Strategic Management: Theory and Practice · TOWS, the SWOT analysis also helps uncover strengths...

Strategic Management: Theory andPractice

Strategy Formulation

Contributors: By: John A. Parnell

Book Title: Strategic Management: Theory and Practice

Chapter Title: "Strategy Formulation"

Pub. Date: 2014

Access Date: March 7, 2018

Publishing Company: SAGE Publications, Ltd

City: 55 City Road

Print ISBN: 9781452234984

Online ISBN: 9781506374598

DOI: http://dx.doi.org/10.4135/9781506374598.n9

Print pages: 246-269

©2014 SAGE Publications, Ltd. All Rights Reserved.

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the online version will vary from the pagination of the print book.

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Strategy Formulation

Chapter Outline

Strengths and Weaknesses

Human ResourcesBoard of Directors

Top Management

Middle Management, Supervisors, and Employees

Organizational Resources

Physical Resources

Opportunities and Threats

The SW/OT Matrix

Issues in Strategy FormulationEvaluating Strategic Change

Strategy, Corporate Social Responsibility, and Managerial Ethics

Effects on Organizational Resources

Anticipated Responses From Competitors and Customers

Summary

Key Terms

Review Questions and Exercises

Practice Quiz

Student Study Site

Notes

This chapter marks a shift from analysis toward recommendations. Reconsidering the firm'scurrent strategic initiatives is the first step in evaluating its activities and thinking about what

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the firm should be doing.

After the firm's mission and ongoing strategic directions are well understood, the organizationcan begin to craft a strategy. The first step in this process, a SWOT (strengths, weaknesses,opportunities, and threats) analysis, enables top managers to position the firm to takeadvantage of select opportunities in the environment while avoiding or minimizing

environmental threats.1. In doing so, the organization attempts to emphasize its strengths andmoderate the potential negative consequences of its weaknesses. Sometimes referred to asTOWS, the SWOT analysis also helps uncover strengths that have not yet been fully utilizedand identify weaknesses that can be corrected. Matching information about the environmentwith knowledge of the organization's capabilities enables management to formulate realistic

strategies for attaining its goals.2.




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Strengths and Weaknesses

The first two elements of the SWOT analysis—strengths and weaknesses—represent internalfirm attributes. In addition, a firm's strengths and weaknesses are considered relative to keycompetitors in its industry. In other words, customer loyalty would be viewed as a strength orweakness for an organization if it is more pronounced in that firm than in most others in theindustry. Hence, strengths can be viewed as artifacts of past success in an organizationwhereas weaknesses can be seen as gaps between an organization's current position and theindustry norm. As an extension of this logic, the notion of gap analysis seeks to identify thedistance between a firm's current position and its desired position with regard to an internalweakness. When possible, a firm should take action to close the gap—especially when thegap leaves a firm vulnerable to external threats in its environment. Simply closingperformance gaps is not sufficient, however. Strategic decisions should accentuatecompetitive advantage, not just seek to match rivals or industry norms.

The value chain is also a useful concept for analyzing a firm's strengths and weaknessesand understanding how they might translate into competitive advantage or disadvantage. Thevalue chain describes the activities that comprise the economic performance and capabilitiesof the firm. The organization is viewed as an intermediary that systemically transforms low-value inputs into high-value outputs. Specifically, the value chain identifies primary andsupport activities that create value for customers. Primary activities in the chain includeinbound logistics, operations, outbound logistics, marketing, and service. Support activitiesinclude the firm infrastructure, human resources management (HRM), technology, andprocurement. Each of these activities plays a role in the transformation and can be evaluated

in terms of effectiveness and efficiency, ultimately connoting strengths and weaknesses.3.

By considering all of the firm's processes from the procurement of raw materials to thedelivery of a final product and/or service, strategic managers can identify discrete activitiesperformed along the way that may add exceptional value to the end product or detract from it.For example, in March 2002, after a gradual decline in travel agency commissions throughoutthe industry, Delta Airlines announced an end to most of the commissions it pays to travelagents. With Delta's ability to trim sales costs through direct selling, airline executives nolonger believed that domestic travel agents were adding sufficient value to justify the

expense.4. Other major airlines followed suit, and by the late 2000s, all major airlines wereutilizing their Internet sites to provide the sales and support services traditionally provided bythird-party travel agencies. Today, firms like Orbitz, Travelocity, and the remaining traditionaltravel agencies have found other ways to add value, such as emphasizing tour packages,online search features, personal service, convenience, or hotel-car-airline packages.

There are three broad categories of firm resources that form the foundation for firm strengthsand weaknesses:

Human resources: The experience, capabilities, knowledge, skills, and judgment of allthe firm's employeesOrganizational resources: The firm's systems and processes, including its strategies atvarious levels, structure, and culturePhysical resources: Plant and equipment, geographic locations, access to rawmaterials, distribution network, and technology.

Each resource category is discussed in greater detail next.




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Human Resources

The most attractive organizational and physical resources are useless without a competentworkforce of managers and employees. A firm's human resources (HR) can be examined atthree levels: (1) the board of directors; (2) top management; and (3) middle management,supervisors, and employees.

Board of Directors

Because board members are becoming increasingly involved in corporate affairs, they canmaterially influence the firm's effectiveness. In examining strengths and weaknesses theybring to the firm, one should consider the following issues:

Prospective contributions of corporate board members: Strong board members possessconsiderable experience, knowledge, and judgment, as well as valuable outsidepolitical connections.Tenure (experience) as members of the corporate board: Long-term stability enablesboard members to gain organizational knowledge, but some turnover is beneficialbecause new members often bring a fresh perspective to strategic issues.Connection to the firm (i.e., internal or external) and ability to represent variousstakeholders: Although it is common for several top managers to be board members, adisproportionate representation of them diminishes the identity of the board as a groupapart from top management. Ideally, board members should represent diversestakeholders, including minorities, creditors, customers, and the local community. Adiverse board membership can contribute to the health of the firm.

Top Management

Three issues should be considered relative to the strengths and weaknesses of any firm's topmanagement.

Backgrounds and capabilities of top managers: Comprehending their strengths andweaknesses in experience, managerial style, decision-making capability, and teambuilding is useful. Although having executives who have an extensive knowledge of thefirm and its industry can be advantageous, managers from diverse and complementarybackgrounds may generate innovative strategic ideas. In addition, an organization'smanagement needs may change as the firm grows and matures. Because firms areoften started by innovative entrepreneurs who happen to be poor administrators, theyoften add key administrators to the top management team, which includes the group oftop-level executives—headed by the chief executive officer (CEO)—all of whom playinstrumental roles in the strategic management process.Tenure (experience) as members of top management: Although lengthy tenure canmean consistent and stable strategy development and implementation, low turnovermay breed conformity, complacency, and a failure to explore new opportunities. CEOturnover is even desirable when the firm is unable to meet its performance targets.Strengths and weaknesses of individual top managers: Some executives may excel instrategy formulation, for instance, but be weak in implementation. Some may spendconsiderable time on internal stakeholders and operations whereas others mayconcentrate on external constituents. As with the board of directors, it is helpful for




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board members to possess complementary skills to function well as a team. In addition,a number of large companies offer financial incentives to sign and retain top executiveswith knowledge critical to the firm.

