coming up with alternatives. Many companies are guilty of doing this when they decide on the strategy that they will pursue without contemplating or contrasting it with other alternatives. Without generating and considering good alternatives, the company has no way of knowing whether the strategy it will pursue is the best under the circumstances.

Let's examine for a moment some strategic alternatives that were suggested but later discarded:

Vertical integration—Nothing in the case information suggests that vertically integrating backward would bene�it the company. Movie production and distribution are very different businesses and demand a level of investment and risk that is beyond the capability of the company to bear. Because it is already the "retail" arm of the movie industry, it cannot vertically integrate forward.

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Strategic alliances—Unfortunately, the case contains no competitive information. This is similar to the situation of a company whose competitors are privately held and about which no information is available. Only managers experienced in the industry and who can obtain information by "picking up the phone" can get around this obstacle. However, two avenues of thought should be pursued: (1) Which of all considered courses of action might bene�it more from, or be done better with, a strategic alliance? (2) What kind of strategic alliance might bene�it the company? Both considerations are an important part of strategic thinking. Diversi�ication—Related diversi�ication means getting into another segment of the entertainment industry. Even though the case gives no information about other segments, that does not mean to say that none of them contains an opportunity. (This sort of thinking comes under the heading of "unthinkable" alternatives mentioned previously. However, suggesting a course of action into another segment such as live theater, broadcasting, TV, professional sports, and the like has to be justi�ied and defended and supported with more information and research.)

As you can see, coming up with two to four alternative bundles may mean coming up with �ive or even six, determining whether they are mutually exclusive, plausible, and would lead to success, and deleting those that do not meet the criteria or combining them with others until they do. Carmike executives, with their additional knowledge of their own and related industries, are perhaps the only group that could mine the above four possibilities for yet another viable bundle. It's a creative and time-consuming process, but ultimately rewarding.

Discussion Questions

1. What is the difference between a strategic alternative and other kinds of alternative (e.g., considering alternative media for advertising, alternative ERM software)?

2. Picture a health center trying to raise funds for AIDS research. What types of strategic alternatives might such a group consider?

3. With respect to Question 2, is it possible to come up with strategic alternatives without �irst knowing what key strategic issues the nonpro�it faces? Why or why not?

4. The section argued for six criteria that strategic-alternative bundles should meet for them to be worth considering in choosing the best one. What if you, the analyst, couldn't come up with a set that met all six criteria? Would meeting �ive be acceptable? Four? If you think a fewer number would be acceptable, give your reasons.

5. Imagine developing and completing a criteria matrix. Some of your criteria would be positively and some negatively correlated. What part of rating your bundles on each criterion would you �ind most dif�icult to do? Why? What tips could you offer to cope with such a dif�iculty?

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In 2010, Carmike CFO Richard B. Hare announced a global box-of�ice sales increase of 7.6% to a record $29.9 billion in 2009.

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6.5 Closing the Loop with Strategic Issues

One last check needs to be performed before beginning to analyze the strategic alternatives and argue for a preferred one, and that is to compare the �inal bundles with the list of strategic issues. Every strategic issue should have been addressed in some way by the elements in each bundle. In our example, two strategic issues were not addressed:

Should it show foreign, classic, cult, or other types of movies? Should it get into domestic or foreign distribution?

This means that either (a) these issues are not as important as we �irst thought and can be deleted from the list; or (b) they are important and the bundles need further work to take them into account. Either solution is acceptable—there is no right or wrong answer. What matters is what is realistic and in the organization's best interest. If, for example, the �ilm- distribution business was not considered before, a great deal of research and data collection about that business—domestic and foreign—needs to be done before an intelligent analysis and decision can be made (this would come under "related diversi�ication"). For the moment, let's assume that we are satis�ied with the bundles as they are and delete those two issues from the list.

Notice also that bundle 3 contained the notion of going international. In fact, going international is the principal dimension that made it different from the other two. But whether the company should go international was never identi�ied originally as a strategic issue. Clearly, as a bona �ide bundle, the issue is important. So it should be added to the list, making the �inal list of strategic issues as follows:

Should Carmike stay regional, expand nationally, or expand internationally? How fast and where should it grow? Should it increase its debt position or go public to secure equity capital? Should it invest in screen, projection, and sound technology? Should it upgrade the quality and amenities of its theaters? Should it experiment with serving hot food and coffees in its theaters?

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Should it sell memorabilia associated with movies it shows? Should it stay in small towns or expand into urban areas and cities? Should it continue to grow through acquisition?

Discussion Questions

1. The sixth criterion for good bundles is to have addressed all the key strategic issues so that the �inal list "matches" the elements of all the bundles. Despite the argument for doing so in this section, do you think this criterion is really necessary? Explain your answer.

2. What would be the problem if they didn't match? Explain. 3. Do you feel that it's somewhat contrived to "make" them match at the end? Try to articulate your thoughts whatever your stance is.

4. Discuss one bene�it that checking back with the list of strategic issues might have on your �inal bundles.

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Summary

This chapter presented a way of developing a list of key strategic issues and why doing so is a fundamental step in creating viable strategic alternatives for the company. Such strategic issues synthesize what really matters to the company—what keeps the CEO up at night and on a "front burner" the rest of the time—and derive from a comprehensive external and internal analysis of the company. A key strategic issue should be phrased as a question whose answer is not known (if it is, for example, "Should the company reduce costs?"—Answer, yes—then the issue should be deleted from the list; it is something the company would do anyway no matter which alternative was chosen).

Before choosing the best alternative, the company must �irst go through a process of convincing itself that it is the best one, which can be done only by comparing it to other equally good alternatives. A strategic alternative as used here comprises a bundle of strategies, a strategic intent, core competence, programs, �inancing method, geographic scope, and any other element that helps �lesh out an alternative future for the company—which is why it is more aptly referred to as a bundle. And the reason the list of key strategic issues is so vital, besides summarizing all the issues that future plans should address, is that the alternative bundles are formed from them.

Creating good bundles is a creative process, and the chapter adds a few techniques to help do this in addition to those in Chapter 3 under strategic thinking. One of them is not really a technique, but rather the willingness to talk informally about what's really important to the company and external changes it should take into account; these are called strategic conversations. It's where one in�luential thinker says the real strategic planning takes place.

Unfortunately, many companies �ind excuses not to go to the trouble of creating good strategic alternatives. Excuses include being in a hurry and it taking too long, it not guaranteeing the "right" answer (so why bother?), being more comfortable thinking about and analyzing the past, not wanting to ask really tough questions (so let's keep doing the same thing), not knowing how to form viable alternatives and not admitting it to save face, disinterest or lack of commitment on the part of top management, and paying more attention to short-term �inancial results instead of long-term strategic performance.

The chapter explains in more detail why having a strategic intent is important and what it is. It is about improving or maintaining market position and also about maintaining or increasing market share. Maintaining market share happens when the company's revenue growth equals that of the industry; gaining market share is possible only when the company grows faster, and losing market share when it grows slower. Major programs are also included in a bundle to show what it is going to take to implement the bundle; every strategy implies a set of programs, though these can be different for different companies. And there must be suf�icient cash—whether from cash on hand (or what can

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quickly be converted to cash), a loan, or an infusion of equity capital—to �inance any bundle if it is to be feasible. A minimum of baseline funds is needed to keep the �irm operating, but additional strategic funds are required to �inance new strategic initiatives.

Creating good, viable, worthy bundles must meet six criteria: be mutually exclusive (involve either/or decisions); contain signi�icant variety; be feasible; lead to success; challenge the organization's existing goals, aspirations, long-held assumptions, and beliefs; and have addressed all the strategic issues. With respect to the last criterion, to the extent they don't, the bundles and/or the strategic issues must be changed so that, in the end, they match. (Everything is �luid until the bundles are ready to be evaluated, so changes are OK.)

The chapter concludes with a case study on Carmike Cinemas, Inc., a movie-theater chain in the Southeast United States in the mid-'80s, which forms a perfect vehicle for illustrating how bundles are formed from key strategic issues and how the strategic issues are modi�ied later to match the bundle elements.

Concept Check

Key Terms

baseline funds Funds needed to support the �irm's current business and ongoing operations, that is, pay current operating expenses, maintain adequate working capital, and maintain current plant and equipment.

bundles Strategic alternatives that comprise strategies, strategic intent, core competence, programs, �inancing method, geographic scope, and any other element that would help de�ine and clarify a future course of action to an observer.

funds Cash that the company can use that is generated from three sources: cash on hand and whatever can be quickly converted to cash, taking on debt or more debt, and getting an infusion of equity capital (selling stock for a public company).

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HERs process Strategic conversations that take place informally in hallways, elevators, and restrooms.

key strategic issues The critical questions and issues the organization must address in its strategic plan and that are a distillation or synthesis of the entire situation analysis.

market position The position in an industry that a company occupies ranked by market share.

program An operational component of a strategy. Every strategy implies a set of programs.

strategic alternative One of many routes a company might take to gain market advantage, realize its goals, or, if no speci�ic goal has been declared, decide where it might go and what it might accomplish.

strategic conversation A free-ranging discussion on a topic of strategic interest to an organization. Because of its characteristic "no-holds- barred" freedom to say whatever needs to be said, it invariably produces ideas and thinking that are ultimately useful in the strategic- planning process and that might not be captured in any formal process.

strategic funds Funds invested to �inance new strategic initiatives.

strategic intent What a company intends to do with respect to market position or market share. For example, maintaining leadership in an industry or overtaking the #1, #2, or #X player in the industry are intents regarding market position. In industries where market share is easy to compute or is monitored closely, a company can aim for a particular market share. However, when this isn't possible, strategic intent devolves into either increasing or maintaining market share.

tactics Programs that are implemented the very next year.

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Chapter 5

Assessing the Company Itself

Robert Harding Picture Library/SuperStock

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Learning Objectives

By the time you have completed this chapter, you should be able to do the following:

Understand what is involved in a thorough �inancial analysis of a company and how to make sense of the data. Perform an analysis of a company's strengths, weaknesses, opportunities, and threats (SWOT analysis). Determine whether a company has a core competence and a competitive advantage. Understand a company's internal and external value chains. Determine the customer-value proposition and how strong it is. Understand the signi�icance of brand reputation, how strong it is, and how to manage it.

Analyzing and assessing the internal environment of the company is a key part of the strategic-planning process. The recent �inancial performance and current �inancial condition is an obvious place to start using quantitative data with which to reach an objective conclusion. There are also more subjective measures including an examination of a company's competitive strengths and weaknesses, its capabilities, and determining which, if any of them, might be core competencies that would give the company a competitive advantage. The value of a company's brand and the effectiveness of its management are also taken into consideration.

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5.1 Analysis of Financial Performance and Condition

Any analysis of an organization usually begins with careful evaluation of its �inancial position. To assess the recent �inancial performance and current �inancial condition of the company, you need three to �ive years of historical �inancial data—income statements and balance sheets (see box on �inancial statements for generic templates)—including the most recent year for which complete data are available.

Financial statements: Generic templates

Income-statement Balance sheet Total revenues (sales) Assets Cost of goods sold (COGS) Cash & cash equivalents Operating income (gross pro�it) Accounts receivable (A/R) Selling expenses Inventory General & administrative (G&A) Other current assets Earnings before interest & taxes & depreciation & amortization (EBITDA)

Total current assets Total �ixed assets

Depreciation & amortization Total assets Earnings before interest & taxes (EBIT) Total liabilities and stockholders' equity Net interest expense Accounts payable Other expense (income) Accrued liabilities Net income before taxes (NIBT) Other current liabilities Income tax expense Total current liabilities Net income after taxes (NIAT) Long-term debt

Total liabilities Common stock Retained earnings Paid-in capital Other equity Total stockholders' equity Total liabilities and stockholders' equity

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To properly assess the �inancial state of a company, you need three to �ive years of historical �inancial data in the form of income statements and balance sheets.

Igor Mazej/iStock/Thinkstock

Each subtotal in bold is equal to the previous bold subtotal minus the items in between. For example, NIAT = NIBT – income tax expense.

Each subtotal is the sum of elements above it Total assets = current assets + �ixed assets Total liabilities = current liabilities + L-T debt Total assets = total liabilities + stockholders' equity

An annual income statement presents a �inancial picture of a company's operations over the previous 12 months. A balance sheet is a "snapshot" at a point in time (usually at the close of a company's �iscal year) that presents a �inancial picture of its assets and the proportion in which those assets are �inanced through debt and equity. In a balance sheet, the total assets equal the total liabilities (debt) and stockholders' equity—the two sides must "balance."

A convenient way of analyzing several years' worth of �inancial data is to create a spreadsheet and enter the data for each year in a different column (Tables 5.1 and 5.2). Doing so enables annual changes in line items and ratios to be computed. More speci�ically, a thorough analysis of multiyear �inancial statements consists of the following elements (Bangs & Pellecchia, 1999):

Computing all liquidity, activity, leverage, and pro�itability ratios for all years. Computing year-to-year changes for all line items (in both the income statement and balance sheet) and all ratios for all years. Computing average annual changes over all years for line items and �inancial ratios. Computing common-size income statements for all years (everything on the income statement expressed as a percent of revenues). Computing a Z- or Z2-score for each year (Calandro, 2007). This computation involves �inancial ratios (see box on Z- and Z2-scores). Forming a conclusion about how the company has been performing �inancially (from the income statements—revenue and NIAT performance) and about its current �inancial condition (from the balance sheets—�inancial structure, cash �low, degree of debt, liquidity), and its overall �inancial health (Z- or Z2-scores).

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Table 5.1: Multiyear income statements for Net�lix

In $ Thousands 2000 2001 2002 2003 2004

Subscriptions 35,894 74,255 150,818 270,410 500,611

Sales - 1,657 1,988 1,833 5,617

Total Revenues or Sales 35,894 75,912 152,806 272,243 506,228

Cost of Goods Sold 24,861 49,907 78,136 148,360 276,458

Operating Income 11,033 26,005 74,670 123,883 229,770

Operating Expenses 62,511 59,138 78,606 109,826 194,129

General & Administrative 6,990 4,658 6,737 9,585 16,287

Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA)

(58,468) (37,791) (10,673) 4,472 19,354

Depreciation and Amortization - - - - -

Earnings Before Interest & Taxes (EBIT) (58,468) (37,791) (10,673) 4,472 19,354

Interest and other income (1,645) (461) (1,697) (2,457) (2,592)

Interest and other expense 1,451 1,852 11,972 417 170

Net Income Before Taxes (NIBT) (58,274) (39,182) (20,948) 6,512 21,776

Provision for income taxes - - - - -

Net Income After Taxes (NIAT) (58,274) (39,182) (20,948) 6,512 21,595

Source: Maddox, B., & Thompson, A. A., Jr. (2007). Net�lix versus Blockbuster versus Video-on-Demand. A case in Thompson, A. A., Jr., Strickland III, A. J., & Gamble, J. E. (Eds.), Crafting and Executing Strategy: Concepts and Cases (15th ed.; pp. C-148 to C-161). New York, NY: McGraw-Hill.

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Table 5.2: Multiyear balance sheets for Net�lix

2000 2001 2002 2003 2004

Assets

Cash & cash equivalents 14,895 16,131 59,814 89,894 174,461

Short-term investments - - 43,796 45,297 -

Other current assets - 3,421 3,465 3,755 12,885

Total Current Assets 14,895 19,552 107,075 138,946 187,346

Net investment in DVD library - 3,633 9,972 22,238 42,158

Other �ixed assets 37,593 18,445 13,483 14,828 22,289

Total Fixed Assets 37,593 22,078 23,455 37,066 64,447

Total Assets 52,488 41,630 130,530 176,012 251,793

Liabilities & Stockholders' Equity

Liabilities

Current liabilities 16,550 26,208 40,426 63,019 94,910

Total Current Liabilities 16,550 26,208 40,426 63,019 94,910

Notes & sub notes payable 1,843 2,799 - - -

Other LT debt 107,362 103,127 748 285 600

Total Liabilities 125,755 132,134 41,174 63,304 95,510

Stockholders' Equity

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Red. conv. preferred stock 101,830 101,830 - - -

Other equity (175,097) (192,334) 89,356 112,708 156,283

Total Stockholders' Equity (73,267) (90,504) 89,356 112,708 156,283

Total Liabilities & Stockholders' Equity 52,488 41,630 130,530 176,012 251,793

Source: Maddox, B., & Thompson, A. A., Jr. (2007). Net�lix versus Blockbuster versus Video-on-Demand. A case in Thompson, A. A., Jr., Strickland III, A. J., & Gamble, J. E. (Eds.), Crafting and Executing Strategy: Concepts and Cases (15th ed.; pp. C-148 to C-161). New York, NY: McGraw-Hill.