Middle Management, Supervisors, and Employees

Even the best strategies will fail without a talented workforce to implement them. A firm'spersonnel and their knowledge, abilities, commitment, and performance tend to reflect thefirm's human resource programs. These factors can be explored by considering five keyissues:

Existence of a comprehensive human resource planning program: Developing such aprogram requires that the firm forecast its personnel needs, including types of positionsand requisite qualifications, for the next several years based on its strategic plan.Strategically relevant knowledge or expertise possessed by members of the firm: Manyfirms place a great emphasis on retaining high-quality individuals in a number of areas,such as research and development (R & D) or sales. This is a critical issue when a firmis heavily involved in global competition. Interestingly, all companies claim to have thebest workforce, but clearly this is not the case.Emphasis on training and development: Some firms view training and development as astrategic issue and seek long-term benefits from its training programs. In contrast,other firms view training as a short-term necessity and emphasize cost minimization intheir programs.Turnover: High turnover relative to levels among close competitors generally reflectspersonnel problems, such as poor management-employee relations, low compensationor benefits, or low job satisfaction due to other causes.Emphasis on effective performance appraisal (PA): Progressive firms utilize PA toprovide accurate feedback to managers and employees, link rewards to actualperformance, and show managers and employees how to improve performance, as wellas comply with all equal employment opportunity requirements. Firms that do notadequately appraise high performers—and reward them—are more likely to lose them.

Organizational Resources

The alignment between organizational resources and business strategy is critical for long-term success. In this regard, seven key issues are noteworthy:

Consistency among corporate, business, and functional strategies: To facilitate strategyintegration, managers at the corporate, business unit, and functional level should berepresented at each level of strategic planning. The strategy at each level shouldinfluence and be influenced by the strategy at the other levels.Consistency between organizational strategies and the firm's mission and goals: Themission, goals, and strategies must be compatible and integrated to reflect a clearsense of identity and purpose for the organization.Consistency between the firm's strategies and its culture: For a strategy to be effective,it must be supported by an organizational culture that emphasizes values that supportit.Consistency between the firm's strategies and its structure: It is important to note anystructural changes that might be required should the organization seek to implement amajor change in strategy.




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Position in the industry: All things equal, firms that possess strong market positions arein a better position to implement strategic changes than those in weak positions. Forfirms operating globally, this assessment must be made in the various nations in whichthe firm operates.Product and service quality: It is important to comprehend how quality levels of thefirm's products and services compare with those of rival firms.Reputation of the firm and/or brand: Many firms have established reputations for factorssuch as high quality and customer service. Recent surveys have identified a number ofstrong brands such as Coca-Cola, McDonald's, Apple, Starbucks, and Google. TheToyota brand lost considerable value after the brake crisis in 2009 and 2010, but

appeared to recover well in 2011 and 2012.5.

Physical Resources

Physical resources can differ considerably from one organization to another, even amongclose competitors. For example, Amazon.com requires different physical plants than aconsulting firm. Nonetheless, five issues concerning the strengths and weaknesses ofphysical resources should be considered:

Currency of technology: All things equal, competitors with superior technology and theability to use it have a decided competitive advantage in the marketplace. This isespecially true in global markets and should be assessed in each of the nations inwhich the firm operates.Quality and sophistication of distribution network: Distribution networks apply to bothmanufacturing and service concerns. American Airlines’ domination of passenger gatesat Dallas/Fort Worth Airport and Delta's similar control in Atlanta give both of theseservice companies a competitive advantage.Production capacity: A continual backlog of orders may indicate a growing marketacceptance of a firm's product, or it may depict serious problems associated withinsufficient capacity. A firm can expand its capacity by increasing production shifts orobtaining additional facilities, but such measures can be costly.Reliable access to cost-effective sources of supplies: Suppliers who are unreliable, lackeffective quality control programs, or cannot control their costs well do not foster acompetitive advantage for the buying firm.Favorable location(s): Ideally, the organization should be located where skilled labor,suppliers, and customers are readily accessible.

In an optimal setting, all three types of resources work together to provide the firm with acompetitive advantage that can be sustained. Following the resource-based perspectiveintroduced in Chapter 1, firm success depends primarily on the combination of resources itpossesses The VRIO (valuable, rare, imitable, and organization) framework helps strategicmanagers evaluate the competitive quality of the resources controlled by the organization on

the basis of four progressive characteristics:6.

Valuable: Can the resource be employed to exploit an opportunity or neutralize anexternal threat? Resources that are merely valuable can assist the firm in attainingcompetitive parity with rivals but not competitive advantage.Rare: Is the resource controlled by a relatively small number of individuals or firms?Resources that are both valuable and rare can produce temporary competitiveadvantage. This is worthwhile, but a resource's scarcity tends to erode over time.



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Imitable: Can other firms easily imitate or acquire the resource? If rivals cannot imitateor acquire a valuable and rare resource, then a firm has the potential for achieving andmaintaining competitive advantage over the long term.Organization: Is the firm poised to exploit the resource? Firms that are able to leveragevaluable, rare, and inimitable resources can attain sustained competitive advantage.While firm resources—both tangible and intangible—ultimately constitute the firm'sstrengths and weaknesses, merely possessing a resource does not always benefit theorganization. Resources are translated into desired results by a firm's capabilities, its

skills at coordinating and leveraging resources to create value.7.

Table 9.1 VRIO Framework8.

ResourceCharacteristic

Definition Implication

Valuable

Can be employed to exploitan opportunity or neutralizea threat

If only valuable, then there is only parity with rivals.There is no competitive advantage.

RareControlled by one or a fewentities

If only valuable and rare, competitive advantageexists but is likely to be temporary.

Inimitable

Costly for rivals to duplicateIf valuable, rare, and inimitable, the firm has thepotential for long-term competitive advantage.

Organization

The firm possesses theappropriate capabilities toleverage the resource

If valuable, rare and inimitable, and if the firm has theappropriate capabilities, then sustainable competitiveadvantage can be achieved.

Capabilities are essential if valuable, inimitable, and rare resources are to be effectivelyemployed. The ability to manage supply chains, adjust pricing, and execute flexibleproduction represent a few capabilities Toyota has leveraged during the past two decades.Although resources and capabilities are sometimes used interchangeably in the popular pressand both can represent strengths or weaknesses, the distinction between the two concepts is

an important one.9.

The unique combination of a firm's human, organizational, and physical resources— astransformed into capabilities—should be emphasized in its strategy. As the firm acquiresadditional resources, unique synergies occur between its new and existing resources.Because each firm possesses its own distinct combination of resources, the particular types ofsynergies that occur will differ from one firm to another. Leveraging these synergies intosustained competitive advantages is a key task of top management (see Case Analysis 9.1).

Case Analysis 9.1 Step 16: What Strengths Exist for the Organization?

Step 17: What Weaknesses Exist for the Organization?




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Resources and strategic capabilities are the foundation for a firm's internal strengthsand weaknesses. The VRIO framework should be employed to evaluate the competitivequality of firm resources. The organization's strengths and weaknesses should benumbered, each with as much depth and justification as possible. Many possibleorganizational strengths and weaknesses can emanate from its resource base,including (but not limited to) the following:

Brand names and recognition

Company reputation

Control systems

Costs (internal)

Customer loyalty

Decision making

Distribution

Economies of scale

Environmental scanning

Executive leadership

Financial resources

Forecasting

Government lobbying

HR

Information systems and technology

Internet presence

Labor relations

Location

Logistics and inventory management

Manufacturing and operations

Market share

Organizational structure

Physical facilities and equipment

Product/service differentiation




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Product/service quality

Promotion and advertising

Public relations

Purchasing and channel management

Quality control

R & D

Sales

Strategic capabilities

Technology and patents

The previous list includes examples of strengths and weaknesses, but there are manyothers. To set the stage for the remainder of the analysis, it is important to state clearlyhow each strength has benefited the organization and how each weakness hashindered it. In many instances, the strengths are the primary catalysts for theorganization's successes, and its weaknesses are the main reasons why it has failed incertain endeavors.

There is no set target for the number of strengths or weaknesses that should beidentified in a case analysis. When only several are identified, however, it is likely thatthe effort is not thorough. When the list becomes too long-as would be the case if all ofthe items in the previous list happened to be associated with strengths and/orweaknesses-it becomes cumbersome to manage in the remaining steps of theanalysis. In this situation, it is necessary to consider pooling several items into a singleone whenever feasible. For example, “expertise in advertising” and “a strong salesforce” could be merged into a single item entitled “marketing expertise.”

Opportunities and Threats

The last two elements of the SWOT analysis—opportunities and threats—are associated withfactors outside the organization. As such, they must emanate from the earlier analyses of theindustry and the macroenvironment (i.e., PEST, or political-legal, economic, social, andtechnological forces). Although an industry-level analysis may identify general factors, thisstage shifts to the firm level and considers how the external forces could affect theorganization under consideration. For example, an analysis of the social forces affectinginvestment houses may identify consumer acceptance of the Internet as a social forceaffecting the industry. Considering online broker TD Ameritrade, this force may be translatedinto both opportunities (e.g., a growing market of potential online investors who are stillutilizing traditional brokers) and threats (e.g., intense competition from the myriad of Internetsources that may erode the loyalty of current customers to Ameritrade offerings).

External opportunities and threats must not be confused with internal strengths andweaknesses. Factors associated with the firm such as a poor financial position, an ineffective




marketing strategy, or a strong brand image are internal factors and therefore must beclassified as strengths or weaknesses. In contrast, factors outside the firm such asdemographic changes, competitive threats, or recent legislation are external factors andtherefore must be classified as opportunities or threats. At the international level, a number ofexternal factors should be considered as prospective opportunities and threats, including thecyclical or seasonal nature of the industry in which the firm operates, as well as the intensityof global competition.

It is also critical to distinguish between opportunities and alternatives, although the distinctioncan sometimes appear to be one of semantics. Opportunities represent the application offorces in the external environment to a specific organization. Alternatives emanate from theSW/OT matrix (discussed later) and represent specific courses of action that the organizationmay choose to pursue. The two are related but must be distinguished. For example,increasing societal interest in Cajun food may present an opportunity for a restaurant. Whenevaluated in the SW/OT matrix relative to internal factors such as the company's existinglocations in Louisiana and its strong reputation for innovative cuisine, this opportunity maylead to an alternative for the company to consider, such as introducing a new line of Cajunofferings (see Case Analysis 9.2).

Case Analysis 9.2 Step 18: What Opportunities Exist for the Organization?

Step 19: What Threats Exist for the Organization?

In the SWOT analysis, one must not only identify strengths and weaknesses but mustalso translate the analysis of the macroenvironment and industry into opportunities andthreats. Although these issues will have been addressed at the industry level earlier inthe analysis, they should be integrated into a discussion that highlights specificallyhow they present opportunities to or threaten the organization. For example, if it waspreviously noted that the industry rises and falls abruptly with economic conditions,then the prospects of a recession may pose a major threat for the firm. If it was notedthat technological advances have not yet been incorporated into production processesin the industry, then application of this technology may become an opportunity worthconsidering for the organization.

There is no set target for the number of opportunities or threats that should beidentified. When only several in each category are identified, however, it is likely thatthe analysis is superficial and key issues have not been included.

The SW/OT Matrix

After the SWOT analysis is completed, alternative courses of action may be analyzed by

creating a SW/OT matrix.10. The SW/OT matrix extends the SWOT analysis by using it as atool for generating strategic alternatives for the firm. This is why it is critical that externalopportunities not be confused with alternative courses of action. Prospective strategic optionsfor the firm emanate from the SW/OT matrix.




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A SW/OT matrix is created with strengths and weaknesses listed vertically on the left side andopportunities and threats listed across the top. Alternatives emerge from the combination ofone or more strengths/weaknesses from the left side of the matrix with one or moreopportunities/threats from the top. For example, a company that can develop and producehigh-quality electronic products in a short period of time—a strength—could take advantageof an increased consumer interest in smartphones—an opportunity—by developing andmarketing one, a strategic alternative. This does not mean that the company shouldnecessarily pursue such a strategy but merely that the alternative warrants furtherconsideration. The SW/OT matrix is a systematic means of developing strategic alternativesavailable to the organization, but it also requires brainstorming and creative skills as well. TheSW/OT matrix helps top managers position a firm in its environment so that it leverages itsstrengths while minimizing the detrimental effects of its weaknesses.

In general, four categories of alternatives emerge from the SW/OT matrix, each representingthe combination of one or more strengths or weaknesses with one or more opportunities orthreats:

Strength-Opportunity: These “offensive” alternatives tend to be the most common andinvolve utilizing an organizational strength to address an opportunity. In the late 2000s,Canadian donut shop Tim Horton's began a campaign to expand rapidly into U.S.

markets.11. Tim Horton was leveraging a strength—its success and strong track recordin Canada—to pursue an opportunity: increasing demand for donut shops in borderingstates. At the same time, Honda utilized two strengths: (1) a combination of motorcyclequality and (2) affordability along with a strong partnership with an Indian manufacturer—to capitalize on an opportunity—increasing disposable income and demand foreconomical transportation in India—to produce and sell more than 4 mil l ionmotorcycles and scooters in India, accounting for more than one-half of the nation's

market share.12.

Weakness-Threat: These “defensive” alternatives involve taking some corrective action




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to eliminate or minimize a weakness so as to minimize the effect of a threat. If an airlinewith an aging, fuel-inefficient fleet (a weakness) is facing the prospects of a substantialincrease in the price of fuel (a threat), it may consider a weakness-threat alternativesuch as consolidating flights or upgrading its airplanes to newer, more efficient models.Strength-Threat: These alternatives involve utilizing a strength to eliminate or minimizethe effect of a threat. Strength-threat alternatives may be offensive or defensive.Suppose a manufacturer with a strong track record of innovation (a strength) is facingthe prospects of increased consumer scrutiny and government regulation of itsproducts because of ecological concerns (a threat). This firm may consider a strength-threat alternative such as a product redesign to address the changing needs of themarketplace and regulatory environment ahead of its rivals.Weakness-Opportunity: These alternatives involve shoring up a weakness so that theorganization can take advantage of an opportunity and may be offensive or defensive.Borders bet on a brick-and-mortar strategy in the early 2000s but changed course in

2008 because of continued growth in online sales.13. Borders sought to overcome aweakness—a lack of a branded e-commerce site—by pursuing an opportunity, growthin the Internet segment. Borders’ action was too late, however, as the companyliquidated in 2011. Motorcycle icon Harley-Davidson, suffering from a 35% decline inU.S. retail sales, opted to join Honda and sought to take advantage of prospects forrapid growth in the Indian market. Unlike Honda, however, Harley is pursuing the mostaffluent Indian consumers with a line of motorcycles starting at more than $15,000,

more than 15 times the average annual salary.14. The ultimate success of Harley-Davidson's strategy remains to be seen.