Financial Ratios

Liquidity Ratios

Current ratio (CR) = Current assets / current liabilities

(When this ratio > 1.0, working capital (current assets – current liabilities) is positive, which is desirable.)

Quick ratio (QR) = (Current assets – inventory) / current liabilities

Inventory-to-net-working-capital ratio (INV/NWC) = Inventory / (current assets – current liabilities)

Activity Ratios

Inventory turnover (INV Turns) = Revenues / inventory

Total-asset turnover (TAT) = Revenues / total assets

Average collection period (ACP) (days) = Accounts receivable (A/R) / average daily sales or revenues/365

Leverage Ratios

Debt-to-equity ratio (D/E) = Total liabilities / total equity

(When this ratio > 2.0, debt is too high and needs to be reduced; when it is negative, debt is so high as to exceed the assets of the �irm and cause stockholders' equity to go negative, a serious problem.)

Debt-to-assets ratio (D/A) = Total liabilities / total assets

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(When this ratio > 0.67, debt is too high and needs to be reduced; when > 1.0, debt is so high as to exceed the assets of the �irm and cause stockholders' equity to go negative indicating a serious problem. Either D/E or D/A ratio is used, not both.)

Times interest earned (TIE) or coverage ratio = EBIT / interest expense

(When this ratio < 1.0, the company doesn't have enough money to pay the interest on the debt, a serious condition only experienced with very high debt.)

Pro�itability Ratios

Net pro�it margin (NPM) or Net return on sales (NROS) = Net income after taxes (NIAT) / revenues

Return on equity (ROE) = NIAT / total stockholders' equity

Return on assets (ROA) = NIAT / total assets

Two ratios reveal how productive assets are—TAT and ROA; when these are declining, increasing one's assets is problematical. Cash �low is made up of operational, �inancial, and investing cash �lows; when overall cash is increasing from year to year, cash �low is positive, otherwise it is negative.

Z- and Z2-Scores

Z- and Z2-scores are bankruptcy predictors, or indicators, developed by Edward I. Altman, a professor of �inance at New York University. The

Z-Score is based on data from manufacturing companies, while the Z2-score is based on data for nonmanufacturing companies. Each is a very

important indicator of a company's �inancial health or imminent bankruptcy.

Both indicators take the form of a regression equation:

Z-Score = 1.21X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5

Z2-Score = 6.5X1 + 3.26X2 + 6.72X3 + 1.05X4

Where X1 = Net Working Capital / Total Assets

X2 = Retained Earnings / Total Assets X3 = Earnings Before Interest & Taxes (EBIT) / Total Assets

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X4 = Total Stockholders' Equity / Total Liabilities X5 = Sales / Total Assets

Note that four of the �inancial ratios have total assets in the denominator and the other has total debt in the denominator. Thus, increasing assets through borrowing is not a good idea �inancially (unless performance improves), while one of the �irst things to do when a company is in �inancial trouble is to sell off some assets and use the proceeds to pay down debt. The �inal scores are compared to the following cutoffs to assess their signi�icance:

Criteria Safe Region Gray Region Bankrupt Region

(Financially healthy) (In serious trouble)

Z-Score > 2.99 1.81 – 2.99 < 1.81

Z2-Score > 2.59 1.11 – 2.59 < 1.11

The last step in the analysis is the most important. What sense can be made of the numbers? What picture do they paint of the company's performance over the past several years and current condition? You could draw any one of the following conclusions:

1. The company is very well managed, has been performing extremely well, and is in strong �inancial condition and overall �inancial health (all key indicators are good and none is bad).

2. The company is very well managed, has been performing extremely well, and is in strong �inancial condition and overall �inancial health except for one major bad thing, for example, having very high debt or declining total-asset turnover (a predominance of good indicators with one or possibly two bad ones).

3. The company turned in a mixed performance over this period and is neither performing well nor in serious trouble. The results are, in fact, inconclusive (an equal or roughly equal number of good and bad indicators).

4. The company's performance and �inancial condition is poor and key result indicators were declining steadily (or precipitously) over time; the company is or should be in serious �inancial trouble except for one major good thing, such as increasing revenues (a predominance of bad indicators with one or possibly two good ones).

5. The company's performance is poor, and key result indicators were declining steadily (or precipitously) over time; the company has not been managed well and is in serious �inancial trouble (all indicators of performance and condition are bad and none is good).

After completing the �inancial analysis, only one of the preceding �ive conclusions is possible. Whichever one is selected, it must be supported with selected statistics that summarize the current �inancial performance, condition, and health of the company, or the conclusion isn't valid. Because the principal ways for a company to �inance any strategic initiative are through cash or debt (or in the case of a public company,

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stock), the �inancial analysis provides essential information to top management as to the company's ability to fund a proposed strategy. As an example, an analysis of the �inancial data for Net�lix presented in the multiyear income statement (Table 5.1) and multiyear balance sheets (Table 5.2) produces the conclusion summarized in the following section.

Example of a Financial-Analysis Conclusion

Based on the income statements and balance sheets to 2004, Net�lix has performed very well �inancially, is in strong �inancial condition, and �inancially healthy.

In 2004:

Revenues increased 86% (for the fourth straight year) NIAT increased 231.6% (also for the fourth straight year) Current ratio is 1.97 (good working capital) D/E ratio is 0.61 (low debt, excellent �inancial leverage) Cash �low is positive, and increased 94.1% to $174.46 million.

This conclusion is #1, where all the indicators are good and none are bad. When the conclusion is supported by data—particularly from the most recent year—it becomes hard to refute.

Discussion Questions

1. What can you tell about a company's operations from looking at the past few years of income statements? 2. How much pro�it a company makes after all its expenses are deducted (NIAT) is shown on the income statement. Yet, a company cannot "spend" the pro�its it makes—it can spend only cash, which is a balance-sheet item. How do you explain this?

3. In a balance sheet, total assets must equal or balance total liabilities + total stockholders' equity. In what other ways is this principle of "balancing" useful?

4. In the newspapers, one often reads about companies that are "not managed well �inancially." Given what you have learned in this section (and perhaps in a previous course on �inance), what do you think this means?

5. The Z- and Z2-scores contain similar �inancial ratios as terms in their regression equations. From this, the two scores would go up with increasing working capital, retained earnings, EBIT, equity, and sales, and with decreasing assets and debt. However, all but EBIT and sales are balance-sheet items. Why do you think such bankruptcy indicators focus on balance-sheet items so heavily?

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Evaluating an organization's strengths based on its competitors can provide a more accurate assessment of the organization.

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5.2 Conducting a SWOT Analysis

Once a company has a �irm understanding of where it stands �inancially, the next part of the internal assessment is conducting a SWOT analysis, which stands for a company's strengths, weaknesses, opportunities, and threats. To be sure, opportunities and threats are more appropriately part of an external analysis, but doing a SWOT analysis is so widespread as part of a strategic analysis that they are discussed together here for convenience. As was discussed in Section 3.2, the search for opportunities is an integral part of strategic thinking.

Strengths

Strengths and weaknesses are the "internal" aspects of the traditional SWOT analysis. Whenever something—or someone—is reviewed or assessed, it makes sense to point out the good points or what was done well, as well as the areas that need improvement. They are two sides of the same coin. This assessment is easy to do super�icially, which is often the case, but dif�icult to do candidly and realistically. It is nearly always subjective, but less so if done by a group with multiple perspectives, which is why companies sometimes hire outside consulting �irms to help them analyze their strengths and weaknesses. Regardless of who conducts it, the strength analysis should compare the �irm to itself at some previous point in its history, perhaps 2–4 years ago, and determine what it is doing better and what has not improved.

It might also be useful to think of strengths as special capabilities or expertise. These are things a company does well that have enabled it to be successful to this point, and how it has prepared itself to compete in the future. Comparing a company's strengths against those of its competitors and identifying the industry's critical success factors (Section 4.1) also provides a useful assessment.