Typically, most of the individual internal-external combinations (i.e., matches betweenstrengths/weaknesses and opportunities/threats) will not produce viable alternatives. Further,several different combinations of internal and external factors can produce the samealternative. Some of the alternatives that emerge might be eliminated from furtherconsideration for obvious reasons (e.g., taking the action would be illegal). In addition, a givenSW/OT matrix might generate a large number of alternatives in a particular category whereasonly a few may be generated in other categories. Emphasis should be placed on the specificalternatives, not the four categories of alternatives. Once generated, strategic alternativesshould be analyzed further.

Figure 9.2 provides a simplified example of a SW/OT matrix for McDonald's. Assume that theSWOT analysis for McDonald's identified strengths of financial stability, brand recognition,and a strong ability to produce consistent products throughout the world. Two weaknesseswere identified as well: (1) a reputation for lackluster taste and (2) a heavy dependence onfried foods. There were two key opportunities: (1) economic growth in emerging economiesand (2) the increasing health consciousness in the United States and other global markets.Two threats were highlighted as well, including the global economic downturn and theincreasing popularity of easy-to-prepare microwaveable foods. A thorough SWOT analysis forMcDonald's would develop many more than two or three factors in each category in oursimple example. Nonetheless, the number and complexity of the factors are kept to aminimum in this example so that the process of developing alternatives can be clearlyillustrated.

Figure 9.2 A Simple SW/OT Matrix for McDonald's

OpportunitiesThreats




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Growth in emergingeconomiesIncreasing healthconsciousness in U.S. andother markets

Global economic downturnGrowing popularity of easy-toprepare items in grocerystores

Strengths

Financialstability andresourcesBrand nameand recognitionConsistency inoperations

Alternative 1: Launch new locations in BRIC (Brazil, Russia, India,and China) nations (S1, S2, O1)Alternative 2: Expand healthier food alternatives (W1, W2, O2)Alternative 3: Launch foods in grocery outlets (S2, S3, T2)Weaknesses

Reputation forbland-tastingfast foodDependence onfried foods

Following the example, three possible alternative courses of action can be identified forfurther consideration. First, McDonald's could emphasize its financial and brand strengthsand seize an emerging market opportunity by expanding aggressively into the rapidly growingBRIC (Brazil, Russia, India, and China) nations. Other nations (e.g., Mexico, South Africa)could also be considered as part of the alternative, but this example assumes that industryand/or external environment assessments highlighted specific advantages of the BRICnations.

Second, McDonald's could address its weaknesses of declining market share anddependence on fast food and capitalize on increasing health awareness in the United Statesand other parts of the world by expanding its offerings of healthier foods such as grilledchicken and salads. McDonald's has moved in this direction in recent years, but most of itsrevenues are still derived from traditional fried foods (e.g., hamburgers, french fries), softdrinks, and the like.

Third, McDonald's could emphasize its brand name and consistency strengths and addressthe threat of increased popularity of easy-to-prepare grocery items by introducing its own lineof grocery products. Other fast-food and fast casual restaurants such as Taco Bell and T.G.I.Fridays have introduced products in grocery stores, and White Castle even distributes itfamous hamburgers, known as “sliders,” in microwave-ready form.

This simple example considers only a few hypothetical items in each of the SWOT categories,suggests only three prospective alternatives, and does not suggest that McDonald's shouldnecessarily adopt any of them. Continuing to implement the current strategy in its presentform—the so-called “no change” option—should be considered. This alternative—denoted asthe final option in the previous example—should be analyzed as critically as the other ones.




Selecting the “no change” alternative should not be considered as a low-risk option becauseresisting change may be just as likely to expose a firm to great danger as embracing it.

The strategic alternatives should also be presented in the strategy level-strategy complexity(SLSC) matrix. The SLSC matrix compares and contrasts the alternatives on the basis ofstrategy level—corporate, business, or functional—and strategy complexity—the extent towhich executing the strategy would require substantial change, resources, and uncertainty.All things equal, the lower the strategy level (i.e., closer to functional level) and the lesscomplex the strategy, the easier it will be to execute. Alternatively, the higher the strategy leveland the more complex the strategy, the more difficult execution is likely to be. For this reason,implementing multiple high level, complex strategies is usually not advisable.

Figure 9.3 applies the SLSC matrix to the McDonald's example. Each of the alternativesexcept the “no change” option appears in the matrix. Although most alternatives influenceeach strategy level to some extent, developing and emphasizing more healthy foods is largelya functional strategy concern most closely associated with production and marketing. Incontrast, launching new locations is associated with corporate growth and involves all of thecomplexities of global operations. Emphasizing frozen foods in grocery outlets involves bothfunctional (e.g., production and distribution) and business level strategy changes. Relativelyspeaking, developing a new distribution channel and producing a line of frozen food might beviewed as a moderately complex endeavor. In this example, the SLSC enables the decisionmaker to examine the strategies available to the firm in terms of resources required forexecution.

Figure 9.3 Strategy Level-Strategy Complexity Matrix for McDonald's

Evaluating the pros and cons of strategic alternatives in a detailed, objective, and thoroughmanner is critical. In some instances, a logistical problem can pose a serious challenge to analternative. When automakers began to develop electric cars in the late 2000s, the need forready access to inexpensive, plentiful electricity had not been fully addressed. If driverscharge their cars at night when electricity demand is low, utility companies will enjoy greaterrevenues without necessarily having to add capacity. However, if drivers charge their carsduring the day when electricity demand is high, utilities will be faced with a capacity problem

and rates will likely rise.15. Given the high demand for electric cars at the time, this potentialdrawback would not be sufficient to preclude the alternative from consideration. The potentialproblem and possible solutions should be seriously considered when evaluating the




alternative, however.

Problems with implementation can often be traced to the lack of a thorough evaluation of thestrategic alternatives available to a firm (see Case Analysis 9.3). For example, it is easy toassume that well-known brands will be readily accepted in new markets or that competitorswill not respond effectively to major strategic changes. Even major retailers, however, can find

themselves battling stiff local competition when they expand abroad.16.

Case Analysis 9.3 Step 20: What Strategic Alternatives Are Available to the Organization?

Alternatives are organizational courses of action that (1) are worth considering becausethey offer some potentially positive benefits and (2) are within the realm of possibilitiesfor the organization. For starters, one alternative is to continue with the presentstrategy. Sometimes this alternative is the most desirable, but typically some changesare needed. Additional alternatives should be identified from the SW/OT matrix in twoways. First, one should consider more fully utilizing one's strengths to take advantageof existing opportunities or palliate threats if the organization is not presently doing so.For example, if an organization has excess production capacity and there exists amarket not presently served, then moving into this market is worth considering.Second, one should also consider taking action to minimize the weaknesses so thatthe organization can pursue opportunities or minimize the effect of threats. It is criticalto identify the S/W-O/T combinations that result in the identification of each alternative,but it is not worthwhile to include alternatives that are obviously implausible orunattractive (e.g., McDonald's could close its fast-food stores to concentrate onpromoting frozen foods through grocery outlets) for the sake of creating a list. All of thealternatives to be considered should be deemed viable upon cursory examination.Alternatives should also be plotted in the SLSC matrix.

There is no set number of alternatives that should be generated. As with theidentification of elements within the SWOT, too few alternatives imply a superficialanalysis whereas too many alternatives can become difficult to assess.

Step 21: What Are the Pros and Cons of These Alternatives?

Some of the alternatives identified in Step 20 may be mutually exclusive whereasothers may not. Inevitably, one must assess the attractiveness of each alternative. It isnot appropriate to subjectively promote one or two that will be recommended later.Rather, pros and cons must be objectively identified for each alternative. Evenattractive alternatives have costs and downsides, and others may have limitedprospects for success-factors that should be converted to dollars whenever possible.For example, quality circles may be proposed as a solution to low morale withoutconsidering the costs. Quality circles require a commitment of time (i.e., lostproduction) and effort if they are to be successful, and management must also bewilling to implement suggestions. In the final analysis, quality circles may be desirable,but no strategy can be implemented cost-free.




Interestingly, the quality circles recommendation also has another problem. Mostscholars and practitioners have reported that quality circles are effective only when partof a larger approach to employee empowerment. As such, a quality circle alternativeshould encompass an overall strategic change as related to the organization's HR, notsimply the implementation of a technique.

It is important to consider competitive responses in concert with this and thesubsequent case analysis step. For example, a McDonald's drop in price for the BigMac cannot be considered in isolation of a likely price cut at Burger King. In manycases, anticipated retaliation is a “con” of the alternative and could ultimately renderthe alternative as undesirable. Assuming that competitor behavior will not change overtime-especially in response to a major strategic change-is shortsighted.

Step 22: Which Alternative(s) should be Pursued and Why?

This phase necessitates an objective and subjective analysis of the pros and consassociated with each alternative. It is important that an alternative not be selectedwithout both arguing for its selection and explaining why competing alternatives wererejected. When two or more options are mutually exclusive, eliminating the options notchosen is just as important as selecting the desired choices. While it is important tospend time analyzing the alternatives, one must resist the temptation to overana-lyzeand avoid making the difficult choices, a process often referred to as analysis toparalysis.

The direction of a strategic change can affect the difficulty of its implementation. In general, abusiness pursuing differentiation can shift to a cost leadership approach more easily than alow-cost business can shift to differentiation. Because a low-cost business is likely to beassociated with value rather than quality, it is difficult to convince buyers that they should paymore because its products are differentiated.

Issues in Strategy Formulation

Crafting a strategy is not an easy task, even with the assistance of tools like the SW/OT andSLSC matrices. When a strategy appears attractive, a number of issues should be consideredbefore it is implemented. Four such issues are discussed in this section.

Evaluating Strategic Change

Should an organization change course when performance declines, or should it stay thecourse? On the one hand, its strategic managers may choose to commit to a strategic courseof action for an extended period of time and enjoy the benefits of specialization, expertise,organizational learning, and a clear customer image. Alternatively, an organization can remainflexible so that it does not become committed to products, technology, or market approachesthat may become outdated. In a perfect world, organizations commit to predictable,successful courses of action, and strategic change is only incremental. However, outcomesare not always predictable.




As with many strategic issues, there are two compelling sides to this debate. When traditionalfirms perform poorly, their strategic managers are exhorted by business analysts to promoteflexibility and strategic renewal to improve profitability. In contrast, when bold strategicchanges fail, pundits assert that a company must return to its “core business.” Hence, it iseasy to migrate freely from one side of the debate to the other, often with convincing empiricaland intuitively appealing arguments.

The needs for strategic flexibility or commitment can be debated on at least four grounds.First, a strategy tends to yield superior performance when it fits with the organization'senvironment. Without strategic flexibility, an organization cannot adapt to its changing externalenvironment. Even if an organization's strategy and its environment are in concert, anenvironmental shift may necessitate strategic change to maintain alignment. Changes incompetition and technology can also necessitate a change in the knowledge base within theorganization if it is to prosper. The state of the environment is not always fully understood bystrategy formula-tors, and top managers may be most likely to contemplate a strategicchange when perceived environmental uncertainty is high.

The economic downturn of the late 2000s prompted many luxury retailers to develop new ormore greatly emphasize existing outlet stores. Saks Fifth Avenue renamed its Off Fifth outletsto “Saks Fifth Avenue Off Fifth” to more closely link the outlets with the Saks brand. Nike

renovated its outlet stores and added new ones to attract bargain shoppers.17.

In contrast, however, a change in any key strategic, environmental, or organizational factorsmay entice strategic managers in a business to modify its strategy to incorporate thesechanges. However, since such variables are constantly evolving, this is a challenging process,and strategic inaction may minimize uncertainty. Indeed, a strategic change is most riskywhen competitors are better equipped to respond if it is deemed successful. As such,strategic change can challenge the assumptions of all organizational members and may bedifficult to implement even with employee support.

Second, flexibility is necessary if an organization is to seek first-mover advantages by enteringa new market or developing a new product or service prior to its competitors. Being a firstmover can help secure access to scarce resources, increase the organization's knowledgebase, and result in substantial long-term competitive advantage, especially when switchingcosts are high. Maintaining commitment to the firm's strategy can preclude movement into

attractive strategic domains.18.

In 2008, Fisher-Price began to emphasize its toys in China, Brazil, Russia, and Poland,developing nations where brand-name American products in many categories were notcommon. Emerging markets like these have fast-growing middle classes. By promoting itsproducts in these nations, Fisher-Price sought to establish a foothold while the market was

still in its infancy.19.

However, even when strategic change results in a successful new product or service, there isno assurance that this success can be maintained. In fact, competitors may distort consumerperceptions and reap the benefits of the initial strategic change. When a consumer goodscompany imitates another, for example, consumers may purchase the imitation productthinking it is the original. If consumers dislike the product, this dissatisfaction can betransferred to the original. On the other hand, a consumer who likes the product may realizethat it is an imitation and transfer the positive associations with the original product to that ofthe imitator. Either scenario can prove costly to the originator.




Third, if a firm's environment is relatively stable, strategic change can be attractive when theorganization's set of unique human, physical, capital, and informational resources change.Resource shifts necessitating strategic change may be more prevalent in some organizationsthan in others. Following this logic, strategic change can improve an organization's ability toadapt by forcing healthy changes within the business. The initial pain associated with changemay be offset by the emergence of a lean, rejuvenated organization with a fresh focus on its

goals and objectives.20.

However, consumer confusion may result from strategic change even when the new strategyrepresents a better fit with the firm's resources. Apple discovered this in 2007 when it cut theprice of the iPhone from $599 to $399 after just 10 weeks on the market. Although customerswho paid the higher price were offered a $100 rebate, many felt a sense of remorse. Inaddition, this rapid price shift might have conditioned prospective customers in the future to

wait for price cuts when new Apple products are released in the future.21. Apple survived thischallenge, and the iPhone continues to be one of the most popular smartphones well into the2010s.

Fourth, strategic change may be necessary if desired performance levels are not beingattained by the organization. In some cases, a change in strategy may be required to improvethe ability of the business to generate revenues or profits, increase market share, and/ orimprove return on assets or investment. In many cases, new CEOs are recruited for thatpurpose.

In contrast, the measures required to implement a change in strategy may necessitatesubstantial outlays of capital, thereby further denigrating the organization's financial position.Considering the Miles and Snow typology as an example, a shift from a prospector oranalyzer strategy to a defender strategy may require investments in sophisticated productionequipment to lower production costs, a characteristic more important to effectiveimplementation of a defender strategy. Likewise, a shift from defender or analyzer toprospector may require substantial outlays to develop or enhance R & D facilities.

Carrefour faced these trade-offs in 2010 when it embarked on a major strategic change.Carrefour was the world's second largest retailer at that time with stores and offerings similarto those of its larger rival, Wal-Mart. After losing global market share for several years, CEOLars Olofsson embarked on an effort to transform the company from a big box selling othercompanies’ brands into a strong consumer label in its own right. Just as IKEA Group foundsuccess by establishing and selling its own brand of furniture, Olofsson envisioned Carrefouras a retailer that emphasizes its own private labels at the lowest prices in the industry. Thestrategic shift required initial outlays of an estimated several hundreds of millions of dollars,including store makeovers and the implementation of a cost-saving stock-management

system the company pioneered in China.22.