Typical strengths that companies have might include the following:

Adequate �inancial resources to implement any likely strategy

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Strong cash �low Strong brand recognition Effective differentiation Effective advertising and promotion Consistent high quality in products/services Effective distribution Economies of scale Insulation from competition Proprietary technology and patents Low-cost leader Product-innovation skills Proven management Visionary CEO, strong leader Productive corporate culture that supports the strategy

The problem is that it can be easy to classify what a company does "well," but what exactly constitutes a "strength"? The answer is subjective; it depends on how high a company's internal standards are and how widely they are shared. For this reason, it should also compare strengths (and weaknesses) with its closest competitors. In assessing whether their company's brand is a strength or a weakness, executives at Wendy's must compare the brand to those of McDonald's and Burger King. Similarly, the athletic apparel offered by Adidas must be compared to the products offered by Nike. Because Wendy's and Adidas are established and successful companies, it is tempting to consider Wendy's and Adidas to possess strengths in terms of brand and apparel. These �irms' standing relative to their closest rivals, however, would suggest that these areas are in fact weaknesses.

Weaknesses

Much like the strengths that a company may possess, weaknesses are also internal. They include problems that need to be corrected, de�iciencies recognized through a comparison with competitors, or de�iciencies relative to proposed strategies such as lacking the resources to grow. Whether or not what is identi�ied is an actual weakness, it is the perception of a weakness that counts.

Some managers have no problem admitting to weaknesses when they are self-evident, while others �ind them hard to own up to in the belief that doing so casts them in a bad light as an ineffective manager. Sometimes, if a company is having problems and the top management team is meeting to discuss them, it is not unheard of for one department to �ind a way of blaming another department for the company's problems. The production manager might blame human resources for inadequate training resulting in low quality. Marketing might complain that engineering and R&D failed to act on its good market intelligence to create new products. Or R&D could complain about a cut in its budget for

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When the top management of struggling companies meets, it is quite common for one department to blame the other for the company's poor performance.

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When Ford Motor Company bought Jaguar, Ford's company executives found multiple weaknesses and wondered how Jaguar had survived.

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something far less important. In all these examples, grappling with weaknesses is not about �inding who is at fault or who is to blame. It is about gaining a realistic understanding of the company's weaknesses so that steps can be taken to alleviate or correct them.

Weaknesses can take many forms, including the following:

Obsolete facilities Key skills and competences missing or obsolete No core competence, hence no competitive advantage Internal operating problems and inef�iciencies Too narrow a product line Long cycle time to get product out Poor marketing skills A culture that hasn't changed

with the strategy Weak or eroding brand image Poor or negative cash �low from operations, including low or negative pro�its, resulting in an inability to service debt or fund needed programs

Weaknesses become real when compared to other companies in the industry. For example, you might think your company has low costs and believe that to be a strength only to discover that your costs are among the highest in the industry. Suddenly, that supposed strength becomes a weakness. A new CEO participating in a SWOT analysis with his or her new management for the �irst time will have a different frame of reference and a different set of standards from the managers, so the CEO might have dif�iculty agreeing with them on what strengths and weaknesses the company has. As noted previously, it is the perception that is important.

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These illustrations show that when making any assessment, even a seemingly casual one like identifying a strength or weakness, you are using an implicit standard or reference in making it. More experienced people will tend to be more critical because they may once have worked in organizations where they have observed things done better, thus raising their own standards. Again, the goal here is not to be "right" at the expense of someone else being "wrong." Rather, it is to reach consensus on what is real and problematic so that it can be attended to and the �irm's future prospects improved.

Opportunities

An analysis of strengths and weaknesses covers what is internal to the �irm, but that is only half the story as it pertains to assessing a company's potential success or failure. In order to stay competitive in an industry, one has to go looking for opportunities that would improve the company's situation.

An opportunity has a speci�ic technical de�inition; it is a product-market issue. It must include a product or service the �irm offers, including the existing ones, and a de�ined customer group at which that product or service is targeted, including the existing ones. The following are examples of real opportunities (and concentration strategies):

Staying with an existing product and existing market and penetrating the market further. Improving the product for an existing market; that is, implementing a product-development strategy. Examples include automobile companies producing new models annually, and software companies releasing upgraded versions of their software. Creating a new product for an existing market, which is also a product-development strategy. Examples include Nike offering athletic apparel in addition to athletic shoes for the same market, Microsoft creating application software for users of its Windows operating system, and Calvin Klein selling perfumes as well as clothes. Expanding the market for an existing product by implementing a market-development strategy, such as promoting the product to appeal to young adults in addition to teenagers or lowering the price so that more people can afford to buy the product. Facebook, for example, has gradually expanded its market from young people to people of all ages. Finding a new market for an existing product, which is another market-development strategy. Examples abound of companies going regional from being just local or a regional company going national or entering a new country, all without changing the product or service. For example, Indian automobile manufacturer Mahindra & Mahindra is planning to start selling pick-up trucks in the United States by 2016 (Hamprecht, 2011).

If a company goes to the trouble of identifying opportunities, it does so only when doing strategic planning, usually once a year. But why not institute and formalize an opportunity-�inding mechanism that would operate all the time, generating ideas and proposals on a continuous basis? This is what is truly meant by "being opportunistic."

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Many companies have instituted new-product-development committees that are responsible for evaluating new-product proposals. For promising proposals, the committee asks for more information or requests a prototype demonstration. Proposals that indicate potential for commercial success are provided with necessary support and development (Cooper, 1993). While such new products could form the basis for a future revenue stream, the probabilities for most companies are distressingly small.

By its very nature, the process can be likened to a funnel, where a large number of items are successively narrowed to a small number: only a few of the many ideas for new projects are researched further, even fewer are found to be feasible, fewer in turn are �inally adopted, and fewer still achieve success. Indeed, many �ields experience a similar, narrowing effect. Consider the example of the game of baseball. Each year more than 2 million youngsters worldwide play on Little League teams, many with dreams of one day making it to the "big leagues." Players who actually reach the minor league level number a few thousand while the active rosters in Major League Baseball include only 750 players.

Contrast such a system to another where the number of ideas vastly increases, and sifting through them becomes a fulltime job for several people. Avenues for involvement include asking customers for suggestions, reaching out beyond engineers to all company employees, and accepting ideas for improvement of all shapes and sizes—not just product innovation. In such an environment, a company can focus on opportunity-recognition, and rejuvenate its revenue model on an ongoing basis.

New technology, or more accurately newer technology brought to market faster, is a rich source of new opportunities. It is a risky business, however, especially when the pace of technological change is very fast. The key thing that separates the good opportunities from the bad ones is how well margins can be maintained over time or how well the resulting product can resist imitation or obsolescence over time. In a hypercompetitive industry, that is dif�icult to accomplish; companies should expect only temporary advantages at best (D'Aveni, 1995).

Change produces both threats and opportunities. Many companies, however, worry only about the threats and do not undertake systematic or frequent enough searches for opportunities. When an opportunity is found, it can take several years to take advantage of it, especially if it requires acquiring and adapting to new technology, understanding a new market, or changing the corporate culture to do it. The earlier it is found the better, thus the search for an opportunity should ideally be ongoing.

Threats

Threats are external to the company. Any "internal" threat is classi�ied as a weakness. Threats are external trends or forces that adversely affect the company. Left unaddressed or even ignored, some threats can wipe out a company. While threats derive from an external- environment scan and analysis, they are discussed here because they are typically included as part of a SWOT analysis. Threats can take many forms:

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Low-cost foreign competition Slower industry growth Costly regulatory requirements Adverse effects of a recession or business cycle Growing bargaining power of customers and suppliers Changing buyer tastes and needs Demographic changes that adversely affect the company Increasing interest rates Raw-material shortages

Implicit in recognizing a threat is the fact that it is a trend moving in a certain direction. Yet at what point—at what value of a trend—does a particular threat become real? For example, companies in the real-estate industry would consider interest rates slowly inching upward as a threat. Or when the price of a critical raw material rises, precisely when does it begin to threaten the company and prompt it to take offsetting action?

One way to deal with this problem is to classify threats on a two-dimensional grid (Figure 5.1). The purpose of doing so is to sort out which threats to pay attention to and do something about, and which to continue monitoring. To plot a threat on the grid you will have to decide on the severity of the likely impact of the threat on the company. Using the preceding interest-rate example, a just-rising interest rate would not have a high negative impact on the company; so it would go into the short-term, low-impact quadrant. However, a fast-rising, high-interest rate would represent a short-term, high-impact threat so would be placed in the upper-right quadrant. It is a judgment call; but again, if done by a group of people, the assessment will be more reliable.