Ironically, Wal-Mart was experiencing some strategic difficulties of its own. Same-store sales inthe United States declined every quarter from mid-2009 to mid-2011, a time marked by arecession and general economic stagnation. Wal-Mart attempted to broaden its appealbeyond traditional price-oriented customers during this period by raising some prices,widening aisles, and adding more brand-name merchandise but was unsuccessful. The bigbox did not break the losing streak until its third fiscal quarter in 2011 when revenuesincreased at a 1.3% clip. Wal-Mart had to cut prices to reverse the trend, but lower margins




also led to a decline in profits.23.

The decision to incorporate a substantial change in strategy can be alluring, especially whenperformance is poor. In some instances, however, strategic change is required for survival, aswas the case for 789 Chrysler dealers that were eliminated in 2010 as part of the company'sbankruptcy reorganization effort. Some dealerships simply closed, while others continuedselling other brands, focused on vehicle repairs, or embarked on new business ventures. InClarkston, Michigan, Chuck Fortinberry opened a furniture store after his Chrysler dealership

closed—while revamping the car store to make vehicles handicap accessible.24. I t i snecessary to recognize the costs associated with strategic change before resources arecommitted.

Strategy, Corporate Social Responsibility, and Managerial Ethics

Strategy decisions should not be based solely on projected effects on financial performance.An organization's strategies at all levels should be compatible with its stance on socialresponsibility and ethics. Strategic alternatives should be considered in light of statedpositions on corporate social responsibility (CSR). Marketers of alcoholic beverages mustconsider whether or not attractive advertising campaigns may attract minors as well. Amanufacturer must consider how a plant relocation might affect the community in which it iscurrently located. Video game developers, for example, must consider how much violence isacceptable in the games they market to various age groups. Hence, there are socialresponsibility and/or ethical considerations facing every organization.

Effects on Organizational Resources

Executing a strategy requires resources that could be used for another purpose. The mostobvious example is capital. If a firm pursues aggressive expansion into an unchartedgeographical area, for example, the capital required will not be available for other purposessuch as R & D or a new advertising campaign. If a firm launches a service enhancement effortby requiring sales representatives to make more frequent visits to existing customers, they willnot be able to pursue new accounts as vigorously as before. These trade-offs should beconsidered before a strategy is adopted.

Unfortunately, many firms do not fully consider these trade-offs. Instead, they devisestrategies whose success depends on “doing more with less.” Managers and employees arestretched thin while new programs are implemented without eliminating old ones. In the end,an organization may find itself performing lots of activities but none of them well.

Anticipated Responses from Competitors and Customers

Strategies are not implemented in a vacuum. Competitive responses should be expectedwhen a substantial strategic change is employed. In many situations, the prospective gainsassociated with a strategic change will be reduced when the response is considered. Forexample, the development of new products may produce few new customers if competitorsrespond quickly by developing a similar offering.

In some cases, considering the retaliation makes an otherwise attractive strategic alternativeundesirable. For example, American Airlines could probably secure more fliers than Delta oncommon routes if its fares were priced below those of the rival. If American initiated a price




cut, however, Delta would almost certainly match it. It is likely that the reduced fares wouldattract few additional fliers to either airline. Hence, both airlines would be forced to operate thesame routes with virtually the same number of customers at lower fares. When competitiveretaliation is considered in this example, American is probably best served not to spark a pricewar with Delta.

Consider another example that illustrates the fact that changes in the competitive environmentdo not always materialize as one might expect. When an airline hub closes, for example, onemight expect flights to and from the affected city to increase in price because of the departedcompetitor. In the United States, however, discount airlines often fill the empty gates, actually

fostering greater price competition.25. Hence, one could argue that it may be in the bestinterest of traditional carriers not to drive less competitive rivals out of key hubs lest they bebombarded by greater competition. Customer responses can be difficult to predict, butresponses to strategic change should be anticipated and accounted for, especially whenthere are substantial shifts in prices or product line.

Given the complexity of competitor retaliation, some firms opt for a blue ocean strategy, anapproach to growth contingent on inventing or discovering a new industry or industry segmentthat creates new demand. In many respects, Starbucks, eBay, and Cirque du Soleilreinvented the coffee house, auction, and circus industries by executing a radically different

approach that opened up substantial, previously untapped markets.26. Put another way,Starbucks did not reinvent the cup of coffee but rather reinvented the coffee shop experience.A large number of firms and new enterprises have failed in their attempts to charter newwaters, however, suggesting that successful blue ocean approaches require research,creativity, and a lot of savvy.

Summary

The SWOT analysis serves as the basis for the formulation of strategies at all levels. TheSWOT summarizes the organization's internal (i.e., strengths and weaknesses) and external(i.e., opportunities and threats) characteristics. Strengths and weaknesses emanate from ananalysis of human, organizational, and physical resources. Opportunities and threats arebased on analyses of the macroenvironment and industry. The SW/OT matrix generatesstrategic alternatives by combining internal and external factors delineated in the SWOTanalysis.

Before a strategy is selected, however, several other considerations should be made. Theseinclude the costs associated with strategic change, the strategy's fit with the organization'sstance on social responsibility and managerial ethics, effects on organizational resources,anticipated responses from competitors, and potential difficulties in implementing the strategy.The SLSC matrix helps evaluate alternatives by considering the level of analysis—corporate,business, or functional—and the degree of strategic complexity.

Key Terms

Blue Ocean Strategy: A growth strategy contingent on inventing or discovering a newindustry or industry segment that creates new demand.Capabilities: A firm's skills at coordinating and leveraging resources to create value (oftencalled strategic capabilities or dynamic capabilities).Gap Analysis: Identifying the distance between a firm's current position and its desired




1.2.

3.4.

position with regard to an internal weakness. All things equal, it is desirable to take actionto close the gap, especially when the gap leaves a firm vulnerable to external threats in itsenvironment.Human Resources (HR): The experience, capabilities, knowledge, skills, and judgment ofthe firm's employees.Organizational Resources: The firm's systems and processes, including its strategies atvarious levels, structure, and culture.Physical Resources: An organization's plant and equipment, geographic locations,access to raw materials, distribution network, and technology.Strategy Level-Strategy Complexity (SLSC) Matrix: A tool for evaluating strategicalternatives that considers the organizational level of the alternative and the degree ofstrategic complexity.SWOT (Strengths, Weaknesses, Opportunities, and Threats) Analysis: An analysisintended to match the firm's strengths and weaknesses (the S and W in the acronym) withthe opportunities and threats (the O and T) posed by the environment.SW/OT Matrix: A tool for generating alternative courses of action by identifying relevantcombinations of internal characteristics (i.e., strengths and weaknesses) and externalforces (i.e., opportunities and threats).Value Chain: A useful tool for analyzing a firm's strengths and weaknesses andunderstanding how they might translate into competitive advantage or disadvantage. Thevalue chain describes the activities that comprise the economic performance andcapabilities of the firm.VRIO (Valuable, Rare, Inimitable, and Organization) Framework: A tool for assessingthe competitive quality of a firm's resources by examining value, rarity, imitability, andorganization.

Review Questions and Exercises

What is the value chain? How is it useful to strategy formulation?How do a SWOT analysis and SW/OT matrix help managers in the strategic decision-making process?What types of alternatives can be generated from a SW/OT matrix?Should an organization change strategies when performance declines? Explain.

Practice Quiz

True of False?

1. The first step in crafting a strategy is the SWOT analysis.2. The value chain is an analytical technique for identifying organizational opportunitiesand threats.3. Opportunities and threats should emanate from the analysis of macroenvironmentaland industry forces.4. A factor can be both an opportunity and a strength.5. Another name for an opportunity is an alternative.6. Choosing the “no change” strategy and thereby recommending that the current strategybe continued is the least risky option.

Multiple Choice




A.B.C.D.

A.B.C.D.

A.B.C.D.

A.

7.

The tool that enables executives to position an organization to take advantage of particularopportunities in the environment while avoiding or minimizing environmental threats iscalled_______.

PEST analysisSWOT analysistotal quality management (TQM) analysisnone of the above

8.

The description of activities that comprise the economic performance and capabilities ofthe firm is known as_______.

the value chainprocess innovationquality assessmentnone of the above

9.

To sustain competitive advantage, firms must acquire or develop resources thatare_______.

difficult for competitors to imitatelong lastingdifficult for competitors to acquire on the marketall of the above

10.

Physical resources include_______.

production facilitiesA.B.C.D.

A.B.C.D.

A.B.C.D.

production facilitiesplant locationsproduction capacityall of the above

11.

Which of the following could not be an example of a weakness?

product qualityfierce competitionhuman resourcesall of the above

12.

Which type of alternative is always defensive in nature?

strength-opportunitystrength-threatweakness-opportunityweakness-threat




Student Study Site

Visit the student study site at www.sagepub.com/parnell4e to access these additionalmaterials:

Answers to Chapter 9 practice quiz questionsWeb quizzesSAGE journal articlesWeb resourceseFlashcards

Notes

1. K. W. Glaister and J. R. Falshaw, “Strategic Planning: Still Going Strong?” Long RangePlanning 32, no. 1 (1999): 107-116.

2. P. C. Nutt, “Making Strategic Choices,” Journal of Management Studies 39 (2002): 67-96.

3. The concept of the value chain is only introduced in this chapter. For a more thoroughdiscussion, see M. Porter, Competitive Advantage: Creating and Sustaining SuperiorPerformance (Boston: Free Press, 1985).

4. N. Harris and S. Carey, “Delta Ends Commissions for Most Travel Agents,” Wall StreetJournal Interactive Edition, March 15, 2002.

5. J. Gapper, “Big Names Prove Worth in Crisis,” Financial Times, Apri l 28, 2010,www.ft.com/intl/cms/s/0/258c534a-50ca-lldf-bc86-00l44feab49a,s01=l.html#axzz1f2CB8HvX(accessed November 28, 2011).

6. J. Barney, “Firm Resources and Sustained Competitive Advantage,” Journal of Management17(1991): 99-120.

7. K. M. Eisenhardt and J. A. Martin, “Dynamic Capabilities: What Are They?” StrategicManagement Journal 21 (2000): 1105-1121.

8. J. Barney, “Firm Resources and Sustained Competitive Advantage.”

9. J. B. Barney, Gaining and Sustaining Competitive Advantage (Upper Saddle River, NJ:Prentice Hall, 2007); D. Teece, G Pisano, and A. Shuen, “Dynamic Capabilities and StrategicManagement,” Strategic Management Journal 18(1997): 509-533.

10. Based on H. Wilrich, “The TOWS Matrix—A Tool for Structural Analysis,” Long RangePlanning 15(2) (1982): 54-66.

11. D. Belkin, “A Canadian Icon Turns Its Glaze Southward,” Wall Street Journal, May 15,2007, B1.

12. J. Murphy and E. Bellman, “Riding Two-Wheelers in India,” Wall Street Journal, June 6,2008, B1.



http://www.sagepub.com/parnell4e

http://www.ft.com/intl/cms/s/0/258c534a-50ca-lldf-bc86-00l44feab49a,s01=l.html#axzz1f2CB8HvX


13. J. A. Trachtenberg, “Borders Business Plan Gets a Rewrite,” Wall Street Journal, March22, 2007, B1.

14. E. Bellman, “Harley to Ride Indian Growth,” Wall Street Journal, August 28, 2009, B1.

15. R. Smith, “Utilities, Plug-In Cars: Near Collision?”, Wall Street Journal, May 2, 2008, B1.

16. S. Jung-a, “Carrefour's Korean Stores to Go Upmarket,” Financial Times, October 7, 2003,18.

17. V. O'Connell, “Luxury Retailers Pin Hopes on Outlets,” Wall Street Journal, April 30, 2008,B1.

18. B. Peterson and D. E. Welch, “Creating Meaningful Switching Options in InternationalOperations,” Long Range Planning 33 (2000): 688-705; M. B. Lieberman and D. B.Montgomery, “First-Mover Advantages,” Strategic Management Journal 9 (1988): 41-58.

19. N. Casey, “Fisher-Price Game Plan: Pursue Toy Sales in Developing Markets,” Wall StreetJournal, May 29, 2008, B1.

20. J. B. Barney, “Is the Resource-Based ‘View’ a Useful Perspective for StrategicManagement Research?” Academy of Management Review 26 (2001): 41-56.

21. R. Karlgaard, “The Cheap Revolution,” Wall Street Journal, October 3, 2007, A19.

22. C. Passariello, “Carrefour's Makeover Plan: Become IKEA of Groceries,” Wall StreetJournal, September 16, 2010, B1-B2.

23. K. Talley, “Wal-Mart Sticks to Low Prices,” Wall Street Journal, November 16, 2011, B3.

24. J. Bennett, “After Getting the Boot, Car Dealers Regroup,” Wall Street Journal, October11, 2010, B1, B2.

25. S. McCartney, “Why Travelers Benefit When an Airline Hub Closes,” Wall Street Journal,November 1, 2005, D1, D8.

26. W. C. Kim and R. Mauborgne, “Blue Ocean Strategy,” Harvard Business Review 82, no. 10(2004): 76-84.

Strategy + Business Reading: 10 Clues to Opportunity

Market anomalies and incongruities may point the way to your nextbreakthrough strategy.

by Donald Sull

During their heyday in the late 19th and early 20th centuries, transatlantic cruise linessuch as the Hamburg America Line and the White Star Line transported tens ofmillions of passengers between Europe and the United States. By the 1960s, however,




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2.

3.

their business was being threatened by the rise of a disruptive new enterprise, namely,nonstop transatlantic flights. As it happened, the cruise ship lines had one potentialstrategy with which to save their business: vacation cruises. Starting in the 1930s,some of these lines had sailed to the Caribbean during the winter, thus using theirboats when rough seas made the Atlantic impassable. And in 1964, when a new portwas opened in Miami, Fla., the pleasure cruise business began to boom.

But the great cruise lines missed this breakthrough opportunity. They saw theirprofitability fall while dozens of startups, including Royal Caribbean and Carnival,retrofitted existing ships to offer pleasure cruises and built an entirely new travel andleisure category that continues to grow today.

Managers and entrepreneurs walk past lucrative opportunities all the time, and laterkick themselves when someone else exploits the strategy they overlooked. Why doesthis happen? It's often because of the natural human tendency known to psychologistsas confirmation bias: People tend to notice data that confirms their existing attitudesand beliefs, and ignore or discredit information that challenges them.