Figure 5.1: Classifying threats grid

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Those threats in the top-left quadrant, that is, having a high negative impact in the short term, should receive priority attention by the company. Those in the top-right and bottom-left quadrants should both receive second priority, with individual threats being handled in appropriate priority order. The least pressing group is that in the bottom-right quadrant, which may need just steady monitoring but no action.

For high-priority threats, a company should begin at once to gather more data about them; assign a committee or task force to track, study, and report on them; and, most importantly, come up with contingency plans for dealing with them. These threats, along with selected threats from the top-right quadrant, should probably be treated as strategic issues.

Discussion Questions

1. Imagine you are part of a top-management team at a strategic-planning meeting. The discussion eventually gets round to listing the organization's strengths and weaknesses. People shout out what they believe are strengths and weaknesses to populate each list. Very seldom is there any discussion that challenges any of the items suggested. What would you suggest to delve a little deeper to ferret out real strengths and weaknesses from those on the list (or even not on the list)?

2. Which carries more weight as a source of strengths: a comparison with the company's own past, its current competitors, or its future strategies? Give reasons for your point of view.

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3. Admitting to shortcomings by people in positions of authority is considered by many to be a sign of weakness or inadequacy. How could such managers be persuaded that it is, in fact, a sign of strength?

4. Is the reluctance to admit mistakes or recognize weaknesses more of an individual failing or an aspect of the prevailing culture? How could this be determined? If the latter, is it easy to change?

5. A company identi�ied "lack of �inancial resources" as a weakness. If this were true only in the event of implementing a certain strategy, then shouldn't the strategy be determined �irst and then the weakness? Or would such a weakness preempt choosing a strategy that required greater �inancial resources? Discuss.

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A company's core competence and competitive advantage have become increasingly important concepts.

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5.3 Core Competence and Competitive Advantage

Core competence and competitive advantage are important concepts in the strategy literature, but the terms are often confused. The following should clarify their meaning:

Capability—the ability to do something (Capability, n.d.); capabilities may or may not be strengths. Core competence—a strategic capability that is simultaneously valuable, rare, costly to imitate, and nonsubstitutable, and one that underpins a company's strategy (Hitt, Ireland, & Hoskisson, 2005). Core competences are the assets and capabilities that can distinguish a company from its rivals. Competitive advantage—a signi�icant edge over competitors. This is often measured in developmental lead time, such as an 18-month lead over the nearest competitor in software. It may otherwise be something an organization can do that competitors can't (e.g., integrate systems ef�iciently) or that an organization has (e.g., patents, a core competence) that competitors lack. Sustainable competitive advantage—the ability to maintain or increase the edge that an organization has over its competitors over time. Given that a competitive advantage erodes over time, sustaining it takes focused effort and considerable resources (Grol, Schoch, & Roger, 1998). It involves "raising the bar" regularly; as soon as a competitor thinks it has caught up, the company in question must have developed something new that maintains the original lead. As Kevin P. Coyne (1986) writes, "The most important condition for sustainability is that existing and potential competitors either cannot or will not take the actions required to close the gap."

Addressing these competencies can allow a company to gain a competitive advantage, and this has been the case for successful companies in various industries. IKEA, a well-known seller of Swedish furniture worldwide, is a prime example of this. When it began operations in the United States in 1985, it used a business model that was unique in the industry. Customers were taken to the top �loor of a large three-story showroom and made to walk a prescribed route through dozens of �inished living room, of�ice, and bedroom, etc. sets, from the third �loor to the second and then to the �irst, where purchases were picked up before paying for them. No matter what the customer came into the store to buy in the �irst place, the idea was to expose the customer to other ideas for every room in the house, thereby selling more. The designs were simple, elegant, and modern, and the prices were low. Also, all furniture was sold unassembled, saving huge costs at the factory and store locations and passing the savings (and delivery and assembly) on to the

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customer. Clearly, the company has grown and is highly successful. Yet no one has been able to duplicate its business model or operations. Its competitive advantages have been sustained.

Case Study Sustainable Competitive Advantage: Southwest Airlines

Southwest Airlines began as a small intrastate operation serving the state of Texas in 1971 with three aircraft (Southwest.com, n.d.). From that limited beginning, Southwest has expanded into the largest airline in the United States (IATA, 2011), �lying to 72 cities in 37 states. While every other major U.S. airline has �iled for bankruptcy protection and consistently reported losses, Southwest has sustained a pro�it for nearly 40 consecutive years. What has made the difference? We have de�ined sustainable competitive advantage as "the ability to maintain or increase the edge that an organization has over its competitors over time." Clearly, Southwest has been able to create and sustain its competitive advantage. Let's take a look at one of the factors that has contributed to this.

Customer Service

By numerous metrics, Southwest Airline's strength appears to exist in its ability to consistently provide superior customer service. According to numerous customer-satisfaction surveys, Southwest ranks �irst among U.S. carriers on customer experience; the airline was ranked #1 by Consumer Reports in 2011 for customer service; and in 2011, MSN Money ranked Southwest in the top ten of all companies for its Customer Service Hall of Fame. In an era marked by high-pro�ile stories of passengers stuck on airport tarmacs in aircraft with no food, beverages, or working bathrooms for many hours and little sympathy from airline personnel (Katrandjian & Schabner, 2011), Southwest has continued to stand out as the airline "with a heart." From small gestures like the continued service of free snacks to the savings afforded passengers by free baggage handling (when all other U.S. carriers are now charging for checked bags), Southwest continues to illustrate that it is a customer- focused operation. Entire websites are dedicated to consumer complaints about major U.S. airlines that range from cancelled and oversold �lights; lost, vandalized, and stolen luggage; to ground holds that approach or exceed federal regulations. Although none of these problems is new to the airline industry (including Southwest), what appears to frustrate passengers the most is the apathetic attitude that airline personnel take toward customer frustration and inconvenience. In other words, the perceived rudeness of airline employees and the feeling

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that passenger problems are "just numbers," often processed by off-shore call centers, contribute to more customer negativity than the original problems themselves. Common customer-service problems that unfold to nightmares for passengers on most airlines are merely inconveniences for Southwest customers who typically leave the negative experiences feeling validated and "whole." When one �light in 2006 was stuck on the tarmac due to deicing delays and a federally mandated crew change, the pilot walked the aisles updating passengers on the delay and accommodations for connecting �lights. Within a few days, passengers received letters of apology and vouchers for the full price of a future trip on the airline (Customer service champs, 2007).

This type of response is standard operating procedure for Southwest—not an anomaly or the charity of one particularly sensitive employee or crewmember—and accounts for a large part of the airline's sustained competitive advantage over other carriers perceived as uncaring about their customers. Customers are even compensated for inconvenience associated with major storm delays—a condition for which no other major airline bears any responsibility. Customer service like this is not an accident; it's a coordinated effort that involves the entire company from top management to the front lines and that is rewarded and valued. Customer service is a way that Southwest Airlines distinguishes itself.

Questions for Critical Thinking and Engagement

1. Although customer service is a well-known and important contributor to Southwest Airline's competitive advantage, it is just one ingredient. Spend some time researching this classic example of a well-managed and well-led organization, and identify other elements that may contribute to its sustained competitive advantage.

2. What perceived barriers prevent other organizations from distinguishing themselves through the kind of service exempli�ied by Southwest?

3. Identify factors contributing to sustained competitive advantage for an organization you are familiar with. What speci�ic strategies does the organization use to continue upping its game and maintaining its edge over its competitors?

4. What role does strategic management play in developing and sustaining competitive advantage? Identify and explain.

McDonald's is another well-known company that has crafted a sustained competitive advantage over time. McDonald's success has been built around providing consistent products in a speedy fashion. Travelers have con�idence that when they enter a McDonald's in Seattle, the Big Mac and French fries that they purchase will taste the same as if they were purchased in Los Angeles or Dallas. Firms such as Burger King have tried to copy McDonald's formula, but no company has been able to duplicate McDonald's success. Importantly, McDonald's executives have been willing to change with the times in order to preserve the �irm's competitive advantage. Although McDonald's business emphasized

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hamburgers and other high-calorie foods for several decades, the company now offers an array of healthy options such as salads and fruit smoothies that appeal to today's customers.