Although it is difficult to overcome confirmation bias, it is not impossible. Managers canincrease their skill at spotting hidden opportunities by learning to pay attention to thesubtle clues all around them. These are often contradictions, incongruities, andanomalies that don't jibe with most of the prevailing assumptions about what shouldhappen. Here is my own “top 10” field guide to clues for hidden breakthroughopportunities, observed in a wide variety of industries, countries, and markets. If youfind yourself noticing one or more of them, a major opportunity for growth could belurking behind it.

This product should already exist (but it doesn't). As the accessories editorfor Mademoiselle magazine in the early 1990s, Kate Brosnahan spotted a gapin the handbag market between functional bags that lacked style and extremelyexpensive but impractical designer bags from Hermès or Gucci. Brosnahan quither job, and with her partner Andy Spade, founded Kate Spade LLC, whichproduced fabric handbags combining functionality and fashion. These attractedthe attention of celebrities such as Gwyneth Paltrow and Julia Roberts. Manywell-known product innovations—including the airplane, the mobile phone, andthe tablet computer—began similarly, as products that people felt shouldalready exist.

This customer experience doesn't have to be time-consuming, arduous,expensive, or annoying (but it is). Consumer irritation is a reliable indicator ofa potential opportunity, because people will typically pay to make it go away.Reed Hastings, for example, founded Netflix Inc. after receiving a US$40 latefee for a rented videocassette of Apollo 13 that he had misplaced. CharlesSchwab created the largest low-cost brokerage house because he was fed upwith paying the commissions of conventional stockbrokers. Scott Cook got theidea for Quicken after watching his wife grow frustrated tracking their financesby hand.

This resource could be worth something (but it is still priced low).Sometimes an asset is underpriced because only a few people recognize itspotential. When a low-cost airline such as easyJet or Ryanair announces its




4.

5.

6.

7.

intention to fly to a new airport, real estate investors often leap to buy vacationproperty nearby. They rightfully expect a jump in real estate values. Similarly,the founders of Infosys Technologies Ltd., India's pioneering provider ofoutsourced information technology services, were among the first to recognizethat Indian engineers, working for very low salaries, could provide great value tomultinational clients. The company earned high profits on the spread betweenwhat they charged clients and what they paid local engineers.

This discovery must be good for something (but it's not clear what thatis). Researchers sometimes recognize that they have stumbled on a promisingresource or technology without knowing the best uses for it right away. Theresulting search for a problem to solve can lead to great profitability. Oneexample was the founding of the ArthroCare Corporation, a $355 millionproducer of medical devices based on a process called coblation, which usesradio frequency energy to dissolve damaged tissue with minimal effect onsurrounding parts of the body. Medical scientist Hira Thapliyal, whocodiscovered this process, founded a company to offer it for cardiac surgery,but that market turned out to be too small and competitive to support a newventure. Undeterred, he looked for other potential uses, and found one inorthopedics, where there are more than 2 million arthroscopic surgeries peryear.

This product or service should be everywhere (but it isn't). Sometimespeople chance upon an attractive business model that has failed to gain thewidespread adoption it deserves. Two archetypal retail food stories illustratethis. In 1954, restaurant equipment salesman Ray Kroc visited the McDonaldbrothers’ hamburger stand in southern California, and convinced them tofranchise their assembly-line approach to flipping burgers. In 1982, coffeemachine manufacturing executive Howard Schultz visited a coffee beanproducer called Starbucks in Seattle. He recognized the potential of a chainrestaurant based on European coffee bars, and he joined Starbucks, hoping toconvince the company's leadership to convert their retail store to this format.When they didn't, he started his own coffeehouse chain, later buying theStarbucks retail unit as the core of his new business.

Customers have adapted our product or service to new uses (but not withour support). Chinese appliance maker Haier Group discovered that customersin one rural province used its clothes washing machines to clean vegetables.Hearing this, a product manager spotted an opportunity. She had companyengineers install wider drain pipes and coarser filters that wouldn't clog withvegetable peels, and then added pictures of local produce and instructions onhow to wash vegetables safely. This innovation, along with others including awashing machine designed to make goat's-milk cheese, helped Haier win sharein China's rural provinces, while avoiding the cutthroat price wars that plaguedthe country's appliance industry.

Customers shouldn't want this product (but they do). When Honda MotorCompany entered the U.S. motorcycle market in the late 1950s, it expected tosell large motorcycles to leather-clad bikers. Despite a concerted effort, thecompany managed to sell fewer than 60 of its large bikes each month, far shortof its monthly sales goal of 1,000 units. Then a mechanical failure forced the




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company to recall these models. In desperation, it promoted its smaller 50ccmotorbike, the Cub, which Honda executives had assumed would not interestthe U.S. market. When the smaller bikes sold well, Honda realized it haddiscovered an untapped segment look ing for two-wheel motor izedtransportation. (The campaign is still remembered for its catchphrase, “Youmeet the nicest people on a Honda.”)

Customers have discovered a product (but not the one we offered). JointJuice, a roughly $2 mil l ion company that produces an easy-to-digestglucosamine liquid, was founded by Kevin Stone, a prominent San Franciscoorthopedic surgeon. He learned about the nutrient from some of his patients,who took it for joint pain instead of the ibuprofen he had prescribed. Manydoctors might have ignored this or even scolded their patients for falling prey tofads, but Stone recognized he might be missing something. He looked up theclinical research on glucosamine in Europe, where it was the leading nutritionalsupplement. (Veterinarians, he discovered, swore by it, and their patients fell forneither fads nor placebos.) Then he built a business around it.

This product or service is thriving elsewhere (but no one offers it here). Inthe early 1990s, a Swedish business student named Carl August Svensen-Ameln tried to store some of his belongings in Sweden while at school inSeattle, but found that all the local self-storage facilities were full. He studiedthe storage industry, already prevalent in the United States, and discovered abusiness model characterized by high rents, low turnover, and negligibleoperating costs. Yet self-storage, at the time, was virtually nonexistent incontinental Europe. Svensen-Ameln and a friend from business school set up apartnership with an established U.S. company, Shurgard Storage Centers Inc.The resulting company, European Mini-Storage S.A., was the first of severalsuch companies that Svensen-Ameln started in Europe, to great success.

That new product or service shouldn't make much money (but it does).Established competitors are often surprised when upstart rivals do well. In his2008 book, The Partnership: The Making of Goldman Sachs (Penguin Press),Charles D. Ellis noted that for decades, Goldman Sachs partners had avoidedinvestment management, which they believed generated lower fees thantrading and investment banking. When Donaldson, Lufkin & Jenrette Inc.published its financial performance as part of a 1970 stock offering, Goldmanpartners were startled to learn that fees and brokerage commissions onfrequent trades added up to a highly profitable business. Shortly thereafter,Goldman expanded into managing corporate pension funds, and aggressivelybuilt its business.

Incongruities like these can offer a critical clue about where your assumptions nolonger match reality. From there, you are more likely to uncover the kinds ofopportunities that you might otherwise have missed—and that your competitors stilldon't recognize. Start by asking yourself, What are the most unexpected thingshappening in our business right now? Which competitors are doing better thanexpected? Which customers are behaving in ways we hadn't anticipated? Take yourselfthrough the list of top 10 clues. Leaders who consistently notice and explore anomaliesincrease the odds of spotting emerging opportunities before their rivals.




Reprint No. 11304

Author Profile:

Donald Sull is a professor of strategic and international management at the LondonBusiness School, where he is also the faculty director for executive education. Hisbooks include The Upside of Turbulence: Seizing Opportunity in an Uncertain World(Harper Business, 2009).

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