The four criteria that distinguish capabilities from core competencies are related to competitive advantage and �irm performance. Valuable capabilities are those that add or create value for a �irm. Rare capabilities are those possessed by no known current or potential competitor. Costly-to-imitate capabilities are those that other �irms cannot develop easily, quickly, or inexpensively. Nonsubstitutable capabilities are those that do not have strategic equivalents. The owners of certain movie franchises have developed signi�icant competitive advantages by building �ilms around compelling characters that are valuable, rare, costly (and perhaps impossible) to imitate, and nonsubstitutable. The Harry Potter, James Bond, and Star Wars series have all earned more than $4 billion at the box of�ice. Toys, video games, and other complementary products built around these franchises have earned signi�icant revenue too.

The following is a list of typical capabilities:

Design and production skills yielding reliable products Product and design quality Technological capability Integrating different technologies to produce a desired system or product for the customer Swift conversion of technology into new goods and procedures Effective promotion of brand-name products Strong brand (well known, high value) Strong customer service Innovative merchandising Excellent training (Hitt, Ireland, & Hoskisson, 2005)

While these criteria appear straightforward, applying them is dif�icult. Take any of the capabilities in the preceding list, for example, and try to apply these criteria. It may take some research to evaluate them. For �irms without a core competence, or with capabilities that meet two or fewer criteria, the strategic-planning imperative is clear. A company must work to develop a core competence that meets all the criteria and that produces a sustainable competitive advantage. On the downside, a core competence can be outdated by environmental change, replaced by substitution, or eroded through imitation and competitive action. In 2011, American Airlines �iled for bankruptcy protection. Like most airlines, American has struggled to create a competitive advantage. It tried to do so by creating the world's �irst frequent-�lier program to reward repeat customers. Unfortunately, its rivals such as Delta quickly introduced their own frequent-�lier programs. Imitation had prevented American from carving out a competitive advantage in the airline industry.

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Discussion Questions

1. The phrase "competitive advantage" is often tossed around loosely in the business press. CEOs will label seemingly anything they do—whether the training they give their people to how they talk to customers to their prices—a competitive advantage. What might be the motivation for why they do this?

2. The concepts of core competence and sustainable competitive advantages are discussed as part of an internal analysis. Yet without an in-depth knowledge of a �irm's competitors, these concepts cannot be realized. Does this mean that an external analysis should always be done before an internal analysis? Discuss.

3. How many capabilities should be included in a search for a core competence? Explain the number you suggest as your answer.

4. Which of the four criteria for determining a core competence is the most dif�icult to answer? Why? 5. List the ways in which a core competence or competitive advantage can erode. 6. Is it more dif�icult to prevent erosion of an existing core competence or develop a new one?

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5.4 Competitive Strength

How competitive is your company? To �ind out, do an analysis very similar to the one done to assess industry attractiveness, except with different factors (see the illustration shown in Table 5.3). As with the industry-attractiveness matrix, assign a weight to each of these factors according to their perceived importance, then rate each factor from the point of view of the company doing the analysis on a scale of 0–1.0, 1.0 being highest, and �inally multiply the weight by the rating for each factor. Here, the factors should re�lect what it takes to be competitive in an industry. When you have �inished, you will have a resultant competitive-strength (C.S.) index at the bottom. The higher the percentage �igure, the more competitive your company is considered to be in the industry, assuming realistic ratings. (While this technique is also highly subjective, it becomes less so when done by a group of people with knowledge of the company.)

Table 5.3: Competitive-strength matrix

Factor Weight Rating Product

Brand reputation 24 0.9 21.6

Customer service 22 0.9 19.8

Cost control 18 0.9 16.2

Innovative capability 14 0.5 7.0

Financial strength 12 0.8 9.6

Management 10 0.8 8.0

Totals 100 C.S. Index 82.2

In Table 5.3, the competitive-strength (C.S.) index of 82.2 shows that the company being analyzed is a strong competitor, given that the factors meaningfully describe its competitive characteristics.

Both indices are used to place the company on the G.E. Matrix, which plots industry attractiveness against competitive strength (Figure 5.2). Notice that the grid is divided into nine cells. If a company were to end up in any of the three cells in the top-right corner of the grid (pink

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squares), the strategy would be to "grow, invest, and build." If it were to end up in any of the three cells in the bottom-left comer of the grid (blue squares), the strategy would be to "harvest or exit" from the industry. (What else can a weak, uncompetitive company do in an unattractive industry?) The remaining three cells are more dif�icult to assess, and strategies should be developed in these situations on a case-by-case basis. The value of plotting a company on this grid is to get an early "take" on the strategy it should follow. Based on the indexes arrived at for the industry-attractiveness and competitive-strength matrices (Table 5.3), the example company would be plotted in a pink square as shown.

Figure 5.2: G.E. matrix

Is the Current Strategy Working?

First of all, what is the company's current strategy? Once it can be articulated (and there could be more than one—see Section 1.6), three questions should be asked to tell you whether it has been working: (1) Has the company made progress toward achieving, or has it achieved, its vision and strategic intent? (2) Have its stated objectives been attained? (3) Is its �inancial performance and condition good or at least meeting expectations? A public company's stock price depends heavily on this last question.

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In 2011, Net�lix faced a �irestorm of criticism about a new strategy. Net�lix executives announced a plan to split the company's video service into two services. Streaming video would continue to carry the Net�lix name. Customers wishing to rent DVDs, however, would have to subscribe to a new service called Qwikster. After thousands of customers abandoned Net�lix, the company quickly changed course and announced that the services would both remain under the Net�lix banner. But the damage had been done. Net�lix stocked lost 60% of its value between July and October of 2011 (Woo, 2011).

Table 5.4: Questions to challenge the current strategy

Questions about scope Questions about choices Questions about process

What assumptions about market trends, competitor behavior, new entrants, changes in technology and customer needs have you made? If those assumptions were wrong, how would the strategy be affected?

What strategic choices are you making, and what are you rejecting? What is the rationale? Are there circumstances or situations that would cause you to choose differently?

How many customers did you interview? How many noncustomers?

Are there trends that could force you to change the way you do business now?

Are you pursuing growth aggressively enough? Are you compromising growth by failing to provide adequate resources?

How did you involve different markets from around the world?

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If you had to triple your growth, what new business would you enter?

Can you reverse a basic assumption held in the industry? How, and what would be the bene�it?

What approaches did you use to develop creative or breakthrough strategies?

What is the de�inition of the market you are in, and what is the logic behind that de�inition?

How are your plans the same as or different from those of your competitors? How will you ensure that you have a different value proposition? What actions have your competitors taken in the last three years to upset global market dynamics? What are the most dangerous things they could do in the next three years?

Have you committed suf�icient resources to your strategic initiatives? Are they linked to your �inancial and HR plans?

What new uses for your products and technologies have you explored?

What have you done to affect global dynamics over that period, and what are the most effective things you could do in the next three years?

Source: From Sarah Kaplan and Eric D. Beinhocker, The real value of strategic planning. MIT Sloan Management Review, 44(2), 73. Reprinted by permission of MIT Press.

In other cases, whether or not a strategy is working is far less clear. Consider the questions shown in Table 5.4. If you �ind that objectives have not been met, resist jumping to the conclusion that the strategy has not been working. The strategy could be appropriate in the circumstances, but the execution of it may be poor; or the company may have underestimated how quickly the objectives could be achieved. However, if the execution was good, then it is likely that the strategy was not working and should be changed. Also, if the company has been making satisfactory progress toward achieving its vision and strategic intent but not achieving its objectives, it could be that the objectives were set too high or were otherwise unreasonable. And a �inancial review of the past three to �ive years' data could also surface some

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problems. Thus, such a review ought to be done carefully, because what you conclude could set the stage for what strategic alternatives you come up with later in the process.

Discussion Questions

1. The matrix that is used to determine a competitive-strength index, like the one that determines an industry-attractiveness index, is subjective. The �inal result depends on the kind and number of factors used in the analysis, how they are weighted, and how the company itself is rated on each of those factors. Discuss some ways of reducing the amount of subjectivity present.

2. Are there certain factors, independent of industry, that are perennially more important than others? Which ones and why? 3. Why do managers and executives �ind it dif�icult to tell an outsider what strategy a �irm is pursuing? Given that they are able to do so, why are their answers different from each other? How might you address this problem?

4. Should a company's strategies be con�idential? Why or why not? 5. Many strategies don't have core competence as an element; yet having a core competence is central to earning above- industry-average pro�its. How do you reconcile this seeming anomaly?

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5.5 Value-Chain Analysis

A value chain can be described in two ways: (1) within a company, the term encompasses the different value-added phases from buying materials to distributing, selling, and servicing the �inal product (Porter, 1985), and (2) outside of the company, it describes the value-added phases from raw material to end-user as a product is produced and distributed, with each phase representing an industry (Abraham, 2006). For simplicity, these two de�initions will be referred to as "internal" and "external" value chains.

The concept of the internal value chain is critical in the �ield of strategic management and has been well examined. While the concept of the external value chain is less explored, it is equally valuable as it entails elements such as upstream/supply and downstream/distribution processes. While such processes may occur outside the walls of a corporation, they hold many strategic opportunities. Consider the following:

Outsourcing—involves moving speci�ic primary or support functions from the internal value chain to the external value chain. Vertical integration—involves absorbing one or more stages of the external value chain and making them internal. Horizontal expansion—involves developing fresh product lines or broadening channels of distribution, including geographic growth. Strategic alliances with suppliers—involves monitoring external suppliers as if they were part of the internal value chain, while not actually owning them. For example, in Toyota's Kaizen system, key suppliers are based close to a factory and provided with signi�icant guidance and training from Toyota to ensure ef�icient production.

Wayne McPhee and David Wheeler (2006) have extended Porter’s concept of internal value-chain analysis in order to look at value-chain operations outside the realm of the company (Figure 5.3). The �igure shows both Porter's initial concept of an internal value chain and the "external" additions set forth by McPhee and Wheeler, in bold. The introduction of value-chain analysis has proven extremely bene�icial in three key areas: cost analysis and reduction, differentiation, and product development.

Walmart provides a good example of an internal and external value chain (Figures 5.4 and 5.5). Depicting these initial stages is relatively easy. Achieving a full and detailed understanding would be possible by speaking with Walmart executives and monitoring the company’s operations over time.

Figure 5.3: Porter's internal value chain extended

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Source: Wayne McPhee and David Wheeler, "Making the case for the value-added chain," Strategy and Leadership, Vol 24 No. 4 (2008) Exhibit 1.41. Copyright © Emerald Group Publishing Limited. Reprinted by

permission.

Figure 5.4: Walmart's internal value chain

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Tim Boyle/Bloomberg News via Getty Images

Source: David W. Crain and Stan Abraham, "Using value-chain analysis to discover customers' strategic needs," Strategy and Leadership, Vol 36, No. 4 (2008), Exhibit 3, 31. Copyright © Emerald Group Publishing Limited.

Reprinted by permission.

Figure 5.5: Walmart's external value chain

Source: David W. Crain and Stan Abraham, "Using value-chain analysis to discover customers' strategic needs," Strategy and Leadership, Vol 36, No. 4 (2008), Exhibit 3, 31. Copyright © Emerald Group Publishing Limited.

Reprinted by permission.

A more detailed examination of Walmart's internal value chain might illuminate the company's aggressive strategy where technology is concerned (one of the support activities). Walmart was not only the �irst retailer to use bar codes, but it also uses satellite communication between stores. It has integrated its POS, RFID, inventory-control, and additional technologies that serve to decrease delivery time, bolster security (including merchandise shrinkage), and lower costs. It has created regional procurement centers to supplement its well-known center in Bentonville, Arkansas (known as "Vendorville"), including a center near Shenzhen, China. Suppliers base their satellite of�ices near well-placed procurement centers—such as Walmart's

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Walmart's internal value chain includes the latest in technological logistics and regional distribution centers worldwide. Suppliers establish satellite of�ices near these centers to reduce costs.

largest supplier Procter & Gamble, which has 300 fulltime employees in Bentonville. Finally, Walmart's hallmark involves focusing on the complete "customer experience," such as personally welcoming customers as they enter the store, helping to locate items, process returns, and transport purchases to the customer's car (Crain & Abraham, 2008).

Since Walmart is just a retailer and not a manufacturer, its external value chain is quite simple. It works with numerous vendors and sells to customers. But despite this outward simplicity, Walmart's secrets of success lie in analyzing its internal value chain.

Discussion Questions

1. Should value chains be a part of a company's external or internal analysis, or both? Discuss. 2. Porter's Five-Forces Model includes the immediate portion of the company's external value chain (the three horizontal boxes—suppliers, rivals, and buyers). Isn't this enough? Why might doing a more detailed value-chain analysis be more bene�icial?

3. The external value chain has two main aspects: "upstream" of the company (its supply chain) and "downstream" (its distribution system). Of course, if the company is a retailer, there is no downstream part because it sells directly to its customers. Can you think of any situation where the supply chain affects distribution or vice-versa?

4. Can you think of any reason why it might be worth a company's time to analyze any of its suppliers' or customers' value chains?

5. To what extent might pursuing a strategy of low-cost leadership involve a company's internal or external value chain?

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Company brands involve a name, term, design, symbol, or any other feature that identi�ies the product as distinct from other products.

age fotostock/SuperStock

5.6 Brand Reputation, Equity, and Loyalty

The American Marketing Association de�ines a brand as a "name, term, design, symbol, or any other feature that identi�ies one seller's good or service as distinct from those of other sellers" (Brand, n.d.). A brand is also a reputational asset, the result of pursuing a differentiation strategy for a considerable number of years (see Section 3.2) that creates very loyal customers. Unfortunately, as an intangible resource, it remains largely invisible in a company's balance sheet. A major reason why companies' stock-market valuations are higher than their balance-sheet valuations (book value) is the value of their brand (Grant, 2008).

Companies can choose to develop a separate brand for each of their products as in the case of Proctor & Gamble, with its 52 brands of beauty and grooming products and 46 brands of household-care products or, if the same promise covers all products, for the entire company like Sony, Amazon.com, or Apple. Promoting individual brands under brand managers, a system of managing them developed by P&G, is like running separate businesses, each having a budget, target customers, and speci�ic competitors. Promoting the whole company as a brand bene�its its whole product line and means that whatever product a customer buys from that company will be "protected" by the same brand promise.

Brand equity is a measure of the value of a brand and can be computed by taking the price premium attributable to the brand, multiplying it by the brand's annual sales volume over a number of years, and calculating the net present value of this revenue stream (Grant, 2008). Given this formula, it is easy to see how brand equity or strength can erode over time. Either the price

premium or total sales of the brand declines as a result of competition, or because the discount rate used in the net present value computation increases as a re�lection of a more dif�icult business climate in the future.

Not only is there a tangible �inancial reason to have a strong brand but also the effect on its target customers is real. Brand loyalty is customers' repeated preference for either particular branded products or for any product of a branded company (Jones & George, 2007). If rivals in an industry are all branded and enjoy considerable brand loyalty, then new entrants will �ind it a major barrier to entry, requiring huge advertising costs and considerable time to build customer awareness and, �inally, loyalty. Trader Joe's, discussed in Section 3.2, has a

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brand trusted by consumers who have become loyal customers; anything it sells under its own private label is immediately trusted and tried by its customers.

Customer-Value Proposition

A customer-value proposition is a succinct statement summarizing why customers you are targeting should buy from you and not your competitors. The unique value offered includes a mix of elements that could be quantitative (like price or speed of service) or qualitative (like design or customer experience). The stronger or more persuasive the company's customer-value proposition is, the stronger will be its brand and the more loyal its customers.

The following are some possible ways in which a company could create value for its customers (Osterwalder & Pigneur, 2010):

Newness—for example, new technology such as a product that is the �irst of its kind, like the iPad. Performance—in products such as cars, computers, or smartphones. These kinds of customer-value propositions quickly erode because competitors catch up. Customization—including recent trends like mass-customization or tailoring offerings to match customers' needs and time available (Ott, 2010). Reliability—like Rolls-Royce jet engines where the probability of failure has to be zero. Design—hard to measure, products nevertheless succeed because their design appeals to customers. Examples include the iPod and the Aeron chair. Brand/status—from wearing a Rolex watch or driving a Porsche or BMW to wearing a logo T-shirt from your university. Price—although this aspect of a transaction is what the customer sees, it is low costs that companies have to worry about. Anyone can lower prices, but making a pro�it at the same time is more dif�icult. This element of customer value works only with price-sensitive customers (like no-frills Southwest Airlines and Ryanair airfares). Cost-reduction—customers, particularly business customers, will buy products that can help them lower their costs; for instance, if they can realize signi�icant savings for bulk purchases or via a hosted CRM application like salesforce.com. Risk-reduction—the role played by warranties, service guarantees, and return policies. These often make the difference in a purchase decision, contributing to the success of companies like Nordstrom and Costco. Accessibility—being able to access a product or service hitherto inaccessible, like NetJets, enabling customers who could never otherwise afford it rent private jets. Convenience—making it easy to buy and use, like iTunes, or Enterprise rent-a-car, which will pick you up and drop you off when you rent a car.

In conclusion, some major outcomes of a successful differentiation strategy are to enhance a company's brand image, increase its brand equity, create strong brand loyalty, and help the company achieve above-industry-average pro�its. The challenge in assessing brand

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reputation, equity, and loyalty is to get customers' input as well as top management's, and to have in place a system for tracking brand equity and brand loyalty so that they don't erode. It is also impossible to have a strong brand without a compelling customer-value proposition.

Discussion Questions

1. Some companies believe they will retain their "brand leadership" for many years, a dangerous assumption. Increasingly, consumers are �inding it dif�icult to distinguish among competing products. What type of resources are brands? Could a brand ever be the ultimate competitive weapon for a company?

2. Could a brand ever be a company weakness? 3. Customer loyalty is more than just repeat purchases. Do you agree? Why? 4. Enterprise Rent-A-Car asks customers two questions: What is the customer's rental experience, and how likely is the customer to rent from the company again? Are these questions enough, or could you think of others in order to determine the extent of customers' loyalty?

5. What organizational capabilities are needed to develop customer loyalty? 6. To what extent does customer loyalty materially add to the value of a company's brand? 7. Brand identity is how a company wants its customers to perceive the product or company, while brand image is the customer's mental image of the brand. If they are different, how can the company reconcile them?

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Strategic decisions cannot be made without a conclusive assessment of the company's resources and capabilities.

Flirt/SuperStock

5.7 Assessing Management and Leadership

The �inal aspect of a company analysis is an assessment of its management and leadership capability. Section 2.2 discussed the differences between leaders and managers.

One of the most dif�icult imperatives for a company is to develop the next wave of leaders. This is particularly important for companies that are committed to promoting from within. First, they have to have a good talent pool, which means hiring carefully people with leadership potential. Then, there has to be a conscious developmental program of putting these people into challenging situations and cross-functional teams and obtaining feedback about them and their performance from those that see them in action (Fulmer, Stumpf, & Bleak, 2009). Finally, it may be possible to groom certain individuals for speci�ic higher-management positions to ensure smooth succession when the time is right, particularly to C-level and vice-president positions.

Evaluating managers and leaders is never done as part of a strategic-planning process, for obvious reasons. C-level and vice-president executives, middle managers, and supervisors are evaluated individually every year by their immediate superior, direct reports, and any groups they have worked with. The CEO and president are evaluated by the board of directors, usually with input from their direct reports.

The following are some key areas that should be included in any evaluation of a company's leadership:

In what regard do their peers and direct reports hold them? Do they command respect? Are they easy to approach and communicate with? How open are they to new ideas and new ways of doing things? Do they learn from past mistakes or tend to repeat them (Pfeffer, 2008)? What ethical standards and values do they espouse? Are they good role models, leading by example? Do they put a high priority on developing the people they supervise? Are they good motivators? Do the people they develop often get promoted?

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Are they critical and demanding—that is, do they have high standards and espouse ambitious goals? Do they put the organization's goals ahead of their own? Are they empathetic and compassionate?

Discussion Questions

1. Is it possible for a top-management team to do a good job of assessing the state of its own management and leadership? Why or why not?

2. Aside from its value as part of an internal assessment of the company, what other bene�its might accrue from a detailed assessment of the state of management and leadership in the company?

3. Given that the assessment just described is quite detailed, do you believe it should be done annually in every strategic- planning meeting? Biannually? Once every three years? Give reasons for your answers.

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Summary

An internal analysis of a company entails arriving at a shared understanding among the strategic-planning team. An essential �irst step is assessing a company's �inancial performance and condition to see whether the company has any �inancial problems that might impact its ability to fund its strategic initiatives in the near future. This requires an examination of its recent history by way of multiyear income statements and multiyear balance sheets.

Conducting a SWOT analysis takes into account the company's strengths, weaknesses, opportunities, and threats. It's bene�icial to determine strengths and weaknesses compared to the previous year and also with current competitors.

The internal analysis must also include an assessment of the company's breadth of capabilities in an effort to see whether any of them give the company a strategic advantage. Each has to be tested against criteria of being valuable, rare, costly to imitate, and nonsubstitutable (having no strategic equivalent) to be considered a core competence and hence give the company a sustainable competitive advantage. To be a strong competitor in its industry, a core competence is highly desirable. If companies don't have a core competence, they should try to acquire one. If they do have one, they should make great efforts to make sure it doesn't erode.

A value-chain analysis provides knowledge of a �irm's internal primary and support activities. Primary activities depict the process of creating a product or service from raw materials or ideas to �inished product. Value-chain analysis informs decisions whether to outsource any primary activities as well as whether to bring into the company any part of the external value chain (the chain of activities that covers a company's upstream supply chain and its downstream distribution channels).

Brand reputation is the customer's perception of what the company is promising. Dimensions of that are its brand equity, which should be preserved or increased, and how loyal its customers are. This should be assessed for each individual brand or for the brand for the company as a whole. The customer-value proposition is a statement of why customers should buy products or services from the company instead of from its competitors.

The �inal consideration is of the �irm's management and leadership: Is this team experienced and suf�iciently knowledgeable to implement any strategy that might be chosen? Are they properly evaluated every year?

Concept Check

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Key Terms

average collection period (ACP) The average number of days it takes a company to collect money owed to it, calculated by dividing accounts receivable (A/R) by the company's average daily sales (revenues/365).

balance sheet A "snapshot" at a point in time (usually midnight on December 31 or whenever a company's �iscal year ends) that presents a �inancial picture of its assets and the proportion in which those assets are �inanced through debt and equity (prepared according to GAAP).

brand loyalty Customers' repeated preference for either particular branded products or for any product of a branded company.

capability The ability to perform actions; requires both expertise and the capacity to deploy resources.

common-size income statement A computation where every line on the income statement is expressed as a percent of revenues.

coverage ratio See TIE ratio.

current ratio (CR) Current assets divided by current liabilities; a value < 1.0 signi�ies negative working capital.

customer-value proposition A succinct statement summarizing why customers you are targeting should buy from you and not your competitors.

debt-to-assets ratio (D/A) Total liabilities divided by total assets.

debt-to-equity ratio (D/E) Total liabilities divided by total stockholders' equity.

�inancial statements Required of public companies both quarterly and annually, and consist of an income statement, balance sheet, and cash-�low statement, along with notes to the �inancial statements.

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G.E. (General Electric) matrix A two-dimensional diagram of industry attractiveness against competitive strength that forms a guide as to whether to invest and build or harvest and exit an industry.

income statement A �inancial summary of a company's operations over the previous 12 months, prepared according to GAAP.

inventory-to-net-working-capital ratio (INV/NWC) Inventory divided by working capital.

inventory turnover (INV Turns) Total revenues divided by inventory; the larger this ratio is, the better.

outsourcing involves moving speci�ic primary or support functions from the internal value chain to the external value chain.

quick ratio (QR) Current assets minus inventory divided by current liabilities.

return on assets (ROA) NIAT divided by total assets.

strengths Strengths are special capabilities or expertise, things a company does well that has enabled it to be successful to this point, and how it has prepared itself to compete in the future. Comparing a company's strengths against competitors' provides a more realistic assessment of them.

sustainable competitive advantage The key condition for sustainability is a state in which current and potential competitors either cannot or will not take steps to close the (advantage) gap.

times interest earned (TIE) ratio Earnings before interest and taxes (EBIT) divided by interest expense; if this value < 1.0, it means that the company doesn't have enough money even to pay the interest owed on the debt it has.

total asset turnover (TAT) Total revenues divided by total assets.

vertical integration involves absorbing one or more stages of the external value chain and making them internal.

weaknesses Weaknesses are internal. They include problems that need to be corrected, de�iciencies recognized through a comparison with competitors, or de�iciencies relative to proposed strategies (e.g., not enough resources to grow).

Z-Score A bankruptcy indicator for manufacturing companies.

Z2-Score A bankruptcy indicator for nonmanufacturing companies.

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